VoxEU Column COVID-19 Global economy International trade

Services trade and COVID-19

While the lockdowns imposed in countries across the world in the wake of COVID-19 will be lifted eventually, social distancing (both voluntary and selective) is likely to stay for longer. This has already had, and will continue to have, a significantly adverse impact on services transactions that require proximity between buyers and sellers. Moving forward, the world could see more regulatory restrictions on services trade on health grounds. This column argues that consequently, trade in services is likely to take longer to recover, with knock-on effects on other sectors of economic activity.

The outbreak of COVID-19 has led to lockdowns in countries across the world, stalling economic activity globally. The IMF and the WTO, amongst other organizations, have already predicted massive losses in economic growth and international trade in countries and regions across the world. The WTO has predicted a 13-32% decline in trade, but these predictions are likely to be underestimates as they are only based on merchandise trade.

In gross terms, services trade accounts for a quarter of global trade in goods and services; the share of services in total trade doubles if we include trade in value added terms (WTO, 2019). This emanates from the growing “servicification” (National Board of Trade, 2012) of economic activity in countries across the world, both developing and OECD. 

Services trade was shown to be more resilient to the 2008 Global Crisis than merchandise trade (Borchert and Mattoo 2009, Ariu 2016) given its low sensitivity to demand shocks and less dependence on supply finance. While COVID-19 has resulted in an immediate supply shock followed by a demand shock, what will matter more this time around will be the social distancing and contagion-related fears. These will have a bearing on services transactions which require some form of physical proximity between buyers and sellers, and which cannot be substituted or replaced by services traded over the internet.

There are four different ways in which services are traded across borders and three of these four “modes of services delivery” (in WTO GATS parlance) require proximity between the buyers and sellers. These include Mode 2 (“consumption abroad” e.g. health and education services), Mode 3 (“commercial presence” or FDI in services e.g. international banking services) and Mode 4 (“movement of natural persons” e.g. IT professionals working onsite abroad and intra-corporate transferees). Mode 1 or “cross-border services trade” includes the entire range of services transacted via the internet, some of which at least continue to be delivered even in work-from-home scenarios.

The adverse effects of social distancing practices in the wake of COVID-19 are going to be the largest for services transacted via Modes 2, 3 and 4 as these require some form of physical proximity between the suppliers and consumers. To put things in perspective, the total value of global trade in commercial services in 2017 was $13.3 trillion of which nearly 60% was transacted via Mode 3, 10% via Mode 2 and 3% via Mode 4 (WTO, 2019). Figure 1 provides a breakdown of services exports and imports by modes of delivery based on the WTO’s ‘Trade in Services by Modes of Supply' (TiSMoS) database.

Figure 1 Composition of global services trade by modes of delivery (2017, US dollar billion)

Source: WTO TiSMoS; own calculations

According to UNCTAD’s World Investment Report for 2018, nearly half of total FDI in 2017 was in the form of greenfield investment, with M&A activity accounting for the rest. This suggests that at least half of Mode 3 services trade may be completely stalled due to this pandemic, with significant adverse effects on the other half too. Thus, at least half of total services trade, nearly $7 trillion in value, easily stands compromised by COVID-19. And even this is likely to be an underestimate, given that several Mode 1 services are complementary inputs to manufacturing and other services in which activity has been drastically affected, if not completely stalled, by the lockdowns.

Some services sectors are going to get more severely affected and are also likely to take longer to recover. These include education, travel, tourism and associated hotels, and restaurant services (which accounted for over 70% of total Mode 2 services exports in 2017) as well as air passenger transport services; transport and distribution services which are related to merchandise trade (and accounted for about a fifth of global services exports in 2017 although two-thirds of these were delivered via Mode 1); and construction and other business services that require the movement of skilled and unskilled professionals across borders (and accounted for over a quarter of Mode 2, 3 and 4 services exports in 2017). In contrast, the effects of the pandemic on insurance, financial, telecoms, and computer-related services are likely to be more limited. This is because most, if not all of these services, can still be delivered online in work-from-home scenarios and are therefore more resilient to any voluntary and selectively imposed social distancing once lockdowns get lifted.

This also has an implication for the effects of the pandemic on significant services trading economies, with the nature and speed of their recovery depending on the intensiveness of the underlying sectors in their GDP and labour force. For instance, 43% of the Swiss labour force can work from home given the concentration of economic activity in insurance, financial, and other business services that do not require the movement of personnel. Similarly, more than three-fourths of India’s (and global) IT services exports are now delivered online as opposed to on-site as before; IT services account for close to 40% of India’s total services exports and along with management consultancy services, is one of the few sectors where the country exhibits a revealed comparative advantage. These services are likely to be more resilient to the social distancing effects of COVID-19.

In contrast, many of the Caribbean and small Pacific islands that rely mostly on tourism and related hospitality services are likely to be severely affected and are also likely to take longer to recover given the physically proximate nature of such services. Keeping this in mind, the UN has already called for a global package of  $2.5 trillion aimed primarily at such tourism-intensive economies.

COVID-19 induced delays in reigniting some of these sectors will also affect other areas of economic activity where these services serve as significant inputs. For instance, distribution, other business, financial, and transport services are major inputs across manufacturing sectors. Total services value-added in manufacturing exports ranges from 30 to 33% across manufacturing sectors (WTO, 2019). Significantly, services value-added also constitutes 90% of services exports with greater reliance on inputs from within the same services sector (WTO, 2019).

In addition to the time it takes to revert to a business-as-usual scenario and a Sars-Cov-2 vaccine being developed for mass deployment, one major determinant of the recovery of global trade will be barriers that countries impose, which in the context of services trade are largely behind-the-border regulatory requirements. Existing literature has already demonstrated the adverse effects of regulatory incidence and heterogeneity in regulation on services trade (Kox and Nordås 2007, Nordås 2016, Nordås and Rouzet 2017, Rouzet et al. 2017), especially that delivered by commercial presence (Kox and Nordås 2009, Andrenelli et al. 2018, De Backer et al. 2018) and on services value added in global value chains (Miroudot and Cadestin 2017). Regulatory incidence and heterogeneity have also been shown to be significant determinants of countries’ propensities to negotiate preferential services trade agreements (Sauvé and Shingal 2016, Egger and Shingal 2018) and of their deeper commitments in such agreements relative to their WTO GATS commitments (Shingal et al. 2018).

The Great Depression and the inter-war period witnessed a rise in border tariffs on merchandise goods, the 1980s were an era of voluntary export restraints, and the 2008 Global Crisis led countries to resort to state aid and subsidies. The need for social distancing and continued fear of the pandemic until a vaccine is available may result in countries imposing additional barriers, especially to trade in services that require proximity between buyers and sellers. Thus, even if business and leisure travel are eventually allowed there are likely to be significant checks on the ground for health reasons (see Shingal 2019 for an analysis of regulatory restrictions on Mode 4 trade). Given the importance of services in general, countries would do well to ensure that such restrictions, while necessary in these times, do not become prohibitive. This would be a crucial determinant of economic recovery in the aftermath of this pandemic.      


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