56668 The World Bank PREMnotes june 2010 nuMBeR 152 Trade The Increasing Importance of Developing Countries in Trade in Services Sebastián Sáez Services play a broad and strategic role in the economy. The new focus in services arises because they have become increasingly tradable, allowing for the emergence of new and improved export activities. Trade in services, particularly business services, has become a dynamic component of trade and an alternative for export diversification for many developing countries. Besides traditional activities (such as tourism), health, information technology, and communication services are among the most successful service exports. Developing countries seem to follow different policy approaches to trade in services, and diverse trade patterns appear to emerge. What determines the participation of a developing country in trade in services? What is the role of international negotiations? International trade is no longer exclusively or time (financial services). Open financial, about goods crossing borders. Trade in servic- telecommunications, and transportation serv- es, particularly business services, has become a ices, are inputs for the production of goods dynamic component of trade as well as an al- and other services. ternative for export diversification in developing Cross-border is not the only means to countries. Increasing tradability of services al- provide services. Trade in services requires lows the cross-border exchange of services, the movement of factors--capital and la- such as professional services, that previously bor--as well as the movement of consumers required providers or consumers to move. across borders (tourism). Developed coun- During 2000­07, before the financial crisis, tries have an abundance of capital, and de- trade in services grew as fast as trade in goods, veloping countries have an abundance of la- at an average rate of 12 percent annually. bor; however, international flows of capital Trade in business services (such as engineer- enjoy a greater degree of freedom than does ing, legal, health, accounting, and manage- labor mobility. Although labor mobility barri- ment services) grew even faster over the same ers affect developing countries' comparative period--at 14 percent. advantages in skill-intensive services, those Services play a broad and strategic role countries have managed to become service in the economy. Low-cost and high-quality exporters. services generate economywide benefits. Em- Despite enormous challenges, develop- pirical research confirms that welfare gains ing countries are exporting services. Besides from services liberalization are substantial traditional activities (such as tourism), and allow a more efficient allocation of re- health, information technology, and commu- sources while contributing to economic nication services are among the most success- growth. As inputs, services facilitate transac- ful service exports. Diverse patterns seem to tions through space (information technolo- emerge: Latin American countries have be- gies, communications, and logistics services) come exporters of services through invest- FROMTHePOVeRTYReDuCTIOnAnDeCOnOMICMAnAGeMenTneTWORK ments abroad, and South Asian countries are mation technology­related services; Chile stronger cross-border service exporters. Fur- exports distribution and transportation serv- ther analysis is needed to identify the policies ices; and Mexico exports communication and factors that determine the participation and distribution services. of a developing country in trade in services. African countries are also participating. Finally, international negotiations do play an In the Middle East and North Africa and the important role, and developing countries Sub-Saharan regions, countries such as must learn how to take advantage of them. Kenya, Morocco, South Africa, and Tunisia provide professional services to Europe; and Services Exports from Developing the Arab Republic of Egypt has developed a Countries world-class call-center sector. The growing A large number of developing countries have phenomenon of health tourism appeals to successfully exported services, both within many developing countries. Exports of their own regions and to high-income coun- health services are successfully provided by tries (figure 1). India's success is well known: countries in Asia (India, the Philippines, and exports of software and business process serv- Thailand), as well as by countries in Latin ices contributed to about 33 percent of In- America and the Caribbean, the Middle East, dia's exports in 2007­08. Brazil, Costa Rica, and North Africa. and Uruguay export professional and infor- Capital-intensive and managerially com- plex services are also part of the story. Providers of construction services from de- Figure 1. Developing Countries' Exports of Services Are Growing Fast, 1999­2008 veloping countries are among the top 225 in- ternational contractors. Firms in developing 500 countries engage in trade across a variety of 450 environmental services segments. Some de- 400 veloping countries are even engaging in fi- Index, 1998 = 100 350 nancial and telecommunications services. 300 250 200 Divergent Patterns among 150 Developing Regions 100 There are differences in trade patterns 50 among developing regions. In South Asia, 0 services exports are mainly concentrated on cross-border services; and within this mode, in 99 00 01 02 03 04 05 06 07 08 19 20 20 20 20 20 20 20 20 20 information technologies, communication Year services, and services that enable them. (cross- Andean Community Association of South East Asian Nations border provision of business and professional Central American Common Market services, among others). In East Asia, services Common Market of Eastern and exports are closely linked to the region's man- Southern Africa Southern Common Market ufacturing exports. In the future, this may of- West African Economic and Monetary fer these countries opportunities to diversify Union to new activities not linked to trade in goods. In Latin America, exports tend to be more Source: World Trade Organization. Note: Corresponds to other commercial services: communica- concentrated on services supply through di- tions, construction, insurance, financial, computer and infor- rect investment in other countries in the re- mation, royalties and license fees; professional and other busi- ness services; personal, recreational, and cultural services. gion. For instance, 61 percent of Chile's in- 2 PReMnOTe june 2010 vestment abroad is in services and energy in- 2006), correlation between export perform- dustries located mainly in neighboring coun- ance and liberalization in services seems tries. Although Brazil's investment abroad is weaker. Liberalization (measured either by much more diversified in terms of both the Economic Freedom Index of the Her- sectors and markets, services play an impor- itage Foundation or the World Bank's Doing tant role. In financial, construction, and engi- Business Indicators) is a poor predictor of serv- neering services, Brazil has been a successful ice export performance (figure 2). Of course, exporter via investment abroad; and the coun- this does not mean that liberalization should try consistently has resorted to all four modes not be pursued; instead, it suggests that liber- for information technology services. Likewise, alization alone does not provide enough mo- Mexico's investment abroad is diversified in mentum to propel the performance of serv- terms of sectors and countries. But services ices exports. Liberalization does not create also play an important role in telecommunica- spontaneously entrepreneurial drive, skills tions, distribution, call-center activities, and endowment, and the managerial capabilities offshoring. Although there is no clear trade required to export services. Complementary pattern in Africa, services have been emerging policies are required to ensure that invest- as an important trade topic. ment in infrastructure and education will take Patterns of market destinations are also place; and that possible market failures such different. Moreover, developed countries are as lack of information, lack of transparency, the main destination markets for service ex- and inadequate regulations will be tackled ports from South Asia. In Latin America, by contrast, the destinations of exports (mea- sured by investment flows) are countries in Figure 2. Relatively Weak Correlation between Openness and the Export of Services the same region. Countries in the Middle Performance East and North Africa region tend to export 160 low ranker services to Europe, whereas South African N services providers are investing increasingly 140 N NNN N N N NN N NN N N N NN in their own region. 120 N N NN N NN NN N N N NN N N N N N NNN N N N 100 N NN N N N NN N N N NNN Domestic Policies and Trade N N Rank 80 N N N N N GN Performance N NN N NN N N N 60 N NG G G G What determines the participation of a devel- N N N N NN N G N 40 N N NG N N NN N GN G oping country in trade in services? Anecdotal N GN G G N N G GG GGGG evidence seems to suggest that developing 20 high GG ranker NN G GGG G G G G G countries with different openness to trade and 0 foreign investment policies (Brazil, Chile, 35 45 55 65 75 85 95 less Economic Freedom Index more Arab Republic of Egypt, India, Malaysia, and Mexico); different tax incentives such as spe- N developing G developed cial economic zones (Costa Rica and Uru- linear (developing) guay), different business environments, and linear (developed) different geographic locations, have been suc- Source: Trade in services data from the World Trade Organi- cessful exporters of commercial services. zation; openness and economic freedom measurements from Complementary policies should support the Heritage Foundation Economic Freedom Index. Note: Trade in services ranking: countries have been sorted liberalization. Although empirical evidence on the basis of export values. According to the Economic suggests that greater liberalization is associat- Freedom Index, most open countries have higher scores. De- veloping countries: y = ­1.525x + 176.33, R 2 = 0.1117; devel- ed with greater economic growth (Mattoo oped countries: y = ­ 0.609x + 69.669, R 2 = 0.0469. june 2010 PReMnOTe 3 (hence the importance of the Aid for Trade Figure 3. People Skills and Availability Are initiative for service exports). Important Determinants of Exports Success Identifying the reasons for the successes 50 low ranker Ranking of other commercial services NN of developing countries and the reasons for 45 N NN N underperformance is still a challenge be- 40 NN NN cause of the lack of data. People and skills 35 NNN N 30 N NN NN availability explain success in services exports NN 25 NN N N (figure 3). Leaving aside the case of trans- N 20 N N N portation and tourism sectors, countries with NNN better human capital endowment tend to be 15 N N N NN N 10 NN N ranked among the most important exporters high 5 N NNN of business services. Other variables, such as ranker NN N 0 business environment and financial attrac- 5 0 5 0 5 0 0. 1. 1. 2. 2. 3. tiveness, seem to correlate less strongly with lowest score highest score services performance. Part of the explanation Ranking of people and skills availability is that the most successful offshoring compa- nies focus less on saving money and more on N countries linear (countries) improving operational performance. They base their strategies "on building a global de- Sources: A. T. Kearney (2007); World Trade Organization statistics database for noncommercial services. livery model rather than offshoring per se. In Note: Other commercial services: communications, construc- other words, when planning for the future, tion, insurance, financial, computer and information, royalties and license fees; professional and other business services; top companies make decisions based on their personal, recreational, and cultural services; excluding trans- portation and travel services, which are less skills intensive. entire enterprise, rather than simply choosing The A. T. Kearney index measures three major categories: fi- the next offshore destination" (A. T. Kearney nancial attractiveness, people and skills availability, and busi- ness environment. In this case, the maximum score is 3.0. 2007, p. 12). Nyahoho (2010) assesses the im- portance of factor intensity as a determinant of trade in services. Human capital is clearly one with few restrictions on the various modes related to exports of computer and informa- of services delivery), low-cost human capital, tion services. Other exports (such as con- and common laws/legal systems. His main struction services and public works, royalties findings are that human capital, teledensity, and license fees, and computer and informa- and restrictiveness variables are the most im- tion services) are positively linked to research portant policy areas available to governments and development intensity. Finally, for servic- to promote bilateral services trade. es in passenger transportation; freight; travel; communications; and personal, cultural, and International Negotiations recreational services, the theory of compara- What is the purpose of engaging in ambitious tive advantage determined by relative factor trade negotiations? It is important to under- intensity seems to have little explanatory pow- stand the role that trade agreements play in er (but proves useful as long as other relevant the contexts of trade liberalization in general aspects are considered, such as industrial and of services in particular. First, they collab- specificities, modes of internationalization, orate in the liberalization process when vest- and legislation). ed interests oppose liberalization and block As determinants of trade in services, Shin- initiatives to open access or prevent the estab- gal (2010), using a gravity model, analyzes mar- lishment of an appropriate regulatory frame- ket size (economic), trade in goods, the pres- work. Second, trade agreements create a ence of an English-speaking workforce, quality more stable framework because they are in- infrastructure, an open policy regime (that is, ternational contracts that cannot be unilater- 4 PReMnOTe june 2010 ally changed. Therefore, they also can create market access for goods. Trade in services lib- a time path for introducing reforms in a grad- eralization should be negotiated on its own ual manner and provide rules that cannot be merit, taking into account the overall potential modified arbitrarily. Finally, trade agreements benefits that are available. provide political support for trade in services liberalization because they ensure reciprocal market liberalization. Bibliography A. T. Kearney. 2007. "Offshoring for Long-Term Many developing countries have been re- Advantage: The 2007 A. T. Kearney Global luctant to pursue multilateral negotiations, but Services Location Index." Chicago, IL. http:/ / there is no clear explanation for that reluc- www.atkearney.com/images/global/pdf/GSLI tance. The political economy of services nego- _2007.pdf. tiations is more complex than traditional trade Cattaneo, O., M. Engman, S. Sáez, and R. M. Stern, negotiations because it deals with domestic re- eds. 2010. International Trade in Services: New forms and issues that are close to social poli- Trends and Opportunities for Developing Countries. cies. At the same time, many countries have Washington, DC: World Bank. actively engaged in regional and bilateral trade Ghani, E., ed. 2009. The Service Revolution in South negotiations in services. Moreover, many de- Asia. New York: Oxford University Press. veloping countries have been willing to negoti- Haddad, M. E., and C. Stephanou. Forthcoming. ate bilaterally with developed countries some Financial Services and Preferential Trading Ar- rangements: Lessons from Latin America. highly demanding rules and disciplines. In ad- Hoekman, B., W. Martin, and A. Mattoo. 2009. dition, trade in services agreements among de- "Conclude Doha: It Matters!" Policy Research veloping countries are also flourishing, where- Working Paper 5135. World Bank, Washing- as services negotiations in the World Trade ton, DC. Organization Doha Round have attracted less Mattoo, A. 2006. "Services in a Development interest and have lagged behind other negoti- Round: Proposals for Overcoming Inertia." In ation groups. Countries still are unable to Trade, Doha, and Development: A Window into the assess possible outcomes in this topic. Issues, ed. R. Newfarmer. Washington, DC: Why does Doha matter for services negoti- World Bank. ations? From the developing-countries' per- Nyahoho, E. 2010. "Determinants of Comparative spective, the World Trade Organization frame- Advantage in the International Trade of Servic- work provides enough flexibility both to deal es: An Empirical Study of the Hecksher-Ohlin with sensitive aspects of services and to address Approach." Global Economy Journal 10 (1). Shingal, A. 2010. "Exploring the Services Trade export-offensive interests. Globally, an ambi- Effect of Preferential Services Agreements." tious outcome in services negotiations will pro- World Bank Institute, Washington, DC. vide the most significant welfare gains of this round. Because of the complex nature of this topic, its overall strategic importance, and the About the Author complementary policies required to fully reap Sebastián Sáez is a senior trade economist at the Inter- its benefits, services liberalization should not national Trade Department, Poverty Reduction and be used as a bargaining chip to trade against Economic Management, World Bank, Washington, DC. This note series is intended to summarize good practices and key policy findings on PREM- related topics. The views expressed in the notes are those of the authors and do not necessarily reflect those of the World Bank. PREMnotes are widely distributed to Bank staff and are also available on the PREM Web site (http://www.worldbank.org/prem). If you are interested in writing a PREMnote, email your idea to Madjiguene Seck at mseck@worldbank.org. For addi- tional copies of this PREMnote please contact the PREM Advisory Service at x87736. 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