Global value chains (GVCs) have transformed trade and development since the late 1980s by fragmenting the production process across borders(Baldwin 2011, Taglioni and Winkler 2016). Coming under multiple labels such as trade in tasks, international fragmentation, offshoring, and the second unbundling, GVCs and their implications have attracted enormous attention from both academics and policymakers in the developing and developed worlds.
Much of the research and discussion on GVCs, however, has focused on the manufacturing sector, despite the critical role of services in GVCs. One of the most startling new facts concerning services has emerged from the development of value added trade concepts (Koopman et al. 2014, Timmer et al. 2014). A joint OECD-WTO project (TiVA) finds that services contribute over half of total value added embodied in the exports of major economies including the US, UK, France, Germany, and Italy. Even for China, traditionally viewed as a goods exporter, over one third of their value added exports come from the services sector.
The role of services in global value chains
The importance of services in GVCs goes beyond their large share of value added. Coordinating dispersed production blocks requires services linkages such as transportation, telecommunication, and various producer services like business and financial services. A well-functioning services sector therefore enables and facilitates fragmentation, leading to an increased reallocation of production stages across borders (Jones and Kierzkowski 1990, Deardorff 2001, Francois 1990). However, despite its key role as an enabler or ‘glue’ that holds supply chains together, the role of services in GVCs is often underappreciated and poorly understood (Low 2013).
In a recent paper, I examine the heterogeneous impact on services liberalisation on countries’ GVC participation (Lee 2018). Using the gravity equation, I test whether a country pair engages in more GVC-trade in goods – through backward and forward linkages – when it has freer trade in services via regional trade agreements (RTAs). By focusing on manufacturing GVCs, I seek to identify the role of services trade liberalisation beyond boosting trade in services, but as an ‘enabler’ for a broader unbundling of production. Furthermore, the empirical analysis explores heterogeneous effects of service RTAs depending on countries’ income level and specific provisions included in the agreement.
Services trade liberalisation: Characteristics and heterogeneous effects
Trade liberalisation in services has some crucial differences from trade liberalisation in goods. First, large service providers are globally concentrated in the developed world (the ‘North’), making the liberalisation in services fundamentally asymmetric. What matters is to get good services into a country which, in most cases, developed countries already have. Therefore, one would not expect a preferential liberalisation in services trade between a developing (‘Southern’) and a developed country to have a symmetric impact on the two partners – it should enhance the quality of services available in the South while having a smaller effect on the North. In the context of GVCs, this means that a services RTA that asymmetrically reduces services restrictions in the South will make it a more attractive destination to offshore certain manufacturing stages.
Second, many of the restrictions in services trade are in fact behind-the-border measures or non-discriminatory in nature. Therefore, services trade liberalisation through RTAs often do not provide substantial preferential treatment to partner countries as is the case for goods (Miroudot and Shepherd 2014). This implies that the effect of service RTAs on bilateral trade flows and GVC participation will depend on specific provisions and commitments included in the agreement.
Consistent with the intuition, my empirical findings show that the effect of services agreements on GVC participation and trade vary depending on country pairs’ income groups. Service RTAs promote trade and, to a larger extent, GVC-trade in goods for developing nation exporters. The trade-enhancing effect of RTAs that cover services is almost double the effect of RTAs that only cover goods for Southern exporters. Both North-South and South-South RTAs in services increase GVC-exports from developing countries to their Northern or Southern counterparts. Furthermore, RTAs that cover services have a proportionately larger effect on GVC-exports compared to gross exports, whereas RTAs in goods are not particularly more important for GVC-exports.
My second set of findings show that service RTAs that grant the right to export services without local presence (i.e. non-establishment rights) are key to increasing GVC-trade between member countries. The non-establishment provisions are particularly important for certain services sectors, those that are not naturally bound by spatial or temporal proximity requirements between the service provider and consumer. While some services require such proximity (e.g. haircuts, care services), modern services increasingly can be provided remotely thanks to the information and communication technology development (e.g. e-learning, online business consulting). Therefore, the non-establishment right will naturally affect certain services sectors (business and financial services) more than others (construction and transport services).
The requirement of local presence is one of the large fixed costs of building international service linkages that are essential for coordinating multiple production blocks. Financial services, for example, can be provided through physical channels (e.g. branches) or through remote channels (e.g. online). A requirement of commercial presence to provide banking or insurance services in a foreign market increases the fixed cost of supplying such services and hence the cost of organising production across borders. The finding that service RTAs with non-establishment provisions leads to an increased reallocation of production activities is an intuitive yet novel finding.
Services play a crucial role in the functioning of GVCs, and services liberalisation is in many ways different from goods liberalisation. Yet, we know little about the trade-effects of RTAs covering services. The new evidence that service trade agreements foster the GVC participation of developing countries has important policy implications. When the production of goods involves intermediate inputs crossing borders multiple times, developing countries that wish to take a more active part in GVCs have more options than just lowering tariffs or non-tariff barriers. Liberalising trade in services can provide new pathways for developing countries to utilise their comparative advantage in global supply chains. Furthermore, allowing the cross-border supply of services without local presence is crucial to increasing countries’ participation in manufacturing GVCs. This new finding warrants further investigation since it is likely to gain relevance as advanced communication technology enables more modern services to be supplied and consumed from a distance.
Author’s note: The views expressed in this column are those of the author and do not necessarily represent the views of the World Bank Group.
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