CPB Netherlands Bureau of Economic Policy Analysis The dynamic effects of European Services liberalisation Globalisation Challenges to Europe and Finland Prime Minister's Office, Helsinki, August 17, 2006 Henk Kox joint research with Arjan Lejour CPB Netherlands Bureau of Economic Policy Analysis

Structure presentation Problem area A single European market for services? Estimated static effects of liberalisation Dynamic effects of services liberalisation Conclusions and possible policy implications

Problem area: What are the longer-term, dynamic gains for EU from services liberalisation? productivity, innovation and competitiveness History: lively debate Commission's proposals for Services Directive (SD): 'trimmed-down' SD version adopted Spring 2006 to be implemented by 2010, also the benchmark year of the Lisbon goals Sapir report 2004: single European market for services is top priority for Lisbon goals Available studies on economic effects: focus only on static economic benefits

Product-market regulation in services Not regulation as such is a barrier to trade and FDI in services Regulating services sometimes for good reasons: ensure quality of service (information asymmetry, consumers) externalities (environmental, safety) prevent misuse of market power Public authorities have regulated services since ages for some these reasons especially professional services medical services

Regulation and trade (I) Many forms of product-market regulation cause fixed qualification costs for firms General qualification educational qualifications (diplomas, certificates) local professional insurance nationality requirements must have local office membership professional association licenses operational demands (inputs, marketing, legal form) Fixed qualification costs could in themselves be a source of scale economies and ... MORE trade!

Fixed (qualification) costs generate economies of scale ... but this only holds in case of open borders or mutual recognition

Policy differences as sunk cost barrier Each country regulates in a different way with different efficiency and administrative burdens Key problem: home-markt qualifications not recognised in other EU countries for exporters: regulation in destination country comes on top of home-market regulation Economic implications for service providers fixed costs for (re-)qualification country-specific ==> sunk export costs market - entry barrier

Costs of policy heterogeneity for individual services firm

Sectoral coverage of Services Directive

Structure of intra-EU services trade 2003 Services Directive mostly about B2B services!

Impacts of reducing policy heterogeneity in EU by Services Directive: our conclusions in a nutshell Bilateral trade in OCS service trade may rise by 30 - 62 % Bilateral FDI may increase by 18 to 36 % Deleting the country-of-origin principle (mutual recognition) from the Directive -as done in 2006 version- reduces trade effects by 1/3 little impact on estimated FDI effects We further fed the trade effects (not FDI) in CGE model for EU, yielding:

Macroeconomic effects SD (CGE model)

Other studies of static welfare gains from SD Copenhagen Economics (2005): CGE model EU consumption increase by 0.6% CoOP contributes about 10% to the total welfare effects, partly FDI-induced Badinger and Breuss (2005): Partial equlibrium model Use estimated trade effects of CPB as input Find significant effects of SD (more entry) on competition, and from competition on employment, investment and productivity

Three channels for dynamic welfare gains in longer run (1) More entry increases competitive selection and consumer choice Recent theory on trade with heterogeneous firms (Melitz, Baldwin, Helpman, Yeaple, Rubinstein): explains why only most productive firms export role of fixed/sunk entry cost reduction of fixed export costs raises participation by medium-sized EU firms: often more productive! gains: average services firm more productive pains: inefficient domestic firms drop out more consumer choice, less firm options for collusion

Firm-size and labour productivity in EU business services,1999: 6 countries inverted-U 1.0 size class of firms

Firm-size and labour productivity in EU business services, 1999: 5 ctrs. other patterns

Three channels for dynamic welfare gains in longer run (2) Liberalisation facilitates knowledge spillovers: through more bilateral FDI in services (studies Haskel, Keller, Javorzcik) through more export of knowledge-intensive business services (IMF study Guerrieri et al. 2005) Speed up original innovation due to more FDI participation: mixed evidence more entry may create incentives for distinctive product innovation: escape innovation (study Aghion & Griffith)

Conclusions Trimmed-down version of SD (2006) leaves some unfinished liberalisation business (CoOP) mutual recognition regulatory standards further lowers hurdle of sunk export costs Dynamic effects of service liberalisation can be considerable more firm entry, generates productivity gains through competitive selection more SME participation more knowledge spillovers (business services) more varieties and possibly also more original innovation Accompanying policies may ease the transition process (social insurance, flexibilise bankruptcy law, re-education)

Thank you for your attention research reports downloadable from: www Thank you for your attention research reports downloadable from: www.cpb.nl

Annex: CPB research on Services Directive (all reports downloadable) Effects Directive on intra-EU services trade / FDI The Free Movement of Service within the EU (CPB Document 69, 2004/5, also: Revue Economique July 2006) Policy heterogeneity as obstacle for international services trade (CPB Discussion Paper 49, 2005) Macro-economic effects Trade-induced effects of the Services Directive and the country-of-origin principle (CPB Document 108, 2006) Role country-of-origin principle Trade-induced effects of the Services Directive and the country-of-origin principle (ENEPRI, WP 44, 2006)