1. Impediments in Services Trade Marrakech 16-03-2005 The impact of policy heterogeneity on trade and direct investment in services Arjan Lejour, Henk Kox

2. Impediments in Services Trade Marrakech 16-03-2005 Frankenstein visits Lisbon

3. Impediments in Services Trade Marrakech 16-03-2005 Contribution of trade to GDP, by sector, OECD average, 2001

4. Impediments in Services Trade Marrakech 16-03-2005 Why so little trade in services? Technical reasons: ► most service products cannot be shipped in boxes ► physical proximity of service producer and consumer often required Alternative international supply form: setting up a local subsidiary (FDI) Regulation-based trade barriers ► Directly trade barriers (non tariff) ► Non-tariff barriers caused by regulation of service markets

5. Impediments in Services Trade Marrakech 16-03-2005 Regulation-based trade barriers for services Many different types ► additional diplomas, certificates, licenses, requirements on input use, marketing, local professional insurance, membership of professional association, juridical form, etc. (EC, 2002) ► common element: qualification costs Different motives for regulations: ► ensure quality of the service or ► reliability of the service provider ► protect incumbent firms ► satisfy special domestic interest groups

6. Impediments in Services Trade Marrakech 16-03-2005 Nature of regulation-caused trade cost barrier Qualification costs for service providers: mainly fixed costs Form an entry barrier that also affects domestic service providers Like all fixed costs, regulation-caused costs could be a source of scale economies...... if borders were open!

7. Impediments in Services Trade Marrakech 16-03-2005 Main barrier for service trade: not regulation as such but regulation heterogeneity Each country regulates in a different way Foreign service regulation comes on top of regulation in home market Causing fixed compliance costs, specific for that export market Compliance costs are independent of firm size → press hardest on SME

8. Impediments in Services Trade Marrakech 16-03-2005 Costs of regulation heterogeneity

9. Impediments in Services Trade Marrakech 16-03-2005 The effects of regulation heterogeneity on trade and FDI Prior work: OECD researchers developed relative measures of regulation intensity level per country (Nicoletti et al.) They found negative impacts of regulation levels on bilateral trade and FDI in services Problem with levels: two countries with same regulation level may have very different regulations in place ► causes additional costs for exporters

10. Impediments in Services Trade Marrakech 16-03-2005 Indicator for bilateral policy heterogeneity For explaining bilateral trade and direct investment patterns we need a quantitative measure for bilateral policy heterogeneity Use OECD International Regulation database ► Database: 1600 regulation items ► Selection of 200 items in product market regulation For each regulation item pair-wise comparison of countries ► yields a matrix of bilateral indicators for policy heterogeneity

11. Impediments in Services Trade Marrakech 16-03-2005 Procedure bilateral heterogeneity indicator: example

12. Impediments in Services Trade Marrakech 16-03-2005 Refinements Heterogeneity indicator: ► an indicator for regulation-caused NTBs ► increases in the level of policy heterogeneity between countries ► specific for each country pair Decomposable for separate regulation domains: ► Barriers to competition ► Administrative burdens on startups ► State control ► Regulatory and administrative opacity ► Explicit barriers to trade / investment

13. Impediments in Services Trade Marrakech 16-03-2005 Application to intra-EU service market To be explained: ► bilateral trade in commercial services (excl. transport) of 14 EU countries, 1999-2001 Model: ► gravity model augmented with policy variables Explanatory variables: ► GDP origin, GDP destination ► distance factors (physical distance, language distance) ► regulation heterogeneity indicators (5 sub-domains) ► indicator for level of product market regulation in origin and destination country ► fixed effects for origin and destination countries (country dummies), year dummies

14. Impediments in Services Trade Marrakech 16-03-2005 Bilateral commercial services exports (ln), 1999-2001, 480 obs TLS/SURCountry of originOf Destination GDP org.0.85*** GDP dest.0.73*** Distance-0.97*** Language-0.50*** PMR org-0.48*** Entr. Barr dest-0.02 Het. Start ups0.83*** Het. Competition-2.66*** Het. reg. & adm.-0.21 Het. State0.04 Het trade&inves-0.22

15. Impediments in Services Trade Marrakech 16-03-2005 Results for trade regressions " Traditional" gravity variables: ► all were significant and had the expected signs Heterogeneity in market regulation has a strong negative impact on bilateral trade in commercial services ► strongest effect: sub-indicator for 'barriers to competition' Several methods (OLS, FE, TLS / SUR) used for testing robustness

16. Impediments in Services Trade Marrakech 16-03-2005 Same procedure for bilateral direct investment  variable to be explained: ─ bilateral inward FDI stocks, EU17 + USA, 1999  model: ─ augmented gravity model with policy variables  explanatory variables: ─ market size (GDP, origin and destination) ─ distance factors (physical distance, language) ─ technology factor (labour productivity in service sector origin country) ─ heterogeneity product market regulation (5) ─ regulation level (PMR, FDI restrictions) ─ fixed effects countries (dummies)

17. Impediments in Services Trade Marrakech 16-03-2005 Bilateral direct investment, 1999, 252 obs TLS/SURCountry of originOf Destination GDP org.0.98*** GDP dest.0.68*** Distance-1.18*** Language-0.07 PMR org-0.92*** FDI restrictions-9.33*** Het. Start ups0.84 Het. Competition-3.46*** Het. reg. & adm.-0.61 Het. State-2.50*** Het trade&inves1.57***

18. Impediments in Services Trade Marrakech 16-03-2005 Results for bilateral FDI Non-policy variables: ► gravity variables all significant and expected sign ► Technology variable (service productivity in origin country): significant positive effect Heterogeneity in market regulation has significant negative impact: ► strongest for regulation domain "Barriers to competition“ ► and FDI restrictions Some policy heterogeneity domains affect choice between exporting and FDI

19. Impediments in Services Trade Marrakech 16-03-2005 Policy context: EC (2004): new proposals that should boost internal service market by 2010. Principal instruments: ► reduce regulation heterogeneity ► Country of origin principle ► abandon discriminating regulations ► single point of contacts for foreign service firms Use our regression results for quantifying possible effects of EU proposals Close reading of proposals and establish their probable impact on heterogeneity

20. Impediments in Services Trade Marrakech 16-03-2005 Impact of proposed EU directive on heterogeneity indicators Component of regulationReduction due to EU directive Regulatory and administrative opacity66 - 77 % Explicit barriers to trade and investment73 - 78 % Administrative burdens on start-ups34 - 46 % Barriers to competition29 - 37 % State control3 - 6 %

21. Impediments in Services Trade Marrakech 16-03-2005 Simulated effect of new EU proposals on service trade and investment

22. Impediments in Services Trade Marrakech 16-03-2005 Conclusions Heterogeneity in regulation hampers trade and FDI in services ► In particular barriers to competition Analysis of effect non-tariff barriers was always elusive (NTBs difficult to quantify) ► our analysis from perspective of policy heterogeneity seems fruitful ► Follow-up: test its explanatory power for the OECD as a whole Results may have implications for future GATS negotiations ► More emphasis on mutual recognition

23. Impediments in Services Trade Marrakech 16-03-2005 Heterogeneity in regulations is the key problem. Some examples An engineer who occasionally provides a service in another country ► must obtain authorisation from the latter ► must meet the professional qualifications required there, even though he is qualified in his home country ► must enrol in a specific register An operator of retail stores wants to establish in other Member States ► is not allowed to use the services of the real estate agents, shop designers, architects, engineers, construction companies, banks and insurance companies with whom he works "at home"