UNCTAD raises development concerns on services liberalization

Original Publication Date: 
16 February, 2006

Trade liberalization alone does not automatically lead to services growth and development in developing countries, and there is a need to establish necessary preconditions such as flanking policies and regulatory frameworks for liberalization to yield development-oriented results, according to a new UNCTAD paper.

The paper, 'Trade in Services and Development Implications' (TD/B/COM. 1/77), was distributed at the 10th session of UNCTAD's Commission on Trade in Goods and Services, and Commodities being held here this week.

The paper, which is based on studies on several services sectors as well as on the experience of several developing countries, highlighted concerns on the effect of services trade liberalization, including displacement of local firms by foreign services providers, the loss of jobs and impact on social services such as education, health and culture.

The evidence suggests that a "one size fits all" approach is inappropriate in dealing with services trade liberalization, and that developing countries need to conduct a cost and benefit analysis of reform.

Providing a brief analysis of the outcome of the WTO's Hong Kong Ministerial Conference, the UNCTAD paper stresses the importance to ensure that the current negotiations will not erode the flexibility, the development-friendly architecture and concept of progressive liberalization enshrined in the services agreement (GATS) and the Negotiating Guidelines for services.

The paper states that concerns and questions about the effect of services trade liberalization have been raised in national assessment studies conducted by UNCTAD. The concerns include:

  1. the possible impact of liberalization on access to essential services, especially for the least favoured segments of the population;
  2. the extent to which liberalization can affect social policy objectives, e. g. in areas such as education, health, and culture;
  3. the magnitude of short-term adjustment costs and how to address them;
  4. the effect on the development of domestic supply capacity, and SMEs, considering that some services activities may require a certain degree of protection before achieving international competitiveness;
  5. the distributional impact of services trade liberalization within and between countries; and
  6. the impact of FDI on development.

The paper also listed several questions on how best to undertake trade reform in services. The issues of the pace and sequencing of reforms and the impact of regulatory frameworks on the final outcome of trade liberalization seem crucial for assuring development gains from services trade liberalization.

"There is also a need to identify flanking policies to strengthen domestic capacities in services," said the paper. "Trade liberalization alone does not guarantee that services needed for growth and development will automatically emerge in developing countries.

"There is widespread recognition that the gains from reform will not materialize or will be seriously undermined if a competitive environment is not assured. A strengthened regulatory framework and the institutional development of competition and other regulatory authorities often represent preconditions for meaningful liberalization."

UNCTAD added that the structure of global markets can impact on the outcome of services trade liberalization. "Given the increasing concentration of many services industries worldwide, there is a real risk that reform in developing countries could fall short of producing the expected beneficial outcomes because of the external trading environment and the dominant market position of global service suppliers," it said.

State of Play in WTO: On the state of play of GATS negotiations, the UNCTAD paper said questions still exist on: the significance of results in both the market access and the rules aspects; the extent to which the negotiations will secure an overall balance of rights and obligations among Members; and whether the negotiations will meet the objectives of their development-oriented mandate.

Annex C of the Hong Kong Declaration "adds new dimensions as regards modal objectives, with differentiated levels of ambition for each mode. It sets out more detail on plurilateral approaches for negotiating services commitments and establishes that Members to whom plurilateral requests have been made are to consider such requests in accordance with paragraphs 2 and 4 of Article XIX and paragraph 11 of the Negotiating Guidelines (which refer respectively to the flexibility for developing countries in opening their markets and to the progressivity of liberalization and affirm the request-offer approach as the main method of negotiation).

As of December 2005, 69 initial offers and 30 revised offers had been submitted. Less than half of the offers include improvements to horizontal commitments on Mode 4, and those who have made changes have not included categories of natural persons of interest to developing countries. New sectors committed contain limitations that act as barriers to entry. Some "backtracking" can also be observed in Members' offers. Some 400 MFN exemptions still remain, and if the proposed improvements in offers were to come into force, the number of MFN exemptions would be reduced by less than 10 per cent.

The paper recounted the attempt by some members to introduce 'quantitative' and 'qualitative' criteria to which individual Members' market opening offers should correspond. "According to the proponents, however, combining a collectively agreed level of ambition with certain flexibilities would ensure a successful outcome in negotiations. As stated by a large number of developing countries, this is a problematic combination. Developing countries emphasized that the fear that the adoption of complementary approaches would lead to a substantial loss of current built-in flexibilities and a consequent reduction of development flexibility. It was emphasized that developmental provisions of GATS Articles IV and XIX, the Negotiating Guidelines and the LDC modalities should remain the benchmark for the negotiations.

"Ultimately, the idea of establishing specific, mandatory quantitative targets for the negotiations was dropped owing to lack of consensus. However, the Ministerial Declaration sets out modal objectives and emphasizes plurilateral approaches. While the specific language referring to the plurilateral approach was subject to intense negotiation, overall concerns of developing countries with the approach - namely that it might result in higher levels of commitments and sectoral initiatives - remain."

The deeper reasons that may lie behind the rather limited quality and number of offers is the lack of understanding about the impacts of services trade liberalization, said UNCTAD. Given that services trade assessments are still at their initial stages, developing countries would enter into liberalization commitments without sufficient data, statistics and information to anticipate their implications. Developing countries lack the resources and technical capacity to carry out such assessments and subsequently to submit their offers within the various indicative deadlines set. The situation is similar with respect to requests.

Assessment in the GATS: According to the paper, a thorough assessment has not yet been undertaken, as so far the assessment has been mainly of information exchange among members and no multilateral conclusions have been drawn from this.

Presentations by members have noted that the assessment process is useful and should be an ongoing process; that countries need assistance to undertake national assessments; data collection and methodology needs to be improved; initial assessments have pointed to the need for flanking policies and regulatory and institutional preparedness and for boosting developing countries' supply capacity to ensure gains from liberalization; and there is a need to address adjustment costs of liberalization, in particular with respect to impact on employment.

Development Implications: The paper adds that the Hong Kong Ministerial Declaration offers guidance on intensifying negotiations and achieving expanded sectoral and modal coverage of commitments. It accelerates the pace of negotiations by establishing modal objectives, emphasizing plurilateral negotiations and setting time-lines.

"Against this backdrop, it is important to ensure that the actual negotiations will not erode the flexibility, the development-friendly architecture and the concept of progressive liberalization enshrined in the GATS and the Negotiating Guidelines.

"In terms of enhancing developing countries' export opportunities, real progress on Mode 4 and on sectors of export interest to developing countries are still absent. The specific attention given to LDCs in the Ministerial Declaration needs to take the form of concrete development outcomes, including appropriate mechanisms for giving special priority to them."

The paper concludes that services liberalization is expected to contribute to enhancing global welfare. There are only a limited number of assessment studies on the development implications. Quantitative assessments have produced inconclusive results. The assessments have emphasized the need for a cost and benefit analysis of reform and liberalization by developing countries. Preliminary findings from national sectoral assessments have highlighted concerns and questions about the effect of services trade liberalization.

It concludes: "The establishment of flanking policies and domestic regulatory frameworks is a necessary precondition for liberalization to yield development-oriented results. Phased and appropriate sequencing in reform and liberalization of services is also a key aspect for building competitiveness and efficiency of domestic supply capacity.

"Public policies supporting and promoting, among others, SMEs, technology and innovation, access to capital and financing, building of human capital and ensuring essential access are of critical importance. Studies have shown that market liberalization may result in different outcomes depending on the services sector and country/region at stake.

"The conclusion from available evidence is that a 'one-size-fits-all' approach is inappropriate in dealing with services trade liberalization."

Review of models: In an earlier section, the paper challenges orthodox economic theory and the quantitative estimates of gains for developing countries arising from services liberalization. The model assessing services liberalization is based on the same assumptions applied in trade in goods. Benefits are expected to result from more competition, lower prices and wider choice, faster innovation and greater FDI and enhanced technology transfer.

The effects of FDI liberalization in services on the development prospects of developing countries constitute an integral aspect of the needed assessment. There is widespread recognition that FDI inflows could bring benefits to the recipient economies. However, determining exactly how FDI affects development has proven to be remarkably elusive.

There is growing recognition that benefits might not be automatic, and that under certain conditions FDI could even produce negative effects on market structure and could lead to crowding out of domestic enterprises, as well as generating other adverse social impacts. Therefore, government policies are needed to enhance the benefits and minimize the costs of FDI.

The results of different studies estimating worldwide welfare gains from multilateral trade liberalization in services differ significantly, ranging from $90 to $688 billion, depending, among other things, on the depth of reduction of trade barriers and gains being distributed between developed and developing countries in proportion to their GDP.

There is a general recognition that, because of uncertainty in the modelling data and assumptions, the results of these studies should be heavily qualified. After reviewing a number of them, the OECD concluded, for example, that quantitative modelling is unlikely ever to be sufficiently accurate to be used directly in the conduct of negotiations, and the results should therefore only be taken as indicative.

The main difficulty facing quantitative approaches to assessing the effects of services trade liberalization is lack of data, leading to the need to make assumptions and approximations. Moreover, results depend on the way trade barriers are quantified and on the specifications of different models. Concerning the quantification of trade barriers, it has been observed that even the best available methods are inadequate.

An additional difficulty is in isolating the effects of trade liberalization from the effects of other intervening variables. It is necessary to take into account the specific features of individual services, as well as the differing impact of trade according to the different modes of delivery.
These issues are not usually addressed in the research that was reviewed.

Considering that quantitative analysis provides important insights into the effects of services trade liberalization, the need exists to refine estimation techniques and modelling to capture the specificities of trade in services. There is an equally urgent need to improve data on services as the basis for formulating policy recommendations to developing countries.

National and Sectoral Assessments: Much of the paper's conclusions are based on findings from national assessments in selected services sectors conducted by UNCTAD.

They suggest that each country should carefully assess the costs and benefits associated with liberalization resulting in employment displacement versus employment creation, skill transfer and transfer of technology; efficiency gains versus effects on the informal sector and employment; local sourcing versus imports and effects on the balance of payments; raising quality standards to facilitate market access versus market entry barriers posed by standards; development of infrastructure versus pressure on existing resources; and positive FDI spillover effects versus crowding out by FDI.

The following is a summary of the paper's findings on various sectors.

Construction and related engineering services: This sector remains a low-margin, highly regulated and high-risk activity, nearly 50 per cent more volatile than manufacturing. Small and medium-size enterprises (SMEs) and the informal sector play an important role and developing countries are striving to build their supply capacity, with government procurement having an important role in that.

An UNCTAD assessment of construction in Jordan found the following concerns with liberalization in this sector:

  • Advent of profit-oriented foreign ownership of service enterprises that does not have any interest in developing local expertise or supply capacity;
  • Increased property prices and increased cost of small-scale construction services;
  • Liberalizing the sectors does not promise 'sustainable' foreign exchange revenue sources from these sectors for the Jordanian economy;
  • Foreign participation did not lead to technological capacity building in these sectors in Jordan;
  • The number of local construction contracting firms forced out of the market for lack of competitive resources has been increasing since 2002;
  • Foreign companies employing foreign workers are paying less than the national average, which forces Jordanian workers out of the job market;
  • Projects funded by international donors are implemented by foreign contractors and service providers, who at times do not abide by the local regulations on licensing, registration and certification;
  • Foreign contractors are not totally committed to joining the engineering association or the construction contractors' association as a formal gateway to providing services in Jordan.

Telecommunication services: They are the main drivers of the global tradability of goods and services, as well as the means for offshoring a wide range of IT-enabled services and business process outsourcing. However, liberalization and privatization of this sector have to be carefully managed to prevent anti-competitive behaviour, ensure universal coverage and affordable pricing, and widen access to all types of services.

A case study in Kenya shows how the expected immediate negative impact on employment has made reforming the sector particularly difficult, as well as how important it is to put in place policies promoting SMEs.

The assessment shows that policies need to be put in place, including: ( i) development and expansion of national and regional infrastructure, and inviting private sector investment and financial support from development; ( ii) establishing the Universal Service Fund to facilitate extension of telecom services to rural areas; ( iii) improving the business environment for investment; ( iv) ensuring ICT human resource development, promoting e-commerce and e-government, and establishing enabling policy and legislative frameworks.

Tourism services: Country studies show that benefits from liberalization of tourism depend on the degree of integration of domestic sector tourism, global business practices, competitive conditions in foreign markets, access to distribution networks, and the degree of leakage. An important factor is the high degree of vulnerability to external shocks and volatility, especially of international tourism flows. Public policies in favour of SMEs are particularly important.

There are significant market access and national treatment barriers in developed country markets, mainly with respect to restrictions on movement of professionals who supply tourism services that developed countries need to ease or remove under WTO's Mode 4 negotiations.

An Indonesian case study showed concern over excessive ownership of land and buildings by foreign investors, who have the capacity to buy land and displace local players from potential tourist destinations, and monopolistic practices applied by large foreign suppliers. For liberalization to proceed successfully, it would need to be supported by complementary policies to help domestic SMEs to compete, and to promote competition and minimize the adjustment cost of land, assets, and employment displacement.

Distribution services: Modernization of distribution services and the entry of foreign firms into developing countries are likely to enhance welfare through increased productivity and efficiency gains and lower prices, provide a greater choice of products and increased competition. However, developing countries may find it difficult to advocate reform in distribution services, since in most developing countries, traditional players dominate the distribution industry, and its modernization could entail significant short-term adjustment costs, including displacement of small retailers, with job losses. They are concerned with the leading position of global retailers on the domestic market, who may acquire dominant market and buyer's power.

A case study of Ecuador showed that in distribution services it is important to avoid a market situation in which the product or service of several sellers is sought by only one buyer - a trend that emerged in wholesale services in Ecuador.

Liberalization under these conditions would simply mean that a domestic monopoly provider would be replaced by a foreign one. To change such market outcomes, more laws, including anti-trust legislation, may be necessary. Trade liberalization in services should be seen not simply as efforts towards elimination of 'restrictive' legislation, but also in terms of 'correcting' market failures.