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The Link between Services Trade Restrictions and Trade Growth Underperformance in Africa

Discussions

The Link between Services Trade Restrictions and Trade Growth Underperformance in Africa

Services trade is increasingly important, yet often restricted in developing countries, writes tralac Associate John Stuart

We live in a world where the production and consumption of services has been growing faster than that of merchandise for some time now. Whilst some services types, such as transport and construction, have developed to some extent over the past few decades, other such as communication services, financial services and information technology (IT) services have advanced rapidly. The productivity enhancements made possible by this development in services have been very large and have been felt in every area of society and the economy. Underlying the advancement in services sophistication has been progress in the ‘fundamental’ service group – information technology and communication (ITC) services.

However whilst considerable gains await the adoption of new services modes and types, some countries lag others in the adoption, rollout and uptake of these services. Under development and investment risk limit the extension of many services types in developing countries and there are both these supply-side and demand constraints on the growth of services sectors in these country groups. Nevertheless, in many cases the services policy environment in developing countries is simply not amenable to rapid rollout and uptake of high value-add services. In Africa, for instance, the aggregate Services Trade Restrictiveness Index (STRI) for the continent is nearly four times that for the OECD 19 countries.

It is no coincidence therefore that services sectors in developing countries are often characterised by oligopolistic market structures with cartel suppliers taking large economic rents (abnormal profits). The problem, although apparently emanating from the private sector, is government-created and abetted in that the governments are typically policy makers, regulators and competitors at the same time. This lack of separation of powers and absence of neutrality by governments entrenches the uncompetitive structure of the sector, prices the lower end of the consumer market out of the market and leads to slower development and technology transfer to the sector (in that the latter is normally driven by competitive pressure).

Consumers and producers therefore pay a premium for services that are often sub-par and the economy is denied the gains that should accrue to the improving production possibilities related to better services. The existence of large welfare gains following services trade liberalisation has been demonstrated in various formal studies, certain of which have been Africa-focused. What is striking about these studies is the extent of the gains shown – significantly more than that for equivalent merchandise trade liberalisation. Yet the popular sentiment is still that merchandise trade liberalisation should be at the top of the agenda for policy reform in developing countries.

How do services impact economies and their trade?

The mechanism by which services impact economic activity depends on whether these services are inputs into the production of physical goods or whether the services are consumed as end-value. The difference between these two paths of impact can best be demonstrated by an example. Transport services could either be delivered as an input into the production of furniture – when the raw lumber and later the finished items are transported by road or rail – or consumed as end-value when a commuter takes a plane on holiday. Generally, services are heavily ‘forward-linked’ in that a far greater proportion of their value is input into other goods or services production than is consumed finally. Some services, such as ICT, are more forward-linked than others, such as tourism; and some have a far wider impact than others (again, compare ICT with tourism or even construction).

What is common to services such as financial, transportation, ICT, professional and business services however, is that they are all part of the value chain into production of end value, whether it is traded domestically or exported. Given the key role played by exports in the growth path of developing countries, the importance of the cost and availability of forward-linked services to export growth therefore becomes apparent. It is this issue – the effect of services trade restrictions (STRs) on trade growth (for a set of African countries) – that is explored in a forthcoming tralac Working Paper by this researcher[1].

The working paper shows that transport STRs appear to have the most wide-ranging impacts, and are relevant for African exporters irrespective of the nature of the export specialisation product group. Financial STRs are relevant especially for the extractive products exporters and professional STRs have some impact on the non-extractive groups. The study did not find much evidence for the impact of communication STRs, but this was in all likelihood due to limitations in the communications STR data.

Policy prescriptions

The policy prescription based on these results is fairly obvious. Within each export specialisation category, the African countries with below average STRs tended to enjoy above average trade growth. Liberalisation of services trade should therefore be on the agenda of Africa’s exporting nations and should be part of a supply-side policy package to boost production and trade. However, this will involve a whole range of coordinated policy initiatives. In the same way that liberalisation of goods trade is a multi-dimensional activity, even more so is liberalisation of services trade. In order to illustrate this dimensionality better, Table 1 below provides an example of a typology for the banking sector. A similar approach could be applied to any of the other services industries however.

Table 1: Example of classifying trade restrictions on banking services[2]

 

Establishment

Ongoing Operations

Non-Discriminatory

The number of banking licenses is restricted

Banks are restricted regarding the manner in which they can raise funds

Discriminatory

The number of foreign banking licenses is restricted

Foreign banks are restricted regarding the manner in which they can raise funds

Services trade restrictions can be broken up into[2]:

  1. Those that restrict establishment, i.e. limit the ability of investors to establish operations in a country. This refers to the commercial presence mode of supply (mode 3)

  2. Those that constrain the ongoing operations

    of an established entity. This refers to the other three modes of supply, i.e. cross-border trade, consumption abroad and presence of natural persons (modes 1, 2 and 4, respectively).

In addition these restrictions can also be either discriminatory – in which foreign operators face different restrictions than local operators – or non-discriminatory.

The two by two basic typology is augmented then by the fact that the items in the second column could refer to any of the supply modes besides mode 3. This gives an idea of the potential complexity of assessing and addressing the overall restrictiveness of the services trade regime. Policies that could affect the restrictiveness of the banking sector therefore would include:

  • Banking regulation (central bank)

  • Exchange control (central bank)

  • Nationality requirements for directors and shareholders (home affairs, companies act)

  • Repatriation of profits (tax legislation)

  • Immigration laws (home affairs)

  • Recognition and accreditation of qualified persons (SETAs, department of education)

The term ‘liberalisation of services trade’ therefore spans the jurisdictions of multiple authorities within the State, unlike that of goods trade liberalisation, which is the primary concern of the department of trade.

The above example and typology applies to banking services, which falls within the super category of financial services (often the definition includes insurance as well). The analysis presented (in the tralac working paper from which this note draws[1]) indicates that the transport sector is the predominant service in Africa when it comes to value added to trade. Transport services are also the first consideration when addressing trade facilitation. This implies that this sector should receive predominant attention when it comes to liberalising the regulations governing the sector. In addition to the analogous items listed in the bullet points above, the ease with which transport services are able to add value to trade also depends on the transport infrastructure. Therefore while not strictly a transport ‘policy area’, the ability of the state to provide and maintain transport infrastructure is key to the transport services provision environment. Poor road and rail networks will restrict transport services as much as over-regulation and regulatory failure.

Services trade liberalisation and poverty

The gains from liberalisation of the transport sector, perhaps more so than that for the other sectors, will be directly felt by the poor. An example provided by Findlay[3] shows how, with a small open economy facing perfectly elastic[4] demand for its exports and perfectly elastic supply of imported inputs, a 33% reduction in transport costs will lead to a 64% increase in value-added of export products. Part of this increase will accrue to labour, which given the primary nature of most of Africa’s exports, will primarily be unskilled labour.

Besides the gains accruing to the poor as participants in improvements in value-added, obvious gains are experienced in their participation as consumers of transport services. Since transport is the backbone of trade, more competitive transport services are able to place cheaper goods into the hands of the rural poor, and raise the value added of the goods they export to the rest of the region, i.e. their terms of trade improve via two mechanisms[3].

Underlying the above example of gains to the poor is the assumption that the state is willing and able to finance the infrastructure needed to enable transport operators to operate. This point was also made above. Key here is the ability of the state and the road agencies to raise funds on international markets to finance the extension of infrastructure.

Gains and losses

Liberalisation of the transport sector, as with the other services sectors, will involve gains and losses, but the various general equilibrium simulations undertaken in this area all indicate large net positive improvements in welfare. First among the losers are the domestic oligopolistic suppliers, who are usually politically connected and willing and able to marshal political support to protect their positions. Other adjustment costs – such as temporary unemployment and redundancy of processes and systems – need to be taken into account as well. A well-rounded policy package will take these costs into account and assist in the transition to new and more competitive technologies of supply. It should always be borne in mind that services are primarily a forward-linked economic activity, and that unless they are delivered competitively the cost structure throughout the economy – traded and non-traded – will be affected. Countries that specialise in and export particular commodities will find their comparative advantage compromised by an uncompetitive services sector, and this much can be read from the results presented in this tralac research as well as other literature.

The role of broader-based policies and services-interlinking

Other policies such as creating industrial incentives, investing in human capital, improving trade and transport infrastructure as well as strengthening institutions are also necessary ingredients of a policy package. This amounts to addressing the capacity and efficiency of the industries downstream of the services sector, which will create more demand for services and raise bid prices for specific service offerings. The unique nature of services is that their deepening is self-fulfilling because an increase in demand for services from downstream industries raises demand for additional services that are forward-linked to the services that are first demanded. For example, the need for trade financing will create a demand for ITC services that serve as the back office for financing services. Innovation in ITC services in turn enhances the potential service offerings of other services; for example ITC sector innovation makes mobile banking possible and creates a new market for consumer banking.

Final word

The world is changing and old patterns of production and consumption are being replaced by new modes of delivery. The economic ‘engine’ of competitiveness is increasingly driven by services, which are becoming ever more complex and inter-dependent. It is the responsibility of every developing nation, especially those in Africa, to pay attention to the development of their services sectors and to actively promote their competitiveness through services trade liberalisation.

.


[1] Stuart, J. (2017). Services Trade Restrictions and Trade Performance in Africa: Some Insights. tralac Working Paper. Stellenbosch: tralac

[2] McGuire, G. (2002). Trade in services – market access opportunities and the benefits of liberalisation for developing economies. Policy Issues in International Trade and Commodities, Study Series No. 19. New York: United Nations

[3] Findlay, C. (2008). Transport services in Mattoo, A., R.M. Stern and G. Zanini (2008). A handbook of international trade in services. Oxford: Oxford University Press

[4] Price ‘elasticity’ refers to the extent of responsiveness of quantity supplied or demanded, to a change in the price.

Discussions

The Link between Services Trade Restrictions and Trade Growth Underperformance in Africa

The Link between Services Trade Restrictions and Trade Growth Underperformance in Africa

11 May 2017

Services trade is increasingly important, yet often restricted in developing countries, writes tralac Associate John Stuart

We live in a world where the production and consumption of services has been growing faster than that of merchandise for some time now. Whilst some services types, such as transport and construction, have developed to some extent over the past few decades, other such as communication services, financial services and information technology (IT) services have advanced rapidly. The productivity enhancements made possible by this development in services have been very large and have been felt in every area of society and the economy. Underlying the advancement in services sophistication has been progress in the ‘fundamental’ service group – information technology and communication (ITC) services.

However whilst considerable gains await the adoption of new services modes and types, some countries lag others in the adoption, rollout and uptake of these services. Under development and investment risk limit the extension of many services types in developing countries and there are both these supply-side and demand constraints on the growth of services sectors in these country groups. Nevertheless, in many cases the services policy environment in developing countries is simply not amenable to rapid rollout and uptake of high value-add services. In Africa, for instance, the aggregate Services Trade Restrictiveness Index (STRI) for the continent is nearly four times that for the OECD 19 countries.

It is no coincidence therefore that services sectors in developing countries are often characterised by oligopolistic market structures with cartel suppliers taking large economic rents (abnormal profits). The problem, although apparently emanating from the private sector, is government-created and abetted in that the governments are typically policy makers, regulators and competitors at the same time. This lack of separation of powers and absence of neutrality by governments entrenches the uncompetitive structure of the sector, prices the lower end of the consumer market out of the market and leads to slower development and technology transfer to the sector (in that the latter is normally driven by competitive pressure).

Consumers and producers therefore pay a premium for services that are often sub-par and the economy is denied the gains that should accrue to the improving production possibilities related to better services. The existence of large welfare gains following services trade liberalisation has been demonstrated in various formal studies, certain of which have been Africa-focused. What is striking about these studies is the extent of the gains shown – significantly more than that for equivalent merchandise trade liberalisation. Yet the popular sentiment is still that merchandise trade liberalisation should be at the top of the agenda for policy reform in developing countries.

How do services impact economies and their trade?

The mechanism by which services impact economic activity depends on whether these services are inputs into the production of physical goods or whether the services are consumed as end-value. The difference between these two paths of impact can best be demonstrated by an example. Transport services could either be delivered as an input into the production of furniture – when the raw lumber and later the finished items are transported by road or rail – or consumed as end-value when a commuter takes a plane on holiday. Generally, services are heavily ‘forward-linked’ in that a far greater proportion of their value is input into other goods or services production than is consumed finally. Some services, such as ICT, are more forward-linked than others, such as tourism; and some have a far wider impact than others (again, compare ICT with tourism or even construction).

What is common to services such as financial, transportation, ICT, professional and business services however, is that they are all part of the value chain into production of end value, whether it is traded domestically or exported. Given the key role played by exports in the growth path of developing countries, the importance of the cost and availability of forward-linked services to export growth therefore becomes apparent. It is this issue – the effect of services trade restrictions (STRs) on trade growth (for a set of African countries) – that is explored in a forthcoming tralac Working Paper by this researcher[1].

The working paper shows that transport STRs appear to have the most wide-ranging impacts, and are relevant for African exporters irrespective of the nature of the export specialisation product group. Financial STRs are relevant especially for the extractive products exporters and professional STRs have some impact on the non-extractive groups. The study did not find much evidence for the impact of communication STRs, but this was in all likelihood due to limitations in the communications STR data.

Policy prescriptions

The policy prescription based on these results is fairly obvious. Within each export specialisation category, the African countries with below average STRs tended to enjoy above average trade growth. Liberalisation of services trade should therefore be on the agenda of Africa’s exporting nations and should be part of a supply-side policy package to boost production and trade. However, this will involve a whole range of coordinated policy initiatives. In the same way that liberalisation of goods trade is a multi-dimensional activity, even more so is liberalisation of services trade. In order to illustrate this dimensionality better, Table 1 below provides an example of a typology for the banking sector. A similar approach could be applied to any of the other services industries however.

Table 1: Example of classifying trade restrictions on banking services[2]

 

Establishment

Ongoing Operations

Non-Discriminatory

The number of banking licenses is restricted

Banks are restricted regarding the manner in which they can raise funds

Discriminatory

The number of foreign banking licenses is restricted

Foreign banks are restricted regarding the manner in which they can raise funds

Services trade restrictions can be broken up into[2]:

  1. Those that restrict establishment, i.e. limit the ability of investors to establish operations in a country. This refers to the commercial presence mode of supply (mode 3)

  2. Those that constrain the ongoing operations

    of an established entity. This refers to the other three modes of supply, i.e. cross-border trade, consumption abroad and presence of natural persons (modes 1, 2 and 4, respectively).

In addition these restrictions can also be either discriminatory – in which foreign operators face different restrictions than local operators – or non-discriminatory.

The two by two basic typology is augmented then by the fact that the items in the second column could refer to any of the supply modes besides mode 3. This gives an idea of the potential complexity of assessing and addressing the overall restrictiveness of the services trade regime. Policies that could affect the restrictiveness of the banking sector therefore would include:

  • Banking regulation (central bank)

  • Exchange control (central bank)

  • Nationality requirements for directors and shareholders (home affairs, companies act)

  • Repatriation of profits (tax legislation)

  • Immigration laws (home affairs)

  • Recognition and accreditation of qualified persons (SETAs, department of education)

The term ‘liberalisation of services trade’ therefore spans the jurisdictions of multiple authorities within the State, unlike that of goods trade liberalisation, which is the primary concern of the department of trade.

The above example and typology applies to banking services, which falls within the super category of financial services (often the definition includes insurance as well). The analysis presented (in the tralac working paper from which this note draws[1]) indicates that the transport sector is the predominant service in Africa when it comes to value added to trade. Transport services are also the first consideration when addressing trade facilitation. This implies that this sector should receive predominant attention when it comes to liberalising the regulations governing the sector. In addition to the analogous items listed in the bullet points above, the ease with which transport services are able to add value to trade also depends on the transport infrastructure. Therefore while not strictly a transport ‘policy area’, the ability of the state to provide and maintain transport infrastructure is key to the transport services provision environment. Poor road and rail networks will restrict transport services as much as over-regulation and regulatory failure.

Services trade liberalisation and poverty

The gains from liberalisation of the transport sector, perhaps more so than that for the other sectors, will be directly felt by the poor. An example provided by Findlay[3] shows how, with a small open economy facing perfectly elastic[4] demand for its exports and perfectly elastic supply of imported inputs, a 33% reduction in transport costs will lead to a 64% increase in value-added of export products. Part of this increase will accrue to labour, which given the primary nature of most of Africa’s exports, will primarily be unskilled labour.

Besides the gains accruing to the poor as participants in improvements in value-added, obvious gains are experienced in their participation as consumers of transport services. Since transport is the backbone of trade, more competitive transport services are able to place cheaper goods into the hands of the rural poor, and raise the value added of the goods they export to the rest of the region, i.e. their terms of trade improve via two mechanisms[3].

Underlying the above example of gains to the poor is the assumption that the state is willing and able to finance the infrastructure needed to enable transport operators to operate. This point was also made above. Key here is the ability of the state and the road agencies to raise funds on international markets to finance the extension of infrastructure.

Gains and losses

Liberalisation of the transport sector, as with the other services sectors, will involve gains and losses, but the various general equilibrium simulations undertaken in this area all indicate large net positive improvements in welfare. First among the losers are the domestic oligopolistic suppliers, who are usually politically connected and willing and able to marshal political support to protect their positions. Other adjustment costs – such as temporary unemployment and redundancy of processes and systems – need to be taken into account as well. A well-rounded policy package will take these costs into account and assist in the transition to new and more competitive technologies of supply. It should always be borne in mind that services are primarily a forward-linked economic activity, and that unless they are delivered competitively the cost structure throughout the economy – traded and non-traded – will be affected. Countries that specialise in and export particular commodities will find their comparative advantage compromised by an uncompetitive services sector, and this much can be read from the results presented in this tralac research as well as other literature.

The role of broader-based policies and services-interlinking

Other policies such as creating industrial incentives, investing in human capital, improving trade and transport infrastructure as well as strengthening institutions are also necessary ingredients of a policy package. This amounts to addressing the capacity and efficiency of the industries downstream of the services sector, which will create more demand for services and raise bid prices for specific service offerings. The unique nature of services is that their deepening is self-fulfilling because an increase in demand for services from downstream industries raises demand for additional services that are forward-linked to the services that are first demanded. For example, the need for trade financing will create a demand for ITC services that serve as the back office for financing services. Innovation in ITC services in turn enhances the potential service offerings of other services; for example ITC sector innovation makes mobile banking possible and creates a new market for consumer banking.

Final word

The world is changing and old patterns of production and consumption are being replaced by new modes of delivery. The economic ‘engine’ of competitiveness is increasingly driven by services, which are becoming ever more complex and inter-dependent. It is the responsibility of every developing nation, especially those in Africa, to pay attention to the development of their services sectors and to actively promote their competitiveness through services trade liberalisation.

.


[1] Stuart, J. (2017). Services Trade Restrictions and Trade Performance in Africa: Some Insights. tralac Working Paper. Stellenbosch: tralac

[2] McGuire, G. (2002). Trade in services – market access opportunities and the benefits of liberalisation for developing economies. Policy Issues in International Trade and Commodities, Study Series No. 19. New York: United Nations

[3] Findlay, C. (2008). Transport services in Mattoo, A., R.M. Stern and G. Zanini (2008). A handbook of international trade in services. Oxford: Oxford University Press

[4] Price ‘elasticity’ refers to the extent of responsiveness of quantity supplied or demanded, to a change in the price.

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