EU services trade liberalization and economic regulation: Complements or substitutes?

Abstract

This paper investigates how national economic regulation shape the impacts of reducing external barriers to services trade for a sample of European countries. Notwithstanding far-reaching integration of services markets there is significant heterogeneity in domestic regulation and governance across European economies. We show this affects the potential downstream productivity effects of external services trade policy. In some cases, liberalization can substitute for weak regulation; in others there is a complementary relationship. Thus, the productivity effects associated with services market access liberalization depend on the quality of domestic economic regulation. EU-specific measures to promote internal trade in services – proxied by implementation of the Services Directive – are found not to have such moderating effects. An implication of our findings is that EU governments should do more to assess how specific dimensions of domestic regulatory regimes influence the size and distribution of the effects of services trade reforms.

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Notes

  1. 1.

    An exception is analysis of the possible implications of trade agreements for public services (education, health) and audio-visual services). See Pedreschi (2017) for discussion and references to the related literature. More generally, see Delimatisis (2017) for an overview of services-related provisions in EU trade agreements.

  2. 2.

    The WTO defines four ‘modes of supply’: Mode 1: cross-border exchange of services via ICT networks; Mode 2: the movement of a buyer or consumer of a services to the (exporting) country where the service is performed; Mode 3: sales of services through establishment of a commercial; presence (i.e., foreign direct investment); and Mode 4: temporary cross-border movement of natural persons (services suppliers). See Francois and Hoekman (2010).

  3. 3.

    Although Mode 1-type trade in services occurring through ICT networks is becoming increasingly important, available data suggest Mode 3 remains the dominant mode of supply for EU countries, accounting for some 70% of total extra-EU services trade in 2013 (Rueda-Cantuche et al. 2016).

  4. 4.

    Prior to Lisbon member states did not necessarily pursue identical external policies in these areas. As a result, EU countries differ substantially in their external (extra-EU) policy towards FDI, reflected, inter alia, in differences in the number of bilateral investment treaties with non-EU countries, the restrictiveness of FDI policy, and the treatment of foreign (non-EU) service providers. Meunier (2017) describes the process leading up to FDI becoming part of the common commercial policy in the Lisbon treaty.

  5. 5.

    This research on the effects of services trade policy is consistent with the empirical literature on liberalization of import tariffs that stresses the downstream effects of tariff reductions on intermediate inputs (e.g., Amiti and Konings 2007; Goldberg et al. 2010; and De Loecker et al. 2016).

  6. 6.

    Their cross-sectional empirical analysis finds no evidence that economy-wide governance indicators play a role in shaping the downstream effect of Mode 1 services trade policies.

  7. 7.

    Copeland and Mattoo (2008) discuss different market failure rationales for regulation of services.

  8. 8.

    We abstract from economy-wide policies addressing anticompetitive practices and state aid (subsidies). Other research has found a complementary relationship between market access and competition law enforcement. For example, using time series data for 42 countries, Kee and Hoekman (2007) investigate empirically the contribution of competition law relative to import competition (openness) and regulation affecting entry and exit of firms. They find that domestic and foreign competition is an important direct source of market discipline in concentrated markets that is complemented by competition policy, which indirectly reduces equilibrium mark-ups by promoting a larger number of domestic firms.

  9. 9.

    The logical subject here is regulation, so that the relationship is limited to one-way complementarity: good regulation enables and magnifies the effect of trade reforms. We are agnostic on the effect of regulatory reform in the absence of trade openness.

  10. 10.

    The construction of such a composite policy indicator is standard in the economic literature assessing the effects of sector-specific policies on the productivity performance of downstream sectors/firms (see, e.g., Amiti and Konings 2007).

  11. 11.

    More detailed data on Mode 3 policies have been compiled by the OECD. However, these services trade restrictiveness indicators are only available starting in 2014. See http://www.oecd.org/tad/services-trade/services-trade-restrictiveness-index.htm.

  12. 12.

    For discussion and assessments of the appropriateness of using US input-output weights as an indicator of the technological linkages between industries see Rajan and Zingales (1998) and Barone and Cingano (2011).

  13. 13.

    When the analysis is conducted without controlling for the capital-labor ratio, the sample expands to include seven additional EU Member States (Estonia, Greece, Hungary, Luxembourg, Portugal, Slovakia, and Slovenia) plus Switzerland. Using this larger sample of countries generates results that are very consistent with those for the smaller sample. Estimation exercises that do not control for the capital-labor ratio are available upon request.

  14. 14.

    Our imputation methodology follows Bourlès et al. (2013), who use many of the PMR indicators we focus on in this article. Their sample starts in 1984. Results from alternative methodologies are available upon request.

  15. 15.

    For each specification observations vary across downstream manufacturing sectors (j), countries (i) and years (t). The dimension of variability that reflects to which and how many services a given moderator variable (GId) applies to does not affect sample size.

  16. 16.

    All the variables have the same country coverage, i.e., the estimation sample remains constant across all regression exercises.

  17. 17.

    More detailed quantification of the downstream effects of trade policy changes is beyond the scope of this paper. Our empirical methodology implies that quantification of the effects of changes in the policy variables alone can only be conducted at the manufacturing sector level. We adopt the simpler approach of looking at the effects of changes in the composite policy indicator (de facto treating it as a policy variable in itself) given our focus on analyzing the potentially heterogeneous role of different dimensions of regulatory governance in moderating the downstream effects of services trade policy as opposed to quantification of the magnitude of these effects. Analogous quantification approaches are used in the literature looking at the impact of import tariff reforms for downstream firms or industries—see for instance Amiti and Konings (2007).

  18. 18.

    Francois and Hoekman (2010) provide references to some of the literature.

  19. 19.

    For example, Baccini and Urpelainen (2014) investigate the hypothesis that governments use trade agreements to support reforms they cannot implement without external assistance. However, their empirical analysis focuses on recently democratized states (developing nations), consistent with the specific theory they develop, and does not specifically highlight services.

  20. 20.

    Interest groups have sought to include disciplines relating to social, political and human rights into trade agreements as well as provisions relating to environmental regulation. This reflects different considerations, including a desire to ‘level the playing field’, address nonpecuniary negative spillovers, export ‘good practice’ norms and internationally agreed standards, and to safeguard the ability of governments to regulate economic behaviour. In the case of the EU, see e.g., Lavenex (2014), Lechner (2016) and Young (2015) on the export of norms and values; Van Den Putte and Orbie (2015) on the substance and drivers of inclusion of labor and related rights into EU agreements, and Spilker et al. (2018), Postnikov and Bastiaens (2014) and Donno and Neureiter (2017) for empirical assessments of whether they have an impact.

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Acknowledgements

This project has received funding from the European Union’s Horizon 2020 research and innovation programme under grant agreement No 770680. The initial work on this paper started as part of the European Commission’s DG ECFIN fellowship initiative 2016-17. We are grateful to three referees and the editor for very constructive suggestions that improved the paper, to Josefa Monteagudo for comments and sharing data on transposition of the EU Services Directive, and to participants in the May 2017 conference on Structural Reforms and European Integration in London and workshops at the AERC, EUI, and the European Commission for helpful feedback and ideas.

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Correspondence to Bernard Hoekman.

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Table 4 Summary statistics
Table 5 FDI regulatory restrictiveness index

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Fiorini, M., Hoekman, B. EU services trade liberalization and economic regulation: Complements or substitutes?. Rev Int Organ 15, 247–270 (2020). https://doi.org/10.1007/s11558-018-9333-4

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Keywords

  • Services trade policy
  • Regulation
  • Economic governance
  • Foreign direct investment
  • EU

JEL classification

  • F61
  • L8
  • O43