THE WORLD BANK 57833 POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise NOVEMBER 2010 · Number 39 JUNE 2010 · Number 18 Uncovering Developing Countries' Performance Trade and the Competitiveness Agenda Trade and Services in Guilherme Reisin Thomas Farole José Sebastian Saez and Arti Grover Goswami The global economic crisis has forced a major rethinking of the respective roles of governments and markets in the processes of trade and growth. Indeed, industrial policy seems to be back in fashion--or, at least, talking about it is. But a renewed "activism" by government in the trade and growth agenda need not mean a return to old-style policies of import substitution and "picking winners." Instead, it may mean expanding rapidly competitiveness by Services play a broad and strategic role in the economy. Trade in services has beena stronger focus on because technological unlocking the constraints the cost of cross-border exchange from infinity to virtually zero, role of government in trade improvements have reducedto private sector­led growth. This note discusses the renewedthereby allowing for new export and growth policy from the competitiveness angle, and it become some priorities for diversification for many agenda. activities. Trade in services, particularly business services, hassuggests an element of exportthe new competitiveness develop- ing countries. Besides traditional activities such as tourism, activities such as health and information and communication services are among the most successful services exports. This note focuses on the determinants of trade in services for develop- ing countries. Export-Led Growth, the Crisis, and the End pacts of the crisis on the policy environment regarding trade of an Era and growth were becoming more apparent. Indeed, in addi- International trade is no longer exclusively about goods cross- tion to raising concerns over the global commitment to trade Empirical research concludes that welfare gains from services The dramatic expansion in global trade business services, ing borders. Trade in services, particularly over recent decades liberalization are substantial, resulting in a more efficient allo- liberalization, the crisis has also led to some serious rethink- has contributed significantly to of trade as well growth, has become a dynamic component diversification,as an alter-and cation of resources conventional to economic growth. As ing of some of theand contributingwisdom regarding the poverty reduction in many developing countries. This In- native for export diversification in developing countries. period inputs, services facilitate transactions result space (informa- growth agenda--the most importantthroughof which is the of rapid export allows has been enabled by of servic- creasing tradabilitygrowththe cross-border exchange two critical tion technologies, communications, and logistics services) or likelihood that governments will play a much more activist structural professional services, that previously required the es, such as changes in global trade: (1) the vertical and spatial time (financial services). Financial three principal reasons role in the coming years. There are services, telecommunica- close proximity of providers and consumers (Ghani 2009; fragmentation of manufacturing into highly integrated tions, transportation and other services actively involved in why governments are likely to be more are key inputs for all Ghani and Kharas 2010). During 2000­2007, before the fi- "global production networks," and (2) the rise of services production trade policy in the coming thus are industrial andof goods and other services andyears. important trade and the growth of "offshoring." as trade in goods, turn, nancial crisis, trade in services grew as fastBoth of these, in at First, the crisis economywide competitiveness (Hoekman determinants ofhas undone faith in markets and discred- were made possible by major technological same period, an average rate of 12 percent annually. Over therevolutions; and and Mattoo 2008; Francois and Hoekman 2010). trade policy ited laissez-faire approaches that rely simply on trade in business services by multilateral trade policy reforms they were supported (such as engineering, legal, health, ac- Despite enormous challenges, developing countries are in- liberalization. Instead, governments and local markets have counting, and management services) grew even faster at 14 per- and broad liberalizations in domestic trade and investment creasingly exporting services. Diverse patterns seem to emerge: been "rediscovered." In this sense, the demand for activist cent. During the crisis, trade in business services as well as in- environments worldwide. Latin American countries have become exporters of services government is likely to go well beyond financial markets and vestment programs in thiscrisis came crashingmore the middle The global economic sector proved to be into resilient through investments abroad, while South Asian countries are regulation, and it will affect the policy environment in which than trade in goods, and investment prospects in this area re- of this long-running export-led growth party during 2008 stronger in cross-border services exports. In contrast to the de- trade and industrial strategies are designed. main2009. Between and Mattoo 2009;of 2007 and the second and strong (Borchet the last quarter UNCTAD 2009). terminants of trade in goods, much less is known about the fac- Second, the crisis has highlighted the critical importance quarter of play a broad and strategic role in the economy. Low-But Services 2009, global trade contracted by 36 percent. tors that determine the participation of a developing country of diversification (of sectors, products, and trading partners) cost and high-quality servicesstrengthen in 2010 (atbenefits. as the recovery started to generate economywide least until in trade in services and the types of policies that can help sup- in reducing the risks of growth volatility. The recent era of the clouds began to form over Europe), the longer-term im- globalization contributed to substantial specialization of 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise port export growth. International negotiations and agreements investment abroad. Likewise, Mexico's outward direct invest- have a potential role to play in this connection, but there is still ment is diversified in terms of sectors and countries, but ser- much to be learned on how best to take advantage of this in- vices play an important role in telecommunications, distribu- strument. tion, call center activities, and offshoring. Although in Africa there is no clear trade pattern yet, services have been also emerg- Services Exports from Developing ing as an important trade topic. Countries The geographic patterns of trade also differ. The destination A large number of developing countries have successfully ex- markets for services exports from South Asia are mainly devel- ported services both within their own regions and to high-in- oped countries. In contrast, in Latin America exports (mea- come countries. India's success is well known: exports of soft- sured by investments flows) are mostly to countries in the same ware and business process services account for approximately region. Countries in the Middle East and North Africa region 33 percent of India's total exports. Brazil, Costa Rica, and tend to export services to Europe, while South African services Uruguay export professional and information technology­re- providers are increasingly targeting countries in Africa. lated services; Mexico exports communication and distribu- Domestic Policies and Trade Performance tion services; and Chile exports distribution and transporta- tion services. What determines the participation of a developing country in African countries are also participating. Morocco, Tunisia, trade in services?1 Anecdotal evidence suggests that successful Kenya, and South Africa provide professional services to Eu- exporters often are very different in terms of openness to trade rope, and Egypt has developed a world-class call center sector. and foreign investment; tax incentives, such as special econom- The growing phenomenon of health tourism is an opportunity ic zones (Costa Rica and Uruguay); the business environment; for many developing countries. Exports of health services are and geographic location. Thus it is difficult to generalize. What successfully provided by the Philippines, Thailand, and India, is clear is that complementary policies need to support liberal- and countries in the Middle East and North Africa and in Latin ization. America and the Caribbean. Although empirical evidence suggests that greater openness Capital-intensive and managerially complex services are also is associated with higher economic growth (Mattoo 2006), the part of the story. Construction services providers from develop- correlation between export performance and liberalization in ing countries are among the top 225 international contractors. services seems to be weaker. Of course, this does not mean that Firms in developing countries engage in trade across a variety of liberalization should not be pursued, just that by itself it may environmental services segments. Some developing countries not provide enough to drive services export performance. Lib- are also engaging in financial as well as telecommunication ser- eralization does not create spontaneously entrepreneurial vices (Cattaneo et al. 2010). drive, improve the skills endowment, or mobilize the manage- rial capabilities required to export services. Complementary Divergent Patterns among Developing policies are required to ensure that investment in infrastruc- Regions ture and education will take place. It is important to identify There are differences in trade patterns among developing re- possible market failures such as lack of information and trans- gions. In South Asia, services exports are mainly concentrated parency, and to ensure that appropriate regulatory regimes are in cross-border services, and within this mode, in information in place. These are areas where the Aid for Trade Initiative can and communications technologies (ICTs), communication ser- play a constructive role.2 vices, and ICT-enabling services (cross-border provision of Identifying the reasons for the successes of developing coun- business and professional services, among others). In East Asia, tries in exporting services and the reasons for their underper- services exports are closely linked to manufacturing exports. formance remains a challenge because of the lack of reliable This may provide opportunities in the future to diversify into data. Leaving aside the case of transportation and tourism sec- new activities not linked to trade in goods for these countries. tors, available data suggest that countries with better human In Latin America, exports tend to be more concentrated on ser- capital endowment tend to be ranked among the most impor- vices that are supplied through direct investment in other tant exporters of business services. Regressing aggregate servic- countries in the region. For instance, 61 percent of Chile´s in- es exports on the average years of tertiary schooling (obtained vestment abroad is in services and energy industries mainly in from Barro and Lee [2010]) yields a positive and significant co- neighboring countries. Although Brazil´s outward investment efficient after controlling for electronic infrastructure and in- is much more diversified both in terms of sectors and markets, stitutional variables, such as contract enforcement. This im- services play an important role. In financial, construction, and plies that human capital is an important determinant of engineering services, Brazil has been a successful exporter via services exports (these results are replicated if a gravity regres- 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise sion framework is used). The find- Figure 1. Human Capital and Services Exports ing that human capital is critical to services exports holds true irre- 14 spective of the data set used, time period of study, or the estimation methodology. A partial correlation 12 services exports, in logs plot between tertiary education and services exports in figure 1 de- picts this relationship. 10 Nyahoho (2010) assesses the importance of factor intensity as a determinant of trade in disaggre- 8 gated services. Human capital is clearly related to exports of com- puter and information services. 6 Other exports (such as construc- 0 20 40 60 80 100 tion services and public works, roy- school enrollment, tertiary (% of gross) alties and license fees, and comput- Source: World Development Indicators (2007). er and information services) are positively linked to research and development intensity. including market size, trade in goods, the presence of an Eng- Other variables, such as business environment and financial lish-speaking workforce, quality of infrastructure, the openness attractiveness, correlate less strongly with services performance. of the trade policy regime toward the various modes of services However, regression analysis suggests that factors such as con- delivery, cost of human capital, and common laws/legal sys- tract enforcement or the rule of law are important determinants tems. Shingal's main findings are that human capital, teleden- of services exports after controlling for Internet penetration. sity, and trade restrictiveness variables have the biggest impact The explanatory power of institutional variables loses signifi- on bilateral services trade and thus should be the policy focus if cance when controlled for higher education. Part of the explana- the objective is to promote services trade. tion is that the most successful offshoring companies focus less Similar to a study on the services trade for the United States on saving money and more on improving operational perfor- (Freund and Weinhold 2002), a cross-country regression analy- mance. These companies base their strategies "on building a sis on services trade determinants also supports the view that global delivery model rather than offshoring per se. In other Internet penetration is critical in altering the geography of ser- words, when planning for the fu- ture, top companies make decisions Figure 2. Electronic Infrastructure and Services Exports based on their entire enterprise, rather than simply choosing the 14 next offshore destination" (A. T. Kearney 2007, 12). When we take institutional variables to bilateral 12 services exports, in logs services trade data, they do not ap- pear to be critical. Instead, what matters more for bilateral services 10 exports is the similarity in institu- tions rather than the absolute qual- ity of institutions. This result is 8 similar to Rose (2000), who found that countries with the same colo- nizers had similar institutions and 6 therefore traded more. Using a gravity model, Shingal 0 20 40 60 80 (2010) analyzes various potential Internet penetration (users per 1,000 people) determinants of trade in services, Source: World Development Indicators (2007). 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise vices provision. Figure 2 shows this positive relationship and experience that could contribute to a process of "learning through a partial correlation plot between Internet users per to learn" from country experiences. There is also much to be 100 inhabitants and services exports. learned from the experiences of emerging market economies. A In a bilateral trade framework, preliminary results suggest services knowledge forum would help concentrate and dissemi- that what matters more in services exports is Internet penetra- nate knowledge that exists in research centers, international tion in the trading partner, as opposed to the exporter. What is organizations, and academic institutions, as well as insights and required for exporting services is access to high-quality elec- experiences of policy makers, regulators, and private sector rep- tronic infrastructure; this need not cover the general popula- resentatives, helping to stimulate fruitful dialogue, exchange of tion of the exporter, explaining why Internet penetration experiences, and learning about good regulatory practices. among the general population may not significantly affect ser- vices exports. This suggests that developing country exporters About the Authors may need to invest in equipment to ensure better quality tele- Sebastian Saez is a senior trade economist in the International communications if the public network is inadequate, or alter- Trade Department and and Arti Grover Goswami is a consultant natively, the government should attempt to create zones where with the Development Research Group and the International Trade the needed infrastructure inputs are supplied. An example of Department of the World Bank. such zones are the software technology parks in India. On the other hand, to successfully export services, it is important that Notes the consumers of services in the partner country have better 1. What follows draws on preliminary results of an ongoing access to good quality electronic infrastructure. work on the determinants of service exports. International Negotiations and Developing 2. Aid for Trade aims to help developing countries, particularly Countries least-developed countries, develop the trade-related skills and infrastructure needed to implement and benefit from World Trade agreements can play a complementary role in promoting Trade Organization agreements and to expand their trade both domestic reforms and opening markets for services ex- (http://www.wto.org/english/tratop_e/devel_e/a4t_e/ ports, thereby contributing to countries' competitiveness and aid4trade_e.htm). trade diversification strategies. But negotiations are resource intensive because they require deep knowledge of the sectoral References policy issues involved and the ability to manage potential nega- A. T. Kearney. 2007. "Offshoring for Long-Term Advantage: The 2007 A.T. Ke- tive consequences of liberalization. Coherence between devel- arney Global Services Location Index." Chicago, IL. http://www.atkearney. opment strategies and policy reforms in the services sector is com/images/global/pdf/GSLI_2007.pdf. critical, yet difficult to achieve. Barro, Robert, and Jong-Wha Lee. 2010. "A New Data Set of Educational At- Because of the resource-intensive nature of services policy tainment in the World, 1950­2010." NBER Working Paper No. 15902. reforms and trade agreement negotiations, developing coun- Borchet, I., and A. Mattoo. 2009. "The Crisis-Resilience of Services Trade." De- tries are confronted with three challenges: (i) improving their velopment Research Group Policy Working Paper 4917, World Bank, Washington, DC. knowledge on regulatory experiences and the impacts of policy Cattaneo, Olivier, Michael Engman, Sebastian Saez, and Robert M. Stern. reforms undertaken in other countries; (ii) identifying alterna- 2010. 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Trade Department is exploring the creation of a "knowledge Mattoo, A. 2006. "Services in a Development Round: Proposals for Overcom- platform" that brings together high-income, emerging, and ing Inertia." In Trade, Doha, and Development: A Window into the Issues, ed. other developing countries. Many organizations have expertise R. Newfarmer, 161­74. Washington, DC: World Bank. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Mirza, Daniel, and Giuseppe Nicoletti. 2004. "What Is So Special about Trade Rose, A. K. 2000. "One Money One Market: The Effect of Common Curren- in Services?" Research Paper 2004/02, University of Nottingham School cies on Trade." Economic Policy 15 (30): 7­46. of Economics. Shingal, A. 2010. "Exploring the Services Trade Effect of Preferential Services Nyahoho, E. 2010. "Determinants of Comparative Advantage in the Interna- Agreements." Working Paper Series, World Trade Institute, Bern. tional Trade of Services: An Empirical Study of the Hecksher-Ohlin Ap- UNCTAD (United Nations Conference on Trade and Development). 2009. proach." Global Economy Journal 10 (1). World Investment Prospects Survey, 2009­2011. Geneva. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduc- tion and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise