Liberalizing services sectors

Examples from the financial sector in both developing and developed countries illustrate the benefits of liberalizing FDI in services. For example, one beneficial effect from opening the banking industry to FDI is an increase in financial flows and, in particular, the growth in syndicated loans that is facilitated by the presence of foreign banks. In developing countries with large domestic markets open to foreign banks, the use of modern payment instruments such as credit cards and cheques has become more widespread, and local banks have been stimulated to use modern computer technologies. Concerns that foreign banks might dominate the domestic market typically have proven unwarranted. Instead, a complementary role has developed between foreign and domestic banks: while the former tend to focus on international transactions, wholesale banking and trade facilitation, the latter have continued to dominate retail banking. This complementarity of roles and tendency towards specialization is not due to regulatory constraints but is largely the result of differences in comparative advantage between foreign and domestic banks.

The pros and cons of liberalization should be analysed in the context of their economy-wide effects, and not on a narrow, single industry approach. For instance, in the area of insurance services the exclusion of foreign insurers and the requirement that primary insurance be bought only from domestic firms may lead to an increased dependency on foreign reinsurers and a resulting outflow of reinsurance premiums. If efficient producer services provided by transnational corporations (TNCs) enhance the export capacity of a host country, the indirect gains in export earnings may be significant and should be taken into account in any policy assessment concerning the presence or exclusion of foreign services companies.

The central policy issue when liberalizing international transactions in services is how best to combine regulation with the discipline of competition. Liberalization is not the same as the absence of regulation. The crucial issue is to identify the extent to which regulation is required to deal with problems of natural monopoly or asymmetric information.

The process of regulation can be fraught with pitfalls. The target of regulation should be to improve the welfare of users of the service. A healthy dose of scepticism is necessary when evaluating arguments in favour of increased barriers to trade such as the infant industry or industrial policy argument, arguments for protection to preserve the balance of payments, or arguments on the basis of optimal tariffs and imperfect or strategic competition.

If a sector is thought to be too sensitive for strategic or social reasons to allow foreign majority ownership, less costly restrictive measures, such as joint ventures, are preferred to outright prohibition of market access. Experience shows that it is almost always possible to find a less restrictive measure to achieve a non-economic objective while at the same time taking advantage of FDI.

The economic costs of market access restriction are illustrated by the following example. Many developing countries maintain policies requiring compulsory trade-insurance coverage with domestic firms. Such insurance tends to be more expensive than that available on world markets. In addition, such coverage is often perceived to be inadequate, inducing traders in developed countries to take out additional insurance with providers of their choice. As a result, about half the merchandise trade flows to and from developing countries were doubly insured in the mid-1980s, implying additional premium costs of some US$3,700 million. In general, policies banning trade in insurance services may raise the profits of local insurers, but do so at the expense of local buyers of insurance. The latter face higher premium costs than charged on world markets and less variety and flexibility regarding coverage of various risks, not to mention the effect of higher insurance costs on the price of merchandise trade. Moreover, many local insurance providers in developing countries are forced to rely on the international reinsurance market to offset risks, thereby substantially reducing any foreign exchange savings associated with compulsory domestic insurance.

By their nature, most services must be produced where they are consumed. As a result the international provision of services typically necessitates either the movement of the factors of production to the consuming market (capital, through foreign investment, or labour, through the cross-border movement of workers) or the movement of consumers to the producing country (tourism, for example). Some services, however, are transacted cross-border (for example, international telecommunications or international air transportation).

Liberalization of international transactions in services often requires a reduction of barriers to entry for international providers. The list of instruments that inhibit such transactions is long and is indicative of the highly restrictive regimes that exist in both developed and developing countries. In addition to denying market access or discriminating against foreign competitors, there exists a panoply of instruments that may unintentionally inhibit the entry of foreign service providers, though they are directed only at regulating the domestic economic environment.

Discrimination may take the form of denying access to preferentially priced inputs and investment incentives; imposing performance requirements such as trade balance or export targets as a condition for receiving investment incentives; restricting external financial transfers; or imposing differential tax regimes for domestic and foreign based firms. Often such measures are at odds with incentives to attract FDI. The domestic regulatory framework, including the guarantee of intellectual and other property rights or prudential regulations in the financial sector, may also discourage FDI in services when discriminating against foreign suppliers. As the delivery of services often involves the movement of labour, market access can be obstructed through the use of visas, residence or work permits and licensing requirements. Differences in regulatory systems across countries make trade in professional labour services difficult. Some countries follow a state-regulated licensing procedure, while others allow professional associations to regulate themselves. These and other differences create the necessity for either standardizing licensing requirements across countries or creating mechanisms for the mutual recognition of qualifications for licensing.

International transactions in services can also be influenced by restrictions on the movement of consumers. The classic example is tourism. The movement of tourists can be restricted either by exit visas in the home country of the tourist, or by entry visas in the receiving country. In addition, restrictions on flows of funds and on the convertibility of foreign exchange may also limit tourism.

Services transacted directly across borders, such as international telecommunications, international air transportation, transborder data flows or audiovisual services can be subjected to market access or quota-like restrictions. Examples are the local content rules that do not allow more than a certain level of imported content in radio and TV broadcasting in many countries. Air-service arrangements determining traffic sharing, cargo sharing practices in maritime shipping and prohibition of cabotage by foreign suppliers illustrate other types of quota-like restrictions applied to cross-border trade in services. Price-based instruments can also discriminate against foreign providers. An example is subsidies to the domestic film and air-transport industries.

The quest for greater efficiency in the services sector does not necessarily need to be pursued in a unilateral context. In fact, there are potential benefits to developing countries under bilateral, plurilateral, or multilateral arrangements. They include greater access to other country's service markets, added credibility that helps government in fending off protectionist pressures, and a move towards more convergence in regulatory practices.

The GATS presents the most comprehensive approach to the liberalization of international service transactions. It should prove beneficial for both developed and developing countries, in the same way that they have benefited from the open global trading system in goods. There are a number of other options for liberalization in international services transactions, such as preferential trading agreements among developed and developing countries. These agreements are second best when compared to multilateral agreements, since they inevitably involve some costs in terms of trade diversion.

International transactions in services are also influenced by international agreements at the industry level. Examples of these are the International Civil Aviation Organization, the Basle Committee on Banking Regulation and Supervisory Practices, and the International Telecommunications Union. These agreements are useful in setting standards for the functioning of these industries.

Reform will be successful only if there is some degree of consensus over its content' sequencing and speed. This is especially important for services as they often constitute the one economic activity of developing countries in which both heavy regulation and state ownership are pervasive. The result is that there is often a near-total absence of experience with competition and a highly charged political sensitivity in defence of the strategic role of the state.

While the process of political consensus-building for policy reform varies among countries, it will be enhanced if the costs to the economy of existing inefficiencies and the potential gains of reform are demonstrated. But reform efforts at the service-complex level are likely to flounder if they are not supported by certain basic macro-institutional reforms, such as the adoption of a transparent and non-discriminatory investment code, a stable and predictable tax regime and an appropriate immigration law.