New Handbook on Trade in Services

The new Handbook on Trade in Services is out now! Don't miss the many interesting chapters, also the one I wrote called "Ricardo Does Services: Services Sector Regulation and Comparative Advantage in Goods". See here for more information about the handbook

Ricardo Does Services is a chapter about how capable regulators can help services liberalization by introducing accompanying "good" regulatory policies so as to make services markets more competitive and not just only "free". This is important factor as many services markets actually need more careful policy design since they suffer from certain market failures. 

The chapter shows that when countries do actually have these capable regulators in place they experience a significantly better effect on exporting goods, particularly those goods which depend on services. The question of course is: what makes a capable regulator? Three things. One, skills and expertise about the market. Two, independence from government interference. And third, a well-defined mandate about what to do. Have a good read!

EU Services Part I

The issue of immigration is currently a hot debated topic and is often put in connection with globalization and the current political backlash. Both are actually two sides of the same coin. If goods which are produced by labour in one country cannot move across borders to another, then people themselves carrying along labour can always decide to move.

This substitution-effect is for economists nothing new as it has been found in several studies regarding trade and immigration. In other words, immigrants displace specific offshore tasks that could otherwise be imported by firms.

Yet, there is more to this relationship between immigration and trade, particularly when looking at services. For instance, this recent paper by Ottaviano, Peri and Wright (2015) finds that next to the reassignment of offshore tasks to immigrants, immigration also has a positive effect on the receiving country’s exports. How does that work?

First, this effect is bilateral between countries. This means that immigrants of a specific country promote exports significantly to that country where they come from. This is predominantly so for services which are known to be language-intensive and institutional-knowledge intensive such as legal or accounting services, recruiting and training services or advertising services, etc.

Obviously, it helps for a firm’s exports when it employs immigrants that know their origin country’s language and institutional structure where these sophisticated services are going to. Second and more interestingly, however, is that this paper also finds an additional aggregate productivity effect. That is, next to their bilateral export effect, immigrants also cause the economy overall and on the whole to have greater levels of productivity and exports.

Putting this in EU context, what does that mean in terms of policy? In my view, a couple of messages come out. For one, it clearly helps to have open borders across countries in that the free flow of skills complement trade, which results in greater economic benefits. In that regard, the four freedoms of the EU, namely those of goods, services, capital and people, are economically at least a rock-solid principle to stick at.

But there is more. It also means that diversity or a multi-cultural workforce is important for economies thriving on services and most EU countries do so. Although that may be an unpopular message in some EU countries right now, fact is that services which carry along most value-added are precisely those that actually benefit from having immigrants in the labour market and are precisely those that many EU countries produce.

Third, the EU needs to deregulate further its services markets. Although all the above results are “corrected” for the effect of burdensome regulations in services sectors, they nonetheless still matter. Many EU countries still have substantial trade and domestic regulations in services in place. A forthcoming World Bank report on the EU shows that lowering services regulations matters a lot for the EU in order to reap productivity benefits.

Fourth, and most important in my view, these results mean that policies related to the movement and employment of labour skills are important. Or, in other words, more efficient labour markets are necessary to foster benefits from cross-border skill movements. For instance, some EU countries have an oversupply of architects whilst others within the EU have a shortage. Making EU labour markets more flexible might bring another big push to unlock exports and productivity effects in services, a much needed factor for overall EU growth. 

Home-Market Effect Tested

The home-market effect is a theory that is part of the so-called New Trade Theory and which states that because of increasing returns to scale and trade costs countries are likely to exports those goods which are consumed most in their markets, or in other words, for which they have relatively large domestic markets. 

The increasing returns to scale will make it that firms are willing to locate in one market whilst trade costs will trigger firms to locate in larger markets. Hence, there is a link between market size (i.e. demand) and exports, not necessarily only imports as classical trade theory would predict. A sophisticated test of the home-market effect is now available in a new NBER paper from Costinot, Donaldson, Kyle and Williams. 

Question: What Do You Think about the WTO?

Upon invitation I recently attended a seminar discussion at a corporate firm in Brussels. In that firm some people of the global foresight department organized a very good seminar in which they wanted to have feedback from me and my colleagues think-tankers about various global trends in today's world economy and what implications that may have for the future. 

Various items passed the table and when it came to international trade, eyes were heading in my direction. In particular, one question about the WTO came up. Of course, that's an often-asked question nowadays, specifically with regards to the possibility that the Transatlantic Trade and Investment (TTIP) may run into difficulties. The question was, therefore, what would happen to the WTO if TTIP fails? Would countries re-direct resources towards the multilateral trading system again, or not?

Well, that's a hard one to predict I said as that question depends on many economic and political factors. However, I did have a couple of things to say, mainly three observations I have come across in the last three years since I have been in Brussels and have visited many seminars, high-level discussions and other events. 

One is that recently I attended a seminar discussion in Florence where quite a few notable economists and policy makers / advisers were present. When discussing the WTO, somehow a generational division seemed to appear in the sense that the older people in the room found it a lot more unacceptable that the multilateral trading system would become in danger compared to the younger generation. This may have long-run implications I said about any real efforts to revive the WTO by future policy makers. 

Second is that in Brussels at least, I often heard the same comment from Commission officials occupied with trade strategy that the ultimate goal of TTIP is to bring back countries, and in particular emerging economies, to the WTO. TTIP could then be seen as an important instrument to revise the WTO. True, without the big economies such as the EU and the US not much gets started in Geneva. Hence, a successful revival of the WTO in the short-term at least could stand or fall with the outcome of TTIP. 

Third, a successful come-back of the WTO will also depend on the future of trade. Although goods trade may peter out, new trade issues may inevitably come up in the future such as digital trade. At ECIPE we have been doing a lot of research on that and to us it seems that precisely developing and emerging economies are more restricted in this area of the global economy than developed countries. This could therefore lead to new tensions at the WTO during negotiations as we have seen in the passed rounds. 

The WTO has several functions of which the most important ones are monitoring member countries' trade regime, dispute settlement resolution and providing a negotiation platform to solve trade issues. Particularly the latter function has been running into difficulties. Hopefully these three observations won't put too much weight in finding a new way for the WTO to negotiate trade. 

Digital Services Exports and Networks

This picture below shows for a large set of countries the relationship between their ability to capitalize on the digital economy and their exports in digital services. 

More precisely, on the horizontal axis an index measuring the so-called network readiness of countries is plotted. This variable comes from the World Economic Forum. It measures the extent to which an economy is prepared to apply the benefits of information and communications technologies (ICTs) in order to promote economic growth and well-being. On the vertical axis on the other hand the amount of digital services exports is plotted for each country.  

This variable comes from the World Bank's Trade in Services Database. Together these two variables illustrate that countries which have a stronger ranking on the network readiness index also show a greater level of digital services exports as their is a positive relationship. 

In particular, countries such as Ireland, Luxembourg and the United Kingdom are relatively strong in exporting digital services compared to what one can expect based on their levels of network readiness. These countries are therefore placed above the orange line.