The World Bank The United Nations Centre on Transnational Corporations 8609 April 1990 U ~~The Urugnahy ound Services in the World Economy Patrick A. Messerlin Karl P. Sauvant with contributions by Bela Balassa Alan Gelb P. Mallampally Surjit Bhalla Kenneth Heydon Mario Marconini Carlos Braga Brian Hindley Russell Pipe Robert Carter Bernard Hoekman Luis Rubio Alberto Diaz Edna Jaime Silvia Sagari Christopher Findlay Chung H. Lee Richard Snape Rainer Geiger James Lee Alexander Yeats . . .. .. .. ... .... . . .. . .. .. . .. . ..... . The World Bank The United Nations Centre on Transnational Corporations The Uruguay Round Services in the World Economy Patrick A. Messerlin Karl P. Sauvant with contributions by Bela Balassa Alan Gelb Padma Mallampaily Surjit Bhalla Kenneth Heydon Mario Marconini Carlos Braga Brian Hindley Russell Pipe Robert Carter Bernard Hockman Luis Rubio Alberto Diaz Ednajaime Silvia Sagari Christopher Findlay Chung H. Lee Richard Snape Rainer Geiger James Lee Alexander Yeats Copyright © 1990 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. United Nations Centre on Transnational Corporations Room DC2-1220 Two, United Nations Plaza New York, NY 10017, U.S.A. All rights reserved Manufactured in the United States of America First printing April 1990 The findings, interpretations, and conclusions expressed in this publication are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent, or to the United Nations Centre on Transnational Corporations (UNCrc). The World Bank and uNcrc do not guarantee the accuracy of the data included in this publication and accept no responsibility whatsoever for any consequence of their use. 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Permission to photocopy portions for classroom use is not required, though notification of such use having been made will be appreciated. The complete backlist of publications from the World Bank is shown in the annual Index of Publications, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Publications Sales Unit, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Iena, 75116 Paris, France. A complete list of uNcrc publications is available free of charge from the Centre at the address given above. Patrick A. Messerlin, former senior economist at the World Bank, is professor of economics at the Institut d'Etudes Politiques de Paris; Karl P. Sauvant is acting assistant director, Policy Analysis and Research Division of the United Nations Centre on Transnational Corporations. Library of Congress Cataloging-in-Publication Data Messerlin, Patrick A. The Uruguay round: services in the world economy / Patrick A. Messerlin, Karl Sauvant; with contributions by Bela Balassa ... [et al.]. p. cm. Includes bibliographical references. ISBN 0-8213-1374-6 1. Service industries-Government policy. 2. International economic relations. 3. Uriguay Round (1987- ) I. Sauvant, Karl P. II. International Bank for Reconstruction and Development. III. Centre on Transnational Corporations (United Nations) IV. Title. HD9980.6.M47 1990 382'.45-dc2O 90-12082 CIP Foreword Global economic interdependence has increased dramat- corporations in services, the benefits and costs for host ically since the mid-1980s. Part of this success stems developing countries, and the role of national foreign from a multilateral framework in the form of the General investmentpolicies inthecontextof amultilateral frame- Agreement on Trade and Tariffs (GATr), which was work. established in 1949 to further a more open commodity The purpose of this book is to contribute to a better trade regime. The GATT system, although far from per- understanding of international trade in services so that fect, has served the international community well, by developing countries in particular may have a stronger providing not only a system of rules and regulations for information base and analytical support for the policy trade but, more important, a forum for multilateral trade decisions that they are being called on to make. To this negotiations in which countries have the opportunity to end, we have asked a number of authors to contribute improve the system by removing trade restridctions to the papers on conceptual, sectoral, and country-specific is- maximum extent possible. sues relating to international transactions in services. In September 1986 at Punta del Este, the international The resulting handbook is a collection of essays that is, trading community began a new round of negotiatons. we believe, both informative and thought-provoking. For the first time, a multilateral round provided a man- Part of the reason that these chapters are so eclectic is date for negotiations on services, raising the possibility that the authors, not the editors or our institutions, have of creating a multilateral framework for international accepted full responsibility for their views. trade in services. The subsequent negotiations have The preparation of this book has provided a valuable aroused intense interest in both developed and develop- opportunity for cooperation and pooling of experience ing countries. This is not surprising, since for most by the World Bank and the United Nations Centre on countries the service sector is now the largest economic Transnational Corporations-both of which are keenly sector and the most important source of new jobs. interested in encouraging informed participation in the Clearly, countries could gain significantly from a sys- Uruguay Round negodations on the part of developing tem that would offer opportunities for specialization and countries and, more generally, in assisting developing improved efficiency in services. For developing coun- countries in their interaction with the world economy. tries, such changes could contribute to increased rates of We hope that this book will be useful to interested growth. Many developing countries have nevertheless persons in government and academia alike. been cautious about the prospect of liberalizing services We should like to thank the contributors to this book trade. Understandably, the heterogeneity of services and for preparing their chapters under a tight time schedule the obvious gap between the levels of development and and Patrick A. Messerlin and Karl P. Sauvant for editing sophistication of service industries in many developing the volume. We are also grateful to the govemment of as compared with developed economies have raised Italy for the support it provided to the United Nations doubts regarding the outcome for developing countries Centre on Transnational Corporations for this project. of liberalizing intemational trade in services. Further- more, as the negotiations have made clear, the scope of international transactions in services extends well be- Stanley Fischer Peter Hansen yond what has been traditionally understood by cross- Vice President Executive Director border trade. Most services can enter international World Bank UNCTC transactions only through sales by affiliates established abroad by large firms or through the movement of people Washington and New York across borders. This raises questions regarding labor movement, foreign direct investment and transnational January 1990 Contents Foreword Introduction PATRICK A. MESSERLIN AND KARL P. SAUVANT 1 Part I. The Constitutional Framework 1. Principles in Trade in services RICHARD H. SNAPE 5 2. Principles in Factor-related Trade in Services BRIAN HINDLEY 12 3. The Uruguay Round Negotiations on Services: An Overview MARIO MARCONINI 19 4. Services-Related Production, Employment, Trade, and Factor Movements BERNARD M. HOEKMAN 27 Part II. Service Industries 5. Banking ALAN H. GELB AND SILVIA B. SAGARI 49 6. Insurance ROBERTL. CARTER 60 7. Construction JAMES LEE 69 8. Air Transport CHRISTOPHER FINDLAY 77 9. Maritime Transport ALEXANDER J. YEATS 84 10. Professional Services PADMA MALLAMPALLY 94 11. Telecommunications G. RUSSELL PIPE 105 12. The Tradability of Services KARL P. SAUVANT 114 Part m. Country Experiences and Perspectives 13. The United States BELA BALASSA 125 14. The European Community PATRICK A. MESSERLIN 132 15. Lessons from the Experience of the OECD RAINER GEIGER 150 16. Developing Country Perspectives KENNETH HEYDON 159 17. Mexico LUIS RUBIO, EDNA JAIME, AND ALBERTO DIAZ 166 18. East Asian Countries CHUNG H. LEE 175 19. India SURJIT S. BHALLA 188 20. Brazil CARLOS ALBERTO PRIMO BRAGA 197 Annexes 1. The Punta del Este Declaration 211 2. The Montreal Ministerial Declaration 216 Introduction Patrick A. Messerlin and Karl P. Sauvant The years 1986-90 may well enter the history of inter- their applicability to the main service sectors identified national economic relations as a period of unexpected in the current negotiations. progress toward a more open world services economy The progress of the negotiations toward an agreement with greater opportunities for trade and development. on principles owes much to the recognition, since the This period stands in sharp contrast to the years 1982-86, inception of the Uruguay Round, of the special concerns when the first initiatives toward placing services on the of developing countries. Development has in fact been agenda of the Uruguay Round met with harsh criticism one of the central themes of the GNS negotiations, and the and-more crucially-a deep and widespread skepti- "development of developing countries" is listed, along cism about the gains to be expected from such an effort. with the promotion of economic growth of all trading During the past three years, however, negotiators from partners, as one of the aims of any future agreement both developed and developing countries have been en- designed to promote trade expansion through progres- gaged in an intense effort in the Group of Negotiations sive liberalization. The challenge since Montreal, espe- on Services (GNS) of the Uruguay Round to explore the cially as far as developing countries are concerned, has issues regarding intemational trade in services and to been to make development an integral part of the agree- arrive at principles that might form the basis for an ment, not an appendage or the subject of a series of agreement on trade in services-an agreement that could waivers and exceptions, as has been the case with trade be put in place by the end of 1990. in goods under the GAIT. Provisions that would increase The progress achieved in the Uruguay Round negotia- the participation of developing countries in world trade tions on services testifies that trade negotiators and na- and expand their exports of services are the main (but by tional decisionmakers are coming to share a perception no means the only) avenues for incorporating the devel- already common among economists: that trade in ser- opment objective into an international services frame- vices is similar in fundamental ways to trade in goods. work. The Montreal agreement foresees provisions that This is not to deny that trade in services has its own would, among other things, promote the strengthening of special characteristics, notably in the modes of deliver- the capacity, efficiency, and competitiveness of the do- ing services to foreign markets. The intangibility and mestic service sector in developing countries. The activ- nonstorability of most services have raised new practical ities of service affiliates of large firms in developing issues for negotiations on services, which must address countries can influence this process considerably, espe- international movements of service providers and factors cially through transfer of technology and skills to people of production-in particular, foreign direct investment in host countries. and labor movement. At the national level, service industries are increasingly Trade negotiators have agreed on a set of concepts exposed to problems of an international dimension and derived from their experiences with trade and foreign have, as a result, adopted the same approaches as their direct investment but taking into account the distinctive counterparts in the goods sectors. Managers of private features of international transactions in services. These and public firms have begun to constitute lobbies for principles were endorsed by the 1988 Montreal ministe- freer trade or for more protection, depending on the rial midterm review and have since then been tested for comparative advantage of their industries or the compet- 1 Introduction itiveness of their firms. At the same time, some govern- the main roads or maritime routes in the past century. ments are beginning to reassess the costs and benefits of Freer trade can be a way to stay in the race instead of new strategies based on freer trade in services. becoming progressively more marginal. As a corollary, The initial aim of this book was to elaborate these as the fact that negotiations in goods and services are held yet relatively new ideas and developments and to dissem- in two different forums-the GATT for negotiations on inate them to a large audience. To our surprise, the book goods and the GNs for services-should not reduce the has done more than initially expected. It provides three potential gains to developing countries from the tradeoffs crucial lessons, one factual and two that concern trade related to a framework for international transactions in policy. services. Current negotiations in services should not First, contrary to widespread skepticism, developing repeat the basic mistake made decades ago, when trade countries do have comparative advantages in particular in agricultural products and textiles were separated from services when services are examined at a sufficiently trade in manufactured goods. That mistake-which has disaggregated level-as should be done and as is done been particularly costly for developing countriehas for manufactured goods. After all, developing countries made the tradeoffs of concessions involving these two have comparative advantages in certain types of cloth- sectors considerably more difficult and has isolated the ing, steel, shipbuilding, electronics, footwear, and food sectors behind highly protectionist barriers. products-but not in the complete range of products in Third, in services as in goods, domestic liberalization these subsectors. Similarly, some developing countries is rapidly choked if there is not an open regime, and trade enjoy comparative advantages in certain subsectors of liberalization without internal market-oriented reforms banking, insurance, air transport, telecommunications, can be costly. Unilateral liberalizations are beneficial tourism, shipping, construction, and professional ser- only if they combine domestic reforms and a unilateral vices, including health care and software development, opening of the borders. Few industrial countries have because of their abundant resources of labor with the been able to take such actions. As in the case of goods, needed skills. This competitive advantage stems from what counts is not so much the speed of the move as a the position of education as one of the relatively more clear commitment to freer trade, with economically developed sectors in developing countries-and, not co- sound measures reducing the range of protection and the incidentally, one of the sectors that is more open to level of rents. To extend unilateral liberalizations into outside influences. multilateral ones is a cost-efficient way of achieving It may be argued that the evidence available in services these goals, and some developing countries are on the is much more fragmentary than that for manufactured verge of following this path. The Uruguay Round comes goods. That is true. But confirmation of these compar- at the right time to consolidate such liberalizations and ative advantages that are being revealed for developing to boost new ones. countries can be found in the more cautious approach that Part I of this book looks at basic economic tools and at industrial countries are now taking in the services nego- their validity and adequacy for analyzing services trade tiations as they recognize that the advantages may not all issues within the familiar framework of trade negotia- be on their side. Once enthusiastic proponents of freer tions which relies on the GAIT tradition. Part II presents, trade in services, these countries have realized-some- for each main group of services, the economic character- times under pressure from their worried services indus- istics of their production (the main "products" delivered, tries-that both industrial and developing countries have the size of the industry, and the key factors of produc- comparative advantages, and their enthusiasm is now tion), the principal modes of delivery, the impact of the tempered by an awareness of the need for give and take current international environment, and the existing meth- in the provisions of an agreement. ods and extent of regulation and protection in industrial Second, comparative advantages in services do more and developing countries. Part III, through case studies than create a large array of potential tradeoffs between of selected countries and areas, examines the basic ques- industrial and developing countries in multilateral nego- tions that the delegations in Geneva will have in mind as tiations on services. Imports of less expensive services they negotiateaframework agreement. In which services from industrial countries would allow developing coun- are their own countries expected to enjoy comparative tries to be more efficient in manufactures, for which advantages and realize gains from liberalization? Which certain services (such as telecommunications) are an service sectors may have to undergo an adjustment pro- essential input. Some services, like some goods, are of cess? The answers to these questions will suggest the crucial importance for development. Being off the main extent of the net gains from liberalization and of the air or telecommunication routes at the end of this century additional benefits that consumers in industrial and de- would be the same kind of handicap as having been off veloping countries will reap from freer trade in services. 2 Part I The Constitutional Framework Principles in Trade in Services Richard H. Snape Services come in a great variety of forms; perhaps more than the demander (a child to be educated). An intema- than goods they are adapted individually to the de- tional transaction takes place when the transaction is mander. Indeed, differentiation of goods frequently between a supplier and a demander who are residents of arises from the services that accompany their sale. With different countries, irrespective of the location of the so many forms of services, how is one to approach the receiver of the service. question of barriers to their trade? One helpful starting In negotiations concerning services trade, as for all point is to look at the means by which trade takes place international trade, considerable emphasis is given to the in order to find common elements in barriers that may exchange of reductions in barriers to trade, as though the extend across a whole range of traded services. If ways importersof services wereimposingacoston themselves of negotiating these forms of barriers can be identified, by importing them. This neglects the gains from intema- it may be possible to develop a general agreement that tional trade that are earned by the importing countries as covers services just as the General Agreement on Tariffs well as the exporters; if there were no importing, there and Trade (GATT) covers trade in all types of goods.1 would be little point in exporting. The gains from trade Both goods and services are produced by labor, capital, in services are similar to those from trade in goods. Trade and other factors of production. International trade in enables a country to concentrate production on the prod- services is the supply by residents of one country to ucts in which it has a comparative advantage; it provides demanders resident in another country of services that access to new products and technology; and it facilitates ae not incorporated in goods (other than in the paper, the achievement of economies of scale in production. As film, disks, and the like used to record and transfer the with trade in goods, economists and others have given a service).2 The receiver of the service may be a person great deal of attention to thinking of situations in which (for, say, a haircut, entertaimnent, or transport), a legal domestic industries should be protected against imports. entity such as a company or government (for insurance But cases in which economic logic (in terms of the orbanking,forexample),orobjectssuchasairplanes (for interests of a country as a whole) supports such protec- repairs or aiuport services) or merchandise (for transport). tion tend to be rare, both in theory and in practice. There For some services it is necessary that the receiver of the is a strong economic presumption that international services be in close proximity to the supplier; for others trade in services, as in goods, is economically beneficial. the supplier and the receiver can be at a distance from Nevertheless, a wide range of barriers does exist to each other. Examples of services that require proximity international trade in services, as in goods. And these are tourist and transport services, surgery, and repairs. barriers do not, in general, exist by accident. Although Those for which it may not be necessary include archi- they may often be the resultof economic misperceptions, tectural and computing services, broadcast entertain- they are frequently the product of domestic political ment, and anything else that can be communicated forces, and invariably they have their defenders. But through the mail or by electronic means. If service sup- despite the political costs that may have to be incurred in pliers and receivers must be in physical proximity, phys- their reduction-and these costs may explain why trade ical movement of one or the other will generally be negotiations are entered into in the form of an exchange necessary. of "concessions"-importing as well as exporting The receiver of the service should be distinguished countries will generally realize economic gains from fromthedemander(thatis,thepayer).Thereceivercould reducing barriers to trade in services as well as in be an object (an airplane to be repaired) or a person other goods. 5 Richard H. Snape Determinants of Trade in Services discourage the export of computing services by countries that would otherwise be well suited for it. Similarly the What determines the patterns of international trade in export by Ethiopian Airlines3 of aircraft repairs and services? Because all production arises from the services training to other African countries and elsewhere would of factors of production, the same considerations that not be possible without complementary capital equip- affect trade in goods can be expected to affect trade in ment. services. Without barriers to trade, countries with rela- Extending the horizon to incorporate international trade tively large amounts of unskilled labor will tend to export in the services of financial capital leads one to consider labor-intensive services as well as labor-intensive goods. countries that are net borrowers and lenders. Net lending Such service exports can be in many forms: the tempo- is the result of an excess of domestic saving over invest- rary movement of construction crews, the manning of ment; net borrowing is the opposite. Such excesses may ships, and the simple processing of electronically trans- be attributable to the choice of individuals between fru- mitted data are three examples. Countries with relatively gality and profligacy, to the state of development of a skilled labor will have a comparative advantage in ex- country, or to the budgetary policies of governments. porting services that require relatively large inputs of Comparative advantage in the export of the services of such labor-architectural and financial services, the financial capital thus will be linked to these considera- writing of computer software, and the like. Countries that tions. for reasons of geography or history have built up skills Many services that can be provided by employees of in ocean fishing are likely to export shipping services, firms (that is, within a firm) can also be provided on a those that have endowments of beautiful scenery will contractual basis from outside the firm. A manufacturer have a comparative advantage in the export of tourist may obtain accounting services from employees or from services, and so on. In other words "factor endowments" a fimn of accountants; cleaning of premises may be are important in determining the pattem of trade in undertaken by employees orby contract cleaners; on-the- services just as with goods. job training may be supplied by employees or by con- Economies of scale and scope are also likely to be tractors; and so on. In each case services may be traded important in some service industries, as for some goods. on the market or produced within the firm. It has been When such economies are particularly important, a large suggested that more services are being supplied on a domestic market may help to provide an advantage on contractual basis than in the past. Some possible reasons world markets. Thus a litigious society is likely to de- for this are changing technology (particularly elec- velop specializations in law that, at least in their interna- tronic), changing laws regarding the responsibilities and tional dimensions, may be marketed internationally. liabilities of firms toward their employees, changing Financially rich countries will develop expertise in finan- composition of the work force, increasing specialization cial institutions and a whole range of interacting financial owing to the growth of knowledge, and increased payroll activities and will tend to export these services. taxes and workers' compensation insurance premiums. H igh-income countries may have an initial comparative This tum toward contracting-out has been referred to as advantage in services that are demanded by people with a splintering of services (Bhagwati 1984). To the extent high incomes. But if labor costs are an important compo- that this splintering of services from goods occurs, it will nent of total costs in such industries, countries with lead not only to expanded domestic trade in services but relatively low labor costs but with the required skills may also to expanded intemational trade. When it occurs be able to compete successfully over time and take because of increasing labor costs, provision of services markets from those that were first in the field-intema- is likely to move to lower-labor-cost countries-pro- tional air transport is an example of this, as are data vided, as noted above, that firms in these countries processing and typesetting. Onceprocessesbecomestan- have access to the required complementary equipment. dardized, production in many areas moves from the It is apparent that a whole range of services may be innovators to countries with abundant labor that possess traded internationally purely as services or may be incor- the required skills and the necessary complementary porated into traded goods. A country may import auto- capital equipment Such developments are analogous to mobile design and build the automobiles itself, or it may those that have occurred in some goods markets. import automobiles-which, of course, incorporate the The availability and quality of the necessary comple- design services. Thus among the factors that determine mentary capital equipment can be particularly important. the pattern of trade in services must be counted not only In data processing, for example, protection of a domestic the barriers to trade in services themselves but also the computer industry, because of its effects on the costs and barriers to trade in goods. Barriers to imports of automo- availability of computer hardware and software, may biles may lead to imports of automobile design. But we 6 Principles in Trade in Services now focus on direct barriers to trade in services rather than transmissions from abroad; restrictions on the placement on indirect effects through barriers to trade in goods. of banking or insurance business abroad; foreign ex- change restrictions; domestic content requirements in Barriers to Trade in Services radio and television broadcasting, in the cinema or the- ater, and in shipping. Regulation is pervasive in services industries, and this in The restrictions on trade in services that are most com- turn affects international trade. Regulation is explicitly parable to restrictions on trade in goods are those in protective of domestic producers only when it discrimi- category 3. Such services have been termed disembodied natesagainstforeigners;otherwiseitwilltendtoprotectsome or separated services (Bhagwati 1984; Sampson and producers against all other producers, domestic and foreign. Snape 1985). As with tariff and nontariff barriers to the Frequently, regulation is designed to protect consum- movement of goods, they are restrictions on the product ers. Consumer protection in goods often takes the form of factors of production, not on the movement of the of the prescription of standards for the goods produced. means to provide the service (as in category 1) or on the Such control on output is much more difficult to enforce receivers of the services (as in category 2). It is to formanyservices-canthequalityofsurgery,education, category 3 that the principles of the GATT are most or insurance be monitored continually? Control is often obviously applicable, but they also apply to the barriers exercised instead by issuing licenses for producers and in categories 1 and 2. by enforcing prudential or other qualifications for entry to the industry (Hindley and Smith 1984). Of course, like Application of GATT Concepts other regulations, restrictions on entry to industries can easily develop into protective barriers for those who are The GATT comprises a set of trading rules that apply already in the industry. generally across commodities and contracting parties. Discrimination against foreign suppliers may be inten- There are exceptions for both countries (developing tional in many cases; in others, the discrimination may countries, in particular) and commodities (agricultural be unintended and subtle. For example, if there are products, in particular). In addition, certain products prudential asset requirements for entry to an industry and have been effectively excluded from the general provi- the assets must be held in the country imposing the sions of the agreement for a considerable time with restrictions, foreigners may be at a disadvantage respect to some countries-the two main exceptions in (Hindley and Smith 1984, p. 381). Ordiscrimination may this category are waivers for many developed countries be a product of the difficulty of assessing foreign profes- for agricultural imports and special provisions for textile sional qualifications for occupations in which registra- and clothing imports from a growing number of devel- tion is required. oping countries by most developed countries. But despite We focus now on barriers to international trade as such these exceptions, which have grown considerably since and not on regulations that may restrict participation by the GA1T was first formulated more than forty years ago, both nationals and foreigners. Depending on the manner the basic thrust of the General Agreement is toward rules in which services are traded, international trade in ser- of general application across countries and commodities. vices can be discriminated against by barriers to the The fundamental principles of GAIT are to be found movement of the suppliers of the service, to the move- specifically in the main articles but are also implied by ments of the receivers of services, or to the trade itself. the force of the agreement as a whole. These principles Examples for each category follow. include nondiscrimination among contracting parties, 1. Barriers to the movement of service suppliers. Re- transparency and predictability of barriers, liberalization strictions on the inflow of labor for construction, artistic of trade, and equality of treatment of foreign and domes- purposes, and the like; restrictions on the inflow of tic products once the frontier has been crossed ("national foreign investment; restrictions on foreign professionals treatment"). It is these principles that are most relevant practicing domestically; taxation of landing or port facil- in considering the extension of the GAIT principles to ities for foreign carriers services and, in particular, to those services that are traded 2. Barriers to the movement of service receivers. Re- withoutmovementofthe serviceprovidersorreceivers. But strictions on residents traveling abroad for education, as noted, they are also relevant to the latter categories. tourism, and so on; restrictions on equipment moving abroad for servicing or repairs Most Favored Nation (MFN) 3. Barriers to trade itself. Restrictions on the place- ment of architecturaL computing, accounting, and other Nondiscrimination in the GA1T is expressed in the most contracts abroad; restrictions on the receipt of electronic favored nation concept in its unconditional form. Article 7 Richard H. Snape I of the GATr provides, "With respect to customs duties Be that as it may, the concept-if not the practice-of and charges of any kind imposed on ... importation or unconditional MFN is quite easily extended to many exportation ... any advantage, favor, privilege, or immu- forms of services trade. For services in category 3-that nity granted by any contracting party to any product is, where the providers and receivers do not have to come originating in or destined for any other country shall be together-and for barriers to trade that resemble tariffs, accorded immediately and unconditionally to the like the application of unconditional MFN is easy. Converting product originating in or destined for the territories of all some of the barriers to services trade to tariff-like imposts other contracting parties." In addition to stating that any would be helpful, for when trade barriers are in the form "advantage" (and so on) has to be extended to all, it of tariffs, the application of nondiscrimination is easy implies that any advantage that is withdrawn from any andvisible. This "tariffication" could apply, forexample, member has to be withdrawn from all-you cannot do to to trade in i_levision, radio, and movie programs, any what you are not prepared to do to your best friend. whether received directly from abroad or on tape, film, Unconditional MFN is a powerful protector of the weak or disk; professional services that are supplied at a dis- and of those who might be regarded as troublemakers.5 tance; placement of insurance and banking business There are exceptions in the GATT to this rule of nondis- abroad; and subscriptions to foreign news, educational, crimination-provisions relating to customs unions and and similar services. Nondiscrimination, then, would free trade areas were part of the GAIT from its inception, simply be the application to all trading partners of the and preferences for developing countries were added same tariff-like imposL With nondiscrimination defined later. Nevertheless, nondiscrimination is at the heart of and measured in this way, unconditional MFN follows GATT. easily: the same tariff-like charges would be applied to The requirement of article I that a concession given to all parties to the agreement, and reductions in the charges one has to be given to all could discourage negotiation imposed on the imports from any source would be of the reduction of barriers. Each country could drag its granted to all, whether or not they gave any concessions feet in negotiations knowing that it would get the benefit in return. from reductions in other countries' barriers whether or Even if barriers to trade in these services are not con- not it reduced any of its own: it could free-ride on the verted to tariff-like levies, nondiscrimination and uncon- negotiations of others. Free riding has been curtailed in ditional MFN can still be applied. For example, if there the successive rounds of negotiations under GATI by are domestic content requirements for cinemas, nondis- negotiating concessions between principal suppliers on crimination implies (as it does already in article IV of the narrowly defined products while at the same time cover- GATr) that the importers should have equal access to all ing a wide range of products in the negotiations as a foreign suppliers; unconditional MFN implies that access whole (Finger 1979). In the Tokyo Round a formula given to any foreign country would be available to all reduction in barriers (with exceptions) was adopted, and membercountrieswithoutconditions. Similarprovisions this also helped to curtail free riding. could apply to engaging foreign professional services if A standard argument why country A should be pre- such engagement is restricted by one means or another. pared to see concessions it has "bought" from country B Thus, where entry to an industry is restricted by licensing extended to country C without C's "paying" for them is arrangements, MFN implies equal opportunity for all that country A will in turn benefit, unconditionally, from foreign suppliers when licenses are issued. any concessions exchanged between countries B and C. When movement of the service provider or receiver is It appears, however, that unconditional MFN is being involved, similar principles can be applied, although in eroded in goods trade as many countries focus more on practice things may be more difficult in some cases. In the bilateral than on the multilateral and systemic aspects transport services bilateral arrangements are common- of trading policies (Snape 1988). In recentyears therehas bilateral reciprocity pervades international air transport, been considerablereluctanceby the main players in GATT while in shipping the 40-40-20 rule7 of the uNcrAD to extend to all members the benefits under new agree- Shipping Code is discriminatory on a bilateral basis. In ments concluded under GAIT auspices, even when these these areas nondiscriminatory tariffs or import quotas agreements have been interpretations of the GATT arti- would be altematives to the present arrangements that cles. Many signatories have extended the benefits only would allow protection of domestic suppliers while also 6- to the cosignatories of the particular agreement. With satisfying the unconditional MFN principle. such attitudes prevalent, there is little likelihood that the When a domestic presence is involved as part of the benefits of agreements on services will be extended to international trade in a service-that is, when the pro- any except the signatories to the relevant agreements. vider needs labor or capital (financial or physical) in the 8 Principles in Trade in Services host country-questions relating to visas, work permits, generally authorized form of discrimination according to and foreign investment policy arise. Again, application source is an import tariff, although in some circum- of an unconditional MFN policy is easily specified in stances quantitative restrictions on imports are permit- principle: the labor and capital of all parties to an agree- ted. National treatment then implies that once the ment should be treated equally with respect to entry and, authorized form of discrimination has been imposed on for labor, with respect to professional and related quali- a product, there should be no further discrimination fications. This does not imply that all types of labor according to national source. should be treated equally-only that nationality should When one views national treatment in this manner, the not be a criterion for differentiation. Similarly, it does way in which it could be extended to services is readily not imply that if professional architectural qualifications apparent. A general agreement on services could include are a condition for practice in the host country, qualifi- a provision for specifying particular means of discrimi- cations obtained in all countries should be treated equally nation against foreign-produced services. Sector-spe- if in fact they are not equal; it is the quality of the training cific agreements could then identify the particular form that should be the criterion, not the country in which it is or forms of authorized discrimination for the services in earned. With respect to both labor and capital the appli- that sector, and particular levels of these forms of dis- cation of unconditional rather than conditional MFN re- crimination could be bound among the parties to that quires that equality of treatment be applied to all parties agreement. National treatment would then imply that in to the agreement-and to all new parties to the agree- all other respects domestic and foreign producers should ment-without specific conditions being imposed once be treated equally. the general agreement has been concluded. The GAIT already provides one example of this in As noted earlier, in many services entry is limited for services; a local content provision is authorized for the both domestic and foreign firms. Postal and telegraph screening of cinema films, but article IV provides for systems are often government monopolies, and restric- equality of treatment in all other ways-that is, for tions on entry to banking, insurance, and broadcasting national treatment. The local content provision is not are common even when these areas are not limited to imposed at importation but at the actual screening time. public enterprises. Entry to many professions is also As noted above, a tariff-like impost could be an appro- restricted. So long as entry is prohibited to foreigners, the priate form of authorized barrier for many services, question of MFN does not arise. If entry is allowed, then including cinema films, if protection of the domestic mFN would imply equal opportunity of access for nation- producer is the objective of policy. als of all other member countries. Unconditional MFN could imply that no specific conditions regarding recip- Liberalization, Transparency, and Predictability rocal rights of entry be attached. Liberalization, transparency, and predictability are con- National Treatment sidered together because of their interconnections. Al- though the GAIT is not an agreement to secure or even to National treatment is to be distinguished from MFN; it attempt free trade, containment and reduction of trade refers to the treatment of foreign products (or suppliers) barriers are fundamental to it. It sets a framework within not with respect to each other but with respect to national which concessions can be negotiated and bound between products or suppliers. Article III of the GAIT requires that contracting parties. There are procedures for withdraw- "internal" taxes, regulations, and the like "should not be ing concessions and for raising barriers, but these are applied to imported or domestic products so as to afford seen as temporary deviations from the norm, although in protection to domestic production."8 It has sometimes practice many such actions have been far from tempo- been implied that for some services national treatment rary. The GAIT's procedures have provided an effective means equality of treatment of foreigners and nationals. basis for reducing tariff barriers, and in its first couple of The word "internal" in article III could suggest that once decades nontariff barriers, at least on manufactured a product has cleared the port of entry, no discrimination goods, were also reduced. More recently, nontariff bar- can be applied against foreign products. But what is the riers, often in exotic forms designed to avoid the restric- port of entry for services that can be traded in a disem- tive provisions of GAIT, have proliferated, and attempts bodied or separated form-that is, separated from the to curtail them have had but moderate success. producer? Perhaps a better way to approach the GAIT Experience with the GAIT and other trade negotiations provision with respect to national treatment is to note that shows that reductions in tariffs are easier to negotiate the GAIT authorizes or legitimizes certain forms of dis- across a broad front than are reductions in nontariff crimination against goods produced by foreigners. The barriers. In general, tariffs are the most easily identified 9 Richard H. Snape form of trade barrier and, in comparison with most forms This said, and if trade liberalization is the objective, it of nontariff barriers, provide relatively little scope for seems wise to approach negotiations on a broad front, bureaucratic licence and chicanery. Therefore they are identifying characteristics that extend across many prod- relatively transparent and their effects relatively predict- ucts, rather than product by product. Costs can then be able. The GAIT itself helps to ensure transparency by offset by benefits within a country to a much greater emphasizing tariffs as the generally authorized form of extent than will normally be possible when a narrowly trade barrier and by requiring notification and publica- defined class of products is being considered. If sensitive tion of trade barriers. products are involved, however, there is a tradeoff be- For services, nontariff barriers, not tariffs, are the norm tween the extent of coverage and the finnness of the (Hindley 1988, p. 3). This in itself creates difficulties for liberalizing thrust ofan agreement. Inclusion of sensitive liberalization: it is hard to get agreement for exchanges products in abroad agreement can lead to ambiguous and of concessions on a range of products when the forms of soft wording, leaving unresolved different interpreta- barriers are disparate and the levels often unquantifiable. tions by different parties. Frequently it is even difficult to verify whether there are International movements of persons and capital have trade barriers, as has been noted in much of the discus- frequently raised sensitivities of a different nature from sion of Japanese trade policy in recent years. In such the international movement of goods. Just as with trade circumstances the emphasis tends to be on single prod- in goods, there are some services that are more sensitive ucts; experience teaches that such an emphasis is less than others-including some services that do not involve conducive to significant liberalization. Thus "tariffica- the international movement of service providers or re- tion" of barriers to services, where feasible, could facil- ceivers (category 3); clothing and textiles have their itate liberalization. parallels in the area of services. So it may notbepossible If this route is not attractive or is not feasible for to have the same set of rules cover even all the services particular services, the GATr provisions for publication that fall into category 3, and, just as with goods, there and notification should be easily applicable to other will be a tradeoff between the extent of product coverage forms of trade barrier. Negotiation, binding, and liberal- by an agreed set of rules and the liberalizing thrust and ization would thus be facilitated. enforceability of these rules. In any case, to try to force into the same mold as category 3 the services that fall A General Agreement, or Sector by Sector, or within categories 1 and 2 would appear unwise, as it Both? would detract from what could be achieved in category 3. These considerations have led to the proposal for a As noted above, the GATT is a general agreement that two-level set of agreements for services: a framework applies generally, although with specific exceptions, to agreement specifying a set of principles applicable to a all parties and all goods. Furthermore, it is an open club, broad range of services and a subsidiary set of agree- accessible to new members on conditions similar to those ments (or annotations) that would apply these principles of foundation membership. to specific service sectors. This is the manner in which Trade negotiations that have centered on forms of bar- the Uruguay Round negotiations on services has been riers across a range of products have been more liberal- proceeding. In the midterm review ministers agreed that izing than negotiations that have focused on specific negotiations for amultilateral agreement shouldcontinue products. Some examples of the latter are the Multifibre and that a framework agreement should incorporate pro- Arrangements, the codes for dairy products and bovine visions on transparency, progressive liberalization, na- meat negotiated in the Tokyo Round of multilateral trade tional treatment, most favored nation treatment and negotiations, and the UNCTAD Shipping Code. Although nondiscrimination, market access, increasing participa- all of these agreements tend to organize and restrict tion for developing countries, safeguards and exceptions, rather than liberalize trade, it should be acknowledged and "regulatory situation," the last item "recognizing" the that it may be the characteristics of these industries that right of developing countries to introduce new regula- have led to the forms of negotiations and that the agree- tions for services, consistent with commitments under ments may be liberalizing in comparison with the situa- the framework. Work is now under way in the Group of tion without agreements. The comparison should be Negotiations on Services to explore the application of made with an alternative scenario for the product in these principles to particular service sectors. question, not with other products. Further, extraction of, for The two-level concept still leaves open the question of example, textiles and clothing from coverage by the general the breadth of coverage of the framework and the sector rules of the GArr may have been the price of maintaining agreements. The GATT covers all goods unless (as for liberalizing coverage by the GATT on other products. agriculture) there are specific provisions for particular 10 Principles in Trade in Services goods: it is, after all, a general agreement. The agree- movements of labor and capital raise particular prob- ments for services could be structured on the same all- lems, and special provisions will be necessary for them encompassing principle, or they could embrace only the in any services agreement-although GATT principles services that are specifically identified. The contrast is could still be applied. between a positive list that includes only those services named and a negative list that includes all services except Notes those specifically excluded. Two recent bilateral free trade agreements take oppo- Grateful acknowledgment is made of comments by Geza site positions on this question with respect to services. Feketekuty, Max Kreinin, Roger Mauldon, and Patrick Messerlin. I. Discussion of maniy of the points covered may be found in The Canada-U.S. Free Trade Agreement adopts the pos- Feketekuty (1988). itive list approach; a recent extension of the Closer 2. The distinction between goods and services can become rather Economic Relationship Agreement between Australia blurred when such "services" as architectural drawings, computer in all ervices programs, and musical recordings are transported in a physical form. and New Zealand provides for free trade in all services 3. "Flying in the Face of Marxist Dogma," Finanmcial Tihes, June unless they are specifically exempted. For a multilateral 22,1989. agreement, and in particular one that does notprovide for 4. This classification is based on thatof Sampson andSnape (1985). free trade, it may be more difficult to adopt the negative 5. The provisions in GATr for safeguarciing industries on a tempo- negative rary basis from "fair' trade do not allow for discrimination, although list approach, although experience with respect to quan- there was considerable pressure from some developed countries for titative trade barriers to goods shows that the negative such selectivity in the Tokyo Round of multilateral negotiations (see list approach is more liberalizing. Thus, in the context of Sampson 1987; Winham 1986), and this pressure has continued in the he Urga on n fte"etrgemncud Uruguay Round. Such discrimination would be mainly against devel- t,he Uruguay Round one of the "sector" agreements could oping countries and has been resisted by them. Trade remedies can be apply to all services except those for which there are applied on a selective basis against members if they cause injury to the specific provisions. industries of other mcmbers by means of export-promoting subsidies orby dumping-practices that are frequently described as unfair trade. 6. There is a tendency for some countries to adopt a unilateral Conclusion approach toward determining whether others have satisfied the condi- tions of new agreements and thus toward extending to others the Although it is likely that countries gain economically benefits under the agreements. This applies in particular to the Subsi- dies Code concluded in the Tokyo Round of multilateral trade negoti- from trading services, as from trading goods, interna- ationg. tional negotiations in services, as for goods, tend to focus 7. That is, 40 percent for the carriers of country A, 40 percent for on the opportunities for exporters and not on the oppor- those of country B, and 20 percent for all others, for cariage of the tunities for gains from importing. Expressed in general 8. Artic e t explicitly permits subsidies on domestic production form, the principles of comparative advantage apply to services trade much as they do to goods, although some References services trade requires the movement of the service pro- vider or receiver. Developed countries tend to export Bhagwati, Jagdish N. 1984. "Splintering and Disembodiment of Ser- services that are dependent on high levels of human, vices and Developing Nations." World Economy 7, no. 2 physical, or financial capital; developing countries have (June):13343. Feketekuty, Geza. 1988. International Trade in Services: An Overview considerable opportunities to export labor-intensive ser- and Blueprint for Negotiations. Cambridge Mass.: American En- vices. Many of the latter services requirc temporary terprise Institute and Ballinger. movement of labor, and others require that complemen- Finger, J. Michael. 1979. "Trade Liberalization: a Public Choice Per- tary capital equipment be available. Barriers to trade in Wieett, eds., CI allenges to a Lrer,Gttfried abern e, and Thomas this equipment, often erected for the protection of do- ington D.C.: American Enterprise Institute. mestic industries, can prevent the development of ex- Hindley, Brian. 1988. "Introducing Services into the GAIT: A Progress ports of these services. Report on the MTN." World Bank, Washington. D.C. Processed. Hindley, Brian, and Alasdair Smith. 1984. "Comparative Advantage Breadth of coverage appears to be an important ingre- and Tradein Services." WorldEconomy 7, no. 4 (December):369-89. dient in achieving an international agreement on services Sampson, Gary P. "Safeguards." 1987. In J. Michael Finger and An- that is truly liberalizing; product-specific agreements drzej Olechowski, eds., The Uruguay Round: A Handbook on the have a history of encouraging organized and restricted Multilateral Trade Negotiations. Washington, D.C.: World Bank. have a history ~~~~~~~~~~~~Sampson, Gary P., and Richard H. Snape. 1985. "Identifying the Issues trade. The main GATr principles of nondiscrimination, in Trade in Services." World Economy 8, no.2 (June):171-81. national treatment, liberalization, transparency, and pre- Snape, Richard H. 1988. "Is Non-Discrimination Really Dead?" World dictability can be applied to trade in services, and the Economy 11, no. I (March): 1-17. Winham, Gilbert R. 1986. International Trade and the Tokyo Round conversion of many of the regulatory barriers to services Negotiations. Princeton, NJ.: Princeton University Press. trade to forms analogous to import tariffs would facilitate the building of a GAIT-like, liberalizing, agreement. But 11 2 Principles in Factor-related Trade in Services Brian Hindley Services and goods differ in a number of ways. But in of providing the service must be to some degree located discussing international transactions, the difference of in the market of the receiver of the service. If a service dominant importance is that whereas goods are tangible is overpriced in one market in relation to another, correc- and, with more or less trouble or cost, can be transported tion of the disequilibrium requires a flow of factors. from one place to another, services, which are a change If profits on the route from A to B are higher than those in the condition of a thing or a person (Hill 1977), are not on the route from C to D, it is necessary to move ships, tangible and cannot be shifted from place to place. aircraft, or trucks-and perhaps crews-from the CD to The outcome of a service-the person or thing changed the AB route. If the earnings of lawyers and doctors in A by the service-can be transported. So can the signifiers are higher than those in B, equalization of earnings by an of property rights generated by a service (for example, a arbitrage-like process will require the movement of law- bank statement or an insurance policy). And, of central yers and doctors from B to A. An integrated market for importance, the means of providing a service-people or a service requires something much more akin to the goods-can be moved. process by which economists imagine that profits are Tlhe nontransportability of services is often expressed equalized among different industries or wages among by saying that the provision of a service requires prox- different occupations than to the process by which they imity of the provider of the service and the good or the imagine that the prices of goods are equalized among person receiving it. For this reason, international trans- different national markets. actions in services are much more likely to require some Even if arbitrage is unimpeded, however, it is unlikely form of international factor movement than are interna- to lead to a situation in which a service is priced the same tional transactions in goods. This does not necessarily in different national markets. Onereason is that provision mean that the factors of production involved in providing of a service in a locality almost inevitably entails the use the service have to move to the country of the receiver of of local as well as imported factors of production. Possi- the service (Sampson and Snape 1985), but that is what bly more important, establishment in B is likely to re- it often means in practice. quire conformity with B's regulatory system, and the This simple fact affects basic economic concepts. Con- regulatory system in effect is likely to affect the sider, for example, the notion of an integrated world producers' costs. Hence there is noreason to suppose that market. For a good, the concept is reasonably clear, it service providers from country A can exactly reproduce implies that the price of the good is the same in each in country B the price-quality combinations that they can national market when costs of transport and differences provide in A.1 in national taxes are taken into account. If the price of a The term 'regulatory system," moreover, must be inter- good is higher in one market than in another, shipments preted broadly in this contexL A national regulatory of the good will be diverted from the low-price to the system is usually taken to consist of rules for specific high-price market. Hence, to produce an integrated world service industries, such as requirements for minimum market in a good, obstacles to flows of the good have to levels of reserves or for minimum years of training at be removed. approved institutions. But an integrated world market for An integrated world market for a service involves dif- a service entails international factor flows, and the term ferent considerations. Arbitrage in goods can occur with- "national regulatory system" must therefore be interpre- out any change in the location of the producers of the ted to include, for example, laws on immigration, laws goods, but this is not true of services. Often, the means regarding the establishment of foreign firms or subsidi- 12 Principles in Factor-related Trade in Services aries or branches of foreign firms, and conditions im- if allowed to locate Korean labor in Europe temporarily, posed on employment generally, such as minimum wage can construct a road or an airport in Europe more cheaply laws and contributions to social security. than any European firm supplying a similar quality of A construction company from a developing country, output. If the output were a product manufactured in using labor from that country and paying its workers on Korea and sent to Europe, like motor cars or television that country's terms, may be capable of constructing a sets, most economists would reject the notion that the highway or an airport of a given quality in Europe more relative cheapness of Korean labor constituted a valid cheaply than could a European company using European reason for resisting the import of those goods. European labor. But a company from a developing country will airports, however, cannot be built in Korea and shipped have great legal difficulty in getting labor from the to Europe; they have to be built in Europe. But despite developing country into Europe. Even if it could do so, this difference, the logic of comparative cost that applied it might not be able to produce more cheaply were that labor, to cars and television sets seems to apply to airports. And once in Europe, subject to European employment laws. that logic suggests that if the airport can be built at a Not all international transactions in services call for lower cost by Koreans, they should build it. That in turn proximity in the immediate geographic sense of labor implies that they should be allowed to locate temporarily employed to construct an airport or highway. "Tradable in Europe for that purpose. services"-or, in the terminology of Bhagwati (1984), Thatanidea is consistent with the logic of comparative long-distance services-do exist. These are services that advantage is not at all the same thing as its being politi- can be provided by a supplier in country A to a user in cally feasible. It is as well to understand, however, that country B without relocation by either of them, such as the fundamental difficulty with the idea of shifting fac- conducting banking business by computer terminal. Any tors of production to a location when the output of the service transaction that takes place within a country factors cannot be shifted is political rather than eco- entirely by mail, fax, or phone, without direct personal nomic. contact, can also be traded internationally. This class of Developing countries, symmetrically, often reject local services is growing rapidly and may be expected to grow establishment by foreign providers of services, even even faster in the future, but it is not yet large in relation when the services cannot be provided otherwise. They to the service sector as a whole. takethis position although the termsof the rejectionoften The scope of tradable services can be extended some- concede, implicitly or explicitly, that foreign providers what by adding to the category services that require only are more efficient than their local counterparts. brief periods of relocation rather than permanent or semi- permanent residence. An architect or consulting engi- Factor Movements to Provide Services neer, for example, may be able to function effectively and the Uruguay Round with a few brief visits to the site of aproject. By contrast, abankis likelytoneedapermanentpresenceinacountry The United States opened the discussion of including if it is to successfully provide a full range of banking services in the GATI with the proposal that negotiations services. be restricted to nonfactor services. Thus it suggested that Another possible exception occurs when potential the emphasis should be on services that can be traded in users of the service can move to the location of foreign the conventional sense-a person or firm in one country suppliers of the service (or when both are able to meet in sells something to a person or firm located in another some third location). Even if service suppliers are not country without relocation of either buyer or seller. free to locate in the national market, temporary reloca- One motive for this suggestion was to avoid too great tion of users of a service might produce many of the an affront to institutional conservatism. The GA1T has in consequences of a national market that is integrated with the past dealt with trade in goods, not with foreign the world market. That this is more likely to be true the investment. Focusing on tradable services seemed more lower the cost of transport services suggests that it is more consonant with GAIT tradition. likely to apply to Luxembourg than to New Zealand. The suggested restriction on the scope of the negotia- These exceptions do not appear to constitute a major tion had the additional advantage ofavoiding the difficult breach in the general rule that factor flows are required and contentious issues of foreign direct investment and to produce an integrated world market in a service. The rights of establishment. It also avoided the at least idea of permitting factor flows, however, is not popular equally contentious issues that would be raised if devel- anywhere. oping countries made a counterclaim regarding a right of Why this should be so is an interesting question. Sup- labor to temporarily reside in a foreign country for the pose thata construction firm from theRepublic of Korea, purpose of supplying services. 13 Brian Hindley This attempt to avoid one set of problems created political problem that the GATE process addresses others. One appeared in the form of a conflict within the through concessions. United States on its negotiating position. Whatever the The structure of protection in a particular country at a tactical advantages of focusing on traded nonfactor ser- particular time must be taken to represent the outcome of vices in GAIT negotiations, many U.S. service suppliers some process of political equilibrium. To change the perceive their main international problem to be the lack protective structure, therefore, the factors that support of a right of establishment in foreign markets. They were the underlying political equilibrium must be changed. An therefore skeptical of the value of negotiations that did exchange of concessions offers one means of achieving not include discussion of rights of establishment. this. By altering the opportunities available to actors in The emphasis on tradable services raised different the domestic political process-by providing exporters problems for developing countries, which were not con- with a direct connection between the barriers they face vinced that the issue of foreign direct investment could in foreign markets and the level of their own country's be avoided. Developing countries perceive that the logic protection against imports-the offer of concessions al- of liberalization in the service sector requires a right of ters the economic interests involved and makes possible service providers to locate in the proximity of service new domestic coalitions. Hence theoffer ofan exchange receivers. They are typically suspicious of foreign direct of concessions is likely to help a government that wishes investment, however, and many are hosti' e to the notion to liberalize but faces domestic opposition and may also of introducing a GATE right of foreign service suppliers put pressure on a government that is not persuaded of the to locate in their territories-a point on which some case for liberalization. developed countries are also likely to have doubts. The U.S. suggestion that the GATE negotiations be That the issue appeared as a problem of foreign invest- restricted to tradable nonfactor services, however, de- ment, however, was a consequence of the way in which fined services in such a way that comparative advantage it had been posed. Analytically, the need of service lay predominantly with developed countries. Hence the industries that make intensive use of capital or skilled great bulk of potential GATT concessions in services labor to locate those factors in potential markets is sym- would come from the developing countries, and this metrical with the need of providers of labor-intensive seemed to preclude the possibility of an equal exchange services to locate unskilled and semiskilled labor in of concessions between developed and developing coun- potential markets. tries within the service sector. Another problem that the emphasis on tradable services One response to this problem has been to point to the raised for developing countries was that whereas service economic gains available to developing countries as a supplicrs based in developed countries might find it result of liberalization in their servicc sectors. That such easier to use local establishments, almost all of the ser- gains exist seems very likely (Hindley 1988), but their vices for which trade without establishment is possible existence does not solve the dilemma for the multilateral are those in which developed countries currently appear trade negotiations. The economic gains that developing to possess a comparative advantage (for example, bank- countries can obtain by liberalizing their service sectors ing and financial services and informatics). Any success- can for the most part be obtained through unilateral ful liberalization in this restricted range of services action. But gains that can be obtained unilaterally are would therefore probably mean an increase in develop- unlikely to be enough to persuade a government to join ing country imports ofservices from developed countries a multilateral liberalization-especially if the govern- without any compensating increase in their exports of ment has already rejected unilateral liberalization, as services. have the governments of most developing countries. In GATT terms, this raises a significant problem. GATr Bhagwati (1987) has suggested a single solution to negotiations center on exchanges of "concessions," these two problems-the desire of U.S. service suppliers where a concession is defined as a reduction in restric- to obtain some kind of establishment in foreign markets tions on imports and where concessions from other coun- and the lack of concessions of interest to developing tries are won at the "cost" of relaxations in one's own countries. Hisproposal is to introduce rights of establish- importregime. Economists often scoff at the language of ment into the GATE talks but to define them to include a GATE negotiations. Ricardo's demonstration of the prin- right to locate labor in a country temporarily for the ciple of comparative advantage, they say, destroyed once purpose of supplying a service. and for all the possibility of regarding increased open- Half of this potential solution has been broached. Early ness to imports as a cost. That is true. It is also true, in the negotiations the United States abandoned its insis- however, that economic analysis offers no solution to the tence on confining the negotiations to tradable services. 14 Principles in Factor-related Trade in Services For example, its first submission to the Group of Nego- shall also apply to restrictions on the setting up of tiations on Services (United States 1987, p. 3) states: agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Mem- The framework should apply to cross-border move- ber State. ment of services as well as to the establishment of Freedom of establishment shall include the right to foreign branches and subsidiariesfor the purposes of take up and pursue activities as self-employed per- producing and delivering the service within the host sons and to set up and manage undertakings, in par- country (emphasis added). ticular companies or firms . . . under the conditions laid down for its own nationals by the law of the The notion of a right of location for labor that is supply- country where such establishment is effected. ing services has been mentioned by a number of devel- oping countries. So far, however, it has been less sharply The last sentence of this passage adds to the right of crystallized. establishment a requirement of national treatment a The Statement of the Trade Negotiating Committee government shall not use differences in nationality as a Meeting at Ministerial Level, issued after the midterm basis for differences in legal treatment Thus the treaty review held in Montreal in December 1988, deals with gives to a Greek national who wishes to set up a bank or the question in terms of definition: an insurance company in France or Germany a legal right to do so, subject to the condition that an otherwise similar Work on definition [of services] should proceed on French or German national would be legally entitled to do so. the basis that the multilateral framework may include A right of establishment as such is very extensive. trade in services involving cross-border movement of Application of the principle of national treatment can services, cross-border movement of consumers, and significantly limit the exercise of that right. For example, cross-border movement of factors of production the two conditions taken together do not prevent a gov- where such movement is essential to suppliers. emient from banning the establishment of new banks, although they do prevent acts or regulations that discrim- A later paragraph, under the heading of market access, inate between the govemment's own nationals and those states: of other countries. Their combined effect is to provide that a government cannotprevent a foreigner from estab- When market access is made available to signatories lishing a bank if it would have allowed a similarly it should be on the basis that consistent with the other qualified national to do so. A govemment can, however, provisions of the multilateral framework and in accor- subject the foreign-owned bank to any conditions that dance with the definition of trade in services, foreign would apply to a bank owned by its own nationals.3 services may be supplied according to the preferred Many governments-some govemments of developed mode of delivery. countries among them-are likely to resist the notion of granting through a multilateral agreement a right of These words clearly do not commit anybody to anything establishment to foreign providers of services. And even much. Nevertheless, the possibility that the negotiation govemments that might support the notion in principle will attempt to liberalize international factor movements would be likely to experience difficulties in practice. The for the purpose of supplying services is open. The ques- United States, forexample, does notpermnit foreign own- tion of the legal and institutional forms available for the ership of U.S. television stations or airlines. purpose is therefore relevant. Partly to deal with this difficulty, two new concepts have developed: the idea of a right of access and the idea Rights of Establishment, Access, and Presence of a right of commercial presence. The third principle of the Declaration on Trade in Services annexed to the The concept of aright of establishmentis fairly clear. For Agreement on the Establishment of a Free Trade Area example, chapter 2 (articles 52-58) of the EEC Treaty, between the United States and Israel illustrates both: which is the legal basis of the European Economic Com- munity, is entitled "Rights of Establishment." Article 52 Each party will endeavor to provide that a supplier of states: a service produced within the other nation is able to market and distribute that service under the same ... restrictions on the freedom of establishment of conditions as a like service produced within the first nationals of a Member State shall be abolished by nation, including situations where a commercial pres- progressive stages.... Such progressive abolition ence within the nation is necessary to facilitate the 15 Brian Hindley export of a service from the other nation or is required The International Movement of Labor to by that Party. Provide Services The idea of a right of access-the ability to market and The general question of the freedom of labor to locate in distribute the service product-is intended to parallel a foreign jurisdiction to provide services has numerous GATI provisions on goods. Article III of the GAT re- subdivisions. "Labor" is a broad term, and the period quires national treatment for goods once duties have been during which it is necessary to "locate" in order to applied at the border. In other words, it requires that effectively provide a service may vary from hours to tariffs (or other border measures, when authorized) years or decades. should be the only means of discrimination between The needs of one form of labor-that involved in the foreign and national suppliers. When applied to services, supply of professional services-has received consider- this idea can raise problems. For many services border able attention (see, for example, University of Chicago measures such as tariffs are an impractical means of Legal Forum 1986). This discussion is relevant to the discrimination, and when the GAIT version of national interests of developing countries in the multilateral trade treatment is interpreted as authorizing only border mea- negotiations, since these countries have considerable sures, advocacy of national treatment tends to merge with potential for exporting professional services. advocacy of free trade in services. The problems of liberalizing international transactions Nevertheless, the basic perception that there is little in professional services and those of liberalizing interna- point in attempting to negotiate a liberalization of partic- tional transactions in labor-intensive services have ele- ularbarrierstointernationaltransactionsifforeignprod- ments in common, but they are not identical. ucts can be blocked by other barriers, such as denial of Liberalization of labor-intensive services may provide a access to distribution networks, is as valid for goods as focus for developing countries' interest in supplying for services. Thus any sensible GATr (or other) agree- services for foreign markets, should the associated prob- ment on liberalizing international transactions in services lems prove to be soluble and negotiable. will attempt to guarantee that service products which As noted above, the problems with making operational have cleared the hurdles authorized by the GAIT winl a temporary right of abode for the provision of services receive national treatment with respect to local distribu- (TRAPS) are primarily political, not economic. Neverthe- tion networks-that is, right of access. less it seems useful to identify some points on which Commercial presence is a related but different concept. decisions are essential and to sketch the consequences of A footnote to the passage quoted above notes: the choices that might be made. Suppose that in country H labor engaged in supplying ... in the area of commercial banking, the concept of a certain service earns $1 an hour, whereas in country F a commercial presence refers to the activities of re- the same labor, similarly employed, is worth $5 an hour. presentative offices, but not to agencies, branches or It seems fair to assume that even if a TRAPS is negotiated subsidiaries of commercial banks. in the Uruguay Round, the number of TRAPS visas issued will not be enough to bring about equalization of the "Commercial presence" therefore encompasses estab- occupational wage rate in H and F. But if the wage rates lishments that are necessary to facilitate cross-border are not equalized, the question arises: who obtains the trade in services. It falls far short of a right of establish- difference between the wage at which H labor would be menL A right of establishment would allow a foreign willing to work in F (say, for simplicity, $1 an hour) and bank to establish "agencies, branches, or subsidiaries." the value of H labor when employed in F? The answer is Rights of establishment, access, or presence pertain to that the difference will accrue to those who receive the organizations (which may be small-for example, firms TRAPS visa rights. of lawyers or architects or the "self-employed persons" The right to employ persons under the TRAPS scheme referred to in article 58 of the EEC Treaty).Establishment could be issued to, say, providers in country F of the of a foreign-owned enterprise may mean that foreigners service that employs this particular kind of labor. Those associated with the enterprise are admitted to the country F employers would have a right to hire in country H at of establishment on privileged terms to perform work $1 an hour labor that in F is valued at $5 an hour. This there. But it does not necessarily mean that. Immigration allocation of TRAPS rights implies that providers of the issues-the question of which persons will be admitted service in F receive the difference. to a country-are in principle separate from establish- At the other extreme, the rights could be issued to mentissues-thequestionofwhichorganizationswillbe workers in country H (on a first-come-first-served basis, allowed to provide services in the country. say, since there are likely to be more H workers willing 16 Principles in Factor-related Trade in Services to work in F for $1 an hour than there are TRAPS visas). dustries in which international transactions require inter- The outcome for the post-TRAPS distribution of income national factor mobility are often unused to foreign com- would then be quite different. Assuming competition petition, and they do not all welcome the prospect. In among F employers willing to pay $5 an hour, allocation developing countries resistance acquires additional po- of TRAPS rights to H workers would mean that those H litical force because industries that feel threatened often workers fortunate enough to receive the rights would be have a central economic position and substantial finan- paid $5 an hour by employers in F. In this case the cial resources (examples are banks and insurance com- fortunate H workers would receive the difference be- panies). In developed countries the industries in which tween the $1 an hour at which they are willing to work employment might be threatened are those that employ in F and the $5 an hour that their labor is worth to F low-wage domestic labor, which, as experience with employers. international trading arrangements in the textiles and An alternative and perhaps more plausible way of dis- garment and footwear industries has made clear, can also tributing TRAPS visa rights to H residents would be to command a great deal of political support. Nevertheless, allocate the rights to H firms that wish to supply the the potential economic gains are there, and many of them associated service in F. The consequence of that distri- would accrue to developing countries-which, by and bution would be that H firms willing to make the attempt large, have shown the greatest resistance to the attempt would receive the $4 an hour difference-in effect, a in the multilateral trade negotiations to introduce ser- substantial subsidy to their export of the service. vices into the GAIT. An issue that is likely to be central to political discus- Of course, even if something like a temporary right of sion of a TRAPS is the application of F employment laws abode to provide services were offered in the Uruguay to H workers entering F under a TRAPS visa. But the Round, developing countries might not regard it as a answer arrived at is not crucial from the standpoint of the satisfactory quid pro quo for the rights of presence or economics of the scheme. In the first place, the displace- establishment called for by developed countries. But ment from employment of competing F workers wiUl be unless the negotiation is to proceed on the basis of controlled by the assumed limit on the number of H threats, either a quid pro quo must be found or the workers admitted to F, not by the wages they receive in possibility must be faced that the bulk of developing F. In the second place, H workers willing to work in F countries wiU not join any eventual agreement-or will for $1 an hour but not allowed to work for less than, say, join it only on terms that make the agreement vacuous, $4 an hour by F law or union rules will be prepared to at least as far as they are concerned. pay $3 an hour for the right to work at the official rate in F. Such a payment can be made in many ways. To Notes determine whether it actually has been made is therefore likely to be difficult or impossible. 1. This is also true of goods at the retail level. The equality of price Another issue that is likely to be central in political to be expected in an integrated world market for a good is the net-of- trasport-cost price at the dock, before any local services have been discussions has more economic relevance: whether the applied to iL An essential difference between goods and services is that limit on the number of TRAPS visas should be for the for many services there is no equivalent of the dock-no point, short service sector as a whole or should be subdivided amnong of delivery to the ultimate user of the service, at which it makes any sense to talk about the price of the service. service industries. The latter course seems more politi- 2. The Financial Timer of July 12, 1988. however, reports John cally feasible, as it would avoid the possibility that Reed, chairman of Citicorp and of the Services Policy Advisory Com- workers in any one industry would bear the full brunt of mittee (which advises the U.S. admninistration), as saying that "U.S. the employment consequences of a TRAPS scheme. It business wanted a global agreement on services with as broad a the employment consequences ~~~~~participation as possible by developing countries. The Reagan admin- might also have the advantage, especially when com- istration should bepreparedto trade offfreermovement of Third World bined with the allocation of TRAPS visas to foreign ser- labor to U.S. projects in retum for greater access for U.S. service vice-providing firms, of increasing the variety of companies to developing markets." Reed's remarks were made as he arrived in Geneva with U.S. Special Trade Representaive Clayton services that such firms have an incentive to export. Yeutter and fourteen members of the cornmittee "to push for swifter progress on services in GAlT's trade-liberalzing Uruguay Round." Concluding Comment 3. The United States (1987, p. 6) noted this difficulty: In some cases in the past, regulators have effectively cartelized a There i no dobt tha improing th abiliy of srvice- given services secto by denying the issuance of new licenes for There is no doubt that improving the ability of service- decades. National treatment obviously has no value in these in- providing factors of production to move internationally stances from the standpoint of trade liberalization. While in a few could lead to significant economic gains for both devel- instances regulatora have established a legitimate need to limit the oped and developing countries. The difficulties in number of participants, a framework agreement should provide for achevianddevelopmg thatresultar arly e poltica tl.Service in- a degree of foreign participation if such restricted drcumstances achieving that result are primarily political. Service in- recur. 17 Brian Hindley 4. This is not equivalent to thepropositian that F residents who are Hill, T. P. .1977. "On Goods and Services." Review of Income and members of the occupation receive $5 an hour. It is not necessary to Wealth 23, no. 4 (December):315-38. the argument that H and F labor be of the same quality. Hindley, Brian. 1988. "Service Sector Protection: Considerations for Developing Countries." World Bank Economic Review 2, no. 2 References ~~~~~~~~~~~~(May):205-24. References Sampson, Gary, and Richard Snape. 1985. 'Identifying the Issues in Trade in Services." WorldEconomy 8, no. 2 (June): 171-81. Bhagwati,Jagdish. 1984. "Splintering andDisembodimentof Services University of Chicago Legal Fonum. 1986. Barriers to International and Developing Nations." WorldEconomy 7,no. 2 (June):133-44. Trade inProfessionalServices. Chicago, 111.: University of Chicago - 1987. "Intemational Trade in Services and Its Relevance to Law School. Economic Development." In Orio Giarini, ed., The Emerging Ser- United States. 1987.ConceptsforaFrarneworkAgreement in Services. vice Economy. Oxford: Pergamon Press for the Services World MTN.GNS/Wf24, October27. Geneva: oATr Secretariat. Forum. GATI Secretariat. 1988. Statement ofthe TradeNegotiating Committee Meeting at Ministerial Level. Montreal. 18 3 The Uruguay Round Negotiations on Services: An Overview Mario Marconini At a meeting in Punta del Este, Uruguay, in September The main objective of this chapter is to shed some light 1986, representatives of countries from around the world on the principal developments that have been largely launched the eighth round of multilateral trade negotia- responsible for bringing the Uruguay Round negotia- tions in the forty years of existence of the General Agree- tions on trade in services to where they are currently. The ment on Tariffs and Trade (GAIT). The ambitious analysis will be undertaken chronologically to bring out character of the Uruguay Round was especially evident the evolutionary character of the negotiations. Where in that for the first time liberalization of trade in services possible, the implications of the various features of the was formally placed on the multilateral negotiating negotiating process for participating countries are dis- agenda. Its inclusion reflected the view of some countries cussed. that the potential for a larger role of services in world trade was restricted by the lack of multilaterally agreed The Initial Steps and the Punta del Este rules governing their trade. Negotiations aimed at estab- Declaration lishing a multilateral framework of rules for this dynamic category of international transactions could furthermore In 1982 the United States submitted to the GA1T a docu- be seen as a way of maintaining the forward momentum ment that placed great emphasis on the importance of of the liberalization process achieved for goods in the services to the world economy and on the GATI as a postwar era. "solid basis" for a framework for trade in services.1 The negotiating process has been complex, reflecting Whereas most countries of the Organisation for Eco- considerable differences in the range and level of sophis- nomic Co-operation and Development (oEcD) could tication of service sectors in participating countries. Per- lend some support to the U.S. initiative, almost all devel- haps even more important, the negotiations have been in oping countries opposed, although to varying degrees, large measure guided by countries' differing assess- the U.S. push to establish a working party that would set ments of the potential contribution that an open and in motion the liberalization of trade in services through liberal trading system in services could make to eco- GAIT negotiations. The opposition was initially based on nomic developmenL Countries in which the tradable the GATT'S lack of legal competence in the matter. services sector is large and services contribute signifi- The work program agreed on in November 1982 rec- candy to gross domestic product (GDP) have seen nego- ommended that national studies on services be under- tiations on trade in services as a crucial element in taken and invited contracting parties to exchange strengthening the world's trading system and developing information, 2butagreementon how the exchange should national economies. For countries in which the service take place was reached only in November 1984. Be- sectors are less developed, the negotiations have been tween 1984 and 1986 seventeen national studies were more difficult to assess, particularly in the absence of circulated, and comprehensive documentation was re- statistical information and of a conceptual foundation on ceived from thirteen international organizations. None of which to base national priorities. Despite these differ- the national studies submitted was from a developing ences, participating countries have undertaken to nego- country. tiate on a framework. The challenge facing all countries By mid- 1986 the persisting disagreement on the ques- alike is to ensure that the framework contains the ele- tion of services continued to threaten the successful ments necessary for promoting greater global welfare launching of a new round of multilateral trade negotia- alongside the economic development of individual states. tions. As a result of two years of intense discussions, 19 Mario Marconini however, the negotiations had gained in complexity as not the ultimate aim but merely a means toward that aim, positions had become more elaborate, going beyond along with transparency. This language sufficed to sat- concerns about the legal competence of GATr to more isfy those countries that could see the merits of expanded fundamental issues such as the suitability of the concep- trade, whether or not that implied a more liberal domestic tual structure and the scope of application of GAIT to economy. As confirmed by the Brazilian position at the services trade, the definition of trade in services, the time, for some heavily indebted developing countries the international competitiveness of services firms, and the prospect of increased trade flows in general was a good role of regulation in the services sector. In a parallel goal to strive for, especially if combined with the recog- development, clusters of participating countries crystal- nition that general liberalization was to perform a sec- lized around common positions on specific issues and on ondary role in the evolving trade in services regime.4 The the general approach to the negotiations. Four main qualification to the liberalization process introduced by clusters became apparent in the periodjustpreceding the adding the word "progressive" was also instrumental in Punta del Este meeting: (1) the United States and some drawing country positions closer. Admittedly, such a OECD countries, which favored the original proposal; (2) qualification carried with it the recognition that services the European Community (Ec), some OECD members, structures and capacities varied widely across countries and some developing countries, which were working and that countries would differ in their capacity to liber- toward an overall compromise; (3) a group of ten devel- alize their markets for services.5 oping countries (the G-10), led by Brazil and India, Another related element was the linkage made between which strongly opposed the U.S. initiative; and (4) a progressive liberalization and growth and development. group of twenty developing countries (the G-20) that Liberalization was identified as a means of promoting were prepared to accept the U.S. proposal depending on not only the "economic growth of all trading partners" the terms. (Richardson 1986). The inclusion of trade in but also the "development of developing countries." services in the ministerial declaration owed much to the Even though expansion of trade had been assigned compromises struckamong thesefourclusters of govern- greater priority than liberalization as such, for some ments. developing countries there was no necessary link be- Negotiations on trade in services were launched tween expansion of world trade and development. It was through part 11 of the Punta del Este declaration of not disputed that trade expansion could contribute to September 1986. Whereas part I, which launched nego- development, but some countries were reluctant to ac- tiations on trade in goods, constituted a decision by the cept that such a contribution followed automatically, GATT contractingparties, partil was drafted as a separate without any qualification. By singling out the develop- decision by ministers in their capacity as representatives ment of developing countries as one of the intended end of their governments. The two-part decision, by setting results of a future agreement, scope was established for up two distinct tracks for negotiations on goods and exploring how to substantiate the link between expanded services, did much to allay the fears of some countries trade and development, and it was ensured that the de- that trade in services would fully become a part of the velopment objective would permeate all aspects of the GAaT. The decision thus reflected an important compro- negotiations. The language of the declaration thus did mise between countries (the United States, the OECD much to meet the desire of some developing countries countries, and some developing countries) that favored that special consideration be given to their situation. the GAIT as a forum for negotiations on services and Finally, the text stated that the framework agreement those (the G-10) that preferred such negotiations to be should "respect the policy objectives of national laws and outside the GAIT conceptual and institutional structure. regulations applying to services." This sentence repre- Despite this strict distinction between goods and ser- sented to many participants an acknowledgment that vices, however, the Uruguay Round as a whole was some national regulations affecting services could be considered a single undertaking to be conducted within maintained alongside a multilateral agreement on ser- the same time frame and under the same "umbrella," the vices trade. This acknowledgment implied a qualified Trade Negotiations Committee (TNC). approach to barriers or obstacles to trade whereby not all In addition to this procedural agreement, a substantive related laws and regulations were to be scrutinized but element in part II that reflected the making of a compro- only those that impinged directly on trade in services.6 mise was the differentiation between expansion of trade The call for respect for national policy objectives created on the one hand and liberalization as such on the other. the possibility that liberalization might be interpreted as Expansion of trade was assigned the status of an objec- a limited undertaking that did not necessarily imply tive to be achieved "under the conditions of transparency deregulation in all cases. It thus helped to narrow the gaps and progressive liberalization." Liberalization was thus between national positions-gaps that in any case were 20 The Uruguay Round Negotiations on Services: An Overview not as wide on this issue as on some others, since devel- particular with relation to the collection and disaggrega- oping countries were not the only ones interested in tion of available statistical data on services, to afford maintaining certain regulations in place. Many devel- participants a better assessment of their negotiating in- oped countries were also reluctant to reform their often terests. During the two years following the Punta del Este sophisticatedregulatory frameworks for services-espe- meeting, the secretariat produced a paper on the subject, cially through multilateral discipline. The position of the and other international organizations-including the In- EC at the time was a case in point.7 temational Monetary Fund (IMF), the United Nations Centre on Transnational Corporations (UNCTC), and the The Negotiating Agenda United Nations Conference on Trade and Development (UNCTAD)-were invited to brief GNS participants on Following the adoption of thePuntadel Estedeclaration, relevant work they had undertaken. the Group of Negotiations on Services (GNS) was estab- * Concepts. Even though efforts were made to intro- lished, with a program for the initial phase of the nego- duce new concepts to fit the mandate's objectives, the tiations that, in broad terms, aimed at addressing discussions still relied to a considerable extent on tradi- underlying issues not resolved in the ministerial declara- tional GATT terminology. Thus, concepts such as national tion while shedding some light on how to fulfill the treatment, most favored nation treatment and nondis- guidelines and objectives agreed on in Punta del Este. crimination, and transparenc8y were put forth as princi- The work program for the GNS agreed on in February ples for a future agreement. Although some countries 1987 consisted of five agenda items. still had reservations as to the applicability of GAIT Definitions and statistics. Some countries main- concepts in their "pure" form, a consensus became in- tained that no progress could be expected from the nego- creasingly apparent that traditional GATT "labels" might tiations unless agreement were reached on a specific be acceptable if they were accompanied by nontradi- definition of trade in services. This argument was based tional conceptual formulations. The discussion on na- on a perceived need to limit the scope of a future agree- tional treatment illustrated this consensus. If national ment so as to exclude "nontraditional" forms of trade that treatment were applied as setout in article III of the GATT, involved more than the movement of the services being it would have different implications for services that provided across borders. Since delivery of certain ser- crossed borders than for those that were delivered vices required proximity between the producer and the through locally established firms in a foreign country. consumer, the claim had been made during the negotia- Cross-border services might be treated analogously to tions that the mobility of factors of production (capital, trade in goods, where national treatment was used to labor, technology, and information) and of consumers ensure that concessions made at the border were not was essential for trade in services. International capital nullified internally by the actions of the government of mobility, it was contended, should be sanctioned in a the importing country. For services involving the cross- framework agreement on trade in services to give firms bordermovementof factors of production, national treat- the choice of establishing in foreign markets to provide ment would no longer apply to the movement of products their services. "Establishment trade" constituted the (or activities) across borders but to the activities of "nontraditional" form of trade most strongly opposed by producers within borders. Such a formulation should some developing countries such as Brazil and India. reflect some agreement on whether national treatment These countries placed great emphasis on the symmetry would apply only after some form of market access (for that would be required if some aspects of establishment- example, establishment) had been granted or whether it related investmnent were included in the agreement if would in effect imply both market access and equal certain forms of permanent capital movements were to treatment for foreign providers in terms of their opera- be sanctioned by future rules and principles applying to tions after access had been granted.9 trade in services, consistency would require that certain * Sectoral coverage. During the Group's delibera- forms of permanent labor movements be sanctioned as tions, there had been few indications of the sectors that well. The full spectrum of definitional possibilities was participants were interested in considering for negotia- thus on the table. At one extreme, trade involving only tion. Some developing countries contended that the cov- services that themselves crossed borders was being con- erage of an agreement on trade in services should achieve templated; on the other, services trade that necessitated a balance of interests for all participants and not repro- the movement of production factors across frontiers was duce the situation persisting in goods trade, where whole being considered. sectors of interest to developing countries, such as tex- On the question of statistics, some countries maintained tiles and agriculture, in effect remained outside GAT7 that a considerable amount of work was still required, in discipline. It had become evident, however, that such a 21 Mario Marconini balance depended on complex linkages between cover- maintained that all laws and regulations that were in age and other elements of the agenda. For example, some place to fulfill policy objectives should be immune to developing country participants maintained that sectoral multilateral disciplines. Other participants tended to coverage could only be resolved once a definition was view objectives as unassailable but not the individual adopted as to what did and did not constitute trade in laws and regulations embodying them. Also, for some services. This contention stood in direct opposition to participants, trade-restricting measures and practices that of several other participants, who considered the were not confined to the public sector but were also very identification of sectors or transactions within sectors of prominently employed by private market operators. Un- interest to be the main means for achieving a workable derlying the discussions on this item was the recognition definition of trade in services. A similar linkage obtained by most participants that, owing to the peculiarities of between coverage and concepts. Whereas some partici- service transactions (for example, their being unaffected pants (mostly developing countries) preferred to know by tariffs), barriers to trade in services were difficult to what sectors were being considered for inclusion before identify, regardless of the policy objectives they might committing themselves on the concepts to be included in embody. the framework, others clearly favored the adoption of a general framework of widely applicable rules and prin- The Montreal Text: Content and Implications ciples irrespective of whether agreement had been reached on including or excluding certain sectors.10 Following an intense period of informal consultations * Existing sectoral arrangements and disciplines. that led to the report to the TNC meeting at ministerial Whereas the original questioning of the GATT's legal level, agreement was reached in Montreal on the text competence became less of an issue after the Punta del setting the guidelines for the future work of the GNS. The Este meeting, the competence of other organizations in text contained some substantive provisions that ad- relation to trade in services was increasingly considered dressed many of the concems expressed during the ne- worthy of careful examination. 11 Several developing gotiations by both developing and developed countries. countries pointed out that even though existing sectoral Perhaps the greatest progress achieved in Montreal arrangements on services had not focused primarily on related to one of the most difficult aspects of the negoti- the services sector as a whole or on the multilateral ations: providing for the development of developing liberalization of trade in services, the services negotia- countries under a framework agreemenL The "develop- tions could hardly be construed as occurring in a com- ment objective' had permeated all aspects of the negoti- plete legal vacuum. In recognition of that fact, the Group ations during the two years preceding the midtern extended invitations to participate in the relevant GNS review, and many participants concurred that develop- discussions to the International Telecommunications ment should be included as an integral part of the agree- Union (rtu), the International Civil Aviation Organiza- ment and not as an "appendage" or a series of waivers tion (ICAO), and UNCTAD (for a presentation of the UN. and exceptions. Many participants' idea of what should Convention on a Code of Conduct for Liner Confer- be sought was very different from the development ap- ences). The participation of these organizations, in addi- proach embodied in part IV of the GAIT, which set out tion to confirming that there was no "legal vacuum," also the guidelines for special and differential treatment for attested to the fact that such arrangements did not have developing countries in the goods area. as their primary objective the establishment of a multi- The Montreal text would largely succeed in creating the lateral framework to expand trade in services and to context for exploring different possibilities for integrat- promote economic growth and development. ing development-related concerns into the agreement Of - Measures and practices contributing to or limiting special relevance was a comprehensive passage headed the expansion of trade in services. The discussion of this "increasing participation of developing countries," item centered on how a future agreement could fulfill the which directly linked greater participation in world trade Punta del Este directive on respecting the policy objec- in services and expanded services exports by developing tives of national laws and regulations. While the deliber- countries to the strengthening of the capacity, efficiency, ations reflected in large measure the acknowledgment and competitiveness of the domestic services sectors in implicit in the Punta del Este declaration that laws and those countries (GAIT 1989a, p. 40). The establishment regulations were often intended to achieve legitimate of this linkage in effect created the scope for the explo- national policy objectives, much thought was devoted to ration of policy options reflecting the strategic role of ways of differentiating between "acceptable" or "appro- services in the national development process, including priate" measures and measures that were candidates for joint ventures, infant industries, and technology trans- negotiated liberalization.12 Some developing countries fer.13 A second element that contributed to making de- 22 The Uruguay Round Negotiations on Services: An Overview velopment an integral part of the agreement was the should be able to choose the manner in which they would language.contained under the concept of progressive deliver their services-through a local commercial pres- liberalization, which tied the progressivity of the liberal- ence, through telecommunication links across borders, ization process to the level of development of individual through local agents, and so on. This formulation of countries. Appropriate flexibility was also deemed nec- market access was closely related to the passage on essary for countries in opening "fewer sectors or liberal- definitions, which stated that "the framework may apply" izing fewer types of transactions or in progressively to services that themselves move across borders or that extending market access in line with their development involve the cross-border movement of consumers, fac- situation" (GAIT 1989a, p. 39). The injection of pro- tors of production, or both. It was recognized that mobil- gressivity into the liberalization process went a long way ity across borders may differ, depending on the mode of toward accommodating the wishes of developing coun- delivery preferred. It was also implicit that giving service tries which perceived the liberalization of trade in ser- firms the possibility of choosing the mode of delivery vices to be feasible only in the long term. Progressivity might create a favorable climate for transfer by these could allow these countries the necessary additional time firms of technological expertise and operational know- and stimulus to engage in domestic liberalization efforts how. For many industrial countries, that freedom of before submitting their service sectors to broader com- choice was considered indispensable in the framework mitments to external liberalization. agreement, but for some developing countries, such free- The third element in the text relevant to development dom impliedasignificantrelinquishmentof sovereignty. and developing countries related to regulatory matters. This was why the Montreal text stated that market access The concept of "regulatory situation" recognized the should be made available in accordance with the defini- differences between regulatory structures in developed tion of trade in services.14 and developing countries (GATr 1989a, p. 40). Even The Montreal text did not resolve the definition issue, though this recognition did not include the claim by but it did give it more precision. Similarly, the sectoral developing countries that development itself was a pol- coverage of the agreement was left open even though the icy objective of national laws and regulations, it gave text stated that certain sectors could eventually be ex- these countries the possibility of introducing new regu- cluded in whole or in part because of certain overriding lations to correct the regulatory asymmetries between considerations (GATr 1989a, p. 38). Finally, the Mon- themselves and their developed counterparts. This pre- treal text included a provision stating that close attention scription, along with the recognition that "governments should be paid to the extent to which any of the negoti- regulate service sectors, e.g., by (among other things) ating objectives in part II of the Punta del Este Declara- attaching conditions to the operation of enterprises tion could be achieved through existing arrangements within their markets," would create the possibility of and disciplines (GAIT 1989a, p. 38). regulating matters relating to technology transfer, invest- ment, and even the movement of labor and personnel. The Post-Montreal Period In addition to these strides toward a consistent treat- ment of development under the framework, the concep- In addition to providing a substantive conceptual basis, tual basis underpinning the discussion of the GNS was the Montreal text contained an elaborate timetable as to expanded to include other innovative formulations. For how the negotiations were to proceed. The GNS was able those traditional GATI concepts that appeared in the text, to meet this timetable despite the four-month interlude nontraditional formulations prevailed, reflecting the after the Montreal meeting caused by the lack of agree- specificity of service transactions as compared with trade ment in other groups of negotiations. 15 in goods. National treatment, for example, was to apply In accordance with timetable, the first issue to be tack- not only to exports of services but also to service provid- led by the GNS was sectoral coverage. To ensure that ers, in effect creating the possibility of treatment no less progress would be made on the issue, ministers had favorable being granted to foreign established compa- instructed the GATT Secretariat to draw up a reference list nies as well as to foreign labor and professionals. There by April 1989. To complement such a list-w.dch was was no most favored nation treatment formulation in not to represent a negotiable document or necessarily Montreal, but market access received a broad formula- reflect all negotiable sectors-participating countries tion stating that "foreign services may be supplied ac- were also invited to submit "indicative lists" of sectors cording to the preferred mode of delivery." Some of interest to them, and it was agreed that no service governments had advanced the concept of "preferred sector would be excluded a priori. This arrangement, mode of delivery" during the negotiations to indicate that which was to be concluded by May 1989, represented an service firms, in gaining access to foreign markets, attempt to address the concern expressed by many par- 23 Mario Marconini ticipants that without at least an indication of the sectors viders. Restrictive regulatory systems applicable to na- countries might be interested in negotiating, it might be tional providers would simply be extended to foreign difficult to expect meaningful commitments with respect providers if the principle were applied without any qual- to other areas of the negotiations. Even though only the ification or reformulation. The financial services sector European Community, Hong Kong, and Poland submit- was a case in point. Providing a comparable level of ted indicative lists, the reference list drawn up by the competitive opportunities for foreign and domestic fi- secretariat served to add some precision to an otherwise nancial institutions through the application of national very broad discussion. treatment is especially difficult, given that some coun- To address the linkages between the coverage issue and tries enforce an institutional separation of banking and the concepts issue, ministers agreed on the need to ex- securities activities whereas others do not. The unquali- amine the implications and applicability of concepts, fied application of the most favored nation principle- principles, and rules for particular sectors and specific traditionally a central element in the multilateralization transactions. By mid-September 1989 the examination of concessions exchanged among trading partners- process had been completed for six sectors: telecommu- could also run into problems, since many of the regula- nications, construction, transport, tourism, financial ser- tory frameworks obtaining internationally reflect vices (including insurance), and professional services. reciprocal arrangements reached among countries. Ex- Undoubtedly, the sectoral testing exercise, although it amples are enhanced telecommunications services and did not involve any real negotiations, was useful in some financial services, as well as civil aviation, which bringing out some of the more relevant features of the has been governed by bilateral reciprocity arrangements sectors examined in relation to the concepts agreed in aimed at achieving an equitable distribution of market Montreal. As the agreement on the formulation of these access opportunities for carriers of trading partners. concepts was only "considered relevant" for the elabora- The sectoral testing exercise benefited from the active tion of a multilateral framework of principles and rules participation of most countries. Although countries' as- on trade in services, definite conclusions cannot be sessments of the exercise varied-some more readily drawn from the exercise. Some of the implications are, finding evidence that sectoral specificities would over- however, revealing. ride the supposed utility of a multilateral framework of Certain concepts do indeed have broad applications generally applicable rules and principles-the exercise across many sectors. Transparency, for example, can constituted a valuable input into the assembling of the feasibly be applied to relevant laws, regulations, admin- main elements for a draft framework, which ministers istrative guidelines, and international arrangements in had earmarked for December 1989. many sectors.16 The same is true of progressive liberal- ization, which is by nature a flexible concept that could What Lies Ahead relate to subsectors, transactions, activities, or even modes of delivery relevant to each sector (for example, In an effort to push forward the negotiations toward the on-line data bases in telecommunications, the phasing fulfillment of the ministerial schedule, the United States out of cargo-sharing arrangements in maritime transport, submitted in October 1989 a very elaborate and compre- and licenses to establish in the domestic market in insur- hensive text-drafted in legal language-on the struc- ance). The concept of "regulatory situation" is also ture of the framework agreement. In addition, thirteen widely applicable; the general aim of readdressing regu- other parties-Austria, Brazil, Canada, the EC, India, latory asymmetries among countries would not be com- Indonesia, Japan, Korea, Malaysia, Mexico, New Zea- promised by the introduction of different types of laws land, Peru, Singapore, and Switzerland-submitted pa- and regulations tailored to the sector in question. For pers on the subject during the second half of the year, but example, in tourism environmental protection and health none had the same degree of legal clarity. On the basis standards might redress asymmetries among regulatory of such documents and related discussions, agreement systems, whereas safety regulations might have a more was reached on a text that will guide the negotiations corrective effect in the air transport sector. during the last year of the Uruguay Round. Even though For some concepts, however, a generally applicable it is early to discern the physiognomy of the final frame- formulation does not suffice to address significant work, the process of assembling the main elements has specificities in certain sectors. For example, it was be- made evident that five areas will be central in determin- lieved in some quarters that defining national treatment ing the nature of the agreement definition, scope, con- so as to require that foreign providers be treated no less cepts, structure (including coverage and modalities of the favorably than national providers was not enough to liberalization process) and institutional aspects (for ex- afford increased levels of market access to foreign pro- ample, therelationshipoftheoNs agreement to the GA1T). 24 The Uruguay Round Negotiations on Services: An Overview Although long-standing issues such as definitions and 4.Thispointwas furtherelaboratedinacornmunicationfrom Brazil concepts have been further refined, the structure of the tothe GNs,publishedbytheBraziliannegotiatorinBatista (1987, p. 62, p-ara 16). agreement has loomed as the crucial issue on which 5. This concem is well exemplified in Argentina's statement that hinges the very utility and attractiveness of the agree- "accounthad to betaken ofthefact thatforhistorical reasons or due to menL Only once a structure is in place can governments different perspectives, some sectors were more highly regulated than others,bothamoangdifferent sezvcesasectors and withinthe samesecur meaningfully initiate the process of exchanging commit- in different countries" (GArT 1985a, para. 63). ments, as only then will they have a clear idea as to the 6. This point was elaborated upon by the Indian negotiator at the rights and obligations emanating from the framework time in Randhawa (1987, p. 165). is the ~7. Just before the Punta del Este meeting the Ec stated that "the agreement. A related element of great importance appropriateness of national regulation of services sectors would need treatment of sectoral specificities. Even though there to be respected as a legitimate constraint on any multilateral action on seems to be wide agreement on the need for annotations trade in services; any agreernent would therefore need to stuike a which while being an integral part of the agreement balance between the benefits accruing from liberalization of trade on a nondiscrniminatory basis and those pursued by regulation of services would "interpret or clarify" framework provisions as sectorsforthepromotion ofdomesticeconornicandpotical goals such they apply to each individual sector, agreement will need as development" (GATr 1986, para. 2). to be reached on the format and content of such annota- 8.InapapersubmnittedbyMexicototheoNs,theconceptofrelative tions. Annotations may, for example, differ considerably reciprocity, based on article 36(8) of the GmIT, figured as a central element addressing the concerns of developing countries. According to among sectors according to whether the realm of activi- the original formulation, developed countries should not expect strict ties of the sector in question is affected by the provisions reciprocity for commitments made to devdoping country signatories of an international agreement-such as those enforced (GATr 1988a, p. 12). 9. A concept that was a modified version of a GATr principle was by the ICAO or the T. that of optional most favored nation treatment, introduced by Switzer- While the importance of this issue is widely recognized land. This was an attempt to limit most favored nation treatment by by all participants, it should also be noted that different providing that countries could choose to grantit to third parties only on participants attach differentdegrees of priority to this and request (GATr 1988a, p. 13). participan- s 10. The U.S. approach, outlined in a document of May 1988, other issues. For example, several developing countries prescribed the negotiation of a multilateral framework of rules and are laying great emphasis on the issue of definition and principles as the first phase of a three-phase procedure forthe conple- on the final formulation that might be given to certain tion of the Urguay Round negotiations on services. The sectoral issue would be handied only in the second phase, starting with the anony- concepts. In particular, a very truculent discussion might mous notification of the sectors on which individual counties would take place in the months leading up to the conclusion of be willing to negotiate (GArr 1988b, p. 8). the Uruguay Round if some countries perceive that the 11. An examination of the activities of tlirteen intemational orga- GNS is giving less priority to "increasing participation of nizations dealing with services was undertaken before the Punta del GNS ~~~~~~~~~~~~~~~~~Este meeting, and a summary of the information made available by the developing countries" than to some other issues. A well- relevant organizations was prepared by the secretariat (GAIT 1985b). balanced consideration of the essential elements of the 12. In a paper submitted to the GNs in December 1987, the BC framework will do much to highlight the complexity of envisaged a system based on the identification of "accepted appropri- ate" and "unacceptable inappropriate" forms of regulation as a means the subject while constituting a last meaningful attempt toward movement on this issue. A "regulations committee"o would be at crafting a truly multilateral framework of rules and set up to exanine relevant measures once the agreement entered into principles governing trade in services. force (GAIT 1987, p. 8). 13. In addition, the concept of increasing participation of develop- ing countries set out improved access to distribution channels and Notes information networks as relevantforthe facilitation ofeffectivemarket access for those countries' exports. It thus implicitly recognized the 1. The Consultative Group of Eighteen, a group of high-level importance for development of data and infomnation infrastructures govemment officials established as a permanent GATT body in 1979, and services. heldthefirst real substantive discussion of tradein services in the GATr 14. See for details GATr (1989a, p. 42). "The choice of mode of in March 1981. That discussion focused on the Enks between trade in delivery could therefore be circumscribed by the definition of trade in goods and trade in services and on the relevance for trade in services services, which should be examined further in the light of, inter alia, of existing commitments under the General Agreement and the most the following criteria: cross-border movement of service and payment, favored nation codes (GAIT 1981). specificity of purpose, discreteness of transactions and limited dura- 2. The recommendation for individual national studies was in itself tion" (GATr 1989a,p. 38). Tbis qualification ofmarket access by linking a compromise between countries that wanted the GATr Secretariat to it to the definition of trade in services to be adopted was the Montreal undertake a general study and those that opposed the involvement of expression of the investment-related concems of some developing the secretariat in matters relating to services. countties, which dated from before the Punta del Este declaration. 3. The views on such issues did not follow a clearNorth-South line 15. Even thoughthe GNS negotiations were on a separate track from in all instances. The issue of regulation, for example, was an important the goods-related negotiations, they also fell prey to the wish of some concem for both developed and developing countries. There was, govemments to put a halt to all Uruguay Round negotiations until however, a certain difference of emphasis; developing countries placed agreement was reached on the four areas on which agreement was not more emphasis on infant industry protection and the balance of pay- reached in Montreal: textiles and clothing, safeguards, agriculture, and ments situation than did developed countries, which gave greater trade-related aspects of intellecual property rights (GATr 1989b,p. 1). prioity to prudential and fiduciary concems. 16. The problems arising from the application of trmnsparency, however, were also common to many sectors. The establishment of 25 Mario Marconini national enquixy points to facilitate the dissemination of relevant mar- - . 1987. News of the Uruguay Round of MTN, December 21, ket information, for example, could involve considerable adrninistra- 1987. NUR 013. tive burden no matter what the sector in question. . 1988a. News of the Uruguay Round of MTN, August 2, 1988. NUR 018. References -. 1988b. News of the Uruguay Round of MTN, May 31, 1988. NUR 016. -. 1989a. "Mid-Term Review Agreements." News of the Uru- Batista, PauloNogueira 1987. "Tradein Services: Brazil's Perspective guayRoundofMTN, April 24,1989. NUR 027. on the Negotiation Process" Sela Capitulos no. 16 (April-June). - . 1989b. News of the Uruguay Round of MTN, February 23, GATr. 1981. Report of the Consultative Group of Eighteen, Fourteenth 1989. NUR 024. Meeting, 25-27March 1981. I5066. Geneva. Randhawa, Param. 1987. "Punta del Este and After. Negotiations cn - . 1985a. Minutes of the Meeting Held on 1-2 April 1985. Trade in Services and the Uruguay Round." Journal of World MDF/10. Trade Law 21, no. 4 (August). -. 1985b. Swmnmary oflnformation Made Available by Relevant Richardson, John. 1988. "What Really Happened at Punta del Este: International Organizations. MDF/17. Understanding the Framework of the Uruguay Round." In Riddle, 1986. Minutes of the Meeting Held on 29 August 1986. Dorothy, ed., Information Economy and Development, F. Ebert MDF/36. Stftung Bomn, p. 202-213. 26 4 Services-Related Production, Employment, Trade, and Factor Movements Bernard M. Hoekman In many countries services account for the largest share and collection of statistics were designed chiefly for of employment and gross domestic product (GDP), and in goods, reflecting the fact that until recently there was not industrial countries most employment growth in recent a great demand for tracking developments in the service years has been generated by services. Furthermore, tech- sector (see appendix 4-A). nological and managerial innovations have created and Cross-country comparisons in the area of services need increased both the demand for and the supply of new to be treated with particular caution. Often nations clas- services, and many types of services are becoming in- sify identical services under different headings or utilize creasingly tradable across frontiers. This chapter dis- different measurement and estimation techniques. For cusses some services-related facts and figures to provide example, wholesale trade activities might be measured a perspective for the sector and country studies in parts in terms of the gross value of goods bought and sold or II and III. in terms of the (estimated) average gross or net margin Standard conventions will be followed in defining ser- of the traders. Banking services may be reported in total vices, trade, and investment in services. In terms of loans and deposits or in gross income instead of as the domestic production and employment, services are con- sum of net interest income and payments received for sidered to include wholesale and retail trade, all transport intermediation services. of freight and people, storage, communications, and Care must also be taken in making comparisons across information-related activities, business and professional time, since the technological changes and increasing services, banking and financial services (including insur- specialization associated with economic growth may ance), and personal, community, and social services. lead to the creation of new services that are not captured Most of these services will be discussed in part II. in existing classification systems. Furthermore, firms Trade in services is defined on a balance of payments may shift from in-house provision of intermediate ser- basis to comprise certain nonmerchandise transactions vice inputs to arm's-length sourcing, or services that between residents and nonresidents of a country.1 The were provided atarm's length might come to be provided discussion of foreign direct investment will be limited to within firms or households. The do-it-yourself phenom- data on the sectoral distribution of stocks in host coun- enon is a good example of a shift of services back into tries.2 the household, with the implication that they will no Beforeturning to thedata,awordof wamingisrequired longer be registered in the national accounts. regarding their reliability and their comparability across countries. Statistics on the service sector are notoriously The Evolution of Services in Economic Structure poor. In contrast to goods, services are usually intangible and are thus difficult to measure. For example, customs Services in GDP agents typically cannot observe flows of services across the frontier, as the services are usually embodied in an As can be seen from table 4-1, in 1965 the share of information flow, a person, oragood. Moreover, since services in GDPrangedfrom a low of 16percent forOman services are often not storable, their production and to a high of 73 percent for Singapore. On average, the consumption usually must take place simultaneously, share of services in GDP varied between 40 and 55 and this too makes them more difficult to register than percent in 1965. Since 1965 the share of services in GDP goods. Finally, existing procedures for the classification has increased for most countries, but this trend is far from 27 Bernard M. Hoekman Table 4-1. Distribution of GDP by Sector, Selected Economies, 1965 and 1986 (percent) ARriculture Industry ManufacturinR Services Group and economy 1965 1986 1965 1986 1965 1986 1965 1986 Low income 42 32 28 35 21 24 30 32 Burma 35 48 13 13 9 10 52 39 China 39 31 39 46 30 34 23 23 India 47 32 22 29 15 19 31 39 Rwanda 75 40 7 23 2 16 18 37 Sudan 54 35 9 15 4 7 37 50 Tanzania 46 59 14 10 8 6 40 31 Togo 45 32 21 20 10 7 34 48 Zaire 21 29 26 36 16 n.a. 53 35 Middle income 20 15 30 36 20 22 50 48 Argentina 17 13 42 44 33 31 42 44 Brazil 19 11 33 39 26 28 48 50 Cameroon 32 22 17 35 10 12* 50 43 Congo 19 8* 19 54* n.a. 6* 62 38* Hong Kong 2 0 40 29 24 21 58 71 Indonesia 56 26 13 32 8 14 31 42 Mexico 14 9 31 39 21 26 54 52 Oman 61 3 23 59* 9 3* 16 38* Panama 18 9 19 18 12 8 63 73 Philippines 26 26 28 32 20 25 46 42 Singapore 3 1 24 38 15 27 73 62 Thailand 35 17 23 30 14 21 42 53 Industrial 5 3 40 35 30 23* 55 61 Australia 9 5 39 34 26 17 51 62 Canada 6 3 40 36 27 n.a. 53 61 France 8 4 39 34 28 n.a 53 63 Germany, Fed. Rep. of 4 2 53 40 40 32 43 58 Italy 11 5 41 39 23 22 48 56 Japan 9 3 43 41 32 30 48 56 Spain 15 6 36 37 n.a. 27 49 56 United Kingdom 3 2 46 43 34 26 51 55 United States 3 2 38 31 28 20 59 67 Developing 29 19 29 36 n.a. n.a. 42 46 Oil exporters 22 18 29 33 15 15 39 49 Manufactures exporters 34 18 31 35* n.a. n.a. 36 44* Highly indebted countries 18 15 32 36 23 23 49 47 Sub-Saharan Africa 39 36 19 25 10 10 42 36 Notes: For some economies indicated by an asterisk (*)the most recent available data are for 1985. Definitions of regions are those used in World Bank (1988). Source: World Bank (1988). uniform. Many nations report a decrease in the relative An inspection of table 4-1 reveals that the share of importance of services in domestic activity; they include services in GDP tends to vary with per capita income. Algeria, Burma, Cameroon, Chad, China, Congo, Costa Middle-income developing countries have a higher share Rica, Madagascar, Mauritius, Mexico, Nicaragua, Nige- of services in GDP than do low-income countries, and the ria, the Philippines, Singapore, Sri Lanka, Tanzania, difference between the two groups is larger than that Tunisia, Zaire, andZimbabwe. The only industrial nation between middle- and high-income countries. for which this occurs is Norway, owing in large measure Reasons for this are not hard to find.4 First, agriculture to exploitation of North Sea oil. Despite such exceptions, and extractive industries tend to dominate in many de- services have become, on average, relatively more im- veloping countries. Second, many types of producer portant in nominal terms. (intermediate) services require a diversified manufactur- 28 Services-Related Production, Employment, Trade, and Factor Movements Table 4-2. Average Annual Growth Rates of GDP by Sector, Selected Economies, 1965-80 and 198086 (percent) GDP Agriculture Industry Manufacturing Services Group and economy 1965-80 1980-86 1965-80 1980-86 1965-80 1980-86 1965-80 1980-86 1965-80 1980-86 Low income 4.8 7.5 2.7 4.9 7.6 10.6 7.8 11.2 5.0 6.6 Burma 3.9 4.9 3.7 4.7 4.4 63 3.9 5.8 4.0 4.8 China 6.4 10.5 3.0 7.9 10.0 12.5 9.5 12.6 7.0 9.4 India 3.8 4.9 2.8 1.9 4.1 7.1 4.4 8.2 4.8 6.0 Rwanda 4.9 1.8 n.a. 0.9 n.a. 4.8 n.a. 4.1 n.a. 1.1 Sudan 3.8 0.3 2.9 0.4 3.1 2.1 n.a. 0.0 4.9 -0.3 Tanzania 3.9 0.9 1.7 0.8 4.2 -4.5 5.6 -4.6 6.7 2.9 Togo 4.4 -1.1 1.9 1.7 6.8 -2.2 n.a. -2.6 5.4 -2.3 Zaire 1.4 1.0 n.a. 1.7 n.a. 2.7 n.a -0.7 n.a. -0.7 Middle income 6.5 23 3.5 2.3 7.6 2.1 7.0 2.5 6.7 2.6 Argentina 3.3 -0.8 1.4 2.3 4.4 -1.7 2.7 0.4 3.9 -0.8 Brazil 9.0 2.7 4.7 2.0 10.0 1.6 9.8 1.2 9.4 3.8 Cameroon 4.9 8.2 4.2 2.0 8.1 15.9 7.0 4.4 7.0 Congo 5.9 5.1 3.1 0.6 10.3 8.4 n.a. 2.9 4.7 3.7 Hong Kong 8.5 6.0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Indonesia 7.9 3.A 4.3 3.0 11.9 1.8 12.0 7.7 7.3 5.6 Mexico 6.5 OA 3.2 7.6 0.3 7.4 n.a. 6.6 3.6 0.4 Oman 12.5 5.7 n.a. n.a. n.a n.a. n.a. n.a. n.a. n.a. Panama 5.5 2.6 2.4 2.2 5.9 -1.4 4.7 0.2 6.0 3.7 Philippines 5.9 -1.0 4.6 2.0 8.0 -3.5 7.5 -1.7 5.2 -0.6 Singapore 10.2 53 3.1 -3.5 12.2 4.4 13.3 2.2 9.7 6.1 Thailand 7.A 4.8 4.9 2.9 9.5 5.0 10.9 5.2 8.0 5.6 Industrial 3.7 2.5 1.2 2.5 3.6 2.5 4.0 n.a. 3.9 2.6 Australia 4.0 3.1 2.6 6.1 2.9 2.0 1.2 n.a. 5.A 3.5 Canada 4A 2.9 0.7 2.8 3.4 2.9 3.8 3.6 5.5 2.9 France 4.4 1.3 0.8 2.8 4.6 0.6 5.3 n.a. 4.6 1.6 Germany, Fed. 3.3 1.5 1.4 3.1 2.9 0.7 3.3 0.8 3.7 2.1 Rep. of Italy 3.9 13 0.8 0.5 4.2 0.2 5.1 -0.2 4.1 2.1 Japan 63 3.7 0.8 1.0 8.5 5.0 9.4 7.8 5.2 2.9 Spain 5.2 1.8 3.0 2.8 5.8 0.8 6.7 0.3 4.6 2.3 United Kingdom 2.2 23 1.7 4.1 1.2 2.0 1.1 2.1 2.9 2.6 United States 2.8 3.1 1.1 3.1 1.9 3.2 2.7 4.0 3.4 3.0 Developing 6.0 3.8 3.1 3.6 7.6 4.6 8.0 5.9 6.4 3.4 Oil exporters 6.8 1.7 3.2 2.4 83 1.6 85 2.4 6.9 1.9 Manufactures exporters 6.7 6.2 3.2 5.0 8.8 7.8 n.a. 8.6 7.4 5.3 Highly indebted countries 6.4 0.7 3.2 1.8 7.3 -0.2 73 0.4 6.8 1.0 Sub-SaharanAfrica 53 0.0 1.9 1.2 9.7 -1.6 9.8 03 5.4 0.1 Note. Definiions of regions are those used in World Bank (1988). Source: World Bank (1988). ing base that is often lacking in many of these countries. Summers 1983; Summers and Heston 1988). This is Finally, to some degree the differences between coun- because use of such prices reduces the dispersion of per tries may come about because prices of many services capita income among nations. tend to be lower in developing than in industrial coun- Table 4-2 reports average annual growth rates of the tries. Research indicates, however, that the share of per components of GDP valued in constant prices. Growth capita spending on services that satisfy final demand is rates for most countries dropped dramatically in 1980- roughly equal in developing and industrial countries if a 86, the main exceptions being low-income countries common set of average international prices is used to such as Bangladesh, Burma, China, India, and Senegal. value the components of GDP (see Kravis, Heston, and For most developing countries services grew slightly 29 Bernard M. Hoeknan fasterthan GDP in both 1965-80 and 1980-86. For devel- services has been the increasing scope for arm's-length oping countries as a whole, industry outperformed ser- sourcing owing to innovations in information technol- vices in 1965-80, while in 1980-86 both industry and ogy, to increasing specialization, and to product differ- agriculture grew faster than services. In lower-middle- entiation. income countries, however, services outperformed both agriculture and industry in 1980-86. A result implicit in Services in Employment table 4-2 is that the share of services in GDP does not appear to increase significantly when measured in con- As can be seen from table 4-3, the relative importance stant prices. That is, growth rates of services output do of services in terms of employment has increased dra- not significantly exceed those of GDP for the principal matically for many countries since 1950.6 The increas- country groups reported. For developing countries as a ing share of employment in services took place whole, the share of industry in total output grows, that of especially in industrial and more advanced developing agriculture declines, and that of services remains rela- nations. In many industrial countries the shareof services tively constant. in total employment is currently more than 60 percent, It is beyond the scope of this paper to analyze in greater and for some it is about 70 percent. For most low-income detail and for a longer time period the evolution of developing countries the share of services in total em- sectoral shares. Stern and Hoekman (1988) reportfigures ployment has risen relatively slowly even though the on the percentage breakdown by sector of U.S. national rising trend has been observed in virtually all countries. income in current prices from 1869 to 1984 and of GDP The figures reported in table 4-3 include government for Japan from 1890 to 1980. Finance, insurance, and activities. Not surprisingly, if public sector employment other private services became increasingly important in is excluded, the average share of services in total employ- the United States after the 1940s, whereas government mentfalls substantially. Blades (1987) has estimated that services expanded significantly after the 1930s. The in- the average share in OECD nations drops to 40 percent, creasing share of other private services reflects a decline which implies that about one-third of employment in in theshare ofpersonal (domestic) services that was more services is in the public sector. Figures reported by than compensated by a substantial increase in business UNCTAD (1988) reveal that the share in developing coun- (intermediate) and medical services. For Japan there tries is substantially higher, at 50 percent. does not seem to be any discemible trend in the relative The main point is that service employment shares tend importance of services over the ninety-year period as a to vary directly with real percapita income. Explanations whole. But when the share of services in output is mea- for this usually revolve around differentials in labor suredin constant prices, a negative overall trend appears: productivity between sectors and fundamental changes the services share, which in 1900 was about 50 percent, in the structure of economies over time. Lagging labor declined to about 34 percent before World War II, rose productivity in services has been shown to be an impor- to a peak of almost 50 percent in 1953, and then declined tant determinant of the growth of service sector employ- to 39 percent in 1969. ment.7 Structural changes are in large part a reflection One conclusion that emerges is that in many countries of the process of economic development and include large increases in the observed share of services in GDP have not taken place recently. This, of course, does not (a) increased female participation rates in the labor mean that the composition of the service contribution to market; GDP has remained constant. The dynamics have been (b) increasing rates of urbanization; occurring within the service sector, as reflected espe- (c) increasing specialization and technological cially by the increasing importance of business (interme- changes that lead to the creation of new (market-ori- diate) services. Green (1985) has demonstrated that ented) service activities; expenditures on producer services as a proportion of the (d) expansion of part-time employment opportunities value of manufacturing output increased on average by (largely in the service sectors); approximately 20 percent in the Federal Republic of (e) growth of government services such as education Germany, Italy, and the United Kingdom between 1975 and health; and and 1981. In the United States most service subsectors (f) growth of international trade and investment.8 have been growing faster than manufacturing output, especially for producer services such as telecommunica- International Trade in Services tions, wholesale trade, brokerage, and business and mis- cellaneous professional services (Adams and Siwaraksa Information on international trade in services is less 1987). The driving force behind the growth of producer comprehensive than data on domestic production and 30 Services-Related Production, Employment, Trade, and Factor Movements Table 4-3. Shares of Employment by Sector, Selected Economies, 1950, 1965, and 1980 (percent) Agriculture Industry Services Group and economy 1950 1965 1980 1950 1965 1980 1950 1965 1980 Low income n.a. 86 80 n.a. 5 8 n.a. 14 15 Burma 70 64 53 9 14 19 20 23 28 China 88 81 74 5 8 14 7 11 12 India 78 73 70 8 12 13 13 15 17 Rwanda 96 94 93 2 2 3 2 3 4 Sudan 92 82 71 2 5 8 6 14 21 Tanzania 94 92 86 2 3 5 4 6 10 Togo 82 78 73 7 9 10 11 13 17 Zaire 87 82 72 7 9 13 6 9 16 Middle income n.a. 56 43 n.a. 17 23 n.a. 27 34 Argentina 25 18 13 32 34 34 43 48 53 Brazil 60 49 31 17 20 27 24 31 42 Cameroon 92 86 70 3 4 8 5 9 22 Congo 67 66 62 10 11 12 21 23 26 Hong Kong 12 6 2 56 53 51 32 41 47 Indonesia 79 71 57 6 9 13 14 21 30 Mexico 60 50 37 17 22 29 23 29 35 Oman 76 62 50 9 15 22 15 23 28 Panama 56 46 32 14 16 18 30 38 50 Philippines 67 58 52 12 16 16 21 26 33 Singapore 8 6 2 20 27 38 71 68 61 Thailand 86 82 71 3 5 10 11 13 19 Industrial 22 14 7 36 38 35 42 48 58 Australia 15 10 7 40 38 32 45 52 61 Canada 20 10 5 36 33 29 44 57 65 France 31 18 9 35 39 35 34 43 56 Germany, Fed. Rep. of 23 11 6 43 48 44 34 41 50 Italy 44 25 12 31 42 41 25 34 48 Japan 49 26 11 24 32 34 27 42 55 Spain 50 34 17 25 35 37 25 32 46 United Kingdom 6 3 3 49 47 38 45 50 59 United States 12 5 4 37 35 31 51 60 66 Developing 81 70 62 7 12 16 12 18 22 Oil exporters n.a. 61 49 n.a. 15 19 n.a. 24 31 Manufacturesexporters n.a. 71 66 n.a. 11 16 na. 16 17 Highlyindebtedcomtries n.a. 51 40 n.a. 18 23 n.a. 31 37 Sub-SaharanAfrica 87 79 75 5 8 9 8 13 16 Note: See note to table 4-2. Table 4-4. World Exports of Merchandise and Invisibles, 1970-87 Value Share of total Average annual change Item (billions of dollars) (percent) (percent) 1970 1987 1970 1987 1970-79 1980-87 1970-87 Merchandise 264 2,080 71 66 20.5 2.5 13.0 Invisibles 110 1,078 29 34 21.0 5.0 14.0 Private services 64 504 17 16 19.0 5.0 13.0 Investment income 26 415 7 13 25.0 6.5 17.5 Other official goods, 8 45 2 1 17.0 2.0 10.5 services and income Unrequited transfers 12 114 3 4 22.0 4.0 14.0 Total 374 3,135 100 100 20.5 3.0 13.0 Note: See text for definitions. Source: an balance of payrnaets statistics. 31 Bernard M. Hoekman Table 4-5. Ratio of Exports of Private Services to the Sum of Exports of Merchandise and Prvate Servkes, 1970 and 1980 (percentage share, based on value) Economies with constant or declining 1970 1987 Economies with increasing share 1970 1987 share ofprivate services ofprivate services Selected developed countries Selected developed countries Australia 16 16 Austria 32 36 Belgium and Luxembourg 20 20 France 23 28 Canada 12 10 Greece 42 44 Germany, Fed. Rep. of 13 13 New Zealand 12 23 Denmark 25 23 Finland 16 16 Ireland 12 11 Italy 23 22 Japan 12 11 Netherlands 22 21 South Africa 24 11 Selected developing economies Spain 48 39 Chile 10 17 Sweden 17 17 C6te d'Ivoire 8 10 Switzerland 25 21 Egyptd 13 53 United Kingdom 28 25 India 13 23 United States 18 18 Indonesia 1 5 Kenya 33 40 Selected developing economies Malaysia 4 12 Algeria 8 6 Morocco 26 32 Brazil 10 7 Peru 15 26 Cameroon 18 17 Philippines 14 32 Colombia 21 17 Saudi Arabia 9 11 Iranb 6 2 Senegal 25 27 Israel 38 29 Singapore 20 21 Korea, Rep. of 17 15 Sudan 9 35 MexicoC 53 24 Thailand 20 24 Nigeria 5 4 Tanzaniae 20 23 Taiwan 12 7 Zaire 2 9 Venezuela 6 6 Zambia 1 5 World 20 20 a. 1986. b. 1984. c. With exports of maquiladoras included, the share of private services in merchandise exports declined from 111 to 24 percent between 1970 and 1987. d. The reported value of exports of private services in 1970 was significantly understated because it did not include travel services. In 1977, the first year for which travel was reported, exports of private services amnounted to 77 percent of merchandise exports. Source: GAIT Secretariat, based on r F balance of payments statistics and natial sources. employment. It is, moreover, difficult to relate trade data invisibles in world trade was about 34 percent (compared to domestic data because the classification systems are with 29 percent in 1970), while that of private services not compatible. As discussedin appendix4-A, care must was 16 percent (17 percent in 1970). Thus while the be taken in interpreting statistics on trade in services. share of invisibles in world trade in merchandise and Since the primary source of information on such trade is invisibles has been increasing, the share of private ser- the balance of payments, this section focuses on the vices has apparently been declining. nonmerchandise components of the current account. Individual country experiences do, of course, vary. In Table 4-4 reports data on the nominal value of world particular, many developing countries experienced a re- exports of merchandise and invisibles for the period duction in the relative importance of merchandise ex- 1970-87.9 Although invisibles and merchandise exports ports after 1970, whereas the converse holds for most grew at similar rates during 1970-80, invisibles out- industrial countries. As can be seen from table 4-5, for performed merchandise after 1980. In 1987 the share of many developing countries the relative importance of 32 Services-Related Production, Employment, Trade, and Factor Movements Table 4-6. World Exports of Private Services, by Category, 197087 (percentage, based on value) Share in exports of Average annual change private servies in exports Service Category 1970 1980 1987 1970-79 1980-87 Passenger transport 5 5 6 19.0 7.5 Shipping 21 16 13 15.0 1.5 Other transport 12 16 11 21.5 0.0 Travel 29 27 29 18.0 6.5 Other market services" 23 30 34 22.0 6.5 Property and labor income 10 6 7 12.0 6.0 Private services 100 100 100 19.0 5.0 a. Includes nonnerchandise insurance, communication services, advertising,brokerage and management services, leasing, merchanting, and other professional and technical services. Source: sas balance of payments statistics. exports of private services has increased dramatically in In general, the relative importance of private services the past two decades. In only four of the twenty industrial increased for developing countries as a group. Declines countries listed in table 4-5 did the relative importance occurred only for fuel exporters and high-income coun- of private services increase, compared with eighteen out tries-that is, for those countries that are net exporters of of twenty-nine developing countries. capital. Low- and middle-income countries experienced an increase in the relative importance of private services. Table 4-7. Exports of Merchandise and Private Services, 1967-87 (percentage annual average growth rates) 1967-72 1972-77 1977-82 1982-87 1967-87 Region Goods Services Goods Services Goods Services Goods Services Goods Services World 14.3 14.1 221 18.4 9.9 11.2 5.6 6.5 13.0 12.3 Western Europe 15.4 14.6 19.6 18.2 9.5 9.9 9.5 8.2 13.4 12.2 NorthAmerica 11.1 8.5 18.4 13.8 11.4 12.0 4.3 7.0 11.2 10.6 Middle East 16.6 16.7 49.0 30.1 5.5 9.4 -16.9 -1.6 12.4 13.2 Asia 17.3 20.6 24.2 24.4 12.4 17.9 8.4 3.7 15.4 16.0 Africa 12.1 10.4 28.5 21.0 6.4 10.2 -9.6 -0.1 8.4 11.1 LatinAmerica 9.8 14.4 23.5 17.1 13.8 10.1 -1.0 2.6 11.7 10.8 Selected Eastern Europe a n.a. n.a. 20.5 13.7 6.7 10.4 -7.5 1.3 n.a. n.a. Developing economy oil exporter 15.4 14.9 42.3 22.5 8.3 7.5 -13.4 -1.5 12.5 10.5 Developing economy manufactures exportersb 15.5 24.2 27.9 26.5 14.1 19.4 8.4 -0.1 16.3 17.0 Least developed economies 5.6 7.3 16.0 7.6 3.2 19.0 -4.1 -7.1 1.4 4.0 Low-income high-growth d 5.5 6.1 20.3 25.3 7.4 17.2 2.8 -4.0 3.9 6.7 Middle-income high-growth 13.3 21.0 32.5 28.6 16.6 21.7 6.1 3.6 16.9 18.7 High-incomehigh-growthf 13.6 12.8 20.6 16.0 11.7 12.3 6.1 6.1 12.9 11.9 All developed economies 14.7 13.9 19.6 17.7 10.1 10.3 83 7.8 13.1 12.1 All developing economies 11.5 15.3 32.4 23.1 9.7 15.0 -3.8 0.6 12.4 13.3 a. Hungary, Poland, and Ronania. b. Argentina, Brazil, Hong Kong, Republic of Korea, Singapore, Taiwan, and Yugoslavia. c. uxcrAD definition. d. Bangladesh, Benin, Bunna, China, India, Kenya, Nepal, Pakistan, Senegal, Sonalia, and Sri Lanka. High-growth countries are those with annual avemge growth rates of GDP of more than 3 percent in 1980-86. e. Algeria, Botswana, Cameroon, Congo, Egypt, Indonesia, Jordan, Republic of Korea, Malaysia, Mauritius, Morocco, Oman, Singapore, Thailand, Tunisia, Turkey, and Yemen. f Austaha, Japan, Norway, and United States. Source: sF balance of payments statistics. 33 Bernard M. Hoekman Table 4-8. Share in World Exports of Merchandise and Invisibles, 1970487 (percent) Merchandise and Private Passenger Region invisibles Invisibles services transport 1970 1987 1970 1987 1970 1987 1970 1987 Westem Europe 52.3 54.9 55.7 58.3 63.5 63.5 65.0 54.9 North America 23.3 17.4 25.3 18.7 18.6 13.9 17.3 19.0 Middle East 2.5 2.7 2.4 3.5 1,9 2.2 2.1 3.1 Asia 11.9 18.1 8.5 13.5 7.9 13.7 9.5 13.3 Africa 4.0 2.0 3.3 2.1 2.0 2.0 1.1 3.9 Latin America 5.4 4.0 4.5 3.2 5.7 4.3 4.9 5.5 Selected Eastern Europe 0.6 0.9 0.7 0.7 0.5 0.9 n.a. 0.3 Developing economy oil exporters 5A 4.6 3.4 3.6 4.1 2.9 2.0 3.2 Developing economy manufactures exporters 3.2 4.9 3.1 33 2.8 4.9 3.5 4.9 Least developed economies 0.7 0.4 0.9 0.7 0.5 0.3 0.6 0.3 Low-income high-growth 1.3 1.8 1.3 1.3 0.9 1.2 0.3 1.6 Middle-income high-growth 3.7 6.8 4.0 5.5 2.4 7.1 0.9 7.6 High-income high-growth 26.8 25.5 28.7 26.4 23.8 20.0 26.3 27.4 Alldevelopedeconomies 83.9 83.4 86.2 85.8 87.7 84.0 91.3 81.2 All developing economies 16.2 15.0 14.0 13.6 12.4 15.1 9.6 18.1 Notes: See notes to table 4-7. Source: IMF balance of payments statistics. Components of Trade in Services and the Middle East, while they are least important for Eastern Europe and Asia. Not surprisingly, since 1970 Table 4-6 focuses on the relative importance of the the fastest growth in the relative importance of invisibles components of private services in world trade. In 1987 in total trade occurred in the Middle East, reflecting exports of transport services and expenditures by travel- tremendous increases in investment income. In general, ers in host countries each made up somewhat less than invisibles became more important for fuel exporters and one-thirdof global private service credits. The remainder least developed countries; between 1970 and 1987 they was a mix of business and professional services, con- increased from 16 to 27 percent for fuel exporters and struction, and exports of labor and intangible property, from 21 to 30 percent for the least developed countries. such as know-how and trademarks. Only two categories They declined in importance for the group of low-in- grew faster than merchandise exports in 1970-80: pas- come, high-growth countries, from 31 percent in 1975 to senger transport and "other market services" (construc- 15 percent in 1987. tion, telecommunications, nonmerchandise insurance, brokerage, operational leasing, processing and repair, Growth Rates of Service Exports and other business and professional services). The slow- est-growing component was property and labor income. Table 4-7 reports growth rates for exports of merchan- Since 1980 shipment and other transport services have dise and private services for five-year intervals starting lagged behind merchandise. l The same qualitative in 1967. 1972-77 was a boom period as far as (nominal) results are obtained with world imports. But because trade values were concerned; many regions registered world exports of shipment are underreported (owing to average annual growth rates of more than 20 percent. To nonreporting of revenues by certain large exporters and alargeextentthis mayhave been theresultof inflationary vessels flying flags of convenience), world imports give forces, but unfortunately data on the volume of trade in a more accurate view of the relative importance of ship- invisibles do not exist. ment in world trade. In 1987 the share of shipment in World merchandise exports grew faster than private world imports was 18 percent, as opposed to the 13 services between 1967 and 1977. The reverse was true in percent reported on an export basis.12 1977-87. Note, however, that Asia demonstrates an op- The relative importance of invisibles and private ser- posite pattern in that private services grew faster than vices in trade varies among countries and regions. Invis- merchandise exports in 1967-82, whereas merchandise ibles are of above average importance forNorth America exports outperformed private services after 1982. Until 34 Services-Related Production, Employment, Trade, and Factor Movements Other Other market Property Labor Shipping Transport Travel services income income 1970 1987 1970 1987 1970 1987 1970 1987 1970 1987 1970 1987 75.2 63.1 44.7 51.0 61.4 64.0 68.2 70.0 27.2 39.3 82.4 71.7 10.1 8.1 27.6 22.9 19.2 13.6 13.1 8.9 72.6 51.9 n.a. 1.8 1.6 1.7 2.5 1.4 1.9 2.0 23 3.0 n.a. 0.2 2.2 1.8 9.8 21.2 16.7 16.1 4.5 10.7 7.8 12.8 n.a. 8.2 3.1 17.3 1.2 1.3 3.0 3.7 2.3 2A 2.4 1.2 n.a. n.a. 1.2 3.7 2.1 3.2 5.5 4.5 10.1 6.5 4.5 3.1 n.a. 0.2 10.7 3.7 n.a. 1.5 n.a. 0.4 03 0.7 1.6 1.1 n.a. 0.1 n.a. n.a. 1.2 1.4 4.1 1.6 8.4 3.7 2.9 3.6 n.a. n.a. 7.3 2.4 3.0 6.6 5.4 6.6 2.7 4.7 2.1 4.4 n.a. n.a. 2.8 3.2 0.2 0.2 0.9 0.2 0.4 0.3 0.8 0.3 n.a. n.a. 0.7 2.3 0.8 2.0 2.5 13 0.6 1.7 1.0 0.9 n.a. n.a. 0.2 0.3 1.0 7.6 4.3 8.2 3.0 8.8 2.8 5.6 n.a. n.a. 2.9 8.7 28.3 26.8 38.1 33.1 15.7 13.9 15.3 14.1 n.a. 60.5 1.1 5.1 93.7 84.4 83.4 84.0 82.7 80.8 86.9 86.1 99.6 99.7 84.5 78.2 7.2 12.9 16.6 16.1 18.2 18.6 11.6 13.1 0.4 0.3 15.2 21.8 1982-87, exports of private services usually grew faster Shares in Global Exports in low- and middle-income high-growth developing countries than exports of merchandise. The same per- During 1980-87 Asia, the Middle East, and Western tains to developing countries that are substantial export- Europe increased their shares in global flows associated ers of manufactures. with both invisibles as a whole and with private services, It is noteworthy that the decreases in the growth rates whereas the shares of Africa, Latin America, and North of exports experienced by many countries and regions America declined.14 High-growth developing countries after 1982 were concentrated in merchandise exports increased their share in total trade, while developing more than in private services. This may in part reflect the countries as a whole experienced a slight reduction. As dependence of the export prices of many services on table 4-8 shows, developing countries increased their domestic rather than international developments. (This share in private services as a whole, reflecting growth in is especially so for those services-tourism, for example exports of passenger transport, shipment, and other mar- where the recipient moves to the location of the pro- ket services. vider.) One hypothesis is that the terms of trade for On a regional basis, much of the increased share in services may well be less sensitive to international passenger transport was attributable to an increase in shocks. For example, in 1979-85 the terms of trade for exports from Asia. In terms of selected country groups, services showed little net change for Australia, despite virtually all of the increase was attributable to the sub- fluctuations, whereas the terms of trade for merchandise stantial rise in exports from middle-income high-growth fell continuously. (See Bureau of Industry and Econom- countries, which increased their world market share from ics 1988 for a more comprehensive discussion.) 0.9 percent in 1970 to 7.6 percent in 1987. The same A policy implication is that diversification of produc- phenomenon occurred for shipment, for which the num- tive activities into services might reduce the sensitivity bers were virtually identical. Asian countries, in partic- of an economy to external shocks. This, however, does ular, increased their share of world shipment exports not necessarily have to be the case; the growth rates of significantly, from 9.8 percent in 1970 to 21.2 percent in private service exports of high-growth developin coun- 1987. (For a detailed discussion, see Miklius 1988; Sien tries fell faster than their merchandise exports. The and Trace 1988.) general inference to be drawn from table 4-7 is that The category "other market services" demonstrates the exports of private services have grown in importance and same pattem. This category is probably of the greatest have tended to be more dynamic than exports of mer- current policy interest, as it has been the fastest growing chandise in the recent past. category of invisible exports for many countries. Fur- 35 Bernard M. Hoekman Table 4-9. Comparison of Countries ThatSpecialize in Tourstn, 1987 orLatestAvailable Year Tourism receipts as Average expenditure Country percentage of exports per arrsval of private services (dollars) Seychelles 50 1,000 Vanuatu 50 930 Kenya 51 520 Mexico 52 650 Nepal 53 225 Thailand 54 560 Netherlands Antilles 56 520 Belize 57 240 Guyana 57 320 Uruguay 57 460 Maldives 57 300 Cyprus 60 700 Malta 60 490 Paraguay 60 1,190 Portugal 64 350 Tunisia 64 360 Tonga 64 530 Fiji 65 530 Jamaica 67 800 Samoa 67 200 Spain 69 450 Barbados 71 800 Morocco 72 450 Dominican Republic 74 510 Indonesia 82 750 St. Kitts and Nevis 86 570 Bahamas 87 790 Gambia 88 490 Haiti 88 760 StL Vincent and Grenadines 90 630 Grenada 94 530 Dominica 97 390 Antigua and Barbuda 98 660 Note: Figures may be biased for countries with incomplete coverage of the components of private services. This is the case for Indonesia, in particular, as it does not report shipment statistics. Sources: Receipts share: ne balance of payments statistics; expenditures: World Tourism Organization (various years). thermore, these services have become an increasingly the temporary movement of labor. The same pattem important determinant of external competitiveness. holds here as for most other categories of services: the Countries in Africa, Latin America, and North America increase in the share of developing countries is attribut- experienced a reduction in their share of world exports able primarily to an increase in exports from Asian of these services, while those in Asia and Westem Eu- countries. rope increased their share. On a more aggregate level, however, little has changed since 1970; industrial coun- Tourism tries have generally maintained their relative share. Industrial nations dominate credit flows associated For many countries expenditures by travelers (tourists) with sales of intangible property. These sales consist in are an important source of revenue. 5This is especially large part of fees for licensing and franchising arrange- true for many developing countries, which often have a ments, trademarks, and technology, all of which can be surplus on the travel account. Tourist expenditures are seen as intermediate inputs. These countries also have a usually varied; they may include outlays on transport, much larger share in world credit flows associated with tours, lodging, entertainment, and souvenirs. Trade in the 36 Serices-Related Production, Employment, Trade, and Factor Movements Table 4-10. Leading Exporters and Importers of Private Services, 1970 and 1987 Exports Imports Value, Share, Value, Share, 1987 1987 1987 1987 Rank (billions (percent) Rank (billions (percent) Economy 1970 1987 cfdolair) 1970 1987 ofdoUars) United States 1 1 56 11.2 Germany, Fed. Rep. of 2 1 65 12.4 France 3 2 53 10.6 United States 1 2 56 10.8 United Kingdom 2 3 43 8.6 Japan 5 3 52 10.1 Germany, Fed. Rep. of 4 4 41 8.2 France 4 4 43 8.3 Italy 5 5 33 6.5 United Kingdom 3 5 33 6.4 Japan 6 6 28 5.5 Italy 6 6 26 5.0 Netherlands 6 7 23 4.5 Netherlands 8 7 23 4.5 Spain 8 8 22 4.3 Belgium and Luxem'bourg 9 8 17 33 Belgium and Luxembourg 10 9 19 3.8 Canada 7 9 16 3.1 Austria 15 10 15 2.9 Switzerland 15 10 12 2.3 Switzerland 12 11 14 2.8 Sweden 10 11 10 2.0 Canada 9 12 11 2.1 Norway 13 12 10 1.8 Sweden 14 13 9 1.7 Saudi Arabia 44 13 9 1.8 Norway 11 14 8 1.7 Austria 18 14 9 1.8 Korea, Rep. of 27 15 8 1.7 Spain 16 15 8 1.6 Denmark 16 16 8 1.5 Australia 11 16 8 1.5 Singapore 22 17 7 1.5 Denmark 17 17 7 1.4 Hong Kong - 18 7 1.4 Taiwan - 18 6 1.0 Mexico 13 19 7 1.3 Korea, Rep. of 32 19 5 1.0 Australia 17 20 5 1.0 Hong Kong - 20 5 1.0 Taiwan 26 21 4 0.9 Mexico 12 21 5 0.9 Greece 20 22 4 0.9 Singapore 40 22 5 0.9 Yugoslavia 18 23 4 0.9 Yugoslaviae 20 23 5 0.9 China - 24 4 0.8 Finland 26 24 5 0.9 Thailand 33 25 4 0.7 SouthAfrica 14 25 5 0.9 Total 437 86.7 Total 444 86.0 World 504 100.0 World 516 100.0 -Not applicable. a. 1986. Source: GAl r Secretariat, based on no balance of payments statistics and national sources. products of service sectors such as hotels and restaurants, econornies. Reported average expenditures by travelers recreation and culture, and domestically provided trans- in the countries included in table 4-9 vary widely, from port will in large part be measured as expenditures by $200 to $1,200. tourists and business travelers, if it is registered at all.16 By region, the shares of Latin America and North Service Trade Balances America in world exports decreased substantially after 1970, while Asian countries more than doubled their It is widely assumed that industrial countries generally share, from 4.5 to 10.7 percent. (For an analysis of this register surpluses in trade in invisibles and that develop- development, see Mak and White 1988; Findlay and ing countries tend to run deficits. One should beware of Forsyth 1988.) Again, middle-income high-growth such generalizations. Although most industrial nations countries did extremely well, tripling their share from 3 have had positive invisible trade balances at some time, to 9 percent Individual country data reveal great differ- in 1987 countries with negative invisible trade balances ences in the relative importance of tourism as well as in outnumbered those with positive balances. This applies "performance" (average receipts per arrival). Statistics to both invisibles as a whole and to private services.17 on the value of travel-related receipts (excluding passen- Furthermore, many developing countries tend to have ger fares) for countries that obtained at least 50 percent positive trade balances in private services. In 1987 of their private services receipts from tourism are re- roughly four out often developing economies registered ported in table 4-9. Not surprisingly, many of the coun- a surplus or were in approximate balance-a figure not tries included in the table are small (usually island) much different from that for developed countries. Differ- 37 Bernard M. Hoekman Table 4-11. Inward Stock of Foreign Directlnvestmentin Services, Selected HostEconomies Value Share of (billions of currency units) services in total FDI Economy and year Total FDI FDI in services (percent) Industrial economies (national currency, except Japan) Australia 1975 7.0 3.1 43.0 1983 18.1 8.5 47.0 Belgium 1970 113.8 11.1 10.0 1981 238.8 41.3 17.0 Canada 1975 37.4 9.2 25.0 1984 81.8 23.6 29.0 France a 1980 89.7 33.1 37.0 1985 129.0 81.7 63.0 Germany, Fed. Rep. of 1976 78.9 26.3 33.0 1985 119.1 54.9 46.0 Italy 1974 5,449.0 1,723.0 32.0 1985 31,769.0 11,752.0 40.0 Japan 1975 1.5 0.3 18.0 1986 7.0 2.0 29.0 Netherlands 1973 20.7 5.8 28.0 1984 58.3 24.9 43.0 Spain 1975 142.8 31.2 22.0 1984 1,097.8 339.2 31.0 United Kingdom 1971 5.6c 0.6 c 11.0 1984 38.5 13.3 35.0 United States 1974 26.5 11.5b 43.0 1986 209.3 111.2 53.0 Latin America (U.S. dollars) Argentina d 1981 2.4 0.6 25.0 1985 3.1 0.9 26.0 Brazil 1971 2.9 0.5 16.0 1985 25.7 5.6 22.0 Chile 1973 0.4 0.1 27.0 1983 2.0 0.7 33.0 Mexico 1971 3.0 0.6 19.0 1981 13.5 3.2 23.0 Peru 1978 0.8 0.2 25.0 1986 1.4 0.4 30.0 38 Services-Related Production, Employment, Trade, and Factor Movements Value Share of (billions of currency units) services in total FDI Economy and year Total FDI FDJ in services (percent) Asia (U.S. dollars) Hong Kong 1981 3.8 2.4 55.0 Indonesia 1977 2.9 0.3 11.0 1985 6.4 0.7 10.0 Korea, Rep. of 1980 1.1 0.3 23.0 1986 2.2 0.7 27.0 Malaysiaf 1972 0.7 0.2 37.0 1984 2.9 1.2 40.0 Philippines 1976 0.5 0.2 34.0 1983 2.0 0.5 26.0 Singapore 1970 0.6 0.3 55.0 1981 8.2 4.2 51.0 Taiwan 1986 5.9 1.4 23.0 Thailand 8 1975 0.5 03 56.0 1985 2.0 0.9 47.0 Africah(U.S. dollars) Egypt 1979 7.0 4.0 57.0 1984 14.9 6.7 45.0 Nigeria 1975 3.0 0.6 20.0 1982 4.3 1.6 37.0 Note: The shares of services were calculated before stock figures were rounded and may therefore differ from the shares that would result from use of rounded figures. a. Cumulative flows, 1975-80 and 1975-85. b. Data for 1974 are not fully coanparable with data for later years because services do not include banking and petroleum-related services.They do include other industries (agriculture and mining but not petroleum). c. Excludes banking and insurance. Services include agriculture and mining. d. Cumulated approved FDi since March 1, 1977. e. Data exclude FDi in oil, insurance and banking. f. Equity shares held by foreign residents in limited liability companies incorporated in Malaysia as of December 31,1984 (paid-up value). g. Cumulated flows since 1971. h. Projects established underthe Investment and Free Zones Law, cumulativel974-79 and 1974-84. Source: uNcfC (1988), pp. 378,380-81. ences between developed and developing nations in net International Factor Movements balances are therefore notas gteatas iscommonlyassumed. 18 Leading exporters and importers of private services are As noted in earlier chapters, the provision or sale of a reported in table 4-10.19 Although relative rankings service frequently requires proximity between provider varied slightly, the top six exporters of merchandise in and receiver. This implies that a commercial presence of 1987 were also the top six exporters of private services. the foreign provider in the country of the consumer may But the ranking for private services is not identical to that be a precondition for provision and that temporary or for merchandise. In particular, the ranking of countries long-term movement of factors of production (capital such as Austria, Mexico, Norway, and Spain is substan- and labor) may be necessary. This section focuses on tially higher for services.20 transactions that are or may be associated with a change 39 Bernard M. Hoekman Table 4-12. Composition of the Service Sector in Inward Foreign Direct Investment in Selected Host Economies by Principal Categories, LatestAvailable Year Industry Share (percent) Value of stock in Banking, services finance (biHlions of and Other Economy and year curency unit) Trade insurance Transport Communications Construction services Industrial courtries (national currency, except Japan) Belgium, 1981 41.3 35.1 n.s.a. n.s.a. n.s.a. n.s.a. 64.9 Canada, 1984 23.6 27.1 55.9 n.s.a. n.s.a. n.s.a. 16.8 a France, 1983 55.1 30.3 55.5 b 1.2 n.s.a. 8.7 Germany, Fed. Rep. of, 1985 54.9 36.2 53.3 c 2.5 0.7 5.1 d Italy, 1985 11,752 12.3 64.5 4.1 n.s.a 19.1 Japan (U.S. dollars), 1986 2 43.7 35.2 e 2.9 29 15.4 Netherlands, 1984 24.9 42.2 24.5 2.8 2.8 27.7 United Kingdom, 1984 13.3 24.1 43.3 g 1.5 1.5 1.5 United States, 1986 111.2 41.3 46.9h 2.1 6.4 33 Latin America (U.S. dollars) Brazil, 1985 5.6 17.7 65.9 J 0.9 n.s.a. n.s.a. 15.3 Mexico, 1981 3.2 33.3 58.4 1.7 n.s.a. 6.1 0.6 Peru, 1985 0.4 40.1 36.6 k 1.9 2.3 0.9 18.0' Asia and Pacific (U.S. dollars) Indonesia, 1985 0.7 44.9 n.a. 2.5 5.7 93 37.5m Korea, Rep. of, 1986 0.7 n.s.a. 12.7 4.0 n.s.a. 18.9 64.4 n Malaysia. 1984 1.2 17.2 64.3 n.s.a. n.s.a. 2 16.5 Philippines, 1983 0.5 19.9 0 55.0 6.1 4 14.9 Singapore, 1981 4.2 32.1 57.8 6.6 2.6 0.7 Thailand, 1984 0.9 39.1 16.1 8.9 28.2 7.8 Taiwan, 1985 1.2 2.1 P 20.3 5.2 n.s.a. 9.2 63.3 Africa (U.S. dollars) Egypt, 1984 6.7 n.s.a. 39.0 n.s.a. n.s.a. 21.3 39.7 Nigeria, 1982 1.6 43.3 q 75 46.4 n.s.a. n.s.a. Not separately available. a. Other enterprises. g. Of which 10.5 percent real estate. m. Indudes 17A percent hotels. b. Of which 39.4 percent real estate. h. Of which 19.1 percent real estate. n. Mainly hotels and tourism. c. Of which 31.8 percent holding companies. i. Includes I percent petroleum-related services. o. Includes property. d. Of which 1.1 percent public utilities. j. 44.4 percent holding companies. p. Foreign trade. e. Includes unclassified services. k. Of which 13.3 percent is real estate. q. Includes business services. f Includes real estate. 1. Includes 2.1 percent tourism and 7.7 percent electic power. Source: UNcrc (1988), p. 593. in residency, in particular foreign direct investment and possible for only a limited number of countries and that movement of labor.21 stock data are often biased owing to the widespread use of historical cost valuation methods (as opposed to cur- Foreign Direct Investment (FDI) rent market value) and the distorting effects of fluctua- tions in the exchange rate. Global data on FDI are scanty, and country data, if re- Table 4-11 reveals that FDI in services varies between ported at all, are usually at a high level of aggregation. 25 and 50 percent of the total stock of PDI in most host The basis for FDI stock and flow figures varies widely, countries. As of the mid-1980s about 40 percent of the and statistics are usually not readily comparable across world stock of FDI and approximately 50 percent of the countries. It is important to recognize, moreover, that annual (new) flow of FDI was in services (Sauvant and breakdowns of FDI in goods and services industries are Zimny 1987). In countries thatreportdata, FDIin services 40 Services-Related Production, Employment, Trade, and Factor Movements Table 4-13. Approximate Stock of Migrant Workers Abroad by Selected Source Country, Early 1980s Approxinate nunber Approximate percentage Value of Remittances as of workers of labor force remaining remittances percentage of total Country (thousands) (millions of SDR) exports Africa Algeria 330 13 380 3 Benin 200 12 56 40 Burkina Faso 2,000 55 106 62 Egypt 700 8 2,040 35 Guinea 3,000 >100 n.a. n.a. Lesotho 160 30 330 78 Mali 3,000 75 40 22 Niger 200 12 9 2 Sudan 630 10 214 24 Togo 300 30 7 2 Asia India 2,000 8 2,100a 20' Pakistan 1,900 7 1,880 68 Philippines 1,200 6 700 10 Ye,A rabRep,of 500 30 920 312 Yemen, P.D.R. 100 20 325 207 Turkey 2,000 30 1,900 37 Europe Greece 170 5 965 14 Italy 2,300 11 2,600 3 Portugal 1,100 28 2,400 45 Yugoslavia 1,000 15 4,050 21 Latin America b Bolivia 700 40 10 1 Chile 300 10 72 2 Colombia 700 25 100 3 Paraguay 550 60 45 7 Uruguay 80 10 n.a. n.a. Mexico 2,000 30 250 1 a. Includes private transfers. b. Data are for the 1970s. In general, the reported figures should be interpreted as giving an indication of order of magnitude only. Remiuances equal the sum of labor income, worker's remittances, and migrants' transfers and are averages forthe years 1980-82. Sources: Forlabor: Africa,Swamy (1985), Dommen (1985) Asia,UnitedNations (1987); Europe,oea (1987); Latin America,ILo (1984). Labor force data from Lo (1988): remittances and total exports from spbalance of payments. has almost invariably become more important over time. local demand, both intermediate and final. Kravis and The distinguishing characteristics of service provision Lipsey (1988) have shown that the export propensity of are probably one of the driving forces underlying this U.S.serviceaffiliatesisquitelow. Because local demand increase. Becausephysicalproximity is often anecessary is often the primary force behind FDIin services, this type condition for provision, FDI of some sort may be re- of FDI, other things being equal, should be less subject to quired. The increase in the relative importance of FDI in the vagaries of the trade policies of trading partners. The services occurs in both industrial and developing econo- main conclusion to be drawn at this point is that the mies, although the increase is more marked for the for- increasing relative importance of services in terms of mer. Much of services FDI in developing countries is domestic production and employment appears to have related either to investment in offshore financial centers gone hand in hand with an increase in the relative impor- and tax havens or to investment in flags of convenience. tance of services in global flows of FDI. In large part the Even when these are excluded, however, the share of increase is attributable to both the process of economic servicesintotalFDI rises in these countries (uNcrc 1988). development and the characteristics, described earlier, In the case of services the motivation for foreign invest- that distinguish the provision of many services. ment is typically not so much exports (or re-exports) as Despite its obvious interest, data on the sectoral com- the ability to provide a service with a view to satisfying position of FDIin service activities is limited. Table4-12 41 Bernard M. Hoekman Table 4-14. Estimated Contribution of Services to World Value Added and Gross Output, 1986 Average share in Average gross Value added Gross output value added output/value Item (billions of dollars) (billions of dollars) (percent) added ratio World a 13,000 23,000 100 Goods related 4,680 9,500 36 2.0 Services Construction 900 2,000 7 23 Distribution 1,700 2,250 13 1.5 Hotels and restaurants 260 400 2 1.5 Transport 650 1,200 5 1.9 Communication 260 500 2 1.9 Finance 520 700 4 1.4 Insurance 130 200 1 1.4 Business services 1,300 1,900 10 1.4 Education and health 390 600 3 1.5 Recreation and culture 130 200 1 1.5 Personal 260 400 2 1.5 Government 1,950 3,000 15 1.5 - Not applicable. a. Excludes Eastem Europe and the U.S.S.R. owing to incompatible national accounts methodologies. Sources: Blades (1987); estimates by GATr Secretariat based on UN national accounts data and World Bank data. shows that FDI in wholesale and retail trade and financial regulations may require establishment; insurance is a services dominates in those countries for which inforrna- typical example. As discussed elsewhere in this book, the tion is available. Almost half of the stock of existing FDI pattern of international trade and production will be in in services reflects the establishment of service affiliates part a function of the incentives and disincentives created by firms whose primary activity is industrial (that is, by national governments; tax regimes and performance goods-related) in nature. In large part these investments requirements are prime examples. are directed toward financial and distribution-related activities and are intended to support production and Movement of Labor sales by parent firms. Thus, much of the investment in finance and distribu- Cross-border movement of people has been a recurring tion is not independent. For Germany, for example, mul- phenomenon throughout history. Migration may be tem- tinational service enterprises controlled 29 percent of the porary or long-term, legal or illegal. In the past two or total outward stock of FDI in 1984, and service affiliates three decades various regions have been demanders of represented 60 percent of the total number of affiliates foreign labor; examples include Europe in the 1960s and and 45 percent of the total assets of all affiliates of early 1970s (approximately 6.5 million foreign workers German-based multinational enterprises. The same phe- in 1974), the Middle East in the latter half of the 1970s nomenon holds for the United States, where the figures (more than 3 million in 1980), Ghana and Cote d'Ivoire were55and68percentrespectively; the shareof services during the 1970s (more than 1 million as of the early in the total outward stock of FDI, however, was only 37 1980s),ArgentinaandVenezuela(about3 millionduring percent (cTc Reporter 1987, p. 19). the 1970s), and the United States (approximately 5 mil- Presumably this indicates that services required by the lion) (ILO 1984). multinational enterprises involved are not available In contrast to the case of FDI, it is not possible to provide abroad, are of insufficient quality, or are too costly. information on the sectoral breakdown of employment Furthermore, they are either not tradable separately or of foreign workers. Fora number of developing countries are too costly to trade. It would be interesting to know employment abroad is an important source of foreign the relative roles of barriers to trade, market structure exchange. As can be seen from table 4-13, this is true of (characteristics), and technological constraints in this Benin,BurkinaFaso,Egypt,Lesotho,Pakistan,Portugal, regard. Forindustries suchasretailbanking,distribution, Turkey, the People's Democratic Republic of Yemen, and hotels and restaurants FDI will clearly be required if the Yemen Arab Republic, and Yugoslavia. Many Latin services are to be provided. For other services national American countries are or have been significant export- 42 Services-Related Production, Employment, Trade, and Factor Movements ers of labor but do not report large revenues. To some of private services in world trade has not changed much extent this presumably reflects nonregistration of remit- since 1970. The share of developing countries in ship- tances. ment and passenger transport increased significantly, while their share in other market services and travel The Relative Importance of the Principal Service increased slightly. The share of developing economies in Industries world receipts of labor income also increased, although the relative importance of labor income in world trade Interest is often expressed in the absolute and relative declined. sizes of specific service sectors in the world economy. The importance of exports of private service in relation Comparable sector-specific data, however, are not cur- tothose of merchandise has grown significantly formany rently available. To provide some perspective for the developing countries, but their share of world trade in sectoral chapters in part II of this book, some estimates private services has increased only somewhat since of the relative importance of different service sectors in 1970. More significant changes have occurred with re- the world economy are developed in this section. The spect to the composition of trade in private services. In sectors include business services, construction and engi- particular, intermediate (producer or business) services neering, communications, distribution, education and have come to play a key role in the competitive process, health, finance, hotels and restaurants, insurance, per- and trade in these "other market services" has been one sonal services, recreation and culture, and transport. 2 of the most dynamic components of trade in invisibles. Table 4-14 reports estimates of the contributions of service sectors to world value added (GDP), which was Appendix 4-A. Measurement Issues and Trade about $13,000 billion in 1986. To estimate the sectoral in Services contributions, the average breakdown of total value added for the OECD economies for 1980-84 was used. Because of the intangibility of most services, trade data Among services, distribution contributed the most to can be derived only from central bank information on total value added, followed by business services, con- flows of foreign exchange or from periodic surveys or struction, transport, and finance. Value added data can censuses of service industries. Banking data pertains to be converted into estimates of gross output by using an payments, not transactions, and thus this source can give average of the ratio of gross output to value added as only an incomplete picture of trade in invisibles. Regis- reported by thirty-seven countries. (This procedure is tered flows of foreign exchange often cover only part of followed because most countries do not report gross a transaction or may apply to a number of transactions. output data for services.) Gross output is the sum of Only payments that are made through resident banks will value added (payments to factor inputs) and intermediate be registered. Furthermore, many payments do not go consumption (payments for intermediate inputs) and can through a financial intermediary-as, for example, when thus be regarded as one estimator of relative market size. bills of exchange are used. Finally, information on cen- Multiplying the value added estimates by the appropriate tral bank cash flows is often reported on a net basis, ratio yields the gross output estimates. These can be making it impossible to determine exports and imports. considered ballpark estimates of the global size of these Since surveys of enterprises focus explicitly on trans- service activities. Excluding government, but including actions, not payments, in principle these problems will construction, they total approximately $10,000 billion. not arise. But surveys give rise to other problems. In particular, they do not capture imports by households and Concluding Remarks by the government or transactions by firms that are not in the registry maintained by the surveying agency. Thus For most countries the relative importance of services itis crucial thatanup-to-dateandcomprehensiveregistry has grown in terms of both domestic production and of the universe of service providers be maintained. Often employmenL Generalizations are difficult to make, how- this will be difficult to attain. Although it is technically ever, as in a number of developing economies industrial feasible to achieve detailed coverage of service transac- output has been expanding more rapidly than services. tions with the use of these sources, this can be both FDI in services has been increasing in relative importance, burdensome and costly. In practice, most countries tend especially in industrial countries, and tends to be concen- to rely primarily on central bank data. trated in distribution and finance-related activities. Service transactions are likely to be substantially un- As faras trade is concemed, itis noteworthy that private derreported in the balance of payments. Services such as services have grown much faster than merchandise trade transport, insurance, legal advice and financial interme- in the post-1980 period but that the relative importance diation may be in part subsumed under the value of the 43 Bernard M. Hoekman goods to which they are related, or they may be misclas- this paper are my own and do not necessarily reflect those of the GArr sified, overreported, underreported, or notreported at all. Secretariat. 1. The sras criterion for residency is used: a change in residency Overreporting may occur for categories such as mer- occurs when factors of production stay abroad for more than one year. chanting (transactions of goods between residents and The relevant nonmerchandise components of the current account are nonresidents where the goods do not cross a frontier). discussed in greater detail below. 2. Frequently the sales of foreign affiliates are an object of policy Some countries define trade in thtis category to include interest, and they are somnetimes considered part of trade in services. the value of the goods traded; others measure only the This chapter takes the standard view that trade oCCUrs only if the service component-that is, the trade margin. Misclassi- transactions are between residents and nonresidents. fication may occur when the payment for a service is 3. See, for exanmple, Fekesekuty (1988). Ths is one of the reasons that balance of payments statstics distingusishmnerchandise from nest reported as the payment for a factor service or the re- merchandise trade and not goods fron services. Nonmerchandise trade verse. Data for services that require movement of the encompasses everything that is not observed by customs agents as consumer, such as medical and educational services, are passing a frontier. 4. It should be noted that to somne extent the reported share of often not reported, even though they may at times be services in ou in developing countties may be too low if activity in substantial. Thus it has been estimated that expenditures the informal sector is widespread. by nonresidents on U.S.-based health and education ser- 5.Bhagwati(1984)discussesvariousexplanationsfortheobserved vices were at least $100 million and $1,6di million dfference in rdative prices. were at last $100million ad $1,600million, 6. Elnployment statistics are genemallynotcomnpamable across coun- respectively, in 1983 (OTA 1986). One result of different tries, owing to widely differing methodologies. The figures in table 4-3 practices and nonreporting is that export and import data are drawn fron a study undertaken by the Intemational Labour Orga- rarely match. Of course, this problem also arises for nization (Io 1986) that is the only source of comparable statistics an merchandise trade, but it is much more prevalent for employment; its drawback is that the data reported are highly aggre- merchanise trae, butit is mch mor prevalnt for gated (only three sectors) and are available only on a ten-year basis. services. 7. See Baumol (1967) and Fuchs (1968) forthe original arguments. Trade may consist of transactions between affiliated Productivity increases, however, vary widely among service sectors, firms or between nonaffiliated entities. There are well- and it is difficult to measure productivity in services. Many of these issues are discussed in Inman (1985). known difficulties with the registration of transactions 8. Among others, Stanback and others (1981), Gershuny and Miles between affiliates. The existence of differential tax rates, (1983), and Stem and Hoekman (1988) contain more detailed discus- exchange restrictions, and investment performance re- sions of these matte. 9. Invisibles encompass all noninerchandise comnponents of the quirements, as well as variations in the degree to which current account with the exception of unrequited transfers. Ihey in- firms are forced to reinvest earnings, lead to transfer cludeflowsrelatedtoportfolioanddirectforeigninvestment,transport pricing strategies that bias reported trade figures. Sepa- of freght and people, expenditures by travelers, flows related to tem- rate statistics on transactions between affiliates do not porasy movement of labor, and sales ofbusiness services and intangible assets. exist on a global basis. This is regrettable because it is I0. The term "private services" denotes the sum of nonmerchandise likely that much trade between affiliates consists of transfers of real resources that are neither official nor financiaL Thus intangibles. private services are equal to invisibles minus investment income and official flows. More specifically, private services include shipment, The conclusion is that data on trade in services are not passenger services, travel, and the nonofficial components of the 5MF very reliable and are likely to be biased downward. category "other goods, services, and income." The last category in- Research indicates that aggregate balance of payments cludes such items as agents' fees, commissions, communications, figures for the United States in the early 1980s, for seri cesalsomcludes propertyandilabourance . and consueing Private example, may have been anywhere from 40 to 100 per- somecountriesdonotreporttheseitens separately, andincluding them cent too low, depending on how trade in services is in private services ensures that at the aggregate level the data reported defined.23 Because of nonreporting of specific catego- will at least be on a comparable basis. I11. Shipment comprises both freight and insurance on freight, the ries or the inclusion of various categories in what is latter being on average about 5 Percent of to world shipment debits. reported for an item, cross-country and cross-regional Byfarthelargestproportionofshipmentpenainstomaritimesranspost, comparisons for specific categories are likely to be bi- which in 1983 accounted for more than 90 percent of world shipment attentio in thischapter debits (sii 1987). Other transport consists in large part of posn services ased. For this reason, most attention in thisd charters and is thus closely related to shipment. focuses on aggregates, as these are less subject to varia- 12 The differencebetween world expons and imports is a measure tions as regards what is covered in the various compo- of the total revenues accning to countries that do not report shipment nents of trade in services, expors (especially Greece) or do not register exports under flags of convenience. In 1970 the discrepancy was small, but in 1980 and 1985 world credits were only 65 percent of world debits. For a detailed Notes investigation of balance of payments shipment statistics see Johansen and Panagakos (1988). Iwould like tothank participantsinaWorld Bank seminaron trade 13. Some of the countries involved are relatively specialized in logistics management, as well as Richard Blackhurst, Alice Enders service exports that are sensitive to foreign economic developments. Patrick Messerlin, Gary Sampson, Karl Sauvant, and Pierre Sauv6, for Examples include oonstruction (Korea), personal services (Philip- helpful discussions and comnments on an earlier version. I am also pines), and transport (Korea, Singapore). In general, much depends on thankful to Sabine Jasani for typing the tables. The views expressed in the pattem of spedalization in different types of services. 44 Services-Related Production, Employment, Trade, and Factor Movements 14. Because many countries do not report data for specific compo- Feketekuty, Geza. 1988. International Trade in Services: An Over- nents of private services, reported country and regional shares will be viewandBlueprintforNegotiations. Cambridge. Mass.: BaUlinger biased. As noted in appendix 4-A and in note 10, data are more forthe American Enterprise Institute. conparable at the aggregate level of private services. Findlay, Christopher, and Peter Forsyth. 1988. "Trade in Transport and 15. According to the World Tourism Organization, internatinal Tourism Services." In Leslie Castle and Christopher. Findlay, eds., tourist arrivals totaled about 360 million in 1987, accounting for Pacific Trade in Services. Sydney, Australia: Allen and Unwin. approximately$160bilionin gross receipts. Forthe world as a whole, Fuchs, Victor. 1968. The Service Economy. New York: Columbia roughly two-thirds of all arriving travelers are on vacation. University Press. 16. Of course, since tourists buy goods (souvenirs, clothing, books, GAIr. 1988. International Trade, 1987/88. Geneva. and so forth) as well as services, total travel expenditures cannot be Gershuny, Jonathan, and Ian Miles. 1983. The New Service Economy: attributed solely to the service sector. The Transformation of Employment in Industrial Societies. Lon- 17. Countries that have had negative balances in recent years don: Frances Pinter. include Australia, Canada, Germany, Ireland, Japan, Norway, South Green,M. 1985. "TheDevelopmentof MarketServicesintheEuropean Africa, and the United States. North America (the United States and Conmunity, United States, and Japan." European Community Canada) is a net importer of passenger transpot, shipment, and travel (September). and a net exporter of other transport. The converse holds for Westem Lo. 1984. World Labour Report. Vol. 1. Geneva. Europe, which is also a net exporter of other market services. . 1986. Economically Active Population: Estimates and Pro- 18. The deficits run by developing countries are primarily attribut- jections, 1950-2025. Geneva. able to net imports of freight and other market services and are often . 1988. Yearbook of Labor Statistics. Geneva. compensated by positive net exports of othertypes of transport services IMF. 1987. World Current Account Discrepancy. Washington D.C. and receipts from travel. Many countries in Africa and Latin America Inman, Robert P. 1985. 'Introduction and Overview." In Robert P. tend to rum defidts on most components of private services, the excep- Inman, ed., Managing the Service Economy: Problems and Pros- tionsoftenbeingtravelandlaborreceipts.Asiandevelopingeconomies pects. New York: Cambridge University Press. are a mix of net importers and exporters. Johansen, Frida, and George Panagakos. 1988. "Transport in Invisible 19. The lists of twenty-five leading exporters of invisibles and of Trade." INu Report 29. World Bank, Infrastructure and Urban private services are quite similar. Develo,ment Department, Washington, D.C. 20. All these countries move up at least ten places: Spain fronm Kravis, Irving, and Robert Lipsey. 1988. "Production and Trade in seventeenth in manufactures to eighth in services, Austria from twen- Servicesby U.S. Multinational Fiuns." NBERWorkingPaper2615. tieth to tenth, Norway from twenty-sixth to founeenth, and Mexico Cambridge, Mass. from twenty-eighth to eighteenth.The]istof topmerchandiseexporters Kravis, Irving B., Alan W. Heston, and Robert Summers. 1983. "The used for purposes of comparison can be found in GA1T (1988). Share of Services in Economic Growth." In F. G. Adams and B. 21. Residency is used here in its statistical sense, that is, movement Hickman, eds., Global Econometrics: Essays in Honor of Law- abroad of factors of production for one year or longer. rence R. Klein. Cambridge. Mass.: mrr Press. 22. Global trade data exist for some sectors, including insurance, Mak, James, and Kenneth White. 1988. "Tourism in Asia and the dvil aviation, maritime transport, and construction. These will be Pacific." In Chung H. Lee and Seiji Naya, eds., Trade andlnvest- discussed in part IL ment in Services in the Asia-Pacific Region. Boulder, Colo.: 23. OTA (1986). Formore on these issues, see Ascherand Whichard Westview. (1987); Stem and Hoekman (1987); rws(1987); Drechslerand Hoffmnan Miklius, Walter. 1988. "Issues in Ocean Shipping and the Asia-Pacific (1988); and White and Walker (1982). Region." In Chung H. Lee and Seiji Naya, eds., Trade and Invest- ment in Services in the Asia-Pacific Region. Boulder, Colo.: References Westvew. oEcD. 1984. Tourism Policy and International Tourism in OECD MemberCountries. Paris. Adams, F., and S. Siwaraksa. 1987. "A Disaggregated Study of the . 1987. The Future ofMigration. Paris. Service Sector." Fishman-Davidson Center for Study of the Ser- 0am, U.S. Congress. 1986. Trade in Services, Exports, and Foreign vice Sector Discussion Paper 28. Philadelphia, Pa.: University of Revenues. OTA-1TE-322. Washington D.C.: GovemmentPrinting Pennsylvania. Office. Ascher, Bernard, and ObieWhichard. 1987. "Improving ServiceTrade Sauvant, Kad, andZbigniewZimny. 1987. "ForeignDirectInvestment Data." In Orio Giarini, ed., The Emerging Service Economy. New in Services: The Neglected Dimension in Intemational Service York: Praeger. Negotiations. World Competition 31 (October):27-55. BaumoL William. 1967. "Macroeconomics of Unbalanced Growth." Sien, Cha Lin, and Keith Trace. 1988. "Trade and Investment in American Economic Review 57:415-24. Shipping." In Leslie Castle and Christopher Findlay, eds., Pacific Bhagwati, Jagdish N. 1984. "Why Are Services Cheaper in Poor Trade in Services. Sydney, Australia: Allen and Unwin. Countries?" Economic Journal 94:279-86. Stanback, Thomas, and others. 1981. Services: The New Economny. Blades, Derek. 1987. "Goods and Services in OECD Countries." Totowa, NJ.: Allenfeld, Osmun. OECD Economic Studies 8:159-84. Stem, Robert M., and Bemard M. Hoekman. 1987. "Analytical Issues Bureau of Industry and Econornics. 1988. "Australia's Service Sector and Data Needs for GATr Negotiations on Services." WorldEcon- and Its Intemational Trade in Services-An Overview." Informa- omy 10:39-60. tion Bulletin 14. Canberra. . 1988. "The Service Sector in Economnic Structure and in crcReporter. 1987. New York: uNcrc. Intemational Transactions." InLeslieCasdeandChristopherFind- Dommen, Edward. 1985. "Footloose and Fancy Free?" uNcrAD. Ge- lay, eds., Pactfic Trade in Services. Sydney, Australia: Allen and neva. Processed. Unwin. Drechsler, Laszlo, and H. Hoffmann. 1988. "Conjectures on Services Summers, Robert, and Alan Heston. 1988. "TIheIntemational Demand in the World Economny with Scanty Data." Working Paper 10. for Services." Fishman-Davidson Center for the Study of the Department of Intemational Economic and Social Affairs, United Service Sector Discussion Paper 32. Philadelphia, Pa.: University Nations, New York. of Pennsylvania. EscAP. 1987. InternationalLaborMigralionandRemittances between Swamy, Gunsshri 1985. Population and International Migration. the Developing ESCAP Countries and the Middle East. World Bank Staff Working Paper689. Washington D.C. ST/ESCAP/471. Bangkok. uNcrAD. 1988. Trade andDevelopment Report. New York. 45 Bernard M. Hoelwan uNcrrc 1988. Transnaioial Corporatwofs in World Development: Wodd Bank. 1988. World Development Report 1988. New Yock: Trends atndProspects. New York. Oxford University Press. White, Kenneth, and M. Walker. 1982. T'ruble in the Travd Ac- Wodd Tourism Organization. Various years. Conm ndiwnofTourism coun." Annals of Tourism Research 9:37-56. Statistics. Madrid. 46 Part II Service Industries 5 Banking Alan H. Gelb and Silvia B. Sagari When the General Agreement of Tariffs and Trade Financial services are defined as comprising (a) deposit (GA1t) was instituted in 1948, its mandate excluded taking and lending, whether in domestic or foreign cur- industries such as banking, insurance, and telecommuni- rency, to govemments, corporations, private individuals, cations. These service sectors were highly regulated and and others; (b) specialized forms of lending, including protected in most countries for various reasons includ- trade financing, loan syndications, and participation; (c) ing, in some cases, their sensitivity with respect to na- trading and dealing in domestic and foreign currencies; tional security or cultural identity. Financial services, to and (d) various advisory and brokerage services. Insur- take one example, involve complex issues of prudential ance is dealt with separately in chapter 6 and is explicitly regulation, monetary policy, and stability of financial excluded from this analysis. markets. Under prompting from the United States, the Uruguay Products, Agents and Markets Round talks have tumed to financial services-banking in particular. This has occurred in part because of the Banking and financial services interact with a broad growing importance of formal finance as gross national range of economic activities and agents and play an product (GNP) per capita rises and because a number of important role in the credit, monetary, and payments developing countries are now seen as sizable prospective systems. They have close relationships with public pol- markets. Another reason is the dramatic growth of trade icy, and their operation is strongly influenced by the in financial services among industrial countries over the regulatory environment and by other aspects of the econ- past two decades, which has been partly spurred by rapid omy. The issue of opening them up to intemational trade technological innovation. is consequently complex. Trade in financial services is defined here as: The first mode of trade in financial services, which • The provision of fiancial services by an institution involves intemational exchange of financial flows and, in one country toaonueessentially, the liberalization of the capital account, al- in one countr. toIaconumern lows agents in one country to enjoy financial services another country (that is, provision of services across p 2 bodes) Ti i areaivlypue om f'rae provided by institutions in other countries. The range borders). This is a relatively pure fon of trade. * of activities in which this is possible is limited because . The provision of services through the establishment of the need for a certain degree of proximity between of subsidiaries, branches, or agencies by a financial i and their clients. Proximity between the institution in a country other than its home country; is usually mreximportan for here, trade is associated with investnent.l supplier and the purchaser is usually more important for services than for goods. At first sight it is not clear why In general, the latter issue has received more attention proximity should be important for financial services in in discussions of barriers to trade in financial services, the same way as for, say, haircuts. But the characteristics whereas cross-border trade has generally been viewed of financial transactions-mainly the need for frequent within the context of the removal of exchange controls information and trust-can make this a pressing need. or the liberalization of capital movements. The distinc- The second mode of trade involves direct foreign in- tion may be important because each of these two forms vestment in financial institutions located in the country of trade may call for different approaches and solutions of residence of the user of the service. Most commonly, in the multilateral trade negotiations. this investment is in the form of locally owned subsidi- 49 Alan H. Gelb and Silvia B. Sagari aries or branches. The issue here is not liberalization of to develop indigenous commercial banks before the late the capital account but the treatment accorded by host 1940s. country regulatory authorities to foreign banking affiliates.3 Although there are some exceptions, foreign banks are much less likely than domestic banks to have an exten- Ownership of Banks sive branch network. This implies that they are usually more dependent on wholesale funds or on funds from Attitudes toward licensing foreign banks and other finan- abroad and that they are more likely to provide services cial institutions vary widely among developing coun- to large clients in the main urban centers than to small tries. Some countries totally exclude foreign financial farmers. The cost structure of foreign banking affiliates institutions; others permit representative offices but not may therefore differ significantly from that of indigenous branches. The Bahamas, Bahrain, Hong Kong, Panama, banks. In particular, they may have a higher cost of funds and Singapore view exports of financial services as a (because of fewer demand deposits) but far fewer staff source of employment and foreign exchange, and in a per unit of assets. They may also rely more on fee-based few, usually small, developing economies foreign insti- income. tutions account for nearly all financial assets. Table 5-1 This bias toward larger clients-and, in most cases, shows the range of experience. The three foreign banks toward subsidiaries of multinational corporations-seg- that operate in Botswana hold all commercial banking ments the financial markets and clearly limits the bene- assets, although there are several smaller indigenous fits that might be derived from the presence of a nonbank intermediaries that take deposits, make loans, sophisticatedandperhapsrelativelymoreefficientfinan- or do both. In Malaysia, which has traditionally had an cial intermediary.4 Many residents of the host country open policy toward the financial system, sixteen foreign who are clients of foreign bank affiliates might in any banksaccountforone-quarterofbankingassets; inChile, case have had access to the corresponding bank head- Kenya, and the Philippines the share of foreign banks is quarters abroad. Conversely, smaller savers and borrow- also appreciable. In Nigeria foreign shareholdings in ers may be left captives of the indigenous financial banks have been tightly limited to create a class of intermediaries and their range of products and services. co-owned enterprises; in Tanzania a foreign-owned But it is also true that the threat of foreign competition, banking system was nationalized after independence. even if only for a limited sphere of business, may cause The representative country of table 5-1 had eight foreign domestic intermediaries to improve their services and banks, which held 6 percent of system assets. products. Historically, the establishment of branches and subsid- The impact of the entry of foreign financial institutions iaries by international banks followed closely the loca- on the balance of payments is not clear.5 On the positive tion of major international clients and the finance of side, these institutions may stimulate inflows of capital, trade. Today the main activities of foreign banking including funds to establish their own capital base if they affiliates in developing countries are still largely in these are subsidiaries; they may act as a conduit for foreign areas, even though the doubling of international bank funds, especially if the international standing of indige- lending that has taken place since 1980 has occurred against nous banks is not adequate to sustain correspondent a background of virtually no increase in world trade. relationships; and they may be able to supply services The case of Uruguay illustrates another common char- that would otherwise have to be imported. On the nega- acteristic of developing countries-the overwhelming tive side, it is sometimes alleged that foreign banking presence of government in many domestic banking sys- affiliates facilitate the export of capital in circumstances tems. In Uruguay the indigenous banking system is, in in which foreign returns exceed domestic returns or fact, totally government owned as a result of the rescue domestic savers face major uncertainties.6 operation mounted by the authorities in the mid-1980s. In India, Tanzania, and many other countries the indige- Banking Systems in Developing Countries nous banking system is state owned because of national- ization. Even in free-market Chile the government's The above discussion takes for granted that the main effective participation in the financial system through the function of the financial services industry is to provide Banco del Estado is about 25 percent. This implies that financial services to clients efficiently and on a more or in many cases trade liberalization in banking services- less competitive basis. But this is not true in all countries. as in certain other service sectors-might amount, in There are important differences between industrial and effect, to breaking a government monopoly. In most developing countries and very large differences among African countries banks are either government owned or developing countries that bear on the question of liberal- foreign owned. Nigeria was the only country in Africa izing entry. 50 Banking Table 5-1. Foreign Commercial Banks in Developing Country Markets Number of Percentage share in Country and date foreign banks total bank assets Argentina, 1987 32 20 Bangladesh, 1986 7 6 Bolivia, 1987 3 3 Botswana, 1986-87 3 100 Brazil, 1987 17 6 Chile, 1987 21 17 Colombia 8 6 Indonesia, 1986-87 10 6 Kenya, 1986-87 11 37 Malaysia, 1988 16 25 Nepal, 1988* 3 6 Nigeria, 1987-88* 15 74 Pakistan, 1987-88 20 12 Peru, 1987 5 2 Philippines, 1986-87 4 19 Senegal, 1986-87 2 4 Thailand, 1988 14 4 Tunisia, 1985 7 1 Turkey, 1986-87 18 4 Uruguay, 1987 8 10 Venezuela, 1987 3 1 Median 8 6 *Joint venture foreign barks Source: World Bank reports. Role Condition Despite some trend toward reform, in a large number of Technical insolvency is widespread among financial sys- developing countries financial intermediaries are still tems in developing countries. Although it is not possible expected to distribute subsidies by means of below-mar- to obtain a complete picture of the situation of banks in ket credit, to cross-subsidize among clients, and to fi- either industrial or developing countries, there is little nance the government through forced investments and doubt that insolvency problems loom far larger in the high reserve requirements. This role may be part of latter. These problems are often not apparent, owing to broad development policy, or it may be imposed to inadequate systems of prudential regulation and supervi- satisfy special interests. To give some idea of the size of sion, but when they surface (sometimes as a liquidity such impositions, subsidies to government and others crisis), it is not uncommon for losses to amount to a through financial systems frequently amount to 3 to 4 multiple of the capital of intermediaries and to a sizable percentofGNP and may reach 7 to 8percentofCNP-this fraction of gross domestic product (GDP)-from a few for a sector in which normal value added amounts to only percentage points to, occasionally, 25 percent. 5 to 6 percent of GNP. For a set of ten developing In general, financial liberalization increases the stress countries the inflation tax averaged 2.6 percent of GNP in on ailing intermediaries. The entry of new and more 1987 (World Bank 1989, box 4.5); the inflation tax in efficient financial institutions that are not burdened with developed countries is typically less than 1 percent of GNP. portfolio problems tends to further undercut existing, There is inevitably some conflict between these objec- distressed, financial institutions. To compensate for loan tives and the entry of foreign banks that expect to operate losses, the latter must try to recover income from good according to the principles of their home countries. For- clients by raising spreads and charges (as occurred in the eign banks will expect to hold and price assets on the savings and loan industry in the United States), but they basis of risk and return rather than according to govern- are likely to face severe competition from new entrants ment directions. Indeed, governments are sometimes not burdened with bad loans. Of course, the objective of reluctant to permit entry because they recognize that it liberalizing markets and opening them up to foreign will be more difficult to persuade foreign institutions to entry is precisely to cause stress to established firms fall in line with their objectives. through increased competition. But this needs to be 51 Alan H. Gelb and Silvia B. Sagari handled carefully in the case of banks; large losses by ples). Intentional operational constraints explicitly dis- depositors are invariably unacceptable, and it will finally criminate against foreign banking affiliates. They are be the government that will have to bear the loss. frequently designed to limit foreign bank operations to certain segments of the financial market while preserving Protectionism other segments entirely for indigenous banks. Acciden- tal operational constraints are those regulations or na- Protectionism in banking services may be defined as the tional economic policy measures which, even though absence of equality of competitive opportunities for for- applied equally to foreign and indigenous banks, have a eign as compared with domestic banks. This can occur differential and negative impact on the ability of foreign through exchange controls or through restrictions on banks to compete in the host country banking market foreign investment. because of the different nature of their operations.8 One Exchange restrictions typically constrain domestic sav- of the most common constraints of this kind emerges ers from acquiring financial assets abroad (although ex- from maximum permissible asset-capital ratios and lim- ternal debt problems have led to constraints on domestic its on the size of loans to individual borrowers in relation borrowers as well). Pension and insurance funds in to capital. Both of these constraints are imposed by most developing countries typically cannot save abroad and countries for prudential reasons, to ensure minimum therefore cannotbe serviced by foreign investment firms. levels of capitalization and portfolio diversification and Capital restrictions may also prevent institutions located so enhance the safety of the institutions. Also for pru- in foreign countries from offering other types of services. dential reasons, many nations treat foreign banking affil- For example, it may be difficult for a foreign institution iates in the host country as independent entities. This to underwrite a domestic security issue in the presence means that asset-capital ratios and lending limits are of exchange controls. (It should be noted that for much based exclusively on the foreign banking affiliate's cap- of the post-World War II period most industrial countries ital, which is typically only a small fraction of the total have also maintained exchange controls.) capital of the parent organization. As a result, the Restrictions on the establishment of foreign banking affiliates' volume of operations and individual loan sizes affiliates take the form of discriminatory barriers to entry can be seriously constrained. and discriminatory operating constraints. The issue In other cases, competitive inequities result from mea- concerning entry is not the existence of barriers as such; sures related to general economic and balance of pay- with rare exceptions entry into domestic banking sectors ments policies. Given the international orientation of has historically not been free in any country. In liberal- foreign banking affiliates' operations, limitations on for- ized market-based systems, entry restrictions typically eign exchange transactions have a greater negative effect specify minimum capital requirements, management in- on them than on their domestic counterparts. Many tegrity, and competence. In other systems, entry restric- developing countries control the expansion of credit tions are varied, ranging from absolute prohibition of any through bank-by-bank credit ceilings rather than through foreign presence to limitations on capital participation in broad monetary policy tools, such as open-market oper- domestic institutions. ations. Such measures discriminate against new entrants There are many ways in which operating constraints and against banks with limited branch networks if allo- affect the ability of foreign banking affiliates to compete cations are made on the basis of deposits collected. This with domestic banks. For example, they may influence constraint is not always easy to abolish. Concerns about the affiliates' funding possibilities by mandating differ- losing control over monetary and credit policy if direct ential access to the central bank discount window, pro- controls are given up are related to the level of sophisti- hibiting the receipt of deposits from the public, or cation of thedomestic financial system and in some cases limiting the number and location of branches. National are well founded. banks may handle all government and parastatal busi- Some governments have deliberately reduced compet- ness, which assures them of large volumes of low-cost itive inequities that affect foreign banking affiliates by deposits. Governments may not require dividend pay- applying regulatory requirements flexibly or by granting ments from nationalized banks, and they may impose the affiliates privileges not extended to domestic banks. special requirements regarding the nationality of top For example, foreign banks, because of their limited management and directors, constrain the type of services branch networks, might be exempt from onerous obliga- that can be offered, and so on. tions to lend to small farmers.9 In some cases, measures Operational constraints can be further classified as thatapply equally toboth groups of competitors can have intentional and accidental (see appendix 5-A for exam- a favorable impact on foreign banking affiliates because 52 Banking of the nature of their operations. All of these measures Political Economy and Welfare may be classifiedaspreferential treatmentmeasures (see appendix 5-A). Sagari (1989) has shown that skilled labor is a source of As in the cases of minimum capital-asset ratios and comparative advantage in financial services. This ex- maximum lending limits, discussed above, many con- plains why the developing countries, which are well straints on banking operations are prudential, especially endowed with skilled labor, wish to extend GAnr-like in developing countries. Prudential regulations establish rules to financial services, and why developing countries the outside limits and constraints placed on banks to have given a less than enthusiastic welcome to such ensure safety and soundness.10 The issue then is not the proposals. Within the principal industrial economies constraints themselves butequality of treatmentbetween inclusion of finance in a GATr-like framework is proba- foreign and domestic banks. This is the national treat- bly less relevant for smaller banks than for the major ment principle discussed at the Montreal midterm meet- multinational banks. ing. In most developing countries national treatment does not prevail, and in many of these countries the Gainsfor Developing Countries regulatory framework is not transparent, which worsens the problem. For example, certain countries have no The issue of the potential gains for developing countries explicit policy of not licensing foreign banks, yet no from free trade in financial services is clearly complex. foreign banks have been licensed for twenty years. This Major developing country banks often have branches in important dimension of liberalization-transparency of the main money centers-to effect payments speedily, to regulation-has been emphasized by representatives of fund positions in foreign currencies through the inter- industrial countries. In this context transparency is defined bank markets, and in some cases (such as the Banco do as the ability of all participants in a market to have equal Brasil) to attract short-term credit to help support the knowledge of and access to regulatory and legal changes. 1 balance of payments. Developing country nationals also In some cases difficulties in achieving exact equality of manage a number of international banks, such as the treatment are the outcome of significantly different for- Bank of Credit and Commerce, Librabank, Bladex, and eign and domestic banking structures. (Any constraints Arlabank. Banks from certain countries, such as the resulting from such differential structures would beclas- Republic of Korea and Thailand, are starting to show sified as "accidental.") For example, in the United States signs of moving into industrial country markets, and it banking and commercial activities are largely separated, was not so long ago that Japanese banks, now major as are banking and securities activities by the Glass- international players, confined their operations to their Steagall Act of 1932, but in many other countries com- home country. These examples suggest that there is a mercial activities may be conducted by companies real possibility that developing countries can export affiliated with banks, and banks can operate in securities banking services. Further, the dynamic efficiency gains markets. This has made it difficult to implement the U.S. forced by opening domestic markets to competition will policy of national treatment with respect to direct invest- probably be needed to spur developing country banks to ment by foreign banking organizations and their non- try to export their services. For most developing coun- banking affiliates. tries, however, the potential gains from the opening of As noted above, foreign ownership of banking institu- banking are still seen to be those deriving from the tions is frequently a politically sensitive topic in devel- presence of foreign banking affiliates in their markets. oping countries. This is especially so when the banking industry is seen as a policy arm of the government, which A General Equilibrium Approach can exert far greater control and moral suasion over national institutions, but it is also a result of the role of An in-depth cost-benefit analysis of this topic should, of banks in implementing monetary policy and financing course, take into account the fact that financial services government out of seigniorage. Banks are typically not are largely intermediates. This increases the already popular institutions (many ethical systems have an aver- large problem of measuring their quantity and quality. sion to interest), and in some cases a fear of foreign In principle, the effects of protecting intermediate ser- banking affiliates is said to add to their unpopularity, vices are similar to those of increasing the cost of inter- regardless of nationality. The poor financial condition mediate goods such as steel. Some authors (for example, of many indigenous financial institutions is also an invi- Bhagwati 1987) have argued that in the case of financial tation to protection by govemments unprepared to face services the negative effects may even be more severe the fiscal cost of financial reform. than for goods. In denying access to efficient banking 53 Alan H. Gelb and Silvia B. Sagari services, the protective policies may deny domestic ex- training. Managers of indigenous banks in developing porters of goods access not only to cheaper creditbutalso countries are increasingly drawn from the ranks of host to the entire vector of services-such as hedging facili- country nationals who have risen to the executive level ties and swaps-that modem international banks can in foreign banks. The experience of these nationals provide to facilitate international commerce. General combines exposure to modem banking techniques with equilibrium welfare analysis of protection suggests that understanding of the local markeL In the longer run this barriers to trade in financial services lead to inefficien- infusion of skills may be the most important spinoff from cies in the allocation of productive resources, distorted the entry of foreign banks, especially given the difficulty consumption patterns, and significant static and dynamic that most developing country banks would now face in welfare losses. Over time, the effect of liberalization of trying to establish themselves in developed markets. trade in financial services can be substantial in breaking down established oligopolistic and corporatist structures An Analysis of Liberalization Options and stimulating change in other sectors. It will be espe- cially interesting to observe the experience of Europe in The full liberalization of banking and financial services the 1990s. (A proposal for the rules that will govern requires both free capital movement and nondiscrimina- banking in the European Community-the EC-iS sum- tory entry and operating conditions for foreign banking marized in appendix 5-B.) But, as discussed above, to affiliates as compared with indigenous banks. Allowing the extent that the clients that benefit from the local foreign financial institutions to offer their services to presence of foreign banking affiliates are largely enter- residents of a country is of little use if such operations prises that could have accessed similar services in inter- are subject to conditions that preclude all competition national markets, overall welfare gains may be smaller. with indigenous institutions and limit profitability. T'he critical question is, therefore, the extent to which Total liberalization would also require-and, indeed, foreign banking affiliates can constitute an actual or exert strong pressure for-the harmonization of national potential source of competition and reduce the power and legislation and policies that determine the operating en- wastefulness of national banking oligopolies. The an- vironment of financial intermediaries. Differences in swer, as well as the willingness of host country authori- regulatory standards are likely to translate into a compet- ties to welcome foreign banking affiliates, may well itive advantage for banks subject to a particular regula- depend on the relative degree of sophistication of the tory regime. Harmonization, however, is difficult; it can indigenous banks and their desire to become more active be expected that each country will prefer its own system. internationally. In less sophisticated markets it is likely The politically sensitive nature of the financial sector that foreign multinational banks will not upset the pre- slows the process of modifying banking laws and regu- vailing level of competition in most retail markets and lations, which is subject to lengthy and complicated will merely insert themselves into typical market niches. political debates. The process followed by the EC in its This points to a general characteristic of direct foreign integration efforts offers an example of some of these investment: gains are less likely when markets remain difficulties.12 Santomero (1989) notes that the United oligopolistic and segmented and are most likely when States itself had a tradition of regulation centering on foreign entry contributes to a effective increase in the product restrictions and geographic limitations, the result number of competitive firms or, perhaps, the breaking of being a fragmented industry with an excessive number a government monopoly. The extent to which opening of participants. He describes the "long and tortuous the banking industry will have such a favorable and road" followed by the industry in its efforts to move widely felt impact varies considerably among develop- closer to full interstate banking. ing countries. The case of the developing countries is even more Foreign banking affiliates, however, can also make a complex: few have a tradition of free capital move- significant dynamic contribution to the development of ments, and the foreign debt crisis has rendered their domestic financial markets. They can introduce modern, foreign exchange problems even more serious. Their sophisticated banking techniques and systems more indigenous banking systems have frequently grown quickly than many indigenous institutions can develop within a framework of distorted signals owing to a com- them. Foreign banks frequently innovate-they have bination ofprotecton and governments' use of the banks introduced a bankers' acceptances market in Spain, as instruments for achieving noneconomic targets. In credit cards and ATMS in some countries, and so on. In most developing countries prudential regulation and su- some countries, such as Kenya, foreign banks have es- pervision are woefully inadequate. In such circum- tablished venture capital affiliates. Another important stances, adjustment to a fully competitive setting cannot contribution of foreign banks is on-the-job management be made abruptly. The speed of adjustment will reflect 54 Banking the costs of reorganizing, of learning, and in general, of Moreover, as discussed above, the distinction between develo,ing new instruments and practices within institu- the provision of financial services by subsidiaries of tions.I Liberalization of domestic financial markets may foreign banks, on the one hand, and their provision need to take precedence over liberalization of capital through branches or across borders, on the other, may be movements (that is, external liberalization). Blejer and pertinent to the design of the preferred approach. In the Sagari (1987) elaborate on the issues of sequencing in case of the EC, operations of subsidiaries of financial financial liberalization. The need is for evolutionary firms headquartered in other member states will continue mechanisms within which steady and phased adjustment to be covered by the principle of national treatment; that of national policies and institutions can take place.14 is, subsidiaries of foreign financial institutions are Another issue related to the opening of the capital treated in the same manner as other incorporated entities account is a propensity of intemational lenders to urge in the host state. This "dual" solution is, to a certain developing country governments to assume ultimate re- extent, counterintuitive since, at least in the short run, it sponsibility for the debts of the private sector. The case is bound to bring about some competitive inequalities of Chile in the 1980s is an interesting example. and fragmentation of markets, in contrast to the objec- Given the unique characteristics of financial services, tives supposed to be achieved though "liberalization." is the Uruguay Round the right forum for discussing their Over the longer run, however, it is expected that market liberalization?15 When the GATT was established in forces will create pressure on governments that will lead 1948, banking was explicitly excluded from its mandate. to the convergence of those national rules and practices But the principles and concepts of the GATT-for exam- that have not been explicitly harmonized at the EC level. ple, the national treatment principle discussed above- Nonetheless, one should be careful not to overestimate might form part of a general framework for agreements the applicability of the experience of the EC to a global pertinent to trade in financial services. Moreover, the approach to multilateral trade negotiations on services. GA1T principles are gradual in process and flexible The economic, institutional, and political characteristics enough to allow a great degree of bilateral adjustment, of the EC differgreatly from those that might be observed which will be crucial in the work undertaken in the Group in a grouping that includes both developed and develop- of Negotiations on Services (GNs). ing countries. EC decisions are made in the context of a The problem with the Uruguay Round forum is the fairly powerful supranational legislature and judiciary to importance of regulation in shaping financial systems which the member states have already transferred a and the highly specialized knowledge needed to modify significant degree of sovereignty and of acceptance of and harmonize different countries' frameworks. An al- the prevalence of Community law over national law. ternative, and perhaps a natural, complement to the GNS is to negotiate issues of trade and investment in the Conclusions financial sector in an international forum supported by agreements among the pertinent central banks. For ex- The U.S. proposal for the liberalization of trade in ser- ample, the Basel risk-based capital framework consti- vices has initially met with a response on the part of tutes an accord among the banking authorities of the developing countries that varies from cautious to hostile. principal industrial countries rather than a formal inter- As with other sectors, this to some extentreflects concern national agreement or treaty. Bringing the developing over the perceived comparative advantage of industrial world on board will probably require the progressive countries and the power of strong vested interests, in- replacement of national laws and regulations with those cluding the interests of governments, which may seek to promoted by this international agency. These measures make the financial system an instrument of public policy could then be enforced by the national authorities. rather than a market-based intermediary. But it also But such regulatory harmonization cannot be expected reflects recognition of the peculiar situation of the bank- to be successfully implemented within a short time. A ing industry in many developing countries. In some promising approach may be that adopted by the EC: countries there is essentially no banking industry in the mutual recognition, whereby each country recognizes sense understood in industrial countries. In many, much the laws, regulations, and administrative practices of of the banking sector is technically insolvent, and mas- other member states as equivalent to its own. This ap- sive and costly efforts are needed to restructure proach precludes the use of differences in national rules intermediaries' balance sheets, reform the management as a means of restricting access. Clearly, however, a of banks, and improve-or, indeed, build-systems of prerequisite to mutual recognition is the harmonization prudential supervision and regulation. These measures of the most essential aspects of legal systems, statutory are frequently necessary before financial systems can provisions, and regulatory and supervisory practices. operate on a market basis. But they cannot be effected 55 Alan H. Gelb and Silvia B. Sagari immediately. The opening of borders to foreign compe- branch networks severely restricts FBAs' access to inex- tition, although an important and necessary part of liber- pensive local sources of funds.16 alization, may proceed in line with wide-ranging * RegulationsthataffectFBAs'accesstocentralbank domestic reforms. discount facilities are also rather common. They put FBAS at a disadvantage in dealing with their liquidity Appendix 5-A. Discrimninatory Operating needs, forcing them generally to hold a larger proportion Constraints of their assets in lower-yield reserves. * Restrictions on the services that FBAs can offer, Constraints that discriminatorily affect the operations of other than those related to deposit-taking and lending foreign banks once they are established in the host make it difficult for FBAS to expand their market share country's markets may impede the ability of foreign because they cannot offer the full line of services permit- banking affiliates (FBAs) to compete with domestic banks ted to domestic banks. Frequently seen examples of in several ways. For instance, they may increase their these restrictions have to do with security management cost of funds or their general operating costs in relation and underwriting business, limits for guarantees, and the to those of domestic competitors or may constrain expan- types of currencies that FBAS can deal in. sion of their operations within the country. The U.S. * Restrictions related to the loan and security por#fo- Treasury Department Report to Congress on Foreign lio may limit the type of borrowers FBAS can service or Government Treatment of US Commercial Banking Or- may force them to hold a larger proportion of their loan ganizations (1979) suggests that these regulations can be portfolio in low-yielding, longer-term loans than is re- grouped into three types: intentional operational con- quired of domestic banks. straints, accidental operational constraints, and preferen- * Tax-related regulations normally lead to higher tial treatment measures. We have further divided each costs of doing business. Examples are a tax rate on of these sets of regulations according to the facets of foreign branch profits remitted to the parent bank that is banking activity they affect. larger than the tax rate on dividends (the analogous payment for domestic banks), exemptions for domestic Intentional Operational Constraints banks of withholding taxes on interest paid to nonresi- dents, and so on. Constraints thatare explicitly established to discriminate * Sundry operational constraints explicitly discrimi- against foreign banks are common in developing coun- nate against FBAs. Examples are ceilings on the annual tries. In many cases such constraints are designed to repatriation of FBAS' profits, differential initial capital limit foreign bank operations to certain segments of the requirements, differential foreign currency reserve re- financial market while preserving other segments en- quirements, restrictions on the sources of funds for cap- tirely for local banks. ital increases, restrictions on the ability to hold liens on * Regulations related to private sources offunds are real property, and regulations concerning the nationality among the most prevalent intentional operational con- of FBA executives. straints. They restrict FBAs' solicitation of some kinds of deposits-for example, retail deposits or deposits of Accidental Operational Constraints specific business sectors-or limit borrowing from non- banks. Deposits are one of a bank's lowest-cost sources In many cases operating regulations or national eco- of funds, and to the extent that deposit-taking restrictions nomic policy measures, although applied equally to for- force foreign banks to use more expensive sources, the eign and domestic banks, have a differential negative result is a significant competitive disadvantage for these effect on the ability of foreign banks to compete in the banks. host country banking market. Frequently, the government'spolicy is to hold its finan- * Limits on the volume of assets, liabilities, or sizes of cial accounts exclusively with indigenous institutions, in loans to individual borrowers are among the most prev- many cases government-owned ones. Among other con- alent of the measures that effectively discriminate sequences, this provides a comparative advantage to against FBAs. The constraints emerge from maximum those banks, typically by making available to them large permissible asset-capital ratios and limits on the size of volumes of low-cost deposits. loans to individual borrowers. Theyare imposed in most * Regulations that affect the number or location of countries for prudential reasons, with the objective of FBAs limit the sources that FBAs can tap for local ensuring minimum levels of capitalization and portfolio deposits. The combination of constraints on acceptance diversification and so enhancing the safety of depository of certain types of deposits and on the expansion of institutions. Also for prudential reasons, many nations 56 Banking treat FBAs in the host country as independent entities. greater proportion of foreign currency liabilities than do Consequently, asset-capital ratios and lending limits are domestic banks. Another example is the waiver of re- based exclusively on the FBAS' capital, which is typically serve requirements on funds raised in the interbank mar- just a small fraction of the total capital of the parent ket, which FBAS use more extensively than do domestic organization. As a result, FBAS' total volume of opera- banks. tions and individual loan sizes are seriously constrained. * Preferential measures related to directed lending Competitive inequities are exacerbated if such measures include flexibility in the application of credit controls are imposed simultaneously with the enforcement of and exemptions from the obligation to support govern- limits on imports of capital. ment bond issues, to participate in rescue operations of * Credit ceilings imposed for purposes of domestic failing firms, or to extend loans to priority sectors iden- monetary policy may apply to both foreign and domestic tified in government development plans. banks, but if foreign banks are relatively later entrants in * Sundry preferential measures include a variety of the market, they have had less time to build up their regulatory features that explicitly or accidentally favor domestic business and are consequently more con- FBAS. Examples are access to special swap facilities not strained in expanding their portfolios. In some cases available to domestic banks (to compensate for the im- lending limits are based on domestic deposit liabilities. pact on foreign bank operations of the denial of access Where this type of constraint is enforced simultaneously to the discount window, for example), flexibility in the with regulations affecting FBAS' access to local deposits, application of foreign exchange controls, and the like. In the resulting competitive inequities are even more sig- some cases governments have offered inducements for nificant. the establishment of foreign banking affiliates in the * Other restrictions resulting from general economic form of special tax concessions or preferential tax treat- and balance of payments policies may lead to competi- ment tive inequities. Because of the international orientation of FBAS' operations, limitations on foreign exchange Appendix 5-B. EC Bank Legislation transactions affect them more negatively than they do their domestic counterparts. Constraints on business The EC's Second Banking Directive is viewed as the with nonresidents, which typically represents a larger centerpiece of EC banking legislation for the post-1992 share of operations forFBAs than for local banks, also has era. Key (1989) discusses a comprehensive proposal for a differential effect. Capital controls tend to be more the directive, dealing with the powers and geographic restrictive on foreign banks that are funding their opera- expansion of banks within the Community. The follow- tions by borrowing from their parent institution. ing points are among the most important aspects of this * Other accidental operational constraints result from complex proposal. measures completely divorced from the banking sector, such as requirements for alien work permits and nation- * Branches of EC banks established throughout the ality requirements. FBAS may be affected more severely Community under this directive would be authorized than domestic banks because they may desire staff of and supervised by the home country (single license their own nationality and because difficulties in obtaining and home country control). work permits may limit their ability to develop their staff. * The directive, however, specifies certain conditions that an EC bank must meet in order to establish Preferential Treatment Measures branches without host country licensing (minimum initial capital requirements and provisions relating to Some govemments have deliberately reduced competi- the identity, extent of holdings, and suitability of tive inequities that affect FBAs by applying regulatory major shareholders). requirements flexibly or by granting FBAS privileges not * The directive introduces a list of "universal" banking extended to domestic banks. In some cases measures powers for EC banks which includes underwriting applied equally to both groups of competitors have a and trading, for customers or on the banks' own favorable impact on FBAs because of the nature of their account, of practically any type of security, partici- operations. pation in share issues, money brokering, leasing, and * Regulations concerning reserve requirements on issuing credit cards, but no insurance activities. deposits or funding in the interbank market, such as Branches of banks chartered by individual EC mem- lower reserve requirements on foreign currency or non- ber states would be permitted to engage in any of the resident deposits than on domestic deposits, decrease listed activities, provided that the EC home country FBAS' cost of deposit funds, since they normally hold a permits such activities. 57 Alan H. Gelb and Silvia B. Sagari The directive acknowledges the public interest ex- The concept seems to be related to two issues: (a) the potential *the pinciple of home coun*y control. I differential impact on foreign and domestic institutions of a highly ception to the pRSClple of home country control. ln regulated host countty environment and (b) the potential market distor- addition, it establishes three specific exceptions: (a) tions created by differences in the laxity of the regulatory framework the host country retains exclusive responsibility for for banking services in the host country conpared with the hone measures resulting from the implementation of mon- country. The first issue implies that in a highly regulated environment itmay be more difficult to achieve national treatment for foreign etary policy; (b) until further coordination, the host banking affiliates than in a more open system. The second calls for the country retains primary responsibility for the super- harmonization of regulatory structures, as discussedin the section "An vision of liquidity; and (C) until further coordination, Analysis of Liberalization Options." host country is permitted to require credit insti- 9. In such cases, foreign banks might need to deposit an equivalent the host country IS permltted to requlre credlt mstl- amount of funds in a low-interest account at the central bank. If loan tutions authorized in another member state to make losses on farm loans are high (as is frequently the case), the penalty of sufficient provision against market risk with respect low interest may be preferable to lending. to operations in host country securities markets. 10. The key comnponents of a banking prudential regulatory frame- work focus on hcensing and other corporate activities, exposure Emits, loans to insiders, capital adequacy, asset classification and provision- The approach to the question of access for non-BC insti- ing, submission of false financial information by borrowers, enforce- tutions tends to follow the principle of reciprocity; under ment powers, treatmnent of problem and failed banks, pennissible or discussion are details on the type of reciprocity (recipro- prohibited activities, and scope, frequency and content of audit pro- p7 grams. For a comnprehensive description of these aspect see Polizauso cal national treatmentor mirror-image reciprocity) and (1989). other concepts (such as the better-than-national-treat- 11. Bankers frequently complain about changes in regulations that ment approach under which the Community would seek take place without their knowledge or advice. 12. For instance, as of April 1989 only four European oountries- to have a non-EC country offer EC banks treatment com- Demnark, the Federal Republic of Germany, the Netherlands, and the parable to that accorded banks within the Community). United Kingdom-had fully liberalized capital movements with re- spect to both other Ec members and third countries. France still prohibited nonbank residents not involved in intemational commercial Notes activities from holding deposits at banks in foreign countries orholding foreign currency deposits, other than those denominated in ECUs, at 1. A branch is a legal entity of the home country and is treated as banks in France. an integral part of the parent bank. A subsidiary is a legal entity of the 13. For an example of the magnitude of institutional reforms host country and is a separate corporation wholly or majority owned by needed by large Indonesian banks, see World Bank (1989, box 7.5). the transnational bank parent. The difference matters because of reg- 14. Even in the case of the Ec, the accession treaties of the new ulatory treatment and, in particular, capital requirements. member states (Greece, Portugal, and Spain) provide for derogations 2. For example, much financial intermediation in Venezuela has or time lags in which to implement the directives in the area of freeing historically been carried out offshore, through banks in Miami and the capital movements. Caribbean. Another example is situations in which surplus countries 15. The U.S. position has clearly been to prefer augmenting the have exported capital and at the same time as they are borrowing oArr to include services. By contrast, the group of ten developing abroad;inBotswana,forexample,majorprojectsare,forthemostpart, countries led by Brazil and India (the G-10) wished to separate any not funded through the domestic financial system, although there is a potential services agreement from the GATr. Within this approach, the surplus of loanable funds. negotiations would be undertaken by the govemments themselves, not 3. An important issue for licensing policy is whether to allow by the GATr contracting parties. foreign branches, subsidiaries, or both. Countries differ in this regard. 16. In some cases official pressures go in the other direction, For example, Botswana allows foreign subsidiaries but not branches, forcing foreign bankers to branchinto specific regions more widely and whereas Uruguay permits branches. In Canada financial reforms have, more quickly than they consider economically reasonable. in effect, brought about the conversion of foreign banking operations 17. Reciprocal national treatment means that the Conmmunity from branch to subsidiary operations, with both positive and negative would offernational treatment to a non-Ecbank provided that its non-Fc effects for the banks concemed. home country offered national treatment to banks from all Ec countries. 4. A common argument for multinationalization of banking cites Mirror-image reciprocity involves an attempt to achieve a precise the benefits to be derived fromintegrating capitaland financial markets. balancing ofthe treatment accorded Ecand non-Ec banksineach other's Terms and availabiliry of credit will notnecessarilybe equalized within markets. different countries. 5. This is trse even without considering the complex problems Refe arising from the protection of an input-such as financial services- rences that is intensively used by the productive sectors of the economy. See the section "A General Equilibrium Approach." Arendt, Georges. 1987. "Horizon 1992: A Decisive Step Towards the 6. According to IMP data, during 1981-87 gross flows of foreign Liberalization of Financial Services in the European Community." investment to developing countries were $118 billion, but net flows, World of Banking (March-April):"8. taking into account dividend remittances, were negative $10 billion. Amdt, H. W. 1988. "Comparative Advantage in Trade in Financial For nonoil developing countries, gross and net flows were $85 billion Services." Banca Nazionale del Lavoro Quarterly Review and $21 billion, respectively. (March):61-78. 7. In Uruguay, for example, the NationalBank, which accounts for . 1984. "Measuring Trade in Financial Services." Banca about 70 percent of the system's assets, handles all govemment ac- Nazionale del Lavoro Quarterly Review (June). 196-213. counts and is not required to pay dividends. Reforms in these areas are Benz, Steven F. 1985. "Trade Liberalization and the Global Service a prerequisite for the evolution of a competitive financial system. Economy." Journal of World Trade Law (March-April):95-120. 8. This notion is linked to the concept of effective market access, which emerged in the context of the Uruguay Round midterm review. 58 Banking Bhagwati, Jagdish N. 1987. "Trade in Services and the Multilateral Key, Sydney. 1989. "Financial Integration in the European Comrnmu- Trade Negotiations." World Bank Economic Review 1, no. 4 nity." International Finance Discussion Paper 349. Federal Re- (September):549-69. serve System, Washington, D.C. Processed. 1987. "Services." In J. Michael Finger and Andrzej Parry, John. 1988. "The Trade Talks Tum to Banking." Global Olechowski, eds., The Uruguay Round: Handbookfor Multilat- Finance (October):29-32. eral Trade Negotiations. Washington, D.C.: World Bank. Polizatto, Vincent. 1989. "Prrdential Regulation and Banking Super- Blejer, Mario, and Silvia Sagari. 1987. "The Structure of the Banking vision: BuildinganInstitution." PsRWorkinglPaperSeriesno.340. Sector and the Sequence of Financial Liberalization." In Michael World Bank, Washington, D.C. Connolly and Claudio Gonzalez-Vega, eds.,EconomicReformand Sagari, Silvia B. 1989. "Intemational Tade in Financal Services." Stabilization in Lwtin America. New York: Praeger. PsPR Working PaperSeries no. 134. World Bank, Washington, D.C. Ewing, A. F. 1985. '"Why Freer Trade in Services Is in the Interest of . 1986. "The Fnancial Services Industry: An Intemational Developing Countries." Journal of World Trade Law (March- Perspective." Ph.D. thesis, New York University, New York. April): 147-69. Santornero, Anthony M. 1989. "European Banking in Post-1992: Federal Reserve System. 1989. "Financial Integration in the European Lessons for the United States." Paper prepared for the conference Community." Intemational FinanceDiscussionPaper349. Wash- "European Banking after 1992." INSEAD, Fontainebleau, France. ington, D.C. Processed. Processed. Gavin, Brigid. 1985. "A GArrforIntemational Banking?" Journal of U.S. Commerce Department. 1976. "U.S. Service Industries in World World Trade Law (March-April):121-35. Markets." Washington, D.C.: Govemment Printing Office. Gray, Jean M.,and H. Peter Gray. 1981. "The Multinational Bank: A U.S. Treasury DepartmenL 1979. Report to Congress on Foreign Financial MNc?" Journal of Banking and Finance 5:33-63. Govemment Treatment of US Commercial Banking Organizations. Grubel, Herbert G. 1977. "A Theory of Multinational Banking." Washington, D.C.: Government Printing Office. Banca Nazionale del Lavoro Quarterly Review (December):349- Walter, Ingo. 1985. "Barriers to Trade in Banking and Financial 64. Services." London: Trade Policy Research Centre. Processed. Heller, H. Robert. 1987. "Future Directions in the Financial Services World Bank. 1989. World Development Report 1989. New York: Intemational Markets." World of Banking (May-June):18-21. Oxford University Press. Hindley, Brian. 1988. "Service SectorProtection: Considerations for Developing Countries." World Bank Economic Review 2, no. 2 (May):225-38. 59 6 Insurance Robert L. Carter Access to insurance contributes to the welfare of risk- ments, which allow several insurers to take shares in the averse individuals and organizations in all countries and insurance of large industrial risks. Altematively, rein- generates other macroeconomic benefits. Most insurance surance enables a direct insurer to transfer a part of the services can be and are supplied domestically. Without risk he has accepted to a reinsurer who undertakes to intemational trade, however, insurance markets would meet an agreed part of any claims that may arise on the not be able to supply all of the insurance demanded for original insurance (Carter 1983). The reinsurer may in very large individual and catastrophic risks. Trade also tum reinsure part of his liabilities. Only through such promotes the spread of innovation in products and pro- intemational spreading of risks is itpossible for domestic cesses and generally stimulates market efficiency. Nev- insurance markets to meet the demand for adequate ertheless, since the 1950s trade in insurance has insurance coverage forvery large individual risks and for increasingly been subject to trade barriers. This chapter natural and man-made disasters. examines the case for liberalizing intemational trade in insurance and suggests how it might be done. The Accumulation of Funds The Nature and Benefits of Insurance Private insurance operates by pooling the premiums col- Services lected from policyholders to create a fund for the pay- ment of claims. In the case of nonlife insurance, such This section reviews how insurance permits the transfer funds are usuatly equal, on average, to between one-and- and sharing of risk, contributes to the accumulation of a-half times to twice the amount of the insurer's annual funds for investment, and provides a mechanism for premiumincome. Because life insuance contracts generally private saving. Among other benefits, insurance gives extend over many years, life insurers accumulate substan- firms the cushion of security they need to undertake tially larger reserves to meet their liabilities to policyholders innovative activities. and so are an important source of funds for capital markets.2 Risk Transfer Personal Saving Insurance is a mechanism for spreading uncertain losses Life insurance, besides providing financial protection over time or over larger numbers of persons. It enables against the risk of premature death, has developed in individuals and organizations to pay an agreed preiium to many countries into an important form of long-term transfer the risk of financial loss arising fronm the occurrence (mainly contractual) personal saving.3 Consequently, of specified loss-producing events to an insurer who, by life insurers have been embroiled in the financial services poolingindividualindependentrisks,reducestheoverallrisk. revolution, competing with banks and other institutions Not all risks are insurable. Among the limitations are for savings and loans and in some countries developing the size of individual losses and of accumulated losses into or being acquired by financial conglomerates. from natural and man-made catastrophes that an insurer can withstand without imperiling its solvency (Berliner The Benefits of Insurance: Summary 1982, pp. 36-37). The boundaries of insurability can be extended by spreading large risks among a number of The transfer of risks through insurance reduces the ad- insurers. One method is through coinsurance arrange- verse financial consequences for policyholders (and 60 Insurance often for third parties too) of those losses that do occur from less than 1 percent in many developing countries to and increases their sense of security (Carter 1979, ch. 2; more than 8 percent in some leading industrial econo- Haller 1975). Business insurance contributes to the ef- mies (see table 6-1). Whereas in 1987 the United States ficiency, development, and competitiveness of the indus- accounted for 45 percent of the world's total premiums, trial and commercial sectors of a country's economy. the total expenditure on insurance in most developing The substitution of insurance for highly liquid contin- countries is far less than the premium incomes of the gency reserves reduces both the cost of risk for all firms world's principal insurance groups. (In 1986 the world- and the risk-financing disadvantages of small firms. wide total premium incomes of the largest U.S., Japan- With insurance, firms have more security and may be ese, and European insurance company groups were, willing to undertake more hazardous activities-includ- respectively, $19.4 billion, $20.6 billion, and $9.9 billion.) ing innovations in processes and products-than they Domestic insurance markets differ widely in their otherwise might. And insurers' loss prevention services structures and competitive behavior. State-owned in- contribute to safety in production and products. surance monopolies exist in the centrally planned econ- The spreading of risks internationally can help to sta- omies and in thirty-eight developing countries bilize a country's balance of payments. Claims paid in (Bickelhaupt and Bar-Niv 1983, p. 83; UNCTAD 1980). foreign currencies can be used to finance imports of Many other developing countries, after gaining political materials and goods needed to reconstruct buildings and independence, have excluded foreign and foreign-owned plant after a major disaster and, in the case of losses that companies from their domestic markets or permit only give rise to liabilities overseas (for example, air crashes), locally incorporated subsidiaries with substantial local to cover the costs of compensation payable in foreign shareholdings.5 By contrast, the insurance markets of currencies.4 most industrial countries contain substantial numbers of domestic and foreign companies.6 In many countries, The Size, Structure, and Competitiveness of however, a relatively small number of insurers domi- Insurance Markets nates the main classes of business. Although many in- surance companies operate abroad, there are fewer than The size of national insurance markets, measured by a dozen American and European companies that are premium expenditure as a percentage of GDP, ranges capable of providing clients with comprehensive insur- Table 6-1. Expenditures on Insurance, Selected Countries, 1987 Total premiwns Premiums per capita (dollars) Total premiums as Economy or group (millions of dollars) Life Nonlife percentage of GDP United States 406,652 678.6 989.6 9.07 Japan 241,069 1,460.7 513.8 8.69 Germany, Fed. Rep. of 81,353 594.9 735.0 6.40 United Kingdom 63,820 705.8 416.0 8.35 France 50,000 381.7 517.1 5.06 Italy 19,741 74.4 269.9 2.35 Spain 10,856 107.5 172.1 3.31 EEC 258,612 371.0 427.8 5.80 Switzerland 16,005 1,357.3 1,089.9 8.02 Korea, Rep. of 11,142 218.8 46.0 8.85 India 3,281 2.6 1.6 1.29 Taiwan 3,241 116.0 48.8 3.33 Brazil 1,522 1.7 9.1 0.86 Malaysia 963 29.1 29.1 2.98 Mexico 901 3.6 7.5 1.02 Egypt, Arab Rep. of 660 2.3 10.7 1.05 Thailand 653 6.6 5.6 1.35 Indonesia 642 0.9 2.9 0.92 Singapore 583 103.8 119.5 2.78 Colombia 510 3.1 14.0 1.53 Tunisia 162 1.3 19.9 1.57 Note: Expenditure is measured by premiums paid domestically, converted into dollars at end-1987 rates of exchange. EEC premiums are estimated as a percentage of GDP. Source: Swiss Reinsurance Company, Sigma, vol. 3/89 (1989). 61 Robert L. Carter ance service worldwide. Examples are the American dence indicates that total average cost curves are L- International Group and GIGNA Corporation in the shaped and that significant economies of scale are ex- United States, Royal and General Accident in the United haustedatpremium income levels thatare low in relation Kingdom, and Zurich in Switzerland. to total domestic premiums even in most developing The presence of a large number of insurers in a market countries (Geehan 1986; Praetz 1985). Differences in does not guarantee competitive behavior; in many coun- distribution systems, however, can influence sales costs, tries competition is constrained by market leadership, and some economies of scope may be achieved by diver- collusion, or supervisory legislation. A feature of com- sifying into other classes of insurance or, possibly, into petitive insurance markets is the need for cooperation other financial services. among rivals in providing insurance for large risks. Al- Developments in information technology exert con- though several insurers may compete for the role of flicting influences on capital requirements. The scale of leading underwriter on a coinsured risk, the support of investment in computer hardware and software required sufficient following insurers must be obtained to fully to compete in the newly developing network-based mar- insure the risk (Carter and Diacon 1988). ketplaces may be beyond the financial means of small Brokers, in those domestic and international markets in insurers. Such investment can, however, reduce the need which they operate, reinforce price and product compe- for extensive branch networks. tition among insurers by making use of their market The efficiency, security, and competitive ability of an knowledge to obtain the contracts that provide the best insurance company vitally depend on the quality of its value for their clients. Also, to some extent the principal underwriting, claims, and investmentmanagement, com- industrial buyers of insurance are able to exert a counter- bined with detailed knowledge about clients, products, vailing power, not least because risk retention (possibly and areas. Nowhere is this more true than in international through the formation of a captive insurance company) markets, as evidenced by the disastrous experience of the can be a close substitute for conventional insurance for Insurance Corporation of Ireland on the London market part of their risks. in the mid-1980s and the large losses in the international reinsurance business incurred during the late 1970s and The Economic Aspects of Production and early 1980s by the Instituto de Resseguros do Brasil and Market Competition the Korean Reinsurance Corporation and attributed partly to lack of experience and insufficient information Like other financial services, the production of insurance (see Hill 1986; Wasow 1986b; Park 1986). services traditionally has relied mainly on a combination Highly trained and experienced underwriters are re- of financial, human, and intangible resources. Although quired to evaluate insurance risks, and for large industrial information technology is increasingly being employed and commercial risks the services of actuaries, survey- in product design, riskevaluation, marketing, and admin- ors, engineers, and other specialists are needed too. Not istration, experienced management and skilled personnel only do policyholders judge an insurer by the way it remain the key to a successful insurance enterprise (J. handles claims, but expert management of claims-the Shelp 1986). largest cost item-is vital to cost control. Finally, the An insurance company requires sufficient capital to investmentreturnsachievedbyaninsurancecompanyon comply with the minimum capital and solvency require- its funds, and so the premiums it can charge, depend on ments specified by the supervisory authorities of the the quality of its financial and investment management countries in which it operates and to compete effectively. and on access to well-developed capital markets. The security of an insurer is judged by brokers and knowl- Given the need for detailed client and market knowl- edgeable buyers on the strength of its capital base, which edge and for servicing before and after sales, insurers also determines the size of risk it can underwrite and its require a local presence in each country in which they ability to provide continuity of cover for clients in periods operate if they are to write a substantial volume of of heavy losses. Since solvency margins are normally business. Local representation is particularly important related to premium income, the larger is an insurer's for personal and small commercial insurance in that capital base, the more business it can write. And, the buyers have strong local loyalties and lack the knowl- larger and more diversified (in terms of classes of insur- edge and resources available to corporate buyers for ance and geographic spread) is an insurer's portfolio of seeking out the best markets. business, the more stable its claims experience tends to be Market behavior and the strength of the competition for and the relatively less it needs costly reinsurance or capital. different classes of insurance are influenced by such Although there are considerable problems in defining factors as market structure, barriers to new entry, and the output for a multiproduct industry, the available evi- practice of fixing premiums before the ultimate claims 62 Insurance costs can be known. The last-named practice induces through the establishment by insurers of production and either collusion between insurers, making premium tar- marketing outlets in foreign markets. Although the latter iffs (often supported by supervisory regulations) a com- is not foreign trade in a conventional sense but direct mon feature of insurance markets worldwide, or price investment, like other financial services, a local market instability. A period of high profits attracts new entrants, presence is important to a direct insurer. Since the 1950s, which leads to price cutting and a fall in profits, causing however, foreign insurers have been forced by trade pro- a reduction in supply and eventually an increase in tection legislation to withdraw from many developing premiums. The danger is that a period of inadequate countries, as evidencedby the changes in market structures premiums may bankrupt some insurers. shown in table 6-2 (see also Carter and Dickinson 1989). The benefits of competition can be seen in lower pre- Itis difficult toassess thesize of international insurance mium rates, in innovations in products and distribution, trade in relation to total business because of the difficul- and in declines in insurers' X-inefficiency or supranor- ties of classifying marine and other trade-related insur- mal profits. Insurers operating in competitive markets ance and the sparsity of published data on insurance trading are more inclined to supply products designed to meet activities. Therefore it is only possible to make broad consumers' needs. Corporate buyers benefit from the estimates of the proportion of total business that is traded. introduction of new types of insurance and the adaptation of existing products to meet changing conditions: the EstablishmentBusiness introduction of partial insurance arrangements that en- able firms to finance their smaller losses internally and The market shares of foreign insurers established in thus reduce their overall risk costs is an example. domestic markets range from zero in countries that have nationalized their industries or totally expelled foreign The Importance of Trade to Nonlife insurers to majority shares in a few countries such as Insurance Saudi Arabia. It is estimated that, as a percentage of total worldwide expenditure on insurance, 9 percentof nonlife Increasingly, technological progress and legal and social insurance premiums and 4 percent of life insurance pre- developments are creating risks in both industrial and miums are written by foreign insurers through local developing countries that are beyond the underwriting establishments (Carter and Dickinson 1989). capacity of national insurance industries. For example, population growth and urbanization are expanding the Cross-Border Trade size of conurbations and thus creating the potential for large natural and man-made catastrophes, such as the Cross-border trade is virtually confined to nonlife insur- Mexico City and Bhopal disasters. At the level of indi- ance business, which, over the past thirty years, has vidual risk, insurance of such risks as aviation product increasingly taken the form of reinsurance. The propor- liability, offshore oil rigs, oil refineries, and satellite tion of nonlife premiums remitted abroad varies consid- launches involves sums insured of about $1 billion, erably, from about 2 percent of domestic nonlife which exceeds the annual premium incomes of many premiums for the United States to 40 percent in some developing countries (see table 6-1). The only way that Arab insurance markets (Ali 1985, ch. 6); overall cross- the insurance industry can satisfy such demands is to border trade probably accounts for about 4 percent of spread the risk intemationally, and in many cases only total world nonlife premiums. the principal intemational insurers and reinsurers possess the experience and knowledge required to underwrite Reasons for Barriers to Trade in Insurance such risks and to deal with large claims. Trade in insurance yields other economic benefits. The Several arguments have been advanced by national gov- transfer of insurance production and product knowledge ernments, by lobbyists for domestic insurance industries, and the spur to competition within national markets that and by UNc'rAD in favor of trade protection for insurance trade generates improve the international competitive services. The vigor with which protection has been position of firms in other industries for which insurance sought has tended to be related directly to the degree of is an important input. comparative disadvantage that national industries suffer in competing intemationally. Broadly, the reasons given International Insurance Transactions can be grouped in three categories. Conswner protection. In all countries, because of the International trade in insurance takes place both through aleatory and fiduciary nature of insurance, governments crossborder movements of insurance services and have legislated to exercise prudential control over insur- 63 Robert L. Carter Table 6-2. Changes in the Structure of Insurance Markets, by Region, 1968-85 1968 1985 Nwnber of companies Percentage of Number of companies Percentage of Domestic Foreign foreign companies Domestic Foreign foreign companies Europe 3,590 1,580 28.6 3,419 1,086 24.1 North America 4,967 360 6.8 5,791 302 5.0 Latin America 749 257 25.5 690 82 10.6 Africa 229 674 74.6 334 115 25.6 Asia 382 705 64.9 543 367 40.3 Australia 408 195 32.3 289 145 33.4 ance enterprises in the interest of insurance consumers an important force lobbying for trade protection. The and others. Supervision usually embraces the solvency motive is usually rent seeking by established insurers. of insurers, the suitability of owners and managers, rein- The exclusion of more efficient insurers from local mar- surance arrangements, and permitted investments, but in kets protects indigenous companies from new competi- many countries it also extends to the rating and terms of tion and enables them to continue to enjoy the benefits insurance contracts, marketing practices, and various of higher profits or X-inefficiency at the expense of other aspects of insurers' activities. In some countries insurance consumers. The size of the gains from trade insurance intermediaries are also supervised. protection enjoyed by local suppliers at the expense of consumers depends on whether the protection afforded Economic reasons, such as: is in the form of a quasi-tariff or a quota restriction on foreign suppliers; the latter produces the highest costs for * Avoidance of destructive competition that might consumers (see table 6-3). lead to excessive selling costs and the insolvency of Generally, countries place fewer restrictions on foreign some insurers reinsurers than on direct insurers. This can split the * Development of local insurance industries to pro- opposition of international insurers and reinsurers to mote local employment and the diversification of the trade protection: the exclusion of foreign direct insurers economy. (Here the infant industry argument is from a country's domestic market presents international frequently invoked to shield from international com- reinsurers with opportunities for increasing their market petition industries that have been established for participation. The opposition to protectionist measures more than a quarter-century.) by those insurance groups that supply both direct insur- • Retention for local investment of funds generated by ance and reinsurance will therefore tend to depend on the insurance operations size and nature of their involvement in particular mar- ; Reduction of the impact of insurance and reinsurance kets, on whether proposed new measures are designed to imports on the balance of payments. create barriers for all foreign suppliers or only for poten- tial new entrants, and on whether the restrictions will Sociopolitical reasons, including: apply to all foreign or foreign-owned suppliers or are to be applied selectively according to the nationality of the * Reduction of the country's dependence on foreign foreign supplier or the nature of its operations. suppliers of a key financial service, the withdrawal of which, perhaps in time of war, could adversely affect Forms of Trade Protection other important economic activities (Skipper 1987) * Cultural or religious considerations. For example, All countries impose some market entry or operating Western forms of insurance organization are not restrictions on existing and potential suppliers on acceptable to some Muslims. grounds of consumer protection. Whether such restric- tions are protectionist from a trade policy standpoint Skipper (1987) adds the status quo factor-that is, some depends on whether they discriminate unfairly against governments may not be convinced that their economies foreign as compared with indigenous suppliers. But will benefit from trade liberalization and therefore, in the granting "national treatment" to foreign insurers may still absence of strong evidence to the contrary, may believe that not allow them to exploit to the full their advantages, and logic dictates maintenance of all existing barriers to trade. local consumers are thus denied the full potential benefits In both industrial and developing countries local insur- of trade. For example, supervisory control of premium ance interests, including state-owned insurers, are often rates and policy terms may preclude a foreign insurer 64 Insurance Table 6-3. The Effect of Market Entry Regulation of Prenium Rates on Insurance Prices (European currency units) United Type of insurance Belgium Denmark France Italy Luxembourg Netherlands Spain Kingdom Term 380 225 285 392 355 195 294 150 House 118 144 195 253 220 164 135 266 Motor vehicle 494 436 413 942 671 354 758 316 Commercial fire and theft 1,296 2,023 3,587 4,896 1,204 1,412 1,765 1,797 Public liability 968 1,257 1,852 1,508 934 714 1,364 798 Note: Some of the differences in premiums may be explained by variations among countries in the potential loss expectancies of the risks insured. For example, differences in the incidence and severity of vehide accidents influence motor vehicle premiums, and variations in accident frequencies and in laws affect liability insurance premiums. Differences in the taxation of insurers and of insurance premiums may also have some effect. But such factors alone cannot account for the wide differences in premiums shown above. In the case of term life insurance, a study undertaken for the European Commission found that much of the variation between British premiums and those charged in the rest of the Community comes about because British insurers are free to detemiine their own premium rates, whereas insurers in most other European countries are required by detailed supervisory regulations to use conservative motality statistics and low interest rates in the calculation of prenium rates (Carter and Morgan 1986). Source: Price Waterhouse (1988). from exploiting its cost advantages, innovating in pre- Measures that adversely affect the degree of control mium rating, or introducing new products. companies can exercise over their business, such as: The obstacles to trade may be divided broadly into two Domestication policies that require foreign insurers categories (Carter and Dickinson 1989): to operate only through locally incorporated subsid- • Paraquantitative measures that directly restrict for- iaries, particularly when a majority of the shares * g Paraqurniaiers inasureslthat insurance serestnces fmust be held by a government agency or by local eign insurers in supplying insurance servicesreint through local establishments or across national bor- resldents ders or that prevent a country's residents from buy- Employment restrctions on the use of expatnate ing insurance from foreign or foreign-owned sta. insurers Reinsurance regulations that restrict the placing of • Paratariff measures that indirectly reduce the foreign arrangements of parenthcompanies. supply of insurance and reinsurance by making it either less advantageous for foreign insurers to sup- Measures that increase capital or operating costs or ply their services or more difficult or costly for local reduce investment earnings. Examples are minimum residents to purchase them capital solvency, deposit, and investment regulations more stringent than those that apply to domestically Industrial, centrally planned, and developing econo- owned insurers and the enforced ceding of reinsurance mies all provide numerous examples of both categories to a state insurer, even though it is not necessary com- of restrictive measures (for details, see Bickelhaupt and mercially and the terms are worse than those obtainable Bar-Niv 1983; Skipper 1987). In some cases it is the in the open market. discretionary manner in which laws are administered that Measures that restrict access to markets, including: poses the greatest obstacles to foreign insurers.8 * The reservation of certain classes of insurance to Restrictions on Establishment state-owned or other domestically owned insurers * Government insurance procurement policies that re- Restrictions on the right of foreign insurers to establish quire the government and other public agencies to in a country are arguably the most serious forms of place their insurance only with state-owned or other restriction on insurance trade (OECD 1983). Direct re- domestically owned insurers strictions, ofwhich there are many examples in centrally * The exclusion of foreign insurers from the advan- planned and developing economies, include both the tages available from membership of local market total nationalization of a country's insurance industry associations. and other laws that totally exclude foreign or foreign- owned insurers from establishing in national markets. Discrminatory taxation ofbranch offices or subsidiaries. Indirect restrictions can be grouped under the following Exchange control restrictions on the remittance of headings. profits. 65 Robert L. Carter Restrictions on Cross-Border Trade of trade restrictions by developing countries,9 but the most important moves toward freeing trade have oc- Many countries, including industrial nations such as cuffed within the EC. France, Italy, and the United States, prohibit residents Since most countries impose few trade restrictions on from placing any insurance abroad with nonadmitted reinsurance, insurers can generally gain access to both insurers (that is, insurers not licensed to write insurance the expertise of the principal international reinsurers and business within that country) or allow them to do so only the underwriting capacity required for the insurance of if insurance cannot bepurchased locally. Most countries large risks. But international reinsurance transactions require compulsory insurance to be purchased only from cannot provide for consumers and national economies all locally authorized insurers. In addition, more than of the benefits obtainable from the opening up of domes- twenty developing countries require imports, and in tic markets to competition from foreign direct insurers. some cases exports, to be insured locally too, and some It is apparent that some countries are better endowed reserve to a state reinsurer the exclusive right to place than others with the skilled human resources and the reinsurance abroad. The same result may be achieved by supporting financial and other services required for the exchange controls that prevent the remittance abroad of efficient conduct of insurance services in general and premiums. business insurance in particular (Walter 1988; R. Shelp The indirect obstacles to cross-border trade include: 1986). Over time the balance of those differences may Tax rules thatpenalize either local residents who insure shift, as is the case with manufacturing industries, but or reinsure abroad or the foreign insurers or reinsurers regardless of subsequent adjustments in trading patters, that write that business, by: trade liberalization for insurance would increase global * Imposing higher taxes on premiums than apply to Thelfare. locally placed insurance and reinsurance Trade negotiators must, however, recognize from the • Imposing withholding taxes on the profits assumed outset that with a fiduciary business such as insurance, to be earned on premiums for insurance or reinsur- governments do have a legitimate interest in protecting ance placed abroad consumers from incompetent or fraudulent foreign oper- * Restricting the tax deductibility by residents of pre- ators, even if the measures to achieve that objective lead rniums for insurance orreinsurance placed abroad to some loss of efficiency; the nature and detail of such * Taxing claims payments received from abroad from protectonist measures and whether they should extend to large corporate buyers of insurance is, however, a nonadmitted insurers. subject of debate.10 In addition, developing countries Measures that restrict access to markets for foreign have a special interest in building up indigenous insur- nonadmitted insurers, such as: ance industries to foster economic diversification and to • Restrictions on advertising by nonadmitted insurers reduce the balance of payments costs of insurance im- or on assistance by local brokers in the placing or ports. They should, however, recognize the implications servicing of insurance with nonadmitted insurers of such policies for the intemational compedtiveness of • IJnenforceability in local courts of uisurance contracts other sectors of the economy, the possibility that scarce arUngedforceabidety wintloc courdmits t insuraneontracs. highly educated labor may be better employed elsewhere arranged by residents with nonadmitted insurers.ithecnm(CrradDckso19;Wsw *in the economy (Carter and Dickinson 1989; Wasow Exchange control regulations that unduly delay the 1986a), and the consideration that a modest long-term remittance abroad of premiums (or of claims payments balance of payments cost may be a reasonable price to or insurers' technical reserves) or permit it only at penal pay for reducing the destabilizing effects of a catastrophe rates of exchange. or a series of large losses. Insurance supervisory regulations that penalize insur- ers who place their reinsurance abroad-for example, by The Problem of Establishment not allowing them to take credit for liabilities transferred to foreign reinsurers when calculating their solvency margins. Not only is the freedom of insurers to establish in terri- tories where they wish to conduct their business impor- Trade Liberalization tant to insurers; the socioeconomic costs are also lower for host countries than those of cross-border trade (see Since the 1950s mostif notalldeveloping countries have table 6-4). Invariably, foreign insurers established in a increasingly protected their domestic insurance markets country find it beneficial to employ and train local labor against competition from foreign insurers andreinsurers. both because labor costs tend to be lower than for expa- Recently there have been a few examples of relaxation triates and because local employees have a better under- 66 Insurance standing of the social and cultural environment and more commenced its program of creating a single market for business contacts. insurance. The difficulties that have been encountered in For multinational trade negotiations, however, estab- moving toward the achievement of that objective provide lishment poses unique problems that the Uruguay Round lessons for wider multinational trade negotiations-not must try to resolve. Although the negotiators recognize least of which is that after thirty years the process is still that effective access to markets for the supply of services not complete! sometimes requires a commercial presence, GA1T rules It was proposed to achieve the common market in two do not cover foreign direct investment. How far govern- stages: first,freedom of establishment to give Commu- ments, including those that have entirely nationalized nity insurers the right to open branches in other member tfheir domestic insurance industries, may be prepared to states subject to the same conditions as national insurers, go toward granting the right of es:ablishment to foreign- and, second, freedom of services to permit unrestricted controlled insurance subsidiaries can be only a matter of cross-border trade between Community insurers and res- conjecture. idents. From the outset it was recognized that supervi- sory and contract laws governing insurance services Policy Measures would have to be approximated to the extent necessary for the proper functioning of a common market. There- Walter (1988) has advocated that the objective of trade fore the first stage of the program, in 1963, was to liberalization in the financial services sector be built on implement the two freedoms for reinsurance, which does the concepts of: not directly affect ultimate consumers. * Equality of competitive opportunity A key issue in regard to freedom of establishment was * heright to establishandinvest inaviable commer- the adoption of uniform Community rules on the autho- cial presence rization of insurance companies, including minimum * National treatment capitalization, and on the solvency regulations that are monitored by the supervisory authority of the country in which the insurer's head office is located. If an intema- The same principles, together with transparency, also tional agreement could be obtained on both these mat- hold for insurance. ters, it would go a long way toward eliminating the Given the resistance of many developing countries to concern of national regulatory authorities regarding con- including services in the Uruguay Round and the demand sumer protection. But the creation of equality of oppor- that can be expected for special treatment under any tunity would also require the acceptance of the principle negotiated GA1T like services framework, a case can be of transparency in regard to market entry and operating made that the industrial countries should concentrate on conditions and the granting to foreign insurers of the negotiations within the OECD, including the updating of right to import the human and other resources they deem the Code on the Liberalization of Current Invisible Op- essential for carrying on their business efficiently. erations. If industrial countries take the lead in liberal- Differences in the views of European governments izing insurance and other services trade among regarding consumer protection continue to delay prog- themselves, their arguments in favor of the long-term ress toward full freedom of services. Therefore the Com- benefits of freer trade will be more credible to developing munity has now adopted directives to bring about by countries. 1990 cross-border trade in business insurance for "large After many years of inaction, the OECD Insurance Com- risks" (defined by size of company), on the grounds that mittee was reactivated at the beginning of the 1980s, and large buyers do notrequire the same degree of protection in 1983 a joint Capital Markets and Invisibles Transac- as other consumers. As noted, the denial of access to tions and Insurance Committee published a detailed sur- international insurance markets has serious adverse im- vey of trade restrictions on insurance (OECD 1983). The plications for the efficiency and competitiveness of firms report stressed that attempts to reduce restrictions on engaged in the production of other goods and services establishment should be given first priority. and thus for the consumers of those products and for national economies. The removal of barriers to cross- A Programnfor Liberalization border trade in business insurance, including trade-re- lated insurance, should therefore be the second priority Governments accept that the movement toward trade for multinational trade negotiations. liberalization for services will need to be progressive and Finally, although the supply of insurance has some to respect national policy objectives. That was the line unique characteristics, it would be sensible for negotia- taken by the EC when at the beginning of the 1960s it tions to take place in a franework of liberalization of all 67 Robert L. Carter services. If negotiations proceed on a sectoral basis, Nottingham, U.K.: Department of Industrial Economnics, Account- is a rik that hey wil becomebogged own ining and Insurance, University of Nontingham. there is a risk that they will become bogged down in Cater, R. L., and G. M. Dickinson. 1989. Barriers to Trade in technical detail. Insurance. 2d ed. London: Trade Policy Research Centre. Carter, R. L., and E. V. Morgan. 1986. "Freedom to Offer Life Notes Insurance across EC Boundaries." Report prepared for the Euro- pean Commission (private circulation). Economists Advisory Group, London. 1. For developing countries, see uNcrAD (1977). As for industrial DeGrey,Rodney. 1984. "A NotSo Simnple PlanforNegotiauing Trade countries, a study of the effects of two (hypothetical) hurricanes that in in Services." Trade Policy Research Centre. Draft. 1984 caused $14 bilhion in insured property losses in the United States Engberg, Holger L 1986. "Capital Formation and Economic Devel- concluded that 42.4 percent of the total losses would have been borne opment: The Role of Financial Institutions and Markets." In by non-U.S. insurers (Al-Industry Research Advisory Council 1986). Bemard Wasow and R. D. Hill, eds., The Insurance Industry in 2. Ratiosofassetstopremiumsvaryamongcountriesforanumrber EconomicDevelopment NewYork: NewYorkUniversityPress. of reasons, butincountries with well-developed lifeinsurance markets Finsinger, J., E. Harnmond, and J. Tapp. 1985. Insurance: Competi- that transact business with a large savings element, asset values can be tion or Regulation. London: Institute for Fiscal Studies. more than five times larger than their total premnium incomnes. See Geehan, R. 1986. "Economies of Scale in Insurance: Implications for Engberg (1986). Regulation." InBemardWasow and R. D. Hill, eds., The Insurance 3. Inthe United Kingdom pureinsurance contracts accountforless Industry in Economic Development. New York: New York Uni- than 10 percent of total life insurance premiums. versity Press. 4. uNcrAD (1977) has reported that "some developing countries, HaDler, Matthias. 1975. Sicherheit durch Versicherung? Bem: Her- aware of their shortage of foreign exchange, allow insurance covers of bert Lang. such risks to be effected in foreign currency ... making it possible, in Hill, Raymond D. 1986. "Brazil: The Insurance Market Consolidation the event of a loss, to secure foreign currency necessary to obtain the of the 1970s." In Bernard Wasow and R. D. Hill, eds., The Insur- replacements or to effect the repairs of damages." ance Industry in Economic Development. New York: New York 5. For a list of developing countries that have nationalized their University Press. insurance industries see uNcrAD (1980). oEtD. 1983. International Trade in Services: Insurance-4dentifica- 6. For details of the structure of the insurance industries of seventy- tion and Analysis of ObstacJes. Paris. two countries with competitive mnarkets, see Swiss Reinsurance Com- Park, Un Hoe. 1986. "Some Thoughts on Proportional Reinsurance." pany (1985). Papers Presented to the Sixth Strategic Conference on Reinsur- 7. Although all of the business of Lloyd's of London is underwnit- ance. London: City Financial. ten in London, the presence of Lloyd's agents throughout the world and Praetz, P. 1985. "A Note on Economies of Scale in the U.K. Property- the business acquisition and information services provided by Lloyd's Liability Insurance Industry." Journal of Risk and Insurance brokers and their correspondents abroad reduce for Lloyd's undeTwrit- (June). ing syndicates the disadvantages of not being localy established inthe Price Waterhouse. 1982. The Cost of "Non-Europe" in Financial countries from which they acquire their business. Services. Washington, D.C. 8. For example, in Norway, where the insurance supervisory Shelp, June P. 1986. "Insurance Industry Technology." In Bemard authority can decide whether there are any benefits to be gained from Wasow and R. D. Hill, eds., The Insurance Industry in Economic admitting new companies, no new license have been issued to foreign Development. New York: New York University Press. companies since 1927. Shelp, Ronald K. 1986. "Services in the Economies of Developing 9. Korea and Taiwan have embarked on a program of limited entry Countries." In Bemard Wasow and R. D. Hill, eds., The Insurance of foreign insurers to theirmarkets. Industry in Economic Development. New York: New York Uni- 10. For discussions of the differing attitudes of European govem- versity Press. ments toward protection of policyholders, see Carter and Morgan Skipper, Harold D., Jr. 1987. "Protectionism in the Provision of (1986) and Finsinger, Hammond, and Tapp (1985). As noted in the Intemational Insurance Services." Journal of Risk and Insurance text, the Ec now distinguishes between the needs of corporate and 54, no. 1 (March). personal buyers of insurance. Swiss Reinsurance Company. 1985. "The World Insurance Supply in 1985." Sigra (November-December). References . Various issues. Sigma. uNcrAD. 1977. Insurance of Large Risks in Developing Countries, TD/B/C.3/137. Geneva. Ali, A. Z. A. 1985. Insurance Development in the Arab WorldL ______. 1980. Third World Insurance at the End of the 1970s, London: Graham and Trotmnan. TD/B/C.3/169. Geneva. All-IndustryResearchAdvisoryCouncil. 1986. CatastrophicLosses: Walter,Ingo. 1988. GlobalCompetitioninFinancialServices. Cam- How the Insurance System Would Handle Two $7 Billion Hurri- bridge, Mass.: Ballinger. canes. Washington, D.C. Wasow, Bemard. 1986a. "Insurance and the Balance of Payments." Berliner, Baruch. 1982. Limits of Insurability of Risks. Englewood In Bernard Wasow and R. D. Hill, eds. The Insurance Industry in Cliffs, N.J.: Prentice-HalL Economic Development. New York: New York University Press. Bickelhaupt, David L, and Ran Bar-Niv. 1983. &nternational Insur- . 1986b. "Insurance in Korea." In Bemard Wasow and R. ance: Managing Risk in the World. New York: Insurance Infor- D. Hill, eds. The Insurance Industry in Economic Development. mation Institute. New York: New York University Press. Carter, R. L. 1979. Economics and Insurance. 2d ed. Stockport, Wasow, Bemard, and R. D. Hill, eds. 1986. The Insurance Industry U.K.: PH Press. in Economic Development New York: New York University _____ 1983. Reinsurance. 2d ed. Brentford, U.K.: Kluwer. Press Carter, R. L., and S. R. Diacon. 1988. "The London Insurance Mar- ket-Behaviour and Survival Strategies for Insurers." In Papers Presented to the Tenth Meeting of U.. Insurance Economists. 68 7 Construction James Lee This chapter discusses the trends and issues important to tween 7 and 8 percent in the 1970s, but this period may trade in construction services, particularly as they relate have represented a temporary, although extended, to the Uruguay Round of multilateral trade negotiations. trough. Levels were higher in the 1960s, largely because Five topics are addressed: the role of construction in of demand for single-family homes. In developing coun- national economies; trends in trade in construction ser- tries the current share of construction in the economy vices; the main issues in this trade and the impediments ranges from 3 percent in Burma, Nepal, and Uganda to to it; the applicability to the sector of several key con- 8percentin Algeria, Libya, andYugoslavia(WorldBank cepts of the General Agreement on Tariffs and Trade 1984, pp. 3, 11). In industrial countries employment (GArTr); and prospects for progressive liberalization. shares are roughly similar to output shares; in developing (For a more extensive discussion of all the above issues, countries employment shares ordinarily exceed output see Lee and Walters 1989.) shares owing to the relatively higher labor intensity of Construction is defined as the application of technology construction. to the building of structures (such as houses) and produc- Second, public and private demands for construction tive facilities (such as factories) by combinations of services are sharply divergent. Construction is closely skilled and unskilled labor, encompassing both public related to investment, and since investment is often tied and private activity. It includes both new projects and to business cycles, private demand for construction ser- renovations and repairs of existing buildings. Services vices fluctuates more than in most other industries-the are an essential element in international construction. peaks are higher than average and the troughs are lower. Materials sold for construction abroad without attendant Typically, these fluctuations are more pronounced in services are simply merchandise exports, but the combi- developing countries. By contrast, the role of govern- nation of services with materials allows firms to bid on ment in construction tends to stabilize public demand. In and undertake large-scale construction projects. Thus, some countries local and central governments account services are a necessary component of participation in for as much as half of demand and "can affect directly or the international construction market and a catalyst for sig- indirectlyalmostalloftheremainder" (Hillebrandt 1985, nificant exports of merchandise, especiay capital goods. p. 8).1 Intemational lending institutions also play an important role in demand markets, again for reasons of The Role of Construction in the National public policy. Hence, construction decisions reflect pol- Economy icy as well as market forces. Third, the construction industry has a distinctive struc- Construction differs from other industries in several ture. It has extensive linkages throughout the national ways. The first is sheer size. Construction output is large economy, since it is an important purchaser of a variety in relation to that of other industries, accounting for of materials (Hillebrandt 1985, pp. 10-12).2 But the roughly 10 percent of global gross national product (GNP) linkages bifurcate according to the type of service pro- and perhaps an even greater share of employmenL Con- vided-design or implementation. Design, which in- struction made up somewhat more than 10 percent of volves the conception of a project, is usually carried out industrial country economic output in the early postwar by architects and engineers. It entails conceptual assess- period and somewhat less than 10 percent in the 1970s ments, feasibility studies, designs for facilities, and proj- and 1980s. Members of the Organisation for Economic ect plans that use detailed drawings and specifications. Co-operation and Development (oEcD) averaged be- Implementation includes procuring financing and sup- 69 James Lee plies, mobilizing labor and equipment, and managing firms in France, Japan, and the United States-the three projects and is carried out by unskilled laborers and nations with the largest number of new construction skilled craftsmen in conjunction with architects and en- contracts-ranked fairly low in foreign dependency; gineers. Technical assistance and training in plant oper- overseas sources accounted for 13.2, 28.9, and 36.6 ation may also be included in the implementation of a percent of new contracts, respectively. construction project. Firms in the international construction market share Fourth, construction is essential to the development three characteristics: size, breadth, and integration. In process, and trade in it often reflects long-term invest- spite of its economic importance, international construc- ment and growth patterns. Construction is said to pro- tion constitutes a relatively small percentage of all con- vide the infrastructure needed for development, act as a struction. Many construction projects are small in vehicle for the transfer of technology to developing scale-building single-family homes or local roads, for countries, assist capital formation, supply the basis for example-and construction firms are also usually small. backward and forward economic linkages, and provide Most projects, therefore, are not ordinarily prospective large amounts of direct and indirect employment (see markets for foreign companies. But large-scale overseas Kirmani 1988, pp. 23-32). Given these critical roles, projects-for example, building airports and petrochem- many believe that freer trade in construction services, ical processing plants-are undertaken by large firms or which would enable these benefits tobe more fully realized, even groups of large firms in the international construc- would be of tremendous utility to importing countries. tion market.3 The firms are characterized by breadth as well as by Trends in International Trade in Construction size. Foreign construction projects require broad sets of Services skills, and contractors who undertake them must possess a special set of abilities.4 As Hillebrandt (1985, p. 7) The international construction market has emerged rela- observes, "The construction economist needs the assis- tively recently, for the most part since World War II. tance of the designer, contractor, quantity surveyor, stat- Before then, the difficulties of long-distance transport istician and accountant, who will know more about largely restricted the construction industry to domestic various aspects of the construction process than he." projects, and the former colonial dependencies were for Finally, because of the advantages of combining fund- the most part captive markets for the industrial coloniz- ing and resources in large-scale projects, joint ventures ers. But by the 1960s and 1970s the situation had arenowcommon.' Manyprojectsrequireextensiveand changed dramatically. Lower-cost transport, the tele- broad capabilities (in labor, material, and capital), and communications revolution, and more rapid economic thus firms must out of necessity integrate functions to development in developing countries contributed to the some extent, often through joint ventures. internationalization of the construction services industry. Newly industrialized countries also became more com- Design petitive in providing foreign construction services. After 1973 foreign-exchange-rich oil-exporters provided a The supply of international design services is dominated large new market. by firms from industrial countries.6 Billings by these International construction has become vitally impor- finms, however, were relatively flat in the mid-1980s. tant to the health of many domestic construction indus- The $4.0 billion total in 1987 represented a slight (3 tries and the firms that comprise them. In fact, "the single percent) increase over 1983-87, largely owing to an statistic that reveals the most about the state of the upturn in 1987 after decreases in most of the intervening construction export market is the ratio of foreign con- years. In 1988 the international market grew by another tracts to total contracts" (Engineering News Record 3 percent. France, the United Kingdom, and the United 1987). Owing to the recent slackness of foreign markets, States saw a slight deterioration in billings over 1983-88, the worldwide ratio of foreign to total construction con- Japan and the Netherlands experienced slight improve- tracts fell from 42 percent in 1984 to 32 percent in 1986. ments, and Canada more than doubled its market share Yet a sampling of the world's 250 largest construction (see table 7-1). firms shows a wide variety of foreign market dependen- The United States accounted for about one-quarter of cies. In 1986 Yugoslav firms obtained more than 75 total billings for foreign design services in 1988. Canada percent of their total new construction contracts from followed with 16 percent, and the United Kingdom, the overseas sources. Swiss firms depended on foreign Federal Republic of Germany, the Netherlands, and sources for 65.6 percent of their new contracts, and for Japan all had shares of between 6 and9 percent. France's Turkish firms the figure was 63.7 percent. By contrast, share fell to a mere 3 percent. In sum, the top seven 70 Construction Table 7-1. Share of International Design Billings, by Supplier Country, 1983-1987 (millions of dollars; figures in parentheses are percentage shares) Country 1983 1984 1985 1986 1987 1988 Canada 269 287 266 204 518 672 (7) (8) (7) (6) (13) (16) France 361 234 239 306 260 139 (9) (7) (7) (9) (6) (3) Germany, Fed. Rep. 253 249 230 282 356 302 (7) (7) (6) (8) (9) (7) Japan 127 166 226 221 259 257 (3) (5) (6) (6) (6) (6) Netherlands 203 228 219 259 358 425 (5) (7) (6) (7) (9) (10) United Kingdom 592 454 463 481 451 440 (15) (13) (13) (14) (11) (11) United States 1,204 1,307 1,165 918 1,042 1,039 (31) (30) (30) (32) (26) (25) Others 841 809 832 869 774 884 (22) (23) (23) (25) (19) (21) Total 3,850 3,464 3,640 3,540 4,017 4,158 Note: Shares may not sum to 100 percent owing to rounding. Source: Engineering News Record (various issues). suppliers were responsible for 79 percent of overall expanded construction activity in coming years in the international design billings. Other suppliers, many of two countries and in the region as a whole. At present, them developing countries, made up the remaining 21 Asia is the largest demand market for construction im- percent. Asia accounted for about one-quarter of the plementation services, followed by the Middle East and demand market, followed by Africa and the Middle East. Africa; each region has about 15 percent of the market. By 1987 Latin America has fallen to roughly a third of Implementation its 1980 level, from $15.8 billion to $5.2 billion in new contracts, or about 6 percent of the current market. Industrial countries also dominate the construction mar- The United States continues to claim the largest share ket, although to a lesser extent than in the design market. of foreign contracts for construction implementation ser- In 1987, as in 1986, $73.9 billion in new construction vices. In 1988 U.S. firms held 25 percent of the total implementation contracts was awarded to foreign firms. market, nearly one-half the U.S. share of the 1980 mar- This total was slightly less than the $81.6 billion awarded ket. Next largest were Italy (14 percent), Japan (12 in 1985 and far below that of any other year since 1980. percent), France (12 percent), and the United Kingdom In fact, the total in 1987 was 45 percent less than in 1981 (10 percent). Together, European suppliers accounted (see table 7-2). In 1988 the international market re- for nearly $41.6 billion in construction contracts, about bounded significantly, increasing by 27 percent to its 50 percent more than the U.S. total. The Republic of highest level since 1981. Korea, which in 1980-83 had boom years when it ac- The reasons for the drop in 1982-87 include the debt counted for roughly 10 percent of the international mar- crisis in Latin America, the collapse of oil prices and the ket, saw its share drop to 1 percent in 1988. The decrease consequent fall in oil revenues, and the war between Iran was largely the result of overreliance on the Middle East, and Iraq, which constrained building throughout the which had 99 percent of Korean contracts. Middle East during the 1980s-directly through the di- version of funds from construction to the military sector Design and Implementation Compared and indirectly through reduced earnings from oil ex- ports.7 The Middle East was by far the largest interna- The design and implementation service industries can be tional construction market in the 1970s, and the recent compared in terms of their absolute sizes worldwide and cessation of hostilities between Iran and Iraq may permit the relative differences in country shares. 71 James Lee Table 7-2. Value and Share of Foreign Construction Contracts, by Supplier Country, 1981-1988 (billions of dollars; figures in parentheses are percentage shares) Country 1981 1982 1983 1984 1985 1986 1987 1988 France 12.1 11.4 10.0 5.4 6.7 7.1 8.6 11.1 (9) (9) (11) (7) (8) (10) (12) (12) Germany, Fed. Rep. 9.9 9.5 5.4 4.8 5.4 5.5 5.9 8.1 (7) (8) (6) (6) (7) (7) (8) (9) Italy 9.3 7.8 7.2 7.8 8.7 7.4 9.2 13.3 (7) (6) (8) (10) (11) (10) (12) (14) Japan 8.6 93 8.7 7.3 11.6 9.4 9.9 11.6 (6) (8) (9) (9) (14) (13) (13) (12) Korea, Rep. of 13.9 13.8 10.4 6.8 4.8 2.6 2.1 1.4 (10) (11) (11) (8) (6) (4) (3) (1) United Kingdom 8.7 7.5 6.4 5.7 5.6 7.0 7.9 9.4 (6) (6) (7) (7) (7) (9) (11) (10) United States 48.8 44.9 29.4 30.1 28.2 22.6 18.1 25.9 (45) (36) (31) (37) (35) (31) (24) (28) Others 26.5 18.9 16.1 13.1 10.6 12.3 12.3 13.3 (17) (15) (16) (16) (13) (17) (17) (14) Total 134.4 123.1 93.6 81.0 81.6 73.9 73.9 94.1 Note: Shares may not sum to 100 percent owing to rounding. Source: Engineering News Record (various issues). The implementation market is much larger than the these issues, some common practices that impede trade design market, by a factor of twenty. This observation are identified. is not intended to downplay the importance of design. Most design firms, as a matter of practice, call for spec- Third-Market Competition through Subsidization ifications that require the use of products made by their country's manufacturing sector and used by its construc- Competition through the provision of subsidies is some- tion implementation firms. Thus in many cases design is times referred to as "offensive protectionism." Currently, a forerunner to implementation. the primary area for competition in construction services In Germany, the United Kingdom, and the United is in developing countries. As opportunities have de- States the shares of the design and implementation clined in these countries, competition has become so submarkets are approximately equal. In France and fierce that many exporters subsidize national firms to Japan, however, the implementation share is more enhance their competitiveness, thereby creating ineffi- than twice the size of the design share. Canada has a cient markets. Government-provided risk insurance, the negligible share of implementation but is the second underwriting of feasibility studies, and the use of mixed largest provider of design services. Some of these credits are all overt forms of subsidization. The OECD differences are attributable to the size of the econ- Gentlemen's Agreement (more formally known as the omy and some to the structure of the economy. His- oEcD Arrangementon ExportCredits) attempts to reduce tory, too, has obviously played a large role (sec thescsubsidydistortionsbyestablishingminimumcredit appendix 7-A). levels (35 percent) and by setting borrowing guidelines to ensure that market rates are in general alignment with Issues and Impediments official credit export rates. In spite of these efforts, the agreement has not solved the subsidies problem. The Services disciplines may be relevant to four generic threshold level only acts to enforce the use of subsidi- issues that are central to the treatment of construction zation as a practice, and subsidies below a certain services in Uruguay Round negotiations: third-market amount are not covered by the agreement. Finally, the competition (subsidies), regulatory concordance, market lack of a formal system for notification has diminished access, and labor movement. Following the discussion of the ability to monitor subsidy practices. 72 Construction Regulatory Concordance struction crews across national borders to work on con- struction projects? Is the denial of access to construction Regulatory differences between national and local juris- crews an unreasonable impediment to trade in construc- dictions can constitute effective barriers to trade, partic- tion services? The answer in each case is probably no, ularly in construction services. In industrial countries, at least in a practical sense. Although the current GAIT market protection for construction services industries disciplines can be extended to cover traded services exists at several political levels: explicit "buy-national" products, they do not now cover the movements of policies at the federal or central level and, at subnational factors of production such as labor. This area is normally levels, explicit or implicit local requirements that effec- regulated by national immigration policies. tively preclude participation in construction projects Nonetheless, the liberalization of labor movements even by nonlocal domestic firms. These practices af- would have profound effects on the construction services fect both the public and the private sector. For exam- industry. There is already considerable movement of ple, many government projects require that the labor, as demonstrated by the significant remittances of contractor be located within so many miles of the workers, which largely flow from industrial and oil-ex- actual construction site. This effectively limits foreign porting countries to developing countries. But in these competition. instances the labor movements are those of individuals, The purpose of protection is often to support small and employment is often secured because of labor short- national firms that cannot compete with large multina- ages. With or without a GAT[1-like agreement, the trend tional firms. Although most firms that participate in toward using low-cost labor from developing countries international construction are large-reflecting the size will no doubt continue. Coupling the management, of most overseas projects-small firms often have an skilled labor, and financial resources of industrial coun- advantage in their own locales, where local regulations try firms with the low-wage labor of developing coun- may favor them. For small firms the extension of liber- tries would be (and already is) a means of keeping overall alization of construction services trade to the local level project costs low. could increase both domestic competition with small Liberalization of labor movements would not only af- and large firms and international competition with fectthepotential for freer movement of workers between foreign firms. Because preferential contract practices industrial and developing countries; it would also allow are not uncommon at the state and local levels, many freer movements among developing countries in cases small firms feel they have much to lose from an agree- where there are considerable income differences. There ment that would liberalize trade in construction ser- are many mechanisms for preventing job displacement vices. among developing countries that could be explored. MarketAccess Impediments to Trade Access to markets is limited by barriers to trade-related Protection of construction service markets is prevalent in investment, including establishment. The right of estab- both developing and industrial countries. Many devel- lishment refers to a firm's ability to set up foreign sub- oping countries, for example, protect their construction sidiaries in other countries. Although it is not inherently a markets by sheltering infant industries, requiring a cer- trade issue, the right of establishment becomes one when tain amount of domestic content, and making use of tax governments restrict participation in certain markets to and procurement discrimination, restrictive licensing locally established companies. This frequently occurs in agreements, and other impediments. Two reasons have service sectors such as construction, where there is often a been advanced to explain the low level of construction need to establish a presence as an adjunct to foreign opera- services trade among industrial countries. The first is tions. outright protection. As Stailson (1985, p. 85) notes, "There has been little trade in construction services be- LaborMovement tween the advanced countries because each has a highly developed local industry with an inside track in bidding Finally, trade in construction services may require pro- on major national projects." The second is that geo- fessional access to the foreign market for presenting graphic distance from domestic sites in industrial coun- proposals, inspecting sites and other local conditions, tries in itself puts foreign firms at a competitive overseeing the proper implementation of projects, and disadvantage, particularly when their labor rates and the like. Is it reasonable to read into this observation a technical expertise areroughly equal to those of domestic much broader right to the wholesale movement of con- firms. 73 James Lee Numerous practices act as impediments to trade in lack of transparency is intentionally discriminatory, construction services. In some countries engineers are measures should be taken to provide equal access for required to pass accreditation examinations given in the foreign and domestic entities. Expansion of the princi- local language and must demonstrate knowledge of the ples in the GATT Code on Technical Barriers to Trade local culture. Somegovernmentprocurementregulations provide some guidance in this regard. But complete automatically award contracts to local engineers except transparency may be difficult, if not impossible, to when the domestic market cannot provide the needed achieve in the construction sector. Many, if not most, services. In other places the prime contractor system countries have no well-developed regulatory apparatus forces foreign firms to act as subcontractors on all major able to collect and assemble into a single compilation all projects unless advanced technology requires a greater construction-related codes and specifications Oocal, regional, degree of foreign participation. Some construction ser- and national). Thus, efforts to inceas transparency might vice exporters are allowed a tax deduction of a certain well concentrate on the provision of essential information. percent of foreign exchange earnings against future losses. One country has over the years required that only MARKET ACCESS. For construction services, issues of indigenous firms perform engineering and design work on market access for labor and capital are extremely impor- certain projects. Many countries have "buy-national" pro- tan. With respect to labor two types of entry might be grams, and on occasion governments finance prebid sur- allowed: short term (temporary) and long term, oriented veys and provide insurance against cost inflation. toward a permanent presence. Similarly, access to the The following practices are generally recognized as the market for the purpose of investment may also differen- principal impediments that restrict or distort trade in tiate between a temporary and a permanent presence. Per- construction services: manent entry might be licensed on a renewable basis and * Government procurement temporary entry on a project-specific or bid-specific basis. * Subsidies * Barriers to investment GOVERNMENT PROCUREMENT. Because of the crucial * Domestic content requirements role of government in the construction industry, procure- * Discrimination ment issues have a large impact on international compe- * Personnel qualifications tition. Although allowances naturally need to be made for national defense and national interests, large-scale Options for Liberalization liberalization of procurement practices could lead to substantial gains in efficiency. Realistically, govern- This section discusses problematic areas for the liberal- ment procurement is one of the most protected interests ization of trade in construction services. Important top- in a country, and the likelihood of broad liberalization ics covered here are the relevant GATr-like principles, seems remote. Nonetheless, progress can be made in trading concerns outside the disciplines of the GATT, and reducing discriminatory treatment, opening some areas prospective winners and losers from liberalization. to competition, and lessening administrative burdens. GA=ITPrinciples PROGRESSIVE LIBERALIZATION. Progressive liberaliza- tion will require an obligation not to impose new barriers The principles of the GATr are intended to ensure foreign and a commitment to reduce those barriers that do exist. firms the right to sell their products in domestic markets To provide for liberalization, the negotiations need to under conditions of nondiscriminatory treatment. This create rules and procedures for formulating disciplines. objective should be the goal for trade in construction They also need to establish exceptions that take into services. Six GATr-like principles that pertain to trade in account national policy objectives (particularly develop- goods are relevant to trade in construction services: ment) and provisions for further negotiations beyond the transparency, market access, government procurement, Uruguay Round. Exceptions may also apply to certain progressive liberalization, increasing participation by types of transactions; thus, in some cases only subsecto- developing countries, and national treatment. ral liberalization will occur. TRANSPARENCY. Personnel qualifications and technical INCREASED PARTICIPATION BY DEVELOPING COUNTRIES. standards vary from country to country and are discussed Because of the one-way nature of current trade patterns in formal and informal forums. In some cases these in construction services, there is a need to increase par- standards are not administered transparently, placing ticipation by developing countries. This implies the de- foreign firms at a competitive disadvantage. Where the velopment of local capabilities. Domestic construction 74 Construction firms in developing countries may require greater tech- Winners and Losersfrom Liberalization nical assistance and access to new technologies to be- come competitive. It is important to distinguish between Comparative advantage in construction services, on the subsidies used by industrial countries to secure contracts whole, will remain with the industrial countries because and assistance provided to aid construction capabilities of their substantial resources in skills, technology, fi- in developing countries. Further, set-asides and buy-na- nance, and management. There are some activities in tional policies may need to be established in a way that which developing countries do have a comparative ad- permits certain levels on a temporary basis. Intemational vantage, but the industrial countries are better situated to organizations may also need to increase the level of take advantage of liberalization because their construc- domestic preferences in the projects they fund to promote tion industries are already much more internationalized development objectives in construction. than those in developing countries. Although it appears that liberalization of trade in construction services would NATIONAL TREATMENT. National treatment applies to lead to significant efficiency gains and thus promote discrimination in the application of laws to foreign and development in many countries, the goal of increasing domestic firms. This principle stipulates that laws and supplier participation by developing countries will re- regulations must apply equally to the operations of both main elusive unless steps are taken to improve their foreign and domestic finns and that firms must be able competitive positions. Progressive liberalization to establish a permanent presence in the host country. should, therefore, take into account the level of develop- Application of national treatment could have wide-rang- ment of individual countries. ing effects; it could conceivably apply to tax, investment Improvement of capabilities would necessarily involve licensing, financial, and other national policy concerns the strengthening of developing country capacity to un- related to construction. dertake construction projects through the development of local expertise. The World Bank already gives a 7.5 Trading Concerns Outside the GAT Disciplines percent bidding preference to domestic firms. (This policy did not, however, completely achieve its intended Because of the unique nature of construction and the goal of increasing domestic firm participation; see trade problems associated with it, liberalization will re- Kirmani 1987, p. 23). Developing countries may re- quire progress in areas outside the jurisdiction of the quire, in addition, more explicit programs for improving GATr. A number of examples come to mind. Financing local expertise and more information on marketpossibil- of large-scale construction projects may require some ities. Improvement of developing countries' ability to acknowledgment of World Bank funding activities. penetrate markets will also hinge on their access to Agreements to decrease the use of subsidies could follow distribution channels and information networks-both some of the guidelines set in the OECD Gentlemen's essential aspects of modern construction practices. Agreement. Labor movement issues would no doubt still There may also be a need for safeguards and other fall under the purview of government immigration poli- exceptions in construction for both economic and bal- cies. Likewise, the establishment of disciplines on the ance of payments reasons. repatriation of profits from overseas construction There will clearly be winners and losers among devel- projects may well follow precedents set by various oping countries as a result of liberalization. Some coun- treaties of friendship, commerce, and navigation and tries, such as Korea and India, are in a better position to by memorandums of understanding between coun- participate in actual projects; countries that lack the tries. requisite skills and resources will probably only be able In other sectors there are established entities that deal to export labor. Those that have a more mobile and with regulation of international trade. For example, spe- educated labor force will have an advantage over those cialized bodies exist for air transport (the International that do not. Moreover, those developing countries that Civil Aviation Organization) and telecommunications have established domestic industries will be more advan- (the International Telecommunications Union). It may tageously placed in the new competitive environment well be that similar international bodies are needed in than those that do not. Trade in construction services construction services, particularly for resolving prob- among developing countries themselves must also be lems of transparency and market access. One purpose addressed. Policies that promote the displacement of of these bodies might be to act as centralized clearing- construction industry workers in one developing country houses for gathering information on country regula- by workers from another developing country may not be tions and developing specifications related to viable. In the end, however, the Uruguay Round negoti- construction. ations are a package agreement, and it is to be expected 75 JamesLee that certain countries will be more competitive in some Notes sectors and less competitive in others. Hence some tradeoffs appear to be inevitable in weighing the overall 1. The World Bank (1984, p. 40) discusses the imponance of the balance of concessions. But, on the whole, the develop- government "as policymaker at the macroeconomic level and as an originator of demand and executor of works at the microeconomic ing countries ought to pursue negotiations in construc- leveL" tion services. 2. The industry links up with other economic sectors in the demand for raw, semiprocessed, and processed materials and the supply of infrastructure and plant throughout an economy. Appendix 7-A. Trade and Specialization In 3. Given sorne type of intemational framework agreement on Construction Services services trade,however. smallerfirms and projects may play anincreas- ing role in construction services. Price Waterhouse (1985, p. 1) notes Specialization and intemational trade have always gone thatthe U.S. industry is comnposed of more than 25,000 fims, of which only about 400 directly engage in interaional projects. hand in hand, and the development of an international 4. Hilebrandt (1985) observes that "size of contrct is clearly the construction industry has, over time, produced special- major determinant of the numberof fims who can undertake work. A izations. The United States has traditionally specialized largecontractrequiresmoreinputsthanasmallcontract,andonly some in oil adacnrtnpjtnof the total number of contractors in a country have these inputs in oil and gas construction projects-not s urprisingly, for available to them. Capital is particularly important in this connection." the country that developed modern petroleum extraction 5. According to Price Waterhouse (1985. p. 2). "Twenty-four practices in the nineteenth century. Dutch firms are percent of all [U.S.] firms who export AEc larchitectual engineering, increasingly associated with water-related projects, such and construction] services participate in joint ventures." Staulson (1985, p. 91), notes that joint ventures in this industry have increased, as the Bahrain Causeway, that are largely based on partly because host goverrments requie foreign firms to join forces similar projects in the Zuider Zee. Swiss firms specialize with domestic contractors and try to breakup contacts among anumber in projects that require difficult tunneling because of of suppliers to avoid single-source dependencies. 6. There are reay no reliable sources of data on trade in construc- their own experience with similar challenges in the tion services. Here, construction design is reported on the basis of Alps. billings and construction implementation on the basis of new contracts. Among the developing countries, despite the lack of Contract awards include the value of goods as wel as services. This large-scale market penetration, areas of specialization follows the accounting procedures of the Engineering News Record. large-scale 7. Still another factor has come into play in the intemational are emerging. Korea has had the most success in entering construction market: more and more construction work is being under- the international construction design market. It exports tkenbydevelopingcountriesthemselvesastheirexpertiseinconstruc- construction design services to other parts of Asia and, don increases. The turnkey project is becoming a thing of the past, in primry tline with the growing sophistication of developing countries' domestic primarily, to the Nfiddle East. Korean firms acquired firms. various construction skills through association with U.S. 8. Hindley (1987) notes that "[the right to relocate labortemporar- firms, first in rebuilding their country after the Korean ily] is widely rejected as politically infeasible." war and then as subcontractors to U.S. firms in the Middle East. Accumulation of these skills eventually References enabled Koreans to work on the more sophisticated parts En of projects and to subcontract unskilled work to devel- gineMrg RNewisRecoJrdl 1987. "Foign Awards Continue DecEne oping countries, such as Pakistan, the Philippines, and Hillebrandt, PatriciaM. 1985. Economic Theory and the Construction Thailand, with even lower wage rates. Korean firms Indusry. 2d ed. London: Macmillan. focused on the Middle East and were very successful in Hindley, Brian. 1987. "Introducing Services into the GATr." Trade Policy Research Centre, London. Processed. doing so, but the drop in oil revenues showed the dangers Kimiani, Syed S. 1987. "A Review of Bank Assistance to the Con- of overspecialization. Korea's world market share stnhction Industry in Developing Countries." Policy Planning and dropped from 11 percent in 1983 to only 1 percent in Research Staff, Infrastructure and Urban Development Depart- 1988. ment, World Bank, Washington, D.C. * - 1988. "The Construction Industry in Development: Issues Other developing countries are also making inroads and Options." Policy Planning and Research Staff,lnfrastructure and into the international construction market. Brazil exports Urban Development Deparment, World Bank, Washington, D.C. "disembodied" construction services (for example, spe- Lze, James, and David Walters. 1989. International Trade in Con- struction, Design, and Engineering Services. Boston, Mass: cialized software applications) that are mostly related to Ballinger. oil and mining and go primarily to other developing PriceWaterhouse. 1985. TheContributionofArchitectural,Engineer- countries in Latin America and Africa. India exports ing and Construction Exports in the US. Economy. Washington, D.C. design services in the consulting and technical fields of Soubra, Yehia. 1987. "Intemational Competition in Construction and troubleshooting, management, and licensing. Firms from Engineering Design Services." uNcrAD, Geneva. Processed. Brazil, China, India, and Yugoslaviarank among the250 StaUlson, Helena. 1985. U.S. Service Exports and Foreign Barriers: largest construction fimns in the world. An Agenda for Negotiations. Washington, D.C.: National Plan- ning Association. World Bank. 1984. The Construction Industry: Issues and Strategies for Developing Countries. Washington, D.C. 76 8 Air Transport Christopher Findlay This chapter reviews recent developments in the air based in the United States and Europe, which now ac- transport and tourism markets with the aim of identify- count for about 73 percent of total scheduled traffic, and ing how these developments may affect policies on trade the rise of airlines based in Asia and the Pacific. This shift in air transport services. It is argued here that traditional is even more marked when only international traffic is principles for guiding trade negotiations, such as those considered. of the General Agreement on Tariffs and Trade (GAIT), Subsequent sections discuss some of the factors that have considerable relevance for air transport issues and will influence the rate of growth of airlines in different especially for the concerns of the smaller developing parts of the world and the scope for exports of their countries. services. An important limitation on export growth is the regulatory system, which is described next. Characteristics of the Industry The Regulatory System Tables 8-1 and 8-2 summarize some features of the air transport industry. Scheduled traffic accounts for about Air transport services between any two cities are con- 90 percent of total traffic and charter flights for the trolled by an air services agreement (ASA) between the remainder. Passenger traffic accounts for nearly three- governments involved. The bilateral strategy was quarters of all scheduled air traffic. Since 1978 total adopted in 1944 following failure to agree on a multilat- traffic has grown at about 6 percent a year; freight traffic eral exchange of market access. There are now about has grown slighdy faster, at 7 percent a year. 1,800 bilateral ASAS. A little more than half of total passenger traffic is The agreements specify: intemational (see table 8-2). Scheduled airlines account for about 90 percent of passenger transport. Intemational * Which airlines will fly on the route transport of freight by air is more important than domes- * The amountofcapacity that airlines fromthirdcoun- tic traffic; about 90 percent of freight traffic is carried by tries will be permitted to offer on the route. scheduled airlines. Table 8-3 shows the regional distribution of traffic. The The airlines that operate on a route usually include one main shift has been the decline in importance of airlines or more designated airlines from each country on the Table 8-1. World Airline Traffic, by Type of Service, 1978-87 (billions of metric tons-kilometers logged) Service 1978 1983 1986 1987 Scheduled Passengers 84 107 131 143 Freight and mail 29 39 48 53 Nonscheduled 15 14 18 20 Total 129 160 197 216 Source: IcAo (1988). 77 Christopher Findlay Table 8-2. World Airline Traffic, by Type of Service, 1987 (percent) Service International Domestic Total Passengers' 48 53 100 Scheduled 39 52 91 Nonscheduled 9 1 10 Freightb 74 26 100 Scheduled 68 22 90 Nonscheduled 6 4 10 a. Percentages are calculated on the basis of passenger revenue Idlometers logged. Figures may not sum to total because of rounding. b. Percentages are calculated on the basis of freight metric tons-kilometers logged. Source: IcAo (1988). route, as well as airlines from third countries. Most of the The designated airlines are required to have substantial capacity on the route is provided by the end-point carri- local ownership and control. In many cases the majority ers. A country's imports of air transport services are thus owner is also the national govemrnment, and then the determined by quantitative controls, and these "import typical policy is to designate only that one airline as the quotas" are allocated to specific foreign fins. The use intemational carrier. of country-specific quotas for each "product" (in this case, each route) is similar to the provisions of the Why Regulate? Multifibre Arrangements (MFA). Fares on each route are ultimately subject to govern- An original motivation for the systems of agreements ment control. Traditionally, target fares were negotiated was to prevent any one country from exploiting the by the airlines themselves and were then referred to the market power inherent in its control over landing rights. governments for approval. Increasingly, fares are set in The argument is still frequently made that without agree- the marketplace, and there is less government involve- ments one side could regulate unilaterally, for profit or ment. Now, once capacity is fixed, market forces set the for strategic purposes. It is also argued that if airlines levels of fares that will fill the seats. Previous attempts were allowed to operate freely, particular airlines, even to set fares as well as capacity often required government without explicit government action, would come to dom- action to counter market forces. The result was a high inate the market At the time the regulatory system was set level of "discounting" and a huge enforcemcnt problem. up, this concem was focused on U.S. airlines, as it still is. The increasing number of airlines in the marketplace and A problem with the current system has been the slow the increasing number of substitute routes (see below) pace at which new suppliers are admitted. New suppli- have made control of capacity difficult and control of ers-unless they have large domestic markets or are fares even more so. importantdestinations-lackbargainingpowerandhave Various formulas are used to fix capacity. Some depend to resort to diverting traffic from other routes to build up on rules based on the traffic loads on a route. In other market share. This strategy has been applied success- cases capacity is fixed rigidly in advance and then rene- fully-by the ASEAN carriers, for example-but the na- gotiated at regular intervals, or capacity is reviewed after ture of the regulatory system suggests that the market an interval at the request of the country that has experi- share of new competitive suppliers is less than it would enced a decline in capacity share. be without the regulations. Table 8-3. Share of Scheduled Passenger Traffc, by Home Region of Carrier, 1978 and 1987 (percent) Region 1978 1987 Europe 34 30 Africa 3 2 Middle East 3 3 Asia and Pacific 13 17 North America 42 43 Latin America and Caribbean 5 5 Note: Figures are for toual domestic and intemational scheduled traffic, by home-base reigon of carrier. Source: ICAO (1988). 78 Air Transport Consumers lose from the regulatory system because of Market Density the barriers to trade that it creates. On the supply side, there are also losers, notably the rapidly developing Tourism arrivals in the Asia and Pacific region have countries. Data on airline costs suggest that a combina- grown at a fast rate, especially in the past decade. The tion of low wages and high skill levels creates favorable rate of growth has been much higher than in the rest of conditions for a highly competitive airline. A number of the world, and the region's share of world tourism traffic the rapidly industrializing countries in Asia and the Pa- is rising rapidly. In 1970 the Asia and Pacific region cific found themselves in this position and were able to accounted for about 3 percent of total tourist arrivals; by compete in the market, contributing to a rise in their 1985 this share had risen to 11 percent. It is generally traffic share (table 8-3). As industrialization and growth expected that over the next decade tourism in the region continue, wage increases, for this industry, tend to offset will grow at rates 25 to 30 percent greater than the world the accumulation of skills, and competitiveness tends to average-for example, at 7 percent a year compared with decline. Countries in the rapidly industrializing stage of forecast rates of just over 5 percent for world traffic. This development, especially those with small domestic mar- suggests a strong positive relationship between eco- kets, are therefore shut out of the international market by nomic growth and the demand for travel services. the regulatory system,andtheyarethe main losers. Thus, Rapid growth in travel volumes means that routes are the shift in the structure of the market toward the Asia generally denser and can support more airlines. There are and Pacific carriers would have been even larger without also more routes on offer. For example, flights to Europe regulation. from East Asia are now offered via Hong Kong, Korea, As noted above, there are similarities between some Japan, and all the countries of the Association of South features of the MFA and the system for regulating inter- East Asian Nations (ASEAN). This is a dramatic change national trade in air transport. Both systems are cur- from the 1940s, when traffic volumes tended to be thin. rently under pressure to reform. The next section Economic development is also likely to be associated surveys forces operating for reform of the air transport with increasing density on the supply side. In the Pacific system. region, for example, economic development has pro- duced waves of competitive newcomers that have chal- Developments in the Market lenged the position of established suppliers. In the late 1970s carriers based in the ASEAN countries gained ac- Market developments that will have important impli- cess to routes to Europe by offering competitive stop- cations for the evolution of the regulatory system overs. Northeast Asia also has competitive carriers-for include: example, Korean Airlines. The market is much more competitive than previously, both within a route and * The increasing density of traffic, especially in the between substitute routes. Pacific, owing to the increase in travel and tourism * The increasing number of competitive airlines Vertical Integration * The use of vertical integration in the tourist industry as a strategy for controlling and monitoring service In its corporate organization, the tourism industry tends quality (the same strategy is also relevant for the toward vertical linkages. A feature of travel demand is freight market) that travelers find themselves buyingservices in unfamil- * The increasing role of the computerized reservation iar countries, perhaps incurring excessive search costs or system (CRS) as a strategic tool for airlines paying excessive prices. The value of economizing on * The development of new twin-engine and four-en- time in travel creates a role for the intermediary who can gine aircraft capable of long-distance flights arrange an itinerary and deliver the services promised. * The increased demand for point-to-point services Predictability of the type of service to be provided is also and the wider options for supplying these services, a selling point with consumers. which have increased the number of international To ensure service quality, many tourism firms have gateways and substitute routes sought ways to monitor and control more effectively the * The trend toward privatization supply of complementary services by other enterprises. * Recognition of the importance of networking and An extreme option is ownership of the other firm; other of access to mass markets, which has led to the methods of forming vertical linkages involve holding integration of domestic and international services only partial equity or none at all. and the multiple designation of international air- Vertical integration has been facilitated by technolog- lines. ical changes on the supply side, including computerized 79 Christopher Findlay booking systems and the connection of local systems governments-a broadening of the capital sources. This with existing international systems. matches the interest by other service suppliers in buying The immediate advantage of integration is that if a into the industry. These pressures from the marketplace system is accepted by a travel agency, flights of that and from within the government-owned companies indi- system's owners will be presented first in response to a cate a rapid extension of the privatization moves that are query. The development of local systems, which is well already under way. In the Asia and Pacific region, air- under way in the Asia and Pacific region, is also seen as lines subject to privatization include Air New Zealand, a defense against reliance on the larger U.S. and Euro- Philippine Airlines, SIA (Singapore), and MAS (Malay- pean systems, which would disadvantage local carriers. sia); Cathay Pacific (Hong Kong) has already been The proliferation of systems and the apparent ease of floated off from its parent company. communication among them suggests, however, that the Moves to change the ownership structures are proceed- significanceofthisparticularadvantagewilldeclineover ing much faster than moves to alter the regulatory envi- time. Indeed, it is in the travel agents' interest to be able ronment. That sequencing is appropriate. In addition to to access as wide an information base as possible and not assisting the airline to develop a structure suited to a more be restricted to any one system. competitive environment, it removes an obstacle to reg- Perhaps the longer-term advantages of these systems ulatory reform. Previously, government ownership, fears will be that they can substitute for equity links in coordi- that subsidization would lead to "unfair practices," and nating services and generating networking advantages. the perception in some countries that retaliation was They are able to maintain carrier identity in the home required were significant complications in the develop- country and avoid complications in negotiating capacity ment of an open trade regime for the industry. under the national ownership requirements of the ASAs. At the same time, they facilitate the creation of compet- Networking itive systems of airlines. For example, when an agent requests a routing, a flight number will be given, but the Experience in the U.S. market illustrates the economies service will actally be provided by a combination of of establishing a large feeder network. carriers. Feeder traffic supports a higher level of traffic in any Another important technological change is in aircraft Fe traf sprt s a hih rlevlo trafi ia one local market, increasing a carrier's share of operating ranges. The development of twin-engine air- departures and attracting a higher share of local craft that can operate over long ranges has widened the traffic. (A carrier with a relatively higher share of scope for more point-to-point services and less hubbing departures will have a more than proportionate share on thin routes. This strategy has obvious advantages for of the market.) serving particular tourist markets, and it can help to ease costait on caact in exs.n ' * By managing the timing of feeder flights, a carrier may be able to support flights that are off-peak in Privatization some local market and so achieve higher overall load factors. * By combining traffic from different origins, airlines Inarapidlygrowingmarket,theprovisionofairtransport may be able to offset variability in demand in any services is a critical link. Some forecasts suggest that may be and tocreaset loa d inctor traffic will grow faster than capacity and that as a result one sector and increase the load factor. resort operators will integrate into airline operations to combined at the hubs and consolidated onto larger control access to services. The interest of both sides will aircrat the uni atn costs. contribute to a widening of shareholding in many airlines. In addition, growth will require the purchase of extra The economies of networking have generated several capacity. As a result of technical changes that have cut issues, including allocation of capacity on intemational fuel consumption and of lower fuel prices, the share of routes and access to domestic points. In addition, Asian capital costs in total operating costs has risen rapidly carriers have expressed concern about the bargaining since the 1970s. Airlines will be reviewing the financing power of European compared with Asian airlines. They of their acquisition of equipment. fear that the United States and Europe will exchange Debt finance, which was favored by govemment-flag domestic rights, permitting airlines in both countries to carriers, tends to place a large demand on eamings and develop more efficient networks in Europe and the to raise debt-to-equity ratios too high. Thus there are United States and to become stronger and more compet- strong demands for extra capital injections by current itive in markets outside their own regions. Finally, the owners or-that failing because of fiscal constraints on economics of networking have led to pressures for inte- 80 Air Transport gration across market sectors, which in turn has created a barrier to forming new networks or subcontracting new opportunities for multiple designation of airlines. services to low-cost members of the group. The divisions between market segments-domestic and international, The Emergence of the Megacarriers for example-will be a source of frustration. The result could be aradical change in the way the system operates. Rapid growth in the travel market, the economies real- ized by the extension of networks, and the value of Policy Issues vertical linkages involving tourism firms and airlines are likely to lead to the creation of systems of firms in the air Many of the original motivations for regulation are no transport industry. Services, instead of being assembled longerrelevant. Traffic is denser, and there are now more by consumers, will be packaged by the consortiums, airlines in the market. There aremoregateways and more whose activities can be coordinated by means of the CRS. routes that are close substitutes, at least in the eyes of The development of the consortiums may extend fur- consumers. The moves toward privatization are diminish- ther, to the emergence of "global airlines" or "multina- ing concern about unfair competition from subsidized air- tional corporations" in the airline industry. At present lines. In short, the market has become more competitive. this step is restricted by ASA rules on national ownership, The interests of the tourist industry are being given but the diminishing role of govemment ownership will more weight in many countries. A regulatory system that broaden the scope for ownership links. These linlks may inhibits growth of capacity in the import-competing air also be valuable because they facilitate monitoring the transport industry is criticized by the tourist (or export) performance of other members of the group. sector, which is a consumer of its services. There may be This development could diminish the importance of the a perception at a national policy level that at least one issue of accommodating new suppliers-an issue of spe- locally owned and protected airline is needed to obtain cial interest to newly industrializing countries, which, as some share of the benefits of a tourism boom. Usually, noted above, are likely tobe highly competitive suppliers however, more efficient fiscal instruments are available of air transport services. The reason is that a typical for this purpose. Furthermore, this argument is uncom- strategy of a multinational corporation will be to locate fortably close to the position that the original regulators production in the most competitive locations, and this of air transport were trying to avoid-the exploitation for would naturally involve the new suppliers as their com- national benefit of the market power provided by control petitiveness increased. The alternative strategy, where over landing rights. But the effect of the emergence of ownership ties are restricted, is to use a series of subcon- the megacarriers on the competitiveness of the market is tracting arrangements. an important policy issue that will have to be considered. he appearance of megacarriers has implications for Within the ASAS, countries can influence the competi- reform of the ASAS. The pace of reform will be deter- tiveness of their local markets by: mined by the attitudes of various groups that have an interest in aviation issues-primarily established suppli- * Promoting fare discounting-if necessary, with the ers, new suppliers, national policymakers, and the tour- use of more flexible rules on fare setting ism sector. As aresultof the developments outlined here, * Reviewing rules on fixing capacity-for example, there may be an alignment of interests between new and moving to reviews of capacity after the event established suppliers, especially in the Pacific, where * Leaving open the option of multiple designation of traffic volume is growing rapidly. The established sup- local airlines pliers will haveanincentivetoencourage the entry of the new * Permitting foreign entry into domestic markets suppliers rather than to discourage it, as has been the case. * Easing the rules on the extent of foreign ownership Established suppliers may not need to decrease their of designated international carriers. absolute size, and they could even grow; their share of flying operations, however, may fall. They would be- Some countries are already unilaterally using these come the managers of the system, earning far higher variations on the standard ASAs. Thus it is not necessary proportions of their profit from commission sales than to establish a uniform market structure and rule of con- from production. This new role for the established sup- duct under the bilateral system. The bigger problem will pliers would ease the structural adjustment pressures be to ensure that local carriers have an equal opportunity from the emerging new suppliers. to pick up passengers in ASA partner countries and in The new consortiums will find the old regulatory sys- other countries. Moreover, the issues involved in market tem increasingly burdensome. Regulations, by making access have been expanded. Previously, the main issues the creation of ownership links more difficult, will pose concerned capacity; now there is increasing concern 81 Christopher Findlay about access to complementary services for both airlines favored nation principles but by a "balance of benefits" and their passengers. on the route. The market access dilemma occurs because efforts to increase the degree of competition for local passengers National Treatment reduce the country's bargaining power in relation to access for its airlines in foreign markets. The country Under the ASA system the national treatment principle "surrenders" conditions relating to market access that applies to such items as landing charges and air naviga- might be used to bargain for similar conditions at the tion fees-once access to the market has been obtained. other end of every route. From the point of view of the Thus the principle is important for exporters who have local air transport industry, concessions have been made gained access to the national air transport system infra- without obtaining sufficient aviation benefits in return. structure in an importing country. Although market ac- GATr-like principles may be useful in managing this cess is a critical issue, principles on market access need dilemma in that they can give a country an external to be supported by rules on national treatment because of standard against which to evaluate its access to foreign the difficulty of avoiding the problem within the ASAS. markets. The extent to which GATr-like principles are An example is the rule that government officials must fly already embodied in the ASAS is reviewed in the next with a national airline. Other issues concern complemen- section. tary services, including access to computerized reserva- tions systems, access to ground handling services, GATT Principles landing and other fees, and access to landing slots. The national treatment principle at present does not The GATr-like principles discussed here in relation to air cover rights of establishment because there are generally transport services are nondiscrimination, most favored limits on foreign investment in local airlines. An exten- nation treatment, national treatment, transparency, and sion in this direction would facilitate market access. The safeguards and provisions for settlement of disputes. principle also does not extend to access to points in the domestic market, where local carriers, although still Nondiscrimination often subject to restrictions, have an advantage over foreign airlines. Nondiscrimination is said to be a feature of ASAS, and indeed the agreements often contain explicit statements Transparency of nondiscrimination among foreign suppliers in access to complementary services, such as airport facilities. Currently, all ASAs are registered with the industry orga- (Whether foreign suppliers are treated the same as na- nization, the International Civil Aviation Organization tionals is a separate issue and is discussed below.) But (ICAO). The published agreements contain the general nondiscrimination in negotiations about capacity is an- rules on setting capacity and the like. But there are often other matter. If a country used the same set of rules for side agreements that are not published and that provide fixing capacity in all its ASAS, the ASAS would not be details on rules used to set capacity and on other forms discriminatory. In practice, however, the rules vary-for of cooperation, such as revenue pooling. The system example, according to the acceptance of multiple desig- would be truly transparent if all aspects of the agreements nation or the use of different systems for setting capacity. were published. In this respect, the ASAs are discriminatory. Safeguards and Settlement ofDisputes Most Favored Nation Treatment Issues about competition with low-wage countries usu- Even if the rules for negotiating market access were not ally arise in discussions concerning third-country carrier discriminatory, the ASAS still would not satisfy the most market access and diversion of traffic through offers of favored nation condition, since the allocation of rights to cheap stopovers or other discounts. Subsidy issues can supply capacity are specific to particular countries (and be handled bilaterally within the ASAs-in the case of even firms) on any one route. In other words, if trips dumping, for example, by renegotiating capacity or the between two points are defined as the "product" for the rules for capacity fixing. The ASAS specify consultation purpose of these negotiations, there is discrimination processes and include the right to terminate an agreement among foreign suppliers of that product; some airlines and negotiate a new one. from other countries can fly the route and others cannot. This bilateral system of disputes settlement has the The exchange of traffic rights is not governed by most disadvantage thatdisputes willbe settledaccording to the 82 Air Transport bargaining power of the two parties. A "rules-oriented" because of pressure from within the market. This could system of settling disputes, such as the GATT tradition of be done initially widtin a general agreement on services, using panels and third parties, ensures that general prin- although many countries may be unwilling to endorse a ciples are adhered to in the resolution of any dispute. general agreement for all services, especially regarding services such as air transport for which negotiating insti- Summary tutions already exist. The value of the GATF approach is that it can complement those institutions in a way that The procedures and rules of the ASAs embody the prin- resolves some dilemmas, particularly those relating to ciple of nondiscrimination only to a limited extent, and complementary services. In the long run this may require they do not meet the most favored nation condition. They some more elaborate statement of how the principles do include national treatment provisions-although not apply to air transport. with regard to investment and access points-but these provisions are difficult to enforce. The ASAS include References some safeguard provisions and a means of settling dis- putes, but the procedure is subject to distortions through Castle, Leslie, and Christopher Findlay, eds. 1988. Pacifc Trade in the effects of relative bargaining power. ASAs are visible, Services. Sydney, Australia: Allen and Unwin. Doganis, Rigas. 1985. Flying OffCourse: The Economics of Interna- although not completely transparent. tionalAirlines. London: Allen and Unwin. There are several options for trying to extend the influ- Findlay, Christopher. 1985. The Flying Kangaroo-An Endangered ence of the traditional GA1T principles into the air trans- Species: An Economic Perspective of Australian International Civil Aviation Policy. Sydney, Australia: Allen and Unwin. port system. Doing so, it was argued above, would help Gialloreto, Louis. 1988. Strategic Airline Management. London: Pit- to resolve the national treatment issues, which are be- man. coming relatively more important. Market access issues ICAO. 1988. Civil Aviation Statistics of the World, 1987. 13th ed. are also significant, but developments in the marketplace Montreal, Canada. hindustries Assistance Commission. 1989. International Initiatives to suggest that some of the problems relating to access by Liberalise Trade in Services: Inquiry into International Trade in new suppliers will dissipate. Services. Discussion Paper 3. Canberra: Australian Government The issue, then, is how to incorporate GA1T principles Publishing Service. Kasper, D. M. 1988. "Liberalising Airline Services: How to Get from into the air transport negotiating system. A first step is to Here to There." World Economy 11 (March):91-107. reassert the relevance of GATT principles to trade in . 1988. Deregulation and Globalization: Liberalizing Interna- services, including air transport, and in so doing to sup- tional Trade in Air Services. Cambridge, Mass.: Ballinger for the port any moves toward more liberal approaches that arise American Enterprise Institute. 83 9 Maritime Transport Alexander J. Yeats It has become increasingly apparent that many previous As far as the relative importance of freight costs is conceptions and analyses of trade and commercial prob- concerned, empirical studies have demonstrated that, lems in developed and developing countries provide an contrary to the assumption often made, maritime trans- inadequate treatment of the influence of transport costs. port charges frequently pose a more important obstacle Although both theory and practical policy studies recog- to both developed and developing countries' trade than nize that different types of barriers work against penetra- do most favored nation tariffs. Investigations by Yeats tion of export markets, past analyses have largely (1976, 1977a) for Indonesian and Indian exports to the concentrated on the influence of artificial (government- United States are representative of these studies. They imposed) trade control measures such as tariffs and quo- show that the average ad valorem transport cost for all tas. Transport costs may have been neglected because products was approximately two to three times the pre- easily accessible data on their incidence was lacking or Tokyo Round tariff rates. Furthermore, some specific because it was presumed that freight costs were relatively products, such as Indian nonferrous metal ores and In- unimportant as compared with tariffs. A series of empir- donesian light consumer goods, had nominal freightrates ical investigations undertaken in the late 1970s showed of more than 50 ptrcent. Brodsky and Sampson (1979) that this latter point was erroneous, as nominal freight demonstrate that ad valorem transport costs for exports rates facing many developing country exports were two to the United States by ten Latin American countries to five times higher than post-Tokyo Round tariffs (see were far more imposing barriers than were tariffs. Samp- Yeats 1981 for a survey). Another reason for the relative son and Yeats (1977,1978) reach similar conclusions for lack of attention may have been the (again erroneous) Australia and the United Kingdom, while McFarland assumption that transport costs pose a natural barrier and (1985) shows that the average freight factor for U.S. imports as such are not subject to policy control. of crude materials averages more than 30 percent. Considerable evidence has now accumulated showing Several recent investigations have also shown that the that many of these preconceptions must be reevaluated. structure of maritime freight rates can have important For example, empirical analyses of liner conference detrimental effects on the composition of trade, since ad freight rates conclude that shipping charges are often valorem transport costs often rise with fabrication and administered prices that are unrelated to the underly- work against the local processing of domestically pro- ing cost of carriage. As an illustration, Deakin (1974) ducedraw materials.1 Nominal transport costs for trade found that among developing countries reach levels exceeding 100 percent on some total aggregate trade flows (Prewo Shipping conferences do not set prices with reference 1974). As a result, maritime freight costs are a significant to social, or even private cost, at least not predomi- constraint on increased South-South trade.2 nantly. Rather they fix their prices with regard to the Aside from the role of these studies in altering the strengths or weakness of demand for the carriage of traditional view of the influence of transport on trade, particular types of goods, using the principle gener- other factors have lent shipping problems great national ally referred to as charging what the traffic will bear. importance. Because of their persistent balance of pay- ments problems, many developing countries have long Similar conclusions have emerged from studies of liner been concerned with the outflow of foreign exchange for conference pricing practices by Bryan (1974) and by invisibles. Chief among these transactions are payments Lipsey and Weiss (1974). for shipping, which have been estimated as absorbing 84 Maritine Transport Table 9-1. World Seaborne Trade, by Country Group, 1970 and 1987 (Estimated) (percent) Share of world Share of world trade, by country groups shipping tonnage GoodsLoaded b Goods Unloaded b by country group Petroleum Dry All Petroleum Dry All registration' Country group a Crude Products cargo goods Crude Products cargo goods GRT DWT Developed market economies 1970 2.0 27.1 60.0 31.1 80.4 79.6 79.1 79.9 83.9 86.6 1987 16.4 27.5 65.3 45.5 72.1 82.3 62.3 67.9 65.8 68.1 Nonmarket Europe and Asia 1970 3.4 8.0 8.1 6.1 1.7 1.1 5.8 3.5 8.9 6.6 1987 9.4 17.7 6.2 8.6 3.5 0.8 10.0 7.0 12.2 9.9 Developing economies 1970 94.6 64.9 31.9 62.8 17.9 19.4 15.1 16.6 6.7 6.3 1987 74.2 54.8 28.5 45.9 24.4 16.9 27.7 25.1 20.9 20.9 Africa 1970 22.5 2.3 9.1 15.2 1.7 4.7 3.6 2.9 0.4 0.3 1986 21.8 8.1 5.0 10.6 5.9 2.3 4.6 4.7 1.3 1.2 Latin America and the Caribbean 1970 12.2 35.4 13.8 16.0 10.5 5.6 4.4 7.2 2.9 2.7 1986 11.7 12.2 13.8 13.0 5.5 4.1 4.4 4.7 4.1 3.9 Asia 1970 56.9 27.0 8.1 31.3 5.5 8.5 6.7 6.4 3.4 3.3 1986 40.9 34.8 9.6 22.4 12.1 9.4 18.5 15.5 14.0 14.4 Europe and Oceania 1970 n.a. 0.1 0.8 0.4 n.a. 0.6 0.4 0.2 n.a. 0.7 1986 n.a. 0.3 0.7 0.4 0.7 1.0 1.0 0.9 1.4 1.4 n.a. Not available. Note: DWT, deadweight tons; GRT, gross registered tonnage. a. For 1970, Developing market economies includes Yugosla- via; for 1987, Yugoslavia is under Developing economies, Eu- rope and Oceania. more than 20 percent of developing countries' export liberalization of maritime transport services lies in the revenues. For example, Yeats (1981, table 1.2) tabulated general imbalance between those nations' participation the share of total export earnings that selected developing in world trade and the volume of shipping tonnage actu- countries paid to foreign carriers for imports and exports ally under their ownership. Because developing coun- in 1977 andfound thatthese payments account for 25-35 tries own a small share of the world fleet, they normally percent of export revenues for such countries as have little direct influence on decisions concerning Bangladesh, Benin, Cameroon, Haiti, Mauritania, Mo- freight rates, which many studies have shown to be rocco, Niger, and Togo. For Burkina Faso, Chad, Jordan, administered prices, or concerning the quality and types Mali, and Somalia the payments were 33-60 percent of of transport services provided for their import and export total export earnings. Government policies favoring na- trade. This can have an important impact on their ability tional shipping lines are also important; Eyre (1987) toachievenational trade anddevelopmentobjectives. As estimates that the financial costs of these measures are an indication of the heavy reliance of developing coun- more than ten times higher than any associated develop- tries on foreign-owned ocean transport, table 9-1 pro- ing country gains (see table 9-2, below). videsabreakdown of theorigins and destination of world seaborne trade for selected years. Developing countries Industry Characteristics and Important originated approximately 47 percent of all tonnage in Institutional Factors 1987-slightly more than the developed market econ- omy countries-yet the combined registration of their An important element that influences the view of most vessels was only about 21 percent of the world fleet. In developing (and some developed) countries concerning Africa the differences are even more striking; these na- 85 Alexander J. Yeats Table 9-2. Estimated Initial Lossesfrom Cargo Reservation Schemes in Selected Developing Countries Shipping balance Cargo carried by Logistic payment ofpayment gains other lines losses Country (millio-s of dollars) (percent) (millions of dollars)b Ratio of losses to gains Argentina 34 50 98 2.88 Brazil 50 55 371 7.42 Chile 5 69 85 17.00 Colombia 11 50 86 7.82 Ecuador 8 60 41 5.13 India _72 58 309 4.29 Indonesia 40 78 362 9.05 Korea, Rep. of 52 50 894 17.19 Malaysia 23 80 480 20.86 Mexico 7 75 502 71.71 Pakistan 17 85 186 10.94 Peru 10 60 57 5.70 Philippines 37 80 224 6.05 Spain 47 55 667 14.19 Turkey 28 75 257 9.18 Uruguay 12 85 61 5.08 Venezuela 10 70 221 22.10 Total 463 - 4901 10.58 -Not applicable. Note: Shipping balance of payment gains assume that home-flag ships operate without any form of subsidy. Logistic payment losses are the extra eamings (rents) of non-national-flag ships attributable to the higher rates and poorer services associated with the cargo reservation scheme. a. Percentage carried by other than the home flag, as reported by the U.S. Maritime Admrinistration, Maritime Subsidies, FebruaTy 1983, supplemented by data from Seatrade and Bremen Institute. b. Dollar value of losses incurred by each country because of inflated freight costs associated with cargo reservation provisions. The figures include costs of various logistic operations (customs documents, bills of landing, export pernits, and so on). Source: Adapted from Eyre (1987). Useful information on the economic costs associated with United States cargo preference schemes can be found in U.S. General Accounting Office (1982,1984). tions account for about 11 percent of all goods loaded, tions that have caused great friction between exporters yet their combined ownership (registration) of world and shipowners (see appendix 9-A). In addition, the shipping is less than one-tenth this figure. The increasing dominance of market economy developed countries in capital-intensiveness of several sectors of marine trans- the ownership of this tonnage suggests that efforts to port (particularly containerized shipping) has been an liberalize trade in maritime transport services will meet important factor working against participation by devel- the greatest difficulty on issues relating to liners.3 oping countries. Stated simply, liners are ships that service a given route The differences in trade origins and fleet ownership under a predetermined time schedule. The routes and reflected in table 9-1 combine with two other significant timetable may be completely predetermined in that nor- institutional factors in maritime transport to form the mally no flexibility is allowed except for time lost basis for many international disputes. The first factor is through accident orbadweather. When two or more liner the longer-term overcapacity that has existed for many companies service a particular trade route, the competi- shipping services, especially in tanker operations. This tion is invariably limited by agreements covering freight problem will no doubt make attempts to liberalize the rates and other aspects of competitive behavior. These sector more difficult. The second factor is the institu- agreements are known as liner conferences. In practice, tional nature of the liner conference system. Although an internal competition among conference members is often unambiguous distinction cannot always be made, ship- restricted by agreements covering pricing, the allocation ping economists have found it useful to group maritime of cargoes and sailings, revenue pools, or the offering of transport services into three distinct markets, for liners, joint services. Some conferences also attempt to resist tramp shipping, and tankers or bulk carriers. Tramp, bulk outside competition by offering deferred rebates or dual carrier, and tanker services are generally contracted in rate contracts-that is, agreements that give lower rates more open markets. They have not been such points of to shippers who pledge not to use other shipping services. contention among trading countries as have liner confer- In addition to these arrangements, many conferences ences, which often operate under oligopolistic regula- admit new lines only on the vote of existing members. 86 Maritime Transport Admission to some "closed" liner conferences may that shipping conferences discriminate against given therefore be difficult or even impossible, although for ports or routes, against incoming as opposed to out- some types of cargoes and consignments liners may going trade, against specific types of products, or come into open competition with tramps.4 against small versus large shippers.8 Other factors have also heightened both developed and * Ad valorem freight rates that appear to escalate with developing countries' concerns regarding the influence the level of product processing, thereby deterring of shipping on their trade problems. An important source exports of processed commodities. of friction in the past has been the perception that liner * Failure to offer promotional freight rates to help new conference freight rates discriminate against specific products get established. Such rates could mean the ports, countries, or products. In part, such charges origi- success or failure of new export ventures. nate from the observation of large differences in rates * De facto discouragement by the existing (North- facing similar products transported over alternative South) pattern of liner conference routes of trade routes.5 Among industrial countries the United States among developing countries-trade that could have has been particularly sensitive to issues involving liner substantial beneficial effects. conference discrimination, and a number of congres- * Liner conference admission policies that preclude sional investigations have been held on the subject.6 entry of vessels of an exporting developing country. Developing countries have voiced related complaints Problems associated with therestrictive membership and have argued that liner conferences are insensitive to regulations are augmented by the failure to provide their industrialization needs in that they do not offer adequate data on profitability, cost of carriage for "promotional" freight rates for new exports. Studies con- actual products, and other operating practices (see ducted by the United Nations Conference on Trade and appendix 9-A). Development (UNCrAD) concluded that such promo- To resolve these and related problems, many countries tional freight rates can mean the difference between have adopted an approach that involves measures for success or failure for new export ventures. The North stimulating the growth of national fleets. UNCTAD has South geographic pattern of shipping routes also poses tabulated some of the reasons that developed and devel- problems for some developing countries, as existing liner routes often tie developing countries directly to one or a opmg countres have advanced for promoting their own few metropolitan states.I It has also been suggested that fleets. existing liner routes limit the commercial contacts of * To prevent disruption of service during hostilities. A developing countries and reduce their bargaining power country dependent on foreign shipping faces the risk in pricing their exports and imports. (Appendix 9-A lists that its trade may be disrupted during wartime. Even some of the main characteristics of liner conferences that a nonbelligerent country, like Argentina in World have often been serious points of contention between War II, may experience severe disruption in trade shippers and liner conference operators.) owing to changes in the supply of shipping capacity. To reduce economic dependence. A country that has Policy Approaches to Maritime Transport no national fleet must rely on foreign shipowners. Problems Commercial profitability is normally the primary consideration for individual shipowners, and, should The institutional arrangements associated with the oper- a given country's trade not provide sufficient profits, ation of liner conferences have been criticized for ad- tansport services might be withdrawn or might be pro- versely influencing the foreign commerce of both vided in old or unsuitable vessels or only at high prices. developed and developing countries. Many of these crit- * To influence conference decisions. A country that icisms are generally regarded as being so important that has its own merchant fleet can claim the right to they would have to be addressed in any code or conven- participate in liner conferences that affect its trade tion that attempted to liberalize barriers to trade in mar- and is thus in a position to influence conference itime services. Stated simply, the key objective of a decisions concerning freight rates and maritime liberalization effort in maritime transport services should transport policy. be to provide countries with the benefits of increased * To foster economic integration. In countries with a competition, which should also serve as a form of pro- long coastline or with inadequate internal transport tection from the abuses listed here. and communications, national shipping may be the only effective link between regions. * Discrimination-the charge that conference liners * To promote exports. Some developing countries deliberately favor their own countries' exports and have used national-flag ships to promote trade in new 87 Alexander J. Yeats products or with new partners. Their experience, schemes) also have additional adverse effects on trade, according to UNCrAD, shows that national lines take employment, and the balance of payments to the extent a more sympathetic view toward promotional freight that they have linkage effects outside the export sector. rates, which can be ofkey importance in these ventures. There appears to be a growing concern among econo- To diversify employment. Domestic construction of mists that cargo reservation schemes are a costly and national fleets may have important linkage effects on ineffective way of obtaining some of the desired ob- employment and secondary production. jectives of the code. For example, Wijkman (1979) notes: One approach for achieving the above objectives arid resolving grievances involving maritime transport was There is little doubt that the cargo reservation formula the adoption in 1974 of a United Nations Code of Con- outlined in the code is an inappropriate instrument to duct for Liner Conferences (see appendix 9-B for a list attain the assumed goals of the Liner Conference of signatories). The code was intended to deal with Code of Conduct. If its aim is primarily promotional, numerous aspects of liner conferences, but its most no- i.e., to develop merchant marines in developing coun- table provision is article 2(4), which concerns sharing tries, then direct subsidies to liner companies by gov- conference trade among member lines.9 There are two emments with maritime ambitions are more efficient. basic elements: (a) in liner trade between any two states, If the aim is primarily regulatory, i.e. to eliminate the national shipping lines of those states shall have monopoly profits in international liner shipping, then "equal right to participate in the freight and volume of rate regulation is more efficient and equally feasible. traffic generated by their mutual trade" and (b) third- If the aim is to provide a more equitable distribution party lines shall have "the right to acquire a significant of income in general or a fairer distribution of tax part, such as 20 percent, in the freight and volume" of revenue and rents from an international common that same traffic. The 20 percent figure is not a fixed property resource, then appropriately designed ves- absolute; it is merely given as an example of what a sel-licensing systems are more efficient. Finally, if the "significant part" of the trade might be. aim is to improve the balance of payments of devel- To most efficiency-oriented economists, the code's oping countries, protective measures to promote a cargo reservation provisions are subject to serious mis- domestic merchant marine are appropriate only in givings, since they represent a classic beggar-thy-neigh- exceptional cases. bor device. Eyre (1987) shows that, to the extent that these provisions make shipping more costly, they can Neff (1980) also argues that the cargo subsidy approach lead to substantial balance of payments losses for coun- is far preferable as a means of encouraging national tries adopting such schemes while Bennathan (1989) fleets, since it brings the cost of such operation out into shows they have increased freight rates for Chile's im- the open and need not have detrimental effects on the porters and exporters. The basic problem here is that in overall level of trade. trying to achieve the national objectives listed above, the code set limits to new competition that led to relatively Negotiations on Maritime Transport: higher freight rates and the transfer of monopoly rents to The Basic Objectives some of the more efficient members of the code's cargo reservation provisions. Eyre has argued that the code has Efforts to liberalize international trade in maritime ser- brought about substantially higher freight rates on many vices should recognize several key points relating to this African-European trade routes. The higher rates were objective. First, the substantial overcapacity and longer- needed to keep less-efficient domestic lines operating, term structural adjustment problems facing providers of but they led to important monopoly gains (rents) for marine transport services will undoubtedly heighten the European-owned vessels. Table 9-2 summarizes recent difficulties encountered in liberalization efforts. Second, projections of the direct balance of payments losses for distinctions must be made between different types of seventeen countries that have formal cargo reservation marine transport services when planning future action. schemes. Total losses from the cargo reservation Specifically, markets for bulk carriers and tankers oper- schemes are more than ten times the accompanying ate under relatively competitive conditions, whereas gains. These figures are based on Eyre's (1987) estimate liner conference services andcoastal shipping operations that, on average, freight costs of carriers involved in the are often highly restricted by govemment and private reservation schemes are 20 percent higher than those of measures. These latter operations will undoubtedly be other "efficient" liners. It should be noted that these the focus of marine transport liberalization efforts in the "inflated" freight rates (the result of the reservation multilateral negotiations. 88 Maritime Transport The third, and perhaps key, point is that any negotia- Issues relating to standards have been of major impor- tions on marine transport services will have to strike a tance for international trade in such goods as some food- balancebetween twodifferentandpotentiallycompeting stuffs, transport equipment, and machinery, and objectives. First, they must attempt to remove existing standards should also be addressed in the negotiations on obstacles to trade in this service sector so that countries maritime transport services. These issues may become can achieve the benefits of increased competition. Such significant in the Uruguay Round negotiations in the an objective may often conflict with cargo reservation context of container sizes, complementary transport schemes (which can be a costly and inefficient means of equipment such as roll-on roll-off vehicles, port equip- pursuing national maritime objectives), as well as with ment, and safety, wage, and related personnel require- diverse national regulations that apply to coastal trade. ments. A potentially useful approach to resolving such The negotiations must also recognize that there are often issues is to attempt to extend the GATT Standards Code important conflicts between existing institutional ar- for goods to maritime transport and other services.12 rangements in marine transport (particularly liner con- Finally, the problem of transparency may become par- ferences) and the trade and industrialization objectives ticularly important in cases in which tax subsidies or of many developed and developing countries. Progress other financial measures directly or indirectly assist na- in the marine transport sector will require an approach tional carriers or in which informal procedures favor the that accommodates these diverse concerns. use of these operators. As in the case of standards, the Given these broad considerations, an important ques- attempt to achieve increased transparency in maritime tion concerns the specific goals that should be pursued transport and other services can draw on extensive par- in the Uruguay Round negotiations. White (1988, pp. allel GAIT efforts regarding trade in goods. 92-99) suggests five objectives to be given priority. The first concerns regulations dealing with rights of Notes establishment. Here there is a need to establish principles for the foreign ownership of domestic business offices, 1. Janssen and Shneerson (1978) estimated the long-run marginal dockside facilities, and related equipment that a foreign these figures with acp iner con typees of commodities and compared carrier may need to conduct local business or offer spe- consistent tendency for LRmcs to lie above actual freight rates for cialized services. Issues conceming the right of estab- primasy and semiprocessed products, while the opposite effect was lishment may be of great importance if a foreign carrier observed for consumption and investment goods. This led the authors intends to extend its operations beyond the main interna- to conclude: 'Me principle of charging according to the value of service that is tional port of entry to further transport of goods in coastal apphed by conferences inplies that high value commodities subsi- trade. If international carriers are denied local facilities dize low value commodities. Excess freight factors escalate in a for cabotage to smaller (coastal) ports, they could be manner similar to tariffs. In comparison to a marginal cost-based placed at a significant competitive disadvantage on al system of chargesa shipping rates tend to encourage trade in raw materials and to discourage trade in processed commnodities [emn- operations with respect to national carriers. phasis added]. A second important issue concems competition and In a related empirical analysis Yeats (1977b) also observed a tendency dealings with state monopolies. In some developing forad valorem freight costs to escalate overmany conmodity process- domesti exporers maybe forally orinfor- ing chaSins. countries, domestic exporters may be formally or infor- 2. There is an important interaction effect associated with the mally required to utilize state-owned shipping compa- common practice of assessing tariffs on a cost-insurance-freight basis nies for maritime transport services. The Uruguay Round (ci.f) that cconpounds the difficulty some geographically disadvan- negotiations should address this problem, since such taged countries have in overcoming adverse competitive effects stem- ming frosn theirhiigherfreight rates. Specificaliy, a c.if. tariff valuation restrictions can place foreign carriers at an important base yields ahigherdutycollected onacomuny's expos siftheseitems competitive disadvantage. experience an unfavorable transport cost differential in respec to A related issue is the concept of national treatment. similar producs exported from other nations. Yeats (1981, p. 144) Articl 3 of he Genral Ageementon Tarffs an Trade shows that adverse freight rates may produce adverse tariff differentials Axticle 3 of the General Agreement on Tariffs and Trade of 5 to 10 points. This analysis suggested that developing countries (GATT) requires that imported goods receive treatment would generally benefit fromn a shift to a free on board (fo,b.) tariff that is equivalent to domestically produced merchandise valuation system such as that employed by Australia, Canada, and the after barriers at the border have been cleared.11 Subsi- United States, as opposed to the c.i.f system used in the EC and Japan. 3. Concem-ing this point an important distinction must be made dies available only to national carriers, cargo prefer- betweenintemational shipping onthe onehand and coastal shipping or ences, bilateral agreements, and cargo reservation cabotage on the other. In many countries coastal shipping is heavily provisions are clearly at odds with the GAIT concept of restricted by national regulations that extend beyond products trans- national treatment, at least as it has been applied to ported by trmp, tanker, or bulk carriers. Efforts to liberalize national regulations goveming coastal shipping will no doubt encounter signif- goods. icant difficulties. 89 Alexander J. Yeats 4. The primary difference between liners and tramp ships is that costs. Goods shipped from Porto Alegre in Brazil to Montevideo liners service regular shipments over a fixed route, while tramps do not actually reach their destination more quickly if sent via Hamburg have fixed routes but carry dry bulk cargo over long distances. One [Federal Republic of Gernany]. In fact Uruguayan woolis shipped utilizes a tramp service by hiring a whole ship, whereas individual to the United States by way of Hamburg even when there are ships shippers may transport only a small portion of a liner's cargo capacity. available going directly to New York. There are some construction differences; liners are usually able to 8. The difficulties associated with establishing empirical proof of generate higher speeds, and their holds are often compartnmentalized. these charges is demonstrated in Fashbender and Wagner (1973). Other Within the liner group a distinction is often made between "break bulk" studies that have tabulated lists of complaints by developing countries and container ships. A break bulk ship is designed to carry a heteroge- against liner conferences indude Richards (1968), uNcrAD (1969), and neous cargo, each consignment being separately packed with no uni- Valente (1971). form pattem. In contrast, container ships utlize standard umitzed 9. For countries participating in the formulation of the uSNcrAD packing devices that allow much of the loading to be done in the Code, there appeared to be general agreement conceming theissues to absence of the mother ship itself. Significant differences exist between be addressed. These are (a) aboliton of the power of conferences to liners and tramps, on the one hand, and tankers and bulk carriers, on decide on the admission of new lines; (b) allocation of cargoes within the other. The latter are highly specialized ships designed to carry a conferences on an intemationally agreed basis rather than by private limited range of cargo such as ores or petroleum. arrangements (the traditional way); (c) transparency of the levels of 5. As a general proposition,discriminaticn in maritime freight rates conference freight rates and the processes of conference decisionmak- orservicesmaybeheldtoexistwhenthechargeforaparticularproduct ing; (d) restriction of the power of making unilateral decisions on contributes more (or less) to the costs and profits required to provide matters vitally affecting the trade and economic prospects of countries; for its shipment than can be explained by soune objective method of and (e) establishment of an independent tribunal to which parties with allocating costs and profits. A detailed study by Fashbender and complaints about the operation of the liner system could have recourse. Wagner (1973) has demonstrated the difficulty of documenting actual No doubt these concems will have to be addressed in any new (GArT- cases of discrimination. These authors providenumerous examples that related) efforts to liberalize trade in maritime services. show how large differences in freight rates for similar products trans- 10. The distinction between a national shipping line and a national- ported over different liner routes of roughly similar distances can often flag line should be noted. A national shipping Ine is defined in the code be accounted for by such factors as port operations, differences in as "a vessel-operating carrier which has its head office of management volumes shipped (if econonmies of scale are important), or the types of and its effective control in that country and is recognized as such by vessels and cargo-carrying systems actually employed. See also uN- that country." That is, there must be a genuine link between the carrier crAD (1969, pp. 308-22), which reached similar conclusions. and the states. Vessels registered under flags of convenience do not 6. For example, the Joint Economic Committee of the U.S. Con- qualify as national shipping lines. This requirement places a natural gress concluded (1965, p. 1): limit on the extent to which developing states win be able immediately The intemational ocean freight rate stricture is weighted against to incease their share of world liner traffic at the expense of developed United States exports. Our exports bear most of the costs of vessel coumtries. National shipping lines may, however, make use of chartered operation, even in trades where imponts approximate exports in tonnage. value and quantity. Article 3, pama. 4 states: "The products of the tefritory of any In its finding no. 3 the committee also noted that a group of liner contracting party imported into the territory of any other contracting companies acting in concert can discriminate against nations by their party shaUl be accorded treatment no less favorable than that accorded operations and by the structure of the charges they adopt. to like products of national origin in respect of aU laws, regulations, Most ocean freight rates are set by steamship conferences whose and requirements affecting their intemal sale, offering for sale, pur- basic purpose is to setfteight rates ar d sailing schedules. But souse chase, transportation, distribution, or use." go eyod picefixngand include pooling arrangements whereby 12. See Stem and others (1986) for an assessment of the various go beyond price fixinguandimclude of arraments whed codes for goods trade that were negotiated in the Tokyo Round. It each member is guaranteed a share of cargo or revenues. United States flag lines are outnumbered in all but J of the more than 100 appears that many of the principles and procedures contained in these active conferences involved in United States foreign trade. In codes could be extended to trade in services. substance foreign lines, some of which are govemment owned, determine freight rates, sailing schedules, and otherconditions vital References to the expansion of American commerce. The monopoly power of the conferences seems to have weakened Bennathan, Esra. "Deregulation of Shipping-What Is to Be Leamed considerably on North-North trade routes since the committee made from Chile," World Bank Discussion Paper No. 67 (Washington: its report, but it is still a significantfactorin many developing countries' World Bank, 1989). trade. Useful comprehensive statistics on long-term trends in the U.S. Bennathan, Esra, and A. A. Walters. 1972. The Economics of Ocean oceangoing fleet can be found in U.S. Departmnent of Transportation Freight Rates. New York: Praeger. (various years). Brodsky, David, and Gary Sampson. 1979. "Intematidnal Transport 7. Del (1966) provides useful examples of how institutional fac- and Latin American Expons to the U.S." Internasional Journal of tors, such as the geographic pattem of liner routes, works against sorne Transport Economics 7 (December), pp. 279-292. developing country intratrade: Bryan, Ingrid. 1974. "Regression Analysis of Ocean Liner Freight The high cost of transport between Latn American ports has Rates on Some Canadian Export Routes." Journal of Transport seriously impeded the development of area trade: in many cases it Economics and Policy (May):161-73. is cheaper to ship goods from Europe or North America than Deakin, B. M. 1974. "Shipping Conferences, Some Economic Aspects between points within the region. For example, the freight rate for of Intemational Regulation." Maritime Studies and Management 2 lumber shipped from Mexico to Venezuela was $24 per ton as (May), pp. 1-18. compared to $11 per ton from Finland to Venezuela, even though Dell, Sidney. 1966. A Latin American Common Market? London: the distance is three times greater. From Buenos Aires to Tampico, Oxford University Press. Mexico the ocean freight rate for chemicals was $54 per ton for Eyre, John. 1987. "Maritime Impact Studies, A Different Game." direct shinent; butifthegoods weretransshipped in New Orleans Paper presented at the 1987 Annual Meeting of the Canadian the rate was only $46, while transshipment in Southampton, En- Transport Research Fonun, SL Johns, Newfoundland, June 10. gland, brought down the rate furtherto $40, despite the tremendous increases in distances involved. Noris it simply a question of high 90 Maritime Transport Fashbender, Karl, and Wolfgang Wagner. 1973. Shipping Conferences, uNcrAD. 1969. Level and Structure of FreightRates ConferencePrac- RatePolicyandDevelopingCountries.Hamburg, FederalRepublic tices and Adequacy of Shipping Services. TD/B/C.4138/Rev.1. of Germany: Verlag Weltarchiv. New York. Jansson, Jan, and Dan Shneerson. 1978. "The Effective Protection . 1988. Review of Maritime Transport. New York. Implict in LinerRate Shipping." Review of Economics and Statis- U.S. Department of Transportation. Various years to 1987. Maritime tics 60 (November) Administration, AnnualReports. Washington, D.C. Joint Economic Committee, U.S. Congress. 1965. Hearings beforethe U.S. General Accoundng Office. 1982. Cargo Preference Require- Subcommittee on Federal Procurement and Regulation. Discrnim- ments Add to Costs of Title aI Food for Peace Program. Washing- inatory Ocean Freight Rates and the Balance of Payments. Wash- ton, D.C. ington, D.C.: Govemment Printing Offie. . 1984. EconomicEffects of CargoPreference Laws. Washing- lipsey, Robert, and Merle Weiss. 1974. "The Structure of Ocean ton, D.C. Transport Charges" Explorations in Economic Research I (Sum- Valente, M. G. 1971. "The Participation of Developing Countries in mer) pp. 162-193. Shipping." In Shipping and Developing Countries. New York: McFarland, Henry. 1985. "Transport Costs for U.S. Imports from Camegie Endowment. Developed and Developing Countries." Journal of Development White, Lawrence. 1988. International Trade in Ocean Shipping Ser- Studies 21,no. 4 (July). vices: The United States and the World Cambridge,Mass.: Harper Neff, Stephen. 1980. "The UN Code of Conduct for Liner Confer- and Row. ences." Journal of World Trade Law. September-October, pp. Wijkman,PerMagnus. 1979. Effects of CargoReservation: A Review 398-415. of UNvcrADs Code of Conduct for Liner Conferences. Stockholm: Prewo, Wilfred. 1974. "The Structure of Transport Coats on Latin Institute for Intemational Economic Studies. American Exports." Weltwirgschaftliches Archiv 114. Yeats, Alexander. 1976. "The Incidence of TransportCosts onIrndones- Richards, P. J. 1968. "Shipping Problems of Underdevdoped Coun- ian Exports to the United States." Bulletin oflndonesian Economic tries." Bulletin of the Oxford University Institute ofEconomics and Studies (November), pp. 61-75. Statistics 29 (August), pp. 177-193. . 1977a. "A Conparative Analysis of the Incidence of Tariffs Sampson, Gary, and Alexander Yeats. 1977. "Tariff and Transport and Transport Costs on India's Exports." Journal ofDevelopment Barriers Facing Australian Exports." Journal of Transport Eco- Studies (October), pp. 97-107. nomics and Policy 11 (May), pp. 141-154. . 1977b. "Do Intemational Transport Costs Increase with Fab- . 1978. "Transport Costs on U.K. Exports." Journal of Trans- rication? Some Empirical Evidence." Oxford Economic Papers port Econonics and Policy 12 (May), 196-201. (November), pp. 458-47 1. Stem, Robert and others. 1986. An Assessment of the Implementation - . 1981. Shipping and Development Policy: An Integrated As- and Operation of Tolyo-Round Codes, Research Seminar in Inter- sessment. New York: Praeger Scientific. national Economics. Discussion Paper 174. Ann Arbor. Depart- ment of Economics, University of Michigan. 91 Alexander J. Yeats Appendix 9-A. The Basic Features of Most Self-Regulated Liner Conferences Feature Comment Relations between member lines Membership Closed, with confidential criteria for the admission, withdrawal, or expul- sion of members. Share of trade The basis for allocation of cargo shares is usually confidential. Pooling Confidential cargo or revenue pooling agreements cover the share of cargo or revenue due to each member line; sometimes there is provision to ensure the carriage of low rated cargo. Sanctions Agreements often provide for sanctions against breaches of the agreement by member lines. Self-policing Self-policing machinery normally exists to ensure compliance with confer- ence agreements. Publication of conference agreements The conference agreement governing operations is generally a confidential document Relations with shippers Loyalty arrangements Loyalty arrangements comprising fidelity clauses with shippers (dual rate systems, contract systems, or deferred rebate systems) are generally em- ployed. Dispensation There are generally no arrangements for giving loyal shippers reasonably prompt dispensation to use nonconference vessels. Publication of tariffs and related No provision for publication is usually made. U.S. Maritime Law regula- regulations tions provides an important exception on U.S. trade. Consultation machinery There is general concentration of authority at conference headquarters. Representation There is generally no representation of merchant interests concerning the setting of rates and other conference operations. Freight rates General freight rate increases Freight rates are imposed unilaterally; the basis for freight rate charges is usually confidential. There are usually no specific provisions for determin- ing freight rates and usually no procedures for prior consultation. The time of notice is not generally specified. Specific freight rates There are procedures for determining freight rates on new cargo items and handling requests from shippers for reductions of specific freight rates but no procedures for consultation on increases of specific freight rates. Promotional freight rates There are usually no specific provisions for determining promotional freight rates. Surcharges Surcharges are generally imposed without prior notice and often without specific justification. Currencies and exchange rates Procedures for consultation existing in the United States and Western Europe in connection with floating exchange rates do not seem to operate effectively, and consultation procedures with developing countries are virtually nonexistent. Other matters Outside competition There are devices to prevent or eliminate outside competition. Averaging of freight rates There is generally provision for the averaging of freight rates over port ranges. Quality of service There is generally no provision for the type or other characteristics of the shipping to be used. Adequacy of service The responsibility for providing adequate service usually rests with indi- vidual lines. Source: Tabulated by Yeats (1981) frm uNcrAD documents. 92 Maritime Transport Appendix 9-B. Contracting Partes to the Convention on a Codefor Liner Conferences, as of 31 May 1988 Algeria Germany, Federal Republic of Norway Bangladesh Ghana Pakistan Barbados Guatemala Peru Belgium Guinea Philippines Benin Guyana Republic of Korea Bulgaria Honduras Romania Cameroon India Saudi Arabia Cape Verde Indonesia Senegal Central African Republic Iraq Sierra Leone Chile Jamaica Sri Lanka China Jordan Sudan Congo Kenya Sweden Costa Rica Kuwait Tanzania C6te d'Ivoire Lebanon Togo Cuba Madagascar Trinidad and Tobago Czechoslovakia Malaysia Tunisia Denmark (except Greenland Mali Union of Soviet Socialist Republics and the Faore Islands) Mauritania United Kingdom of Great Britain & Egypt Mauritius Northern Ireland (on behalf of the Ethiopia M U.K., Gibraltar and Hong Kong) Finland MoroccoUruguay France Venezuela France Netherlands (for the Gabon Kingdom and Aruba) Yugoslavia Gambia Niger Zaire German Democratic Republic Nigeria Zambia 93 10 Professional Services Padma Mallampally Professional services may catertoproducers of commod- other service providers is unclear. Existing typologies ities and other services or directly serve the needs of final based on international or national classification systems consumers. Feketekuty (1986) defines professional ser- for economic activities or products are not very helpful vices as the application of knowledge and skills by in determining what to include. Table 10-1 presents an experts to meet clients' needs. A study prepared for the illustrative list that is fairly broad in scope. Organisation for Economic Co-operation and Develop- One group of services of considerable interest for the ment (oEcD) describes professional services as multilateral trade negotiations is professional business services, such as accounting, legal services, manage- the provision of intellectual or specialized skills on a ment, consultancy, market research, architectural and personal, direct basis, based on extensive educational engineering services, and computer-related services (in- training . . . some take a broader view and would cluding hardware-related consulting, installation, data pro- include most forms of cultural, artistic, or intellectual cessing, and the development and implementation of endeavor as professions. It is also recognized that the software).' In many of these activities firms located in definition is not static, and that occupations over time developed market economies have a clear comparative can rise to professional status. (Arkell and Harrison advantage and engage in international transactions, often 1987, p. 4.) through transnational service corporations that began by catering to their corporate clients when the latter ex- The professional services sector, taken as a whole, is tended their activities abroad. distinguished more by the characteristics of the service Several developing countries, however, are also rapidly provider than by the service outpuL Professional service strengthening their domestic and international capabili- providers have recognized expertise (as attested by their ties in such business services as software services, data education, training, experience, and often, certification processing, project management, and consultancy. The or licensing) and enjoy considerable independence and inclusion in the multilateral trade negotiations of these personal responsibility. Professional services thus cut services, as well as of certain nonbusiness professional across several other service categories grouped by type services such as those provided by doctors, nurses, and of activity, product, or user. For instance, professional teachers, could be of interest to developing countries. services of one kind or another are an essential part of Developing countries with large numbers of educated producer services such as construction and engineering, people may also be able to build up capabilities at the trade, financial services, transport, and communications, lower (or less knowledge-intensive) end of many profes- as well as consumer services such as tourism, entertain- sional services. If the dividing line with respect to skills ment, and health care. Given this overlap, classifying is not drawn too rigidly, this would broaden their range certain service activities separately as professional ser- of interest considerably. vices implies that the principal element in these services, In the context of the multilateral trade negotiations, any whether they are provided to producers or to consumers, consideration of international transactions in profes- is the interaction between professional individuals and sional services must address cross-border trade, foreign recipients. Examples that come readily to mind are legal direct investment, and the international movement of and medical services. persons. Few professional services are traded through The cutoff point with respect to the degree and nature cross-border transactions in the service output alone. of expertise and skills that separate professionals from This chapter attempts to examine the significance and 94 Professional Services Table 10-1. The Liberal and Intellectual Professions Actuary Dentist Optometrist Agronomist Designer Osteopath Analyst Dispensing optician Animated cartoonist Doctor (general practitioner Pharmacist Architect or specialist) Photographer Archivist Document researcher Physicist Artist Physiotherapist Auctioneer and valuer Economist Practitioner of dentistry Auditor Engineer (various disciplines) Process-server Author Estate agent Psychologist Estate manager Publicist Biologist Estimator Broker Sales representative Geologist Sculptor Chemist Graphologist Social worker Chiropractor Guide Sociologist Composer Sports instructor Computer scientist Interior designer Stage manager Conference interpreter Statistician Consultants of various kinds Journalist Stockbroker Legal consultant Judicial officer Surveyor Property consultant Marriage guidance counselor Landscape gardener Teacher Organization and method Lawyer Topographer consultant Town planner Tax consultant Masseur Consulting engineer Midwife Veterinary surgeon Criminologist Notary public Window dresser Decorator Nurse Writer Note: This list is not confined to the traditionaUyhlimited number of professions in the strict sense of the term, such as advocates, notaries, judges, doctors, and architects. It was drawn up by the Conunission of the European Comnmunity to represent the collectivity of liberal and intellectual professions in the present state of development of science, technology, and social institutions. These are occupations which, irrespective of the legal status (salaried or self-employed) of those who pursue them, are characterized by independence and personal responsibility and are not primarily economic in their content. Source: Reproduced with minor modifications from Nusbaumer (1987, p. 85). 95 Padma Mallampally nature of international transactions in selected profes- education and entertainment can be embodied in sional services, the existing regulations that influence goods-books, tapes, or computer discs, for example- those transactions, and some of the main issues relating and traded across frontiers, but under present practice to the application to professional services of the key this would normally be classified as trade in goods, not principles that would form the basis for liberalization. services. Some cross-border trade in professional ser- vices is conducted through transborder data flows on Professional Services in National Economies international communications channels, and this is likely to increase rapidly as a result of the dynamic growth in As a nation develops, professional services are needed to telecommunications. But the expertise involved in most support the growth of the manufacturing sector of the professional services extends well beyond the pure infor- economy and of the infrastructure and social services that mation component, andpure cross-border trade probably determine the quality of life. It is difficult to quantify on represents only a small part of international transactions the basis of currently available empirical evidence ex- in these services. In other words, the value of services actly how important professional services are in the delivered or received through the movement across bor- global and national economies. For the OECD countries ders of individuals (as sellers, buyers, or both) and the taken as a whole, business services, social and commu- temporary or permanent establishment of production nity services, and recreational and cultural services, in- facilities in other countries must be taken into account to cluding both free-standing services and those directly get a correct picture of the international market for pro- linked to the production of goods, together represented 7 fessional services. Butalthough the value of services sold percentage points out of the 45 percent of value added or purchased through the movement of producers or accounted for by the market services sectorduring 1980- customers for limited periods of time is generally in- 84 (Blades 1987). It is estimated that business services cluded under cross-border transactions between resi- account for about 5 percent of the gross domestic product dents and nonresidents (that is, as exports and imports (GDP) of the European Community and that their output reported in balance of payments statistics), data on sales by makes up 5 to 10 percent of all intermediate inputs into foreign affiliates are lacking for most countries. the productive branches of the economy (Commission of In recent decades intemational transactions in services the European Community 1988). Furthermore, employ- have grown rapidly as a result of growing worldwide ment in professional services has been growing rapidly. trade, investment, and interdependence in the goods sec- In the United States during 1982-87 employment in tor as well as in services themselves. It is not known "business and professional services" and legal services, precisely to what extent professional services as a group which together account for 20 percent of services em- have shared in this growth, but available information ployment, has grown at 6 percent or more a year; em- shows that despite extensive barriers there is a sizable ployment in services in general grew at about 3 percent amount of international activity through the establish- a year and employment in the goods-producing sector at ment of foreign affiliates in certain professional services 2.5 percent a year (Sinai and Drury 1988). In five other such as accounting, management consultancy, and mar- industrial economies (Belgium, France, the Federal Re- ket research (see UNCTC 1989a). Data on sales by foreign public of Germany, and Sweden) employment growth affiliates of U.S. companies confirm its importance. Data rates in business services were 24 percent or more during for the United States also indicate that in certain other 1979-86, as against growth rates of 10 percent or less in professional services, such as education, health, and legal total employment (UNCTC 1989b). Similar approximate services, there is considerable trade in the form of direct indicators of the relative significance of professional export (or cross-border transactions as defined for bal- services for developing countries are, unfortunately, not ance of payments purposes); see table 10-2. readily available. Products and Markets in Selected Professional International Transactions in Professional Services Services This section describes operations and trends in several In addition to being intangible and nonstorable, profes- professions that are significant for international trade in sional services are intensive in human capital or sldls, services: accounting, law, computer services, and health and their delivery often requires close interaction be- care. An attempt is made, drawing on available data and tween the producer and the customer. Intemational trans- studies, to examine the nature of international transac- actions in professional services therefore involve much tions in those services and their significance for devel- more than pure cross-border trade. Such services as oped and developing countries. 96 Professional Services Table 10-2. U.S. Trade in Selected Professional Services, 1983 (billions of dollars) Foreign revenues of US. firms US. revenues offoreiRn firms Direct Affdiate Direct Affiliate Service exports sales Total imports sales Total Accounting 0.2-0.5 3.7-4.5 3.9-4.5 ... 0.7-0.9 0.7-0.9 Education 1.6-2.3 0.0-0.1 1.6-2.4 0.1-0.3 ... 0.1-0.3 Engineering 1.1-1.6 4.0 5.1-5.6 0.1-0.3 0.9 1.0-1.2 Health 1.0-2.5 1.1 2.1-3.6 ... 0.4 0.4 Legal 0.0-2.0 0.1 0.1-2.1 0.0-1.0 ... 0.0-1.0 Management and consulting 0.6-1.4 1.2 1.8-2.6 0.0-0.5 0.1 0.1-0.6 Software 2.5-2.6 3.2-4.4 5.7-7.0 0.0-2.2 0.0-0.2 0.0-2.4 All services, except banling 61.0-75.1 87.5-97.3 152-169 44.0-563 68.5-74.8 113-131 All services, including banking n.a. n.a 161-178 n.a n.a 118-147 ... Zero or negligible. n.a. Not available. Source: OTA (1986, pp. 41,42). Accounting Services count for 15 to 25 percent of the revenues of the principal accounting firms in the United States. The principal services provided by the accounting indus- Many large accounting firms also engage in manage- try are auditing and accounting services and tax-related ment consulting and have diversified into areas beyond services. In the United States auditing and accounting are the traditional ones. These lines of business-including estimated to account for 50 to 75 percent of the major the planning, design, and installation of computer sys- accounting firms' revenues (OTA 1986, p. 48), and it is tems for processing business transactions and the provi- likely that this share is similar in other countries. In sion of information to management-evolved from the providing auditing and accounting services, accountants financial information and advisory services provided in seek to ensure and improve the integrity of financial the accounting and tax areas and from the modern appli- information reported by the clients and advise clients on cations of computers to management needs. The range the organization of their record-keeping and financial of services offered by some major business firms also control systems. Auditors provide corporations and other includes strategic planning, market and feasibility stud- organizations with an independent opinion that the finan- ies, tailored business research, and merger and acquisi- cial statements prepared by these bodies fairly present tion assistance (Rossi 1986, p. 137). OTA estimates that the operational results and financial position of the busi- management consultancy accounts for slightly less than ness, in accordance with specified accounting standards. 10 percent of the revenues of the principal accounting In most countries publicly held corporations are required firms in the United States. to issue independently audited financial statements on In developed market economies the accounting ser- the basis of audits conducted by certified public accoun- vices business has been intemationalized to a significant tants (CPAs), who have passed uniform Pational qualify- degree, mainly through the activities of the largest firms. ing examinations. In the United States and some other This process began in the nineteenth century, when Eu- countries requirements for certifying accountants, en- ropean accounting firms followed their clients as the forcing accounting standards, and setting limits on the latter undertook investments and activities abroad, scope of accountants' activities are largely determined mainly in the colonies. The roots of this process lay in by the profession itself (in the United States by the the intimate knowledge that accountants and auditors American Institute of Certified Public Accountants). In build up with respect to their clients' operations and other countries governments assume significant respon- financial transactions, in their mutual trust, and in the sibility for this regulatory function. advantages of continuing such a relationship. The tre- Tax-related services provided by accountants to indi- mendous growth of U.S. transnationals since the 1950s viduals and organizations include consultation, tax plan- has created a similar demand for overseas auditing, ac- ning, and preparation of tax retums required by various counting, and other advisory services from U.S. account- taxing authorities. These services are estimated to ac- ing firms. This pattern of growth has now been 97 Padma Mallamnpally Table 10-3. The International Activities of the Largest Accounting Firms, 1986 Fee Nwnber offoreign affiliates Nwnber of staff (millions of dollars) Developed Developing Percentage Percentage Firm name and home country Total countries countries Total foreign Total foreign Arthur Andersen 141 82 59 36,117 44 1,924 30 (United States) Coopers & Lybrand 397 249 148 38,500 65 1,695 50 (United States) Peat-Marwick 297 168 129 32,183 55 1,672 35 (United States) Ernst & Whinney 332 211 121 28,800 56 1,492 39 (Urnited States) Klynveld Main Goerdaler 498 396 102 30,894 n.a. 1,137 89 (Netherlands) Binder, Dijker, Otte 294 258 36 13,027 n.a. 531 n.a. (Netherlands) DeardenFarrow 193 137 56 5,717 84 211 86 (United Kingdom) Spicer and Oppenheim 227 166 61 7,775 72 263 75 ((nited Kimg Wm) n.a. Not available. Note: Thefinms included are the topfini sfromneachof the threecountries included nalistpreparedbyuNcrcofthetwentylargestfimns worldwide. The data for different fmns may vary in terms of coverage of member, representative, correspondent, and affiliate firms. For details, see uNcrc (l989a),p. 196. Source: uNcrc (I989a), pp. 194-95. supplemented by the search for new opportunities in brand of accounting methods can be offered worldwide. foreign markets. OTA estimates that direct exports plus As a result of the strong advantages built up by the large affiliate sales by U.S. accounting firms amounted to $4.0 firms through this system, there is a high degree of bilion-$4.5 billion in 1984. (Sales in the United States market concentration; according to one estimate, in 1983 by foreign accounting firms are estimated at less than $1 the world's nine largest firms probably controlled more billion.) The OTA data also suggest that affiliate sales than one-third of the world's accounting business account for 90 percent of the total foreign revenues of (Noyelle and Dutka 1987, p. 39). Available data point to U.S. accounting firms and an even higher proportion of considerable concentration in the accounting market in the U.S. revenues of foreign accounting firms. This high- that large companies, including transnational corpora- lights the importance of the direct relationship with cli- tions, are audited by the largest affiliations (see Bavishi ents necessary for the delivery of accounting services. and Wyman 1983, pp. 135-39). This is, however, not the The international activities of selected top accounting case in other segments of the market, where competition firms are shown in table 10-3. These firms have estab- for the business of small and medium-size firns is in- lished extensive networks of affiliates in developed as tense (Noyelle and Dutka 1987, p. 113). Consequendy, well as developing countries. The typical organizational numerous small and medium-size firms, as well as inde- form for these activities has been to join forces with pendent professionals, are active in both domestic and existing local entities, creating a network of national foreign markets. Furthernore, although international affiliates that are owned and managed locally but are transactions are dominated by firms from the developed linked to an international organization that retains coor- market economies, increasing participation of firms from dinating and standardizing responsibilities. To some ex- developing countries such as India and Tunisia has been tent this pattern has emerged because of local regulatory observed in international transactions in accounting ser- requirements that branch offices be set up in partnership vices (uNcTc 1989b). with locally licensed accountants, but it has also been Nevertheless, the present pattern of international trans- influenced by the need to involve local professionals actions in accounting indicates that the comparative ad- with an intimate knowledge of the language, culture, vantage in this industry lies with finns from the United business practices, and laws of the host country. States and theUnited Kingdom and some otherEuropean The international network provides a legal framework countries, where the coordinating offices of the main under which certain training and development costs can accounting networks are located. The competitive ad- be shared, personnel can be exchanged, and a unique vantages enjoyed by these firms include access to trans- 98 Professional Services national clients, expertise, experience with the standards legal profession, services provided abroad by lawyers required by transnational corporations' home countries, and legal service firms are generally confined to legal and, in some cases, internationally known brand names. consultation, often on their home countries' laws. Such Economies of scale and scope endow these networks activities include provision of legal advice, participation with additional advantages, such as extensive informa- in negotiations, and preparation of documents. tion capabilities and development of new products, that U.S. and British law firms have tended to extend their not only accrue to users but are likely to be passed on operations abroad by opening their own branch offices, rapidly within the network and enjoyed by national affil- whereas European business law firms rely extensively on iates, yielding benefits to the countries in which account- loose network affiliations that provide referrals. In addi- ing transnationals operate. An important benefit is likely tion, private lawyers work in foreign firms as counsel for to lie in the training and professional education in which transnational corporations or travel abroad on a tempo- large accounting transnationals invest. This transfer of rary basis. Access to sophisticated telecommunications soft technology can, under appropriate conditions, be equipment that facilitates contacts with clients and home diffused to other national entities, strengthening their country office has increased the tradability of legal ser- capabilities and competitiveness and possibly resulting, vices and the mobility of lawyers. eventually, in overseas sales for the host countries. This The principal overseas business of transnational legal factor is likely to be of great interest to developing services firms is located in a few large international countries in assessing the benefits and costs of liberalizing banking centers such as London, Paris, Brussels, Hong international transactions in the accounting subsector. Kong, and Singapore, where firms cater to the legal work required in the preparation of financial and related doc- Legal Services uments. Although comprehensive data concerning inter- national transactions, even of the largest firms, are Legal services include the representation of clients in unavailable, international transactions in legal services civil and criminal courts, the negotiation and preparation are assumed to be dominated by the large U.S. and of legal documents, and other legal consultation and British firms. A 1983 survey of the 200 largest U.S. law advice. In the United States all these activities are in- firms showed that 50 of them had one or more offices cluded under a single category-the practice of law- abroad, in developing and developed countries (Crabb and, except in New York and a few other states that allow 1983). According to OTA estimates, foreign revenues of foreign legal consultants to practice, are reserved for U.S. legal firms amounted to more than $2 billion in locally licensed lawyers. In other countries, such as the 1983, while U.S. sales of foreign law firms were about United Kingdom certain areas of law are reserved for half that amount. Direct exports and imports-that is, qualified local lawyers, but others, especially those of a cross-border transactions-are the predominant mode consultancy type, can be undertaken by nonlawyers as (see table 10-2). Thus, despite the obstacles posed by the well. country-specific nature of legal practice and the opposi- The available information suggests that national legal tion of local law firms to the establishment of foreign law services industries are highly competitive, even in the offices, there appears to be a fair amount of international United States; there the sector has been growing rapidly transactions in legal services, at least as far as some since 1979 and some very large firms have emerged. developed countries are concerned. Most firms are, however, relatively small; U.S. practices The growth of the international market for legal ser- often have one or two lawyers and receipts of less than vices is difficult to foresee, given the existing national $100,000 a year. Business clients accounted for 49 per- regulations on entry of foreign firms and the relatively cent and individuals for 44 percent of the U.S. legal limited nature of international legal services activity at service industry's total revenue; the remainder repre- present. It has been suggested that the evolution of the sented government purchases of legal services and other legal market is likely to depend on the evolution of sources of income (oTA 1986, p. 82). additional relationships between barnks and law firms. International transactions in legal services take two Recent reports also suggest that developments such as forms: services provided to customers in foreign markets mergers and takeovers, privatization, and relaxation of and services provided to foreigners in domestic markets. restrictions in some countries have generated new de- As in many other services, national clients with transna- mand for intemational legal services (New York Times, tional activities are a significant source of foreign de- May 12, 1988). In any case, it seems likely that the trend mand for the services of a given country's legal firms. toward increasing internationalization of legal services Owing to thenatureofnational regulations goveming the in the industrial countries will continue. Information is 99 Padma Mallampally not available however, as to whether similar forces are 1990. This is still a minuscule proportion of the world at work for the legal services of developing countries. market, which is estimated at perhaps a thousand times that amount. Assuming supply availability, future Computer Software and Software Services growth is likely to depend on the ease with which large numbers of software professionals can move across bor- In recent years there has been a tremendous growth in the ders and on the development of alternative delivery worldwide information industry and the market for com- modes. Nevertheless, the industry provides a good exam- puter services, including computer systems and software, ple of the opportunities that could emerge for developing data processing, and related advisory services. The de- countries, at least for a period of time, in service areas velopment and use of software for a wide variety of that are experiencing rapid growth in international de- applications is leading to a growing demand for the mand for specific skills. services of computer professionals, who are involved in software development as well as in the actual provision Health Care of services related to use of software. These services are particularly important in the case of customer-specific Health care-primarily provided by doctors, dentists, software, where consultation and training are important and nurses-is an important segment of the services factors. sector in developed countries and also in developing Atpresent, the worldmarketfor standardizedandpack- countries, many of which include itin their public invest- aged software-the most rapidly growing and profitable ment allocations as a basic service for the community. sectorof the industry-is dominated by theUnited States Although data are not available, there are likely to be and a few other developed countries. The large invest- substantial differences in the capital-intensity and re- ment required, the costs of distribution, and the risks search-and-development-intensity of medical services in work to restrict entry into the packaged software segment developed and developing countries. The structure of the of this sector. Companies and individuals from both health care industry also varies significantly among industrial and developing countries are, however, devel- countries; private institutional and individual providers oping software to suit specific needs and modifying dominate in some countries, whereas publicly provided software packages for clients abroad. Such services are services are significant in others. seen as an importantpotential source of foreign exchange International transactions in health services take sev- earnings for some developing countries, such as India eral forms: cross-border movements of physicians, and Brazil. For instance, India's somewhat special com- nurses, and related professionals, cross-border move- bination of a well-developed system of higher education, ments of patients or consumers, and international activ- links with educational and technological establishments ities of hospital managers, consultants, and others in developed countries, emphasis on industrialization, involved in the planning, design, and operation of health and widespread use of English has led to the emergence care facilities. U.S. experience suggests that although of a large pool of scientific and engineering talent capa- health professionals from developed countries often ble of providing software services abroad. In recent years work abroad under aid, development, and exchange pro- India has emerged as a visible provider of professional soft- grams, they rarely go abroad on their own to establish ware services to developed countries (see Srivastava 1989). individual practices (Feketekuty 1986, p. 36). Several To date, the principal mode of delivery of these ser- large health management companies, especially U.S. vices-accounting for 80 percent of overseas earnings concerns, entered the international market in the early by Indian software companies-has been delivery to 1970s, however. These companies drew on their consid- clients on site. The close contact this permits with the erable comparative advantage in technology and man- client, as well as the constraints with respect to interna- agementexpertiseto deliveravariety of services ranging tional communications at the present stage of their de- from the design, construction, and operation of health velopment in India, favor onsite production. Offshore care systems to the provision of auxiliary services to production (in India) and delivery of "separated" soft- individual hospitals. Such companies may establish ware to foreign buyers have been limited, although some branches, subsidiaries, or joint ventures. They are active major American companies have moved some software- primarily in Western Europe, the Americas, the Middle developing activities to India. Establishment of local East, and the Pacific area (uNcTc 1989a, p. 28). affiliates by Indian firms has not yet played a role in the Exact data on the purchase of health services by patients delivery of Indian software services to foreign markets. from other countries is lacking. The available informa- Exports of computer software and software services tion indicates, however, that such movement occurs not from India are projected to be about $200 million in only from countries with less developed medical facili- 100 Professional Services ties to sophisticated medical centers in Westem countries through affiliates' activities as well as directly with cli- but also within developing regions. ents. The practice in some countries of limiting permitted The delivery of health services through the movement transfers to a certain proportion of capital investment of providers themselves is likely to be of most interest to poses a particular difficulty for professional services health professionals of some countries. Doctors and firms, which are typically labor-intensive. Restrictions nurses from some developing countries with a relatively on transborder data flows can affect firms' ability to abundant supply of medical skills have moved in fairly conduct transactions through affiliates and directly. significant numbers to both developed and developing General or industry-specific rules that prohibit or limit countries in which there is a demand for their services. foreign equity participation can hinder the ability of Such moves may be for a limited time, as in the case of firms to establish affiliates abroad. Although most devel- many South and Southeast Asian doctors practicing in oped market economies are relatively open to foreign the Middle East, or may be more permanent, as in the direct investment, a number, including Australia, Aus- case of Indian, Filipino, and other physicians who have tria, Canada, France, New Zealand, and Norway, require migrated to Europe and the United States. (In 1976 prior authorization for certain types of inward invest- stringent visa and qualifications regulations went into ments, which may act as an impediment to foreign direct effect in the United States, making such moves more investment (OECD 1987). Several developed countries difficult.) also exclude or limit foreign ownership in sectors such In the case of health services, where there are visible as banking, insurance, telecommunications, and broad- differences in the cost of services as well as in the range casting, which have a significant professional compo- and quality of services available, the efficiency benefits nent. There seem to be few restrictions on foreign direct to both consumers and producers from free international investment in professional services as such, possibly transactions seem obvious. Nevertheless, numerous pro- because regulations relating to the movement or licens- tectionist forces arise from considerations relating to ing of foreign professionals effectively limit the delivery preserving health professionals' income levels, protect- of foreign professional services. ing existing health care firms, and, in developing coun- In developing countries rules and regulations regarding tries, preventing the depletion of skilled personnel, who the establishment of foreign affiliates are generally, al- are often trained at public expense. Other, and equally though not invariably, stricter than in developed coun- important, considerations concern protection of consum- tries with respect to entry control, screening, and the ers, which leads to strict regulation of entry through degree of foreign ownership permitted. Most developing accreditation or licensing procedures. countries limit the range of activities in which wholly owned affiliates of transnational corporations can be Restrictions on International Transactions in established and stipulate minority foreign ownership in Professional Services many areas or reduction in foreign ownership over time. In several developing countries service activities such as Restrictions on international transactions in professional finance, transport, posts and telecommunications, and services are mainly imposed at the level of the firm or public services, including health and education, are the individual provider (Feketekuty 1986, p, 34) to hin- closed to foreign direct investment. Although it is diffi- der the establishment of local production facilities or the cult to identify specific restrictions regarding foreign physical presence of foreign professionals. The most direct investment in professional services, in some coun- important such measures include restrictions on foreign tries certain professional activities are specifically re- direct investment, reservation of certain professional served for entities with majority national ownership, activities for citizens, certifriation and licensing require- (accounting, law, and architecture in Thailand) or for ments for professions, and immigration rules and regu- fully nationally owned enterprises (legal services in the lations. Other barriers are less significant or less Republic of Korea, in which foreign investment is nor- common. Rules that limit the scope of activities permit- mally restricted). ted to firms in a particular professional category gener- One of the most directly protective regulations that ally apply to national as well as foreign providers; they affect intemational transactions in professional services are particularly relevant to accounting frms that have is the requirement of citizenship as a prerequisite for diversified their services. Restrictions on the use of practicing certain professions. Many developed coun- firms' intemational names do not seem to bewidespread tries (forexample,France, Germany,Japan, and Switzer- (Noyelle and Dutka 1987, p. 63). Foreign exchange land) restrict important areas of legal practice to citizens, controls on intemational payments and transfers affect mainly on the reasoning that the lawyer is an "officer of the ability of intemational firms to conduct transactions the court" and that these duties are so related to a vital 101 Padma Mallampally public institution that they cannot be entrusted to the period, may also be controlled by denying entry outright citizens of another country (Crabb 1983, p. 6). These or by requiring entrants to go through a long and compli- countries do allow noncitizens to engage in direct legal cated approval process. In 1977, for instance, objections consultation, but even then there are regulations concern- by the Japanese bar to the entry of an American lawyer ing whether the foreign lawyer may advise on home led to a freeze on visas for foreign lawyers wishing to country law, international law, or local law. open offices in Japan as well as for those who wished to Another significant impediment to the mobility of the consult with Japanese clients. Only after a counterprotest individual professional arises from licensing require- by the U.S. government and a number of reports, studies, ments in the regulated professions, such as accounting, and proposals did the Japanese government pass, in legal services, architecture, and medicine. In most coun- 1986, the Foreign Lawyers Practice Bill, which allows tries both local and foreign providers of such services are foreign lawyers to practice on a limited basis in Japan if carefully regulated through requirements concerning reciprocity is maintained (Noyelle and Dutka 1987, p. 76). length and type of education and qualifying examina- In the accounting profession, Arthur Andersen member tions. The purpose of these regulations is to ensure the firms reported difficulties in transferring professional quality of the service and to protect clients. In most cases personnel into foreign locations in sixteen countries the regulations tend to discriminate against foreign pro- (eight OECD member countries and eight developing viders, as countries are reluctant to give credit for educa- countries) out of twenty-seven surveyed (Rossi 1986, p. tion and training received in other countries. 154). In software and management consultancy, profes- In countries such as the United Kingdom and Japan, sionals from various countries have complained that although access to the local bar is not limited by citizen- under existing ad hoc arrangements countries can rewrite ship, the requirements for further study, examinations, at will the rules for granting temporary business visas and clerkship or training periods effectively serve as (UNcrc 1989b, p. 40). In the health care professions, deterrents. In accounting most countries are fairly liberal foreign doctors wishing to enter the United States face in granting foreign auditors the right to practice, permis- stricter immigration barriers since 1971 because require- sion being based on partial or total equivalency for ments for issuance of visas to foreign doctors have been diploma and work experience gained abroad. Neverthe- tightened on the grounds that there is no longer a shortage less, countries may prescribe that practicing accountants of physicians in the country. be residents of the host country for a certain period of time, place undue emphasis on matters having little to do Liberalization Concepts and International with professional competence, and impose unreasonable Transactions in Professional Services bureaucratic delays in procedures and examinations for foreigners (Rossi 1986, p. 157, reporting on a survey of The nature of professional services makes it difficult in accounting firms by Arthur Andersen). Health care is mostcasestodrawaclearlinebetweenattemativemodes another area in which professionals face rigorous certi- of delivery-cross-border trade, establishment of for- fication requirements in host countries: to practice in the eign-ownedorforeign-associated enterprises, and move- United States, for instance, a foreign doctor must obtain ment of professional persons. Transactions in a certificate from the Education Committee for Foreign professional services generally require the physical prox- Medical Graduates. The conditions include the imity of the provider and the client or consumer. Thus committee's approval of the applicant's foreign medical some of the concepts that were formulated during the school diploma, a rigorous test of facility in the English Uruguay Round and were incorporated in the midterm language, and tests on medical and clinical sciences. In agreement assume special dimensions and significance addition, the doctor must complete a residency in the in the area of professional services. United States and pass a state licensing examination The most important considerations have to do with the (Feketekuty 1986, p. 4). concept of market access. Access of professional ser- Immigration rules and requirements are also a formida- vices to international markets will in many cases require ble barrier to international transactions in professional the right of establishment or the right of firms or individ- services. Visas and work permits are particularly impor- uals to set up and operate undertakings in other countries. tant for the licensed professions, since most countries The right of commercial presence or the right to set up link the right to practice to residence as well as to an agency or representative office would facilitate not certification requirements. Visas are often issued on the only cross-border trade but also trade conducted through basis of whether individuals can meet licensing require- short-term movement of persons and might be relevant ments. The number of foreign entrants into the practice for services that can be delivered through temporary of a service activity, whether temporarily or for a longer relocation of professionals-for example, management 102 Professional Services consulting, market research, and computer software ser- reasons such as ensuring the growth of the domestic vices. But for many others, including accounting, legal sector and employment, remain important. Thus, al- and medical services, and other licensed services that though regulations that represent obstacles to interna- require continuous contact with the market and the client, tional transactions in professional services could be temporary relocation is nearly impossible or is quite re-examined to see if their protectionist content could be inadequate. reduced without affecting the attainment of national Consideration of the right of access in the sense of policy objectives, it cannot be assumed that all or even full-scale establishment and long-term presence could most obstacles will be eliminated in the long run. bring a range of foreign direct investment and labor Finally, the basic theme of the current negotiations on movement issues within the framework of the multilat- services-the promotion of "the economic growth of all eral trade negotiations. Whether this will indeed be the trading partners and the development of developing case will depend on how trade in services is defined and countries"-requires that the special interests of devel- how "cross-border movement of factors of production oping countries be addressed. This would mean the in- where such movement is essential to suppliers" is inter- corporation of measures to provide increased access to preted. The ministerial declaration on negotiations on developed country markets for professional services that trade in services, adopted at the midterm review meeting could be exported by developing countries. Such mea- of the Uruguay Round specified certain factors for fur- sures might deal with provision of improved information ther examination in this connection, including cross-bor- regarding markets and opportunities and recognition of der movement of services and payments, specificity of educational and professional qualifications. Perhaps purpose, discreteness of transactions, and limited dura- more important, attention must be given to measures for tion (GA1T 1989b, p. 38). strengthening the domestic capabilities of professional In the case of professional services the concept of service industries in developing countries. One possibil- market access must also include the right of individuals ity would be to increase developing countries' access to to practice, which includes mutual recognition of educa- professional services technology by linking the granting tional qualifications and licensing. This would require or renewal of firms'establishment rights to their training harmonization of or at least some agreement with respect efforts. to broad principles relating to educational standards and professional practice in different areas. Such an approach Concluding Remarks would also seem necessary if the principles of national treatment, most favored nation treatment, and nondis- Professional services are significant in the economies of crimination are to be applied. both developed and developing countries. Many of these If the broad interpretation of trade to include cross-bor- services are highly regulated with respect to domestic as der movement of factors of production is applied to trade well as international transactions. Liberalization of trade in services, the need for transparency is particularly in professional services is therefore likely to have impor- obvious forprofessional services. Ensuring transparency tant consequences for both groups of countries. may in fact be a formidable task. The parties involved Freer trade in professional services can be expected to would need information on laws, regulations, and guide- improve the efficiency of resource allocation in accor- lines relating not only to trade but also to foreign direct dance with the principle of comparative advantage. This investment and to accreditation or licensing of profes- would mean that buyers, whether producers or final sional individuals. consumers, would pay lower prices for importable pro- International transactions in many professional ser- fessional services. Because a number of professional vices have been dominated by large firms from a few services are in fact intermediate inputs into the produc- developed market economies. Many countries, espe- tion of goods and other services, this should lead notonly cially in the developing areas, will face issues relating to to lower prices for consumers of the imported services service quality, educational standards, licensing, immi- but also to lower production costs in several industries, gration and labor movement as they consider freer trade which might in tum enhance their export capabilities. In regimes. Hence the concept of progressive liberalization addition, the fact that delivery of many services requires seems of special relevance to trade in professional services. the establishment of affiliates, the participation of indi- It is widely recognized that liberalization of trade does vidual professionals from the exporting countries, or not mean deregulation. The right of countries to regulate both could provide opportunities for the transfer of tech- the professions through rules formulated by govemmen- nology (or skills and knowledge) to the recipient or host tal or professional bodies to ensure quality standards and economy. This should be of particular significance for protect consumers, as well as for other socioeconomic developing countries, which are likely to be importers of 103 Padma Mallampally professional services involving relatively advanced References skills from the industrial countries. On the export side, countries would gain in terms of Arkell, Julian, and Ian S. Harrison. 1987. "A Sectoral Study on the larger markets and higher prices for their exportable Relevance of the oEC Conceptual Framework to Intenational Trade in Consultancy Services." oEcD Secretariat,Paris. Processed. services. Available information on the present pattern of Bavishi, Vinod B., and Howard E. Wyman. 1983. Who Audits the trade (including cross-border transactions, services de- World: Trends in the Worldwide Accounting Profession. Storrs, livered through short-term movement of buyers and pro- Corn.: University of Connecticut Center for Traninational Ac- counting and Financial Research. viders, and sales by affiliates) suggests that in many Blades, Derek. 1987. "Goods and Services in oEn Countries." oEcD knowledge-intensive professional services the compara- Economic Studies 8:159-84. tive advantage lies on the sideof thedevelopedcountries. Conmission of the European Comununity, Directorate General for Some deelopin countres aremaking heir pesenceEconomic and Financial Affairs. 1988. "The Econonmics of 1992: Some developing countries are making their presence An Assessment of the Potential Economics of Completing the felt in international markets for highly skilled profession- IntemalMarketofthe European Community." EuropeanEconomy, als in certain areas, and, given the range of services no. 35 (March). involved, there may be further scope for such involve- Crabb, Kelly Charles. 1983. "Providing Legal Services in Foreign Countries: Making Roorn for the American Attomey." Colwnbia ment. For many developing countries, however, interest Law Review 1983:3 (December):1-57. is likely to lie in the export of professional services that Feketekuty, Geza. 1986. "Professional Services: An Overview." In are relatively labor-intensiveor thatinvolve practitioners University of Chicago Legal Forum, Barriers to International who are less highly skilled. Trade in Services. Chicago: University of Chicago Law SchooL GAIT. 1989a. "Reference List of Sectors: Note by the Secretariat." Given the variety of services involved and the fact that MTN.GNS/W/50. Geneva. Processed. different professional services are likely to be of export - . 1989b. Ministers' Declaration. Midterm Review Agreenents. interest to different countries, efforts toward trade liber- PL 2. MTN.TNC/I 1. Geneva. Noyelle, Thierry, and Anna B. Dutka. 1987. International Trade in alization must take into account several factors if they Business Services. Cambridge, Mass.: Ballinger for the American are to be relevant to developing as well as developed Enterprise Institute. countries. These factors include differences in skill and Nusbaumer, Jacques. 1987. Services in the Global Market. Boston, labor intensity of different professional services, in their OECO. 1987. ControlsandeImpedimentsAffectingInwardDirectInvest- modes of delivery, and in the relative roles of firms and ment in OECD Member Countries. Paris. individual practitioners in their trade. The existing distri- OTA, U.S. Congress. 1986. Trade in Services: Exports and Foreign bution of competitive advantages in professional ser- Revenues-Special Report. Washington, D.C.: Govenmuent Print- ing Office. vices makes issues related to mobility of professional Rossi, Frank A. 1986. "Govemtnent Impediments and Professional individuals of greater concern to developing countries Constraints on the Operation of Intemational Accounting Organi- than those related to establishment or foreign direct zations." In University ofChicago Legal Forum, Barriers to Inter- invesunent, on which the developed countries place con- national Trade in Professional Services. Chicago: University of investment, on which the developed ~Chiicago Law School. siderable emphasis. Incorporation of both these concerns Sinai, Allen, and Michael Drury. 1988. "Services and the Job Quality in a balanced manner is therefore a major task in the Debate." In Coalition of Services Industries, The Services Econ- formulation of an intemational framework covering in- omy 2, no. 4 (October): 14-22. (Data fromn Bureau of Labor Statis- tics and Boston Company Econormic Advisers, Inc.) temational transactions in professional services. Srivastava, Saurabh. 1989. "Computer Software and Data Processing: Their Expon Potentials." Paper prepared for the uNcrAD-iauER Note seminar on "The Role of Services in the Development Process: Intemational Experience and Its Relevance to India," New Delhi, April 27-29. Processed. 1. It is interesting to note that the proposed reference list of service uNCrC 1989a. ForeignDirect Investment and Transnational Corpora- sectors prepared by the GATr Secretariat in the context of the discus- tions in Services. New York. sions of the Group of Negotiations on Services contains a subgroup . 1989b. "Professional Business Services." Paper prepared for entitled "professional services" only under the category of business the Workshop for GNS Negotiators on the Activities of Transna- services. See GATr (1989a, p.4-1). tional Corporations in Services, November 11-12, Montreux, Switzerland. Processed. 104 11 Telecommunications G. Russell Pipe Telecommunications has been revolutionized in the past Second, the current multiplicity of telecommunications thirty years. Until the 1960s only a limited range of basic services makes possible greater mobility in the location services-mainly telegraph, telephone, and telex-was fordelivery of manufacturedand service products. Com- available to residential and business users. These ser- panies seek to base computer communication centers in vices were usually provided by government-owned and countries that offer a liberal regulatory environment and -operated public telecommunications organizations capabilities that are both low cost and technologically (PTos). Telecommunications services were traditionally advanced. These considerations have become important considered a natural monopoly. Because of the large for financial, transport, tourist, and other services. Many economies of scale involved in production, efficiency companies are regionalizing their data processing oper- demanded that one producer provide services for an ations, and countries are accordingly taking steps to give entire country. As public utilities, the PTOs strove to themselves a competitive advantage and attract these provide universal service-to achieve the greatest possible hubbing activities. National rivalries are now largely penetration of installed telephones among the public at large. between developed countries, but the insensitivity of New technologies based on digitization (the conver- telecommunications to time and distance is enabling gence of computer and telecommunications technolo- such developing countries as Jamaica, Morocco, Singa- gies) have greatly expanded the range of basic services pore, and Thailand to position themselves to capture far and have created a cluster of enhanced, or value added, greater international traffic. services. These technological changes have removed Third, in most developing countries there is a greater much of the theoretical rationale for the case that tele- inflow than outflow of communication traffic, generat- communications is a natural monopoly, and several ing significant foreign revenue for the government. Gov- countries have introduced competition in the provision emments and PTOS do not want to jeopardize this of certain services. Basic services-those associated important source of revenue. A number of developing with universal telephone service-are usually main- countries, however-including Argentina, Jamaica, the tained on a reserved, or monopoly, basis whereas en- Republic of Korea, Malaysia, Mexico, Morocco, Singa- hanced or value added services are open to competition. pore, and Thailand-are investigating whether lowering It is these enhanced services, utilized mainly by busi- international tariffs and relaxing certain regulatory con- nesses, that are usually considered tradable. They are at ditions may actually bring about an increased volume of the core of the Uruguay Round negotiations for three traffic and, consequently, higher net balances. Countries main reasons. that position themselves to become such centers are First, the greatest potential growth in telecommunica- likely to be assured of considerable growth and positive tions is in value added and information services offered balances in international traffic. commercially to business users by PTOs or other provid- ers and used in intrafirm networks set up by companies Recent Developments for their own worldwide operations. Countries' policies regarding these burgeoning new services may signifi- Available estimates for some member countries of the cantly influence growth in other service sectors. Thus the Organisation for Economic Co-operation and Develop- sector has become integral to economic development and ment (oEcD) show that the telecommunication sector's to trade in services. proportion of gross national product (CNP) is comparable 105 G. Russell Pipe to the share of the steel or the textile sector. Even these video, or data form. Strong growth trends are expected figures underestimate the importance of the sector owing in national markets, but it is not clear what percentage of to the difficulty of evaluating private sector investments these services is internationally traded. related to telecommunications and of separating domes- tic from international income. In 1980-84 the share of Technological Change transport, storage, and communications in gross domes- tic product (GDP) was 7 percent in developed countries Digitization-the encoding of information in a binary and 6 percent in developing countries (GATr 1988-9, pp. form rather by means of the analog method, which uses 23-30). wavelike representations of sounds-has vastly in- Because of their potential central role in the Uruguay creased the speed and reliability of telecommunications. Round, the market for value added network services The new digital environment exhibits two outstanding deserves particular attention (see table 11-1). Although characteristics: service convergence, which means that a definition is difficult to establish, value added network any and all services can be furnished through the same services are basically services that use the basic tele- storage and transmission medium, and connectivity and phone network to manipulate information in voice, interoperability, which means that multiple users, Table 11-1. The World Marketfor Value Added Network Services (bilions of dollars) Country or region 1988 1989 1990 1995 United Kingdom Information services 0.680 0.866 1.039 1.813 Processing 0.038 0.066 0.096 0.172 Messaging 0.090 0.144 0.215 0.403 Other 0.022 0.040 0.064 0.112 Total 0.830 1.116 1.414 2.500 France Information services 0.225 0.270 0.372 1.075 Processing 0.034 0.054 0.081 0.292 Messaging 0.046 0.074 0.170 0.450 Other 0.019 0.024 0.034 0.190 Total 0.324 0.422 0.570 2.070 Gernany, Fed. Rep. of Information services 0.240 0.310 0.391 0.910 Processing 0.025 0.040 0.060 0.215 Messaging 0.030 0.052 0.080 0.280 Other 0.014 0.018 0.025 0.140 Total 0.309 0.420 0.556 1.545 Other European countries Information services 0.505 0.679 0.875 1.342 Processing 0.048 0.077 0.115 0.413 Messaging 0.033 0.066 0.350 1.677 Other 0.027 0.035 0.048 0.269 Total 0.613 1.857 1.388 3.701 United States Information services 4.400 6.250 8.200 12.320 Processing 0.404 0.661 0.982 3.046 Messaging 0.930 1.240 1.580 2.920 Other 0.229 0.326 0.477 1.983 Total 5.963 8.477 11.239 20.269 Japan 1.700 2.750 4.000 9.150 World 9.739 14.042 19.254 39.172 Source: Systems Dynamics, value added network service monitor. 106 Telecommunications whether real persons or devices, can process and share a transaction.... The same information that is carried resources across network boundaries (Butler 1988; Pipe over a network to trigger a transaction can serve to 1989, pp. 10-17). Currently, all types of data travel on initiatepayment, verification andsettlementprocedures" highly defined and standardized paths, which make up (Bruce, Cunard, and Director 1988, pp. 185-86). what has been described as the world's first electronic Electronic data interchange (EDI) is a new and rapidly highways. expanding form of intrafirm transactional service. In This transformation in telecommunications has led to North America large retail clothing and food stores are lower barriers to market entry for manufacturers of rapidly introducing EDI systems. The European Commu- equipment and providers of data services; declining cost nity (EC) is sponsoring research on the development of structures in other industries for the processing and trans- standardized EDI systems. Application of these systems mittal of information; and new services and new ways of could decrease the time and costs of customs documen- delivering traditional services. In 1983, for example, it tation and other frontier formalities, which, it has been cost $12,000 to $14,000 per month to lease the U.S. half estimated, add 10 percent to the cost of cross-border of a private transatlantic voice channel; today the cost is trade. The ports of Hamburg, Rotterdam, and Singapore $4,000 to $5,000 (Wellenius and others 1989, pp. 7-12). have already used EDI to cut clearance time to less than New satellites and submarine cables will further reduce an hour. these charges. Basic Services: From Public Utility to Service Industry Market Forces The trend toward regulatory change in telecommunica- Private entrepreneurs and large international users have tions affects facilities, services, and customer equipment. been instrumental in creating and adapting new services The telecommunications infrastructure consists of cable, to fit their particular needs. A combination of technical satellite, and microwave transmission systems, switch- advances, reduced transmission costs, looser regulatory ing systems, and other equipment that are used to per- restrictions, and growing user demand for sophisticated form basic telecommunications functions. Japan, the new services has led to the creation of many value added United Kingdom, and the United States allow competi- networks and other specialized information services that tion in the provision of facilities and basic services. As operate internationally. These new data services of June 1989 Japan had forty-seven type I carriers-pro- viders of services through their own circuits and facili- permit instantaneous, long-distance interactive inter- ties. Other countries are gradually opening such basic actions via transnational computer-communication services as mobile telephony to competition. The Euro- systems. More specifically, by collapsing time and pean Community's telecommunications policy calls for space (at decreasing costs), data services permit cer- PTOS to retain exclusive rights over monopoly basic tain services to be produced in one place and con- services until 1992; whether these rights will be extended sumed in another place.... The result is an increase beyond that date is to be reviewed by the Commission in in the transportability and, consequently, tradability 1990 or 1991. of certain services-they can be delivered via the The transformation of telecommunications from a mo- telecommunications network (Robinson, Sauvant, nopoly public service to a highly commercial sector has and Govitrikar 1989, p. 3). led to the restructuring of several PTOS and the opening to competition of some of their previously exclusive The fusion of computers and communications has cre- operating responsibilities. This is occurring in both de- ated an array of transactional services. Multinational and veloped and developing countries, although lack of in- some national enterprises are using telecommunications frastructure in many developing countries is a significant services for a wide variety of transactions within firms impediment to modernization of services and regulatory and among user groups of related firms. Examples of policies. Institutional and regulatory restructuring is tak- networks of related businesses are the international bank- ing place along three lines: ing network (Society for Worldwide Interbank Financial Telecommunications-swIFT) and the airlines data sys- * Separation of telecommunications from postal ser- tem (Societe Internationale Telecommunications vices. This gives telecommunications organizations Aeronautique-srTA). Transactional networks are "in- full responsibility over their operations and ends tended to increase the efficiency of transactions by re- their subsidization of the losses of postal services. ducing the amount of time and the number of * Separation of regulatory from operational functions. independent steps it takes to complete, verify, and settle A government ministry or special regulatory agency 107 G. Russell Pipe is responsible for supervising telecommunications 1. Unrestricted competition in all kinds of basic and service operators and, particularly, the operators of value added services the national telecommunications transport network. 2. Unrestricted competition in all services except tele- * Diversification of sources of telecommunications phone services services. It is now widely accepted that value added 3. Monopoly on basic services and competition in value services, because they provide a variety of special- added services ized communications and information services, 4. Monopoly on basic services and some value added should be open to competition. Because a maximum services. degree of flexibility and minimum restrictions exist in several countries, these services are able to build Aconsiderationinchoosingaregulatory structure is the efficient global networks (rru 1989, pp. 33-5). amount of protection in the form of monopoly provision for basic services to be given the general public (residen- It is widely accepted, in developed and developing tial customers). Unrestricted competition in all kinds of countries alike, that PTos, even those that are publicly services (option 1) imposes no restrictions on resale or owned, should operate as commercial companies. This shared use and gives users and competing service pro- means thatthey must focus on costs,pricing, and services viders the greatest freedom in using network services. in relation to costs, and that subsidies should be limited. Option 2 reserves telephone services (which typically Internal organization and management must emphasize generate 80 to 90 percent of the revenues that a PTO customer service, cost awareness, financial discipline, receives to finance all its social andpolitical obligations). and productivity in staff performance (rTu 1989, pp. That approach is flawed, however, because advances in 33-35). The rru recommendations are mainly addressed technology, such as the introduction of facsimile, are to developing countries, many of which are in the early continuing to upgrade and expand the capabilities of stages of considering how to cope with rapidly changing telephone services. technology, demands for new services, regulatory ques- Integrated services digital networks (ISDNs) are rapidly tions, and the growing economic role of telecommuni- being introduced in Europe, Japan, and North America. cations. They provide a combination of digitized services (voice, In the past, business users have often been charged data, video, and broadcasting) through a single optical artificially high tariffs in order to subsidize residential fiber circuit. If voice telephony is maintained as a basic subscribers, offset postal service deficits, or transfer service reserved for exclusive provision by PTOs, will monies to the state's general revenues. Developing coun- ISDNs be defined as a "new basic service" or as a cluster tries are now challenged to reconsider these long-stand- of enhanced services? Organizations of users-such as ing practices and determine whether restructuring the International Telecommunications Users Group telecommunications to be more open and more commer- (INTUG), a confederation of business telecommunica- cially attractive to foreign enterprises and investors will tions users in twenty-three countries-have argued that better serve their development and trade objectives. Ob- PTOs should be obliged to be flexible in regulating ISDN jectives for the sector include improving the national services and should not attempt to use standards or tariffs telecommunications infrastructure and its ability to offer to force users to depend heavily on public networks. an array of modem business services and strengthening Option 3 is also unsatisfactory to many value added service industries so they are viable domestically and service entrepreneurs and users because it relies so heav- competitive in international markets. ily on decisions of regulatory authorities, which may stress political rather than objective, technical consider- Value Added Services: Regulatory Alternatives ations. It is not clear whether resale by value added services would be permissible. It can be argued that the Enhanced, or value added, services are provided by amount of basic transmission to be allowed in a value companies that lease transmission facilities from a net- added service before it is regarded simply as a basic work operator. A value added service provider is one that service or resale of a basic service can be decided arbi- combines basic services with computer processing appli- trarily because of the lack of theoretical bases for judg- cations that use the subscriber's information or informa- menL tion from other sources. Option 4-perpetuating a monopoly on a basic service There are several policy options for competition in and opening some value added services to competition- services,assuggestedbyWelleniusandothers (1989, pp. is the current situation in most countries. The 1992 19-23). objectives of the European Community, as set forth in 108 Telecommunications the 1987 Green Paper on Telecommunications, includes tions of the Group of Negotiations on Services (GNS) was restructuring the telecommunications sector of EC mem- the idea that telecommunications services should be bers to conform in most respects to the first option. considered central to a framework agreement on ser- vices. Telecommunications specialists may have been International Arrangements preoccupied with introducing new services and with regulatory matters, and they may have been reluctant to Traditionally, national PTos were chartered to provide concede the suitability of trade policy experts to decide telecommunications services to all types of customers, crucial matters concerning the sector and how it should and international telecommunications was organized ac- be governed in the future. cording to bilateral agreements between PTos. (This sit- A 1988 survey of telecommunications officials and uation is in contrast with that in such sectors as banking trade experts provided some insights on the question of and insurance, in which multinational enterprises have the tradability of telecommunications services.I The been established.) Technical and operating standards as results were unexpected. Basic telephony services (trans- well as accounting principles have been developed by port services) were considered tradable by 45 percent of committees of the International Telecommunication respondents, basic services (in an ISDN environment) by Union (lTU), and accordingly, a high degree of connec- 55 percent, enhanced (value added) services by 82 per- tivity has existed between national entities. cent, and enhanced (value added) information services International telecommunications services are pro- by 84 percent. The high proportion that considered basic vided through joint arrangements between Piros. Interna- telephony tradable contradicted many earlier analysis tional networks operate almost exclusively on a that placed basic services outside the realm of trade. cooperative basis with no customer-to-customercontact; Another survey question was whether jointly provided the originating carrier never deals directly with residents international voice, data or image services handled by of foreign countries. Privately constructed facilities are, two PTOs involve trade, since only an exchange of traffic however, being established to link a limited number of takes place. Eighty percent, evenly distributed between countries by means of undersea cables and communica- all respondents, indicated that such services "lend them- tion satellites. These new facilities, such as the global selves to be traded" (OECD 1988; Mansell 1989). digital highway being constructed by Cable & Wireless The tradability of communications services tended to and the PANAMSAT and Orion satellite systems, will be viewed according to theway they are used. Fifty-eight operate country to country, no longer relying on joint percent of respondents regarded intracorporate net- arrangements. But in the foreseeable future the tradi- works as being involved in trade, whereas the figure tional cooperation between PTOs can be expected to was 62 percent for closed user groups such as swFr and continue in most countries. SITA, 76 percent for companies using EDI and other systems to communicate with customers and suppliers, Toward a New Attitude and 90 percent for online and commercial information processing and retrieval services. Sixty-two percent of Attention to the trade-related dimensions of telecommu- those responding considered services less tradable if they nications originated with research on services by the are provided by a monopoly rather than by multiple GATT Secretariat and Contracting Parties during 1982- providers, whether public or private. 85. Even after the Uruguay Round was launched, the The survey also asked about the role of telecommuni- telecommunications community appeared to be largely cations services in international trade. More than 60 unaware that its specialty might become important for a percent viewed telecommunications as an intermediate new trade regime. This was partly because many tele- service that supports other services such as aviation, communications managers in PTOs and user organiza- banking and insurance rather than as a cleaily identifi- tions have a technical orientation and view able and defined sector. All groups of respondents telecommunications largely as a transparent conduit for viewed the role of telecommunications in roughly the the transmission of messages-as an enabling technol- same proportions, except for the Japanese, who saw ogy for all types of applications -ather than as an end in telecommunications more as a clearly defined service itself. sector. The transformation of telecommunications into a motor for economic growth is generally recognized by telecom- Lessonsfrom a Case: The Canada-U.S. Approach munications specialists and has been the catalyst for many of the regulatory reforms described above. Less The Canada-U.S. Free Trade Agreement embodies the recognized and accepted at the outset of the delibera- concept of telecommunications network-based services 109 G. Russell Pipe (originated by the OECD) for determining the coverage of ployed to keep out competitors to national PTOs. A ser- telecommunications services. An annex refers specific- vices agreement may extend the national treatment prin- ally to telecommunications network-based enhanced ser- ciple to foreign enterprises that are not established in a vices and computer services. The definition of enhanced country's territory. National treatment of nonestablished services is left to the telecommunications regulatory entities would imply that the same regulatory conditions authorities of the two countries. The agreement recog- must be granted to nonestablished foreign service pro- nizes a number of rights and obligations regarding the viders. Applying national treatment to nonestablished provision of enhanced services, including access to and telecommunications services may, however, be espe- use of basic telecommunications services of various types. cially difficult, since the provider may have no real The Canada-U.S. agreement has been cited as a possi- knowledge as to how users apply the service. ble model for multilateral agreements on telecommuni- cations. The agreement is limited to enhanced Most Favored Nation Treatment telecommunications and computer services, and it im- poses obligations on service providers as well as extend- International telecommunications services are estab- ing rights to users of basic services. It largely ratifies the lished according to bilateral agreements. If most favored regulatory status quo between the two countries. As the nation treatment were to be applied to this sector, thus Uruguay Round negotiations reach an advanced stage, introducing a multilateral dimension, considerable re- some countries, even the United States, tend to support alignment of existing arrangements-in particular, of more comprehensive coverage of telecommunications international charging and accounting practices that services than is provided for under the agreement. originated in an era of monopolies for all types of ser- vices-might be necessary. Today questions are being Application of the Montreal Concepts raised as to whether the present long-standing system is hindering rather than facilitating international trade A pivotal issue for negotiations on telecommunications (Ergas and Paterson 1989). A multilateral services trade services in the GNS was whether the discussion should be regime, however, should take into account existing inter- limited to telecommunications services-those offered national commitments, especially because they may af- by PTOS-and certain types of value added services or fect nonsignatories of the services agreement. should be broader, covering access to and use of national telecommunications transport services. Considerable MarketAccess emphasis has been placed on telecommunications as a transactional service that facilitates the delivery of other It is not possible to delink the principle of market access services such as banking and travel services and so from other provisions in the Montreal declaration. In enables suppliers and users of those services to execute simple terms, market access means the degree to which market transactions more efficiently and effectively. the ability of service providers to offer a service in a Liberalized access to and use of specialized telecommu- foreign markct is affected by entry barriers or other nications services are vital to such advanced applications requirements. It embraces access to and use of distribu- (GATr forthcoming). tion systems, and telecommunications networks are spe- The Montreal ministerial declaration stipulated that cifically identified. Theministerial declaration states that several concepts and principles must be examined in the access rights imply that "foreign services may supply preparation of a framework agreement. They include according to the preferred mode of delivery." By explic- national treatment, most favored nation treatment, mar- itly linking rights of access to mechanisms for the deliv- ket access, progressive liberalization, and increasing par- ery of services, the ministers underscored the key role of ticipation by developing countries. In addition, the need telecommunications, which undoubtedly will be chosen for safeguards and exceptions must be considered. as the delivery vehicle by companies in most sectors. Market access in the context of telecommunications National Treatment services has been referred to as the right to plug into national telecommunications networks. In operational In the case of telecommunications, the principle of na- terms, access to the distribution system of a host country tional treatment may not be so much to ensure the equal- has been taken to mean the ability to lease telecommuni- ity of treatment within national markets as to allow firms cations circuits to transport information both within and to enter foreign markets and to accord equal treatment to among countries, reasonable and nondiscriminatory all enterprises operating in a national market. Licenses, pricing of services, freedom to choose attachment equip- ownership rules, and other restrictions have been em- ment, flexibility as to interconnection standards, and 110 Telecommunications rights to process and store information (United States tries a shortcut to entering foreign markets with service 1988, p. 11). Many developing countries are cautious exports, countries that decide to sign the services agree- about granting such rights because of the advantages for ment may be faced with the necessity of addressing transnational corporations, especially in the remote de- urgent infrastructure problems. livery of services from operational bases in developed Satellite technology offers the possibility of bypassing countries. But developing countries that help to facilitate local telephone systems and transmitting all types of market access through telecommunications channels messages by means of mobile earth stations. To a large will have the same rights to exploit domestic and inter- extent, satellite communications make the geographic national links to market their own products and services remoteness of land-locked and island countries irrele- in developed countries. vant. A growing number of developing countries are capitalizing on their skilled manpower, favorable wage Progressive Liberalization rates, and low overheads to mount small information- based services for offshore customers. Remote data pro- Progressive liberalization has been defined as the facili- cessing, such as keypunching, for foreign customers is tation and promotion of trade across borders and the well established in Barbados, Korea, and thePhilippines. stimulation of international competition, especially by Software development has become an export industry for increasing market access, but with due respect for na- India; orders and custom products aredelivered electron- tional policy objectives. National policy objectives may ically to Europe to save delivery time. The creation of call for telecommunications to retain a public utility special telecommunications trade zones, orteleports, may character and universal service mandate or for the sector be an incentive for certain developing countries to capture to be an engine of economic development and a conduit a small portion of the world data services markets. for international trade. Regulatory reform in Europe, Genuine difficulties are certain to arise in ensuring that Japan, New Zealand and the United States has expanded development benefits flow from the services agreement. the zone of commerce and trade to cover most if not all Simply calling for "improved access todistribution chan- telecommunications services, but in all countries regula- nels and information networks" for developing coun- tory and legislative bodies are asserting the interests of tries, as in the ministerial declaration, is not enough; private residential customers. developing and developed countries alike will have to For the telecommunications sector the challenge of expend considerable effort and costs. The most effective progressive liberalization may be to prepare new rules to and viable ways of accelerating telecommunications de- deal with international competition-rules for guiding velopment may be for developing countries to give tele- competition among countries that choose to permit com- communications more attention and larger financial petition in various segments of the telecommunications allocations in national development plans, encourage system, and rules for connecting competitive telecom- developed countries to increase their contributions to the munications networks in countries that permit competi- development programs of the rru, and call for multilat- tion with national telecommunications monopolies in eral lending institutions to allocate greater resources to countries thatdonot (Feketekuty 1989, p. 260). Will such this sector. rulemaking be limited to liberalization of cross-border trade in telecommunications, or will it require major Safeguards and Exceptions reforms in domestic telecommunication market struc- tures? This is a complex question that cannot be an- Telecommunications is a critical feature of the national swered without taking account of the other principles in infrastructure and the engine of economic development. the agreement. Short-term safeguards for this sector may be appropriate under a services agreement. But the benefits of progres- Increasing Participation by Developing Countries sive liberalization and other principles should not be unnecessarily reduced by the introduction of safeguards International studies commissioned by the rru have con- and exceptions. There are several questions that govern- cluded that developing countries are unlikely to achieve ments should consider in deciding whether to push for economic growth and mount service export programs exceptions. Would efforts to make telecommunications without an adequate telecommunications infrastructure. services more commercial and cost-based be compro- Mobilizing the necessary capital, human resources, and mised by exempting subsidies from coverage? Are tech- technology to reduce the tremendous gap between devel- nical standards in telecommunications appropriate for oped and developing countries is a long-term challenge. exclusion, or would standardization be better treated Because telecommunications offers developing coun- under existing GAIT codes? Is the concept of dumping 111 G. Russell Pipe relevant to the potential underpricing of telecommunica- the existing international telecommunications system, tions services? Should public procurement of telecom- and to encouraging greater access to technology. munications services be included in the govemment The Uruguay Round negotiations on services have not procurement code or applied according to certain stipu- only focused on the tradability of telecommunications lations and conditions? services but have also lent urgency to the necessity of reforming telecommunications regulatory policy in most The Regulatory Situation countries. In the course of the negotiations, telecommu- nications has been recognized as the essential core ser- In the 1970s the notion that telecommunications is a vice-the motor for delivering most information natural monopoly began to be challenged, and the eco- intensive services. Some GNS delegations have argued nomic and trade dimensions of the sector emerged. It is that trade in services should be defined as transactions undeniable that the strict, comprehensive regulatory pol- that involve cross-border movement of data and informa- icies that have existed in telecommunications con- tion, including access to the services of public telecom- strained private entrepreneurs seeking to offer enhanced munications services and domestic distribution systems. services. The concept of appropriate regulation in the The centrality of telecommunications services to devel- services agreement may help determine the proper but opment and trade is likely to become an important ele- not excessive level of regulation of telecommunications ment in comparative advantage among developing services. countries. Several countries, including Argentina, Sene- gal, and Singapore, have seized telecommunications as Assessing National Opportunities a major tool of development and trade expansion. This has led them to modernize their domestic infrastructures The potential role of telecommunications in a multilat- and liberalize their market structures. Organizations eral service agreement is formidable. Assessing risks and ranging from the ITU to the World Bank have called for opportunities is likely to be a complex and difficult reforms in telecommunications regulatory authority, a exercise because of serious definitional problems con- market situation forenhanced services, and greaterrights ceming the direct and indirect effects of covering partic- for business users. ular services under the agreement. The indirect In many respects, developing countries face a narrow- consequences for liberalization of exempting value ing zone of choices in telecommunications policy. This added services may have significant implications for should not be viewed as inappropriate or undue pressure, other service sectors. Considerable methodological and for it is clear that prudent modernization of telecommu- statistical work also needs to be undertaken to determine nication regulation and services will benefit the national the size and characteristics of national and international interests of all countries. telecommunications markets. It must be recognized, nevertheless, that the pace of Notes Uruguay Round negotiations leaves little time for a sys- tematic evaluation of the potential impacts of different I.AquestionmairepreparedbyTDRslnc. was sentto 502individuals policy choices on this sector. National capitals are nec- residing in forty-eight countries who had professional responsibilities in intemational organizations, national governments, businesses, essarily the focal points for formulating trade policy on higher education and research, joumalism, and consultancy. The re- services, and this process should increasingly involve spondents were selected according to their interest or involvement in consultations with appropriate ministries and private or- telecommunications or trade policy. A total of 197 responded, about 50 percent from Europe, 35 percent from North America, and 15 percent ganizations. Since telecommunications IS a core service from Japan. Trade negotiators at missions in Geneva were included in with many cross-sectoral implications, ministries of the European group of respondents (TransnationatData and Comnu- communications (or their equivalents) should be con- nications Report November 1988, p. 5). sulted for their technical, economic, and regulatory in- puts into national policymaking. References A challenge of particular importance to developing Bruce, Robest R., Jeffrey P. Conard, and Mark D. Director. 1988. The countries is reconciling the trade and development as- Telecom Mosaic: Assembling the New Insernational Structo re. pects of an agreement. Telecommunications is a power- London: Butterworths. ful tool for development that can be exploited by Butler, Richard E. 1988. "Global Agreements for Worldwide Connec- developing countries as a vital conduit for many kinds of tivity." rru, Geneva. Processed. Ergas, Henry, and Paul Paterson. 1989. "International Telecommuni- service exports. Serious consideration should be given to cations Accounting Arrangernents: An Unsustainable Inheri- devising mechanisms that will accomplish tangible re- tance?" Presented at colloquium on the Development of sults, to obtaining infusions of capital, to strengthening Intemational Telecommunications, Villefranche-sur-Mer, France, June 1-3. Processed. 112 Telecommunications Feketekuty, Geza. 1989. "Intemational Network Conpetition in Com- OECD. 1987. The Telecommwzications Industry-The Challenge of munications." In PeterRobinson, Karl P. Sauvant, and Vishwas P. Structural Change. iccp Series, no. 14. Paris. Govitrikar, eds. Electronic Highways for World Trade: Issues in - . 1988. Telecommnunications Network-Based Services: Irphli Telecommunications and Data Services. Boulder, Colo.: cationsforTelecommunicationsPolicy. iccp Series, no. 18. Paris. Westview. Pipe, G. Russell. 1989. Telecommunications Services: Considerations GATf. 1988-89. International Trade 1988-89. Vol. 1. Geneva. for Developing Countries in Uruguay Round Negotiations. Ge- .Forthcoming. Trade sin Telecmmnunications Services. Note neva: UNCrAD. by the Secretariat, Multilateral Trade Negotiations in the Uruguay Robinson, Peter, Karl P. Sauvant, and Vishwas P. Govitrikar, eds. Round. MTN.GNS/W/52. Geneva. 1989. Electronic Highwaysfor World Trade: Issues in Telecom- Hobson, Chris. 1989. 'How Telecon Services are Provided." Trans- munications and Data Services. Boulder, Colo.: Westview. national Data and CommunicationsReport (May):15-16. United States. 1988. "New PoLcy Directions, Analysis of the Rele- rru. 1989. The Changing Telecommunications Environment: Policy vance of theTradeCommittee's'Conceptual FrameworkforTrade Considerations for Members of the nu. Report of the Advisory in Services' to Trade in Nonbasic Teleco_mmuiations Network- Group on Telecommunications Policy, Intemational Telecomnu- based Services." Submission of the United States to the oEa)/CCP, nications Union. Geneva. October 27. Mansell, Robin E. 1989. "Telecommunications Network-Based Ser- Wellenius, Bjorn, and others, eds. 1989. Restructuring and Managing vices Regulatory Framework." Transnational Data and Commu- the TelecommunicationsSector. A World Bank Symposium. Wash- nicationsReport (January):15-23. ington, D.C. 113 12 The Tradability of Services Karl P. Sauvant Services often have to be produced when and where they port and trade. Most business services-banking and are consumed. For this reason, the possibility of trans- financial services, insurance, engineering, data services, porting, and hence of trading, many services is limited, accounting, consultancy, advertising, public relations, and foreign direct investment or labor movements are legal services, research and development, market re- often required to bring them to foreign markets. search, management, and architectural services-fall This situation is changing fundamentally as the in- into this category. Until recently, they had to be con- creased application of data services made possible sumed when and where they were produced. In contrast through themerger of telecommunications and computer to the situation with manufactured goods, the time and technologies permits a number of services (especially space of their production and consumption could not be business services) to be produced in one location and separated. One implications of this was that the principle simultaneously consumed elsewhere. The potential for of comparative advantage had only limited applicability growth of trade in services and the conditions for realiz- for international trade in services. ing this potential are of particular importance to the In spite of these inherent obstacles, trade in services has Uruguay Round, especially as regards the treatment of reached considerable proportions-approximately $560 data services and theirrecognition as a core service. This billion by 1989 (see GAIT 1989). During most of the chapter focuses on the impact of data services on the 1980s trade in services grew even faster than trade in tradability of services and on some of the implications manufacturing goods. associated with increased tradability. Owing to the nature of services, the main vehicle for Some services are easy to trade-international trans- growth in international transactions in services has been port and tourism are examples. But since most services foreign direct investment rather than trade in services. As are intangible and nonstorable, they are difficult to trans- table 12-1 shows, the growth of both outward and inward Table 12-1. Selected Developed Market Economies, 1981-87 (average annual percentage growth) Trade in services b Foreign direct investment in services Couantry Services GDP' Exports Imports Outward Inward Canada 8.7 7.6 9.2 15.2 c 10.0 c Germany, Fed. Rep. 4.7 3.8 3.8 11.3 9.2 Japan 15.7 5.7 8.8 29.3 21.9 Netherlands 3.8 3.9 4.2 16.8d 11.6d United Kingdom 9.7 9.0 9.9 38.5 e 17.8 e United States 8.6 6.8 9.9 9.6 20.6 Note: Based on national currencies, current prices, except for data for Japan, which are based on dollars. a. utilities, trading, construction, transport, communications, and other services. b. Private nonfactor services-shipment, travel, other transport, and other private goods, services, and incone. c. 1980-86. d. 1980-84. e. 1981-84. Sources: United Nations, Department of International Eccnomic and Social Affairs, data base; IMP balance of payments statistics, vols. 37 and 39, and various national sources. 114 The Tradability of Services foreign direct investment for the principal industrial or to obtain funds. The services were typically produced countries during the 1980s was considerably higher than and consumed face-to-face, when the customers were in the growth of gross domestic product (GDP) of services the bank. Trade through mail, telephone, telex, or travel and of exports and imports of services. The overwhelm- was not impossible, but it was typically cumbersome, ing share of the growth of foreign direct investment in time-consuming, impractical, and expensive, especially services took place in finance (including insurance) and when interactive transactions were required. Today, a trade (UNCTC 1989). By the end of the 1980s services had substantial number of banking services can be obtained become the largest single foreign direct investment sec- through automated teller machines (ATMs), which are tor; it accounted for approximately 40 percent (about linked up into national and international networks. The $400 billion) of the world's stock of foreign direct in- banking services that can beprovided in this mannernow vestment and between 50 and 60 percent (about $60 nearly amount to afull branch service: customers can use billion) of annual flows of foreign direct investment. As ATMs to pay bills, deposit cash and checks, buy travelers' a result, foreign direct investment has become the main checks, transfer money, order checkbooks, and obtain vehicle for the delivery of services abroad. For example, "fast cash" and immediate balance statements. Further- in 1982 U.S. exports of private nonfactor services were more, such services as lending to firms, consumer fi- about $33 billion, as against approximately $178 billion nance, mortgage lending, securities underwriting, of sales byU.S.affiliates abroad. Similarly, U.S. imports currency bond trading, foreign exchange services, of services in the same year amounted to about $33 brokering, cash letters, and fund collection and disbursal billion, compared with about $125 billion of sales by services are increasingly becoming available electroni- foreign service affiliates in the United States (Sauvant cally. These banking services can now be obtained through 1986a, p. 20). computer communication systems; they are consumed in Tlhe limited tradability of many services is an important one place while they are being produced elsewhere. reason why foreign direct investment, which increased Transnational corporations have gone the furthest in rapidly in the 1980s, has been more important than trade developing transportability. Many of these firms, and in the internationalization of the service sector. The especially the largest ones, have established intemal impact of data technologies is likely to change this transnational computer communication systems that are pattern. used to assist a wide range of corporate activities, includ- ing funancial management, marketing, distribution, in- The Impact of Data Services ventory control, and accounting. Parent firms, for instance, can undertake all accounting services for their The 1980s witnessed the rapid development of data foreign affiliates or can handle their financial manage- technology-technology that is grounded in microelec- ment. Many transnational corporations have, in fact, tronics and operates on the basis of digital signals. One become dependent on the transnational use of data ser- consequence of this technology has been the conver- vices to manage their operations better and more effi- genceofcomputerandtelecommunications technologies ciently and to exploit new business opportunities. Take and the emergence of data services: data processing, American Express, for example. information storage and retrieval, software, and digital telecommunication services. Data services are rapidly Today American Express could not function without expanding industries, both domestically and internation- the capacity to move information across national bor- ally (Sauvant 1986b). ders with speed, accuracy, reliability and security. We Data services are also fundamentally changing the rely on our international systems to allow us to pro- manner in which other services are delivered to foreign vide a wide range of services: authorization of credit markets because they permit instantaneous, interactive, card transactions, replacement of lost or stolen long-distance transactions by means of transnational com- travellers' cheques, travel reservations and other puter communication systems-systems that link comput- travel services, banking transactions by our interna- ers with one another for communications purposes. By tional bank, and trading in securities, bonds and a host collapsing time and space, data services make itpossible of other financial instruments. for certain services-the information-intensive ser- International communications also have made it vices-to be produced in one place and consumed simul- possible for American Express to develop new ser- taneously in another. vices for our cardholders and for the establishments Retail banking provides an illustration. In the past, that accept the American Express card. customers had to go to a bank to transact their business- Another new product that is the direct result of to inquire about checkbook balances, to transfer funds, information-age technology is the automatic teller 11s Karl P. Sauvant machine, which enables our travelling cardholders tion may become particularly important for such infor- to withdraw cash or travellers' cheques in a rapidly mation-intensive services as banking and other financial growing number of outlets around the world. services, insurance, consulting and engineering, many (Spero 1985, pp. 6-7.) professional services, research and development, educa- tion, and data services themselves. Network-based trade A recent study concluded that transnational corporations in banking has already reached considerable propor- have become "dependent on computerized flows of in- tions.1 formation to conduct their business today-and will be more so tomorrow" (Business International 1982, p. 2). Implications The use of data services in conjunction with transna- tional computer communication systems makes it possi- The emergence of data services, by creating a substantial ble for a whole range of other services to be provided network-based trade option where before there were no internationally within transnational corporations. This or only very limited choices, is fundamentally changing means that the services involved have become more the manner in which information-intensive services can tradable, albeit only within firms. be delivered to foreign markets. Data services are there- Closed user group networks extend this possibility to fore a core service; they not only constitute industries in the sharing of services among certain firms, particularly their own right but also provide the means for overcom- in service industries that are information-intensive and ing the inherent obstacle to trade in many services-the especially dependent on the exchange of information. intangibility,nonstorability,andhencenontransportabil- Most prominent among these networks are the Society ity of these services. This section explores some of the for Worldwide Interbank Financial Telecommunications implications of this fundamental change. (swIFr) and the Societd de Internationale Telecom- munications Aeronautiques (srrA). SWIFr, an interbank Comparative Advantage and the International Division data network for international banking transactions, be- of Labor came operational in 1977 and by 1988 linked nearly 2,600 users in 60 countries, including about 95 percent Increased tradability means, first of all, that information- of the world's top 500 banks. Between 1978 and 1988 intensive final services (bill payments, insurance poli- the number of messages carried annually increased from cies, software, and so on) can be delivered abroad by way 21 million to 255 million (SWIFr Annual Report, various of telecommunication lines. It also means that individual issues). S1TA is a worldwide network of leased lines that components in the services production chain can become in 1988 carried nearly 500 billion characters among 336 tradable and that specialization can take place, as in airlines in more than 100 countries (SrrA Annual Report, manufacturing. The production process of information- various issues). Closed user group networks have intensive services can be split up, individual service emerged in insurance, shipping, and hotels and have components can be produced in countries that have a become the backbone of international transactions in comparative advantage because of, for example, lower their respective industries. Membership is required in costs, and these components can subsequently be sent to order to benefit from the services being provided. the place where the final product is required. The con- There is no reason why the international provision of cepts of specialization and comparative advantage thus information-intensive services should remain limited to become fully applicable to the production and trade of transactions within transnational corporate networks or information-intensive services-not only final services among firms that are members of certain closed user but also semifinished ones.3 groups. Once the technical problem of transportability To take an illustration of the impact of data technology, has been solved (at acceptable cost), all the services that a New York insurance firm has established an affiliate in are already being traded within firms or among members Ireland to process insurance claims.4 A transadantic of ausergroup can also be made available to thirdparties, telecommunications line links the affiliate to the parent at arm's length and on a commercial basis. Thus the company's data processing center in the United States. increased application of data services is making a whole Insurance claims collected in the United States are range of services tradable, in that service products can be shipped daily by air to Ireland, where they are processed. delivered over a distance. In this manner, trade options The claim information is then sent through transnational are created for firms that in the past could not serve computer communication systems back to the United foreign markets or had to serve them through foreign States, where checks are printed and explanations of affiliates or the temporary movement of labor. This op- benefits are mailed out. There were two motivations for 116 The Tradability of Services moving a part of the firm's operations abroad: lower fulfil specialized tasks in the framework of a global labor costs and difficulties in finding enough skilled international (intrafirm) division of labor and trade the workers to process insurance claims at home. results of their labor through transnational computer For many services, the possibility of an international communication networks. In the extreme case-in in- division of labor in the production of information-inten- dustries that are very information-intensive-some for- sive services has existed up until now only in a very eign affiliates may be reduced to terminal affiliates that limited sense. Increased tradability is therefore bound to merely enter data such as insurance or travel information have profound implications for supply patterns and for while mostof the value (forexample,riskcalculation and the structure of service industries. The corporations that fare construction) is added elsewhere. That would repre- are the first to take advantage of the potential offered by sent a complete reversal of the current situation of for- the new data technologies may be the first to reach global eign service affiliates and could have profound effects economies of scale and may therefore acquire a substan- on the character, impact, and level of foreign direct tial advantage with respect to local and other rivals. investment in services and on its importance for host countries. At the same time, however, it would open new Effects on the Nature of Foreign Service Affiliates possibilities for substantial growth in network-based in- trafirm trade in services. The possibility of splitting up the production process, specializing, and taking advantage of an international The Potential for Network-Based Growth of Trade in division of labor can have significant implications for Services foreign direct investment in services and for the nature of service affiliates abroad. Manufacturing firms can If the impact of data services is indeed of the nature build transnational affiliate networks, and an intrafirm suggested earlier, there is considerable potential for a division of labor can allocate capital-intensive and skill- dynamic increase in network-based trade in final and intensive activities to parent corporations and labor-in- semifinished services, both among and within firms. In tensive (and, in particular, unskilled-labor-intensive) other words, substantial new business opportunities may operations to foreign affiliates, perhaps in developing arise for firms that take advantage of the possibilities countrieT. The high level of intrafirm trade between offered by data services. The size of this potential is manufacturing parent firms and their foreign affiliates is difficult to ascertain, and for many services, such as a manifestation of that ability. Service firms also build government, it is certainly negligible. But it is clear that, transnational affiliate networks, but so far, precisely because of the limited tradability of many services to because of the low tradability of many services, it has not date, the relative importance of international trade in been as easy for them to split their production activities services does not reflect the relative importance of ser- so as to match the factor proportions of subprocesses vices in the domestic economy. with the factor prices of host countries. Consequently, Thus, for instance, although the service sector accounts intrafirm trade in the services sector is considerably for 50-60 percent or more of the gross national product lower than in the manufacturing sector. (GNP) of the developed market economies, it makes up As a result (if U.S. data are indicative), foreign service only about one-fifth of the total trade of all countries. affiliates, unlike their manufacturing counterparts, ap- Trade in industrial products involves about 45 percent of pear to be more like their parent firms in terms of skill world industrial production, whereas in services it is levels, the use of soft technology, and physical capital roughly 10 percent (Clairmonte and Cavanagh 1984, p. intensity-they tend to reproduce abroad the factor pro- 224). The relatively low degree of internationalization of portions used at home (see table 12-2). Foreign service the service sector compared with that of the industrial affiliates are more like miniature versions of their parent sector is even observable in foreign direct investment (at firms than specialized units in a worldwide production least to the extent that U.S. data are indicative). By the network; that is, they are more complete and free-stand- mid-1980s the average foreign content of U.S. service ing than foreign manufacturing affiliates. Traditionally, firms (excluding banks) with investment abroad was foreign service affiliates are more valuable to their host considerably lower than that of their industrial counter- countries than are their manufacturing counterparts in parts: only about 17 percent of the total assets and sales terms of skills, soft technology, and physical capital and 11 percent of the total employment of these firms intensity but not in terms of exports. were abroad. By comparison, the figures for transna- Increased tradability may change this situation funda- tional manufacturing corporations were approximately mentally. Affiliates no longer need to be free-standing twice as high, and those for petroleum firms were even miniature versions of theirparent fimns. Rather, they can higher than that (see table 12-3). Service firms are now 117 Karl P. Sauvant Table 12-2. Characteristics of US. Service and Manufacturing Transnational Corporations, 1982 Variable Services Manufacturing R&D intensity R&D expenditure as percentage of sales Parents 0.11 3.03 Affiliates 0.10 1.15 In developing market economies 0.13 1.31 In developing countries 0.02 OA6 R&D employment as percentage of total employment Parents 1.05 4.91 Affiliates 0.75 2.27 SkIll level (compensation per employee, in thousands of dollars) Parents 24 30 Affiliates 19 17 In developed market economies 20 21 In developing countries 15 9 Capital intensity Physical capital intensity (thousands of dollars) a Parents 52 30 Affiliates By industry of parent 21 20 By industry of affiliate 26 20 Assets per employee (thousands of dollars) Parents 192 97 Affiliates 214 57 In developed market economies 164 65 In developing countries 348 39 Trade (percentage of sales) Parents Total exports 6.1 11.1 Exports to affiliates 1.3 4.3 Imports from affiliates 0.9 2.9 Affiliates Total exports 40.3 34 Exports to parents 4.3 8 Imports from parents 83 12 Note: R&D, research and development a. Net property, plant, and equipment per worker. Source: uNcrc (1989),p. 111. Table 12-3. Share of Foreign Affiiates in Total Activities of U.S. Nonbank Transnational Corporations, 1984 Share offoreign affgliates in Industry Sales Assets Employment All industries 26.2 19.7 25.9 Manufacturing 27.3 24.4 30.3 Petroleum 41.7 34.2 31.1 Other industries 25.3 21.7 39.7 Services 16.6 11.3 16.9 Finance, insurance, real estate a 12.0 9.7 27.9 Trading 18.0 14.7 16.5 Transport, communications, public utilities 6.5 7.1 10.7 Construction 23.6 22.5 16.3 Professional business and other services 11.6 12.7 10.9 Petroleum-related services b 28.7 20.5 25.6 a. Includes holdings and financial affiliates of industrial corporations, excluding nonbusiness entities.. b. Oil and gas field services, petroleum wholesale trade, petroleum tanker operations, gasoline services stations, and the like. Source: uNcrc (1989), p. 53. 118 The Tradability of Services engaging in more investing abroad than are industrial considerable. The infrastructure, in turn, can be used to ones, but worldwide, the service sector is considerably build specialized networks of, for example, the intrafirm less transnationalized than the industrial sector. or closed user group variety. In sum, transnational com- The point is not that within a few years the share of trade puter communication systems are of central importance in services in total trade will be as high as the share of for the growth of trade in information-intensive services: services in GNP or that the share of services production they are the electronic highways for world trade in ser- traded will be comparable to that for industrial produc- vices. tion. But the comparisons do suggest that once the intan- Computer communication systems are useful only if gibility, nonstorability, and nontransportability of one has access to them. The technical aspect of access- certain services are no longer obstacles to trade, there for instance, which protocols to use in order to have a could be a dynamic expansion in trade in services. technical interface-is the province of the International Telecommunications Union and no longer presents a Realizing the Potential major problem. A related issue concerns the right to connect equipment to the telecommunications net- The extent to which this potential can be realized and work-a right that is restricted in many countries. These exploited depends on a number of factors. Perhaps the technical and administrative matters have profound eco- most important of these are the ability to utilize the nomic implications, notonly because they canbebarriers underlying technology, the availability of the required to trade but also because the choice of standards and the network infrastructure, access to transnational computer permission to connect certain equipment to a network communication networks, and access to markets. can give considerable advantages to one firm over an- The ability to utilize the underlying technology, be it to other. export or import services or to manage transnational There is also the question of access to the growing affiliate networks better, is the technological precondi- number of specialized private or quasi-private computer tion for benefiting from the increased transportability of communication systems and the databases associated information-intensive services. Data technology as such with them, most of which are of the intrafirm or closed is widely available in the international market. But the user group type. For instance, airline computer reserva- development of specialized application software (that is, tion systems have become an important component of the machine-readable programs, procedures, and rules the airline industry and a lucrative source of revenue. If that allow the electronic devices making up a computer an airline has established such a system, should other communication system to perform certain tasks and so airlines be permitted to list their flights on it as well, and turn a stationary service into a tradable one) requires if so, in what order? The significance of these questions highly specialized skills, sophisticated hardware, consid- can be seen from the following facts. In 1984 about erable research and development, and extensive experi- three-quarters of the 21,000 United States travel agents mentation-all of which are very expensive. were linked to computerized reservation systems, and In addition, the utilization of the underlying technol- four of the six most important systems gave preference ogy, and especially the application of digital telecommu- to the airlines that owned them in listing flights on the nications technology, require computer communication computer screens. Travel agents make about 85 percent networks. In addition to merely transporting data, these of their bookings on flights shown on the first screen and networks have such value added features as packet 50 percent on the flights shown on the first line of a switching, automatic rerouting, intermediate storage, screen.5 Access to such specialized networks is there- compatibility services, maintenance-related support ser- fore an important factor in the effective utilization of data vices, and electronic mail services. The operators of technology-especially since such networks are likely to value added networks normally lease lines from basic become more important in the future-and it is a precon- carriers (for example, AT&T in the United States and post, dition for benefiting fully from the increased tradability telegraph, and telephone-P'rr-systems in other coun- of information-intensive services. tries) and combine them with computer equipment of The last factor is access to markets. A number of their own, thus creating enhanced computer communi- existing regulatory and administrative practices impede cation systems dedicated solely to the transport of data. the delivery of data services via computer communica- International systems of this kind can be created by tion systems. Many of them are indirect and include linking up national networks. This process is virtually primarily technical measures and regulatory and admin- complete among the industrial countries and is taking istrative practices. Most of them focus on the flow of data place in a growing number of developing countries, but services as such, especially the provision of data process- the difference in coverage and sophistication is still ing, information storage and retrieval services, and soft- 119 Karl P. Sauvant ware (Conference Board 1984). They are mainly im- their services, can provide the services from home posed to encourage the growth of domestic data indus- through computer communication systems. A whole tries (the case of Brazil is particularly prominent here; range of new opportunities is being opened up, and firms see UNCTC 1983) andto increase the revenue of MsTS. But in all countries are potential beneficiaries. Still, the dis- overall, the existing measures are relatively unimportant tribution of benefits, especially between developed and and do not represent major obstacles. developing countries, appears to be uneven, precisely This situation could, however, change drastically as because the ability to use data technologies is unevenly soon as the volume of services traded via computer distributed, the infrastructure is inadequate in developing communication networks reaches a sizable amount and countries, the networks are mostly located in developed national authorities begin to appreciate fully the impor- countries, and hence the ability to export and import tance of this development for the entire service sector. At services via computer communication systems is un- that point the full arsenal of traditional trade instru- even. ments-including taxes and tariffs on data flows, local Not surprisingly, therefore, service firms from indus- content requirements, infant industry measures, and var- trial countries and, subsequently, the governments of ious other forms of protectionism-could well come into these countries, have taken the lead in efforts to establish play to restrict or encourage network-based trade in a stable, predictable, and transparent international frame- services. Such a development would obviously hinder work for trade in services-a framework that would the growth of such trade and impede the realization of permit the progressive liberalization of this trade. Logi- the potential promised by the increased tradability of cally, furthermore, this framework would have to cover information-intensive services. Logically, those who data services as a core service, especially the enhanced have thebestchance to benefit from increased tradability digital telecommunications component (see Feketekuty have the greatest interest in establishing an international 1988, 1989). The input of the private sector into relevant framework for trade in services in general and data intemational negotiations-first in the framework of the services in particular. Such a framework would, most Organisation for International Co-operation and Devel- importantly, prevent the introduction of new barriers to opment (OECD), then in the framework of the Uruguay transborder data flows. Round-bears this out. In the OECD these efforts led to This raises the question of who would benefit from the the adoption of a Declaration on Transborder Data Flows trade-creating potential of information-intensive ser- in April 1985 (see Sauvant 1986) The declaration ac- vices. The first to benefit would be firms from industrial knowledged that, to date, transborder flows of economic countries, which have developed the application of these data are subject to few restrictions; it underlined the technologies furthest, have access to the required infra- importance of transparency and stability of policies, reg- structure, and they have created most of the existing ulations, and practices for investment and trade in this networks. In addition, most transnational corporations- field; and it drew attention to the social and economic which use data services for intrafirm purposes-are benefits to be drawn from access to data. Most important, headquartered in industrialized countries. But firms from the declaration established for the first time the principle developing and socialist countries stand to benefit as well that govemments should avoid creating unjustified bar- because data services provide them with a wider range riers to transborder data flows. In the Uruguay Round the of options for obtaining the services needed for their private sector, especially in the United States, consis- development, be it in terms of the manner in which they tently stressed the importance of data services and the can be obtained (import or foreign direct investment), the need to ensure an open international system for the flow range of suppliers, or, more generally, information about of enhanced telecommunications services (see Robin- international markets. Developing countries also have son, Sauvant, and Govitrikar 1989). Only such a system opportunities for developing exports of services that are would allow the full realization of the potential offered information-intensive and in which they have (or can by the increased tradability of services. develop) a comparative advantage. These include soft- ware, information storage and retrieval, engineering ser- Conclusions vices, and accounting-in principle, all the services the tradability of which has been increased through the ap- Technological changes have opened new opportunities plication of data services. in the area of trade in services. Data services themselves For some services increased tradability may even help have become more tradable, and because they are core to sidestep, at least to a certain extent, the thomy question services they help make other services more tradable as of labor movement. For instance, software specialists, well. Firms in both developed and developing countries instead of having to move to another country to produce can benefit from these opportunities. But the awareness 120 The Tradability of Services of these developments and opportunities is not wide- providers but also obligations-regarding, for example, spread in either developed or developing countries. Rais- restrictive business practices, the impact on the balance ing awareness is therefore an important task, as is bridge of payments, training, and the like. In other words, the building between, on the one hand, specialists in data international framework should be holistic. services and, in particular, telecommunications and, on The increase in tradability may lead foreign service the other, trade policymakers and specialists. affiliates in information-intensive industries to become A good part of this awareness raising, especially in less complete and free-standing and may thus decrease developing countries, ought to focus on the importance their potential to contribute to host countries. Govern- of data technologies and their core nature, the need to ments may have to examine whether the right of estab- master these technologies, and the necessity for strength- lishment should be complemented in certain industries ening the infrastructure through which access to world by a "duty of establishment" to ensure that foreign ser- service markets can be obtained. Training, technology vice affiliates contribute to national development rather transfer, and investment in the telecommunication infra- than becoming merely terminal affiliates. structure are, therefore, priority tasks. Since the require- The precise nature of the new opportunities is still far ments in this field are beyond the capacities of many from clear. Which services are becoming more tradable, developing countries, a massive infusion of technical to what extent, and in what manner? Which components assistance is required. in the service production process are becoming tradable Access to world service markets requires that the net- and could conceivably be produced elsewhere? It is works through which services can be provided be effec- necessary to take a whole series of information-intensive tively open to all service providers-that is, not closed service industries, select their principal products, exam- to some service providers or biased in favor of others. ine the production processes for each, and identify the This issue increases in importance as enhanced telecom- components that are becoming tradable through the use munications services in a growing number of countries of data technologies. Such practical work, which re- are liberalized and as parts of the networks become quires technical cooperation that could be highly useful privatized and hence closed to general usage. Service for developing countries in particular, could be an im- providers may increasingly face a situation in which the portant task for regional and international organizations most sophisticated parts of the electronic highways for with an interest in ensuring that all countries benefit as trade in services are not generally accessible. (In goods much as possible from the increased tradability of ser- trade it is simply assumed that producers have access to vices. the transport system-roads, railways, and airplanes- but this assumption cannot be made for network-based Notes services trade.) To develop an equitable regime in this respect is, therefore, an important public policy task. But 1. Seethedata on swlFrabove. This may also explain, atleastpartly, it is not an easy one, because many of the networks have whythenumbrofforeign offices ofthe largest 1OOtransnationalbanklcs barelyincreased,fromn4,413 in 1980to4,660in 1985; seeuNTrcic(1989, been built or are being built through private investment, p. 75). often precisely with the purpose of giving some firms or 2. Toa certain extent,this is theintemationalextensionof aprocess groups of firms an advantage over their competitors. that has already taken place within countries. In the United States, for example, many service companies have moved some "back office" Access to world markets also requires that service clerical, accounting, and data processing operations away from urban providers have access to consumers. National develop- headquarters sites (such as New York), where office costs, housing ment objectives must, of course, be taken into account costs and taxes are high. too. To establish a framework that promotes these 3. The pointis not that, sofarthe concept ofcomparative advantage twn has not applied to services. Countries endowed with certain attractions goals is an important international public policy task, and (including scenery) obviously have a comparative advantage in tour- this is the objective of the current Uruguay Round of ism, countries with substantial unskiled labormay have a comparative negotiations on trade in services, including data services, advantage intheexportoflabor-intensive services suchas constnuction, and coumtries with substantial skilled labor may have a comparative But access to consumers is only one aspect of access; advantage in the export of software or engineering services. Factor additional conditions must be met before a network- endowments have always played a role, but within the confines of the based growth of trade in services can make a full contri- limited transponability of services. bution to the economic growth of all trading partners and 4. "The Growth of the Global Office," New York Timnes, October 18,1988. to economic development. Furthermore, since the new 5. See "A Choice of Brands 'Economist, August 25,1984, p. 14. opportunities in trade in services allow transnational 6. Taxing data flows or puting a tariff on them may be difficult, service providers to have a considerable impact on eco- but it is not impossible. The tax could be placed on the volume of data transmined, as is done with long-distance tdephone trffic, or (a more nomic development, an international public policy difficult altemative) on the value of the data transmitted. As with framework should contain not only rights for service 121 Karl P. Sauvant shipments of goods across borders tax authorities could request that a ConferenceBoard. 1984.RegulatinglnternationalDtaTransrrission: bill of lading or customs declaration be added to each economically The Impact on Managing International Business. New York. relevant data package sent. Such a 'data bill of lading" could indicate Feketekuty, Geza. 1988. International Trade in Services: An Overview the nature and value of the data involved. The technology for adminis- and Blueprint for Negotiations. Cambridge, Mass.: Ballinger for tering volume-sensitive or value-sensitive rates appears to exist. It is the American Enterprise Institute. worth noting here that the OATr Valuation Code has setan intemnatioal -. 1989. 'International Network Competition in Telecommu- precedent for assessing certain services. The GATr Committee on nications." In Peter Robinson, Karl P. Sauvant, and Vishwas P. Customs Valuation decided at the end of 1984 that it is permissible (as Govitrikar, eds., Electronic Highwaysfor World Trade: Issues in desired by developing countries) to include the value of software in the Telecommunication andData Services. Boulder, Colo.: Westview. calculations when determining the value of a carrier medium such as a OATr, Committee on Customs Valuation. 1984. "Decision on the Val- tape, althoughitis also pemissible (as desired especiallybytheUnited uation of Carrier Media Bearing Software for Data Processing States)totakeonlythecostorvalueofthecarriermediumintoaccount. Equipment, Adopted by the Committee on 24 September 1984." As the chairperson of the committee remarked, "Indeed, if the technical VAUI8 and VAL/8/Add.l. facilities are available to the parties to the transaction, the software can GArr. 1989. International Trade 1988-89. Geneva. be transmitted by wire or satellite, in which case the question of customs Robinson, Peter, Kar P. Sauvant, and Vishwas P. Govitrikar, eds. 1989. duties does not arise" (OATr 1984). But the issue is precisely the Electronic Highwaysfor World Trade: Issues in Telecomnmwoica- increasing availability of these technical facilities and the possibility tion and Data Services. Boulder, Colo.: Westview. that customs authorities may imposeatariffontransborderdata flows. Sauvant, Kad P. 1986a. International Transactions in Services: The It may well be only a question of time before data flows are subject to Politics of Transborder Data Flows. Boulder, Colo.: Westview. taxes or tariffs. _. 1986b. Trade and Foreign Direct Investment in Data 7. This is, of course, the logic of the Brazilian policy on transborder Services. Boulder, Colo.: Westview. data flows (see uNcrc 1983). SrrA. Various issues. Annual Report. Spero, Joan E. 1985. "Intemational Trade and the Infonrnation Revolu- References tion." Harvard University Center for Information Policy Research, Cambridge, Mass. Processed. swiFr. Various issues. Annual Report. BusinessIntemational. 1983.TransborderDataFlow:lssues,Barriers UNCrC: 1983. Transborder Data Flows and Brazil: Brazilian Case and Corporate Responses. New York. Study. New York. Claimronte, Frederick F., and John H. Cavanagh. 1984. "Transnational . 1989. Foreign Direct Investment and Transnational Corpo- Corporations and Senices: The Final Frontier." In Trade and rations in Services. New York. Development: An rNcrTAD Review, no. 5. New York: United Na- tions. 122 Part III Country Experiences and Perspectives 13 The United States Bela Balassa This chapter focuses on the effects that liberalization of a well-educated labor force, including a whole range of trade in services may have on the United States. It professional expertise in financial, legal, and technical examines U.S. "revealed" comparative advantage in ser- subjects' (pp. 44-45). Here too, a size effect has been vices as indicated by the available trade data, barriers to postulated. Sapir and Lutz found that human capital and exports of U.S. services abroad, and restrictions on im- scale are the factors that determine comparative advan- ports of services into the United States. It concludes with tage in insurance services. This conclusion applies to a discussion of the position taken by the U.S. government total insurance as well as to merchandise and non- and private interests with regard to liberalization of trade merchandise insurance. Total and nonmerchandise in- in services. surance appear to make relatively intensive use of higher education, whereas merchandise insurance appears to be The Determinants of Comparative Advantage in relatively intensive of secondary education. Services The implications of these results for the United States depend on the country's relative endowment of physical The best-known empirical investigation of comparative capital (for freight and passenger transport) and human advantage in trade in services is a nearly decade-old capital (for insurance). Among the fifty-two countries paper by Sapir and Lutz (1981), who sought to explain studied by Sapir and Lutz, the United States ranks fifth international trade in services in terms of intercountry in terms of the ratio of physical capital to labor, behind differences in factor endowments and country size. Israel, Switzerland, Sweden, and Norway. It appears, Freight, passenger services, and insurance were ana- then, that the United States has a comparative advantage lyzed, and the sample of countries varied according to in freight services and in passenger transport. The coun- the availability of data. The authors hypothesized that try ranks seventh-behind New Zealand, Canada, Yugo- comparative advantage in freight services is positively slavia, Austria, the Republic of Korea, and the related to an economy's capital-labor ratio (on the as- Netherlands-in terms of the level of secondary educa- sumption that shipping is capital-intensive) and to coun- tion, measured by the ratio of enrollment to the size of try size (because of the existence of scale economies in the relevant age cohort. It follows that the United States shipping). The results support the first hypothesis-that has a comparative advantage in merchandise insurance. countries relatively well endowed with physical capital Finally, the United States ranks first in terms of the level have a comparative advantage in freight services-but of higher education, measured by the ratio of enrollment not the second. to the relevant age cohort This means that it has a Transport of passengers is also considered to be capi- comparative advantage in nonmerchandise insurance as tal-intensive.The hypothesis that comparative advantage well as in total insurance. in passenger transport is positively related to the country's capital-laborratio is borne outby the empirical "Revealed" Comparative Advantage in Services results. It further appears that a positive trade balance in travel contributes to the export of passenger transport To shed light on the U.S. comparative advantage in a services. wider array of services, the concept of "revealed" com- Carter and Dickinson (1979) have suggested that in parative advantage has been used. This concept, origi- international trade in insurance the essential element "is nated by Balassa (1965), interprets a country's 125 Bela Balassa comparative advantage in terms of its relative trade per- present context, however, since regulations on transport formance (net exports). It has been widely used in inves- services are similar in most countries. tigations of merchandise trade. Sapir and Lutz also predicted that the United States Sapir and Lutz found that passenger transport and would be a net exporter of insurance. This turns out to be freight services are exported by capital-abundant coun- the case for primary insurance but not for reinsurance, in tries and that the United States is such a country. The which the United Kingdom appears to possess traditional United States might therefore be expected to be a net advantages. exporter of passenger transport and freight services. But The United States' large net import balance in travel as table 13-1 shows, the United States has a net import largely reflects its comparative disadvantage in this balance in both passenger transport and freight that is not labor-intensive activity. This import balance would be fully offset by its net export balance in port services. reduced to some extent if foreign exchange restrictions ap- Further discussion of these items is not necessary in the plied by a number of developing countries were eliminated. Table 13-1. U.S. International Sales and Purchases of Services, 1987 (millions of dollars) Services trade Sales Purchases With unaffiliated foreigners 66,482 66,256 Passenger fares 6,882 7,423 Other transport 16,989 18,164 Freight 4,700 10,999 Port services 11,575 6,360 Other 714 805 Insurance 2,285 3,168 Primary insurance, net 1,596 552 Reinsurance, net 689 2,616 Travel 23,505 29,215 Royalties and license fees 2,171 522 Business, professional, and technical services 4,270 1,425 Accounting, auditing, and bookkeeping 27 37 Advertising 108 140 Computer and data processing 629 61 Database and other information services 138 28 Engineering, architectural, construction, and mining, net 936 368 Installation, maintenance and repair of equipment 1,023 506 Legal services 148 56 Management, consulting, and public relations 379 50 Medical services 516 n.a. Research and development, commercial testing and laboratory services 182 127 Other 184 52 Telecomnmunications 2,105 3,701 Financial services 3,731 2,077 Education 3,804 513 Film rentals 740 48 With affiliated foreigners 14,988 6,210 With foreign parents 2,923 3,150 Royalties and license fees 240 1,083 Other services 2,683 2,067 With foreign affiliates 12,065 3,060 Royalties and license fees 7,049 150 Other services 5,016 2,910 Total 81,470 72,466 Source: AscherandNWhichard(1989). 126 The United States The large positive balance in royalties and license fees international telephone calls is owed to the foreign car- is not related to the Heckscher-Ohlin explanation of riers that terminate the telephone calls because the ac- trade flows but is, rather, explained by the United States' counting rates used in transfers among the carriers have technological advantages. not been reduced along with the actual rates paid. If it The United States has a large net export balance in were not for this discrepancy, the United States would business, professional, and technical services and for all not have a net import balance in telephone services items within the category except for accounting, audit- (Federal Communications Commission 1988). ing, and bookkeeping and advertising. (It has small im- In financial services the United States has exports of port balances in these items.) $3,731 million and imports of $2,077 million. A careful U.S. net exports in computer and data processing ser- study by Hilaire and Whalley (1986) confirms the U.S. vices are large: sales total $629 million and purchases export surplus. The authors applied estimates of the $61 million. Software services (excluding custom pro- spread between deposit and lending rates for U.S., U.K. gramming) account for two-thirds of the total. This cat- and Canadian banks and for banks in their largest partner egory consists of both prepackaged software and rights countries to corresponding data on the assets and liabil- to use, reproduce, or distribute such software. Also in the ities of domestic banks with nonresidents and of nonres- computer and data processing services category are inte- ident banks with residents. These yielded an estimate of grated hardware-software systems and system analysis, the value of intermediation services provided by domes- design, engineering, and custom programming services. tic banks to depositors and borrowers abroad, and by The United States has a net export balance in database nonresident banks to domestic depositors and borrowers. and other information services, with sales of $108 mil- The combined financial intermediation charge was ap- lion and purchases of $28 million. Business and eco- portioned between the parties to calculate the intema- nomic database services and miscellaneous database tionally traded components. The results show U.S. services fall under this category. banking exports of $4.03 billion and imports of $3.04 Net export balances are also shown for engineering, billion, as against U.K. exports of $2.55 billion and architecture, construction, and mining (sales of $936 imports of $4.40 billion and Canadian exports of $0.72 million and purchases of $368 million); installation, billion and imports of $0.42 billion. Thus the United maintenance and repair of equipment ($1,023 million States appears to have a revealed comparative advantage and $506 million); legal services ($148 million and $56 in banking services. million); management, consulting, and public relations In education U.S. exports were $3,804 million and ($379 million and $50 million); research and develop- imports were $513 million. Exports in film rentals were ment, commercial testing, and laboratory services ($182 $740 million and imports were $48 million. million and $127 million); and other services ($184 The information provided so far concerns transactions million and $52 million). Sales of medical services with unaffiliated foreigners. Transactions within multi- amount to $516 million; data on purchases are not avail- national corporations exhibit a large net export balance able but are likely to be small. for the United States, with sales of $14,988 million and A seemingly abnormal case is telecommunications, in purchases of $6,210 million (table 13-1). which U.S. sales are $2,105 million and purchases are $3,701 million. The imbalance is entirely attributable to Barriers to Services Trade in the United States telephone services, in which the United States has a large and Abroad import balance; it has a net export balance in other telecommunications services. The net importbalance for The U.S.Report on Foreign Trade Barriers (USTR 1989) telephone services is a recent phenomenon that is ex- reviews perceived foreign barriers to U.S. services ex- plained by differential rates of increase in the volume of ports in various countries. Some of its observations fol- telephone calls and by differential rates of change in the low. cost of the calls. Between 1985 and 1987 the volume of telephone calls from the United States to other countries, Restrictive investment laws, administrative nontrans- measured in minutes, increased by 47 percent, whereas parency, legal and administrative restrictions on re- calls from other countries to the United States increased mittances and arbitrary application of regulations and by only 27 percent (Federal Communications Commis- laws limitU.S. service exports to Brazil. Service trade sion 1988). In 1987 the volume of outgoing telephone possibilities are also affected by limitations on foreign calls totaled 3,153 million minutes, as against 1,567 capital participation in many service sectors (p. 20). million minutes for incoming calls. Moreover, about 75 The Indian government either partially or entirely cents of every dollar collected by U.S. carriers from runs most major service industries. Restrictions on 127 BelaBalassa trade in services follow the same pattern and rationale Copyright of computer applications has become impor- as restrictions on trade in goods and foreign invest- tant in recent years. The Brazilian government has man- ment Officials fear allowing more scope to foreigners dated that all data received from unrelated parties be would diminish control over strategic industries, ad- processed in Brazil, and it has limited foreign equity versely affect inefficient service monopolies and add participation in Brazilian information industries. In other a new drain on foreign exchange (p. 87). countries no copyright protection exists for collective Korea continues to maintain restrictions on some work such as databases and software, and database cre- service sectors through a "negative list." In these ators are effectively excluded from protection. Several sectors foreign investment is prohibited or severely countries provide no protection, or only weak protection, circumscribed through equity participation or other for computer software and programming. restrictions. Those sectors of greatest interest to In accountingandadvertising, foreignaccountingfirms U.S. investors and service providers include profes- may notbe allowed to operate unless they are in partner- sional services (such as accounting, legal and fman- ships with domestic frms, and majority foreign partici- cial services) advertising, maritime transport, and pation may not be allowed in the advertising industry. telecommunications services (pp. 120-21). State corporations may have a monopoly position in insurance, and marine insurance for exports and imports This section reviews barriers to U.S. services abroad of may be reserved for domestic firms. Some countries the kind described above. It interprets services in a require foreign insurers to cede 30 to 60 percent of all broader sense to include patents, trademarks, and copy- transactions to the state-owned reinsurance company and rights. This is appropriate, since intellectural property limit the equity that may be owned by foreign insurance involves service transactions. companies. Finally, insurance firms may be prohibited A variety of products, including foodstuffs, beverages, from establishing subsidiaries and joint ventures with pharmaceuticals, agrochemicals, chemical compounds, noninsurance enterprises. agricultural machinery, and metal alloys, are not patent- The offer of what in U.S. terminology is called en- able in one country or another. Some countries set con- hanced telecommunications services (in most other ditions for patent protection-requiring, for example, countries the term is value added telecommunications that patented pharmaceuticals embody new technology. services) may be limited to a state-owned or state-fran- In several instances, especially forpharmaceuticals, only chised monopoly. Even where foreign firms are permit- processes can be protected, and other producers may, ted to compete with state-owned telecommunications consequently, enter the field with competing products administrations, restrictive terms and conditions im- that have been manufactured by different processes. posed on the use of telephone lines may make competi- Patent protection is often available for only a short tion difficult or impossible. For example, Japan's period, thereby limiting the firm's interest in the manu- Ministry of Education uses the TRON (Real Time Opera- facture of the product. Obtaining patent protection may tion System Nucleus) system as a technical specification be a slow process that gives other producers an opportu- for personal computers, and the NTT (the company that nity to establish themselves. provides basic telecommunications services) has an- Continuous use of trademarks may be a requirement for nounced that it will require TRON for the next generation their registration. The process of registering trademarks of the digital communications network. is often slow, and the enforcement of trademark protec- Restrictions are also imposed on legal and financial tion has encountered problems. It may not be possible to services andon construction, architectural, and engineer- register service marks (trademarks pertaining to ser- ing services. All of these restrictions are described in vices). USTR (1989), which considers them important obstacles As for copyright, there have been disputes between the to U.S. exports of services. United States and other countries regarding the limita- There is no comparable compilation on U.S. barriers to tions imposed on the value of broadcasting and video imports of services except for the report by the European material originating in the United States and regarding Community (Ec 1989). That study notes that the United taxes on this material. Other disputes have concerned States has entered an exception to article 11(5) of the copyright laws. Some countries have no copyright laws Patent Application Treaty, effectively postponing the for books or audio and video recordings. Others have date by which foreign patents become valid in the United such laws, but their practical application is deficient, and States. It further observes that the application of the there is considerable pirating of copyrighted material. cabotage principle effectively denies foreign air carriers Furthermore, the duration ofcopyrightprotection is often access to the internal U.S. market and that, with some very short. limited exceptions, U.S.-flag air carriers must be used for 128 The UnitedStates international transport of government property and fed- Organisation for Economic Co-operation and Develop- eral employees. ment (OECD) to undertake a study on services with a view In waterborne transport, access to domestic trade (that to identifying areas for future negotiations. This led to is, trade that uses coastal, intercoastal, and inland water- the preparation of a paper entitled "Elements of a Con- ways) is reserved forU.S.-flag vessels built in the United ceptual Framework for Trade in Services." States and owned by U.S. citizens. U.S. law prohibits In the meantime the United States pressed for further foreign vessels from carrying cargo or passengers from discussion of trade in services in the GA1T framework oneU.S. portto another if the secondU.S. port is the final and proposed that the work of the GATr include a study destination. And at least 50 percent of all international of the topic. Afteraprolonged debate between the devel- cargoes generated by programs sponsored by the U.S. oped countries, which came to support the U.S. position, government is allocated to U.S.-flag vessels unless none and the developing countries, which opposed such a are available. study, the trade ministers agreed in November 1982 that Laws and regulations that affect foreign suppliers of countries "that were so inclined could undertake national services other than transport are far less significant de- studies of trade in services." terrents. State governments, however, regulate banking, The United States was the first to circulate a national insurance, transport, and certain communications, and study, in the spring of 1984. This study was part of a the wide variety of differing requirements complicates strategy for building support for the negotiations that the operations of foreign businesses. became part of the Uruguay Round. The strategy has been successful; trade in services is on the Uruguay Developing the US. Position on Liberalization of Round agenda. Trade in Services The interrelationships between government and busi- ness have been important to the development of the U.S. U.S. proposals for liberalizing trade in services conform position on trade in services. As Feketekuty (1988, pp. to the general philosophy of deregulation in the United 5, 70) notes: States, where, over the past decade, important steps have been taken to deregulate aviation, truck transport, and International trade in services has become an impor- banking. Statements by U.S. authorities emphasize the tant issue because international trade in services has potential gains from the liberalization of services trade become big business, and the enterprises that conduct for all participants, not just the United States. According trade are counted among the largest corporations of to the official U.S. statement submitted to the General the world.... A model of the world economy that Agreement on Tariffs and Trade (GATf) in 1982 by does not accommodate trade in services has become William Brock, then the U.S. Special Trade Representa- increasingly unacceptable to enterprises selling ser- tive, "the basic goal of any future negotiations should be vices. These enterprises do not see a fundamental dis- to expand opportunities for trade, making possible the tinction between the sale of services and the sale of economic gains that can be obtained from trade based on manufactured goods to customers in other countries. comparative advantage" (Brock 1982, p. 238). But the fact that U.S. political and business groups were in the These statements are supported by a variety of business vanguard in introducing services issues in the trade ne- surveys. Mention may be made, in particular, of Price gotiations reflects the belief that liberalizing trade in Waterhouse (1985), which reported on the results of a services would benefit the United States. The extensive survey of Fortune's Directory of Service Companies barriers against U.S. exports of services described in the (Price Waterhouse 1985). It should be added, however, previous section bear out this perception. that the interests of large business firms lie not only in Trade liberalization in services was mandated by the their services exports but also in the production of ser- Trade Act of 1974, which for the first time stated that vices abroad. Thus, from the point of view of the balance "the term 'international trade' includes trade in both of payments, there may be a divergence between the goods and services" (section 102). Section 121, which national interest in promoting exports and the interest of dealt with the reform of the GATI-, directed the adminis- the firm in selling services, no matter where they are tration to seek "the extension of GA1T articles to condi- produced (Kravis and Lipsey 1988). tions of trade not presently covered in order to move toward more fair trade practices." Although the United The United States Service Proposal States was not able to get more than a few references to services trade in the Tokyo Round agreements, it subse- On October 23, 1989, the United States introduced a quently persuaded the other industrial countries of the comprehensive proposal on services in the Uruguay 129 BelaBalassa Round of multilateral trade negotiations. The U.S. pro- * Payment and transfers relating to provision of a posal seeks to open work services markets. It is a flexible covered service. States that, subject to IMF regula- proposal, as it provides for countries to take limited tions, each country should permnit free payments and reservations for those existing measures that do not con- transfers related to services that are provided across form to the agreement. Reservations could be entered for the border or by means of a commercial presence a finite period of time and would provide the starting located in its territory point for future rounds of liberalization of trade in ser- * Short-term restrictionsfor balance of payment rea- vices. sons. Allows countries temporarily to apply restric- The principal obligations that countries would assume tions, except forexchange controls or restrictions, in under the U.S. proposal are divided into two parts. Sev- the event of a balance of payments crisis or under eral provisions concern various ways of providing mar- certain other conditions, to be reviewed annually in ket access (articles 4 to 7). Others are designed to protect consultation with the AMF. market access (articles 8 to 15). Market access includes the following items: Under article 22 countries may enter reservations to • Establishment. Extends the right to establish or ex- articles 4-8 and article 13 with respect to specific ser- pand a business in another country in order to provide vices or specific aspects of existing legislation. Article pandabusceiness inanothrcountry in order to provide 22 further calls on countries to withdraw these reserva- a service in that country . Cross-borderprovisionofservices.Extends theright tions as soon as circumstances permit and makes them to sell a service that is produced by one country in subject to periodic negotatons. another country This reservation approach, representing a negative list, * Temporary entry for service providers. States that is superior to the use of a positive list, under which countries should facilitate the temporary entry of countries indicate the obligations they are willing to service providers assume with regard to various services. The latter alter- native would be likely to encompass a limited number of * Licensing and certification. States that such mea- sures shouldrelate principaly to competence or abil- items and cannot extrapolate into the future. itystouprovideservies and shouldr nooetdiscriminate At the same time, the proposed agreement provides the against foreignersi possibility for countries that wish to undertake additional against foreigners. obligations to negotiate separate protocols that would Other substantive obligations include the following apply only to their signatories. This would permit further items: deregulation in particular sectors for the participating * National treatment. States that foreign service pro- countries. viders should receive treatment no less favorable One may object, however, to the introduction of special than that accorded to domestic service providers agreements in the U.S. proposal. These agreements * Nondiscrimination. States that the benefits of the would permit the exclusion of selected sectors by indi- agreement should apply to all signatories, with vidual countries, which would go against the objective agreed-on exceptions of trade liberalization in services. * Exclusive service providers and monopolies. Re- Under article 18 it is further proposed to establish a quires countries to ensure that an exclusive or mo- Committee on Trade in Services, composed of represen- nopoly provider of services does not discriminate tatives from each of the participating countries. The between domestic and foreign service users committee should have final decisionmaking authority * Domestic regulation. Recognizes the right of each with regard to the interpretation and application of the country to regulate services and introduce new mea- agreement. sures as long as they are consistent with the agree- All in all, the U.S. approach embodied in the proposed ment and are administered in a reasonable manner. agreement represents an effort to develop a mechanism Countries mustalso provideforaprompt hearing and whereby countries commit themselves to liberalization review of complaints. in services. The United States specifically recognizes the * Transparency. Requires countries to make public all right of countries to regulate services but wants to mini- measures relating to services under the agreement. mize the trade-distorting effects of regulations. Except in urgent circumstances, countries should publish new measures before they become effective Conclusions and allow time for prior notification and comment. * Government aid. Prohibits government aid for ser- The liberalization of trade in services has been a long- vices if such aid causes injury to another country standing objective of the United States. This objective 130 The United States conforms to the apparent comparative advantage of the Prospects." Paper prepared for the National Bureau of Economic United States in service industries, especially in modem Research Conference on International Economic Transactions: Is- sues in Measummrent and Empirical Research, Cwnbridge, Mass., services. It can be expected that freeing trade in services August 3-4. will improve the U.S. balance of payments. The exis- Balassa, Bela. 1965. "Trade Libemlizafton and 'Revealed' Compara- tence of extensive barriers to exports of U.S. services tive Advantage." Manchester School (May):99-121. , . . ~~~~~~~~~~~~Brock, Williarn E. 1982. "A Sirnple Plan on Negotiating on Trade in supports this conclusion. Sevices." Worn TEconody November):229e40n Although U.S. officials have stressed the gains that Carter, R. L., and G. M. Dickinson. 1979. Barriers to Trade in Insur- liberalization of trade in services would bring to the ance. Thames Essay 19. London: Trade Policy Research Center. world economy, the benefits that the United States would EC. 1989. 1989 Report on U.S. Trade Barriers. Brussels. Federal Commrunications Comnission. 1988, International Account- obtain lie behind the single-minded determination on the ing Rates and the Balance of Payments Deficit in Telecommunica- part of U.S. authorities to pursue this goal. In fact, the tions Services: Report of the Comnmon Carrier Bureau of the idea of freeing trade in services originated in the United Federal Commsunications Commission. Washington, D.C. Feketekuty,Geza. 1988. International Trade in Services. An Overview States, and U.S. authorities spearheaded the effort in the and Blueprintfor Negotiations. Cambridge, Mass.: Baflinger for OECD as well as in the GATT. the American Enterprise Institute. In the United States, public authorities and business Hilaire, Frances, and John Whalley. 1986. "Sorne Estimates of Trade have collaborated to support liberalization of trade in Flows in Banking Services." Working Paper 8615C. Centreforthe Study of Intemational Economic Relations, Department of Eco- services. This cooperation reflects a common view as to nomics, University of Westem Ontario, London, Canada. the advantages of freer trade for the United States. In the Kravis, I. B., and R. E. Lipsey. 1988. "Production and Trade in Service case of business, however, it also reflects the potential by U.S. Multinational Fimns." NBCR Working Paper 2619. Cam- bridge, Mass.: National Bureau of Economic Research. benefits from sales of services produced abroad, in addi- Price Waterhouse. 1985. Business Views onPublicPolicy andInterna- tion to the gains to be obtained from exports of services. tional Trade in Services: The Results of a Survey of Fortune's The U.S. services proposal to the GATT concerns trade Directory of Service Companies. Boston. in services as well as investment in service industries. It Sapir, Andr6, and Emst Lutz. 1981. Trade in Services: Economic DetermiwantsandDevelopment-Relatedlssues. World Bank Staff seeks to open world services markets while allowing Working Paper 480. Washington, D.C. countries to take limited reservations for those existing UsTR 1989. 1988 National Trade Estimate Report on Foreign Trade measures that do not conform to the proposed agreement. Barriers. Washington, D.C. Whichard, Obie G. 1988. "Intemational Services: New Information on U.S. Transactions with Unaffiliated Foreigners." Survey ofCurrent Note Business (October):27-34. The authoris indebtedtoCarol Balassa, PatrickMesserlin,and Karl Sauvant for helpful comments. References Ascher, Bemard, and Obie G. Whichard. 1989. "Developing a Data Systemn forIntemational Tradein Services: Progress,Problems, and 131 14 The European Community Patrick A. Messerlin Liberalization of services in the European Community national product (GNP) of the EC-the equivalent of the (EC) sends three clear messages to the current and future, GNPS of all the developing economies together. In the multilateral negotiations on services. mid-1980s EC banking and insurance represented one- 1. As predicted by economic theory, unilateral liberal- third and one-fourth, respectively, of world business in ization pays. Three or four EC states undertook unilateral those sectors. The EC fleet accounted for one-fourth of liberalization of services during the 1970s and 1980s, world shipping capacity, EC transport for one-fourth of more than ten years before the EC initiated its 1992 the air traffic of the countries of the Organisation for program. Because these liberalizations were trade ori- Economic Co-operation and Development (OECD), and ented (they opened national markets to foreign competi- EC investment in telecommunications equipment for tion), they have yielded large gains to the consumers of more than 40 percent of OECD investment. these "liberal" EC states. 2. Unilateral liberalizations are fragile. A host of do- Unilateral Liberalizations as a Driving Force mestic and international factors have joined forces to close markets that had been liberalized. Monopolies that Only the United Kingdom and, more marginally, the provided many services before liberalization have re- Federal Republic of Germany, Ireland, and the Nether- tained considerable influence in the small national mar- lands have been able to undertake unilateral liberaliza- kets. Nonliberal EC states have inhibited competition by tion in airlines, banking, securities, and telecom- keeping their own markets closed. As a result it has munications.1 All of these moves share three features. proved difficult to maintain a substantial level of compe- They have followed common time sequences, and the tition in liberalized service markets in the long run. resulting convergences have considerably eased the 3. Reinforcing and expanding unilateral liberalizations 1992 program. They offer alternative solutions to the inside the EC has required a multilateral liberalization- delicate balance between competition and privatization the 1992 program, which was nurtured by the unilateral that may be of some interest for developing countries. liberalizations and is consolidating them by diluting for- Last, and of the utmost importance, they all include a mer dominant firms in larger markets. The program also crucial trade component that qualifies them as genuine makes liberalization attractive to EC states unable to trade liberalizations. undertake unilateral liberalizations in that it decreases the political costs of implementing liberal policies. Common Liberalization Sequences These three messages suggest that the Community's experience can be a driving force in the Uruguay Round Financial services provide the most complete illustration negotiations on services. The 1992 program, however, is of common time sequences in unilateral liberalizations. merely domestic liberalization. It does not contain an During the 1970s and 1980s public policies and regula- explicit foreign trade policy in services, and this missing tions have been a crucial engine of innovation in finan- aspect has nurtured fears of a "Fortress Europe." If the cial services. In banking, macroeconomic policies have 1992 program is implemented behind high barriers, it been accompanied by an endless flow of new financial will generate huge distortions that will be detrimental to products-Eurobonds, fixedrate Euronotes, floating rate the welfare of the Community and the world. The huge notes, note issuance facilities (NIFs), revolving under- 2 size of the EC service sectors has fueled these fears. wridng facilities (RUFs), and swaps of all kinds. In Services account for roughly 60 percent of the gross insurance, innovations have been fueled by domestic 132 The European Community policies, in health care, for example, and by intemational were well adapted to provide standardized services with policies such as freer trade in goods, which gives rise to the use of traditional technology-transport of small larger risks. These innovations have required easier ac- numbers of air travelers between a few important towns, cess to increasingly large capital markets. In such an basic phone calls, and so on. But protected flag carriers environment some financial operators-such as the "uni- and post and telecommunications operators (PTos) have versal" banks or insurers that provide most of the finan- not been able to provide efficiently the "new" services cial products-have exhibited comparative advantages. made possible by modem technology. Examples of such All unilateral liberalizations in financial services have services are "charter" air transport of large crowds of sought to favor the emergence of these new types of tourists to a host of exotic places and "electronic high- operators and their access to large and flexible stock ways" that provide a wide range of services-from data markets by following a three-step pattem: removal of transmissions to "chatlines" and telephone games-to the barriers between the various parts of the banking individuals or firms who hook their computers to their industry to facilitate the move toward universal banks; telephones (Feketekuty 1989). Monopolies could not abolition of foreign exchange controls to provide the cope with such a rate of innovation. Market competition large amounts of funds needed by financial operators; was necessary. and the introduction of stiff competition in the stock The capacity of public firms to discriminate and cross- market-the key market for an industry increasingly subsidize between the markets of traditional services dominated by securitization. reinforced the complexity of the problems raised by Germany has long had universal banks and no ex- diversity. The best illustration is provided by PTos. More change controls. By contrast, British financial services profitable than flag carriers (their average net income were heavily regulated at the end of the 1960s. Starting represented 10-20 percent of their revenue, as against in 1971, however, the interest rate cartel operated by the 5-7 percent for flag carriers), PTOs were able to subsidize principal British clearing banks was dismantled and the equipment manufacturers massively. For instance, direct markets serviced by the banks and the building societies subsidies from French Telecoms to French equipment (the main savings and mortgage institutions in Britain) producers have amounted to more than ECU 1 billion a were integrated. In 1979 Britain abolished foreign ex- year since 1983, and roughly 65 percent of the costs of change controls, finally catching up with Germany. In the videotext Minitel are subsidized by French Telecoms the mid-1980s the balance between the two countries (OECD 1988, p. 30;LeMonde, June 30, 1989 andJuly 17, changed. German financial services, although liberal- 1989). Despite this strong grip on their sector, PTOS have ized, remained protected from foreign competition, been unable to forecast the demands with the highest whereas Britain, starting in 1986, was the first to open growth (for instance, mobile phones in the French case) the stock market to stiff foreign competition. The new and to raise the financial and human resources necessary regulations aimedatcreating one market (by merging the to match competition-driven markets in providing the Euromarket and the London StRck Exchange) and one "new" services. type of operator (by merging brokers and jobbers into Privatization of public monopolies was seen as the market makers); giving the Bank of England a decisive natural way to create the competitive markets required role in the crucial market of gilts (British government by the "new" services. Unilateral liberalizations, how- securities); and introducing a drastic trade component. ever, show that there can be a conflict between competi- The admission of corponate members to the stock exchange tion and privatization, especially as the latter is rarely a regardless of nadionality and with no preset limit on the constraint-free choice. The privatization of British numberof seatsavailablehasbeenatthecoreof theincreasing Telecoms was an unexpected consequence of British importance of the London Stock Market since then. rules on the public budget,3 and the German constitution Financial services elsewhere in the EC have followed has prevented privatization of the Bundespost. Govern- the same pattern of evolution. Most EC states have taken ments that are obliged to privatize may want to make the the first step by now, and nearly half have reached the step more attractive by selling firms with a flow of future second step (the exceptions are Greece, Ireland, Portugal, potential rents-that is, by selling monopolies. Private and Spain). Only Britain has fully achieved the third step. buyers of such public monopolies are likely to oppose any future move toward competition that might erode the Competition and Privatization rents expected or paid. A sound liberalization sequence can overcome the po- A powerful force behind liberalization in services was tential conflicts between competition and privatization. the brake on the potential growth of many service sectors If new services-those that public monopolies are un- exerted by the existing public monopolies. Public firms able to provide-are opened up long enough before 133 Patrick A. Messerlin traditional ones, competitive markets can evolve that are to make liberalization credible.6 In a single year (1989), large enough to reduce the potential anticompetitive several drastic measures were taken: the Bundespost impact of privatization. This is be illustrated by three was split into three corporations (post, bank, and tele- examples. communications); its monopoly in customer equipment In Britain, the liberalization of charter air transport (a was ended; competition from private firns in data and new" service) in the 1960s and 1970s gave birth to mobile telecommunications was introduced; the markets that by 1984 represented one-third of all British Bundespost's ability to cross-subsidize was reduced by air transporL In that year Britain began to liberalize the requiring that German Telecoms use flat-rate charges traditional scheduled services by privatizing the flag (easier than the former usage-sensitive tariff for compet- carrier, British Airways, and by tacitly setting up a du- itors to match) in some data services; and the first net- opoly with a private carrier, British Caledonian (Vickers work of mobile phones was licensed to a private group and Yarrow 1988).4 In 1988 the duopoly collapsed with led by Mannesmann.7 Large competitors have been the takeover of British Caledonian by British Airways, convinced and have begun large-scale operations. but the negative effects of the collapse on competition Meganet (a subsidiary of German insurance firms) has were limited because the large charter carriers were started leasing lines in bulk from German Telecoms and powerful enough to buy half of the route licenses and of selling capacity on them for data traffic. Volkswagen, the 5,000 airport slots owned by British Caledonian and IBM, and EDS (General Motors), among others, have submitted to bids by the Civil Aviation Authority. begun to provide a wide spectrum of value added ser- British telecommunications offers a different story. vices. But in the absence ofprivatization, the competitive Britain began to liberalize traditional and new services fringeofsmalleroperatorsthatmaybecrucialforreaping almost simultaneously, in 1982, when Mercury was li- all the potential gains from liberalization remains cau- censed to offer the traditional voice services and to tious. operate a network of the new value added services. At that time value added services represented only 1 percent Domestic Liberalizations as Trade Liberalizations of telecommunications revenues in Britain. As a result, the prospects for competition did not look very encour- All the unilateral lieralizations undertaken by the EC states, aging, especially since the government explicitly estab- although domestic in nature, rapidly incorporated a trade lished a duopoly consisting of British Telecom and component and became authentic trade liberalizations. Mercury (both privatized firms) for the first phase of First, liberal EC states felt it necessary to set up bilateral liberalization, 198489. It was feared that the two finns agreements among themselves and with the United would share a reason to oppose further liberalization- States to strengthen their liberalizations. Air transport the need to undertake huge investments to modemize an provides an illustration: multiple designation (licensing old network, in the case of British Telecom, or to create more than one domestic carrier for a given route), re- a new one, in Mercury's case (Vickers and Yarrow, moval of restrictions on capacity and frequency, and the 1988; Beesley and Laidlaw 1989).5 The new regulatory automatic approval of airline fares (except in case of environment, however, was liberal enough to allow Brit- disapproval by both countries) were introduced in bilat- ish consumers to take full advantage of a wave of tech- eral air agreements between liberal EC states (Britain- nological progress and to generate an explosive growth Netherlands, Britain-Ireland, and so on) after 1984. of demand for private telecommunications networks, Second, unilateral liberalizations offered consumers basic services (mobile phones), and value added ser- new opportunities for substituting services produced in vices. In less than five years the size of the markets under different EC states, including nonliberal states. Because competition has become so large that the British govern- of this larger set of potential "arbitrages," the prices ment can contemplate a huge injection of new competi- charged in all EC states were driven by the prices emerg- tion: at least one firm, British Railways, with its huge ing in the more competitive markets of the liberal states. and modern telecommunications network, can compete Telecommunications is a good illustration of the power on equal terms with British Telecoms and with Mercury; of arbitrage. In 1985-86 the tariff reductions that AT&T three more licensees (in addition to the two initial ones) introduced on transatlantic calls made phone calls from in mobile phones; and, possibly, authorization for firms France to the United States 30 percent more expensive to resell part of their private telecommunications net- in relative terms and obliged French Telecoms to lower works to third parties. its own tariff by 20 percent. Heavy additional pressure The German experience in telecommunications sug- was imposed by the new tariffs of British Telecom, gests that when privatization is ruled out, a quicker and which made calls to the United States from eight of the more massive introduction of competition is necessary EC states 15 percent cheaper (on average) if they were 134 The European Community routed through Britain. Modem technology increased the scheduled fares and were similar to those in the deregu- role of arbitrage. Since British Telecoms and AT&T were lated U.S. markets (McGowan and Trengrove 1986, p. able to offer large multinational clients a better service 78). In 1987 scheduled fares on European routes with a and to persuade them to locate their telecommunications significant charter presence were estimated to be 40 hubs outside nonliberal countries, the PTOs concerned percent lower than fares on routes with little or no charter have been forced to take a more liberal attitude with their competition (Financial Times, December 24, 1987). In largest clients in order not to lose them. 1985 Mercury's phone tariffs were, on average, 15 per- Arbitrage seems to have played a more important role cent lower than those of British Telecom; in 1989 they than bilateralism. For example, in banking EC states were were 30 percent lower (Beesley and Laidlaw 1989, p.29). concerned that their markets might lose business to more The impact on tariff structures has been even greater. open financial markets in other EC members. Indeed, the Average price changes underestimate the impact from failure of some EC states to liberalize their stock ex- competition because liberalizations tend to increase the changes has benefited the stock markets of the most prices of costly services and to compensate by huge liberal EC states. The London Stock Market reform trig- decreases in less costly services. For instance, commis- gered a general movement away from the Continental sion rates on the London Stock Market increased by 5-25 stock exchanges, which obliged other EC states to begin percentfor transactions of less than 50,000, decreasedby to liberalize their own regulations, and the liberalization 20-35 percent for bargains of 50,000-500,000 (the larg- of some Continental stock exchanges in turn induced the est part of the market), and remained stable for larger London markettorelax some of its stringentregulations. purchases (Price Waterhouse 1988, p. 133). Tariffs on The opening of domestic markets to foreign producers the London-Amsterdam route increased by 5-15 percent of services has been the most important feature of the for the most expensive seats, whereas inexpensive fares unilateral liberalizations. Vested interests understood (late bookings in economy class) were offered at a 60 this point well and tried to stop arbitrage and bilateralism. percent discount. In telecommunications the PTOS of the nonliberal Ec These new tariff structures reflect the reduction or states (France and Germany) have refused to conclude elimination of the cross-subsidization policies of domes- operating agreements with Mercury, which was obliged tic monopolies. Following liberalization in Britain, price to enter into market-sharing agreements with British structures in telecommunications have diverged from Telecom.8 In airlines the International Air Transport those in Continental Europe. In 1987 local calls were Association (IATA) deliberately designed complex rules twice as expensive in Britain as in France or Germany, for air fares to ensure that travelers from nonliberal EC whereas long-distance trunk calls were 50 to 70 percent states could not take advantage of the proximity (by more expensive in France and Germany than in Britain. road or rail) of European airports to one another to In the few niches that have seen stiffer competition, price benefit from the few existing liberal policies (Kasper changes have been larger. In 1987 intemational leased 1988, p. 77). lines were 30 to 100 percent more expensive in France and Germany than in Britain (Muller 1988, p. 139). The The Gains from Unilateral Liberalizations most recent prices for private lines are considered roughly in line with costs in Britain (although long-dis- Britain's unilateral liberalizations of the early 1980s tance traffic is still subsidizing short-distance circuits) were profitable enough to induce a few other Ec states whereas in Continental Europe they are, on average, four (Germany, Ireland, and the Netherlands) to undertake times costs (Financial Times, May 10, 1989).9 similar policies. Gains from liberalizations come from three sources: lower prices for consumers, larger mar- LargerMarkets kets, and new comparative advantages revealed by more competitive firms. Lower prices brought about by domestic liberalization are a sure way of increasing the size of domestic markets Lower Prices and thus the probability that domestic exports will become internationally competitive-a goal that in- Liberalized airlines, banking, and telecommunications dustrial policies often fail to achieve at a reasonable have all experienced price decreases. A few months after cost. the introduction of the 1986 regulations, commission The number of stocks traded in the London Stock rates on the London Stock Market had decreased by 20 Market grew by 20 percent in the first six months after percent on average. In 1986 average British air charter the introduction of the new 1986 regulations. This fares were lower by 10 to 30 percent than the comparable growth was mainly attributable to the competitive "beta- 135 Patrick A. Messerlin type" stock markets, defined as those with six or more charter company, Britannia, has been responsible for market makers (or four quoting firm prices). roughly as many passenger-kilometers as Air France on Air charter markets-now more or less liberalized in the intra-European routes, the second largest EC flag most EC states-represented more than 60 percent of carrier after British Airways. In the second half of the total European air markets in 1987. The British liberal- 1980s two charter airlines, Britannia and Dan-Air, ac- ization was the first and has been the most far-reaching counted for more passenger-kilometers than Swissair. In up to now, as can be seen in the fact that in 1987 British telecommunications the experience acquired in the lib- charter services represented 60 percent of independent eralized cellular phone market in Britain has allowed intra-European charter air traffic and more than twice the British Telecom to buy 20 percent of McCaw Cellular, share of Germany (the second largest in the EC). one of the largest U.S. firms in this booming niche and In telecommunications the ratio of calls as a share of the first truly national cellular network in the United British gross domestic product (GDP) or to exports in- States. creased in relation to the coiresponding ratios for Ger- many and France by 15 percent and 25 percent, The Limits of Unilateral Liberalizations: Toward a respectively, between 1980 and 1986. During the same Multilateral Effort period calls from Britain to the United States as a share of total calls between the two countries increased by 8 Despite these large gains, unilateral trade liberalizations percent, reflecting decreased relative prices. Meanwhile, have proved fragile, and their political costs can be high. the corresponding proportion decreased by 7 percent for Voters may find it easy to accept that cheaper air tickets Germany and by 13 percent for France. In some niches for holidays improve their welfare, but-as users of changes were more dramatic. The British market for subsidized short-distance phone calls-they are harder value added network services is estimated to represent to convince that loss of these subsidies might be offset 80 percent of the total European value in the late 1980s. by the increased efficiency in the economy brought about The British mobile phone market-operated by two by cheaper long-distance calls. Firms-the direct bene- (soon, five) firms under competition-had five times ficiaries of telecommunications liberalizations-have more subscribers than the German or French markets, little incentive to lobby for liberalization if they are able which are run or dominated by PTos. to pass through their telephone bills to consumers, as most European firms did during the 1970s and early Revealing New Comparative Advantages 1980s, when telecommunications still accounted for less than 10 percent of their costs. As a result, the late 1980s New comparative advantages are revealed by firms saw some erosion of the unilateral liberalizations in two working under the strict discipline of high competition ways. and minimal rents. It is currently estimated that at least First, unilateral liberalizations have been under strong one-fourth of the existing market makers in the London pressures in the liberal EC states. The competitive forces Stock Market will leave in the near future. In the gilts introduced in domestic markets have been eroded by market alone ten market makers of the initial twenty- former, but still powerful, monopolies. Flag carriers have eight have retreated since 1986, and the current leading reacted to lower profits brought about by increased com- four account for roughly 50 percent of the market. (Prior petition by buying substantial shares in the emerging to liberalization, however, the two leaders in a field of competitors, as KLM did on the London-Amsterdam only eight firms accounted for 75 percent of the market.) route. This vulnerability to old vested interests has also Over the past ten years the number of tour operators been observed in the United States; in the early 1980s the licensed in Britain increased from 473 to 703, and the U.S.governmentrenouncedamorecomprehensivecom- profit margins of the top thirty slumped from 4 percent petition policy in air transport under the double pressure in 1983 to roughly zero in 1987-88, leading to difficul- of foreign governments and of European and U.S. carri- ties for the charter airlines (such as British Island Air- ers (Kasper 1988, p. 80). In telecommunications duopo- ways) that depend on them. lies complain bitterly about being excluded from new Benefits from such disciplines are most visible in the licenses-an example is British Telecom in mobile sectors that have been liberalized for the longest time, phones-and lobby heavily for them. such as charter air transport. Massive entry in air charter Second, gains from unilateral liberalizations have led markets has selected the most successful tour operators the nonliberal EC states, initially hostile to liberalization, to build large low-cost charter carriers able to compete to introduce quasi-liberalizations-"quasi" because the with and become credible alternatives to foreign-flag sectors concerned are still sheltered from foreign com- carriers. Since the mid-1980s the largest British (and EC) petition. Air transport offers good examples of quasi-lib- 136 The European Community eralizations. Flag carriers have created their own charter The 1992 Program carriers behind high barriers, as Lufthansa did with Con- dorandAirFrance with AirCharter. "Flag charters" were This section reviews the part of the 1992 program de- conceived by their owners largely as a deterrent to the voted to internal trade liberalization in services and the entry of domestic independent air carriers, which as a corresponding economic gains that can be expected. It result have had a difficult time growing. In 1987 the then examines the competition rules embodied in the average size of the French and German independent Treaty of Rome, which have been the engine of the carriers was 7 percent and 40 percent that of the British intra-Ec liberalization and have made the Court ofJustice ones. The 35 percent stake that Air France was able to the cornerstone of that liberalization, and the elements of buy in TAT (the fourth largest French air carrier) in 1989 an EC foreign trade policy on services that might emerge led to increased dominance by the flag carrier. In such in the wake of the 1992 program. closed markets, domestic competition is easily inhibited. For instance, a recent attempt by Aero-Lloyd, the fourth The 1992 "Single Market" in Services biggest German charter airline, to compete on domestic scheduled routes with Lufthansa failed because a large The part of the 1992 program that deals with services proportion of Lufthansa's passengers use internal flights consists of fifty-one directives to be drafted and adopted only to connect with international flights and enjoy al- between 1986 and 1992.10 As of January 1990 more than most free internal flights. Finally, quasi-liberalized mar- half have been adopted and the rest tabled. The program kets remained under political control. In 1988 a proposal has adopted the broadest definition of services: it deals to merge two small (by British standards) French and with trade in services related to factor movements-in- Belgian charter carriers, Point Air and Trans European, cluding labor movement-and to cross-border move- was blocked by the French govemment (this was in sharp ments of consumers as well as of services. Its sectoral contrast with the govemment's blessing of the takeover scope is wide, covering previously untouched services of UTA-the only large independent French carrier-by such as insurance, shipping, road transport, and profes- Air France). Similar experiences can be observed in sional services. Finally, the 1992 program interprets telecommunications and posts (express freight); most progressive liberalization essentially as meaning that the European PTOs have created private subsidiaries-for less developed EC states will be granted longer time instance, French Telecom created Chronopost (express periods for adopting common rules. Appendix 14-A mail) and Transpac (data traffic). focuses on the most important directives in each service Having kept foreign competition at bay can be a source sector. of future difficulties, as French banking illustrates. In the 1980s the French govemment actively pursued a policy The Gains to Be Expected of "universal" banks, and France has some of the largest world conglomerates of banks-insurers-brokerage The 1992 program aims at dismantling intra-EC barriers. houses. But because these giant "universal" banks were Despite previous unilateral liberalizations, these barriers consolidated through state ownership and regulations in remain substantial, as indicated by the low ratio of intra- noncompetitive markets, it is difficult for them to attain EC to extra-EC trade in services, which is 25 to 30 percent, the Cooke Committee standard for capital adequacy (a or half of the corresponding ratio for goods. As a result, minimum ratio of capital to assets of 8 percent), which price reductions and welfare gains can be expected to be will become the standard in the post-1992 Community. large. Studies done under the auspices of the Commis- To improve their competitive situation in post-1992 sion (the Cecchini report) estimate that price reductions Europe, French banks might have to acquire foreign will be 21 percent (in Spain) to 4 percent (in the Nether- firms. But that would require capital and would increase lands) in financial services, about 10 percent in air trans- assets, causing further deterioration of the Cooke ratios. port, 5 percent in road transport, and 3 percent in In air transport the increasing dominance of Air France professional services, for total estimated savings to con- has inhibited a necessary decrease in wage costs; pilots' sumers of roughly 2 percent of the GDP of the EC (Emer- wageshaveabsorbed70peicentofthedecreasein laborcosts son and others 1988). allowedbythenew747 400aiicraftboughtbytheflag acrier These studies give to scale economies a large role that (Le Monde, September 3, 1989). Under these circum- some have found excessive. In a substantial range of stances, European liberalization is an attractive solu- services, such as retailbankingand insurance, economies tion. of scale are likely to be small (Neven 1989), and the 137 Patrick A. Messerlin "single" European marketcould offer more opportunities if they abused a dominant position. Moreover, airlines for differentiating products in diversified markets than carrying out a task of "general interest" (flag carriers) for homogenizing them to make possible massive econ- were also subject to competition rules insofar as the omies of scale (Centre for Business Strategy 1989). application of such rules did not obstruct the perfor- Others, however, have argued that adding dynamic ef- mance of theseparticular tasks-areminder of the article fects to the static effects measured by Emerson greatly 90 philosophy. increase the gains to be expected (Baldwin 1989). De- spite these controversies on the extent of the gains, there FINANCIAL SERVICES. Through a growing number of is a consensus that the 1992 program will bring substan- cases looking at national banking associations and com- tial benefits to the Community. mission rates in commodity markets, the Court is exert- ing increasing pressures for a strict enforcement of The Engine of the 1992 Program: Competition competition rules in banking (Commission of the Euro- Rules pean Community, Reports on Competition Policy, vari- ous years). The main contribution of the Court, however, EC competition rules are embodied in three articles of has concerned the definition of the mutual recognition the Treaty of Rome: article 85, on collusive practices; principle governing cross-border trade in insurance ac- article 86, on abuses of dominant power; and article cording to which each EC state will recognize the licens- 90, which states that public firms are not exempt from ing rules of the others and will apply its own operating competition rules embodied in articles 85 and 86 ex- rules on a nondiscriminatory basis to EC firm affiliates cept as necessary for their "general interest" tasks. (see appendix 14-A, "Banking"). In four recent rulings Until the mid-1980s these rules were barely used in the Court extended to this trade two basic concepts services because existing service providers, benefiting elaborated for trade in goods in the Cassis de Dijon case: from noncompetitive markets, had no motive for in- the obligation that EC states not erect trade barriers be- voking them. Competition-oriented markets shaped by tween themselves and the relevance of the public interest unilateral liberalizations since then have generated test as a restriction on freedom to provide services. firms and people that are eager to see their rights to According to the Court, existing Community law does competition enforced and to take cases to the Euro- not provide sufficient harmonization to justify a claim pean Court of Justice. that the public interest is already protected by the home state of the exporters of insurance services. Small poli- AIR TRANSPORT. In a 1986 ruling on a case examining cyholders ("mass" risks, in Community jargon) could Air France's allegations of price undercutting by the thus be confused about the real coverage offered by French tour operator Nouvelles Frontieres, the Court insurance products imported from other EC states. In stated that EC competition rules apply to scheduled air other words, "imperative reasons relating to the public transport. That ruling has definitively brought the sec- interest" may justify restrictions on the freedom to pro- tor-which since 1962 was exempted from the enforce- vide cross-border insurance services for small policy- mentof articles 85 and 86-back undercompetition rules holders. (van Bael and Bellis 1987). This ruling on insurance has been criticizedas a setback In April 1989 a second ruling extended, de facto, the to intra-EC liberalization (Hindley 1988). If greater har- scope of competition rules to routes between the EC and monization in "mass" risks is difficult to achieve in the the rest of the world. The case concerned the Frankfurt- near future, the Court's ruling would de facto limit the Tokyo route. Two German travel agents discovered that, 1992 program to large policyholders ("large risks")-the because of the difference between the market exchange only ones supposed to be capable of mastering the prob- rates and the exchange rates used by the IATA when lems arising from "imported" insurance contracts. setting theglobal network ofEuropean fares, theLisbon- The "general interest" principle, however, is suffi- Frankfurt-Tokyo fare was much less expensive than the ciently complex to have a positive impact on liberaliza- simple Frankfurt-Tokyo fare. An association "for the tion. First, it has obliged the Commission to definitively campaign against unfair competition," backed by flag abandon the harmonization route in insurance and to airlines, lodged a complaint of unfair competition and adopt the much less heavily regulatory approach of mu- price undercutting against the two travel agents. The tual recognition through branching. This is the meaning Court stated that price-fixing agreements for flights be- of the proposal by the vice-president of the EC Commis- tween EC and non-EC airports were under the scrutiny of sion, Leon Brittan, to allow insurers to sell the full range article 86 if they induced competitors to charge exces- of their products on the basis of a single license (see sively high or low prices fares on a single route-that is, appendix 14-A, "Insurance"). Second, the principle wilt 138 The European Community be useful for solving the disputes likely to emerge when The 1992 program has indirectly led to the emergence enforcement of mutual recognition requires a precise of the first elements of the EC foreign trade policy in border between licensing and operating rules. Finally, services, as illustrated by the debate on reciprocity in the principle can be apowerful argumentagainst monop- banling and the Commission's desire that it (instead of the oly power. For instance, if the basic telecommunications EC states) negotiate bilateral air agreements after 1992. network is of "general interest" and could, under the Rome The most elaborate elements concern the shipping sec- Treaty, be entrusted by EC states to a single operator tor. Two directives of the four on shipping in the 1992 (Financial Times, June 29,1989), the result may be a program specify rules involving non-EC states. The first stronger enforcement of article 90 than under the present directive deals with "noncommercial" advantages en- circumstances. joyed by foreign fleets in markets in which EC fleets are operating. The directive introduces regulations and pro- TELECOMMUNICATIONS. In telecommunications the cedures that, except fora few points related to the respec- Court launched the 1992 program by reaffirming that tive roles of the Council and the Commission in trade article 90 of the Treaty of Rome subordinates public policy in services, are similar to those of the EC anti- firms to competition. A first ruling (on telex forwarding, dumping law, which is an instrument with a well-estab- in 1985) stated that government-sanctioned monopoly lished protectionist and anticompetitive impact. This practices could conflict with article 86 of the treaty. In first directive has already been enforced, in 1988. A 1987 the Commission used the procedure for the first Korean shipping firm, Hyundai, was accused of noncom- time under article 90 in the 1992 program as the legal mercial advantages by European liners operating in the basis for the directive liberalizing telecommunications European-Australian Conference and was subjected to a terminal equipment. Such a procedure (which can be "redressive" duty of approximately 25 percent. As a applied only if public firms that enjoy exclusive rights result, Hyundai has stopped its operations on the route. use them in a way that restrains competition) authorizes The seconddirectiveprovides forcoordinated Commu- the Commission to act without a vote by the EC states. nity action with diplomatic initiatives or countermea- Because of this procedure, the directive on terminals has sures in cases in which third countries restrict access of been enforced and continues to be valid, although four EC shipping companies to ocean trade. The threat of EC states (Belgium, France, Germany, and Italy) have Community action-which makes this directive similar asked the Court to examine the legitimacy of the toaU.S. Section 301 case, but limited to shipping-cov- Commission's use of article 90. Since then, the Commis- ers bulk and liner cargoes, tramp services, passenger sion has used the article 90 procedure twice: as a basis transport, and movement of people or goods to or be- for liberalizing the Community's ECU 65 billion market tween offshore installations. The first case under this of value added services and to request regulatory changes directive, which concerned the routes between Europe in the Dutch express mail regulations (Financial Times, and the United States, was lodged in 1987 and was January 9, 1990). renewed in September 1989. The concept of "fair" trade is not ignored in other The Emerging EC Foreign Trade Policy in Services services, even if it has not been embodied in directives so far. As shown below, it has surfaced in the banking The 1992 program deals exclusively with intra-EC mat- dispute between the EC and United States. In air transport ters. The number and force of the trade barriers to be the unfair advantages allegedly enjoyed by "low-wage" dismantled if the EC opens its borders to foreign services air carriers have been cited. In telecommunications the indicate how deeply entrenched is protection of some first liberalizations in services are not, at this stage, sectors (table 14-1). Whatever the borderline between giving rise to actions such as those against Hyundai in the Commission's and the EC states' powers in trade shipping, but they have triggered increased imports of policy in services turns out to be, the EC states will retain telecommunications equipment, which have already many ways of influencing trade in services in the near been under antidumping actions. In July 1987 and March future. (For instance, airports and air control are still 1988 the ad hoc office of the EC Commission initiated an under the jurisdiction of the EC states, and restrictive antidumping case against exports of mobile cellular practices in this domain may create substantial barriers phones from Canada, Hong Kong, and Japan. This action to freer air transport.) The figures confirm the leading was echoed in the warning by Oftel, the British watchdog role of Britain and the foot-dragging of France, Italy, in telecommunications, against service providers that Spain (and, at this time, Germany). It also suggests that the lure users with cheap, low-quality mobile phones but smaller EC states may be more open than the larger ones. impose high call charges. 139 Patrick A. Messerlin Table 14-1. Main EC Barriers, as Reported by U.S. Firms, 1985 Service Belgium Denmark France Germany Greece Ireland Italy Netherland Portugal Air transport 2 1 3 2 1 1 2 1 Banking Construction 1 Insurance 1 1 1 4 2 2 3 1 1 Films and broadcasting 2 2 2 2 2 2 2 2 2 Professional services 2 4 1 2 1 Telecommunications 2 2 2 5 2 2 2 2 2 Tourism 1 2 2 3 4 Total, excluding shipping 10 6 14 14 9 7 15 6 10 Percentage 8.3 5.0 11.6 11.6 7.4 5.8 12.4 5.0 8.3 Shipping 2 5 4 4 4 5 3 5 1 Total, including shipping 12 11 18 18 13 12 18 11 11 Percentage 73 6.7 10.9 10.9 7.9 7.3 10.9 6.7 6.7 Note: The U.S. Trade Representative study is based on reports by U.S. exporters of services about "selected problems" they encounter. As a result, it tends to mirror the capacities of the United States to export-that is, it overestimates barriers in relatively open states or sectors and underestimates the others. This is why another source has been considered for shipping (White 1988). Sources: For all services except shipping; ussR (1985). For shipping; White (1988). The EC 1992 Program and the Uruguay Round workers from developing countries; some will be re- on Services cruited by Ec firms, as in the case of the flagging-out shipping policies examined above. But it will undoubt- What implications and lessons does a successful 1992 edly hamper many firms from developin~ countries in program have for the Uruguay Round negotiations? The exploiting their comparative advantages. implications concem the impact on the EC's negotiating position of the crucial choice made by the 1992 pro- The Impact on the EC Negotiating Attitude gram-to adopt the widest scope of trade in services. Lessons follow from the fact that the 1992 program has That no service sector is a priori excluded from the already begun to test many of the main concepts to be agreement has allowed the EC to balance as much as embodied in the Uruguay Round, as best illustrated by possible the interests of its potential exporters and im- the rules on market access and competition. porters in the Uruguay Round negotiations. To this ex- tent, the 1992 program has decreased the likelihood of a Scope "Fortress Europe"-a combination of intra-EC liberaliza- tion with high extemal protection. The 1992 program embraces the widest scope the Uru- Trade balances are an indicator of the likely reactions guay Round agreement on services could consider: it of EC service industries to a world liberalization under covers movement of consumers and of the factors of Uruguay Round auspices. Negative or deteriorating bal- production required for producing and selling services as ances are likely to be used as an argument for protection; well as cross-border trade in services, and it includes increasingly positive balances could support protrade future as well as existing services. The scope of the arguments. Table 14-2 shows the trade balances between program has influenced the Community's responseto the the EC and the rest of the world for fourteen service invitation in the Montreal ministerial declaration to sub- sectors. There may be active lobbies for protection mit an indicative list of service sectors of interest; the EC against the rest of the world in four industries: telecom- was one of only three Contracting Parties to table such a munications, advertising, films and broadcasting, and list, and its list covers all internationally tradable service sea freight. Three industries-banking, insurance, and sectors. There is, however, a significant difference be- travel-might favor a freer EC trade policy. The attitude tween the 1992 program and the EC approach in the of the other sectors is more difficult to predict, either Uruguay Round: the EC opposes coverage by the Round because trade balances are positive but deteriorating or agreement of trade in services that requires labor move- because no clear trend has emerged. Table 14-2 is con- ment other than that of "skilled and key personnel and firmed by table 14-1, which also suggests that telecom- for a limited duration." This limit will not harm all munications, films and broadcasting, shipping, and air 140 The European Community liberalize within a multilateral framework. That raises a question: will the 1992 program, which aims at creating United EC a customs union in services (or, to use the current word- Spain Kingdom Total (percentage) ing of the Uruguay Round, a regional integration ar- 2 3 18 10.9 rangement) increase trade distortions by facilitating 3 3 1.8 trade between the constituent territories and raising bar- 1 2 1.2 riers to the trade of other contracting parties with such 1 1 18 10.9 territories-as most of the custom unions in goods did? 2 2 22 13.3 Or might regional agreements in services differ from 3 2 15 9.1 2 2 25 15.2 custom unions in goods in that they generate more forces 4 2 18 10.9 able to inhibit trade distortions than do customs unions? 1 7 13 121 The second alternative seems the more plausible be- 14.0 10.7 1l0.0 cause prior to regional agreement services are regulated by a host of international agreements that make it diffi- 8 3 44 26.7 cult to increase the barriers between the members of the 25 16 165 regional integration agreement and the rest of the world. 15.2 9.7 100.0 These agreements were necessary because service pro- ducers put much more emphasis on establishment for market access than did producers of goods. The follow- ing list gives a flavor of this extensive pre- 1992 network of agreements and their impact on the EC. transport are good candidates for supporting protection- In banking the rules adopted under the aegis of the Bank ist policies, whereas banking should be more supportive for International Settlements have been incorporated in of freer trade because it is more open. the EC directives, and bilateral agreements on coopera- The sectors in which protectionist pressures are likely tion between agencies in charge of monitoring securities to be the highest (telecommunications and air and sea markets have been signed between non-EC and EC coun- transport) are also likely to be the most difficult to tries. In insurance the directive on motor insurance must Table 14-2. EC Trade Balances in Services, 1980-86 (billions of ECUS) Service 1980 1981 1982 1983 1984 1985 1986 Banking 0.89 0.95 0.80 1.77 2.32 2.88 3.12 Insurance 0.31 1.26 1.05 1.22 1.08 2.65 4.08 Telecommunications -0.11 -0.31 -0.47 -0.58 -0.47 -0.36 -0.33 Air freight 0.51 0.50 0.48 0.53 0.69 0.92 1.08 Air passenger 2.14 2.12 2.38 2.82 3.33 3.20 1.60 Seafreight 1.15 0.15 0.07 -1.14 -2.08 -2.32 -1.61 Sea passenger 0.25 0.28 0.42 0.41 0.41 0.54 0.53 Other transport 0.04 -0.28 -0.72 -1.37 -0.73 0.46 -0.47 Advertising -0.36 -0.37 -0.57 -0.83 -0.87 -1.02 -1.16 Films and broadcasting -0.12 -0.21 -0.21 -0.24 -0.30 -0.28 -0.46 Trade 0.05 -0.39 -0.20 0.39 0.08 -1.27 0.19 Other business services 1.92 2.53 2.56 2.82 2.76 2.79 2.70 Construction 2.61 3.50 3.57 3.00 3.58 3.15 2.62 Travel -0.58 0.23 2.38 6.49 10.47 11.86 5.76 Property incomes -1.53 -1.56 -1.89 -1.81 -2.31 -2.42 -2.60 Other services 2.14 3.48 3.56 3.88 2.61 5.28 6.33 Unallocated 3.07 3.31 3.38 3.52 4.25 4.39 4.30 Total 12.35 15.18 16.61 20.87 24.82 30.46 25.67 Note: There are no doubt many problems with these data. The main one is that they capture cross-border trade flows and not sales of services related to foreign presence-a cacial point for such sectors as banking. Source: Matlisse (1989). 141 Patrick A. Messerlin remain compatible with the green card system that covers of "effective market access," defined as the situation in non-EC countries. A U.S. life insurer can do business in which service providers of the two countries enjoy "com- Britain under the 1986 Financial Services Act if its home parable competitive opportunities" (to use the wording state is considered a "designated territory" under the of the Second Banking Directive) in the two markets. act-like, for example, Pennsylvania is. In airlines the This concept sheds some light on reciprocity and pro- 66 air agreements between EC states are intertwined with gressive liberalization. the 218 agreements involving the 22 European members of the European Civil Aviation Conference (ECAC). That RECIPROCrrY. Reciprocity is the threshold of mutual Norway and Sweden are part of the SAS airline network concessions that trade partners consider satisfactory with Denmark has necessitated special adjustments to EC enough to sign a trade agreement. It is a concept used in rules to grant the Community's passport to SAS. In tele- negotiations, not in economics. In cross-border services, communications the technical rules adopted by the Inter- national treatment links reciprocity to host country rules, national Telecommunication Union (lTU) are enforced as it does in trade in goods. That financial services by the European PTOs. EC rules are compatible with exported by EC banks are subject to U.S. regulations in regional agreements involving non-EC countries, such as the United States and the other way around seems to be the future MDNS (Managed DataNetwork Services) elab- an acceptable bargain for the two partners and is gener- orated by Europe's twenty-two PTOs. ally the equilibrium point of the negotiation. By contrast, that suppliers of services are subject to host country rules Market Access Rules does not lead to such an acceptable bargain: producers in the most liberal country are seen as disadvantaged in Market access clauses, which are harder to define in the comparison with producers in the less liberal country. context of services than of goods, have already been Although there is no economic rationale for this propo- tested in actual situations in the Ec. The 1992 program has sition consumers may prefer the more stringent rules. had to find operational ways of using such concepts as The "comparable competitive opportunities" concept national treatment,reciprocity,andprogressiveliberalization. makes assessing reciprocity more complex because it compares host and home country rules. The rule of the NATIONAL TREATMENT, AND MORE. The Montreal decla- most regulated home country could be chosen as the ration defines national treatment by the "no less favor- internationally agreed standard for reciprocity. In this able" provision. For cross-border services, the concept restrictive option U.S. banks would operate in the EC of treatment "no less favorable" in respect of all regula- under U.S. rules-that is, they would not be able to tions than that accorded domestic services in the same engage in securities activities in the EC or to enter simul- market has a clear meaning, similar to the accepted one taneously into all the EC states. (Such an option is close for trade in goods. But this definition is plagued by many to the 1988 position of former EC Commissioner de problems when services are "traded" through the estab- Clercq.) Conversely, the rule of the most liberal home lishmentofsuppliersin "importing" countries.Forinstance, country could be chosen as the international standard. it may exclude situations in which the domestic provider in Then EC banks would operate in the United States under the importing country is a monopoly, as in air transport or rules similar to those of the EC; that is, they would be able telecommunications in many developing countries. to conduct securities business in the United States, to This first source of problems is modest compared with branch freely, and to provide cross-border services the second: what does the Montreal definition mean throughout the country (which U.S. banks are not al- when one trade partner imposes stricter regulations on its lowed to do). This option is close to mutual recognition domestic firms than another partner-a situation that is and to the principle adopteA in July 1989 by the BC and likely to be very frequent, if not the rule? The EC faced Switzerland in an agreement on nonlife insurance that this problem in the specific context of the banking sector opens EC markets to Swiss firms on condition that Switz- in a (sometimes acrimonious) debate with the United erland adapt its insurance laws to those of the EC. States and Japan.13 Similar cases are likely to emerge in In the mercantilist approach to trade negotiations, this other service sectors if the 1992 program succeeds. For wide range of options leaves no equilibrium point that is instance, in air transport the fifth freedom between two easily acceptable by both partners. As a result, the EC has EC states will become close to a cabotage right after 1993. chosen to leave the task of finding such an equilibrium Such situations have led the EC to expand the definition point to procedures (internal consultations and negotia- of national treatment (the "no less favorable" clause) by tions with the trade partner) that are applied case by case. a provision that takes into account the mode of delivery Such an approach seems to be plagued by an opportunis- of services in foreign markets. The EC forged the concept tic attitude and could endanger the multilateral trading 142 T he European Community system, as illustrated by the acrimonious banking debate Competition Rules between the EC, Japan, and the United States, which has been summarized as follows: "Reciprocity is a missile Competition rules have been crucial to the Ec internal aimed at Tokyo which will land in New York and ex- liberalization. Lessons to be drawn for the Uruguay plode on Capitol Hill" (Financial Times October 28, Round can be grouped around the three types of compe- 1988). Although there may be some basis for this fear, tition rules: "antimerger" (antitrust) rules, rules against two points are worth noting. the "abuse of a dominant position," and rules against First, countries that take the mercantilist approach to "collusive practices." multilateral negotiations tend "involuntarily" to favor There is one crucial motive-in addition to the usual solutions that are the most economically sound for the one of promoting competition-for including competi- trading partners. Country A tries to get country B's tion rules in the Uruguay Round: such rules are an markets as open as possible-a policy beneficial to the extremely economical way of regulating an economy. consumers of country B-and the other way around. There are three reasons for this. First, competition rules Second, reciprocity is not only a conflict between trading do not require lengthy provisions: the Treaty of Rome partners but it is also a conflict of interests within each devotes 3 articles (out of 246) and fewer than 60 lines to domestic industry of the two trading partners. For in- these rules. Second, since they concern only real prob- stance, the restrictive option described above would lems revealed by the functioning of the markets, they favor U.S. banks that already have a subsidiary in one EC minimize the need for reregulation and thus the risk of state (and are thus able to branch through the Community premature or excessive reregulation-a danger in multi- and reap all the benefits from the 1992 program) over lateral negotiations, which are always quick to consider U.S. banks that are not already established in the EC. By all possible problems. Third, they maximize the effi- contrast, the large influx of foreign securities firms into ciency of the minimal set of reregulations really neces- the EC brought about by the liberal option could be sary by offeringasure way of enforcing theseregulations beneficial to Continental stock exchanges-in which if they are consistent with the interests of consumers. there are a lot of niches to be exploited-in relation to London. ANTLMERGER RULES. Antimerger rules are unlikely to be part of the Uruguay Round agreement because in many PROGRESSIVE LIBERALIZATION. The concept of progres- countries many services areprovided by public orprivate sive liberalization is essential in the context of the par- monopolies or duopolies, as in telecommunications. The ticipation of the developing countries in the Uruguay experience of the Community suggests, however, that Round. The concept of "comparable competitive oppor- the absence of antimerger rules will not impede the world tunities" can take progressive liberalization into account liberalization; such rules at the EC level have played no in two ways. First, it suggests that developing countries role in the intra-EC liberalization, since they were need to create competitive structures in their own ser- adopted only in December 1989. vices sectors in order to open them. It thus recognizes More interestingly, the EC experience even suggests that developing countries may face the heavy task of that mergers-apart from their economic pros and building new, competition-oriented, domestic regula- cons-can be a positive force for adopting a trade liber- tions-a point often emphasized by developing country alization program. Mergers offer to each member firm a negotiators. Such a perspective is present in the 1992 share in the comparative advantages of the other suppli- program: the Community's less developed countries ers and in other national markets that may have larger or have often been granted a longer time period for opening more dynamic demands. National monopolies or domi- their sectors so as not to put them at risk. nant firms can thus reduce the risks associated with trade Second, industrial countries may agree to give firms liberalization through mergers, which become a crucial from developing countries advantages greater than those instrument for dissolving the "national champions" in- granted by these countries to firms from industrial coun- herited from the 1970s. For instance, the emerging Eu- tries. They can do so by defining what they judge as ropean "megacarrier" consisting of British Airways, "comparable" to the competitive opportunities they KLM, and Sabena offers an unique opportunity for im- offer. Industrial countries may be eager to graduate their proving the efficiency of Sabena by linking it to two reciprocity threshold to the level of development of their efficient and wealthy firms and for achieving a partial trade partners, especially if they do not feel trapped by a privatization of Sabena at the same time. (British Air- rigid rule of "special and differentiated" treatment. ways and KLM will each own 20 percent of the shares of 143 Patrick A. Messerlin the new Sabena World Airlines.) Both effects can only services will be liberalized, but networks will not, lead- make Belgium's air transport policy more liberal. ing to the risk that the network owners will abuse their There are similar recent examples involving firms from dominant position if they provide services and compete developing countries. For instance, Singapore Airlines with mere suppliers of services. and Swissair have signed a cooperation agreement with Rules against abuses of a dominant position allow the exchanges of equity. This agreement indirectly rein- solution to potential competition to be shifted from ex forces the links between Singapore Airlines and Delta ante general regulations to ex post specific cases, as Airlines (aU.S. company), and opens the way forsimilar shown by telecommunications value added services. deals with SAS, Finnair, and a few other airlines. It Under the 1992 program PTos will keep their monopoly generates a "global aviation system" that reduces the on networks but will make them accessible to competi- risks of changes associated with world liberalization for tors in value added services. Preventing network-owner each member firm and thus lessens the fears of the PTOs from abusing their privileged position to eliminate govemments concemed. competitors has led to special rules of conduct (see This role of mergers can also be observed in the equip- appendix 14-A, "Telecommunications"). In other words, ment industries linked to service sectors. This is best liberalizing cross-border services-such as value added illustrated by the telecommunications equipment pro- services-has led to thereregulation of the providers (the ducers, which have constituted consortia for definite PTOs) of equipment (networks) and services (basic ser- tasks.t4 For instance, the recent German bid for a mobile vices) that are not yet liberalized. Such a situation gen- phone license was granted to a Mannesmann-led consor- erates complex questions. Should reregulation be applied tium that included British, French, and U.S. firms. Four to the PTos alone, or should the regulatory activities of the other offers also involved British firms, including cover newcomers as well? A satisfactory solution is British Telecom itself. In the short run, such mergers, unlikely to reside in static and detailed regulations; it is which are now frequent in telecommunications and con- more likely to emerge from the analysis of a concrete struction, are a partial substitute for liberalization of the situation in which a given service provider perceives that public procurement procedures. They lay the ground for it faces abuse of a dominant position, in the light of the the still rare successes of individual firms (Ericsson in economically sound criterion of competition rules: the the United States, AT&T in Italy, Sony in Britain, and interests of the consumers. Fujitsu in Britain and Germany). In the long run, they Rules against abuses of a dominant position are neces- ease the introduction of more competition-oriented rules sary for effective enforcement of codes of conduct and in public tenders. similar regulations, as illustrated by the computerized There is a point, however, at which the costs of such reservation systems. The two emerging EC megacarriers mergers or consortia become higher than the gains. are organized around two CRss, with, so far, no future Mergers may reach sizes that will hinder the emergence competitors in the EC, and with international connec- and survival of otherwise efficient mavericks and will tions.15 As CRss are extremely expensive (both in phys- thus make competitive markets impossible. In airlines, ical and human capital), they are operated by joint for instance, the coalition between British Airways, KLM, ventures of airlines that have been exempted from com- and Sabena and the one between Air France, Lufthansa, petition rules (another example of limited use of antimer- and Iberia would in 1985 have represented 50 to 55 ger rules). The Commission is well aware of the risks of percent of the air services operated by all the EC airlines. such an exemption, and the exemption has been subject In sum, the absence of antimerger rules is an easily to conditions that ensure free access to the systems, acceptable risk only if there are competition rulesagainst elimination of biases between air carriers, and more abuse of a dominant position. flexibility for the contracts offered to travel agents. It has also been complemented by the adoption of a mandatory RULES AGAINST ABUSE OF A DOMINANT POSMON. Dom- code of conduct insisting on nondiscriminatory and inant positions are likely to be frequent in many service transparent use of the CRS. But the credibility of the sectors because a successful Uruguay Round will merely exemption and of the code relies on the threat imposed open the legal possibility for obtaining better access to by the existence of rules against abuses of a dominant networks run by dominant firms (monopolies). These position and on the ability of firms to complain on a networks include telephone lines run by PTos, computer- case-by-case basis. ized reservation systems, or cRss-the electronic net- All these considerations are of special interest for the works that allow travel agents to book flights and Uruguay Round. Many bN;ieve that "sectoral annota- facilities-run by airlines; slots run by airport authori- tions"-that is, additional provisions interpreting and ties; roads controlledby governments; and soon. In sum, clarifying frameworkprovisions for each individual sec- 144 The European Community tor-will be necessary. That could represent a great based inside or outside the Ec states. The implied risk in danger for the Round: interminable negotiations and terms of extraterritoriality may inhibit enforcement of increasingly ambiguous, inconsistent or useless clauses, the code. The adoption of rules against collusive actions offering a back door for protection. One can argue that in the Uruguay Round would offer a way of solving this many "sectoral annotations" could be avoided by com- type of problem. petition rules. Third, the Uruguay Round will adopt safeguards and Two final remarks are necessary. First, competition is provisions that have a similar economic impact, such as often stiffer than initially expected. In telecommunica- antidumping and antisubsidy regulations (Hoekman and tions, private networks are only stating up. Public firms Leidy 1990). The GATT experience in such matters is in similar services can generate competition pressures; crystal clear either provisions are designed with eco- for example, SNCF, the French railways company, has nomically sound constraints (nondiscriminatory mea- decided to create its own worldwide reservation system sure, compensation, and so on) and are rarely used, as based on the technology of Sabre, the CRS developed by illustrated by the GATT article xIx, or they rely on am- American Airlines (Le Monde, November 30, 1989). biguous concepts ("unfair" competition, domestic indus- Second, a balance between the regulations to be applied try, and injury thatare rapidly captured by domestic firms to dominant private or public firms should be main- looking for protection and are used as devices for enforc- tained. These two types of firms have different ways of ing collusive practices with public sponsorship abusing a dominant position, and the Uruguay Round (Messerlin 1990a). The concepts embodied in competi- framework should take this difference into account, as tion rules against collusive practices offer a way of the Treaty of Rome did by supplementing article 86 limiting this phenomenon of capture. (focusing on private firms) with article 90 dealing with public firms. A Brave New World: Competition in Regulations RULES AGAINST COLLUSIVE PRACTICES. The EC experi- Services are regulation-intensive. As a result, compara- ence shows that competition rules against collusive prac- tive advantages in services are determined by the ability tices are a crucial ingredient in the initiation of of states to generate the best rules: states that open their liberalization in services. Including such rules in the service sectors will compete in regulations. The more Uruguay Round framework would be useful for three market access is granted, the stiffer is the competition. main reasons. This is best illustrated by the mutual recognition princi- First, Uruguay Round provisions are unlikely to lead to ple, which can mean better treatment of foreign firms an immediate application of essential provisions to some than does national treatment. For example, if British service sectors. For instance, the most favored nation licensing or operating rules are better designed than clause is unlikely to be applied in air transport because French rules, French branches of the British banks will this sector relies on a host of bilateral arrangements. As enjoy better treatment than French banks. a result, it is likely that there will be a "freeze" in this Developing countries may be afraid to compete on sector. The danger is that the freeze in liberalization of these terms because they may feel "disadvantaged" and some sectors will continue forever and become a de facto "unprepared." But there are good reasons for them to permanent exception, as in the case of textiles in goods. accept the challenge and to participate in the "uneasy" Accepting a freeze is a risk that can be taken only if there free market revival (Henderson 1988). are provisions that permit market forces to reveal a desire First, competition in regulations will induce developing to move toward more competition. In the EC experience countries to elaborate their own regulations. Far from the enforcement of rules against collusive practices has inhibiting their capacity to regulate-a fear often ex- started the liberalizations in air transport and telecommu- pressed by developing countries-an economically nications equipment, in particular. sound Uruguay Round will be a stimulus for them to Second, many industrial and developing countries al- adopt better regulations. The EC experience in the past ready have active competition rules. When applied to decade can be best described as a continuous effort to service sectors, these national rules can easily lead to move from a set of inefficient regulations to a new set of problems of extraterritoriality, which are political and rules that are more efficient because they support a legal nightmares. In such circumstances, actions can take higher level of competition. There is no better illustration decades or be abandoned, to the detriment of an econom- than the ongoing competition between the London and ically sound procompetitive solution. For instance, the Continental stock exchanges. The 1987 crash revealed EC code on cRss applies notjust to Amadeus and Galileo the weaknesses of some of the new regulations in the but to aU CRSs operating in the Community, whether liberalized London International Stock Exchange, from 145 Patrick A. Messerlin too stringent rules on shareholders' preemption rights to Appendix 14-A. The 1992 Program, by Service medieval methods of transfer. Continental stock ex- Sector changes took these weaknesses as an opportunity to step up the removal of old regulations and the introduction of BANKING. The main new directive, the Second Banking new ones, and the past two years have seen a constant Directive, deals with the creation and implementation of emulation among the regulatory bodies of the national a single EC banking license. After 1992 (and as in the stock exchanges. past), bank subsidiaries, which are classified as factor- Second, competition in regulations will be as dynamic related trade in services in the EC framework, will be as in goods. Comparative advantages will shift, as they governed by the national treatment clause-that is, they do in goods. By liberalizing long-regulated national mar- will be treated by the host EC state as domestic banks in kets, the 1992 progran has imposed adjustment efforts terms of licensing and operating requirements. For in- on the "free" markets that prospered during the nonlibe- stance, a French subsidiary of a British bank will be ral period, such as the Eurobond market, the reinsurance treated as a French bank. The crucial innovation of the market, and the insurance markets of the Isle of Man and directive concems the provision of cross-border banking the Channel Islands. And the EC financial integration is services (for instance, money transfers) and bank accelerating the pace of U.S. and Japanese reforms of branches, which are classified by the EC as cross-border regulations that have imposed tight constraints on U.S. services. After 1992 these services will be ruled by the and Japanese banks and insurance firms in their domestic principle of mutual recognition; each EC state will rec- markets. Similarly, the expected liberalization in EC tele- ognize the licensing rules of the others and will apply its communications has attracted the "Baby Bells"-the own operating rules on a nondiscriminatory basis to regional U.S. phone monopolies bom of the breakup of branches of banks licensed in other EC states. For in- the Bell System. The restrictions on their U.S. operations stance, a French branch of a British bank will be under have induced them to invest in mobile phones, cable British, notFrench, licensing rules and will operate under television, computer services, and fiber optic cables all French operating rules concerning monetary regulations, over the EC: six "Baby Bells" (out of seven) have in- liquidity, and the like. vested in such liberal EC states as Britain and Germany, In fact, banks operating throughout the Community and, even more remarkably, three have invested in would be largely regulated by their home countries. The France and two in Spain and Italy. exact coverage of mutual recognition is still uncertain Finally, the gains to be expected by developing coun- because the borderline between licensing rules and oper- tiries from liberalizing services are enormous. Liberaliza- ating rules is difficult to draw with precision at this stage. tion of services opens competition in equipment, as For instance, will a firm operating under a British build- shown by the EC experience in telecommunications. ing society license be able to offer variable mortgages or Competition in services has induced European PTOs to money market funds in the whole EC, including in EC abandon their traditional domestic suppliers for cheaper states that prohibit such mortgages and funds? If so, the sources, and new services have induced European con- French ban on such mortgages will "disadvantage" sumers to buy new equipment. Developing countries French banks in relation to British banks or to banks from have largely benefited from these evolutions: the market EC states that allow this service. Similarly, the German shares of their exports of telecommunications equipment ban on money market funds will work to the "disadvan- to EC countries increased, on average, by 20 percent in tage" of German banks. the first two years after the beginning of liberalization, The main benefit of the mutual recognition approach is and in only a few years some developing countries have to require the minimal effort in regulatory harmoniza- upgraded their products from phone sets to small termi- tion-a huge gain in efficiency when twelve countries nals (Messerlin 1990b). These increased exports will are involved. Because of its enormous potential impact, give developing countries the means to pay for increased the mutual recognition principle is likely to trigger creep- imports in services, which in turn will allow them to ing resistance to liberalization, as indeed has been seen improve the efficiency of their economies by decreasing in the efforts of some EC states (led by France) to impose the costs of services used as inputs. The estimated gains withholding taxes on capital to prevent capital movements from the 1992 program to the EC countries-2 percent of and limit competition. The ambiguity of the principle is also their total GNP-look impressive. It is likely, however, likely to generate cases for the Court of Justice. that they greatly understate the gains to be expected in The Second Banking Directive is flanked by two direc- developing countries, where the lack of adequate tele- tives-on mutual funds (the "undertakings for collective communications or finance often has an infinite cost, investment in transferable securities," or UCITS, in EC since it inhibits potential exports. jargon) and on "investment services" (brokers, dealers, 146 The European Community and so on). The directives apply to these two types of airport en route to the final destination). Without these two securities firms the same mix of national treatment and conditions-particularly the first one, which represents a mutual recognition principles. The three directives con- shift from bilateral to multilateral liberalization-airlines stitute the backbone of the 1992 program as it applies to have no strong incentives to enter new routes. banking and securities. The minimal harmonization in pru- The ambiguity of the December 1989 package is that it dential matters is covered by eight directives on banking, includes these provisions, but only as nonbinding agree- five on securities, and three on capital movements.16 ments. The 1987 package has not allowed a major break- through in these matters. The coverage of multiple INSURANCE. The 1992 program inherited the free estab- designation increased from 5 percent of the scheduled air lishment principle that was adopted in 1973 for nonlife routes in June 1987 to 7 percent in June 1989, mainly insurance and in 1979 for life insurance. The huge effort because of Britain's policy. The coverage of the fifth to harmonize the regulations of the EC states necessary freedom is even lower: one fifth-freedom service was to transform this principle into actions failed. Insurance operated by a Community airline before 1988 and only markets remained closed, except for reinsurance. As a 14 in 1989 (Commission 1989). result, the 1992 program initially focused on the right of TELECOMMUNICATIONS. The content of the 1992 pro- firms to provide services across the borders of the EC gram conceming telecommunications has been con- states. Its main success concems the nonlife "large firmed and refined by the December 1989 agreement. risks"-property and damage risks that involve firms of The program relies on two main directives that strike a a minimum size, as measured by number of employees, delicate balance between forces in favor of and against turnover, and assets, and that are estimated to represent liberalization. 50-65 percent of the nonlife market. After 1991 such The directive on telecommunications services states risks will be offered by insurance firms operating under that value added network services will be liberalized but home country rules, which implies mutual recognition of that the PTOs will keep their monopoly in basic services. insurance regulations among EC states. The crucial point-the borderline between the two types In the remaining areas of nonlife insurance ("small" of services-is defined by the December 1989 agree- policyholders) and in life insurance, progress has been ment by mid-1991 value added services will cover limited. As a result of rulings by the Court of Justice advanced services, such as electronic mail and access to (discussed above), the current 1992 program allows EC computer data bases, and in early 1993 they will be insurers to compete in all EC states only under host extended to cover basic data communications-at 25 to country rules. The expected impact of such measures is 30 percent a year, the fastest growing part of the mar- not high: insurers will not be keen to undertake the huge ket-leaving only telex and voice telephony to basic costs of penetrating markets in a alien legal environment, services. 18 except through mergers-an ambiguous move from the The directive on open network provisions (ONP) aims point of view of competition. As a result, the vice-pres- at harmonizing the conditions under which the liberal- ident of the Commission, Leon Brittan, recently pro- ized telecommunication services industry would gain posed that the same approach as in banking and securities access to the networks. It states three basic rules: tech- be followed: insurers would be free to set up branches nical harmonization that allows full connectivity among in other EC states and to sell their products on the basis the EC networks; minimal standards required for private of a single license and supervision from the home coun- firms under competition; and harmonization of the prin- try (Financial Times, November 28, 1989). ciples for setting tariffs, preferably on the basis of cost. More detailed regulations are to follow the directive. The AIR TRANSPORT. The December 1989 package expands fact that they will be drafted by a body emanating from the decisions made in the December 1987 package. the twelve Pros has raised fears of collusion or abuse of Quota (capacity-sharing) arrangements are dismantled, dominant positions by PTos. the initiative of basing prices on costs is given back to airlines by generalizing the "double disapproval" proce- SHPPING. During the 1980s shipping suffered from a dure, and discounts are authorized.17 These provisions, decline of activity coupled with the emergence of new however, are not likely to introduce significant changes competitors-an unusual feature among services, and in competition and fares unless new rights regarding one unfriendly to liberalization. During these years EC market access are adopted: "multiple designation" (that state shipping policies were limited to waivers to cabo- is, the capacity to designate more than one carrier to tage rules and to more liberal grants of cargo reserva- operate the same route) and the fifth freedom (the capac- tions. The progressive implementation of "flagging-out" ity to set down and pick up passengers at an intermediary policies (opening ship registers, with fewer constraints 147 Patrick A. Messerlin on hiring, meaning lower taxes and wages) is introducing times more funds than the five privatizations undertaken between 1981 a subsidy policy through a "fiscal" delocalization of the and 1984. of scheduled services took off in 1984 with 4. Liberalizatiouifshdldsevcsto ffi 94wt industry. The flagging-out policies have only a modest relaxations of the licensing rules (icenses were given to fly any route, liberalization component in that the protectionist bias except some specified ones) and the domestic fare approval system againt crws fom dveloing ounties s reuced fa- (Bamnes 1988). against crews from developing countries is reduced, fa- 5. To license new competitors (such as British Railways) or to cilitating movement of semiskilled labor. Finally, the authorize the resale of leased lines from British Telecotn might have drift of liner conferences into cartels backed by interna- been alternatives to the duopoly, if one ignores potential entry by large tional agreement (the UNCTAD Liner Code) has made foreign finms. Interestingly, Mercury relies on Hong Kong Telecoms virtually impossible the adoption of more competitive formost of its profits (Financial Times, June 10,1989). virtually impossible ~~~~~~~~~6. Until 1987 Germany was considered the most protectionist F-c rules within the EC. state in telecommunications by any standard: a 100 percent state- The 1992 program in shipping mirrors these problems. owned monopoly dominated public procurements in telecommunica- Liberalization is slow: freedom to provide services be- tions, and there was no separate regulatory agency, no other network to provide operator, no separate subsidiaries in competitive markets, and no tween EC states has been adopted, but freedom to provide unrestricted use of leased liEnes for value added services (Muller 1988, services within EC states has not. (So far, this is the only p. 172). 1992 directive to be rejected). Competition has difficulty 7. This decision has applied to low-speed data services since April in emerging: liner conferences have been granted a 1989 and to the much more important high-speed data services (64K bit per second and 2 megabit per second lines) since June 1989. "block exemption" from the competition rules of the 8. Mercury's ability to survive as an independent firm was attrib- Rome Treaty. utable to the fact that it was owned by Cable & Wireless, a firm that had a long tradition of world-wide telecommunication systems (Ergas and Paterson 1989) and was well established in other key areas, such ROAD TRANSPORT. In road transport the 1992 program IS as Hong Kong; to the most recent technology, which makes possible starting from scratch with the issuance of 15,000 special considerable flexibility for locating telecommunications hubs in other permits, to be distributed by EC states, that will be valid countries; and to the competitive pressures from the other side of the .limited periods and wil enable haulers to do business Atlantic (although U.S. Judge Harold Greene did bar a joint project of for llmlted penods and Wlll enable haulers to uo Dusmess Nynex and Cable & Wireless for a transatlantic fiber optic telephone across the Community. cable Financial Times, February 15, 1989). 9. This is confirmed by recent estimates from a National Utility BUSINESS SERVICES AND LABOR MOVEMENT. The main Services study according to which a standard 3-minute long-distance main call is three times more expensive in Germany than in Britain and a business services dealt with in the 1991 program are local call is 25 percent less expensive in Germany than in Britain accounting, television programming, and the legal and (Financial Times, June 30, 1989), medical professions. Nine directives deal with the pro- 10. Directives are Community laws that have to be introduced as gressive introduction of the mutual recognition principle national laws. Thecomplete 1992program deals withmany othertopics gressive recognition s~~~~~~~~~~n addition to trade in servicers and rests on 279 directives. The Coin- in professional services to ensure free movement of mission is increasingly worried about delays in transforming directives skilled labor. Enforcement of this principle is likely to be into national laws. a long, contentious process. Semiskilled or unskilled 1 1. For a view about the Ec 1992 program and the Uruguay Round embracing manufacturing and services, see Sapir (1989). For a view labor (for instance, in the construction sector) is partly focusing on 1992 and developing countries in services, see Nicolaides covered by EC provisions dealing with public procure- (1989). ment, as illustrated by the recent contract for the con- 12. Policies such as flagging out cast some doubt on the value of ,of the Great Bet Bridge in Denmark; the inial the inmmigration argument raised by all industrial countries for limiting struction of the ureat Belt Bndgitm Denmarx; t,.e ]mal labor movement. Would foreign crews recruited by Ec firms be "less clause calling for use of Danish labor was dropped after foreign" than foreign crews employed by foreign firms? the Commission intervened. 13. For a detailed and comprehensive analysis, see Key (1989). Under artidcle 58 of the Treaty of Rome, subsidiaries of non-Ec banks benefit from aU the rights accorded by Community law. There were Notes roughly 530 foreign bank branches in the Ec as of February 1989 (Fitchew 1989). Grateful acknowledgment is made of comments by Bela Balassa, 14. Some mergers or consortia cover equipment and services, as, Geza Feketekuty, Brian Hindley, Bemard Hoekman, Gary Sampson, for example, the recent "pact" between British Telecom, s7mr of Italy, Andre Sapir, Pierre Sauve, Jonathan Scheele, Richard Snape, Maria- and Telefonica of Spain on network modemization, mobile cornmuni- Francesca Spatolisano and Jean Waelbroeck and of the assistance of a cations, value added services and intemational communications (Fi- great number of people at the Conmmission of the European Comunties. nancial Times, December 19, 1988). 1. In a veryfew instances the absence of nationalfirms has allowed 15. Galleo is built by British Airways, Kt.M, and Sabena (with Ecstatestobe hberalforalongtime-DenmaTkintelecommunications Alitalia and Swissair) and Amadeus by Air France, Lufthansa, and and Luxembourg in airlines are examples. Iberia (with sAs). Galileo is connected with United Airlines (a U.S. 2. Nws are note issuance facilities (revolving facilities that enable airline) and Amadeus with Texas Air (a U.S. airline) and with several borrowers to issue a stream of short-term notes). Rups are revolving Asian-Pacific airlnes through Abacus, the common CRs of Cathay underwriting facilities, a kind of guaranteed NSw. Pacific, China Airlnes, Malaysian Airlines, Philippine Airlines, and 3. The "Rytie rules" stated that private financing of public firms Singapore Airlines, which was developed with the tedmical suppon of should be allowed only if this would result in improved efficiency-a Cable & Wireless. condition close to a veto with the British Treasury as umpire (Ryrie 16. In banking the main harmonizations concem solvency stan- 1989). The privatization of British Telecoms required the raising of 2.5 dards, own funds, accounts of banks and of foreign branches of banks, 148 The European Community cross-border provision of house mortgages, and principles to be Hoekman, Bemard, and Michael P. Leidy. 1990. "Antidumping for adopted by supervisory authorities in dealing with institutions in diffi- Services?" in Matthew Tharakan (editor), Policy Implications of culties. In securities harmonization provisions deal with information to Antidumping Measures, Amsterdam, North Hudand. be provided in case of sales to the public or of acquisitions of major Kasper, Daniel M. 1988. Deregulation and Globalization: Liberaliz- holdings and with insider trading, with derogations for Greece and ing/nternationalTradeinAirServices. Cambridge,Mass.: Balin- Portugal. Capital adequacy directives covering credit risk and risks ger for the American Enterprise Institute. related to interestrate, exchangerate, position, and settlementarebeing Key, Sidney J. 1989. Financial Integration in the European Conmnu- drafted. Capital movements provisions spell out harmonizations with nity. Intemational Finance Discussion Paper 349. Washington, a longer period of transition for Greece, Ireland, Portugal, and Spain D.C.: Federal Reserve System. and a safeguard clause in case of major macroeconomic problems. Mathisse, Thierry. 1989. The European Conununitys External Trade 17. The 1987 directive on capacities replaced the traditional capac- in Services. Luxembourg: Eurostat. ity sharing rule (50-50 percent) with a lower quota (45-55 percent and, McGowan, Francis, and Chris Trengrove. 1987. European Aviation: in October 1989, 40-60 percent). The 1989 agreement targets a 25-75 A Conmnon Market? Institute for Fiscal Studies Report Series no. peroent quota by the end of 1992. Fares that "reasonably reflect the 23. London. costs of an individual airline" should be approved by the EC states. Messerlin, Patrick A. 1990a. 'Antidumping Regulations or Procartel Discount and deep discount fares are available for off-peak periods and Law? The BC Chemical Cases." International Econornic Depart- specific passenger categories. Fare measures are accompanied by safe- ment, World Bank. Processed. guards if fares drop by more than 20 percenL . 1990b. "Note on the Benefits from Liberalization in Services 18. But Ec states that wish to issue license conditions for data for the Developing Countries." Intemational Economic Depart- cormsunications will be able to do so if the conditions are nondiscrim- ment, World Bank. Processed. inatory and are vetted by the Commission. Greece and Portugal have Muller, Jurgen. 1988. The Benefits ofCorpleting the Internal Market received a potential derogation up to 1996 if their public services are for Telecommunication. Vol. 10 of Research on the "Cost of at risk. Non-Europe ,"Basic Findings. Commissionofthe European Com- munities. References Neven, Damien J. 1989. "Structural Adjustment in European Retail Banking: Some Views from Industrial Organization." Working Paper 311. Centre for Economic Policy Research, London. Baldwin, Richard. 1989. On the GrowthEffect of.1992. NBERWorking Nicolaides,Phedon. 1989. "1992: Services and Developing Countries." Paper Series no. 3119. Cambridge, Mass.: National Bureau of Royal Institute ofIntemational Affairs, London. Processed. Economic Research. oEcD. 1988. The Teleconmmunications Industry: The Challenges of Bames, Fod. 1988. "The Impact of Partial Deregulation in the United Structural Change. Paris. Kingdom Doenestic AirTransponMarket." InoEcD,Deregulation Price Waterhouse. 1988. The Cost of "Non-Europe" in Financial and Airline Competition. Paris. Services. Vol. 9 of Research on the "Cost of Non-Europe, Basic Beesley, Michael E., and Bruce Laidlaw. 1989. The Future of Tele- Findings. Commission of the European Communities. communications. London: Institute of Economic Affairs. Ryrie, William. 1989. "The Healthy Discipline of Private Finance." Centre for Business Strategy. 1989. 1992: Myths and Realities. Lon- Financial Times, May 24, p. 12. don Business School. Sampson, Gary. 1987. "Safeguards." In J. Michael Fmger and Andre Commission of the European Community. 1989. Report on the First Olechowski, eds., The Uruguay Round: A Handbook on the Mul- Year of lmplementation of the Aviation PolicyApproved in Decem- tilateral Trade Negotiations. Washington, D.C.: World Bank. ber 1987. Com (89) 476 final. Brussels. Sapir, Andre. 1989. Does 1992 Come before or after 1990? On - Various years. Reports on Competition Policy. Regional versus Multilateral Integration. Discussion Paper 313. Emerson, Michael, and others. 1988. "The Economics of 1992." Eu- Centre for Economic Policy Research. ropean Economy, no. 35 (March). Ungerer, Herbert, and Nicholas P. Costello. 1988. Telecommunica- Ergas, Henry, and Paul Paterson. 1989. "Intemational Telecommuni- tionsinEurope. EuropeanPerspectives. Commissionof the Euro- cations Accounting Arrangements: An Unsustainable Inheri- pean Communities. tance?" Monash University, Melboume, Australia. Processed. usTR. 1985. "Selected Problems Encountered by U.S. Services Indus- Feketekuty, Geza. 1989. "The New World Information and the New tries in Trade in Services." Washington, D.C. Processed. Trade Dimension in Telecommunications Policy." IDATE Confer- van Bael, Ivo, and Jean-Francois BeDis. 1987. Competition Law of the ence on Communications Services, Montpellier, France. Pro- EEC. Bichester, Oxfordshire, U.K.: ctH Editions. cessed. Vickers, John, and George Arrow. 1988. Privatization: An Economic Fitchew, Geoffrey. 1989. " 1992: New Opportunities for U.S. Banks Analysis. Cambridge, Mass.: mrr Press. and Businesses in Europe." European Community News, no.7. White, Lawrence J. 1988. International Trade in Ocean Shipping Henderson, David. 1988. "Perestroika in the West: Progress, Limits Services: The United States and the World. Cambridge, Mass.: and Irnplications." Group of Thirty. Processed. BaDinger for the American Enterprise Institute. Hindley, Brian. 1988. "Creating an Integrated EEc Market for Financial Services." London School of Economics. Processed. 149 15 Lessons from the Experience of the OECD Rainer Geiger Looking at the experience of the OECD with trade in in the Uruguay Round, and efforts to strengthen and services can be useful for those involved in international update these instruments parallel the negotiations. service transactions and in the Uruguay Round of nego- The OECD approach to services is not monolithic; in- tiations. There are several reasons for this. struments that have evolved separately in various insti- tutional settings coexist and interact. But all of these * The OECD framework is multidisciplinary and mul- instruments are based on the same underlying philoso- tilateral. Its approach combines basic policy princi- phy: an open international environment for transactions ples and specific sectoral rules and includes both in goods, capital, and services is not only beneficial to commitments by governments and standards of be- the expansion of trade and to international welfare but havior for market operators. also serves the enlightened self-interest of each partici- * Many of the key concepts put forward in the interna- pant. Although the rate of progress toward liberalization tional negotiations on services have already been may vary from country to country according to the level tested through OECD experience. of economic development, all members adhere to the * The OECD brings together a representative sample of same principles and rules of the game and benefit from countries that account for the bulk of international nondiscriminatory treatment. Many of the concepts that transactions in services. are implicidy or explicitly included in the OECD instru- ments coincide with the key principles stated in the part Of course, caution is needed in drawing conclusions of the Uruguay Round midterm review that deals with from OECD experience. The diversity of actors at a services. broader international level and the complexity of the Throughout, the term intemational transactions in ser- issues under negotiation defy easy generalization. One vices is defined to include all modes of delivery: cross- should not forget, however, that although OECD member border movements of services, cross-border movements countries share broad economic goals, they do not nec- of producers or consumers of services, and provision of essarily have the same interests where trade in services services through establishment or commercial presence is concerned: their competitive positions in various ser- in the recipient country. vice sectors may be different, and their regulatory re- gimes are far from being harmonized. Consensus on A Policy Framework for International Transac- common principles has sometimes been difficult to tions in Services achieve, and where progress has been made, it has been through relentless persuasion and peer pressure rather The OECD framework consists of two main types of than through legal rulings. Yet since the inception of the instruments. The Code of Liberalization of Capital OECD in 1961, and even under its predecessor, the Or- Movements and the Code of Liberalization of Current ganisation for European Economic Co-operation (oEEc), Invisible Operations (hereafter, the Capital Movements there has been a continuous process of liberalization in Code and the Invisibles Code) were adopted in 1961 by capital movements and services amnong members and in decision of the OECD council and are legally binding for most, if not all, cases with respect to nonmembers. All of member countries. The Declaration and Decisions on the instruments discussed in this chapter predate the International Investment and Multinational Enterprises international negotiations on services nowbeingpursued (hereafter, the 1976 Declaration), adopted by OECD 150 Lessonsfrom the Experience of the OECD member governments in 1976, has no legal force but is domestic suppliers. National treatment for foreign-con- supplemented by implementation procedures set forth in trolled enterprises operating in host countries is dealt council decisions. Taken together, these instruments with in the 1976 Declaration, which is complemented by cover the main features of intemational transactions in the Guidelines on Multinational Enterprises. "Operat- services. Other policy principles and recommendations ing" has been interpreted to require some form of com- adopted by the council and dealing, for instance, with mercial presence in the country concerned-that is, a competition and specific sectoral aspects are also relevant, subsidiary, branch, or sales office. If such a commercial Cross-border transactions in services and related trans- presence is established, the foreign-controlled enterprise fers between residents and nonresidents are covered by has to be given treatment no less favorable than that the Invisibles Code to the extent that the activities fall accorded to domestic enterprises in like situations. The within one of the categories listed in the code's annex A. qualification "in like situations" means that in certain The annex includes all service sectors (with the notable circumstances, and for legitimate reasons other than exception of informatics and data services, which were nationality, foreign suppliers of services may be treated hardly developed when the code was adopted). For each differently, provided that such treatment does not affect sector the annex defines in more detail the commitment the competitive situation of the enterprise concerned. to eliminate restrictions that is stipulated in general terms Thus, for reasons unrelated to nationality (such as pru- in article 1 of the code. dential supervision or to prevent tax evasion), foreign Provision of services through investment and establish- branches may be given different, but equivalent, treat- ment in the recipient country comes within the purview ment as compared with subsidiaries or branches of do- of the Capital Movements Code, annex A of which lists mestic enterprises. the activities to be liberalized. One of these activities is The national treatment instrument provides the neces- direct investment.1 The obligation to liberalize covers sary complement to the freedom of entry and establish- all forms of direct investment, whether through subsidi- ment granted by the Capital Movements Code. Although aries, branches, or acquisition of other types of control- both the code and the declaration interact closely, only ling interests; the choice as to which form an investment the code is legally binding. In the context of an overall may take rests with the investor. review of the 1976 Declaration scheduled for 1990, For foreign direct investment to be liberalized, it is not efforts are being made to strengthen members' obliga- sufficient that transactions and transfers be authorized in tions under national treatment by making that part of the a formal sense; nonresidents must be given effective declaration a binding instrument. access to business operations within the general framework The Guidelines for Multinational Enterprises, which of the hostcountry's laws andregulations. This understand- apply to the behavior of intemational market operators ing was made explicit in a 1983 amendment to the code.2 in the fields of both goods and services, directly address Cross-border movements of suppliers of services are multinational enterprises. Although they are not legally not covered by the codes, which do not explicitly require binding, they carry the weight ofjoint recommendations liberalization of establishment by physical persons. by all OECD govemments, and follow-up procedures Some services, however-such as construction, engi- have been set up at both national and international levels neering, and professional services-re frequently pro- to ensure their effectiveness. vided through temporary movement of suppliers and cannot be considered to be effectively liberalized when Key Concepts of the OECD Instruments this important mode of delivery is excluded. To become effective, an understanding would have to include move- Although the legal nature of the OECD instruments and ment of persons. Further efforts toward liberalization their modes of implementation differ, they are based on through amendment of the code are especially needed in a common set of concepts and principles, including the area of professional services. A 1985 report by the progressive liberalization, nondiscrimination, national OECD Committee on Competition Law and Policy rec- treatment, competition, and standards of behavior for ommends the removal of entry barriers to professional multinational enterprises. services that discriminate against foreign service provid- ers on the sole basis of their nationality. Progressive Liberalization Liberalization of direct investment and establishment is not in itself a sufficient guarantee of effective market The concept of progressive liberalization is common to access if foreign suppliers, once established in the host the Declaration of Punta del Este and the OECD instru- country, are subject to discriminatory treatment that cre- ments. For the OECD, it is based on the following ele- ates significant competitive disadvantages in relation to ments. 151 Rainer Geiger * All members undertake a firm commitment to the tions among members that is created by the maintenance objective of liberalization and submit to a regular of reservations is mitigated by a standstill provision. That examination procedure that encourages steady prog- is, new restrictions not covered by an existing reservation ress toward that goal. cannot be introduced, and new reservations on items * The pace of implementing this objective depends on listed in annex A (which includes, among other things, each member's particular situation, especially its direct investment) cannot be lodged except under the level of economic development. limited circumstances mentioned above. Under the na- * All members subscribe to common rules of the game tional treatment instrument, members may maintain ex- and submit to international surveillance of the way ceptions that have to be notified to the OECD. In May in which they carry out their obligations. 1988 members agreed on a standstill commitment under * Liberalization, once attained, is irreversible (stand- which new exceptions will no longer be admitted. still), and remaining restrictions are subject to exam- Rollback is an essential feature of progressive liberal- ination with a view toward their gradual elimination ization. Any restrictive measure maintained under the (rollback). codes, whether by reservation or derogation, as well as any exception to national treatment, is subject to periodic Under the two codes, members have several possibili- examination aimed at the removal of the measure. The ties for obtaining dispensation in accordance with their prohibition of new restrictions is intended to ensure the economic and financial situation. The most far-reaching maintenance of the liberalization that has been attained. exemption, which is now largely irrelevant, is provided in article 7(a) of the Capital Movements Code. Under it, Nondiscrimination a member, for reasons related to its economic develop- ment, can invoke a derogation from the totality of the This principle is fundamental to relations among mem- liberalization obligations. A few members initially bers under the codes and the national treatment instru- availed themselves of special status under the code, but ment. It has two important elements. First, liberalization Spain, Greece, and Turkey have dropped this derogation measures and remaining restrictions should not discrim- and are now assuming full responsibility under the code, inate among members. (This obligation also applies to leaving Iceland as the only country still invoking the members having recourse to reservations or derogations clause. Since the derogation cannot be re-established under the codes.) Second, most favored nation treatment once it is withdrawn, article 7(a) has become obsolete for applies to all members who adhere to the codes and all countries but one. comply with the rules, regardless of the state of liberal- Under the remaining clauses of article 7, if a liberaliza- ization they have attained.3 Thus the codes, in accor- tion measure leads to serious economic and financial dance with their multilateral character, take a firm difficulties in the country concerned, it can be with- position against reciprocity provisions; these and other drawn, and if there are serious balance of payments forms of discrimination are, as a matter of principle, not difficulties, the measure can be temporarily suspended. permitted. In the area of direct investment and establish- In both cases derogations must be confined to the mini- ment, however, and in particular in the financial services mum necessary to remedy the difficulty, and the validity sector, a number of members did maintain reciprocity of the derogation is judged by the OECD council. The provisions-some of them rarely activated-which they continuing justification for a derogation is closely mon- were notready to remove. It was felt that such provisions itored until the derogation is ended. should be distinguished from other types of restrictions The most common way of obtaining a dispensation is that are covered by reservations. Accordingly, they are to lodge reservations under specific items of the codes, dealt with in a separate council decision (annex E of the as provided in article 2(b) of both codes. These reserva- Capital Movements Code) which enumerates all existing tions are recorded in separate annexes, which are integral reciprocity measures, and they are subject to the same parts of the instruments. Reservations can be entered procedures as ordinary reservations concerning their re- only if: view and progressive elimination. The council decision refers only to existing reciprocity * A new obligation is created measures and does not mention the treatment of new * An existing obligation is extended ones. But since reciprocity is a deviation from the non- * An obligation has just begun to apply to a member. discrimination principle, which is essential to the multi- lateral nature of the OECD instruments, any exception in Thus, under the most important items of the Capital its favor should be narrowly construed. Reciprocity pro- Movements Code, the inequality of rights and obliga- visions that are not explicitly allowed should be consid- 152 Lessons from the Experience of the OECD ered prohibited. In other words, the standstill obligations practice consistent with international law and no less concerning reservations also apply to restrictions based favorable than that accorded in like situations to domes- on reciprocity. The same reasoning would also apply to tic enterprises." the national treatment instrument, under which new ex- It is clear from the language of these instruments that ceptions based on reciprocity should not be introduced. they do not intend to place nonresident operators and Article 10 of the Capital Movements Code and the locally established foreign-controlled enterprises in a Invisibles Code provides that "members forming part of better position than domestic enterprises. As stated in an a special customs or monetary system may apply to one interpretation of the code by the competent committee, another . . . other measures of liberalization without the liberalization provisions "do not entitle a nonresident extending them to other members." This article, which to engage in an economic activity without compliance undoubtedly appliestotheEuropeanEconomicCommu- with the general regulations of the member concemed," nity, allows members of the system to liberalize among and the same consideration applies to national treatment. themselves without extending the liberalization mea- National treatment does not necessarily provide foreign sures to other OECD countries. It does not justify the operators with effective access to markets for services in introduction of new discriminatory restrictive measures. countries in which services are heavily regulated. Many Liberalization of services within theEuropean Economic countries have general economic regulations conceming Community must be judged against these standards, in entry and operating conditions in service industries that particular if they involve any new reciprocity clauses affect both domestic and foreign suppliers. The main with respect to other OECD countries. types of government intervention in service sectors in- The question of whether bilateral free trade agreements clude: such as the Canada-U.S. Free Trade Agreement qualify as customs unions under article 10 has not yet been * Public monopolies, whereby entire sectors are closed resolved within the OECD. The notion of a "special sys- to private involvement, whether by foreign or do- tem" implies the establishment of permanent and institu- mestic enterprises tionalized arrangements between the contracting parties - Government-sanctioned private monopolies that with the goal of removing customs and other trade bar- have the same effect riers, but the required degree of economic cooperation * Mixed public-private monopolies or sectors domi- and integration of the partners has not been defined. nated by government-owned enterprises that enjoy Although the legislative history of the codes seems to preferential operating conditions indicate that free trade agreements were thought to come * Concession or license requirements that limit the within the purview of article 10, it is for the competent total number of firms operating in the sector, regula- OECD committee and, ultimately, the council to deter- tions on rates and prices, and other restrictive oper- mine the applicability of article 10. Any interpretation ating conditions. will have to take into account the importance of main- taining the multilateral nature of the code, which should The situation is further complicated because certain reg- not be undermined by the proliferation of special ar- ulations are implemented at the regional or municipal rangements among members. The national treatment rather than the national level or have been delegated to instrument does not now contain any clause similar to nongovernmental bodies, as in the case of professional article 10 of the codes, and it is doubtful whether a clause services. that would justify discrimination between foreign-con- Laws, regulations, and other measures that establish trolled enterprises already operating in the territory of the public monopolies, government-sanctioned private mo- member country concerned would be acceptable. nopolies, or a combination of the two, like nondiscrimi- natory economic regulations in general, do not fall under National Treatment the liberalization commitment stipulated by the codes, nor are they contrary to the national treatment instru- Whereas nondiscrimination applies to relations among ment. They are considered part of the economic frame- members, the principle of national treatment pertains to work in member countries. Yet they may severely limit measures taken by governments with respect to market or frustrate competition by foreign providers of services. operators. Under the codes nonresidents must be able to The asymmetry of regulations, particularly in banking carry out service transactions and related transfers on the and financial services, is another cause for concern, as same basis as residents. National treatment, as defined in liberalization based on national treatment simply may the 1976 Declaration, means "treatment under [the mem- not lead to a comparable level of market access for all ber countries'] laws, regulations, and administrative trading partners. (Universal banking versus separation 153 Rainer Geiger between banking and securities operations is the most on competition of the 1976 OECD Guidelines for Multi- striking case in point.) national Enterprises. Should national service regulations, even if nondis- In international discussions on restrictive business criminatory in a formal sense, be subject to international practices, reference is often made to intragroup arrange- scrutiny and negotiation? Where is the line between ments within multinational enterprises that may involve, "appropriate" and "inappropriate" regulations? Is it per- among other things, market allocation and production missible to define the scope of "natural monopolies-for transfer pricing and cross-subsidization. Under the com- example, in telecommunications-in an extensive man- petition laws of most countries, such intragroup practices ner,to include equipmentandvalueadded servicesareas, are not considered harmful unless they constitute an where competition is clearly possible? Is it acceptable to abuse of a dominant position and adversely affect com- maintain strict entry rules in sectors, such as transpcr where petition outside the affiliated enterprises. The United economic evidence shows that markets are "contestable"? Nations Code and the OECD guidelines follow the same These questions are under discussion within the OECD, approach. Examples of abuses of dominant positions but the issues have not yet been resolved. Public monop- given in the guidelines include: olies and other formally nondiscriminatory measures are now subject to transparency commitments and critical * Anticompetitive acquisitions review. The OECD Committee on Competition Law and * Predatory behavior toward competitors Policy, among others, is reviewing regulatory reforms in * Unreasonable refusal to deal member countries' service industries, the effects of such * Anticompetitive abuse of industrial property rights reforms, and actions taken to fight anticompetitive prac- * Discriminatory (that is, unreasonably differential) tices by operators. This review is expected to lead to pricing and the use of pricing transactions between policy recommendations that may contribute to trade affiliated enterprises to adversely affect competition liberalization in these areas. outside these enterprises. Competition and Corporate Behavior Abuse of dominant positions under these provisions presupposes the existence of marketpower. Determining Trade liberalization in goods in the post-World War II whether market power does exist requires careful exam- period has been accompanied in many member countries ination of relevant product and geographic markets tak- by the development of competition legislation designed ing into account, among other things, the characteristics to prevent the replacement of trade barriers with private of the products or services concerned, the availability of restrictive practices among market operators, such as substitutable products or services, the degree of concen- price-fixing and market allocation agreements. It is not tration in these markets, entry barriers, and the existence surprising that similar concerns are raised with respect to of foreign competition. the liberalization of services. Many countries have heav- It should not be concluded that in the absence of anti- ily regulated service sectors that have not been subject to competitive practices the OECD guidelines are irrelevant the full force of competition laws or have even been to intragroup arrangements. According to the guidelines, totally exempt from such legislation. One aim of the multinational enterprises should "take fully into account regulatory reforms now under way in many countries is established general policy objectives of the member to create more competitive markets for services and to countries in which they operate" and "allow their com- apply competition law more vigorously. In addition, ponent entities freedom to develop their activities and to competition policy criteria should apply to trade restric- exploit their competitive advantage in domestic and for- tions enforced by nongovernmental organizations (for ex- eign markets, consistent with the need for specialization ample, shipping conferences) and by professional bodies. and sound commercial practice." Although the OECD At the international level, competition policy principles guidelines do not create any legal obligation, govern- are set out in the Set of Principles negotiated within the ments thathave adopted them expectthem tobe observed United Nations Conference on Trade and Development by multinational enterprises, and follow-up procedures (UNCTAD) and adopted by the United Nations General at the national and international levels provide an oppor- Assembly in 1980. These principles apply to goods and tunity for raising any issues encountered in their applica- services alike, with no sectoral exemptions, and cover tion. Thus, the guidelines constitute an important both collusive practices among competitors and abuses balancing element to the commitments undertaken by of market power by dominant enterprises. Similar but governments under the codes and the national treatment less detailed principles are contained in a special chapter instrument. 154 Lessons from the Experience of the OECD Implementation Surveys of members' policies with respect to specific services provide descriptive material and an opportunity Two OECD committees are primarily responsible for im- to analyze the reasons for and effects of these policies. plementation and surveillance: the Committee on Capi- Question-and-answer sessions provide an opportunity tal Movements and Invisible Transactions (cMIT) and the for informal exchanges of information and frank discus- Committee on International Investment and Multina- sions of specific national measures. tional Enterprises (CIME). The cMriTs mandate is deter- mined by the two OECD codes. The CIME has an overall Examination and Consultation mandate for all investment policy issues arising in OECD and specific responsibilities for the implementation of Reservations maintained under the Capital Movements the 1976 Declaration. In addition, several other OECD Code, as well as the initial and continuing justification committees deal with questions relating services: the for any derogations, are examined country by country, Insurance Committee, the Committee on Financial Mar- each country being examined by the cmrr every three to kets, the Maritime Transport Committee, the Tourism four years. Ad hoc discussions are held as specific im- Committee, and the Committee for Information, Com- portant issues concerning members' policies arise. Ex- puter and Communications Policy. The Trade Commit- aminations under the Invisibles Code have thus far been tee is carrying out a comprehensive analysis of trade in conducted by sector rather than country by country. services in connection with the Uruguay Round; both Discussions of exceptions to national treatment have sectoral and conceptual issues relevant to the negotia- focused on categories of exceptions, but recommenda- tions are being discussed. tions have been addressed to individual members. The institutional framework set up under the codes is Examinations under the Capital Movements Code are somewhat different from other working arrangements carried out according to an established procedure. The within the OECD. Whereas all other committees are com- country concerned submits a memorandum explaining posed of representatives of member governments acting its position under the code in light of its economic and by consensus, the cmrT, which is in charge of implemen- financial situation and stating the reasons for any restric- tation of the codes, is a body of experts named by tive measures it wants to maintain. The secretariat then governments in their individual capacities. It can decide prepares a working document for the cmiT analyzing the by simple majority, and it reports directly to the OFCD situation and putting forward proposals for recommen- council. Although the CMIT experts are understandably dations by the committee. After discussion by the com- sensitive to the interests of the governments that nomi- mittee, a report is submitted to the council, which makes nate them, and although a formal vote is rarely taken, the final decision on the committee's recommendation. these special rules have contributed to the committee's Experience has been somewhat differentfor each code. operational effectiveness. Under the Capital Movements Code, relatively little progress was achieved in the 1960s and 1970s, but in the Transparency andNotification 1980s liberalization has proceeded at a rapid pace-ex- change controls on capital movements have been drasti- Transparency is achieved through formal notifications cally curtailed or completely abandoned by one country by members, through surveys undertaken by the OECD after another. In the area of direct investment and estab- secretariat, and through informal question-and-answer lishment, significant progress has been made in disman- sessions. Under the codes and the national treatrnent tling restrictive authorization procedures. Countries that instrument, members are required to notify the OECD of have taken important steps toward liberalization of in- all restrictive measures requiring a reservation or dero- ward investment include Australia, Canada, France, gation to the codes or constituting an exception to na- Japan, New Zealand, Spain, and Turkey. In some coun- tional treatment. They also report any relaxation or tries, including the Federal Republic of Germany, Swit- removal of restrictive measures and, more broadly, zerland, the United Kingdom, and the United States, this changes in policy having a bearing on the OECD instru- item, apart from a few minor sectoral exceptions, has ments. Members have also agreed to report potentially been fully liberalized. Services is the main area in which restrictive measures even if it is not clear whether they restrictions on inward investment and exceptions to na- actually qualify as a reservation, derogation, or excep- tional treatmentare still relatively important, but here too tion. Measures such as public monopolies that are not there has been an encouraging move toward liberaliza- discriminatory are nevertheless reported in the interests tion. For example, in banking and financial services, no of transparency. member country excludes foreign investment as a matter 155 Rainer Geiger of principle, and restictions have been substantially The clarifications of the guidelines provided by the relaxed in recent years. It should be stressed that liberal- committee in response to requests from governments ization does notnecessarily imply deregulation. Opening and the OECD's Trade Union Advisory Committee dur- sectors up to foreign competition does not mean that ing the period 1976-84 were compiled in OECD (1986). nondiscriminatory regulations maintained for public pol- In the area of national treatment, the relevant council icy purposes, such as prudential controls in financial decision does not refer explicitly to interpretation and services or safety regulations in transport, have to be clarification, but it is understood that this task is part of abandoned; they may even have to be strengthened in the committee's responsibilities in monitoring the appli- some instances to meet the new challenges of global cation of the instrument. A publication issued in 1985 markets and internationalized transactions. clarified the meaning of national treatment generally and Within the areas covered by the Invisibles Code, prog- in relation to six categories of measures in which excep- ress has been uneven. Although by 1960, when the code tions to national treatment have been recorded: official was adopted, a considerable degree of liberalization of aids and subsidies, tax obligations, government procure- cross-border services had been achieved (especially in ment, investments by established foreign-controlled en- the field of payments for services rendered), during the terprises, access to local bank credit and capital markets, 1960s and 1970s there was little further movement to- and corporate organization (OECD 1985). ward reducing the remaining barriers. Liberalization gained new momentum in 1979, when the OECD council Updating andRevising the Instruments decided to start updating the code (see "Updating and Revising the Instruments," below). Four sectors have Starting with a council decision in 1979, the cMrr has already been covered: tourism, audiovisual services and been engaged in updating the sectoral parts of the Invis- works, insurance, and financial services. In each, the ibles Code to take account of technological changes, the purpose is to expand the range of service operations increased importance of services, and the growing inter- subject to liberalization and to encourage members to nationalization of economic activities. A complete in- relax or abandon any restrictions they have on those ventory is madeof members'restrictions on international operations. Progress has been impressive in the field of trade and investment in the sector concerned. The rea- payments for tourism services, which is now almost sons for and the relative importance of these measures entirely liberalized within the OECD. In banking and are then analyzed, and proposals for revisions are elabo- financial services, most members have made efforts to rated. Finally, the remaining restrictions are examined open their national markets, but further progress is under these new provisions. needed, particularly in insurance, where significant re- Four sectors have already been covered: insurance, strictions remain with respect to establishment and cross- travel and tourism, audiovisual services, and financial border services. As several council recommendations services. In cooperation with the Committee for Infor- have stressed, the case for libc.alization of insurance mation, Computer and Communications Policy, a new related to international trade in goods is particularly project has been launched to explore the possibilities for strong and should be vigorously pursued. liberalization in the areas of value added network ser- vices, computer services, and computerized information Interpretation of the Instruments services. The next area in which work could be started is professional services. In the course of notifications, consultations, and exami- In May 1989 the council, acting on a joint proposal by nations, questions frequently arise as to the meaning of the CMIT and the Committee on Financial Markets, the instruments in a concrete situation. It was felt that the adopted revisions to the Invisibles and Capital Move- authority and effective application of any interpretation ments Codes. The decisions affect three areas: of the existing provisions could be best ensured if inter- pretation were entrusted to the committee in charge of * Capital movements. Many operations are now sub- the day-to-day implementation of the instruments. Ac- ject to liberalization for the fust time; these include cordingly, questions conceming interpretation of the short-term capital movements and some innovative codes are discussed by the cmrr, and its conclusions on activities-such as money market operations, short- important matters are usually submitted to the council for term financial credits and loans, forward operations, approval or information. Issues arising under the 1976 swaps, andoptions-that were not covered previously. Declaration are dealt with by the CIME. Procedures re- * Banking and investment services, asset manage- garding the OECD guidelines have been laid down in a ment, and agency services, such as investment re- council decision on intergovemmental consultation.4 search and advice 156 Lessonsfrom the Experience of the OECD - Establishment The provisions of the Capital Move- pants. Reciprocity and discriminatory bilateral arrange- ments Code have been supplemented by an addition ments do not conform to that idea and, at most, should to the Invisibles Code establishing the general prin- be admitted only as temporary expedients. ciple of equivalent treatment for branches and agen- Taken together, the OECD instruments constitute a com- cies of nonresident enterprises as compared with prehensive international framework covering most as- domestic enterprises and setting out detailed stan- pects of international transactions in services. They are dards for assessing the observance of this principle. multidisciplinary in nature, combining general princi- ples and sectoral arrangements and different modes of These amendments, which extend the codes to all aspects delivery of services-that is, cross-border services as of banking and financial services, will come into effect well as establishment. Obligations undertaken by gov- after the Council has examined the reservations that ernments are supplemented by standards of behavior members wish to maintain with respect to the new items. addressed to market operators. Apart from the sectors that are still considered "natural Implementation procedures have been set up for noti- monopolies" in most countries (for example, basic tele- fication, examination, consultation, interpretation, and communications services and public utilities), it is in review. The effectiveness of these procedures lies pri- transport that restrictive regulations are most entrenched marily in the political will of all participants, peer pres- and liberalization is most difficult to achieve. In both air sure, and the momentum created by a continuous process and maritime transport, many countries are still attached of discussion and negotiation. The progress thus far to the idea of maintaining national flag carriers even if achieved has been significant. these are not internationally competitive. Recently, how- Continuing vigilance, however, is needed to resist pro- ever, there have been significant efforts to make air tectionist pressures and to preserve a truly multilateral transport more subject to competition and to reduce the framework for international transactions in services. The scope of economic regulation. existing instruments have to be kept up to date to reflect A forthcoming study by the Committee on Competition changes in the economic and technological environment Law and Policy concludes that there is no economic and the regulatory reforms being undertaken in member justification for maintaining entry restrictions and rate countries. Exchanges of views leading to a common regulations in road transport where markets are fully understanding of the issues should involve not only "contestable" (OECD forthcoming). In this area, too, there govemments but also nongovemmental groups repre- is a strong case for promoting both national and interna- senting the various actors in intemational transactions. tional competition through regulatory reform and liber- Finally, intemational surveillance of countries' policies alization. and compliance with the instruments needs to be rein- forced. Conclusions Whatever the outcome of the Uruguay Round of nego- tiations on services, the OECD instruments will retain The instruments that make up the OECD framework for their relevance for cooperation among members. Their international transactions in services are varied and com- importance already extends beyond the OECD area as a plex-a reflection of historical developments, the divi- point of reference for policy discussions among all those sion of responsibility between government departments interested in an efficient service sector, which is funda- and OECD committees, and growing awareness of the mental to economic development. economic importance of the service sector in all member countries. Although the instruments are based on firm Notes principles and commitments, they nevertheless allow sufficient flexibility to reflect important differences in 1. Direct investment is defined as "investment for the purpose of the economic and financial situations of member coun- establishing lasting economic relations with an undertaking much as, in particular, investments which give the possibility of exercising an tries. They are evolutionary in nature, moving step by effective influence on the management thereof." step toward greater liberalization and taking into account 2. The amendment states that the obligation to liberalize covers fundamental changes in technology and market condi- "regulations or practices applying to the granting of licenses, conces- sions, or similar authorizations, including the conditions of require- tions. Standstill and rollback commitments have been put ments attaching to such authorizations and affecting the operations of in place to prevent backsliding from the level of liberal- enterprises, that raise special barriers or limitations with respect to ization already achieved. nonresident(as compared toresident)investors, and thathavetheintent The instruments are based on the belief that an open or the effect of preventing or significantly impeding inward direct investment by onresidents." multilateral trading system is in the best interests not only 3. According to article 8 of the codes, "any member lodging a of international welfare but also of individual partici- reservation under article 2(b) or invoking the provisions of article 7 shalL neveriteless, benefit from the measures of liberalization taken by 157 Rainer Geiger other members, provided ithas complied with the procedure laid down 5. According to a report by the Committee on Competition Law in article 12 or article 13 as the case may be." and Policy, 4. The relevant passages are As deregulation in domestic markets increases the efficiency and The Committee on Intemational Investment and Multinational competitiveness of carriers under the force of competition, it wil Enterprises (hereinafter called "the Committee") shall periodicaly provide a powerful incentive for those carriers to expand their or at the request of a member country hold an exchange of views services abroad and thus create pressures toward intemational on matters related to the guidelines and the experience gained in liberalization. Progress in this field ultimately depends on the their application. The Committee. shal be responsible for clarifica- willingness of govemments to accept a higher degree of intema- tion of the guidelines. Clarification wil be provided as required. tional competition and a cestain multinationalization of corporate The Committee shall periodically report to the council on these structure in air transport, away from a strict policy of protecting matters. national flag carriers. (oECD 1988, p. 79.) The Committee shall periodically invite the Business and Industry Advisory Committee to ornc (BLAc) and the Trade References Union Advisory Committee to oECD (tuAc) to express their views on matters related to the guidelines. In addition, ex- changes of views with the advisory bodies on these matters may OECD. 1985. National Treatment for Foreign-Controlled Enterprises. be held upon request by the latter. The Committee shal take Paris. account of such views in its reports to the council. . 1986. OECD Guidelines for Multinational Enterprises. If it so wishes, an individual enterprise wiU be given the Palis. opportunity to express its views either orally or in writing on 1988. Dereg.t tio and APol and to e Deregulation of issues concemiing the guidelines involving its interest. Road Transport. Paris. The Committee shaU not reach condusions on the conduct of individual enterprises. 158 16 Developing Country Perspectives Kenneth Heydon A multilateral process of liberalization of trade in ser- dence of many developing countries may render the vices offers significant opportunities for gain, whether concerns more acute. through increased efficiency, as national barriers are As trade expands, sector-specific adjustment will re- reduced, or through export opportunities, as other flect the impact on the country concerned of increases in countries' barriers are lowered. The impact of each of both imports and exports. On the import side, three these elements will depend on the circumstances of examples illustrate the diversity of issues that are likely individual countries. There is, nevertheless, a general to emerge. presumption that a reduction of economic distortion in service activities and the adoption of national policies * The liberalization of transborder data flows and that provide similar incentives to production in the do- greater use of electronic information services from mestic and export markets wil foster sustained growth overseas sources may lead countries at all stages of and more resilience to external shocks. Moreover, given development to be apprehensive about the depen- the nature of forward linkages from service activities, the dency and vulnerability associated with the storage political economy of service sector protection, and pat- abroad of nationaUly important databases. terns of skills transfer, it is arguable that liberalization of * Increased admission of foreign-based insurance the service sector may yield greater gains than might be companies may be seen as impinging on the host expected on the basis of experience with the goods government's ability to monitor the insurance sector. sector's role in macroeconomic management. (Ac- Whether individual developing countries realize gains cording to Okediji 1986, fund accumulation in the from liberalization, however, does not depend only on a Nigerian insurance market, the largest in Sub- sustained commitment to liberalization at the national Saharan Africa, has enabled insurance companies to level. It also depends on the capacity of a multilateral, act as fimancial intermediaries and to invest large rules-based negotiating process to foster export opportu- sums in the economy.) nities for developing countries, to encourage the transfer * There may be concern that liberalization could in- of skills and technology, and to allow a gradual absorp- hibit access to the financial market by smal enter- tion of the adjustment strains that expansion of trade is prises or rural interests in developing countries if likely to entail. banks, whether domestic or foreign based, prove more interested in the modern urban sector. Adjusting to Liberalization Sector-specific adjustment strains associated with in- Liberalization of the service sector is likely to give rise creased exports may arise when the market does not to adjustment pressures-some specific to the sectors reflect and balance the full costs and benefits of the concerned, others of a more general, cross-sectoral na- activities undertaken. Such stresses maybeevidentin the ture. The concerns associated with these strains (or costs) tourism sector of particular countries as increased flows do not constitute arguments against liberalization, but of visitors raise concems about environmental protection they should not be discounted either. The problems iden- or cultural integrity. Export-related strains may also arise tified here are not exclusive to developing countries, and in the area of professional services as outflows (albeit many parallels exist between the experience of devel- temporary) of highly qualified nationals deplete the oped and developing countries. But the degree of depen- available human capital. 159 Kenneth Heydon Beyond these pressures associated with individual sec- ity are uniformly high in their traditional areas of opera- tors, two general concerns arise in all areas of service tion-foreign exchange, international transfers, and ex- activity. At the macroeconomic level, these have to do portcredits-the impact on local banks' traditionalretail with possible strains to the balance of payments; at the business is relatively modest. In Australia the entry of microeconomic level, they involve the impact of liberal- foreign banks has provided a catalyst for increased com- ization on indigenous service providers. petition, and despite fears of foreign domination, local Concerning the former, it is necessary to distinguish banks still account for about 90 percent of total assets. two situations. Inthefirst,persistentbalanceofpayments The net employment effect of liberalization is corre- strains that arise from the import of a particular service spondingly difficult to determine. Liberalization that af- are invoked to support import substitution of that service. fects cross-border transactions may lead to employment In the second, foreign exchange outflows that stem from losses as local producers are displaced, but these may be the import of a particular service and cause short-term offset by employment gains from improvements in re- balance of payments problems are offered as grounds for source allocation and by possible dynamic efficiency temporary restrictions on foreign exchange. As to the gains. Moreover, there may be no first-round employ- first situation, liberalization of the service sector can ment loss in the local industry if liberalization induces indeed prompt a sustained balance of payments strain increased establishment-based transactions. that may necessitate import contraction, adjustment of the exchange rate, or general demand restraint. But this Development Opportunities: Reducing will not always be the case. Liberalization may in fact Domestic Barriers have a positive effect on the balance of payments as a consequence of commercial presence as opposed to A reduction in domestic barriers to service imports is cross-border transactions, even taking into account the likely to give rise to development opportunities in the outflow of dividends or other remittances. For example, short term. The reason is that gains in efficiency are increased reliance on locally established foreign-based realized as the quality of services becomes better, the direct insurers with a substantial capital base may in- costs of protection are lowered, and resource allocation crease retention capacity, lower dependence on interna- is improved. In the longer term there are likely to be tional reinsurance, and actually reduce outflows of dynamic growth opportunities from the transfer of skills, foreign exchange. Foreign exchange savings may be frequently as a consequence of the operations of multi- realized in the construction and engineering sector national service providers. through the "build, operate, transfer" formula, under which the foreign contractor assumes responsibility for Efficiency Gains project finance. Even where liberalization of the service sector is associated with sustained outflows of foreign For a wide range of sectors, protection of indigenous exchange, the balance of payments argument cannot be service providers, which limits access by foreign firms, used to support import substitution in any particular reduces the quality of service on offer. This observation sector unless alternative opportunities for import saving applies to countries at all stages of development, but it and the relative costs of domestic production in each has particular relevance for many developing countries. activity are considered. In most developing countries the range of available fi- As for the second kind ofbalance of payments problem, nancial services is limited-domestic sources of long- short-term restrictions on outflows of foreign exchange term funding are scarce, there may be no interest-bearing to cope with periods of temporary difficulty are likely to instruments for parking large volumes of short-term be regarded as legitimate as long as they are not used to funds, and there is likely to be only minimal access to limit or frustrate the relationship between a parent com- commodity and interest futures markets. Developing pany and its overseas affiliate. country experience suggests that legitimate goals of de- At the level of the firm, liberalization of trade in ser- velopment and the protective environment they can en- vices may be perceived as placing strains on indigenous gender may impose costs through reduced efficiency of service providers and possibly eroding their market po- the banking sector-in particular, through low direct sition. Again, however, this will not always be the case, mobilization of savings. Insurance services in develop- as experience in the banking sector illustrates. Case ing countries are frequently more expensive and less studies of eleven developing countries suggest that there efficient than those available in developed countries: is considerable scope for complementarity of activities premium rates are lower in foreign markets and the between domestic and foreign banks (Germidis and payment of indemnities is more generous and prompt. Michalet 1984). Although foreign banks' levels of activ- Import substitution policies in construction and engi- 160 Developing Country Perspectives neering services, by limiting exposure to imported tech- borne by unprotected industries is the increase in nology, have frustrated the development of design capa- wages that is shifted on to them by industries that bility. In many developing countries restrictions on the receive protection (Clements and Sjaastad 1984). flow of financial and human resources into government Protection causes a general increase in nominal telecommunications monopolies have inhibited the effi- wages as import-competing industries expand and as cient management of those resources. labor seeks increased wages to compensate for the Policies that restrict the operations of foreign providers higher living costs brought about by protection. of services may raise the income of local sellers but act Those least able to absorb these costs are export as a tax on local buyers-for whom, in many cases, the industries, which are frequently price takers, con- services are inputs into theproduction and exportof other strained by international competition, and unable to goods and services. The widespread nature of user dis- pass on to consumers the costs of higher wages. This ability and intersectoral costs can be illustrated by the is why it can be said that a tax on imports is a tax on effects of restrictions on information, computer, and exports. On the basis of this analysis, the general communications (ICC) services on manufacturing, pri- equilibrium costs of service sector protection are mary industry, and other services. The experience of the likely to beparticularly high when-as is not uncom- maquiladoras-Mexican industrial plants that assemble mon in developing countries-labor-intensive ser- semifinished products for U.S. firms-is an example. vice industries that cater mainly for the domestic According to Barrera (1988), although the situation is market receive relatively higher levels of protection now improving significantly, the telecommunications than do manufacturing or primary industries, which services provided between Mexico and Texas by are more dependent on export markets. Mexico's Secretariat of Communications and Transport * Most service activities offer opportunities to benefit notonly have failed to satisfy the needs of the newborder from expansion of markets or economies of scale. industries but have been a significant obstacle to the But in many developing countries that are seeking to development and operation of new projects in the man- develop services, such opportunities are likely to be ufacturing sector. This case illustrates a broader point: only partly realized. In these circumstances signifi- improved access to producer services (through liberal- cant costs may arise from the protection of services ization) may increase developing countries' opportuni- that are important inputs to other industries-fre- ties to develop exports in the goods sector as the wider quently in the manufacturing or primary sector- availability of ICC and financial services makes possible where the existing scope for economies of scale is greater international fragmentation of manufacturing ac- much greater. tivity. * Producer services-precisely because of their strate- In primary industry self-imposed restrictions on trans- gic role-may receive a higher level of protection in border data flows and access to internationally traded many developing countries than do intermediate information services deny governments the opportuni- goods. Indeed, in many developing countries inter- ties of transparent commodity markets and inhibit the mediate goods, unlike intermediate services, are efficiency of such markets in responding to changing likely to receive preferential import treatment. For circumstances. National policies that unnecessarily im- example, India's machinery imports have increased pede the movement of information or that require local greatly since 1980 as the interests of user industries, duplication of information can also entail a high cost for mostly government firms, have prevailed over other service activities. In 1981 Brazil's Special Secre- equipment providers, mostly private busi- tariat of Informatics required Varig, the Brazilian inter- nesses (Desai 1989). By contrast, many producer national airline, to move its reservation system from services, such as banking and insurance, involve Atlanta in the United States to Rio de Janeiro-a move significant government ownership and are more that cost the airline $23 million in reinstallation charges. likely to be shielded from foreign competition. Beyond these specific examples, there is a broader question: whether the service sector has characteristics The Transfer of Skills that make the costs of protecting services higher than those normally expected for protection of goods. Three Over the longer term, perhaps the strongest case for ways in which services may differ from goods are exam- service sector liberalization has to do with the transfer of ined here. soft technology (management, technical, professional, and other skills) associated with the activities of foreign- In the goods sector, it has long been acknowledged based service providers. For example, experience with thata significant component of the cost of protection the development of tourism in Africa suggests that exter- 161 Kenneth Heydon nal partners are needed not so much for financial reasons The Scope for Benefits and the Level of Development (few African airlines have been unable to obtain external loans) as for gaining access to knowledge, communica- Clearly, the scope for individual developing countries to tion, and organization (Green 1979). gain development opportunities from trade liberalization The transfer of service sector skills frequently takes the will depend on the extent of their barriers to service form of formal training programs or of technology em- imports. Comprehensive data are lacking on the extent bodied in the service provided. It is at the day-to-day of service sector protectiorl, particularly on the relative operational level, however, that transfer of skills appears levels of protection for services and goods, which are to be most beneficial and widespread. The American importantforgeneralequilibrium analysis. Nevertheless, International Group (AIG), in its insurance operations in there is evidence over a wide range of sectors that devel- Kenya and Nigeria, reserves for the home office deci- oping country barriers to trade in services, whether they sions concerning the structure of the financial portfolio concem cross-border trade or establishment of foreign- but has transferred to local entities 100 percent of motor owned finns, are sufficiently high to provide ample vehicle underwriting (Wasow 1984). Irtemational ac- scope for development gains from liberalization. This is countants Arthur Andersen & Co., in their new practices not to deny that developing country regulations are likely overseas, seek to transfer ownership oaid management to be relatively sparse in areas of consumer protection or responsibility to local "national practice entities" (Rossi in rapidly evolving, technologically advanced service 1986). In maritime transport joint-venture arrangements activities. with foreign partners in Guinea, Guyana, and Jamaica The opportunity for individual countries to derive de- helped resolve technical problems with bauxite ship- velopment benefits from liberalization also depends on ments (UNCTC 1982). In software production the risk that the nature of service linkages at different stages of devel- technological change will overtake developing opment and the consequent impact of the cost of protect- countries' competitive strengths can be reduced through ing service activities. Of particular importance are joint ventures and the associated transfer of technology., forward linkages, whereby services are inputs for other (In eighteen months up to mid-1986 Japanese firms economic activities. Input-output data suggest that at all established twelve joint ventures for software develop- stages of economic development all types of manufac- ment in developing countries.) Finally, experience in the turing are more dependent on distribution services (no- engineering and consulting sector illustrates how joint- tably transport and communications) than on all other venture activities can be a transition toward greater local types of services (Park and Chan 1989). Thus the costs responsibility. In the thirty years needed to construct the of inefficiency in distributive services are high. At pro- Caracas Metro, the Bechtel organization has been able to gressively higher stages of development, however, the move from joint-venture participation to partnership relative importance of distribution services as inputs into with a Venezuelan engineering company that is increas- manufacturing declines and that of producer services ingly assuming more responsibility and control (Ste- (notably banking, insurance, and professional services) phenson 1984). increases. In a dynamic context, therefore, service sector Experience in various sectors suggests that although protection is likely to have its most serious effect on some skills can be acquired on the open market without development and growth prospects when it introduces giving multinational enterprises access to the local ser- inefficiency into producer services or frustrates transfer vice sector, there are particular benefits to be derived of skills in that area. from the transfer of skills through the continuous, longer- term interaction of people within a well-organized The Benefits ofMultilateral Action framework of accountability. More generally, the UNCTC has identified extensive transfers of soft technology and It is generally acknowledged that greater use of foreign- has concluded that, in contrast to the situation of manu- based services can contribute to significant improve- facturing companies, the skills required for production ments in quality and cost. But why shouldthis benefit not of services tend not to be centralized in parent companies be derived through unilateral liberalization rather than but rather to be spread to host country operations. It within a multilateral framework that might limit individ- seems that service firms are less able than manufacturing ual countries' room to maneuver and might impose ob- firms to split the production activities of their affiliated ligations on them? networks to match the factor proportions of subprocesses One answer is that the interests of smaller or more with the factor prices of host countries (UNCTC 1989). vulnerable trading countries are likely to be best served 162 Developing Country Perspectives by a multilateral, rules-based framework. Recent devel- trade. Multinational banking institutions with a develop- oping country experience suggests that in practice, the ing country as country of origin account for about 20 per- alternative to multilateral liberalization is not unilateral cent of branches and 6 percent of subsidiaries throughout dismantling of barriers but bilateral confrontation. For the world; India, Mexico, Singapore, and Thailand are example, in July 1986, following extensive section 301 among the top 20 income earners in intemational tour- investigations, an agreement for improved access for ism; and 33 of the 250 largest international construction U.S. insurers in the Republic of Korea was announced. and engineering contractors are from developing coun- Cho (1988) has suggested that since the Korean market tries. Moreover, for many developing countries services remains partially cartelized, the limited admission of are likely to represent a growing component of exports, additional firms may create vested interests against a even though the amounts involved may not be large in multilateral, rules-oriented approach to liberalization. global terms. Recent developments in the maritime transport sector- Opportunities for developing country exports may re- including the antidumping enquiry conducted by the flect, in part, attributes peculiar to the countries con- European Commission against Hyundai Merchant Ma- cemed-physical and cultural characteristics that attract rine, Korea, and the investigation of Taiwan's shipping international tourism; strong links with host countries practices by the U.S. Federal Maritime Commission- (which have helped foster intradeveloping country trade also reflect bilateral pressures. The potential punitive in construction and engineering services); and linkages measures associated with such investigations are consid- between national service providers and their clients of erable and, without casting judgment on the cases in the sort that prompted developing country banks to ex- question, it is likely that developing countries would be pand their overseas operations in the wake of the expan- better off pursuing their interests within a multilateral sion abroad of nonfinancial corporations. framework. Other opportunities reflect characteristics of the indus- Another, perhaps more contentious, advantage of a tries themselves: declining entry costs in Icc services as multilateral process is that it may facilitate a broader advances in microelectronics reduce communications appreciation of the infrastructural disabilities of many costs; opportunities for niche markets such as the key- developing countries and of the need for parallel action punching services exported by the Philippines to the to address these deficiencies. This is directly related to United States; and the requirement for familiarity with the form that a services framework might eventually "mature" technology such as that gained by Brazil's take. A critical question that can only be touched on here construction firms through their work in tropical and arid is whether the agreement on services should go beyond regions. the present situation, whereby skills transfer is widely In many of the activities listed above, the critical factor provided on the basis of private sector initiative, and seek in translating potential export opportunities into realized to incorporate guarantees or conditions concerning the competitiveness willbe labor intensity and the advantage circumstances under which such transfers might be that many developing countries have in their ready sup- made. plies of low-cost personnel. Many service activities have important areas that are relatively labor-intensive: in the Export Opportunities: Reducing Foreign tourism sector, labor in hotel operations accounts for Barriers about 50 percent of costs; the operational aspects of construction and engineering services use large amounts Trade expansion will create opportunities for countries of labor; in maritime transport, a principal element of that have viable service industries and a realized or shipping costs is the direct wage bill for crew; and in the potential export capacity. This section discusses compet- distribution side of banking and financial services, labor itiveness in the export of services, the benefits that may is still the largest component of costs, even in technolog- be realized from liberalization, which are different for ically advanced banks. Some entire service activities, countries at different levels of development, and the such as data input and software production, are at present advantages of multilateral liberalization. heavily labor-intensive. Two factors complicate any assessment of the real Developing Country Competitiveness nature of the services competitiveness of individual countries, whether developing or developed. First, Although the nature of developing countries' competi- strength in labor-intensive subsectors may not translate tiveness is difficult to characterize, there are indications into a genuine comparative advantage for the sector as a of revealed comparative advantage that suggest a grow- whole. Second, in mostsectors thenature of competitive- ing, if modest, role for these countries in international ness will be obscured by the presence of significant 163 Kenneth Heydon government support. For example, a study of compara- also undermine some elements of labor-intensive com- tive advantage in various service sectors found that Bra- petitiveness. Examples include the generalization of zil, Korea, and Taiwan have a revealed comparative computerized character recognition for data input and advantage in maritime transport substantially above the computer-aided software production. level predicted on the basis of relative factor endow- These constraints on competitive opportunities for ser- ments. In each case, however, the government provides vice exports by developing countries-while indicating significant support to its own maritime fleet through that such opportunities, however real, must not be exag- subsidies or protective cargo regulatory measures (Sapir gerated-should not be invoked as arguments against and Lutz 1981). liberalization. Indeed, they underline the benefits of lib- eralization that is instrumental in fostering the transfer of The Scopefor Benefits and the Level of Development skills and technology. Countries at relatively early stages of development may The Benefits of Multilateral Action find that, as new entrants, they are constrained from effective participation in some service activities because How much developing countries' export opportunities of an inability to achieve the necessary economies of will benefit from multilateral trade liberalization will scale. Local insurance companies in some developing depend in part on the extent to which the multilateral countries are likely to be undercapitalized and to have framework facilitates concerted international action to unbalanced portfolios; premium income may not be reduce barriers to services in which developing countries high enough to meet liabilities because the local market have a particular interest. This in turn will depend in large does not produce enough income to allow sufficient measure on the treatment of labor-intensive services and spread. In ICC services, costs of entry may indeed be of services that require significant short-term relocation lower if all that is required is simply to "plug in" to the of providers. Of central importance will be the extent to network. But this will not be the case if an independent which agreement can be reached on the notion of "essen- network is needed or if there are significant deficiencies tiality" in respect to temporary movement of service in the basic telecommunications infrastructure. providers (as a condition for effective delivery of a Competitiveness based on low labor costs is not static. service) and how this is interpreted in the course of As development progresses, wage levels are likely to bilateral negotiations and the exchange of "concessions." rise, blunting the competitive edge. To illustrate, as low- wage countries acquire skills needed for support func- Some Policy Implications tions, their airlines become more viable, but competitiveness diminishes as the skill factor is more The fact that liberalization may create adjustment strains than offset by the rise in the general wage level (Findlay does not mean that it should not be pursued, but it does and Forsyth 1986). Rising wage levels were a primary mean that the liberalization process should take account reason for the fall in Korea's share in international con- of those problems. Similarly, the fact that domestic sup- struction activity, from 11.2 percent in 1982 to 2.8 per- port for local service industries may create distortions cent in 1987. An important corollary, however, is that does not mean that all suppon should be eschewed, but although some countries lose competitiveness as their it does mean that assistance should be provided in a way wage costs rise, opportunities may open up for other that minimizes distortion. This section looks at some countries at earlier stages of development. The propor- policy implications, first in a national framework and tion of Korean nationals working on Korea's overseas theninthecontextofamultilateralliberalizationprocess. projects fell from 93 percent in 1979 to 47 percent in National policies of support for the service sector will 1986 as low-cost labor began to be drawn from Indone- be least likely to compromise the attainment of liberal- sia, Pakistan, the Philippines, and Thailand. ization goals if assistance is time bound, so that it does Therearealsoexogenouslimitstolabor-intensivecom- not discourage necessary innovation and flexibility, and petitiveness, as technological change alters the relative neutral as between production for the domestic market importance of labor and capital inputs or directly reduces and for export. Neutrality is likely to mean less emphasis the labor intensity of particular functions. The most on import restrictions, which foster domestic sales but pervasive influence is related to the use of Icc services, tax exports, and more on support for necessary service whether through the growing importance of electronic infrastructure, which yields comparable benefits for both information networks in tourism or the extensive auto- the domestic market and exportactivity. Paradoxically- mation of routine work inbanking and financial services. given the case for policy neutrality and nondiscrimina- Within the ICC sector itself, technological change may tion among broad industry groups-where specific 164 Developing Country Perspectives support for individual services is judged to be warranted, ization of export potential, for more efficient allocation it is likely to be more effective if it is applied selectively. of domestic resources, and for steady increases in the Westphal (1981) suggests that support for infant indus- stock of service sector skills and knowledge. If national tries is unlikely to succeed if it is applied to a large policies are outward oriented and if the international number of different activities within an economy. framework helps countries to address the adjustment Experience in the banking and financial services sector process, developing countries, whatever their circum- suggests two other national policy considerations that stances, can expect to find opportunities for net benefits may be relevant for particular countries. First, if overall in a multilateral, rules-based process of liberalization of welfare gains are to be realized, liberalization measures trade in services. may need to be accompanied by broad macroeconomic adjustment. Where there is financial distress, the relax- References ation of restrictions on foreign financial institutions with- out more general financial reform may enhance Barrera, Eduardo. 1988. 'Advanced Telecommunications between competition only marginally while exacerbating sol- Mexico and Texas: The Example of Maquiladora Programs." In competition only marginally ~~~~~Texas Departmnent of Commerce, Texas/Mexico Authority: Infra- vency problems in the financial system (Gelb 1988). structure Finance Summit. Dallas. Second, care may need to be taken in the sequencing of Cho, Yoon Je. 1988. "Some Policy Lessons from the Opening of the liberalization between sectors. Experience in Korean Insurance Market" World Bank EcononmicReview 2, no.2 finan- ~(May):239-54. Latin America suggests that if liberalization of the fman- Clements, Kenneth W., and Larry A. Sjaastad. 1984. How Protection cial sector is carried out before liberalization of the Taxes Exporters. Thames Essay 39. London: Trade Policy Re- current account, it may, through induced capital inflows, search Centre. encourage a rapid and destabilizing appreciation of the Desai, Ashok V. 1989. "The Politics oflndia's Trade Pocy." InHenry encourage ~~~~~~~~~~~~~R. Nau, ed., Domestic Trade Politics and the Uruguay Round. real exchange rate. New York: Columbia University Press. At the international level, as noted earlier, the success Findlay, Christopher, and Peter Forsyth. 1986. "Trade in AirTransport of a multilateral services framework in fostering the and Tourism Services." Paper prepared for the Sixteenth Pacific Trade and Developmnent Conference on Trade and Investment in liberalization opportunities open to developing countries Services in the Pacific Region, Wellington, New Zealand, Janu- will depend in part on its role in reducing baffiers to ary 1987. services in which developing countries have a particular Gelb, Alan. 1988. "Liberalizing Banking and Financial Services: Costs interest and in promoting those forms of trade that en- and Benefits for Developing Countries." Paper prepared for a seminar at the Centre for Applied Studies in Intemational Negoti- courage transfers of skills and technology. If the con- ations, Geneva, May 1988. Draft. cerns of developed and developing countries about Germidis, Dimitsi, and Charles-Albert MichaleL 1984. International adjustment strains are to be allayed, the negotiating Banks and Financial Markets in Devdoping Countries. Paris: OECD. framework will have to ensure, first, that liberalization Green, R.H. 1979. "Toward Planning Tourism in African Countries." is achieved gradually, allowing individual countries to In Emanuel de Kadt, ed., Tourism-Passport to Development? accommodate increased trade flows according to their Perspectives on the Social and Cultural Effects of Tourism in partculr crcumtanes,and, second, that a clear dis- Developing Countries New York: Oxford University Press. particular circumstances, and, second, that a clear dis- Okediji, Olubunmi. 1986. "Govemment Participation in the Nigerian tinction is drawn between liberalization and deregula- InsuranceMarket.' Joumal of World Trade Law 20,no. 5:540-53. tion. Most of the sector-specific adjustment concerns Park, Se-Hark, and Kenneth S. Chan. 1989. "A Cross-Country Input- discussed earlier relate to the need for a sound regulatory Output Analysis of Intersectoral Relationships between Manufac- tory ~turing and Services and their Employment Imnplications." World framework. Although deregulation and liberalization Development 17, no. 2:199-212. tend to go hand in hand in the sense that progress in one Rossi, Frank A. 1986. "Govemment Impediments and Professional creates strong pressures for movement in the other, they Constrints on the Operations of Interational Accounting Organi- are no the sme. Inividul counries, n seekng to zations." University of Chicago Legal Foruim 1986:135-67. are not the same. Individual countries, in seeking tO Sapir, Andr6, and Emst Lutz. 1981. Trade in Services: Economic remove their discriminatory restrictions on trade in ser- Determinants and Development-Related Issues. World Bank Staff vices, will not be required to abandon all of their market Working Paper 480. Washington, D.C. regulations. Indeed, in countries that have only a rudi- Stephenson.John C. 1984. "TechnologyTransfer by the BechtelOrga- nization." In Ronald K. Shelp and others, eds.. Service Industries mentary regulatory framework, the more dynamic envi- and Economic Development. New York: Praeger. ronment frequently associated with trade liberalization uNcrC 1982. "Transnational Corporations in the Shipping Industry: may require that particular regulations, especially those The Case of Bauxite/Alumina." E/C.10/1982/14. control, be . 1989. "The Role of Transnational Corporations in Services. relating tconsumerprotection orprudential control,beIncluding TransborderData Flows." E/C.10/1989/14. strengthened. Wasow, Bemard. 1984. "Technology Transfer in the Insurance Indus- Developing countries need not regard service sector try." In Ronald K. Shelp and others, eds., Service Industries and liberalization as a negative-sum game. Progressive lib- Econic DevelopmenL New York: Praeger. Westphal, Larny E. 1981. Empirical Justification for Infant Industry eralization will provide opportunites for the fuller real- Preection. World Bank Staff Working Paper 445. Washington, D.C. 165 17 Mexico Luis Rubio Edna Jaime Alberto Diaz Mexico has been experiencing great changes in trade Industry (sEcoFI) blocked the implementation of a mech- policy. Over the past dtree years virtually all of the anism devised by the central bank (Banco de Mexico) protectionist framework that characterized the country's that would have allowed exporters to import goods by international trade has been dismantled. In 1986 Mexico means of a "certificate of right to import for exports" became a member of the GATT, and two years later about (DiMEx-the Spanish acronym). SECOFI'S opposition to 90 percent of all its imports had been fully liberalized, modest liberalization meant that liberalization, when it with 20 percent the maximum tariff. In fact, trade liber- came in 1987, was thoroughgoing. The elements that had alization has gone well beyond any agreement with the fostered liberalization consolidated their positions in the GATr, essentially out of a conviction that trade is inher- administration that began its term in December 1988. ently good for the development of the economy. Al- The rationale for liberalization and deregulation is both though some sectors-notably motor vehicles, economic and political. The current economic team is microcomputers, and pharmaceuticals-remain to be convinced that freer trade will be beneficial for the liberalized, the Mexican government's thrust toward economyandforthe developmentofthecountryandthat modernization and integration into the world economy is a stronger economy will make for a politically stronger clear. Except in these industrial sectors, all quotas and nation. Thus freer trade is seen as a vehicle for both import-permit requirements have been eliminated. In economic recovery and political consolidation. addition, foreign investment has been deregulated and These changes in attitude have had a significant effect foreign investors are now on the same legal footing as on trade policy. A strong conviction that trade is inher- any domestic investor.I All-out trade liberalization in ently good for the country, along with greater homoge- goods and services, however, will require significant neity and cooperation within the administration, gives policy action in the area of domestic regulations. Further- policymakers more room to maneuver and enables them more, services of interest to Mexico will have to be tobe strong and effective advocates of Mexico's national included in any Uruguay Round agreement. interest (as distinguished from sectoral and special inter- Liberalization of trade policy has been made possible ests). This broader view does not mean that Mexico will by a change in the govemment's perception of the im- be easier to deal with in the new round of GATI negotia- portance of intemational trade and economic reform for tions. A coherent policy approach, strong convictions the development of the country. In the past the Mexican about liberalization, and a commitment to liberalization govemment was dominated by protectionists who fa- and deregulation-all aspects of Mexico's "visionary" vored discretionary decisionmaking processes in matters outlook-are likely to make the country one of the tough- of trade, investment, and economic policy in general. Not est players in the process. surprisingly, conflict rather than cooperation character- The new policy environment has important implica- ized relations among the ministries involved in trade tions for negotiations on services. First, the current lead- policy. Starting in 1985 the govemment began to incor- ership of SECOFI, the govemment office directly in porate free traders into its ranks at the highest levels. charge of trade negotiations, sees foreign trade as an Trade policy became a battleground as the protectionists instrument of development rather than as a hindrance to tried to stave off liberalization and domestic deregula- it. This means that the three industrial sectors still under tion. In 1985, for instance, the Ministry of Trade and protection will be gradually liberalized. Actual liberal- 166 Mexico ization in motor vehicles, pharmaceuticals, and micro- would alter the current structure of each. The main computers may be slower than in the rest of the economy emphasis is on the domestic impact of foreign competi- (which faced almost complete liberalization in less than tion-a decisive factor in the political process of liberal- eighteen months), both because of the complexity of ization-but barriers to access of Mexican services these sectors and, ironically, because the absence of abroad also receive attention. The section concludes with political pressures from other ministries means that lib- an assessment of the potential comparative advantages eralization of these sectors can proceed at a steadier and and disadvantages of each service area. more rational pace. The thrust will not change, but all the parties involved will have more time to adjust Negotia- Banking and Financial Services tions on services, by contrast, will involve technically oriented ministries, such as Communications and Trans- Mexico's financial sector is integrated mainly by two port, that do not see trade asan inherent source of wealth. types of financial intermediaries: banks and brokerage But the influence of the economic ministries may be the houses. There are nineteen commercial banks-national, decisive element in liberalizing services and carrying out multiregional, and strictly regional-and eight develop- a profound transformation of Mexico's economy. mentbanks. (here are also more than forty development Decisions on services, despite being politicized, are funds that allow commercial banks to discount credit for likely to be swifter than were those on liberalization of specific purposes with subsidized interest rates). Mexico goods-not because the ministries responsible for ser- has more than 30 brokerage houses and 150 investment vices are so willing to liberalize, but because of the partnerships (sociedades de inversi6n). The commercial overall process of economic transformation that the banks represent roughly 60 percent of the financial mar- country is undergoing. Liberalization of services will ket. For decades the nonbanking part of the financial involve govemment offices-for example, the Ministry industry suffered from regulations and market conditions of Communications and Transport and the Ministry of that strongly favored the development of the banks. The Ecology and Urban Development-that so far have not expropriation of the private banks in 1982 led to a had any experience with trade politics and have not had dramatic reshuffling of financial resources and savings and to deal with foreign competition (or, for that matter, any a consequentrapid growth of nonbanking financial entities. kind of competition). Furthermore, many offices within The financial sector is tightly regulated by the Ministry these ministries are traditionally suspicious of competi- of the Treasury, by the Banco de M6xico, by the National tion, regardless of its origin, and heavily inclined toward Banking and Insurance Commission,andby theNational discretionary decisiomnaking processes. What can be Securities Commission. Until recently, interest rates for expected is dynamic and complex behind-the-scenes deposits were set by the Banco de Mexico; commercial negotiations between trade negotiators and the technical banks had to maintain at the central banks high levels of ministries. reserve deposits, which were used to finance the govem- In the negotiations on the liberalization of services, ment deficit; and commercial banks had to lend up to 20 govemment positions will be closely tied to other key percent of their funds at concessionary interest rates for variables such as macroeconomic policy, liberalization such purposes as agriculture and low-income housing. of imports, and overall deregulation. Opposition by the Beginning in April 1989 all three features began to technical ministries will be significant and politically change. Interest rates are now being set by individual eroding. Concessions in the context of Uruguay Round banks; reserve requirements have been reduced to a negotiations will be possible only if sectors and issues of minimum and are now intended to guarantee the finan- interest to Mexico (such as labor-intensive services) are cial stability of the banking system rather than to finance included. But should such key issues become negotiable, the govemment; and concessionary funds have been Mexico is likely to be an active supporter of rapid liber- reduced to less than half their former size. alization of services, as of trade in goods. Domestic financial deregulation is being undertaken for two reasons. The first rationale is to increase the Sectors efficiency of the market and to improve dhe banks' ability to compete in a financial system that, with the growth of Services include various economic areas, of which some the brokerage houses as full-fledged intermediaries, has have many competitive players whereas others are char- become very competitive. The second rationale is more acterized by virtual or legal monopolies. Liberalization subde; its ultimate target has not yet been disclosed to of foreign competition would affect each sector differ- the public. For years, foreign banks and nonbanks have ently. What follows is a description of the main service been active participants in domestic financial markets. sectors and an assessment of how foreign competition Since they are functioning within a legal framework that 167 LuisRubio, Edna Jaime, andAlberto Diaz is to a large extent obsolete, more often than not they experience is thinner, and the capital base of the largest operate outside the boundaries of the law. Many of the and most competitive institutions is very small. Hence foreign banks for instance, are involved in de facto foreign competition would probably affect nonbanking intermediation; for a fee, they accept "loans" from com- intermediaries as a sector more than banks. panies and lending to other parties, often under the guise Two issues have to be resolved when considering lib- of an exchange of "matching funds" between a company eralization of the financial markets: the costs of liberal- with excess cash and one in need of money. Domestic izing and the costs of not liberalizing. A more deregulation is clearly meant to incorporate all financial competitive financial sector would reduce costs (by de- entities in the country into a modern legal and regulatory creasing financial margins and by developing tailor- framework. It might seem obvious that deregulation made products and services) and would make the rest of looks toward an eventual liberalization of the system the economy more competitive. Furthermore, an open with respect to foreign competition, but whether this will financial system would free resources to finance the actually happen remains to be seen. government deficit (if any) without crowding out the But even before the recent deregulation, market forces private sector and would give Mexican firms access to had long (since 1982) compelled the banks to become Mexicans' savings abroad (the "flight capital" that has more competitive. In 1988, for example, traditional accumulated in foreign banks). An open financial system sources of deposits (certificates of deposit, savings would presumably expand the pool of savings available bonds, and the like) fell dramatically: in September 1988 for lending and investing, including, as a matter of nontraditional sources of funds (securities of all sorts) course, Mexicans' savings abroad. Liberalizing the fi- represented 1 percent of total deposits in commercial nancial sector would entail losses for the shareholders of banks, but by February 1989 they had grown to 78.9 the (probably few) entities that would fail. It would not percent of all deposits (CAIM 1989). These changes reflect bring about unemployment, for the most obvious way for a continuing restructuring of the financial sector that foreign entities to compete in Mexico would be to hire began with the expropriation of the commercial banks in precisely those professionals with experience in the busi- 1982 and is being accelerated by the rapid deregulation ness. Moreover, it is not self-evident that foreign finan- of the industry that has been taking place since 1988. cial intermediaries legally competing in the domestic Banks have had to compete with other financial interme- market would be more efficient than efficient domestic diaries, both domestic and foreign, in an increasingly entities. At present that is the case, but it is largely sophisticated arena. The process of financial deregula- because the "rules of the game" (reserve requirements tion clearly responds to these circumstances. and preferential sectors) are ubiquitous for domestic Can the financial system be competitive if it is fully players but nonexistent for de facto competitors outside opened to foreign competition? The answer is not clear- the boundaries of the law. cut. Undoubtedly two or three large banks with national It is the costs of not liberalizing that should be carefully coverage that have invested heavily in technology and assessed. Foreign banks and nonbanks regularly operate communications and have begun to build intemational and compete in Mexico's financial markets. They have networks of offices and services could readily attain the an extreme advantage over domestic firms owing to the levels of efficiency and competitiveness needed for suc- laxity with which they interpret laws and regulations and cess in an open market. Most of theregional banks, which to their much lower costs. Their costs are lower because have clearly demarcated geographic locations and offer they do not have to comply with onerous reserve require- specialized services, could successfully compete on their ments or to maintain a network of offices throughout the own. The multiregional banks and some large national country-an enormous burden for domestic banks. For banks that have failed to invest in technology are likely the regulators, not liberalizing is the worst of all worlds, to collapse when confronted with foreign competition. A for they have virtually no control over foreign entities. strong case could be made that, as part of the process of Liberalization would allow greater rationality in the fi- liberalization and domestic deregulation, the govern- nancial system and would add competitiveness to the ment should consider privatizing these banks by selling economy as a whole, all at a relatively small cost. them to foreign banks or intermediaries. This could fa- cilitate deregulation and introduce a competitive finan- Insurance cial sector while reducing the losses of the existing players (as entities). As for the brokerage houses and The insurance market has traditionally been reserved for other nonbanking intermediaries, a few entities could Mexican companies, although reinsurance is almost en- withstand competition and others could not. In compar- tirely run by foreign firms. Large intemational insurance ison with the banking industry, available expertise and firms have representative offices in the domestic market, 168 Mexico but their role is limited to a small, albeit critical, sector. Construction and Engineering Altogether, there are forty-eight domestic insurance firms, of which two are government owned, two are in Construction represents about 5.5 percent of GDP, above reinsurance only, and two are mutual companies. Of the the average for the developing world (3-5 percent) and total, 56 percent offer the whole range of insurance below that for the industrial countries (5-9 percent). services and policies (life, accident, health, automobile, Consulting in engineering and construction represented professional risk, damage, buildings, civil responsibility, 0.24 percent of GDP in 1987. (In Brazil the share was and so on), 25 percent are concentrated in life only, and twice that, and in the United States it was four times the the rest are specialized in individual markets. Six firms, share in Mexico.) Construction involves 12,976 firms, including the two owned by the government, which the largest 5 of which represent more than 80 percent of insure all governmentproperty and employees, represent the markeL The largest firms compete successfully in the the bulk of the insurance business. The total size of the international markets-mainly in Latin America- insurance market is minuscule: in 1981 it represented against other international construction giants, particu- 0.91 percent of gross domestic product (GDP) and in larly in hydroelectric projects, pipelines, and water 1987, 1.04 percent. Life insurance accounted for 0.36 systems. But these firms' competitiveness is limited percent of GDP and damage insurance for 0.68 percent because construction and engineering firms in other (Malpica 1988). countries are subsidized by their own governments. Fur- The insurance business is regulated by the National thermore, there are many barriers to access: in the Banking and Insurance Commission and is governed by United States, for instance, foreign construction firms the Law of Insurance Institutions, the Law of Insurance must post a bail bond amounting to 125 percent of the Contracts, and several specific regulations. Al of these construction value-a cost no Mexican firm could af- hinder foreign individuals or firms from owning shares ford. of domestic insurance firms and prohibit Mexicans from Domestic regulations in this industry are similar to contracting policies with foreign insurance entities (a others, but with two important differences. First, given rule often ignored). the nature of the sector and the frequency of earthquakes As in the banking system, de facto foreign competition in Mexico, construction, particularly as regards struc- exists in Mexico. This is because a significant number of tures, is heavily regulated, but these safety regulations Mexicans own personal insurance policies (mainly life are not designed to restrict foreign firms. Second, the and health) contracted with foreign insurance firms. Un- government is the largest contractor in the country, and like banks, insurance companies need no physical pres- the power inherent in government procurement consti- ence, except in reinsurance, and they do not have tutes a barrier to access by foreign firms. significant risk assets in the country aside from their own With the minor exceptions of some construction and portfolio investments. As in banking, foreign companies engineering consultants that do not directly compete do not have to abide by the regulations that apply to with Mexican firms, foreign construction and engineer- domestic firms. This makes liberalization (with deregu- ing companies do not operate in Mexico. This sector lation) an attractive proposition in that it would put all could remain strongly competitive and could become insurance companies on an equal footing. But foreign oneofMexico'swinners,largelybecauseofitsrelatively competition would most likely signal the demise of the strong presence in export markets. Consulting firms in domestic insurance sector. The small size of the domestic this sector would be complementary rather than compet- firms and of their market-and therefore of their capital itive. base and reserves-makes them sitting ducks for foreign competitors, unless newcomers are forced to operate Maritime Transport within the restrictive and competition-restrained regula- tory framework. In that case, foreign companies would According to recent statistics, Mexico's maritime fleet be able to share in the market, thus affecting local firms' ranks fortieth in the world in size, well below the fleets profitability, but they would add no benefits to the econ- of Brazil and Argentina (UNcTAD/PNUD/SECOFI 1988, p. omy at large. Such a scheme would add no competition 4). Mexican-flag vessels transport only 21 percent of all but would maintain the monopoly position of those maritime cargo, 4 percent of ocean trading, 60 percent of firms, both national and foreign, that decided to partici- coastal trade, and less than 3 percent of exports. pate in the market, whereas liberalization-within new The Mexican fleet consists of ferries, tankers (mostly and appropriate regulations-would probably lead to the owned by PEMEX, the country's oil monopoly), cargo death of most local insurance companies except for those ships, and a container transport firm. Altogether there are that merged with or were acquired by foreign companies. about ninety-nine ships of more than 1,000 metric tons 169 LuisRubio, Edna Jaime, and Alberto Diaz capacity (UNcTAD/PNUD/SECOFI 1988, p. 6). In each case, commercial airlines moved 13.5 million people among regulations have created a monopoly that excludes com- 70 cities; 68 percent of their passenger traffic was within petition, both domestic and foreign, and raises transport Mexico. Total cargo volume in 1987 was 73,369 metric costs. Government rules and regulations have also cen- tons inside Mexico and 79,612 to or from the country; 46 tralized and made discretionary the issuing of permits percent of the latter was handled by Mexican carriers and concessions for loading and unloading ships-a (Nacional Financiera 1988, p. 233). situation that has made maritime transport an extremely The laws, rules, and regulations governing this industry expensive and unreliable mode of shipment. One evi- are established by the Ministry of Communications and dence of unreliability is that of the country's 133 ports, Transport. All air service, be itpassengerorcommercial, only 27 are physically in condition to function as ports requires a concession, a permit, or both. Concessions for and only 14 of these are actually used for cargo loading regular commercial service are usually given for a max- or unloading. Because of the lack of modem equipment imum period of thirty years, which can be extended for in Mexican ports, virtually all container cargo is shipped ten years at a time. Concessions for nonregular services overland into Mexico from U.S. ports. (taxi and private jet) are granted for one year at a time. Coastal shipping is reserved to Mexican liners, and Mexico has signed with several countries reciprocal ocean trading is tightly regulated by the Ministry of agreements and treaties that guarantee the "third, fourth, Communications and Transport. The rationale for these and fifth freedoms"-transport of passengers, cargo, and regulations is to combat unfair practices when competing mail. More than twenty-five foreign airlines offer regular with ships of other countries and to seek maritime self- service to and from Mexico, mostly as a consequence of sufficiency. As a result of this policy, about 10 percent such agreements. In addition, Mexico has granted eight of all nonfactor expenditures in the balance of payments, unilateral concessions. or about $500 million, is accounted for by maritime Aside from the obvious benefits that liberalization of transport costs.3 air transport would entail for overall efficiency and com- The reality of the industry being so different from the petitiveness in the industry, the only other advantage to pretensions implicit in the regulations, it is obvious that be expected from liberalization would be the "eighth foreign competition wouldharm onlyafew largemonop- freedom"-the right of a foreign airline to provide ser- olies and would greatly benefit the economy at large. The vice between two or more domestic cities. There are two potential benefits of liberalization for users of the service things to consider here. First, given the share of foreign and for consumers would be enormous and quick to passenger trips that are handled by foreign companies, it appear. Most ocean trade is already handled by foreign is highly unlikely that the domestic market would be ships, and it appears that the only relevant Mexican dramatically changed. At present about 40 percent of company in this business would be able to remain com- international passenger traffic is handled by domestic petitive. Thus, most of the costs of liberalization would carriers; under liberalization probably not more than 40 be borne by the companies involved in coastal shipment. percent of all domestic passenger service would end up For liberalization of maritime transport to succeed, how- being handled by foreign operators,4 although the latter ever, domestic land transport would also have to be would probably gain some additional foreign traffic. deregulated. At present, regulations concerning the do- Increased competition and reliability of service might mestic handling of foreign containers, customs, land well translate into more demand for service, which might transport services, schedules, and tariff decisions are so entail a net growth in the potential share of foreign narrow and so biased toward monopolies that even the companies in the market and a decrease in domestic most efficient maritime transport system could not undo airlines' share. The influence of Mexico's geography the extreme costs implicit in the domestic transport sys- should be kept in mind: liberalization would probably tem. At writing, the land transport system was undergo- bring with it enormous competition in the northem re- ing radical deregulation, but the change will not be gion of the country and in a few highly profitable corri- complete until the existing law is modified. dors while leaving the rest of the nation unaffected. In fact, many U.S. regional carriers already offer service Air Transport between several northem Mexican and southem Ameri- can cities. Of the 286 domestic air transport companies, 2 have The other consideration is also related to Mexico's national coverage and an extensive foreign network, 9 geography. Although the impact of liberalization in most provide regional services, and the rest offer air taxi services may well be the same in Mexico as elsewhere, services. Altogether there are 5,162 aircraft, of which transport is clearly a different issue. If the Mexican 728 are used as commercial liners. In 1987 the two large govemment is committed to liberalization in services, 170 Mexico transport-particularly land and air-presents a di- Consulting is similar to marketing. There are more than lemma: how tobalance the interests of the consumer and 1,500 consulting firms in the country, but the largest 15 the service providers in an industry in which the provid- represent about 80 percent of the market, Of these, vir- ers are unlikely ever to be capable of competing on any tually all have direct links with the world's largest con- grounds other than their ability and efficiency. But the sulting firms. In fact, most of the largest international situation is more complex than it appears at first sight, consulting finns are represented through wholly owned for even if transport services were fully liberalized, some subsidiaries. Barriers to access are small and relatively areas would benefit greatly and others could even be unimportant. Still, many Mexican finms have been able worse off, creating politically untenable regional differ- to develop their own market niches, many compete fre- ences. The other side of this equation is that an efficient quently and successfully with large concerns for consult- transport system would liberate forces and resources in ing services awarded by entities such as the World Bank, unheard-of ways, fostering economic growth and ex- and others have developed particular areas of expertise ports. Hence the only long-term solution to this dilemma that have allowed them to win contracts over their for- is to liberalize all transport services while fostering eign competitors in third countries, including the United niches for existing transport companies so that all regions States. of the country are properly covered. Thus, in both consulting and marketing, liberaliza- tion-which in this case simply implies the elimination Professional Services of petty restrictions to access-would represent addi- tional opportunities for development rather than bank- Two types of Mexican professional services-marketing ruptcy. In fact, consulting and marketing may prove to and consulting-are very competitive worldwide. The be two sectors in which liberalization could bring net marketing sector has a large number of fnrms, but the benefits as a result of exports. Since these are, to a large fifteen largest cover about 80 percent of the market. extent, "people businesses," and since most, if not all, Eleven of the fifteen largest firms are representatives of employees of consulting and marketing firms in Mexico or partners with large international marketing compa- are Mexican nationals, the potential for future competi- nies, and four of the five largest firms are branches of tiveness in these sectors is virtually unlimited. These two such concerns. Yet the largest marketing firm is wholly areas also show that foreign competition, even if some- Mexican owned. Competition among these firms is in- what restricted through laws such as that on foreign tense; in fact, the large Mexican firms have begun to investment, does not necessarily hinder domestic com- export their expertise and have started a network of petition and, furthermore, can strengthen domestic firms representative offices in other countries, primarily the over time. United States. Most of the services related to marketing (such as audio and video, design,photography, drawings, Information and Communications and recording facilities) are available in Mexico at com- petitive prices and qualities. The broad field of information and communications is For all practical purposes, the marketing subsector has characterized by a variety of firms, regulations, laws, and been open to competition for decades; although the laws practices. Firms range in size from small software man- on foreign investmentrestrict access to foreign concerns, ufacturers to the telephone company, which had assets most, if not all, world marketing giants are already in worth about $5 billion in 1987. Each segment of this Mexico through partnerships or representative offices. sector faces different types of competition, and the abil- Hence, liberalization would not affect this area of busi- ity to compete also varies widely. Some sectors are ness significantly. Since cultural differences make it already experiencing direct competition whereas others necessary for foreign marketing firms to maintain struc- have never been subjected to it. In some cases, actual tures similar to those currently existing, liberalization practice has altered the thrust of regulations, making the may strengthen the bargaining power of foreign partners sector quite competitive. Value added services require but is unlikely to alter the overall nature of the business. permits or concession from the Ministry of Communica- But related services could experience tough competition tions and Transport, but these are usually granted without from their counterparts abroad. These services use high any distinction between nationals and foreigners. technology and require multimillion-dollar investments In general, those services in this sector that are govern- to become competitive worldwide. Although some Mex- ment-owned or -operated monopolies have tended to be ican suppliers could afford such investments, most could of relatively poor quality and incapable of competing at not, and it is this subsector that will suffer most. present. In some instances these deficiencies have been 171 LuisRubio, Edna Jaime, and Alberto Dtaz partially overcome. The postal service, for example, is a existing network, and how to charge competing compa- government monopoly, but foreign courier services have nies for the use of the network in a way that impedes grown dramatically over the past decade; most or all of Telefonos de M6xico from charging monopoly prices. these are either fully owned subsidiaries of foreign firms Implicit in the debate is the definition of "basic services" or partnerships with Mexicans. Although these courier or, more specifically, whether long distance would be services have affected the postal system's market, they subject to competition. The latter is not an irrelevant have also added a new dimension to the sector. At first, issue, for at present 84 percent of Teldfonos de Mdxico's most courier services handled international service be- earnings comes from long distance services.5 Whether tween Mexico and therestof the world, butoverthe years and how the telephone company is privatized are two the same type of service has become available for the critical competitive issues, for a private monopoly may domestic market The couriers, in fact, provide an alter- be less politicized than a government-owned monopoly native to an inefficient and antiquated postal service. but no less predatory. Similarly, Teldfonos de M6xico, a monopoly owned In the area of informatics, there are two, largely unde- mainly by the government, has been incapable of offer- veloped, subsectors in which Mexico could easily find a ing the kind of service an open economy requires and will comparative advantage. One is software development. It increasingly demand. Many substitutes for its service is estimated that between 1984 and 1988 software sales have been created (such as microwave communications increased at an average annual rate of 26 percent, systems and private satellite links), but these are all whereas hardware sales grew 17 percent a year. Pur- private, although they require government concessions chases of computer software in Mexico were estimated or permits. at approximately $135 million in 1987 (Verut 1988). There are two broad areas in which competition, both This is the fastest-growing market segment of the com- national and foreign, could have a significant impact on puter industry. Although imports have traditionally dom- communications. First, there are several specific mar- inated the software market-they represent 72 percent of kets-cellular communications, visual communications, total consumption, with the United States accounting for and so on-that are not formally within the scope of the a90 percent share of imports-several Mexican firms are government monopoly. These markets are all open to developing competence in software designed in Spanish private investment, and since technology is the corner- for the Mexican and U.S. markets. (Both markets repre- stone of the business, foreign investors will be the obvi- sent $42 million and could be expanded rapidly by add- ous suppliers and investors, whether in partnership or ing other Spanish-speaking countries.) But in spite of through wholly owned subsidiaries. Liberalization of some powerful examples of successes in exports of soft- services will not change this process; as in other areas, it ware, this field is largely unexplored. Liberalization will may strengthen thebargaining powerof foreign investors do little to change the current domestic picture, since with respect to their Mexican counterparts (and potential legal and illegal importation of software has forced all partners) but will not alter the structure of the market one domestic suppliers to be competitive. iota. In comparison with other services such as consult- The other area in which Mexico could easily have a ing and marketing, however, Mexican partners would be comparative advantage is in data processing, a field in at a severe disadvantage. In sectors in which human which both its costs and its local ingenuity could allow capital is the key to the business, such as consulting, it to compete successfully in the world market. This marketing, and even banking, Mexican partners would subsector, however, has not been developed at all. maintain their ability to negotiate regardless of laws and regulations restricting access to foreign investors, but in ComparativeAdvantages andDisadvantagesin Services sectors in which the key is technology and capital, po- tential Mexican partners would lose their monopoly The only obvious competitive advantage that Mexico power once the law grants equality to national and for- currently enjoys is in the price and skills of its labor force, eign investors. which constitutes the single most important source of The other area in which competition would have a competitiveness in the country's exports today. Al- significant impact on communications is at the core of though there are many other service sectors in which the the business. At present, the telephone company main- Mexican economy might develop comparative advan- tains a monopoly in the basic telephone services, as it tages and compete successfully in the international mar- does in local services in the rest of the world. Current ket, as of today, Mexico has a proven comparative debate centers on two critical issues: how and where to advantage only in labor-intensive services. The prospect liberalize the service while making the best use of the of not obtaining liberalization in this "sector" would 172 Mexico create a politically difficult environment for liberalizing out key changes, and the changes affect areas that have other services, even if liberalization is (and is perceived traditionally given those ministries their sources of dis- to be) in Mexico's best economic interest. cretionary power. One scenario of the outcome of this Mexico appears to have potential comparative advan- process would be that regulations are unequaUy modern- tages in sectors such as marketing, consulting, informa- ized and that many cntical issues remain unresolved, tion processing, software, financial services (in some reducing the economy's overall potential for competi- respects), and construction-provided that barriers to tiveness or, more appropriately, keeping the economy entry are eliminated. (There, are no specific export barri- from being as competitive as it might otherwise be. The ers in services.) The monetary importance of these sec- foremost issue of the Mexican economy in the next two tors today is rather small, but the potential-in the or three years will be precisely the scope and depth of context of liberalization-is enormous. Two unlikely changes in present regulations. Privatizing government industries-airand maritime transport-couldfmdcom- concerns will be crucial to deregulation, for without petitive niches. Given Mexico's geography and the rela- deregulation, greater competitiveness of the economy as tively small U.S. maritime fleet, it is not inconceivable a whole cannot be attained. that Mexican firms could develop competitive regional The second consideration has to do with the definition businesses. The same may be true for some regions and of services. At present, the Uruguay Round agenda re- corridors in the air transport business along the Mexico- flects-although it is not limited to-the interests of U.S. border, where small Mexican airlines could develop those countries that have an obvious comparative advan- their own market niches. tage in services, and the list of services currently under discussion reflects their priorities. From the perspective Conclusions of countries that could experience losses in service sec- tors as a result of liberalization, the question has to be, There are three critical considerations in assessing the what kind of tradeoff might make this prospect politi- likelihood of liberalization in Mexico and its potential cally bearable? For Mexico, the main issue is the inclu- benefits and costs. The first is the domestic policy and sion of labor-intensive services as a full-fledged service. regulatory framework and how it may affect and be From its point of view, labor is as much a service as any affected by liberalization. The second concerns the price other. Undoubtedly, the issues involved differ from those that Mexico will demand as the bare minimum from its in other sectors. But, ultimately, each sector has peculiar- GATT partners in exchange for liberalization. The third is ities that raise sensitivities in various countries. In the how the potential perceived benefits might impinge on case of Mexico's labor-intensive services, the United the process of decisionmaking about liberalization of States would have to radically alter its immigration laws services. and liberalize flows of people-a prospect that poses Probably the most important issue for both the long- political difficulties. But liberalization creates political term development of Mexico and for liberalization of problems for Mexico and for every country in the nego- services is the existing regulatory framework. Current tiations. Why should it be easier for Mexico to modify regulations tend to restrict competition in most sectors long-standing laws in sensitive areas such as communi- and to generate monopoly situations, the costs of which cations, foreign investment, intellectual property rights, are paid by domestic users of the services in the form of and so on? The argument for liberalization has nothing high prices and low quality. Liberalization, unless ac- to do with other countries' actions; Mexico will benefit companied by the dismanding of those barriers to access from freer trade. But for political reasons, negotiators and of the discretionary and antiquated regulations should attempt to maximize the benefits for Mexico's would only slightly alter the present general picture. exporters, including exporters of labor-intensive ser- Competitiveness would be somewhat improved by liber- vices. Liberalization of one's own market carries its own alization of services, but without deregulation (or, more benefits, but liberalization of both one's own market and exactly, without a thorough overhaul of existing regula- one's export markets is the best of all worlds. tions) liberalization would fail to realize its two most The third consideration has to do with the rationale for important potential benefits: adding competitiveness to liberalizing services. With a few exceptions, Mexico's the rest of the economy and forcing Mexican suppliers service suppliers will suffer heavy losses from liberaliza- of services to become competitive. Although a modern- tion. Unlike the case of trade in goods, however, the ization of the entire regulatory framework affecting the losses will fall solely on shareholders; workers and em- economy is currently in process, its success depends on ployees will have to adjust but will not be out of jobs, ministries other than the one that is attempting to carry and consumers-individual and industrial-will be net 173 Luis Rubio, Edna Jaime, and Alberto Dfaz beneficiaries, both as direct recipients of services and That is the rationale that has prevailed in the case of through the indirect efficiencies and cost reductions that goods. There is no reason why it should be different for liberalization of services might bring with it. services. In fact, the rationale for liberalizing services ought to dwell on the benefits to the rest of the economy rather Notes than on the possibility of generating extraordinary results in some areas of services in exchange for losses in others. 1. The new foreign investment regulations liberalize investment in An analysis of the foremost service sectors in the Mexi- both goods and services.IThere are, however, specific sector regulations in aU services, and somne of these limit or hinder foreign participation. can economy demonstrates that there is substantial po- 2. The only existing statistic, which probably understates the tential for benefits in some subsectors, while the losses market, indicates that foreign banks handle about $1.5 bilion in peso- in others are likely to be punitive. Yet the benefits for the denominated assets and about 10 percent of the money market. In addition, foreign banks handle Mexicans' capital abroad, which may economy as a whole in terms of, for example, an efficient amount to $40 billion. Everything together would be 50 percent of the transport system or a modem communications network Mexican financial system (Penialoza Webb 1989). cannot be ignored. Some limited losses in a few service 3. UNCrAD/PNUD/sEaOFs (1988), p. 1 1. Total transport costs, includ- sectors could translate into significant gains for the econ- ing land transport and port services, were SDR 853 milion in 1987, of which SDR415 million was in shipment Soane undisclosed, but proba- omy and for society at large. Furthermore, exports of bly small pan of the remaining SDR 438 million was in port services goods may become more competitive as a result of (DMF balance of payment statistics, 1988, p. 450). increased efficiencies or lower costs in key services. 4. This does not hold true for cargo traffic, where foreign compa- nies, particularly ovemight carriers, are increasing their share of han- As in any other process of liberalization, some sectors ding service. would gain while others would decline. Such specializa- 5. El Financiero, March 8, 1989. tion is naturally to be expected from a process of liberal- ization and deregulation. But the analysis suggests that a References few sectors could not only survive but could become extraordinarily successful. Others would gradually de- cAIB. 1989. "La modemizacion del Sistema Bancario." CAJE 7, no. I cline until they virtually disappeared. Attempting to help (March):8. Malpica, L. 1988. "El sector servicios en el GATr: efectos en la all sectors to survive would be self-defeating, for that actividad aseguradora." Corercio Exterior 38, no. 11 (Novem- would be not only extraordinarily costly but also unsus- ber):1005. tainable. The rationale for liberalizing should be pre- Nacional Financiera. 1988. La Economra Mexicana en Cifras. 1Oth ed. Mexico City. cisely to promote specialization so that comparative Pefialoza Webb, T. 1989. "La banca mexicana: situaci6n actual y advantages, whether in services or elsewhere, become perspectivas frente a la apertura de los servicios financeros." obvious and are exploited. More efficient and less costly Comnercio Exterior 39, no. 6 (June):512-34. production of goods as a result of liberalization of ser- uNcrAD/NuD/sEcoFL "Resumen transporte maitimo." Estudio nacio- nal sobre el sector servicios en Mexico. Mexico City. Processed. vices would in itself be a significant benefit. Verut, Caroline. 1988. The Mexican Marketfor Computers, Peripher- Liberalization of services should be seen as an instru- als and Software 1989. Washington, D.C.: United States Trade ment of policy aimed at a stronger economy as a whole. Center, U.S. Department of Commerce. 174 18 East Asian Countries Chung H. Lee This chapter discusses pattemns of trade in services for six sified into manufacturing, and the service sector has developing countries of Asia-Indonesia, the Republic consequently contracted. of Korea, Malaysia, the Philippines, Singapore, and Table 18-2 presents data on trade in nonfactor services Thailand. It reviews these countries' policies on trade in (passenger services, travel, other transport and private services and the main features of their regulatory frame- goods, services and income). In all of the countries under work in three specific service industries-telecommuni- study, exports of services grew rapidly; the average cations, banking, and ocean shipping. The chapter annual growth rate, ranged from 29.7 percent for Indone- concludes with policy recommendations and an analysis of sia to 10.4 percent for Singapore. Imports of services also the possible consequences of the recommended options. expanded during this period, at average annual growth Trade in services is here defined broadly to include rates varying firom 18.4 percent for Korea to 3.3 percent transactions that result from foreign direct investment in for the Philippines. The high growth rates of imports services and from temporary international movements of occurred during a period when these countries main- labor, as well as cross-border transactions in services that tained relatively restrictive policies on imports of ser- parallel trade in goods. Hence, trade in services includes vices. Imports might thus have increased more rapidly international transactions, whether carried out across a under a more liberal trade regime for services. border or by foreign affiliates, in accounting, advertising, It is possible that the quality of data on services simply banking, building, construction, engineering, franchis- improved in the 1980s as trade in services began to attract ing, hotels and motels, insurance, leasing, legal services, more attention and that trade in services therefore ap- motion pictures, telecommunications, data processing, peared to have grown faster than it actually did. To test and information services, tourism, and transport. Also this hypothesis, the average annual growth rate of trade included are remittances by workers employed abroad. in nonfactor services was calculated for two subperiods, 1977-80 and 1981-86. According to table 18-2, trade in Services: The International Dimension services grew faster during the first subperiod, except in Indonesia. The high growth rates for the whole period Table 18-1 illustrates the importance of the service sec- can thus not be attributed to inproved collection of data tor in the developing Asian countries. In 1960 the share on trade in services in the 1980s. of services in GDP ranged from 33 percent for Indonesia It has been argued that the industrial countries will gain to 79 percent for Singapore. Except in Indonesia, ser- comparative advantage in the services sector as they vices constituted the most important sector in these coun- become transformed into postindustrial economies tries. Between 1960 and 1986 the share of services in GDP (Shelp 1981). If this is true, industrial countries should increased for Indonesia, Korea, and Thailand but de- have a surplus on the services account in the balance of creased for Malaysia, the Philippines, and Singapore. payments, and the developing countries should have a The decrease for Singapore may seem puzzling, since the defiCit. The available evidence does not, however, sup- country had a rapid rate of economic growth during this port such an argument. Among the developing Asian period and the service sector normally expands in rela- countries, only Indonesia and Malaysia run a deficit in tion to other sectors as the economy grows. The answer services; the rest, especially Singapore, do not. During may be found in the unique history of Singapore as an 1976-6 Singapore had a significant surpluis in its ser- entrep6t city. With development, the economy has diver- vices account, reflecting its status as a service-oriented 175 Chung H. Lee Table 18-1. The Structure of GDP in Six Developing Countries of Asia (percentage of GDP in current prices) 1960 1970 Other Other Agriculture Manufacturing Industriesa Services Agriculture Manfacturing Industries' Services Indonesia 51 9 6 33 45 10 9 36 Korea, Ree. of 37 14 6 43 26 21 8 45 Malaysia 33 8 10 49 29 12 13 46 Philippines 26 20 8 46 28 23 7 43 Singapore 4 12 6 79 2 20 10 67 Thailand 40 13 6 41 28 16 9 46 a. Includes mining, utilities, and construction. b. Constant prices. Sources: Asian Development Bank (1988); World Bank (1987, 1988); and World Bank data tapes 1988. Table 18-2. Trade in Nonfactor Services, 1976-86 Average annual growth, Country 1976 1977 1978 1979 1980 Indonesia Credit 96 98 186 244 251 31.5 Debit 1,414 1,538 1,839 2,172 2,588 16.4 Net -1,318 -1,440 -1,653 -1,928 -2,337 Korea, Rep. of Credit 1,138 2,162 2,989 3,063 3,375 35.2 Debit 978 1,666 2,473 2,616 3,002 34.8 Net 160 496 516 447 373 Malaysia CTedit 335 413 497 609 876 27.5 Debit 707 879 1,061 1,604 2,255 34.2 Net -372 -466 -564 -995 -1,379 Philippines Credit 467 464 648 684 933 20.2 Debit 579 667 703 827 998 14.7 Net -112 -203 -55 -143 -65 Singapore Credit 2,391 2,615 2,890 3,401 4,612 18.3 Debit 907 1,086 1,230 1,577 2,221 25.5 Net 1,484 1,529 1,660 1,824 2,391 Thailand Credit 352 408 600 735 1,051 32.1 Debit 618 691 765 1,007 1,212 18.6 Net -266 -283 -165 -272 -161 n.a. Not available. -Not applicable. Note: Nonfactor services include shipping, passenger services, other transpon, traveL and other private goods, services, and income. a. 1977-85. Source: Im balance of payments statistics, data tapes, 1988. 176 East Asian Countries 1980 1986 Other Other Agriculture Manufacturing Industries a Services Agriculture Manufacturing Industries a Services 24 13 29 34 26 14 18 42 15 30 11 44 12 30 12 45 22 21 17 40 21 17 20 42 23 24 13 40 26 25 7 42 1 30 9 60 1 27 11 62 25 20 9 46 17 21 9 53 Average annual grcwth, 1981 1982 1983 1984 1985 1986 1981-86 382 458 511 557 829 n.a. 283 a 4,134 4,282 3,956 4,010 5,157 n.a. 17.1 a -3,752 -3,824 -3,445 -3,453 4,328 n.a. - 4,568 5,630 5,567 5,772 4,964 5,174 8.6 3,556 3,603 3,749 3,983 3,905 3,777 4.1 1,012 2,027 1,818 1,789 1,059 1,397 - 1,119 1,433 1,744 1,890 1,922 1,708 12.7 2,401 2,955 3,728 4,215 3,877 3,135 6.9 -1,282 -1,522 -1,984 -2,325 -1,955 -1,427 - 1,297 1,379 1,417 1,359 1,843 1,820 13.1 1,275 1,535 1,450 1,073 775 664 -4.2 22 -156 -33 286 1,068 1,156 - 7,221 8,700 8,605 7,290 6,185 5,296 5.2 2,737 3,244 3,504 3,888 3,738 3,363 7.8 4,484 5,456 5,101 3,402 2,447 1,933 - 1,278 1,461 1,623 1,811 1,869 1,857 10.2 1,451 1,406 1,688 1,763 1,674 1,463 3.9 -173 55 -65 48 195 394 - entrep6t economy. The Philippines' surplus is probably second half of the 1970s and the early 1980s (Kim 1988; largely attributable to its exports of construction services Lee 1985). Although many traded services tend to be to the Middle East, and such exports accounted for a intensive in the use of technology and capital, giving the significant portion of Korea's services exports in the industrial countries a comparative advantage in these 177 Chung H. Lee services (Sapir 1985), there are other services in which sidiaries of foreign multinational service enterprises the developing Asian countries have a comparative ad- (MSEs) and whether some of their own firms will be able vantage, as the experience of Korea and the Philippines to become successful MSES. illustrates. It is thus unwarranted to presume that liberal- Because a country's comparative advantage and the ization of trade in services will lead to a global restruc- competitiveness of its firms are not the same, these are turing of economies in which the industrial countries issues that are different from the question of comparative rapidly become postindustrial service economies while advantage. As Lipsey and Kravis (1985) point out, firms the developing countries are becoming industrialized. in certain industries may be highly competitive in foreign As an indicator of the importance of trade in services countries even though their home country, given its in the overall balance of payments of a country, the ratio internationally immobile factors of production, does not of nonfactor services traded to merchandise traded was have a comparative advantage in these industries. Thus calculated for both exports and imports for 1976-80 and it is quite possible that although some of the developing 1981-86 (table 18-3). During the first period the annual Asian countries have a comparative advantage in certain average ratio of services exports to merchandise exports service industries, fms in those industries may not ran from 2 percent for Indonesia to 37 percent for Singa- possess the competitive edge to become MSES or may not pore, whereas the annual average ratio for imports ranged even be able to compete with foreign subsidiaries in their from 13 percent for Singapore to 26 percent for Indone- own country. Liberalizing trade in services could there- sia. The figures for the second period do not vary much fore lead to an expansion of MSEs based in industrial from those for the first period except for the Philippines, countries without a similar expansion by service firms in where the export ratio increased from 20 to 33 percent. the developing countries, although the latter countries For Indonesia services exports were insignificant in may increase their exports of services. The success of comparison with merchandise exports, whereas for Korea's construction firms in exporting construction ser- Korea, the Philippines, Singapore, and Thailand they vices indicates, however, that MSEs from developing were significant, accounting for a large portion of these countries can compete successfully with those from in- countries' foreign exchange earnings. Furthermore, dustrial countries. since in Korea and Singapore merchandise exports ex- The importance of foreign MSES in the developing panded rapidly during these periods, the parallel expan- economies of Asia is demonstrated by the share of direct sion in their services exports indicates that merchandise and foreign investment in services. During 1982-86, 44.5 services exports need not be substitutes for each other. percent of foreign investment in Korea, or $785.4 mil- It is tempting to infer from table 18-3 that Singapore lion, was in services. The corresponding figures for has a comparative advantage in services, whereas Indo- Taiwan were 21.3 percent ($600 million), and those for nesia and Malaysia do not. Since trade in services has Thailand were 31.6 percent ($434 million). Indonesia is been generally restricted in these countries, such figures an exception, with only 8.8 percent ($619.6 million) of cannot be relied on to reveal comparative advantage. But foreign investment in services. they do indicate that some industrial countries have a In recent years, Korea, Taiwan, and some other devel- comparative advantage in certain services such as bank- oping Asian economies havebegun making directinvest- ing, insurance, and telecommunications, whereas some ments in other parts of Asia. As of 1986 Korea had developing countries have a comparative advantage in invested $92.6 million in Indonesia, Malaysia, the Phil- construction services, ocean shipping, and domestic ser- ippines, Singapore, and Thailand, and as of 1987 Taiwan vices.I This implies that if trade in services is liberalized, had invested $86 million in these countries. This invest- exports of services will increase for both developing and ment is now mostly in labor-intensive manufacturing industrial countries. industries, in which Korea and Taiwan are losing com- Since services are in general intangible and require the parative advantage owing to rising wage rates and cur- movement of providers or demanders for the exchange rency appreciation. It is likely, however, that direct to take place, sales of services by foreign subsidiaries of foreign investment in services, especially financial ser- multinational enterprises may be expected to be far more vices, will soon follow as the demand for such services important than cross-border trade in services (Lee and by manufacturing subsidiaries in other countries in- Naya 1988). For instance, the revenues generated by creases. foreign subsidiaries of U.S. service firms are approxi- Recently it has been argued that the returns on foreign mately 120 percent of their direct exports (OTA 1986). direct investment, whether in manufacturing or in ser- Thus, what is of concern to the governments of the vices, should be included in trade in services, as they are developing Asian countries is whether firms in their the payments for services provided by multinational service industries will be able to compete with the sub- enterprises to their subsidiaries (Rugman 1987). Al- 178 East Asian Countries Table 18-3. Ratio of Nonfactor Services Traded to Merchandise Traded Country 1976-80 1981-86 Indonesia Export 0.02 0.03 a Import 0.26 0.29a Korea, Rep. of Export 0.25 0.24 Import 0.18 0.16 Malaysia Export 0.08 0.13 Import 0.24 0.30 Philippines Export 0.20 0.33 Import 0.18 0.18 Singapore Export 0.37 0.38 Import 0.13 0.15 Thailand Export 0.17 0.25 Import 0.20 0.20 a. 1981-85. Source: B1P balance of paymnents statistics, data tapes, 1988. though there is a dispute as to the share of the returns that 1985) provide a useful guideline for identifying such can be attributed to services provided by multinational barriers. enterprises (Ramstetuer and Lee 1989), it is now widely recognized that provision of services within multina- 1. National treatment. "Foreign services and their tional enterprises is critical to the continued existence of suppliers should be treated on the same basis as do- the enterprises (see, for example, Rugman 1980). If it is mestic firms supplying these services." In other accepted that some of the returns on foreign direct invest- words, laws and regulations should be applied with- ment should be regarded as trade in services, liberalizing out discrimination to domestic and foreign firms. trade in services would mean liberalizing foreign direct 2. Least restrictive regulations. If regulation of an investment not only in services but also in manufacturing industry is justified, it should be done in the least and natural resources; that is, it would mean liberalizing restrictive manner possible. all direct foreign investment. 3. Nondiscrimination. This is the most-favored-na- tion principle extended to services. Government Policies toward Services 4. Right to sell. This principle would prohibit the practice of denying market access to foreign service As is true in most countries, service industries in the firms, provided that access does not conflict with developing Asian countries are regulated to an extent "sovereign goals and interests." unmatched in other industries. Some regulations are 5. Transparency. "Regulations that hamper or explicitly protectionist in intent; others are not, although distort trade in services should be transparent, i.e., they may function as barriers to trade in services. As open and unambiguous." Alexander and Tan (1984) pointed out in their study of barriers to U.S. service trade in Japan, a regulation does It is clear from the above list and from the barriers found not have to be overtly protectionist to be an obstacle to in the developing Asian countries (see appendix 18A) trade in services. Thus, an examination of the laws or that most barriers to trade in services are obstacles to the regulations pertaining to a service industry is not enough establishment and operation of foreign subsidiaries and to determine whether there are barriers to trade in ser- to the employment of foreign personnel. Negotiationsfor vices. In the absence of clearly identifiable barriers such liberalizing trade in services can therefore be expected as tariffs, the following principles and procedures pro- to be much more complex and complicated than their posed in the U.S. Study on Trade in Services (USTR counterpart for merchandise trade, since they must deal 179 Chung H. Lee with the right of establishment, foreign direct invest- a commercially operated optical fiber cable link for its ment, and the international movement of labor, as well southern region. The link will be extended to Hong as with standard tariff and nontariff barriers. Kong, Indonesia, and Thailand (Jussawalla 1989). To highlight some of the difficulties involved in nego- Domestic liberalization of telecommunications in these tiations on services trade, we will take a close look at countries does not mean that they would welcome for- three industries-telecommunications, banking, and eign telecommunications services. There are strong na- ocean shipping-that differ greatly in terms of the types, tionalistic sentiments for preserving the national cultural motivations, and effectiveness of regulatory policies. heritage and identity, which some think would be under- Telecommunications represents an industry with new mined by the internationalization of telecommunication and rapidly changing technology; banking is an industry services and the consequent influx of Western values and that has been used as an instrument for industrial policy ideologies (Clairmonte and Cavanagh 1984). Whatever in many developing Asian countries; and ocean shipping validity this argument may have, it is a force opposing represents a case of an infant industry or of national the intemationalization of telecommunications services. security. In investigating the motives for protecting the telecom- munications industry, one must recognize the impor- Telecommunications tance that many govemments attach to the acquisition and development of modem technology. According to Historically, telecommunications links and systems have Pack and Westphal (1986), Korea, Singapore, and Tai- been introduced under the protective aegis of state mo- wan have protected certain industries in which they do nopoly. This has been so for a number of reasons, most not have a static comparative advantage in order to help prominently economies of scale, national security con- them acquire the technical, institutional, and marketing siderations, and, in certain instances, the suppression of tools to achieve international competitiveness.2 This political dissent. In many developing Asian countries motive is different from the rent-seeking motive for government post, telegraph, and telephone (Prr) monop- protection and from cases that are explained in terms of olies were the norm well into the 1970s and still persist the "capture" theory of regulation.3 Korea and Singa- in some cases. The main ways in which telecommunica- pore, among others, see service industries such as tele- tions networks are regulated and protected from compe- communications as the next logical step in technological tition are monopolization by a single enterprise run or advancement and as industries in which to achieve inter- chartered by the government; government-mandated national competitiveness. For them the protection of technical standards; state procurement practices that these industries is necessary for economic develo4pment favor a select circle of large suppliers; restricted entry of and for catching up with the industrial countries. foreign entities such as manufacturers or network oper- ators; and state-run radio and television broadcasting. Banking In all countries licensing of radio and television broad- casters is tightly controlled by national authorities. The In developing Asian countries domestic banks are pro- basis for such restrictions has been the presumed scarcity tected from foreign competition through such practices of the radio frequencies available for broadcasting. Re- as banning or limiting the establishment of branches by cent developments in transmission, modulation, and foreign banks; not allowing foreign banks to underwrite switching techniques have, however, greatly increased government securities; forbidding foreign banks to offer the available capacity, and the scarcity of radio frequen- certain services, such as managing trust funds or issuing cies and television channels can no longer be used as a negotiable certificates of deposit; and prohibiting the basis for regulating the radio and television industries. purchase of local property or business premises. These Singapore has a government-owned telecommunica- practices are carried out, however, with varying degrees tions authority, but it is run on a commercial basis. It of intensity. At one extreme, Indonesia, Malaysia, the provides news services at subsidized costs, and its radio- Philippines, and Thailand impose severely restrictive paging and mobile communication systems help the conditions on foreign banking. At the other end is Singa- business community compete effectively in global mar- pore, probably one of the most open countries in the kets. Indonesia's government-owned Prr system is also world in terms of banking. According to one study, run on a commercial basis. The Palapa satellite system foreign banks hold 89 percent of all financial assets and provides cost-efficient telephone and television services 75 percent of all deposits in Singapore (ASEAN-U.S. Busi- to remote islands of Indonesia, linking them together in ness Council 1988, p. 62). Between the two polar cases a modem telecommunications network. Malaysiaprivat- is Korea, which began banking liberalization in the early ized its Prr system several years ago and now provides 1980s. Foreign banks are now allowed to borrow from 180 East Asian Countries the Bank of Korea, the country's central bank, and to sell the developmentof national fleets (Sien and Trace 1988). negotiable certificates of deposit They are, however, Indonesia, Malaysia, the Philippines, and Thailand have still restricted in such activities as investment trusts and adopted a policy of cabotage-of reserving domestic securities investment, and they cannot invest in mort- shipping and government cargo for national-flag ships. gages, since foreigners are not allowed to acquire land as In some countries "govemment cargo" is defined so an investment asset in Korea (Young 1989). Many of these broadly as to include almost all cargo (Miklius 1988). restrictions will be lifted after 1992; foreigners will then be The most popular new policy instrument is the cargo- allowed toinvestdirectlyinKorean securitiesuptoacertain sharing agreement, which is the result of bilateral nego- limit, and foreign securities companies will be able to tiations between trading countries or is declared establish branches and joint-venture securities companies. unilaterally. Flag discrimination through cargo-sharing There is no need to rehearse here the arguments in favor agreements, although in use much earlier, was legiti- of deregulating the banking industry and opening it up to mized by the adoption in 1974 of the Convention on a commercial and investment activities by foreign banks. Code of Conduct of Liner Conferences. Barriers such as those noted above curtail the ability of Many developing Asian countries have negotiated banks to offer attractive interest rates to their depositors, cargo-sharing agreements or have adopted them unilat- to realize capital growth and control costs, and to facili- erally (Brooks 1985). In late 1983 Thailand signed an tate customers' access to their deposits. Although restric- agreement with Korea for a 40-40-20 cargo allocation tive banking regulations may confer benefits on the small rule in trade between the two countries. Malaysia has number of citizens who are in a position to marshall signed agreements with Bangladesh, Turkey, and Indo- financial resources and to profit from lending them for nesia, and Indonesia has negotiated bilateral agreements domestic development, and although the timing of bank- with Japan, Korea, and Taiwan for carriage of logs and ing deregulation might be in dispute, the overall effect of with Taiwan for carriage of general cargo. Even Singa- regulation is definitely antithetical to economic develop- pore, which maintains a fairly liberal policy on ocean ment (McKinnon 1988). shipping, signed a 50-50 cargo-sharing agreement with Domestic financial liberalization should precede the Indonesia for Indonesia-Singapore trade. opening of the market to foreign banks, and it has to go The Philippines adopted its first cargo reservation leg- beyond liberalization of interest rates. For instance, in islation in 1976. The legislation specified that all govern- Taiwan, where most banks are managed by the govern- ment cargoes, including any cargoes being moved by ment, liberalization of interest rates is unlikely to pro- private corporations that received financial benefits from duce competition among the banks (Lee and Tsai 1988). the government, were to usePhilippine ships. In 1982 the In such a market foreign banks are likely to carve out governmentofthePhilippines, tosupportitsfailing fleet, their own monopolistic niche, leaving the economy extended cargo sharing on a 4040-20 basis for all liner worse off. cargo unilaterally, by executive order. This led to a In some developing Asian countries restrictive mea- confrontation with the United States. Faced with action sures on the entry and operation of foreign banks have by the Federal Maritime Commission that would effec- existed for more reasons than to protect domestic banks tively have barred Philippine-flag vessels from U.S. from foreign competition. Government control over fi- ports, the government was forced to withdraw the exec- nancial institutions, especially banks, has been the most utive order (Brooks 1985). important instrument for controlling the allocation of In addition to cargo sharing, countries have adopted credit and, thus, of real resources (see, for example, Cole financial assistance schemes that include such measures and Park 1983; Lee 1988). Liberalizing the banking as reduced income and other taxes, tax holidays, lower system means the loss of control over the allocation of interest rates on loans to finance ship purchases, and resources and the reduction and alteration of the lower (or no) import duties. Other schemes include eq- government's role in the economy. It goes further than uity participation and government ownership and opera- deregulating an industry to achieve competitive effi- tion of shipping companies. These financial aids are ciency; it means a fundamental change in what has been responsible for some of the problems of overcapacity regarded in many of these countries as the appropriate role currently facing the shipping industry. For instance, in of the govemment in promoting economic development, the 1970s, following the first oil shock, the Korea Mari- time and Port Administration began offering subsidies to Ocean Shipping designated large shipping companies as a way of expand- ing the fleet. In response to the subsidies, the companies In recent years many governments have intervened ac- rushed into the world market, picking up second-hand tively in ocean shipping as maritime aspirations led to vessels at an inflated "Korean rate." As was to be ex- 181 Chung H. Lee pected, the Korean shipping industry is now burdened Fundin 1987.In 1985 thegovernmentauthorizedKorean with a huge debt and a fleet of aging ships. companies to issue convertible bonds in overseas mar- kets, and at present foreign securities firms are allowed Recent Experiences with Liberalization to own up to 10 percent of the paid-in capital in large Korean securities companies. Furthermore, according to Under pressure from the U.S. government, the Korean a timetable announced by the Korean government in government agreed on July 21, 1986, to open its insur- December 1988, foreign investors will be allowed to ance market to a certain number of U.S. insurance finns. make direct purchases of Korean stocks in 1992. The agreement provided that (a) two U.S. firms would Foreign banks have operated in Korea since the mid- participate in the fire pool by July 1986; (b) the member 1960s but have been subject to many discriminatory companies would determine the method of sharing pool restrictions. Lately, these restrictions have been phased premium income; (c) one U.S. firm would be licensed to out. Foreign banks may now obtain membership in the enter the life insurance market by the end of 1986; and KoreaFederation of Banks andthe Clearing House. They (d) qualified U.S. firms would be permitted to enter both may engage in trust business, have access to the central the life and nonlife insurance markets (Cho 1988). It is bank rediscount window, and issue certificates of de- clear from these agreements that the Korean insurance posit. Foreign banks, however, still face restrictions in market had been aregulated marketbefore being opened acquisition of real estate (Namn 1989). to the U.S. firms, and it still remains so, but now with In recent years the information sectors of the industrial U.S. participants. As Cho points out, opening a regulated countries have become increasingly liberalized, and their market to a few foreign firms may have made Korea multinational enterprises have gained much from the worse off, as the gains from increased competition may process. This is not surprising, since much of the liberal- be more than offset by the loss of monopoly rents. ization has been directed at the demand or user side, at A similar point has been made by advocates of a slow the insistence of firms that have joined into effective and gradual process of financial liberalization in Korea. domestic and international lobbying groups in favor of Chung (1988) argued that the price-earnings ratio in the deregulation. Korean stock market was too low (at the time of his Even in developing countries the pressure for liberal- writing) and that the opening of the market to foreign ization seems to have come from the user side. For investors should wait until the ratio went up high enough instance, in 1987 the Korean Computer and Communi- to prevent the newcomers from reaping excessive capital cation Promotion Association, which consists of provid- gains. Chung attributed the low price-earnings ratio to a ers of databank and computer power services, requested deep-rooted distrust of the securities market among the govemment to eliminate all restrictions on the use of Korea's public, which sees little difference between the leased lines for domestic as well as international non- market and a gambling house, and to its general mistrust voice data communications. of business firms. There was, however, external pressure as well. Talks If these are the reasons for the low price-earnings ratio, between the United States and Korea regarding U.S. and if the public's perception is correct, foreign investors access to the Korean telecommunications market began would lose by investing in the Korean security market; in 1987 and continued through 1989. Pressure from the only in the opposite case would they gain. It seems that United States increased with the passage of the Omnibus unless the government knows better than thepublic, there Trade Act of 1988. TheUnited States requested complete is no reason to prohibit foreign investors from investing opening of the telecommunications market, with some in Korea and from making mistakes that the Korean exceptions such as telephone and telex services. Korea public is trying to avoid. If foreign investors have better basically agreed to open the market and introduce more information than the Korean public, their participation competition, but in gradual steps (Sung 1989). will improve resource allocation in Korea, although in The intemational business community has benefited in the process they will gain financially. It seems, then, that two main ways from liberalized govemment policy to- unless the government knows better than the public, there ward information services. First, intrafirm communica- is no compelling reason not to open the capital market to tions, whether domestic or intemational, have become foreigners soon. If the govemment does know better, it less expensive and more convenientL The reduction in should provide its information to the public as quickly costs and the improvement in services have been and as widely as possible. achieved in part by establishing intrafirm data and voice Korea has begun opening its financial and capital mar- networks. For example, General Motors, IBM, and Gen- kets. As a first step it established two corporate-type eral Electric all have their own worldwide private data funds-the Korea Fund in 1984 and the Korea-Europe systems that operate independently of the common car- 182 East Asian Countries riers. These corporations have to lease lines from the monopoly will behave competitively. For example, common carriers, but the prices of leased lines have Korea used to have only one private air carrier, Korean fallen close to costs (Jussawalla 1989). Second, value Air, which practiced price discrimination between the added or third-party services are now available to closed domestic market for international travel and the customers in greater quantity and variety and at lower more competitive international market. When airline costs than previously, as a result of liberalization. Both deregulation in the United States and the entry of more processes, particularly the latter, have contributed sub- U.S. carriers brought about increased competition within stantially to the volume of international trade in infor- the Korean domestic market, this price discrimination mation services among the principal industrial virtually disappeared. countries. Although the initial beneficiaries of liberalization are Relaxation of Foreign Equity Control the business communities of industrial countries, there is every expectation and indication that liberalization of the The developing Asian countries are very diverse, but information sector will eventually benefit the developing each reduces its ability to attract foreign investment in countries as well. As Snow (1985) points out, such service industries by placing restrictions on the extent of liberalization is both a cause and a symptom of economic foreign ownership. These restrictions especially limit the development. In recognition of this, some countries, such inflow of investment in high-technology industries, as Korea, have begun considering initial steps toward where intellectual property rights are the main moti- deregulation of the information sector, particularly in vating factor for investment, and they thus inhibit data communications. Hong Kong, where the telecom- transfer of technology from industrial to developing munications networks have been in private hands for countries. some time, is acting as a catalyst for the construction of modernized telecommunications networks northward Relaxation of Controls on Foreign Banking across the Chinese mainland in anticipation of its absorp- tion into China at the end of the 1990s. For the reasons mentioned above, some developing Asian countries have adopted protectionist legislation Policy Recommendations that is heavily disadvantageous to foreign banks. These banks have to contend with limits on the range of services On the basis of the information and arguments presented they may offer, prohibitions against the purchase of local in the preceding sections the following initiatives are properties or business premises, restricted access to host- recommended. country government funds, and inability to underwrite host-country government securities. Relaxation of these Greater Liberalization and Privatization in the Informa- controls should be carried out in a manner that does not tion Sector provoke speculative capital inflows; otherwise the result could be a loss of domestic monetary control and, con- The developing Asian countries should examine the sequently, economic instability. The painful experiences benefits to be gained from relaxing the often onerous of Chile and Argentina in the 1970s make clear the regulatory and nonregulatory controls in their telecom- importance of containing short-term speculative capital munications and other information-intensive industries. inflows during financial liberalization. In particular, domestic and overseas telecommunications networks and the services they provide merit special Relaxing Limits on Professional Services by For- consideration as the nerve center of the information-in- eigners tensive sector. Specific policies could include high-level inquiries into changes in telecommunications policies- Understandable protectionist impulses have given rise to an initiative already undertaken by virtually all the prin- legislation in the developing Asian countries that sharply cipal industrial countries; partial or complete limits the ability of foreign professionals to practice their privatization of networks or network components; and occupations. These restrictions are typically found in easing of restrictions regarding procurement, standard such professions as financial planning, architecture, en- setting, licensing, and the like. gineering, construction, law, telecommunications, and Privatization does not necessarily lead to improve- accounting. Some of these industries are the technolog- ments in welfare; the outcome may simply be a private ically most advanced ones, and allowing foreign profes- monopoly. But if it is accompanied by the opening of the sionals to practice their occupations locally could permit market to international competition, even the private a beneficial transfer of technology. 183 Chung H. Lee Relaxing Restrictions on Foreign Construction Services positive effect by fostering improved efficiency in ser- vice industries and hence a decrease in the prices of Some developing Asian countries, especially Korea, service-intensive commodities. If those commodities are have demonstrated that their construction services can exportables, liberalization will bring about an increase in compete internationally. Their exports are, however, the country's exports; if they are importables, itwill lead limited mostly to other developing countries because of to a decrease in imports. Liberalization will thus have a severe restrictions in the industrial countries. The export favorable effect on the merchandise account in the bal- of construction services is a complicated issue, as it is ance of trade, although it may have an adverse effect on related to immigration policy. A way needs to be found the services account. The effect of liberalization of trade to distinguish international migration for temporary em- in services on trade in goods needs to be further elabo- ployment from immigration and to treat the former as rated and empirically estimated. Only by taking into trade in services. account linkage effects such as this can a country make correct policy decisions on its trade in services. Conclusions Although the preceding arguments point out the advan- tages of liberalization, whether unilateral or multilateral, Many internationally traded services are intermediate they do not address the problems involved in implement- services that enter into the production of goods and other ing liberalization. Given the above-mentioned advan- services. Local service firms may not be able to compete tages, one would wonder why so many of the developing with imported services or services provided by foreign Asian countries have not carried out liberalization uni- affiliates, but as cheaper or better services become avail- laterally. able, local manufacturing or service firms that use these The responses of the developing Asian countries to services will become more competitive internationally. liberalization in services have varied, reflecting differ- This linkage effect has been widely observed in the ences in their comparative advantage in trade in services industrial countries, and there is no reason why it would and the relative service-sector shares in their economies. not be the same in the developing Asian countries that For instance, among ASEAN countries Singapore and then have many successful manufacturing industries. What Thailand are the most enthusiastic for liberalization, these countries need to consider is whether to develop whereas Malaysia, Indonesia, and the Philippines, with their own service industries, meanwhile suffering a com- their deficits in services trade, are less so. The latter petitive disadvantage in industries that rely heavily on group is especially cautious about opening up sectors these services, or to utilize imported services and become such as banlcing, insurance, transport, and telecommuni- more competitive intemationally. cations, since opening of these sectors, unless accompa- One benefitto the hosteountry of allowingdirectforeign nied by reciprocal opening of sectors in which they have investment is the transfer of technology. There is no a a comparative advantage, would mean further deteriora- priori reason why such benefits would not accrue to the tion in their balance of payments. Even if this deteriora- host country when the investment is in a service industry. tion is short-term, it is not a problem these countries can Since services are generally provided by their producers easily ignore. Multilateral liberalization should alleviate in direct contact with consumers, there are probably more this concem. opportunities for technology transfer to the host country. Another benefit of a multilateral process of liberaliza- There are good reasons why many infrastructural and tion is that it helps a pluralistic, democratic government other activities-such as electricity, water, transport, to overcome opposition to liberalization by domestic health, broadcasting, and education-remain in govern- groups that have benefited from protection. To counter menthands during economic development (Snow 1988). this opposition the government needs to garner support To the extent that particular sectors such as telecommu- for liberalization from groups that are potential benefici- nications become privatized or deregulated, however, aries, and a greater number of domestic groups emerge they serve as a touchstone against which users, voters, as gainers under multilateral liberalization than under and taxpayers can measure the relative efficiency and unilateral liberalization. The government may thus be flexibility of the public sector, which may then be com- able to get the support and overcome domestic opposi- pelled to operate more efficiently. tion to liberalization. Given the political liberalization Finally, an argument may be made against liberalizing that is at present taking place in many developing Asian trade in services on the grounds that it has a negative countries, this political economy case for a multilateral effect on the balance of payments of the developing process may well be the most important of the arguments Asian countries. But, on the contrary, it may have a that have been made in favor of the process. 184 East Asian Countries Lee, Chung H. 1985. Government PromotionMeasuresfor Construc- Notes tion Service Exports to the Middle East. Korean Economic Policy 1. It has been proposed that in return for more liberal treatment of Case Studies, no. 14. Honolulu, Hawaii: East-West Population imports of services fromn the United States, countries of the Association Institute. of South East Asian Nations (AsEAN) should be allowed to send their - 1988. "Economic Policies and Institutions for the Economic nationals to work on a temporary basis in the United States as construc- Development of Korea: Comparisons and Contrasts with Taiwan." tion workers or domestic maids (Lee 1988). This position is consistent In Conference on Economic Developnent Experiences of Taiwan with Bhagwati's (1987) proposal that if direct foreign investmnent in and Its New Role in an Emerging Asia-Pacific Area (11). Taipei, services is to be included in trade in services, the mobility of foreign Taiwan: Institute of Economics, Academia Sinica. labor and its service on a temporary basis should also be included. Lee, Chung H., and Seiji Naya, eds. 1988. Trade and Investment in According to Miklius (1988), (non-Japanese) Asian ocean carriers Services in the Asia-Pacific Region. Boulder, Colo.: cis-Inha Uni- have only a 4 percent cost advantage over nonsubsidized U.S. carriers versity and Westview. on a 1,700 TEu (twenty-foot equivalent unit) vessel, although Asian Lee, Yuan. 1988. "AsEAN-us. Trade in Services: An ASEAN Perspec- crew costs are about 30 percent of the U.S. costs. This is so because the tive." In Tan Loong-Hoe and Narongchai Akrasanee, eds.,ASEAN- cost differential is primarily in the area of crew wages and insurance U.S. Economic Relations: Changes in the Economic Environnent U.S. crew costs are about 25 percent of total marine expenses, and andOpportunities.Singapore:InstituteofSoutheastAsianStudies, marine costs are 19 percent of total costs. Miklius expects that the trend Singapore. toward larger container vessels will continue and that thus the compar- Lee, Yung-san, andTzong-rongTsai. 1988. "Development of Financial ative advantage the developing countries have in ocean shipping will System and Monetary Policies in Taiwan." In Conference on Eco- erode further. nomic DevelopmentExperiences of Taiwan and Its New Role in an 2. This is not the same as an infant industry argument, which Emerging Asia-Pacific Area 11. Taipei, Taiwan: Institute of Eco- justifies the protection or, preferably, the subsidization of an industry nomics, Academia Sinica. unable to compete as yet with foreign competition. According to Pack Lipsey, Robert H., and Irvin B. Kravis. 1985. '"he Competitive Posi- and Westphal (1986), the former underlies the industrial strategy of the tion of U.S. Manufacturing Firms." Banca Nazionale del Lavoro East Asian governments, which is designed to achieve "dynamically Quarterly Review(June):127-54. efficient isdustrialization" by managing technological change. McKinnon, Ronald I. 1988. Financial Liberalization and Economic 3. According to the "capture" theory of regulation, members of the Development: A Reassessnent oflnterest-Rate Policies inAsia and regulated industry indirectly capture the regulators' powers and use Latin Anerica. Occasional Paper 6. San Francisco, Calif.: Interna- them to their own benefit (Stigler 1971). tional Center for Economic Growth. 4. It should be noted, however, that if a given industry is to be Miklius, Walter. 1988. "Issues in Ocean Shipping and the Asia-Pacific promoted, providing a cost advantage to domestic producers with Region." In Chung H. Lee and Seiji Naya, eds., Trade and Invest- subsidies is superior to placing a cost disadvantage on foreign produc- ment in Services in the Asia-Pacific Region. Boulder, Colo.: ers (Hindley 1988). Westview. oTA, U.S. Congress. 1986. Trade in Services: Exports and Foreign ResourcespecialReport. Washington, D.C.: Goveniment Print- References ing Office. Nam, Sang-Woo. 1989. "Liberalization of the Korean Financial and Alexander, A., and H. W. Tan. 1984. Barriers to U.S. Service Trade in Capital Markets," Paper prepared forpresentation at policy confer- Japan. Santa Monica, Calif.: Rand Corporation. ence sponsored by the Korean Development Institute and the ASBAN-Us. Business Council. 1988. "The ASEAN-US. Economic Rela- Institute of Intemational Economics,Washington, D.C., December tionship: Overcoming Barriers to Business Cooperation." Wash- 12. Processed. ington, D.C. Processed. Pack, Howard, and Larry E. Westphal. 1986. "Industrial Strategy and Bhagwati, Jagdish N. 1987. "Trade in Services and the Multilateral Technological Change: Theory versus Reality." Journal ofDevel- Trade Negotiations." World BankEconomic Review 1, no.4 (Sep- opment Economics 22:87-128. tember):549-69. Ramstetter, Eric D., and Chung H. Lee. 1989. "Trade in Services and Brooks, Mary R. 1985. Fleet Development and the Control ofShipping Retums on Foreign Direct Investment." 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Corporations and Services: The Final Frontier." In Trade and Sien, Chia Lin, and Keith Trace. 1988. "Trade and Investment in Development: An UNCTAD Review, no. 5. New York: United Shipping." In Leslie V. Castle and Christopher Findlay, eds., Pa- Nations. cific Trade in Services. Sydney, Australia: Allen and Unwin. Cole, David C., and Yung Chul Park. 1983. FinancialDevelopment in Snow, Marcellus S. 1985. "Regulation to Deregulation: The Teleoom- Korea, 1945-1978. Cambridge, Mass.: Harvard University Press. munications Sector and Industrialization, with Evidence from the Hindley, Brian. 1988. "Service Sector Protection: Considerations for Pacific Rim and Basin." Telecommunications Policy 9, no. 4 Developing Countries." World Bank Economic Review 2, no. 2 (December):281-90. (May):205-24. . 1988. "The State as Stopgap: Social Economy and Sustainabil- Jussawalla, Meheroo F. 1989. "Telecommunications Technology, De- ity of Monopoly in the Telecommunications Sector.' 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Intemational Economics. . 1985. "Selected Problems Encountered by U.S. Service Indus- tries in Trade in Services." Washington, D.C. 186 Appendix 18-A. Barriers to Trade in Services Indonesia * Insurance. Market access is denied; foreign insurers are not permitted to establish branches or subsidiaries. * Leasing. The application process for obtaining authorization for new leasing operations is not transparent, as it lacks specified criteria; there are percentage limitations on foreign ownership and expatriate employment; and leasing of imported goods is not permitted. * Motion pictures. There are quotas on film imports; market access is denied to foreign film distributors. * Franchising. Trademarks are poorly protected, and trademark litigation involves costly court proceedings. * Maritime transport. There is a percentage requirement for national-flag carriers. Republic of Korea * Accounting. Market access is severely limited, and activities are restricted to foreign joint-venture firms. * Advertising. Radio and television commercials produced abroad are forbidden, and equity ownership by foreign firns in agencies that purchase media space and time is prohibited. * Banking. Branch banking is restricted, equity participation is limited to 50 percenL Foreign banks may not acquire title to property such as real estate, vessels, and aircraft. * Motion pictures. There are quantitative restrictions on film imports and screening quotas for local films on television. * Maritime transport. Foreign carriers are prohibited from owning assets such as trucks, chassis, or facilities in Korea. Malaysia * Advertising. All broadcasting materials must be produced locally, using local labor. * Insurance. Market access is denied; foreign insurers are not permitted to establish branches or subsidiaries. * L-easing. There are percentage requirements for foreign ownership and expatriate employmenL * Motion pictures. Use of foreign technical experts is restricted. Philippines • Banking. Foreign ownership is limited; establishment of foreign bank branches is prohibited. - Franchising. The central bank must approve all contracts calling for royalty payments. * Insurance. Cessions to unauthorized foreign reinsurers are limited. Leasing. There are percentage limitations on foreign ownership and expatriate employmenL e Motion pictures. There are quotas on film imports. * Air transport. The national carrier receives preferential treatment in charter flight operations and pays lower taxes than foreign carriers. * Maritime transport. The national-flag line receives preferential tax treatment. Singapore * Banking. Entry and operations are restricted, and foreign banks may not have branch operations. * Insurance. Market access is denied, foreign insurers are not permitted to establish branches or subsidiaries, and a portion of reinsurance must be purchased locally. * Motion pictures. Use of foreign technical experts is restricted. * Maritime transport. There are discriminatory bilateral agreements. Thailand * Advertising. Market access is limited; the establishment of wholly owned or majority-owned branches or subsidiaries is not permitted. * Banking. Establishment of new foreign banks and additional branches is banned. * Insurance. Market access is denied; foreign insurers are not permitted to establish branches or subsidiaries. * Leasing. There are percentage limitations on foreign ownership. * Motion pictures. Use of foreign technical experts is restricted. * Air transport. The national carrier has a monopoly on ground handling services. Source: usTR (1985). 187 19 India Surjit S. Bhalla The servicesectorinIndiahasbecomeanimportanttopic "credit-starved" rural sector. Although the data are indi- for three reasons. First, economists and policymakers rect and incomplete, the similarity of growth rates for the have recognized that the service sector is an integral part periods before and after nationalization suggests that a of the development process rather than a stepchild to the marked acceleration of value added in banking was not formerly overriding priority of industrialization. Second, one of the outcomes of nationalization. the role of trade in services has expanded rapidly enough 2. "Other services" have been stagnant, at around 6 to draw the attention of those who make rules and poli- percent of GDP, for the past three decades, whereas the cies. Third, India, along with Brazil, has been a leader of tourist trade component (hotels and the like) increased the Group of Ten (G-10), which has taken a position on from 9.4 percent in 1960 to 12.6 percent in 1986. trade in services that is in directopposition to theposition 3. Govermment services (public administration and de- notonly of the developedworld, ledbytheUnitedStates, fense) increased steadily, from 3.8 percent in 1960 to 4.7 but also of the rest of the developing world. percent in 1980. During the past six years this share has A surprising aspect of growth in the developed world increased to 5.8 percent. This "expansion" is important over the past two decades has been the significant rise in for assessing rates of growth; given the difficulty of the share of the service sector. For example, in the United measuring productivity in govemment, it might be ques- States the share of services in gross domestic product tioned whether the purported acceleration of the Indian (GDP) increased from 59 percent in 1965 to 67 percent in growth rate during the 1980s (from 3.5 to 5.0 percent per 1986. It was expected that in developing countries the capita) is not in large part attributable to the growth of growth of services would be slower and that as the share the government sector. of the primary sector decreased, a large proportion of the Tables 19-2 and 19-3 present data for different com- decline would be absorbed in the "lead" manufacturing ponents of services exports and imports. Again, three sector-the "engine of growth." findings emerge. But this expectation has been belied in India's case. As 1. The share of service exports (excluding official trans- table 19-1 shows, the share of manufacturing in GDP fers) in total exports rose from only 25 percent in 1960 increased from 15 percent in 1965 to 19 percent in 1986, to almost 40 percent in 1986. but this growth was markedly less than in, for example, 2. The three components of service exports that have Thailand (from 14 to 21 percent during the same years) shown the most expansion are travel (that is, tourism), and Turkey (from 16 to 25 percent).' Meanwhile, the miscellaneous (a catchall category that includes consult- service sector (including other services) expanded from ing, data processing, accounting, financial services, and 37 percent in 1965 to 47 percent in 1986. the like) and private transfers (remittances of Indian Three observations may be made about the figures in nationals). The last category has burgeoned since the table 19-1. mid-1970s, reflecting the export of labor services to the 1. The banking and insurance sector has grown tremen- Persian Gulf countries. In 1980 such transfers accounted dously; its share in GDP increased from 1.2 percent in for one-fifth of total exports, but the share fell to only 15 1960 to 3.5 percent in 1986. It is noteworthy that the rate percent in 1986. of expansion of this sector was notmuch different for the 3. These three categories are also the ones that show a two decades 1960-70 and 1970-80. The banking sector surplus in the net account (table 19-3). Travel shows a was nationalized in 1969 and the insurance sector in surplus not because tourism is flourishing (there are 1971, with the statedpurpose of providing services to the fewer than 750,000 visitors a year from countries exclud- 188 India Table 19-1. The Share in GDP of the Nonservice and the Service Sectors at Factor Cost (percentage of GDP) Sector 1960 1965 1970 1975 1980 1984 1986 1987 Nonservice sector 65.0 62.8 62.7 58.9 57.3 55.2 53.1 52.5 Primary sector 50.8 47.6 48.5 43.3 39.6 37.2 34.3 33.3 Manufacturing 14.2 15.1 14.2 15.6 17.7 17.9 18.8 19.2 Service sector 35.0 37.2 37.3 41.1 42.7 44.8 46.9 47.5 Utilities 10.0 10.9 11.5 11.5 11.3 13.0 14.1 14.5 Construction 4.6 5.0 5.8 5.0 5.0 53 5.6 5.8 Electricity, gas and water supply 0.6 0.8 1.1 1.3 1.6 2.0 2.2 2.2 Transport, storage, and communications 4.9 5.0 5.1 53 4.7 5.7 6.3 6.6 Services 24.9 26.4 25.8 29.6 31.4 31.8 32.7 33.0 Trade, hotels and restaurants 9.4 10.4 11.0 13.8 12.0 12.4 12.6 12.5 Banking and insurance 1.2 1.6 1.8 2.7 2.8 3.4 3.5 3.6 Real estate 4.3 3.9 4.0 3.7 6.0 5.1 4.9 4.8 Public administration and defense 3.8 4.5 4.5 4.9 4.7 5.2 5.8 6.1 Other 6.2 6.0 4.6 4.6 5.8 5.7 5.9 6.0 Source: Central Statistical Office, National Accounts Statistics; Old Series for 1960-79, New Series for 1980. ing South Asia, and that number has remained stagnant and abetted by official policy. It is unlikely that total for several years) but because Indians cannot easily travel receipts (black and white) show a trade surplus for obtain foreign exchange for travel abroad. The figures on India. net travel earnings thus reflect an artificial surplus. Ex- ports of travel (tourism) are encouraged but because of India's Position at the Uruguay Round Negoti- various bottlenecks, including the overvalued exchange ations rate, tourists prefer other countries. And imports of travel (business travel or tourism by Indian citizens) are effec- At the ministerial meeting in Punta del Este in 1986, tively curtailed because a traveler can obtain only the India (with Brazil) led the developing countries' opposi- equivalent of $500 in foreign exchange only once every tion to the introduction of services within the GATr three years. Business travelers have to go through cum- framework. This stand was based on several rationales; bersome procedures to get foreign exchange. The net the following list is meant to be comprehensive, although result is a black market for foreign exchange that is aided "unofficial." Table 19-2. Merchandise and Service Exports as a Share of Total Exports (percent) Type of exports 1960 1965 1970 1975 1980 1984 1986 Merchandise 74.6 75.3 77.1 74.5 54.7 60.5 62.2 Services 25.4 24.7 22.9 25.5 45.3 39.5 37.8 Travel 1.8 1.4 1.5 3.4 9.7 4.5 7.5 Transport 5.3 5.1 5.9 4.6 3.0 3.3 3.2 Insurance 1.0 1.1 0.6 0.7 0.4 0.4 0.4 Investment income 1.7 1.0 2.7 2.1 7.1 3.0 3.0 Government 6.0 4.4 1.7 1.9 0.7 0.5 0.6 Miscellaneous 4.3 2.5 3.0 3.2 5.5 12.0 8.8 Private transfers 5.3 9.1 7.5 9.7 18.9 15.8 14.3 Note: Exports exclude officialtransferpayments. Miscellaneousservices lumps togetherproducerand business services such as computer software, data processing, research, management, legal and other consulting, engineering and design, advertising, market studies and public relations, accounting, maintenance and quality control, and banking and financial services. Source: Reserve Bank of India, Report on Currency and Finance. 189 Surjit S. Bhalla Table 19-3. Gross Exports and Imports of Services (rmilions of dollars) Type of service 1960 1965 1970 1975 1980 1984 1986 Travel Exports 32.1 31.7 36.9 219.1 1,477.7 755.4 1,284.7 Imports 25.4 22.7 23.5 25.2 114.4 344.3 295.6 Net 6.7 9.0 13.4 193.9 1,363.3 411.1 989.1 Transport Exports 93.7 112.6 140.9 300.4 458.1 541.5 548.8 Imports 51.7 58.6 103.7 226.3 449.9 772.0 596.6 Net 42.0 54.0 37.2 74.1 8.2 -230.5 -47.8 Insurance Exports 17.0 24.6 15.5 44.3 61.3 74.7 66.3 Imports 12.2 12.8 16.1 28.2 43.1 70.7 81.0 Net 4.8 11.8 -0.7 16.1 18.2 4.0 -14.8 Investment income Exports 29.8 22.9 64.2 134.3 1,083.4 492.9 511.2 Imports 130.0 283.5 362.7 329.7 470.3 1,330.9 1,507.7 Net -100.2 -260.6 -298.6 -195.7 613.1 -838.0 -996.7 Goverrnent Exports 107.1 95.5 39.8 120.5 110.9 88.1 105.9 Imports 44.7 32.8 30.4 37.7 59.7 70.8 108.3 Net 62.4 62.8 9.4 82.9 51.2 17.2 -2.4 Miscellaneous Exports 76.9 54.2 73.3 208.1 841.3 1,986.9 1,510.0 imports 72.7 103.7 102.7 197.8 848.6 1,092.0 1,184.7 Net 4.2 -49.6 -29.4 10.3 -7.3 894.8 325.3 Private transfers Exports 94.3 199.3 180.4 625.4 2,874.6 2,621.5 2,435.0 Imports 35.3 33.2 17.5 15.5 14.7 12.8 11.8 Net 59.0 166.1 163.0 609.9 2,859.9 2,608.7 2,423.2 Total services Exports 507.6 540.7 0.0 1,652.1 6,907.3 6,561.0 6,461.6 Imports 371.9 547.2 656.7 860.6 2,000.7 3,693.6 3,785.7 Net 79.0 -6.5 -656.7 791.5 4,906.6 2,867.4 2,675.9 Note: Figures exclude official transfers. Source:: Reserve Bank of India, Report on Currency and Finance.. *The introduction of services within the GAIT would * Liberalization of trade in services "may not result in deflect the GAIT'S attention from other, more press- comparative advantage and protection of infant ser- ing issues such as nontariff barriers and agricultural vice industries in [developing countries]. Besides, it subsidies. may imping2e on national sovereignty and economic •Since the GAIT has notbeen effective in "protecting" ambitions." or advancing developing countries' interests in the area of trade in goods, it would be singularly irratio- Do these positions represent genuine economic con- nal to expect it to help those countries in the area of cerns or are they meant for political consumption? If the services. latter, then what are the real reasons for India's leader- *Services trade is a form of neoimperialism; service ship of the opposition to introducing services into the industries are dominated by multinationals, and GATr? The validity of each of the above arguments is opening up trade is an invitation to be gobbled up. examined below. *In any case, services is such a new sector that even * No services in the GAITbecause the GAITagenda the economists (including the GAIT'S own) have is alreadyfull. Implicit in this argument is the belief that difficulty in defining it. Hence, it would be just a there are diseconomies of scale to a bureaucracy. There futuristic indulgence to try to figure out what is truth in this argument, although it is ironic that India, would happen if trade in services were to be liber- which has one of the world's largest bureaucracies, alized. should be advancing it.3 But in this case, if services were 190 India under the rubric of the GATr, economies of scale would cannot avail itself of this negotiating opportunity be- be realized because issues of protection, comparative cause it has not been adversely affected by textile quotas. advantage, and the like would apply equally to goods and Jethanandani (1989) notes that "the only year in which to services. Furthermore, since the distinction between [textile) quotas were fully utilized was 1987, while for goods and services is becoming blurred, it would not be the remaining years [India's] quotas were grossly under- rational to have two different organizations arguing utilized, especially the European quotas. Even in 1987, aboutjurisdiction. our quotas for some commodities like bed-linen and It is unlikely that the Indian negotiators were unaware made-ups were underutilized." of these factors. Rather, their stand might have been To sum up, although the argument that nontariffbarri- motivated by the time-tested maxim that if you do not ers have hurt developing country exports has merit, it is want something to happen, set up a committee to study not an argument that Indian policymakers can convinc- the problem. Even if an alternative GATr-like organiza- ingly advance. tion were eventually setup, itwouldprobablybeplagued * Services trade is neoimperialism (visions of by startup problems concerning its proper domain and Citibank andAT&Tdominating the world market). This the distinction in specific cases between goods (which isidenticalwith an earlierview thatopening up theworld would belong under the GATr) and services. market for goods would lead to General Motors' owning * GATI has not been effective in protecting develop- the world. Then came Ford; then came Mercedes-Benz; ing country interests. This view is completely consistent then came Toyota; then came Hyundai; then came with India's stated position on political and economic Pronto-Saga. The "neoimperialism" argument is singu- "realities"-that the outside world is largely responsible larly anachronistic and has an autarkic implication: for domestic problems. In India this is labeled the "for- since trade leads to domination by foreign nationals, eign hand position." Nayyar (1987), for example, gives self-reliance is the only course left. the following explanation for India's bad export perfor- * Trade will not protect infant service industries. mance: "The increasing incidence of protectionism in Again, there may be validity to this argument. Indian the industrialized countries, embodied in the escalated policymakers and industrialists, however, have been cry- tariff structures and a range of unquantifiable nontariff ing themselves hoarse for forty years about their need for barriers, also places a limit on the growth of manufac- protection now so that they will be able to compete later. tured exports" [italics mine]. But Indian exports (manu- And while the future has arrived, Indian industrialists are factured and total), instead of rising to a ceiling imposed still not competitive internationally. Infant industry pro- by outside restraints, have shown a steady and persistent tection has been in force from independence in 1948 to decline in market share since the 1950s. Unless, as is thepresent, andIndia's share in world trade has declined, unlikely, the "foreign hand" was explicitly aimed at from approximately 2.5 percent in the early 1950s to India, a legitimate question arises: wasn't something barely 0.5 percent. These are certainly not logical grounds else besides lack of foreign demand responsible for the on which to argue for the advantages of infant service export debacle of the past forty years? Several authors industry protection, at least from the Idian point of view. (for example, Manmohan Singh 1964, Bhagwati and The clue to the persistence of the infant industry argu- Srinivasan 1975, Lucas 1986, and Bhalla 1989) have ment lies in the political economy of India. The indus- argued that the price demand elasticity for Indian exports trialists are loathe to give up protection-indeed, a is not less than unity. It is therefore likely that the leading Indian industrialist seriously suggested that the explanation for the lack of growth of Indian exports has way to solve the problem of the government deficit was more to do with domestic policy than with the policies to raise the import tariff. (With tariff rates estimated at of the GA1T or the developed world. It is also difficult to about 125 to 175 percent, India may already have the imagine that the Republic of Korea, Taiwan, and now highest tariff structure in the world; see table 19-4.) A China would argue that the GATI and the world trade new empirical twist is now advanced to support the case system had not advanced their interests. for import protection: Japan and Korea succeeded with But what about, for example, textile quotas? True, restrictions on imports, so why cannot India? This these barriers exist, and in the interests both of trade and argument is repeated ad nauseam at government meet- of textile-producing countries such as India it is impor- ings, and it would not be amiss to classify it as yet tant that they be removed. A call to dismantle such another Indian mantra. Its proponents (and they include developed country barriers would be a good negotiating many distinguishedIndian academiciansandpolicymak- position for India. The tragedy, however, is that India ers) fail to mention that the Koreans and others had to 191 Surjit S. Bhalla Table 19-4. Comparative Nominal Tariff Rates, 1985 (Mean Ad Valorem Tariffs, by Country) Intermediate Capital Consumer Manufacturing Country goods goods goods sector Argentina 21.2 25.0 21.9 22.9 Bangladesh 97.9 80.5 116.1 100.8 China 78.9 62.5 130.7 91.2 Hungary 14.2 15.0 22.6 20.9 India 146.4 107.3 140.9 137.7 Mexico 25.5 23.5 32.2 24.7 Morocco 21.6 18.1 43.0 27.3 Pakistan 75.0 73.8 127.3 89.8 Philippines 21.8 24.5 39.0 28.0 Thailand 27.8 24.8 8.5 33.6 Turkey 29.4 54.9 55.3 37.1 Yugoslavia 18.0 20.7 20.0 19.0 Note: The taziff rates are for 1985 or the most recent year. Includes cEr and other imnport duties and flat duty (if any). Source: World Bank snm. country tariff files. exportin order to expand and survive; hencegovemment Egypt and Yugoslavia are also members of the G-10. import policy was a nonbinding constraint on efficiency. The economic performance of India over the past forty years can, at best, be described as disappointing, and the India's Position and Its Domestic Policy search for leadership on the basis of traditional (and increasingly archaic) Third World views concerning cap- As hinted above, there seem to be few "genuine" reasons italism and neocolonialism is considered a worthy sub- for India's opposition to the introduction of services stitute for the lack of domestic growth and glory. within the GATr framework. What, then, accounts for There are other factors which explain India's stand and India's position? show that Indian policymakers and negotiators cannot be Clues to the real rationales can be found by examining accused of inconsistency. They have to do with the India's domestic economic policies. Further, clues to domestic policy environment, which is characterized by possible changes in India's position can be derived by a plethora of domestic controls, regulations, and restric- examining the changes (such as they are) in Indian eco- tions. These restrictions have been documented exten- nomic policy. And, extending this line of argument, clues sively and eloquently in the literature (see, in particular, to the G-10 position can be gleaned by examining the Bhagwati and Desai(1979) andBhagwati and Srinivasan collective performance of the G-10 countries in the 1975). That things have not changed that much for the world economy. better is documented in Srinivasan (1989) and in table The G-10 countries-those leading the fight against 19-4, which clearly shows that India has by far the the introduction of services in GAiT-are Argentina, highest rate of tariff protection in the world. Ahluwalia Brazil, Cuba, Egypt, India, Nicaragua, Nigeria, Peru, (1989) has demonstrated that this high level ofprotection Tanzania, and Yugoslavia. With few exceptions, the has been associated with zero total factor productivity correlation between membership and lack of good do- growth (for the years 1960 to 1983). But the policymak- mestic or foreign economic performance is striking. It is ers have not yet budged from their stance that protection doubtful whether any objective analysis would conclude is needed for infant/geriatric industries. that this group, collectively or individually, represents a If the policymakers deem protection desirable for desirable path of development for any developing coun- goods, then it is a minor extension to demand it for try. Interestingly, the group includes no Southeast Asian services. The arguments are the same, the reasoning is countries and no countries with an enviable record of the same, and the fallacies are the same. Hence there is development. no inconsistency in India's stand-its view is that freer There is an additional political explanation for India's trade in goods will notbenefit Indiaand neither will freer membership and leadership of this club. India has always trade in services. prided itself on being a leader of the Third World. This The next section briefly examines domestic policy in is a hangover from the heady days of nonalignment and some important service sectors and the expected impact Nehru, Nasser, and Tito-and it is no coincidence that of trade liberalization on these sectors. 192 India Foreign Investment doors to foreign investment and new technology are slammed shut. It is no wonder that this group opposes the An important aspect of the political economy of India, introduction of trade in services; it resists other Indian and one that affects all sectors (goods and services), is entrants, so how do foreign investors stand a chance? the Indian attitude toward foreign investment. The lapse The second group is made up of Indian policymakers of time between application to invest and eventual ap- who believe it inappropriate to allow foreign investment proval is inordinately long, and foreigners find it to take "the cream of the cream." Their argument is that costly-hence their eventual decision to invest else- the domestic market is regulated and provides rents; why where. As world trade and international investment have should foreign corporations obtain rents at the expense burgeoned in recent years, foreign investment has also of Indian corporations? These policymakers feel that in exploded. While China was obtaining $2 billion to $3 a first-best world of competition, there would be no billion in fresh foreign investment inflows every year reason for opposing foreign investment. during the past few years (before the tragic events ofJune This argument is an important one, both because it has 1989), India was limping along with, at most, a couple a basis in economic theory (rather than narrow self-inter- of hundred million dollars. Reform of policies toward est) and because it has many followers in India. That foreign investment can affect export growth, as a com- foreign investors would obtain the cream is not in doubt. parison of India and China indicates. The two large But it is not clear why one should have to wait for the economies had almost identical levels of manufactured nirvanaof the first-bestworld to obtain economic growth exports in 1977-$3.73 billion for India and $3.68 bil- by way of foreign investment and technological upgrad- lion for China. The average annual growth rate for the ing. Clearly, supposing that foreign investment is al- decade 1967-77 was also fairly similar-16.8 percent lowed and that foreign investors compete with Indian for India and 15.1 percent for China, in nominal dollar investors and export more than they import (through terms. But after the policy change in China in 1977, remittances or inputs), why should one care whether a manufactured exports grew to $27.6 billion in 1987, foreigner or an Indian industrialist makes the profit? whereas the figure for India was only $8.9 billion in This is especially so since in a fast-changing technolog- 1987. That India's foreign investment policy has not icalworlditisatbestpresumptuoustobelievethatIndian changed is indicated by the fact that foreign investment firms can deliver new technology. And should not the in India is estimated to have increased to $250 million Indian industrialists' profit be weighed against losses to in 1988, whereas in smaller economies such as Malaysia the Indian consumer through bad-quality goods or bad and Thailand the figures are in the billions. service? But there is an important lesson in the answer There is a simple reason why foreign investment in to the last question: consumer choice has been systemat- India is extremely low: the rules and regulations are too ically and deliberately neglected by Indian poicymakers. stringent. Equity of more than 40 percent is not allowed, and that is the "good news." India, because of its political Telecommunications stability and potential for economic growth, does offer an attractive investment proposition, as is indicated by It is amusing to note that in this important and advanced the costs that corporations have incurred to obtain a technological field the argument most often bandied foothold in the protected Indian market. The recent ex- about is that of self-reliance. The architect of this policy ample of Pepsi-Cola is a graphic reminder of the tribula- was until recently a leading executive in telecommuni- tions and the gains involved in foreign investment. This cations in the United States. Although this attempt to firm had to lobby intensively for at least three years bridge the technological gap by a country not known for before it was allowed to enter India on condition that its its technological prowess would ordinarily be question- export-to-import ratio would be five to one (exports able, the special circumstances behind the "foreign stamp included processed foods). The fight against Pepsi- of approval" provided by the policymaker returned from Cola's entry was led by an Indian industrialist who is a abroad was considered sufficient reason to bet on suc- leader in the domestic soft drink market. cess. Some money would have been lost, however, since The opposition to foreign investment-whether in the policy targets are three to four years behind sched- goods or in services-is led by two groups. The first, and ule-nd foreign investment may now be allowed in. obvious, group consists of the industrialists and entrepre- Apart from the pursuit of self-reliance, there is a genu- neurs who have thrived in the regulated market; it in- ine economic reason for India's not wanting any compe- cludes both the private sector and, in the case of services tition within the telecommunications industry: "the (banking, insurance, telecommunications, and so on) the manufacture of public switching equipment is a govern- public sector. In the name of self-reliance and profits, the ment monopoly and equipment supply is regulated by the 193 Surjit S. Bhalla Indian government" (Saxena 1989a). The private sector tionally uncompetitive price structure. This led to the and foreign corporations (for example, NEC and Erics- emergence of kit-assembly units and fragmentation. son) are allowed in telecommunications manufacturing PMP (Phased Manufacturing Program) has been a (facsimile devices, cordless telephones, pay telephones, failure and indigenisation has remained a dream." and so on) on condition thatthe approvedcompanies will (BIcP 1989, p. 2.) transfer technology and increase exports. No action, of course, is expected by anybody (including Software the BICP) on the recommendations contained in this im- portant study. The growth of the world computer software industry in Apart from the fact that a lot of domestic assemblers recent years has been explosive. Unfortunately, the In- receive rent (and that many obsolete computers are sold dian software industry, notwithstanding the often-re- to computer-illiterate officials), the sad reality is that a peated claim that India possesses one of the largest potentially profitable service industry such as software technological manpower bases, has not partaken in this is not allowed to develop. Development of nonobsolete growth. In 1987 Indian software exports were less software requires modern machines-and modern soft- than $75 million-in a worldwide industry estimated ware. And it is highly unlikely that domestically assem- to be close to $80 billion. Could India have done bled PCs or minicomputers will allow Indian software better? engineers to partake in the world market. Edward There are two reasons why India has not done well in Yourdon, the publisher-editor of American Program- this area in spite of a comparative advantage. The first mer, commentedconcerning India's claims to becounted pertains to the desire for self-reliance common to many among the leaders (potential or actual) in software devel- Indian policymakers. A recent news magazine story re- opment, "If an analogy is drawn between software devel- ported how the claims of a major U.S. insurance com- opment and the aircraft industry, then the software being pany are sent daily for computerization and processing programmed in India is at the Wright brothers' stage, in Ireland. This exercise provides jobs, much-needed while the world demands are for advanced Boeings" foreign exchange (in terms of salaries), and experience (Economic Times, August 30,1989). in software development. Contrast that with the situation Again, the moral is the same. The domestic policy in India, where such an arrangement could be treated as regime makes it impossible for Indian entrepreneurs to a foreign intrusion. benefit from the changing and expanding world environ- The second reason has to do with Indian policy towards ment. The potential, however, is certainly there, in terms computer hardware. Domestic industry has been encour- both of absolute numbers and relative wages. A well- aged (at the expense of quality and technology), with the trained software engineer can be hired in India for less result that, according to reports, there are more than a than $500 a month. But the policymakers would rather hundred firms assembling personal computers (PCs) in protect a few computer manufacturers than allow the India, and theirtotalproduction in 1987 was40,000. (The Indian software industry to develop. World Bank considers that a single assembly plant The experience of a small Indian consultancy firm is should optimally handle about 55,000 computers.) A telling. On the basis of an export order for consultancy simple Indian-made PC (now obsolete in the United services, the firm wanted to import a software product States) sells for $1,500, and a more advanced computer called SAS. Ostensibly, software has been placed on open for about $3 ,500-prices that are about two to three times general license (oGL), and any importer can import items the world price. This fact is not unknown to some domes- on OGL without official permission as long as an import tic policymakers; a recent study by the Bureau of Indus- duty (60 percent in the case of software) is paid. The finn trial Costs and Prices (BICP) found that the Indian placed the order for the software, little realizing that a computer assembly industry was characterized by nega- Kafkaesque end-game was in store. Just before the pay- tive value added. The conclusions of this study are a valid ment was due to be released, the firm was informed that commentary on India's misguided industrial policy of the item was not on OGL after all and that it could be high tariffs and domestic competition: imported only with the permission of the Reserve Bank of India (Rm). Permission was duly sought from the RBI, Delicensing and deregulation was meant to generate and after much signing of documents, the import of SAS internal competition which would lead to decline in was about to be approved. But a snag was discovered: prices, and widening of the market. However, the prior permission of the Department of Telecommunica- absence of export-thrust, in conjunction with tions was needed. Documents were dutifully forwarded liberalisation of imports, have resulted in an interna- and meetings were requested and held, only for the firm 194 India to be told that SAS was within the domain not of that incentive to provide service, since the customer can only department but of the Departnent of Electronics. Unfor- go to another nationalized bank. Overseas, there is a tunately, foreign firms are not accustomed to inordinate growing number of Indians who, if given adequate ser- delays in payment for minor transactions of only $2,000, vice, would readily open an account with an Indian bank, and the domestic fm was in danger of losing both the particularly because of the economies of scale in trans- consultancy contractand the acquisition of sAS. The firm actions (for example, remittances to India). Indians approached the Department of Electronics, where the abroad, however, shun such banks simply because of the officials, on learning that the software to be imported was memory of bad service received at home. a data management and statistical package, objected that How would liberalization in banking services affect packages that manage data and do regressions were India? Again, without domestic policy reform, partici- domestically available. The case was referred back to the pation in the world system will entail losses. Customers RBI. After three months of trying, permission to import would seek out companies that provide service, and was not granted. It is tempting to dismiss the above story nationalized Indian firms may not have heard of this as apocryphal, but it is unfortunately true. And it hap- particular commodity. And if nationalized Indian firms pened in a year when an export drive was on and income open more branches abroad, will Indians and non-Indi- from exports was exempt from income taxation. ans flock to them? It is doubtful. The moral is the usual one: if a service industry has no incentive to provide Banking and Insurance service, it will not do so. The banking industry was nationalized in 1969. At pres- Insurance ent there are twenty nationalized banks, in addition to the State Bank of India and its eight associatebanks. Foreign Insurance is yet another industry nationalized in the banks in India are not banned-Citibank, American Ex- national interest A single firm, the General Insurance press, and others are allowed in India on a limited basis Corporation of India, has the entire market in its domain. with the proviso that each new branch has to be approved. Nationalization of insurance took place under the rubric Foreign banks are allowed to have only one branch in of "garibi hatao," or removal of poverty, in 1971, two large cities such as New Delhi. At the end of 1987 there years after the "experiments with socialism" were begun were 21 foreign banks (none with equity of more than 40 by Prime Minister Indira Gandhi. Indian insurance com- percent), operating 136 branches. In contrast, national- panies operate through subsidiary companies in thirty- ized Indian banks had more than 50,000 branches, with two countries; they sold insurance worth $50 million in about 6,000 in the metropolitan cities. Although the 1986-only $1.5 million per branch per year. Since domestic expansion of India's banks has been rapid insurance is nationalized, the profitability of these for- (deposits have increased twentyfold since 1969), expan- eign subsidiaries is unclear, but it is unlikely that many sion abroad has been painfully slow-from 45 branches non-Indians (or Indians) are buying policies from these in 15 countries in 1969 to 147 branches in 25 countries firms. in 1984 (Saxena 1989b). What will liberalization of trade in services do to the The nationalized domestic banks have to lend to the domestic insurance industry? It will hurt it-which is "priority" sectors at subsidized rates. But they are not why trade in insurance activity will be futile until the subsidized in turn and have to make up the losses by domestic industry is deregulated. If that happens, it is setting interest rates on consumer deposits below market likely that Indian firms, in this highly personalized activ- rates. Why cannot the banks be subsidized for the subsidy ity, will do much better than foreign entrants-if they are they offer to "priority sectors" and the banking sector be allowed access to the latest technology. But that would opened up to competition? It is politically not possible. mean a decrease in self-reliance. And why is it not politically possible? Which political interest group (besides the public sector banks them- LaborMigration selves) would lose if competition were introduced? None; but the subsidies, it is stated, would increase the Labor movement is the only area in which liberalization budget deficit. And would not the increase in banking without domestic policy reform will benefit the Indian efficiency increase economic growth through more pro- economy. Indeed, it is the one "service" area in which ductive investments (see McKinnon 1988) and therefore liberalization should be a major demand of the Indian increase incomes and reduce the deficit? negotiators. Rather than arguing that services do not Banking is a labor-intensive and now a computer-soft- belong in the GATT, Indian negotiators should take the ware-intensive industry. At present, the banks have little opposite line: services do belong in the GATr, and labor 195 Surjit S. Bhallt services are an essential component of trade in services. 1. Figures for other developing countries are available in Hock- As was shown above, such trade (primarily with the man, this volume. Persia Gulfcounties) as accuntedfor 1 to 2 per- 2. Premn Kusnar (India's Commferce Secretary) in New York Tines, Persian Gulf countries) has accounted for 15 to 20 per- October 2, 1985; quoted in Prasad (1989). cent of India's export earnings. Semiskilled labor is 3. Heller and Tait (1984) report that among about sixty contdes abundant and relatively cheap in India, and itis in India's considered, India had the largest share of govemment employees in nonagricultural employment-54.35 percent. The next highest were comparative advantage to export such services. There is Benin (49.8 percent) and Botswana (33.8 percent). little in economic theory or practice to suggest that such 4. The logic is eminently simplstic: since the belief is that com- services are outside the purview of negotiations. petition will lower prices, why not self-reliant competition in the form There is a genuine meeting point between those coun- of high tariffs and lots of inefficient domesui finns? 5. The BICP stuidy reports that almost 60 percent of total purchases tries (such as the United States) that argue against the of PoC is by the public sector. Further, "most PCs are used merely as introduction of labor services (the United States) and word processors, which is a very high-cost substitution for traditional those that might argue for completely free entry. Coun- typewriters in a rsource-scarce country" (BICP 1989, p. 2). tries such as the Federal Republic of Germany have shown that labor can migrate (for example, from Turkey) References on a job basis without immigrating. Ahluwalia,Isher J. 1989. "ProductivityinIndian Industry." Centerfor Policy Resesrch, New Delhi. Processed. Conclusions Bhagwati, Jagdish N., and Padma Desai. 1979. India: Planning for Industrialization. Industrialization and Trade Policies since 1951. This chapter has attempted to convince the reader of a Delhi: Oxford University Press for the Development Centre, omco. Bhagwati, Jagdish N., and T. N. Srinivasan. 1975. India. Special simple and often-repeated point that much of Indian Conference Series on Foreign Trade Regimnes and Economic De- economic policy has been a wrong for the past forty years vclopment 6. Cambridge, Mass.: National Bureau of Economic and that it is futile to attempt to make economic calcula- ReseSrch. Bhalla, StwJit S. 1989. "India's Exports, Imports and Exchange Rates: tions about the potential gains and losses from the intro- A Comparative Quantitative Analysis." The Policy Group, New duction of a trade in services agreement under the GATr Delhi. Processed. or any other organization. Nor is it worthwhile to exam- BaCP. 1989. Report on Computers and Peripherats. Vol I. New Delhi. ine India's international position on such matters (for Ghose, Lolita. 1989. "Export Subsidies-What You See Is Not What You GeLt" Paper prepared for the Confederation of Engineering purposes of negotiation), since the positions are those of Industries. The Policy Group, New Delhi. Processed. a bit player in intemational trade in goods and services Heller, Peter S., and AUen TaiL 1984. Government Employmsent and and do not themselves have much economic content. Pay: Some International Comparisons. IMF Occasional Paper 24. Washington, D.C.: Intemational Monetary Fund. The straightforward fact is that the economic calculus Jethanandani, Kishose. 1989. "India and Its Asian Competitors in the has not been a factor behind economic decisions in India World Textile Market: Trade Flows in a Quota Controlled Trade (although a marginal improvement has been observed in Regime 1971-1986." The Policy Group, New Delhi Processed. recent years). The policymakers have been involved in a Lucas,RobertE. B. 1986."Demandforlndia'sManufactusdExports.- recent years). The policymakers J~-ournal of Development Economics 29(l):63-76. loop of their own making, and, as with all loops, only a Manmohan Singh. 1964. India's Exports. Oxford University Press. tangential attempt will allow escape. It should also not Nayyar. Deepak. 1987. "India's Export Performanmc, 1970-5: Un- be forgotten that the policymakers (bureaucrats, intellec- derlying Factors and Constraints." Economic andPolitical Wee ky, BOhMAy. Anntal number (May). tuals, industrialists, and politicians) have benefited enor- P OMsad, L 1989. "Levelling the Playing Field in Intemational Trade in mously, in both monetary and nonmonetary terms, from Services." Paper prepared for an uNcrAD-lauER seminar, IJER, the existing apparatus of discretionary decisionmaking. New Delhi, April 27-28. Only amajor economic reform will allow In"a to Saxena, R. B. 1989a. "Role of Services in the Development Process: Only a major economlc reform wll allow toA Study of India's Selected Producers Services." Paper prepared change its stance on international issues. There is a for an umcrAD-aER seminar, New Delhi, April 27-28. creeping realization that India has lost out in the devel- Saxena, S. S. 1989b. "oATr and Services: StrategyforNegotiations on opment race and that a principal reason has been its Services." Paper prepared for an uil27-ata semlina, xtZP, New Deli.i April 27-28. autarkic policies. Once economic reform allows genuine Srinivasan, T. N. 1989. "India's Foreign Trade Policy and the Political competition, gains from external and internal trade in Economy of Development Planning." Yale University, New goods and services will automatically follow. Haven, Conn. Processed. uNcrAD. 1988. Trade and Development Report. New York. Wolf, Martin. 1982. India's Exports. Oxford University Press. Notes World Bank. 1987. "India: AnIndustrializing Econorny inTransitios." Report 6633-IN. Washington D.C. The author is grateful to Indrani Iyer for discussions and research assistance. 196 20 Brazil Carlos Alberto Primo Braga Brazil has traditionally played an active role in multilat- would be best served by the use of regulatory instruments eral organizations, and the negotiations under the Gen- other than restrictions on foreign capital investment in eral Agreement on Tariffs and Trade (GATT) are no services. exception (see Martone and Primo Braga 1988). The discussions on extending GAIT disciplines to interna- Brazil and the Multilateral Negotiations on tional trade in services provide a contemporary example Services of Brazil's engagement in the multilateral arena. This diplomatic activism has not precluded free-rider As table 20-1 shows, service activities, as defined for behavior in the previous GATr rounds. (Brazil entered the national income accounts purposes, have maintained a Uruguay Round with only 600 tariff positions-approx- relatively stable share of the gross domestic product imately 5 percent of the total-bound under the GA1T.) (GDP) over the past five decades. The share of employ- Since the end of the Tokyo Round, however, industrial ment in services in the total labor force has increased countries have been stepping up their demands for reci- from 24 percent in 1950 to 31 percent in 1965 and to 42 procity in trade negotiations, particularly with respect to percent in 1980 (ILo 1986; World Bank 1988). All of newly industrialized countries, and Brazil has been one these figures tend to underestimate the real economic of the principal targets of this campaign. The growing size of the service sector because they do not adequately demand for reciprocity and the U.S. push to include the cover the informal sector, which is highly intensive in "new themes" in the GA1T agenda posed problems for service activities. (See Bhagwati 1987c, pp. 20-21, on Brazilian negotiators. In the Uruguay Round Brazil is for problems with developing country data on services.) the first time being asked effectively to match trade The relative stability of the share of services in GDP concessions offered by other contracting parties. In ad- masks significant structural changes in the sector. During dition, several issues on the table are perceived by Brazil the 1980s, for instance, communications and financial as "zero-sum games" in which benefits for industrial activities grew at a much faster pace than other service countries would imply losses for Brazil. The negotiations industries such as commerce and transport.1 Although it on services constitute one of the most important cases in would be inappropriate to assume that Brazil is about to this regard. (Other topics in the negotiating agenda that enter a tertiary stage of economic development, knowl- are considered to be against Brazilian interests are trade- edge-based service industries have been among the most related aspects of intellectual property rights-TRIPs- dynamic sectors in the Brazilian economy in the 1980s.2 and trade-related investment measures-TRLMs. See Furthermore, the sheer size of the service sector suggests Martone and Primo Braga 1988, table 10; Primo Braga the importance of trade negotiations in this area for 1989a.) Brazil. Brazil's resistance to negotiations on trade in services The pressure to broaden the scope of the multilateral has been both ideological and pragmatic. At the ideolog- negotiations to include trade in services may be traced ical level, Brazil refuses to accept as a development back to the 1970s (see Feketekuty 1988). It was only in policy theruleof static comparative advantage underfree November 1982, however, that the United States for- trade. At the pragmatic level, Brazil is concemed about mally presented at the GATT ministerial session in Ge- foreign direct investment in this area under the misappre- neva a proposal for a new round of multilateral trade hension that free trade in services is synonymous with negotiations that would emphasize the "new themes"- laissez-faire. Itis argued here that the Brazilian economy services, TRIPs, TRiMs, and high-technology products. 197 Carlos Alberto Primo Braga Table 20-1. Sectoral Shares of Gross Domestic Product, Brazil, at Factor Cost and Current Prices (percnt) Year Agriculture Industry Services 1939 16.9 25.5 57.6 1950 17.8 30.1 52.5 1960 15.0 32.5 52.4 1970 10.1 35.9 54.0 1980 13.0 34.0 53.0 Source: Conjunlura Econouca (vanious issues). The proposal encountered strong resistance from devel- September 1986. A dual-track approach was adopted as oping countries. Although this opposition and the Euro- a compromise between the conflicting views on services. pean Community's lack of enthusiasm about the idea of There were, however, some important differences with a new round in the middle of an economic recession respect to Brazil's 3riginal proposal. The negotiations derailed the U.S. campaign, the Ministerial declaration were to be conducted under GA'Tr auspices, procedures, did include a recommendation that interested contracting and practices. And even though the Uruguay Round was parties prepare national studies on services and that the launched "as a 'single political undertaking' comprising GATr be used as an informal forum for exchanging the two legally independent negotiating processes, one on study results. goods within GArr and the other outside GATr on ser- Throughout this process, Brazil opposed the U.S. ini- vices" (Nogueira Batista 1987, p. 21), the ministers of the tiatives for both practical and ideological reasons. Prac- contracting parties authorized the Group on Negotiations tically, the natural negotiating strategy for Brazil, given on Services (GNS) to report to GATT's Trade Negotiations its structure of comparative advantages, was to empha- Committee. The central issue of whether these negotia- size the backlog of problems in the multilateral trade tions would lead to an extended GATT (the U.S. position) system. (This theme also allowed Brazil to capture the or to a "services compact" outside the GATr (the Brazil- high moral ground by stressing the numerous industrial ian position) was not explicitly addressed by the Punta country trade policies that were maintained in open de- del Este declaration. fiance of GATT disciplines.) There was also a perception In the initial stages of the negotiations Brazil adopted that the U.S. campaign tended to stress liberalization in a "muddling-through" strategy designed to buy time. It service industries in which Brazil was not competitive, argued that not enough was known about service indus- and this perception was transformed, by way of a mer- tries in developing countries. and that the negotiating cantilistic calculus, into the concept of a zero-sum game. experience already accumulated by the countries of the The ideological motivation reflected the belief that the Organisation for Economic Co-operation and Develop- U.S. proposals were nothing more than a sophisticated ment (OECD) in this area put developing countries at a new form of colonialism aimed at reserving knowledge- disadvantage. Brazil accordingly suggested that initial intensive industries for the developed countries.' efforts should be directed toward data collection, and it The "blockade" strategy, which centered on the issue refused to accept proposals for "fast-track" negotiations of GATr's competence to address trade in services, suc- on services. The United States in its turn pushed the ceeded in delaying the negotiating process. But as time negotiations in the direction of the application of GAIT went by, its effectiveness decreased; the reaction of the principles to services and pressed for a fast pace (see industrial countries led to a gradual isolation of the Yeutter 1986,1988). "hard-liners" led by Brazil and India. In 1985 Brazil took In a parallel movement, Brazil raised doubts about the the initiative in offering a compromise, formally present- wisdom of pursuing negotiations without a better under- ing the "dual track" approach as a way of addressing the standing of basic concepts-for example, of what ex- "old" problems of the multilateral trade system in parallel actly constitutes trade in services. The target here was the with negotiations on services (see Maciel 1986; U.S. emphasis on"rights ofestablishment"asanecessary Bhagwati 1987a, 1987b). Under this proposal, however, component of a move to liberalize trade in services. the negotiations would not necessarily be under GATT Brazil refused to accept the idea that services transac- auspices or use GATr procedures, and linkages between tions of subsidiaries of transnational corporations in a negotiations on goods and on services were considered country's domestic market should be treated as intema- unacceptable. tional trade (see Brazil 1988a). Brazil also pointed out After tense negotiations that at tdmes led analysts to fear that trade liberalization was not an end in itself but a for the future of the GA1T, the eighth round of the possible means of promoting economic development. It multilateral trade negotiations was finally launched in argued that the whole negotiating process should be 198 Brazil informedby this ultimate goal and that developing coun- The future of Brazil's participation at the GNS seems to tries should be granted special and differential treatment. be inevitably entangled with the evolution of the debate The intellectual underpinnings of Brazil's conceptual on foreign direct investment in services. Brazil's poli- queries can be summarized as follows. cies toward the service sector should not, however, be discussed only from the perspective of the trade negoti- * Legal. Brazil argued that since GAT[ does not cover ations. The relevant issue for Brazil is to identify the set foreign direct investment or guarantee that a con- of domestic policies for the service sector that will max- tracting party should have access to the resources of imize the country's economic welfare. To address this another contracting party, there was no GATE legal question, the next two sections survey the competitive- precedent for the U.S. position that restrictions on ness of Brazilian service industries and the principal foreign direct investment should be considered bar- regulations that apply to the sector. riers to trade.4 * Economic. Brazil challenged the validity of the The Competitiveness of the Brazilian Service comparative advantage concept as a basis for under- Sector standing trade in services (see Dias 1988; Brazil 1988a). The pervasive existence of noncompetitive Table 20-2 summarizes the services account in Brazil's market structures in services, the importance of in- balance of payments. As is well known, this type of data trafirm trade, the use of restrictive business practices tends to underestimate the importance of international by transnational corporations, the perception of sig- trade in services.5 Nevertheless, the table suggests that nificant positive externalities, and, in many cases, the Brazilian economy has been experiencing a recurring the requirement of factor mobility were cited as deficit in its service transactions with the rest of the indications that the positive and normative prescrip- world. As one would expect of a country that has histor- tions of conventional trade theory could not be ap- ically relied on foreign savings for its development, the plied to trade in services. Government intervention items related to past capital flows (interest, profits, and in trade in services was accordingly presented as dividends) are the main sources of this chronic deficit. It economically justifiable. is true that these items-particularly interest income that * Political. Such noneconomic considerations as the banks earn on foreign loans-are not included in the importance of national control of services for na- most frequently used definitions of trade in services. tional security and cultural integrity were cited as (The debate on definitions is summarized in Feketekuty further arguments against restricting the sovereign 1988, ch. 5; see also Sapir 1982 and Sampson and Snape right of a nation to regulate domestic economic 1985.) The performance of the remaining service-re- activities at will. lated components of the balance of payments, however, confinms the picture of Brazil as a net importer of ser- Despite Brazil's resistance to discussions on the appli- vices. cability of GATr disciplines to trade in services, the From 1982 on, the deficits in nonfactor services as well debate in the GNS rapidly evolved in that direction, under as in transactions associated with technological transfers the influence of several proposals from developed coun- tended to decrease. This development, however, was tries. At the same time, the coalition of developing coun- related more to macroeconomic factors than to improve- tries regarding negotiations in services was weakened; ments in the competitiveness of the country's service some of these countries adjusted their negotiating agen- industries or technological capacity. In response to the das to reflect other priorities (Argentina and agriculture, foreign debt crisis Brazil initially adopted a mix of trade for example) or developed a more explicit negotiating and macroeconomic policies designed to enhance its position on services (India and the issue of labor-inten- balance of trade surplus.6 As a consequence, the deficit sive services; see Balasubramanyan 1987). On the eveof in transport (the main item among nonfactor services) the Montreal ministerial meeting in December 1988, fell significantly as imports declined and the demand for Brazil had already adapted to these developments. It registration and operation of foreign ships under the continued to refuse to discuss issues related to foreign Brazilian flag diminished. (As noted in GArr 1989, p. 33, direct investment, but it brought up a series of consider- "Brazil records shipment only when foreign carriers are ations on the applicability of GATT7 concepts-transpar- involved, and not when its substantial merchandise ex- ency, for example-to services, and it acknowledged ports are transported on Brazilian carriers.") In a parallel that multilateral disciplines should contribute to the grad- development, the principal import among technology-re- ual elimination of restrictions on international trade in lated services, specialized technical services, fell dra- services (see Brazil 1988b). matically as Brazil's economic crisis led to a curtailment 199 Carlos Alberto Primo Braga Table 20-2. Services Account, Brazil, Selected Years (mnillions of dollars) Item 1950 1960 1970 1975 1980 1982 1984 1986 1988' Total -283 -459 -815 -3,238 -9,740 -15,526 -12,743 -13,246 -14,370 Receipts 43 193 378 1,328 3,144 3,294 3,203 2,783 3,046 Payments -326 -652 -1,193 -4,566 -12,884 -18,820 -15,946 -16,029 -17,416 Capital income b -74 -155 -353 -1,674 -6,621 -11,940 -10,999 -10,678 -11,371 Interest -27 -115 -234 -1,440 -6,311 -11,354 -10,203 -9,327 -9,832 Receipts 2 3 50 364 1,146 1,197 1,246 918 759 Payinents -29 -118 -284 1,804 -7,457 -12,551 -11,449 -10,245 -10,591 Profits and dividends -47 -40 -119 -235 -310 -586 -796 -1,351 -1,539 Receipts - 1 - 2 234 277 3 41 2 Payments -47 -41 -119 -237 -544 -863 -799 -1,392 -1,541 Otherservices -209 -304 462 -1,564 -3,119 -3,588 -1,744 -2,568 -2,999 International travel -3 -48 -130 -313 -241 -846 -153 -509 -589 Receipts 5 24 30 71 126 65 65 85 117 Payments -8 -72 -160 -384 -367 -911 -218 -594 -706 Transport -121 -78 -185 -917 -1,936 -1,456 -760 -826 -1,015 Receipts 16 46 159 356 814 998 1,295 1,147 1,314 Payments -137 -124 -344 -1,273 -2,750 -2,454 -2,055 -1,973 -2,329 Insurance -9 -7 -13 2 86 -18 -114 -117 132 Receipts 1 4 10 54 138 84 37 60 337 Payments -10 -11 -23 -52 -52 -102 -151 -177 -205 Govermment -38 -12 -69 -237 -112 -122 -120 -193 -558 Receipts 9 31 36 82 59 62 74 52 65 Payments -47 43 -105 -319 -171 -184 -194 -245 -623 Sundry -38 -159 -65 -99 -916 -1,146 -597 -923 -969 Receipts 10 84 93 398 628 610 484 480 452 Payments 48 -243 -158 497 -1,544 -1,756 -1,081 -1,403 -1,421 a. Prelminary. b. Does not include reinvested profits. Source: Central Bank of BraziL of investment.7 As table 20-3 illustrates, trade in ser- among the top fifteen international air freight carriers, as vices (including nonfactor services and technology-re- classified by metric ton-kilometers logged.8 And a few lated service activities) did not expand during the 1980s Brazilian construction firms-for example, Mendes Jr. either as a proportion of trade in goods or in relation to and Norberto Odebrecht-won a place among the lead- GDP. ing international contractors in the early 1980s (see Veri- The picture that emerges from this data reinforces the llo 1988, pp. 181-86; OTA 1987, table 14). perception of Brazil as an inward-oriented economy. At Even with these qualifications, the analysis of the de- the world level, Brazil's participation in trade in nonfac- gree of internationalization of the Brazilian service in- tor services remains marginal. In 1984, for instance, dustry presented so far is incomplete. An important Brazil was ranked thirty-fourth among exporters of non- channel for the internationalization of service activities factor services, with a share of 0.50 perrent of world at the global level has been foreign direct investment. exports, and twenty-sixth among importers of these ser- Many analysts have called attention to the fact that vices, with a share of 0.85 percent of world imports (OTA foreign direct investment in services has been growing 1987, p. 69). Of course, sectoral analyses qualify these at a faster pace than trade in services (as defined for observations. International trade has always been impor- balance of payments purposes).9 tant for service industries such as shipping, tourism, and Transnational corporations are the main actors in this motion pictures. For others, such as engineering and process whereby service-related investments have been construction services, the degree of international in- responsible for a growing share of the total flow of volvement has increased significantly since the mid- investments originating in developed countries. Brazil 1970s. Furthermore, several Brazilian companies are has maintained that the right of establishment should not important actors on the international scene. In 1986 be addressed in the Uruguay Round (see Brazil 1988b, Varig was the only developing country carrier to rank p. 2). There are two basic problems with this approach. 200 Brazil Table 20-3. Trade in Services as a Share of Trade in Goods and of GDP, Brazil, 1980-88 (percent) Trade in services as share of 1980 1982 1984 1986 1988 Trade in goods 15.4 18.3 13.8 17.1 15.6 GDP 2.8 2.5 2.6 2.3 2.2 Note: Trade in services is defined as exports plus imports of nonfactor services and transactions associated with technological transfers. Source: Compiled by the author on the basis of Central Bank of Brazil data. First, in the case of services the distinction between surprising, in that services are regulation-prone both for barriers to trade and barriers to investment is even more economic reasons (the existence of natural monopolies, imprecise than in the case of goods. Physical proximity imperfect information markets, and perceived extemali- between consumers and providers-or, in more general ties) and for noneconomic reasons such as concern about terms, factor relocation-is often a necessary condition national sovereignty (see Hindley and Smith 1984). In for the efficient provision of many services. As a conse- the case of Brazil, the impact of growing regulation was quence, the broader the scope of the negotiations, the magnified by macroeconomic instability; control of the larger the potential benefits of trade liberalization will rates chargedby public utilities, forinstance, fostered the be. Second, Brazil's approach does not address the ques- gradual nationalization of these companies, given the tion of the proper policy toward foreign direct investment prevailing inflationary environment. in service activities. The possibility that unilateral liber- The adoption of an explicit import-substituting indus- alization may be attractive on its own economic merits trialization strategy in the second half of the 1950s in- is often missed when the debate is dominated by a creased the attractiveness of the Brazilian market for mercantilistic calculus, as tends to occur in trade negoti- foreign manufacturing companies. Foreign direct invest- ations. (This point is also made by Hindley 1988.) ment became a natural "tariff-hopping" tactic, and trans- national corporations were major beneficiaries of the Regulations That Affect Foreign Direct Invest- rents generated by the Brazilian trade regime. This also ment and Trade in Services contributed to diminishing the relative weight of service- related foreign direct investment with respect to foreign The history of foreign capital involvement in Brazil's direct investment in the manufacturing sector. services sector dates back to the nineteenth century. In By the late 1970s foreign direct investment in services the first decades after independence in 1822, foreign (including reinvestment) accounted for only 19 percent interests were concentrated in shipping and import-ex- of the total stock of foreign capital in the Brazilian port activities, including trade financing. In the second economy (see table 20-4). And this figure, which has half of the nineteenth century, foreign direct investment remained relatively stable, overstates the weight of ser- played a significant role in building up the country's vice-related investments to the extent that it includes infrastructure. By 1929, on the eve of the modem indus- foreign direct investment in holding companies that con- trialization era in Brazil, the sectoral distribution of trol activities in manufacturing, mining, and agricul- foreign direct investment showed a heavy concentration ture. Of course, this aggregate stability masks changes in service-related activities, particularly railroads and in the composition of foreign direct investment in ser- urban public utilities. Since then, foreign capital has vices over time. The participation of foreign capital in gradually shifted away from the service sector and to- financial services, for instance, has increased faster than ward manufacturing. This evolution was basically the in most other service industries. The aggregate data, resultant of two forces: the impact of government regu- however, suggest that internationalization of the services lations and the proindustrial bias created by Brazil's industries through foreign direct investment is notoccur- development and trade policies. ring in Brazil with the same vigor as in industrial coun- The overall environment for foreign direct investment tries. Foreign direct investment in services accounted for in Brazil remained favorable until the 1980s. The consti- approximately 40 percent of the world stock of foreign tutions of 1946 and 1967 and the constitutional amend- direct investmentby themid-1980s, and about SOpercent ment of 1969, as well as ordinary laws and regulations, of new worldwide foreign direct investment flows are were relatively liberal in their treatment of foreign capi- now service related (GAiT 1989, p. 42). This difference tal. (For a summary of the modern evolution of Brazil's between these figures and those for Brazil may be ex- legislation toward foreign capital see Almeida 1989.) plained in part by the asymmetry in macroeconomic Service industries, however, were increasingly affected performance between Brazil and the industrial nations by government regulations. This development was not during the 1980s (see Primo Braga 1989c). But the 201 Carlos Alberto Primo Braga Table 20-4. Foreign Direct Investment (FDI) in Services, Brazil, 197148 (millions of dollars; figures in parentheses are percentage shares) Sector 1971 1975 1978 1980 1982 1984 1986 1988 Public utility services 157 219 238 43 45 44 55 58 (36.3) (15.5) (9.3) (1.2) (1.0) (1.0) (1.0) (0.9) Productionanddistributionofelectricity 142 205 210 0 0 0 0 0 (32.8) (14.5) (8.2) (0) (0) (0) (0) (0) Production and distribution of gas 6 .. 7 6 .. (1.4) () (0. 3) (0.2) (w ,) (, Maritime andriver transport 9 11 7 9 17 18 17 20 (2.1) (0.8) (0.3) (0.3) (0.4) (0.4) (0.3) (0.3) Highway transport .. 3 12 25 25 23 33 33 (..) (0.2) (0.5) (0.7) (0.6) (0.5) (0.6) (0.5) Air transport .. .. 1 1 1 2 3 3 ( G ()()) ( ( ) (0.1) ( ) Sewerage 0 .. 1 2 1 1 1 2 Water supply 0 0 .. .. .. .. 1 1 (O) (O)()()()()()() Financial services 81 369 496 572 771 849 1,129 1,496 (18.7) (26.2) (19.5) (16.5) (17.3) (19.4) (21.2) (23.6) Conmmercial banks 67 180 260 328 467 552 772 943 (15.5) (12.8) (10.2) (9.5) (10.5) (12.6) (14.5) (14.9) Investment banks 14 169 207 217 222 219 258 295 (3.2) (12.0) (8.1) (6.3) (5.0) (5.0) (4.8) (4.6) Other financial institutions 0 20 29 27 82 78 99 258 (0) (1.4) (1.1) (0.8) (1.8) (1.8) (1.9) (4.1) Otherservices 195 822 1,812 2,853 3,637 3,494 4,148 4,796 (45.0) (58.3) (71.2) (82.3) (81.7) (79.6) (77.8) (75.5) Real estate 3 35 62 107 120 121 140 166 (0.7) (2.5) (2.4) (3.1) (2.7) (2.8) (2.6) (2.6) Insurance 8 19 51 87 81 84 94 100 (1.8) (1.3) (2.0) (2.5) (1.8) (1.9) (1.8) (1.6) Tourism 4 12 19 20 21 27 28 29 (0.9) (0.9) (0.7) (0.6) (0.5) (0.6) (0.5) (0.5) Consulting, property management, advertising, and so on 77 464 1,152 1,798 2,337 2,067 2,649 3,080 (17.8) (32.9) (45.2) (51.8) (52.5) (47.1) (49.7) (48.5) Technical services and auditing 19 89 147 201 265 324 190 233 (4.4) (6.3) (5.8) (5.8) (6.0) (7.4) (3.6) (3.7) Trade, including export and import 82 203 381 640 813 871 1,047 1,188 (18.9) (14.4) (15.0) (18.5) (18.3) (19.9) (19.6) (18.7) Publicity 2 0 0 0 0 0 0 0 (0.5) (0) (0) (0) (0) (0) (0) (0) TotalDlinservices 433 1,410 2,546 3,468 4,453 4.387 5,332 6,350 (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) FDI in services/total FDi (percent) 14.9 19.3 18.5 19.8 21 19.2 19.1 20.7 ... Less than $0.5 mnillion or 0.2 percent. Note: All data refer to the FDt position (investnents plus reinvestinents) at the end of the year, except for 1988 data, which refer to the end of June. Source: Compiled by the author on the basis of Central Bank of Brazil data and Goncalves (1988, p. 103). dynamism of knowledge-based service industries in Bra- substitution policy for the sector. The role of transna- zil throughout the decade indicates that something else tional corporations, diminished significantly in compar- is at work. ison with the experience with irnport substitution in The explanation seems to be related to the evolution of manufacturing. In part, this difference simply reflected government policies toward service activities. In addi- preexisting restrictions on foreign control in some sec- tion to the growing array of regulations for service indus- tors-for example, certain transport activities and the tries, Brazil has implemented an explicit import news media-or the nationalization of the sector, as in 202 Brazil telecommunications.13 In other cases new regulations To sum up, Brazilian service industries operate in a were introduced with the explicit goal of promoting highly regulated environment. 5 The regulations have a domestic entrepreneurship in knowledge-intensive sec- significant antitrade bias, as the information summarized tors such as telematics (computer software, data process- in table 20-5 suggests. Some of these regulations are ing, information services, and the like). similar to nontariff barriers and basically restrict trade in The new regulations were not created in a vacuum; they nonfactor services. Others control the movement of ser- were closely associated with the adoption of interven- vice suppliers, mainly through restrictions on foreign tionist policies designed to foster high-technology sec- directinvestment.Andsomeregulationscartelizecertain tors in the Brazilian economy. The best-known example service activities by restricting the access of new en- in this area is the market reserve policy for loca1ll owned trants, whether foreign or national. minicomputer and microcomputer companies. 4 This Some analysts tend to dismiss the utility of regulation policy began to evolve about 1976 and was made law inventories by arguing that national "regulation of the with overwhelming congressional support in 1984. A services sector is constituted by state intervention in the company that wishes to operate in the mini and micro pursuitofnationalpolicy objectives which remnain within segments of the computer market must have at least 70 the sovereign right of governments" (Nayyar 1987, p. percent of its stock under Brazilian ownership, and if 12). This is a truism that does not address the basic there is a minority foreign partner, Brazilian control of economic question posed by these regulations: their net the technology is required. A parallel development oc- economic cost. Accurate estimates of these costs would curred in telecommunications equipment (see Banco require detailed sectoral analyses-a task that is beyond Nacional de Desenvolvimento Economico e Social the scope of this article. There are, however, many indi- 1988; Inter-American Development Bank 1988; Mody cations that these costs are substantial. 1989). TELEBRAS, the state-owned holding company for Brazil's financial sector, for instance, has one of the the telecommunications sector, has used its monopsonist lowest efficiency indexes in Latin America.16 Knowl- power to force transnational corporations to transfer edge-intensive service activities are burdened by high- majority voting rights to Brazilianpartners as acondition cost inputs developed under market reserve conditions. for continuing to qualify as suppliers for TELEBRAS' The Reinsurance Institute of Brazil (Instituto de affiliates. The company has also used procurement poli- Resseguros do Brasil), a government organization that cies to foster local research and development. Despite has the monopoly on reinsurance operations in the coun- these discriminatory policies, transnational corporations try, accumulated huge losses when it was exposed to are allowed to maintain majority equity positions in their export rivalry in an ill-fated attempt to export services jointventures, and there have been no attempts to impose during 1975-82 (see Soares '986, pp. 47-48). Many technological control as in the case of the market reserve analysts regard the Brazilian fleet for general freight as for computers. technologically outdated (see Sanson and Garlow 1986; As one would expect, these policies are tantamount to Motta Veiga and others 1988). Against this background, a tax on the provision of knowledge-intensive services. the next section analyzes the costs and benefits for Brazil Prices for microcomputers and minicomputers-and, to of liberalization of trade in services. an even greater extent, for peripheral equipment-are well above international levels. Telecommunications Liberalization of Trade in Services: Benefits equipment also sells at a premium in the protected Bra- and Caveats zilian market. (see Inter-American Development Bank 1988, pp. 159-66). The economic benefits of liberalization for Brazil would Strategic trade policy-basically, the concept of mar- tend to take the form of a more efficient service sector, ket reserve-was enshrined in the Brazilian constitution Brazilian firms and consumers would have available of 1988. The overall tone of the new constitution regard- services with a better combination of price and quality. ing foreign capital is not as liberal as that of its predeces- Given the large size of the Brazilian service sector, a sors. The possibility of explicit discrimination is hinted liberalization movement could be expected to yield sig- at by the introduction of the concept of the "Brazilian nificant welfare gains-the more so because most of company of national capital" (seeBrazil 1988c, art. 171). these services are intermediate inputs for other produc- Itis true that the constitution's ultimate impact on foreign tive activities. capital will depend on the complementary legislation, There are, however, important qualifications to these but its general thrust does not seem to favor trade liber- conclusions, derived from the normative prescriptions of alization or foreign direct investment. the theory of comparative advantage. First, trade liberal- 203 Carlos Alberto Primo Braga Table 205. Impediments to Trade in Services in Brazil Sector Type of barrier Description Air transport Entry restrictions Foreign companies can serve the Brazilian market only if authorized by bilateral agreements Regional transport is reserved for national regional airlines Domestic requirement Computerized reservation systems can be provided only by local companies Government procurement Government favors national companies in its acqui- policies sitions of air services Banking Prohibition of certain kinds Foreign investment in the savings and loan sector is of deposits and services not pennitted Limitation on expansion of In practical terms, Brazilian authorities have not al- branch networks lowed foreign direct investment in commercial bank- ing, even through the expansion of existing subsidiaries and branches of foreign banks Restrictions on access to Banco do Brasil and state-owned banks are the bank- govemment deposits ers for the public sector Constraints on investment Foreign banks are allowed to have a maximum voting portfolios control of 33 1/2 percent and up to 50 percent own- ership of the capital investment banks Business services Advertising Govemmentprocurement National companies are favored in contracts con- policies trolled by the public sector Quotas No more than one-third of advertising may be of foreign origin Accounting, law, Personnel qualifications Professional requirements are tantamount to barriers management consulting to practice by holder of foreign degrees Construction and Domestic requirement Two-thirds of employees must be Brazilian national- engineering Tax discrimination Tax discrimination Tax rate is higher for foreign than for local engineers Personnel qualifications Foreign engineers (graduated after 1961) are required to take a qualifying exam to practice Bureaucratic barriers Technical service contracts provided by foreign com- panies must be approved by the Instituto Nacional de Propriedade Industrial Films, television, Entry restrictions Television and radio stations may be controlled only radio, and video by Brazilian nationals products Quotas Cinemas are required to program Brazilian films at least 140 days a year At least 25 percent of the titles offered by video outlets must be Brazilian films Domestic requirement Local work and local contract requirements apply to film production Short Brazilian films must be screened Insurance Entry restrictions Since 1966 nonew authorization to transact insurance has been granted 204 Brazil Sector Type of barriers Description Constraints on investment Foreign capital may control no more than 50 percent portfolios equity and 30 percent of voting stock Restrictions on foreign supply Import insurance has to be placed with national com- panies Government procurement State companies are required to use 100 percent na- policies tionally controlled firms Shipping Domestic requirement The owners, the commanders, and at least two-thirds of the crew members of national ships must be of Brazilian citizenship Cabotage restrictions Inland and coastal waterways are reserved exclu- sively fornational shipping, exceptif public necessity dictates otherwise Cargo preference 40 percent of general cargo in international trade is to be carried by Brazilian-flag ships Telecommunications Entry restrictions Telecommunications activities are a state monopoly and telematics Market reserve or "law of similars" apply to the provision of certain information services (for exam- ple, provision of software) Control of transborder data Commercial data processing abroad not allowed ex- flows cept under exceptional circumstances Government procurement Government may favor the acquisition of software policies produced by national companies Discriminatory fiscal benefits Special income tax deduction for users of national software Tourism Discriminatory treatment Fiscal and credit incentives only available to compa- nies under national control Note: There are many other trade barriers that are not service-specific but that affect trade in services. Among them is Brazil's complex system of foreign exchange controls. Sources: Based on infonnation available in Brazil (1988c); Coopers & Lybrand (1986); Gongalves (1988); Kasper (1988); Lee and Walters (1988); Motta Veiga and other (1988); UaT (1989); Walter (1988); White (1988); and Wildman and Siwek (1988). ization in itself is not a sufficient condition for a more supplier. Accordingly, general statements such as those efficient supply of services in the domestic market. For presented above are often disputed. example, if the opening of the service sector to foreign Some of these doubts usually evolve into noneconomic direct investment is not accompanied by the correction arguments for protection. For example, comparative ad- of faulty government regulations, the end result will be vantage may be cited as a rationale for trade that requires a mere redistribution of the rents generated by the regu- factor relocation. But concerns about transnational lations. (See the analysis of the opening of the Korean corporations' command of market power and about the insurance market in Cho 1988.) Such an outcome may potential for interference by these firms in domestic even generate negative welfare effects from a national politics may be strong enough to foster protectionist point of view. Second, there are legitimate doubts about measures despite considerations of efficiency. The most the adequacy of conventional normative prescriptions interesting qualifications, however, appear in the context for liberalization of trade in services-for example, in of noncompetitive market structures or service activities the case of a country that faces a monopolistic foreign that promote positive externalities. 205 Carlos Alberto Primo Braga The provision of many services requires significant concern reflects partial-equilibrium analyses focused on investments in infrastructure and expensive maintenance the results of a relaxation of trade restrictions; in reality, of distribution networks-transport and telecommunica- the net effect on the balance of payments is uncertain. tions are examples. These high fixed costs open the Other factors to be taken into account are the possibility possibility of increasing returns to scale and thus of that exports of both goods and services will expand in imperfect competition. Imperfect competition does not response to the reduction of the antiexport bias in the alter the conventional wisdom about the superiority of economy and that the reform will induce additional cap- free trade over autarky, but it does raise the prospect that ital inflows. Furthermore, the fact that Brazil has consis- government intervention will improve welfare more than tently been a net importer of services must not be will the market outcome (see Krugman 1987). Knowl- interpreted as a demonstration of across-the-board lack edge-intensive sectors, in turn, notonly are characterized of competitiveness in services. Brazil has already dem- by economies of scale (because of the fixed-cost aspect onstrated its international competitiveness in several ac- of research and development) but also offer many learn- tivities, such as civil engineering and construction, and ing possibilities that can lead to intertemporal positive in others, such as tourism and production of software, the externalities. potential for growth in a competitive environment is The "new interventionism," which is quite popular in significant. Brazil, provides a fresh rationale for continuing a devel- The identification of winners and losers in the event of opment strategy based on import substitution and the a liberalization movement is not an easy task. Given the pursuit of dynamic comparative advantage. The implica- high degree of distortions in the Brazilian economy, tions of this rationale, of course, are not confined to marginal liberalization movements at the sectoral level service activities. But thecharacteristics of many service may even bring some unpleasant surprises. The distor- industries make them natural candidates for strategic tions also tend to qualify the usefulness of designing trade policies. liberalization strategies that are designed on the basis of The use of protectionism to capture high-rent sectors or revealed comparative advantage. And educated guesses to foster industries with potential positive externalities derived from conventional trade theory such as the is, however, a tricky business. Most often, the political Hecksher-Ohlin-Samuelson model have to deal with the economy of the process transforms these interventions complex question of the treatment of information as "a into implicit transfers to powerful interest groups at the genuine production factor" (Lanvin 1989, p. 114). expense of society as a whole (see Dixit 1987; Krugman The most dynamic service activities, such as commu- 1987); the Brazilian informatics policy provides a good nications, management, finance, and professional and example. Furthermore, protectionist measures are technical services, tend to be information-intensive. Pro- clearly second-best policies for protecting industry. As duction, however, may in many cases be competitively Hindley (1988) has pointed out, the economic ranking of organized along labor-intensive lines. Banking provides import-substitution instruments provided by conven- a good illustration. The principal national private banks, tional trade theory does apply to trade in services. In BRADESCO and IrAu, are organized as labor-intensive other words, Brazil would be better off if it subsidized systems built around a high-technology core that allows "strategic" sectors instead of trying to promote them sophisticated interbranch operations. Although this op- through barriers to trade and foreign direct investment. erational profile may not provide a sound basis for inter- Hence, both on efficiency grounds and from a political national expansion, it would probably be able to economy perspective, there are reasons for Brazil to withstand a higher level of foreign competition in the pursue liberalization of trade in services and indeed to Brazilian market. Software production is another sector liberalize unilaterally while at the same time carrying out in which Brazil may attain positive results by exploiting broad economic reforms designed to promote across-the- its relatively cheap skilled labor force. Construction and board economic efficiency. (For a summary of the main engineering activities provide an interesting counterex- policy reforms required in this context see Martone and ample. The successful outward drive of some large Bra- Primo Braga 1987.) Needless to say, the pace and the zilian contractors in the early 1980s was not sustained order of this liberalization movement pose daunting over time, partly owing to the economic crisis that dom- problems for Brazilian policymakers. Some of the usual inated most developing economies (the main markets for concerns with respect to the economic implications of the Brazilian companies) from 1982 on. In any case, the services liberalization, however, are misplaced. For ex- Brazilian "success stories" cannot be explained by the ample, the impact on the balance of payments is often possibility of sending cheap low-skill workers abroad. presented as an impediment to trade liberalization (see Firms that relied on this type of arrangement soon found Kume and Carvalho 1987, p. 24; OTA 1987, p. 70). This that the costs were much higher than expected.17 To the 206 Brazil extent that the Brazilian construction sector seems to be It would, however, be naive to expect major changes in losing internationalcompetitiveness (Gongalves 1989,p. Brazil's negotiating posture on the basis of the reasons 359), one could think of it as a potential loser from provided here. The extensive array of regulations that liberalization. apply to the Brazilian service sector has created strong For more "traditional" tradable services, such as tour- vested interests against liberalization. And the prospects ism and transport, orthodox trade theory seems to pro- for any liberalization policy amid macroeconomic insta- vide more robust predictions. In the case of tourism, for bility are dim at besL Awareness of the potential benefits instance, Brazil has typical Ricardian comparative ad- of liberalization of trade in services may, nonetheless, vantages. Additional efforts toward international adver- foster a productive debate on the rationale of Brazilian tisement of the country, the correction of distortions in trade policies for the sector. the foreign exchange market (the "cambio-turismo" in- troduced in January 1989 was a major step in this direc- Notes tion), and deregulation of air transport would certainly translate into a much better performance of the interna- 1. For recent data on theperformanceof the Brazilian economy and tional travel account in the balance of payments. By its structure of production, see 'As Contas Nacionais,' Conjuntuwa Econsrmica, September 1988, pp. 38-50. contrast, the fate of domestic transport services in a more 2. For a discussion of the role of services in economic development competitive environmentdoesnot seem verybright. This see Bell (1973), Riddle (1986), and Primo Braga (1989b). See also is particularly true with respect to sea transporL High Bhagwati (1987c) for some imporant caveats conceming the stages approach to economic development. capital intensity, a technologically outdated fleet (a ca- 3. Branford (1987, p. 73) points out that President Samey's decla- sualty of diminished capacity to invest during the 1980s), ration announcing Brazil's Nationallnformatics Planin 1986 explicitly and worldwide overcapacity suggest that Brazilian ship- mentions the threat of "scientific and cultural colonialism." ping companies would be among the losers in a liberal- 4. For the GATr mandate, see Roessler (1986). The U.S. approach was based on theproposition that forinany services, tradabiitiy requires ization movement. market presence (see Feketekuty 1988). Finally, another frequently voiced concern with respect 5. For example, service transactions such as technical assistance to liberalization of trade in services stems from the associated with capital equipment sales are often entangled with trade in goods; tourismi expenditures do not cover the black market for misconception that it is synonymous with an argument foreign exchange; and workers remittances are not included in the for laissez-faire (see Corden 1974). In reality, this link services accounL For further details see Ascher and Whichard (1987) does not exist, and there are many circumstances in and Goncalves (1988). which government intervention is required to corct 6. This strategy was abandoned in 1986 with the Cruzado plan, but the ensuing foreign exchange crisis forced its reintroduction in 1987. market distortions. The basic point made here is that For details see Martone and Primo Braga (1987, 1988). trade protection is an inefficient way of dealing with 7. Imports of specialized technical services, which are intimately these distoions. associated with investment activities, fell from $284 million in 1980 to $93 million in 1988 according to Instituo Nacional da Propriedade Industrial (1989, p. 200). It is worth mentioning that gross capital Concluding Remarks fonnation as a share of GDPdeclined from22.5 percentin 1980 to 17.1 percent in 1987 (Conjunsura Economica, September 1988, p. 49). The economic argument for liberalization of trade in 8. If both domestic and intemational flights are counted, Varig ranked twelfth; see Kasper (1988, table 2-12). services has been reviewed here from the point of view 9. See Sauvant and Zimny (1987) and Balasubramanyan (1989). of the Brazilian economy. As noted above, Brazil may For additional data on worldwide foreign direct investment flows see extract significant benefits from a liberalization move- oATr (1989). 1 0. For details on the history of foreign direct investment in Brazil ment tailored to the peculiarities of its economy. This see Baer (1989, ch. 10). Villela and Suzigan (1973) provide useful conclusion by itself would be enough to recommend information on Brazil's policies toward foreign capital for 1889-1945. Brazilian participation in the GNS. It is also important to 1 1. For example, by 1929 the sectoral distribution of U.S. direct recognize that a negative agenda (that is, participation on investment in Brazil was as follows: manufacturing, 23.7 percent; recognize ~~~~~~~~~~~~~~~~distribuition of petroleum, 1 1.9 percent; public utilities,including trans- the basis of a "blockade" strategy) would tend to limit port, 50.0 percent; trade, 8.2 percent; and other activities, 6.2 percent. Brazil's influence on the design of an eventual code for See Baer (1i9 9, p. 216). srie.18 12. The rapid increse in foreign direct investment associated with services, ~~~~~~~~~~~~consulting, repreentation, participation, property management, and Another important argument in favor of an active ne- advertising during the 1970s explained the relative growth in the share gotiating posture at the GNS follows from the simple fact of service-related foreign direct investment reported in table 20-4 for that for a country like Brazil a "rules-oriented" world is that period. international system13. The provision of services in teleconimurnications, for instance, preferable to a "power-oriented" intematonal system bas been reserved for state-owned enterprises since 1962; see Soares (see Jackson 1978, pp. 98-101). Multilateralism is the (1986, p. 55). best defense against aggressive bilateralism. 14. Transnational corporations were allowed to continue operating in the mainframe market. For details about Brazil's infornatics policy 207 Carlos Alberto Prima Braga see Fnischtak (1986), Cline (1987), Tigre (1987), and Inter-American Conjuntura Economica. Various issues. Rio de Janeiro. Development Bank (1988). Coopers & Lybrand. 1986. Profile of Banking and Finance in Brazil. 15. Brazil was the country with the largest number of barers to Sao Paulo, Brazil. trade in services in the inventory conducted by the office of the U.S. Corden, W. M. 1974. Trade Policy and Economic Welfare. London: Trade Representative in 1985, according to Berg (1987, p. 9). Clarendon. 16. Welch (1989)constructed "efficiency indices" forthefinancial Dias, Vivianne V. 1987. "Produc,ao e Com6rcio de Servi,os: Notas sectors of Latin American cotmtries using ratios between M2 (total Conceituais." Revista Brasileira de Comercio Exterior 14 (No- credit extended) and sectoral value added. 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"Identifying the Issues Affairs, Novemnber 30. Washington, D.C., George Washington in Trade in Services." WorldEconomy 8, no.2 (June):171-81. University. Processed. Sapir, Andre. 1982. "Trade in Services: Policy Issues forthe Eighties." Columbia Journal of World Business (Fall):77-83. 209 Annex 1 The Punta del Este Ministerial Declaration Meeting in Punta del Este (Uruguay) from 15-20 Sep- Part I-Negotiations on trade in goods tember on the occasion of the special session of the GAIT Contracting Parties, ministers of GATr member countries The Contracting Parties meeting at Ministerial level adopted a Declaration launching a new round of multi- Determined to halt and revise protectionism and to lateral trade negotiations-the Uruguay Round. The remove distortions to trade Declaration falls into two parts. Determined to preserve the basic principles and to As contracting parties, the ministers adopted Part I of further the objectives of the GAiT the declaration regarding trade in goods. It establishes Determined also to develop a more open, viable and the objectives and principles of the negotiations, and the durable multilateral trading system launch of issues on which negotiations will take place. Convinced that such action would promote growth and The Declaration provides for a standstill and rollback on development trade restrictive or trade distortive measures under which Mindful of the negative effects of prolonged financial governments undertake not to phase out their existing and monetary instability in the world economy, the in- breaches of GAIT disciplines. debtedness of a large number of less-developed contract- As representatives of governments meeting on the oc- ing parties, and considering the linkage between trade, casion of the Session, the ministers further decided to money, finance and development launch a negotiation on trade in services, and adop.ed Decide to enter into Multilateral Trade Negotiations on PartII of the Declaration in thatregard. Ithasbeen agreed trade in goods within the framework and under the aegis that these negotiations will not be placed within the legal of the General Agreement on Tariffs and Trade. framework of GATI, but that GAIT practices and proce- dures will nevertheless apply to them. A. Objectives Ministers then adopted the Ministerial Declaration as a Negotiations shall aim to whole as a single policy commitment launching the (i) bring about further liberalization and expansion of Uruguay Round. The negotiations are to extend over four world trade to the benefit of all countries, especially years. less-developed contracting parties, including the im- provement of access to markets by the reduction and Ministerial Declaration on the Uruguay Round elimination of tariffs, quantitative restrictions and other non-tariff measures and obstacles; Ministers, meeting on the occasion of the Special Session (ii) strengthen the role of GAiT, improve the multilat- of Contracting Parties at Punta del Este, have decided to eral trading system based on the principles and rules of launch Multilateral Trade Negotiations (The Uruguay theGATTandbringaboutawidercoverageof worldtrade Round). To this end, they have adopted the following under agreed, effective and enforceable multilateral dis- Declaration. The Multilateral Trade Negotiations (MTN) ciplines; will be open to the participation of countries as indicated (iii) increase the responsiveness of the GATr system to in Parts Iand II of this Declaration. A Trade Negotiations the evolving international economic environment, Committee shall hold its first meeting not later than 31 through facilitating necessary structural adjustment, en- October 1986. It shall meet as appropriate at Ministerial hancing the relationship of the GA1T with the relevant level. The Multilateral Trade Negotiations will be con- international organizations and taking account of cluded within four years. changes in trade patterns and prospects, including the Reprinted from GATT Focus, 8 October 1986 211 The Punta del Este Ministerial Declaration growing importance of trade in high technology prod- required to make, concessions that are inconsistent with ucts, serious difficulties in commodity markets and the the latter's development, financial, and trade needs. importance of an improved trading environment provid- (vi) Less-developed contracting parties expect that ing, inter alia, forthe ability of indebtedcountries to meet their capacity to make contributions or negotiated con- their financial obligations; cessions or take other mutually agreed action under the (iv) foster concurrent co-operative action atthe national provisions and procedures of the general agreement and international levels to strengthen the inter-relation- would improve with the progressive development of ship between trade policies and other economic policies their economies and improvement in their trade situation affecting growth and development, and to contribute and they would accordingly expect to participate more towards continued, effective and determined efforts to fully in the framework of rights and obligations under the improve the functioning of the international monetary General Agreement. system and the flow of financial and real investment (vii) Special attention shall be given to the particular resources to developing countries. situation and problems of the least-developed countries and to the need to encourage positive measures to facil- B. General principles governing negotiations itate expansion of their trading opportunities. Expedi- (i) Negotiations shall be conducted in a transparent tious implementation of the relevant provisions of the manner, and consistent with the objectives and commit- 1982 Ministerial Declaration concerning the least-devel- ments agreed in this Declaration and with the principles oped countries shall also be given appropriate attention. of the General Agreement in order to ensure mutual advantage and increased benefits to all participants. C. Standstill and rollback (ii) The launching, the conduct and the implementation Commencing immediately and continuing until the of the outcome of the negotiations shall be treated as formal completion of the Negotiations, each participant parts of a single undertaking. However, agreements agrees to apply the following commitments: reached at an early stage may be implemented on a Standstill provisional or a definitivebasisby agreementprior to the (i) notto take any trade restrictive or distorting measure formal conclusion of the negotiations. Early agremnents inconsistent with the provisions of the General Agree- shall be taken intoaccount in assssing theoverallbalance of mentor the Instruments negotiated within the framework the negotiations. of GATT or under its auspices; (iii) Balanced concessions should be sought within (ii) not to take any trade restrictive or distorting mea- broad trading areas and subjects to be negotiated in order sure in the legitimate exercise of itS GATr rights, that to avoid unwarranted cross-sectoral demands. would go beyond that which is necessary to remedy (iv) Contracting Parties agree that the principle of Dif- specific situations, as provided for in the General Agree- ferential and More Favourable Treatment embodied in ment and the Instruments referred to in (i) above; Part IV and other relevant provisions of the General (iii) not to take any trade measures in such a manner as Agreement and in the Decision of the Contracting Parties to improve its negotiating positions. of 28 November 1979 on Differential and More Favour- Rollback able Treatment, Reciprocity and Fuller Participation of (i) that all trade restrictive or distorting measures incon- Developing Countries applies to the negotiations. In the sistent with the provisions of the General Agreement or implementation of standstill and rollback, particular care Instruments negotiated within the framework of GATr or should be given to avoiding disruptive effects on the under its auspices, shall be phased out or brought into trade of less-developed contracting parties. conformity within an agreed timeframe not later than by (v) The developed countries do not expect reciprocity the date of the formal completion of the negotiations, for commitments made by them in trade negotiations to taking into account multilateral agreements, undertak- reduce or remove tariffs and other barriers to the trade of ings and understandings, including strengthened rules developing countries, i.e., the developed countries do not and disciplines, reached in pursuance of the Objectives expect the developing countries, in the course of trade of the Negotiations; negotiations, to make contributions which are inconsis- (ii) there shall be progressive implementation of this tent with their individual development, financial and commitment on an equitable basis in consultations trade needs. Developed contracting parties shall therefore amongparticipants concerned, including allaffectedpar- not seek, neither shall less-developed contracting parties be ticipants. This commitment shall take account of the 212 The Punta del Este Ministerial Declaration concerns expressed by any participant about measures integration of this sector into GAIT on the basis of directly affecting its trade interests; strengthened GA1T rules and disciplines, thereby also (iii) there shall be no GATT concession requested for the contributing to the objective of further liberalization of elimination of these measures. trade. Surveillance of standstill and rollback Agriculture Each participant agrees that the implementation of Contracting Parties agree that there is an urgent need to these commitments on standstill and rollback shall be bring more discipline and predictability to world agricul- subject to multilateral surveillance so as to ensure that tural trade by correcting and preventing restrictions and these commitments are being met. The Trade Negotia- distortions, including thoserelatedto structural surpluses tions Committee will decide on the appropriate mecha- soastoreduce the uncertainty, imbalances andinstability nisms to carry out the surveillance, including periodic in world agricultural markets. Negotiations shall aim to reviews and evaluations. Any participant may bring to achieve greater liberalization of trade in agriculture and the attention of the appropriate surveillance mechanism bring all measures affecting import access and export any actions or omissions it believes to be relevant to the competition under strengthened and more operationally fulfillment of these commitments. These notifications effective GA1T rules and disciplines, taking into account should be addressed to the GATr secretariat, which may the general principles governing the negotiations, by: also provide further relevant informatior.. (i) improving market access through, inter alia, the reduction of import barriers; D. Subjects for negotiations (ii) improving the competitive environment by increas- Tariffs ing discipline of the use of all direct and indirect subsi- Negotiations shall aim, by appropriate methods, to dies and other measures affecting directly or indirectly reduce or, as appropriate, eliminate tariffs, including the agricultural trade, including the phased reduction of their reduction or elimination of high tariff and tariff escala- negative effects and dealing with their cause; tion. Emphasis shall be given to the expansion of the (iii) minimizing the adverse effects that sanitary and scope of tariff concessions among all participants. phytosanitary regulations and barriers can have on trade Nontariff measures in agriculture, taking into account the relevant intema- Negotiations shall aim to reduce or eliminate non-tariff tional agreements. measures, including quantitative restrictions, without In orderto achieve theabove objectives, the negotiating prejudice to any action to be taken in fulfillment of the group having primary responsibility for all aspects of rollback commitments. agriculture will use the Recommendations adopted by Tropicalproducts the Contracting Parties at their Fortieth Session, which Negotiations shall aim at the fullest liberalization of were developed in accordance with the GAWT 1982 Min- trade in tropical products, including in their processed isterial Programme and take account of the approaches and semi-processed forms and shall cover both tariff and suggested in the work of the Committee on Trade in all non-tariff measures affecting trade in these products. Agriculture without prejudice to other alternatives that Contracting Parties recognize the importance of trade might achieve the objectives of the Negotiatons. in tropical products to a large number of less-developed GATTArticles contractingparties and agree that negotiations in this area Participants shall review existing GA rr articles, provis- shall receive special attention, including the timing of the ions and disciplines as requested by interested contract- negotiations and the implementation of the results as ing parties and, as appropriate, undertake negotiations. provided in B(ii). Safeguards Natural resource-based products (i) A comprehensive agreement on safeguards is of Negotiations shall aim to achieve the fullest liberaliza- particular importance to the strengthening of the GA1T tion of trade in natural resource-based products, includ- system and to progress in the MTNs. ing in their processed and semi-processed forms. The (ii) The agreement on safeguards: negotiations shall aim to reduce or eliminate tariff and -shall be based on the basic principles of the General non-tariff measures, including tariff escalation. Agreement; Textiles and clothing -shall contain, inter alia, the following elements; trans- Negotiations in the area of textiles and clothing shall aim parency, coverage, objective criteria for action including to formulate modalites that would permit the eventual the concept of serious injury or threat thereof, temporary 213 The Punta del Este Ministerial Declaration nature, degressivity, and structural adjustment, compen- elaborate, as appropriate, further provisions that may be sation and retaliation, notifications, consultation, multi- necessary to avoid such adverse effects on trade. lateral surveillance and dispute settlement; and -shall clarify and reinforce the disciplines of the Gen- E. Functioning of the GAIT system eral Agreement and should apply to all contracting par- Negotiations shall aim to develop understandings and ties. arrangements: MTN agreements and arrangements (i) to enhance the surveillance in the GATT to enable Negotiations shall aim to improve, clarify, or expand, regular monitoring of trade policies and practices of as appropriate, agreements and arrangements negotiated contracting parties and their impact on the functioning of in the Tokyo Round of multilateral negotiations. the multilateral trading system; Subsidies and countervailing measures (ii) to improve the overall effectiveness and decision- Negotiations on subsidies and countervailing measures making of the GATT as an institution, including, inter alia, shall be based on a review of Articles VI and XVI and through involvement of Ministers; the MTN agreement on subsidies and countervailing mea- (iii) to increase the contribution of the GATT to achiev- sures with the objective of improving GATT disciplines ing greater coherence in global economic policy-making relating to all subsidies and countervailing measures that through strengthening its relationship with other intema- affect international trade. A negotiating group will be tional organizations responsible for monetary and finan- established to deal with these issues. cial matters. Dispute settlement In order to ensure prompt and effective resolution of F. Participation disputes to the benefit of all contracting parties, negoti- (a) Negotiations will be open to: ations shall aim to improve and strengthen the rules and (1) all contracting parties, then procedures of the dispute settlement process, while (2) countries having acceded provisionally, recognizing the contribution thatwouldbemadeby more (3) countries applying the GATr on a de facto basis effective and enforceable GA1T rules and disciplines. having announced, not later than 30 April 1987, their Negotiations shall include the development of adequate intention to accede to GAIT and to participate in the arrangements for overseeing and monitoring of the pro- negotiations, cedures that would facilitate compliance with adopted (4) countries that have already informed the Contract- recommendations. ing Parties, at a regular meeting of the Council of Rep- Trade-related aspects of intellectual property rights, resentatives of their intention to negotiate the terms of including trade in counterfeit goods their membership as a contracting party, and In order to reduce the distortions and impediments to (5) developing countries that have, by 30 April 1987, international trade, and taking into account the need to initiated procedures for accession to the GAT, widh the promote effective and adequateprotection of intellectual intention of negotiating the terms of their accession property rights, and to ensure that measures and proce- during the course of the negotiations. dures to enforce intellectual property rights do not them- (b) Participation in negotiations relating to the amend- selves become barriers to legitimate trade, the ment or application of GATT provisions or the negotia- negotiations shall aim to clarify GA1T provisions and tions of new provisions will, however, be open only to elaborate as appropriate new rules and disciplines. Ne- contracting parties. gotiations shall aim to develop a multilateral framework of principles, rules and disciplines dealing with intema- G. Organization of the negotiations tional trade in counterfeit goods, taking into account A Group of Negotiations on Goods (GNG) is established work already undertaken in the GATT. to carry out the programme of negotiations contained in These negotiations shall be without prejudice to other this Part of the Declaration. The GNG shall, inter alia complementaryinitiatives thatmaybe taken in theWorld (i) elaborate and put into effect detailed trade negotia- Intellectual Property Organization and elsewhere to deal tion plans prior to 19 December 1986; with these matters. (ii) designate the appropriate mechanism for surveil- Trade-related investment measures lance of commitments to standstill and rollback; Following an examination of the operation of GAIT (iii) establish negotiating groups as required. Because articles related to the trade restrictive and distorting of the interrelationship of some issues and taking fully effects of investment measures, negotiations should into account the general principles goveming the nego- 214 The Punta del Este Ministerial Declaration tiations as stated in B(iii) above it is recognized that vices, including elaboration of possible disciplines for aspects of one issue may be discussed in more than one individual sectors, with a view to expansion of such trade negotiating group. Therefore each negotiating group under conditions of transparency and progressive liber- should as required take into account relevant aspects alization and as a means of promoting economic growth emerging in other groups; of all tradingpartners and thedevelopmentof developing (iv) also decide upon inclusion of additional subject countries. Such framework shall respect the policy ob- matters in the negotiations; jectives of national laws and regulations applying to (v) coordinate the work of the negotiating groups and services and shall take into account the work of relevant supervise the progress of the negotiations. As a guideline international organizations. not more than two negotiating groups should meet at the GAIT procedures and practices shall apply to these same time; negotiations. A Group on Negotiations on Services is (vi) the GNG shall report to the Trade Negotiations establishedtodeal with these matters. Participation in the Committee. negotiations under this Part of the Declaration will be In order to ensure effective application of differential open to the same countries as under Part I. GA1T secre- and more favorable treatment the GNG shall, before the tariat support will be provided, with technical support formal completion of the negotiations, conduct an eval- from other organizations as decided by the Group of uation of the results attained therein in terms of the Negotiations on Services. Objectives and General Principles Governing Negotia- The Group of Negotiations on Services shall report to tions as set out in the Declaration, taking into account all the Trade Negotiations Committee. issues of interest to less-developed contracting parties. Implementation of results under Parts I and II Part 11-Negotiations on trade in services When the results of the Multilateral Trade Negotiations Ministers also decided, as part of the Multilateral Trade in all areas have been established, Ministers meeting also Negotiations, to launch negotiations on trade in services. on the occasion of a Special Session of Contracting Negotiations in this area shall aim to establish a multilat- Parties shaU decide regarding the international imple- eral framework of principles and rules for trade in ser- mentation of the respective results. 215 Annex 2 The Montreal Ministerial Declaration Negotiations on Trade in Services 6. Ministers agree that, before the concepts, principles and rules which comprise a multilateral framework for 1. Ministers reaffinn the objectives for negotiations on trade in services are finally agreed, these concepts, prin- trade in services agreedatPunta delEste. Ministers agree ciples and rules will have to be examined with regard to that substantial progress has been achieved in pursuit of their applicability and the implications of their applica- these objectives. tion to individual sectors and the types of transactions to 2. Ministers take note of the report of the GNS to the TNC be covered by the multilateral framework. contained in MTN.GNS/21 which they consider an impor- 7. Ministers agree that negotiations on the elaboration tant basis for further work directed towards the achieve- of a multilateral framework of principles and rules for ment of these negotiating objectives. This work should trade in services should proceed expeditiously. To this proceed in a parallel and interrelated fashion. end, the following concepts, principles and rules are 3. Ministers note the understanding reached on statis- considered relevant tics and on existing international arrangements and dis- cipline as set out in paragraphs 7 and 8 of the GNS report. (a) Transparency 4. Work on definition should proceed on the basis that the multilateral framework may include trade in services Provisions should ensure information with respect to all involving cross-border movement of services, cross-bor- laws, regulations and administrative guidelines as well der movement of consumers, and cross-border move- as intemational agreements relating to services trade to ment of factors of production where such movement is which the signatories are parties through adequate pro- essential to suppliers. However, this should be examined visions regarding their availability. Agreementshould be further in the light of, inter alia, the following: reached with respect to any outstanding issues in this (a) Cross-border movement of service and payment. regard. (b) Specificity of purpose. (c) Discreteness of transactions. (b) Progressive Liberalization (d) Limited duration. 5. Ministers agree that work should proceed, without The negotiations should establish rules, modalities and excluding any sector of trade in services on an a priori procedures in the multilateral framework agreement that basis, with a view to reaching agreement on the sectoral provide for progressive liberalization of trade in services coverage under the multilateral framework in accor- with due respect for national policy objectives including dance, inter alia, with the considerations that coverage provisions that allow for the application of principles to should permit a balance of interests for all participants, sectors and measures. Provisions should also be estab- that sectors of export interest to developing countries lished for further negotiations after the Uruguay Round. should be included, that certain sectors could be ex- Specific procedures may be required for the liberaliza- cluded in whole or in part for certain overriding consid- tion of particular sectors. erations, and that the framework should provide for the The aim of these rules, modalities and procedures broadest possible coverage of sectors of interest to par- should be to achieve, in this round and future negotia- ticipants. tions, aprogressively higher level of liberalization taking Reprinted from News of the Uruguay Round of Multilat- eral Trade Negotiations, NUR 023, 14 December 1988. 216 The Montreal Ministerial Declaration due account of the level of development of individual exceptions, e.g., based on security and cultural policy signatories. To this end the adverse effects of all laws, objectives. regulations and administrative guidelines should be re- duced as part of the process to provide effective market (h) Regulatory Situation access, including national treatment. The rules, modalities and procedures for progressive It is recognized that governments regulate services sec- liberalization should provide appropriate flexibility for tors, e.g., by granting exclusive rights in certain sectors, individual developing countries for opening fewer sec- by attaching conditions to the operations of enterprises tors or liberalizing fewer types of transactions or in within their markets for consumer protection purposes progressively extending market access in line with their and in pursuance of macro-economic policies. As- development situation. ymmetries exist with respect to the degree of develop- ment of services regulations in different countries. (c) National Treatment Consequently, the right of countries, in particular of developing countries, to introduce new regulations is When accorded in conformity with other rrovisions of recognized. This shouldbe consistentwithcommitments the multilateral framework, it is understood that national under the framework. treatment means that the services exports and/or export- 8. Other elements mentioned in MTN.GNS'21, as well as ers of any signatory are accorded in the market of any new ideas and concepts participants may wish to put other signatory, in respect of all laws, regulations and forward, will also be considered. administrative practices, treatment "no less favourable" 9. It is understood that the acceptability of the multilat- than that accorded domestic services or services provid- eal framework will be dependent on the initial level of ers in the same market. negotiated commitments of signatories. (d) Most-Favoured-Nation/Non-Discrimination Future Work The multilateral framework shall contain a provision on 10. Future work should provide for. m.f.n./non-discrimination. (a) The compilation by the secretariat of a reference list of sectors by February 1989. This process could (e) Market Access be assisted by submissions by participants. (b) Invitation to participants to submit indicative lists When market access is made available to signatories it of sectors of interest to them with a target date of May should be on the basis that, consistent with the other 1989. provisions of the multilateral framework and in accor- (c) The process of examining the implications and dance with the definition of trade in services, foreign applicability of concepts, principles and rules for par- services may be supplied according to the preferred ticular sectors and specific transactions should begin mode of delivery. as lists become available. (d) Further work as necessary on the role of intema- (t) Increasing Participation of Developing Countries tional disciplines and arrangements and on the ques- tion of defimition and statistics. The framework should provide for the increasing partic- 11. The GNS should endeavour, by the end of 1989, to ipation of developing countries in world trade and for the assemble the necessary elements for adraft which would expansion of their service exports, including inter alia permit negotiations to take place for the completion of through the strengthening of their domestic services ca- all parts of the multilateral framework and its entry into pacity and its efficiency and competitiveness. force by the end of the Uruguay Round. (g) Safeguards and Exceptions Further negotiations will be necessary on provisions for safeguards, e.g., for balance-of-payments reasons, and 217 Contributors Bela Balassa, Professor of Political Economy, Johns Edna Jaime, Centro de Investigacion para el Desarrollo Hopkins University and Consultant, The World Bank, (CIDAC), Mexico City, Mexico Washington, D.C., U.S.A. Chung H. Lee, Professor of Economics, University of Surjit S. Bhalla, Executive Director and Senior Fellow, Hawaii at Manoa and Research Associate, Resource The Policy Group, New Delhi, India Systemslnstitute at East-West Center, Honolulu, Ha- waii, U.S.A. Carlos Alberto Primo Braga, Professor of Economics, Faculdade de Economia e Administracao, University James Lee, Manager, International Accounts, Data Re- of Sao Paulo, Sao Paulo, Brazil sources, Inc., Washington, D.C., U.S.A. RobertL. Carter, Norwich Union Professor of Insurance Padma Mallampally, Transnational Corporations' Af- Studies, University of Nottingham, Nottingham, fairs Officer, UNCTC, New York, New York, U.S.A. United Kingdom Mario Marconini, Economic Affairs Officer, GATT, Ge- Alberto Diaz, Centro de Investigacion para el neva, Switzerland Desarrollo (CIDAC), Mexico City, Mexico Patrick A. Messerlin, SeniorEconomist, The WorldBank ChristopherFindlay,ProfessorofEconomics, University and Professor of Economics, Institut d'Etudes of Adelaide, Adelaide, Australia Politiques de Paris, Paris, France Rainer Geiger, Deputy Director, Financial, Fiscal and G. Russell Pipe, Project Director, Telecom Services Enterprise Affairs, OECD, Paris, France Trade Project, Amsterdam, Netherlands Alan Gelb, Chief, Socialist Economy Reform Unit, Luis Rubio, Director General, Centro de Investigacion Country Economics Department, The World Bank, para el Desarrollo (CIDAC), Mexico City, Mexico Washington, D.C., U.S.A. Silvia B. Sagari, Senior Financial Economist, The World Kenneth Heydon, Principal Administrator, Division of Bank, Washington, D.C., U.S.A. Trade Relations with Non-member Countries and Commodities, OECD, Paris, France Karl P. Sauvant, Acting Assistant Director, Policy Anal- ysis & Research Division, UNCTC, New York, New Brian Hindley, Professor of Economics, London School York, U.S.A. of Economics, London, United Kingdom Richard H. Snape, Professor of Economics, Monash Bernard Hoekman, Economic Affairs Officer, Economic University, Clayton, Victoria, Australia Research and Analysis Unit, GAIT, Geneva, Switzer- land Alexander J. Yeats, Principal Economist, The World Bank, Washington, D.C., U.S.A. 218 Selected World Bank and UNCTC Publications on Services World Bank Stem, Timothy E. Nulty, and Richard D. Stem. A World Bank Symposium. 1989. Construction Industry: Issues and Strategies in De- veloping Countries. Emesto E. Henriod and others. Seatrade, Logistics, and Transport. Hans Jiirgen Pe- 1984. ters. Policy and Research Report No. 6. 1989. Credit Guarantee Schemes for Small and Medium Staying in the Loop: International Alliances for Enterprises. Jacob Levitsky and Ranga N. Prasad. Sharing Technology. Ashoka Mody. Discussion Technical Paper No. 58. 1987. Paper No. 61.1989. Deregulation of Shipping: What is to Be Learned Techniques of Privatization of State-Owned Enter- from Chile. Esra Bennathan, with Luis Escobar and prises. Charles Vuylsteke, Helen Nankani and Re- George Panagakos. 1989. becca Candoy-Sekse, with the assistance of Anne Ruiz Palmer. Technical Papers No. 88, 89 and 90. 1988. Financial Information for Management of i Develop- ment Finance Institution: Some Guidelines. Mau- Trade Finance in Developing Countries. Yung Whee rice C. Mould. Technical Paper No. 63. 1987. Rhee. Policy and Research Report No. 6. 1989. Housing Demand in Developing Countries. Stephen The Uruguay Round: A Handbook for the Multilat- Malpezzi, Stephen K. Mayo, and David J. Gross. eral Trade Negotiations. Edited by J. Michael Fin- Staff Working Paper No. 733. 1985. ger and Andrzej Olechowski. 1987. Labor Market Performance as a Determinant of Mi- The World Bank Economic Review. May 1988. Vol- gration. Wim P.M. Vijverberg. LSMS Working ume 2, No. 2. Paper No. 59. 1989. UNCTC Private Provision of Public Services in Developing Countries. Gabriel Roth. Oxford University Press. Transnational Corporations in Services: Impact, 1987. Policies and Options for Developing Countries. New York. United Nations. Forthcoming. Reform of State-Owned Enterprise: Lessons from World Bank Lending. Mary Shirley. Policy and Key Concepts in International Investment Arrange- Research Report No.4. 1989. ments and Their Relevance to International Transactions in Services, UNCTC Current Stud- Restructuring and Managing the Telecommunica- ies. Series A. No. 12. New York. United Nations. tions Sector. Edited by Bjom Wellenius, Peter A. Forthcoming. 219 Selected World Bank and UNCTC Publications on Services The Activities of Transnational Corporations in Ser- UNCTC Current Studies. John Dunning. Series A, vices. New York. United Nations. Forthcoming. No. 9. 1989. New York. United Nations Publication. Transborder Data Flows and Mexico: A Technical Transnational Corporations in the Construction and Paper. New York. United Nations. Forthcoming. Design Engineering Industry. 1989. New York. United Nations Publication. Transnational Bank Behaviour and the International Debt Crisis. Joint UNCTC/ECLAC Unit. New York. Data Goods and Data Services in the Socialist Coun- United Nations. Forthcoming. tries of Eastern Europe. 1988. New York. United Nations Publication. Services and Development: The Role of Foreign Di- rect Investment and Trade. 1989. New York. Foreign Direct Investment and Transnational Corpo- United Nations Publication. rations in Services. 1988. New York. United Nations Publication. Transnational Service Corporations and Developing Countries: Impact and Policy Issues, UNCTC Foreign Direct Investment, the Service Sector and Current Studies. Series A, No. 10. 1989. New York. International Banking, UNCTC Current Studies. United Nations Publication. Series A, No. 7. 1987. New York. United Nations Publication. Transitational Corporations and the Growth of Ser- vices: Some Conceptual and Theoretical Issues, 220 The World Bank The United Nations Centre on Transnational Corporations Thc ears 19X6-9(t mna Nell enter ihe histor! of international econiomiiic relations as a period of rapid progress tom *ard a mlore open wkorld( sers ices economn w ith greater opportLI- ilities for trade andii (de %elopmirent This vol-im1e, initendle(id as a n U(ic to thle econlomlics underl\ ing the l ru'uaL\ Roun(d necotiationis on Ser\ ices. suggtcS tihree lessons. First contrar\ to skidespread skepticisim. (developinl) countries do ha e compnarati e a(dvalntalges ill Certaiin aspects ot atir transport bhanki ng. inlsuranlce. tourism. shipping. con1- strructioti. telecolilillullicatiolns. and professional ser ices. iarlueing sott\k are de\ elOplielnt and hIealtl care. Thesc ac aintages cerie tfromii tlhe oCntries relati\Cl \iaUnhdalt resoUrces ot' lahor \k ith the need(edt skills. Second, conliparati\i e advantages l er ices do more than create potential tra(tcots hbt weenl rfitustrial iandde\elopilngCoulitries ii multilaiteral necotiations on ser ices. Certain goo(ds exported bh deeeloping countries are essential inputs into scr ices, and certain services ( Such as telecomimilluniicationis) are essential inputs into manuf actures. L iberali,ationl willf facilitate dce eloping couLntries exports ofogoods. and imiiports ot'less-expenisie serscices x%ill increase th.e clicienc\ otf the deeloping cconomies. Both eOolutions ss ill hoost de\ elopment. Third. in scr ices as in goods. doiestic and( exterinall measures cannot be isolated tFromi each other. Domestic liberali/ation is rapidlN chokeld ifthele is not an open regimne. and trade liberali,ation \\ ithout iiterinazl market-oriented retorims cian be costlx T he lirugua\ Round( coniies at the ri eht time to consolidate liberalih/ations and to encourace nes ones. PIart I ot this hook looks at the alidit\ and adequacy ot basic economilic tools for anal\ Aing ser ices trade issues withii thetic familiar xn tradition of trade negotiations. Part 11 presenits tor each malian group of serk ices. the economic characteristics of their production, the niotes ot deli ery! the impact of the current international environment, and( the existing methods and extent ot( reeullationl anid protection in industrial anid developing coulitries. Part Ill. through case Studies of selected countries, examines the basic questions that the delegations in Geiie a xsill haw e in niiin(l as they negotiate a trllle\ (ork agreement-in particulair the balance bet eeni the costs ot adjustirg to a more open environment and the ains troi liberafliation. C h'.vier d o bN (iu'O 'i' Parakammaz m il ISBN (0-2 13-1374-6