Regional Agreements and Trade in Services CARSTEN FINK “Trade in Services and International Agreements” Hanoi, Vietnam, May 23-27, 2005

Overview Introduction Economics of regional integration in services Architecture of regional agreements A small case study: the China-Hong Closer Economic Partnership Agreement

Introduction

Examples of RTAs in services Early agreements: EU NAFTA Newer agreements: MERCOSUR ASEAN Bilateral FTAs: US-Vietnam, Thailand-Australia, Japan-Mexico, Singapore-Japan, many others Many more agreements are being negotiated

Why negotiate regionally? What international trade agreements can offer: Foster deeper liberalization at home and abroad through reciprocity-based market access negotiations Enhance credibility of the current trade regime and of future reforms Promote regulatory cooperation Possible reasons for negotiating regionally: More effective bargaining, deeper liberalization Political imperative

Will there be trade preferences? Time Protection GATS Bilateral ASEAN T3T3 T2T2 T1T1 PMPM PFPF PGPG

Economics of regional integration in services

Can there be preferences in services? Measures affecting services trade are typically not tariff-like instruments, but: Limitations on entry of firms Foreign equity limitations Quotas on outputs and foreign service workers Requirements regarding the legal form of establishment Non-discriminatory regulatory measures Can there be exclusionary rules of origin?

Example of preferences in services Bilateral air service agreements: preferential allocation of output quotas Preferential relaxation of foreign equity limitations (e.g., Thailand-US) Preferential access to certain regions within a country (e.g., Hong Kong-China FTA) Preferential recognition of foreign qualifications (e.g., EU mutual recognition)

Welfare effects of trade preferences Lesson from goods trade (tariffs): Trade creation: consumers gain from lower prices Trade diversion: loss of fiscal revenue, possibly loss of quota rents Welfare effects are ambiguous Preferential liberalization in services is more likely to lead to welfare gains: Little or no (static) cost of trade diversion, as measures typically do not generate benefits for the importing country

But MFN liberalization is preferable Offers access to the most competitive service providers Avoids complexity for negotiators, administrators and businesses Other gains from trade (economies of scale, more intense competition, knowledge spillovers) are likely to be bigger if liberalization is non-discriminatory

And there are (different) trade diversion costs Second-best providers may benefit from first mover advantages, due to the importance of location-specific sunk costs in services Sequence of liberalization matters, benefits from eventual MFN liberalization may be smaller

Why then negotiate regionally? Political imperative More efficient bargaining Negotiations may be less complex Less scope for free riding on MFN principle Certain forms of regulatory cooperation are more feasible and desirable within a smaller group of countries (regulatory harmonization, mutual recognition) Learning-by-doing (infant industries) at the regional level

Rule of origin (denial of benefits) Determines extent of preferences From an economic perspective a liberal rule of origin is to be preferred, but then regional liberalization approaches MFN liberalization Possible approaches: Local incorporation Local incorporation and substantial business operation Domestic ownership and control Employment of domestic residents

Example: Mexico’s NAFTA commitment in financial services 0 5,000 10,000 15,000 20,000 25, US Spain Holland Canada Includes investments of U.S. based European banks FDI in millions of US$ Source: World Bank (2004)

Foreign Participation in the Mexican Banking Sector Name of Mexican Institution Foreign bank ownershipMarket Share Santander MexicanoSantander Hispano (Spain)5.7 SerfinSantander Hispano (Spain)8.5 BBVA-BancomerBBVA (Spain)19.7 BitalSantander & BCP (Portugal)9.0 Citibank 4.0 J.P.MorganJ.P.Morgan (USA)1.8 Chase ManhattanChase Manhattan (USA)0.2 DresdnerDresdner (Germany)0.2 ING Barings BankING Bank NV (Netherlands)0.2 Source: Salomon Smith Barney (2000)

Architecture of regional agreements

Broad lesson from past RTAs RTAs tend to show broad commonality, both among each other and vis- à -vis the GATS, as regards the standard set of disciplines directed towards the progressive opening of services markets : Scope/coverage (similar carve-outs – e.g. air transport, public services) Core disciplines are also typically similar Limited actual liberalization achieved

Architectural divergences Essentially two competing models, with few attempts at reconciliation: ‘ GATS approach ’ (e.g., ASEAN), including in terms of approaches to liberalization (hybrid scheduling) or ‘ NAFTA approach ’, including through scheduling on the basis of negative lists of non-conforming measures

‘NAFTA model’ Services disciplines address issues of cross- border trade (modes 1 and 2), complemented by generic (i.e. non-services specific) disciplines on investment and the temporary entry of business people Right of non-establishment (no local presence requirement as a pre-condition to supply services) But weaker (if any) disciplines on non- discriminatory quantitative restrictions

Hybrid versus negative listing In principle, both approaches can be made to yield similar liberalization harvests In practice, negative lists sometimes combined with lock in/ratcheting up requirements Negative list approach promotes gains in transparency and may encourage a domestic regulatory audit of service sector regimes Downsides: administratively burdensome; may deprive policy flexibility for future measures Non-binding lists of non-conforming measures a good-governance compromise?

Denial of benefits (rules of origin) Majority of RTAs covering services opt for a liberal (i.e. substantial business operation) rule of origin, with a view to promoting third country FDI inflows into the integrating area But some evidence of more restrictive rules aimed at limiting benefits to insiders (e.g., China-Hong Kong CEPA, Andean Pact)

Limited progress on rule-making Little progress to date in RTAs in developing disciplines on the unfinished agenda of the GATS: Domestic regulation (e.g. necessity test) Emergency safeguards (even within ASEAN) Subsidies More positive advances on services procurement

Liberalization challenges Progress on Mode 4 trade uneven and generally limited even in RTAs Sensitive sectors tend to remain the same across negotiating settings (e.g. maritime, aviation, audio-visual services, despite limited advances in some agreements) Some sectors (e.g. land transport) lend themselves more readily to RTA liberalization

Progress on regulatory cooperation Evidence is mixed; harmonization and mutual recognition are challenging even among a limited subset of partners (e.g., accountancy in ASEAN, EU services directive) Some RTAs have registered progress (US- Singapore) RTAs promote regulatory dialogue, the benefits of which may be reaped outside of trade agreements but in a manner that nonetheless facilitates and promotes trade and investment

Multilateral disciplines on RTAs Key disciplines of GATS Article V: Substantial sectoral coverage Elimination of all discrimination through elimination of existing measures and/or prohibition of new measures Flexibility for developing countries in establishing more restrictive rules of origin Weaker disciplines compared to corresponding goods disciplines

A small case study: the China-Hong Closer Economic Partnership Agreement

Background Defying most other RTAs in services, China’s commitments under CEPA imply actual liberalization and actual preferences Special circumstances: “One country, two systems” formula China’s accession to the WTO

WTO market access commitments Source: WTO

Structure of CEPA Little, if any, general disciplines Liberalization content spelled-out in Annex 4 of the Agreement Sectoral classification follows GATS W120 Hybrid scheduling No modes of supply identified Signed in 2003, entry into force in 2004 CEPA II, with additional liberalization commitments, signed in 2004

WTO versus CEPA: examples Source: WTO and

WTO versus CEPA: examples Source: WTO and

CEPA rules of origin Definition of Hong Kong-based service suppliers includes: Substantive business operations At least three years of establishment Payment of profits tax in Hong Kong Own or rent premises in Hong Kong 50 percent of staff should be local residents

Have foreign investors responded? Early indications indicate ‘yes’: 28 percent increase in new foreign-invested enterprises from 2003 to 2002 But still too early to tell Stronger FDI response to CEPA in the short term, as service providers do not face joint venture requirements?

Response of Hong Kong firms Source: Applications for Certificate of Hong Kong Service Supplier