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Institute for International Integration Studies IIIS Discussion Paper - page 4 / 41

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1. Introduction

Services are the largest sector in the global economy and their importance is expected to continue to grow. Services account for approximately two thirds of world GDP and over half of total employment in industrialised countries (WTO, 2005). However, the share of services in world trade has lagged behind. WTO (2005) estimates that services account for only 20 per cent of global trade flows. While this figure may slightly underestimate the level of service trade, due to the intangible nature of services compared to goods and the interdependence of services and foreign direct investment flows that makes the measurement of services trade difficult, the difference is still significant.

The growing role of services and their increasing importance to trade flows led to the General Agreement on Trade in Services (GATS) in 1995. This agreement governs the rights and obligations of World Trade Organisation (WTO) member countries in the area of services trade. The outcome of the current Doha Round world trade negotiations is expected to continue the process of liberalisation in services trade. The aim of these negotiations is to further reduce the barriers that restrict trade in services.

One contribution of this paper is to further analyse the determinants of trade in services, with particular attention paid to the role and measurement of barriers to services trade. When an agricultural or manufacturing good is imported into a country, the most common form of protection imposed is a tariff. The level of a tariff is usually known and its impact on the price of the good can be estimated. This is not the case for service products. A commercial bank wishing to establish a branch in another country or a doctor hoping to set up a practice in a foreign country cannot simply pay a tariff and establish their business. Trade in services such as these typically requires the movement of people and capital between countries. In most countries there exist a range of legal and regulatory requirements that must be satisfied before the establishment of such services. 1

The effects of these non-tariff barriers are difficult to measure. A second objective of this paper is to generate a series of quantified estimates of the barriers to services trade for a range of industrialised countries (primarily the OECD countries) and their main trading partners.

These objectives are achieved using a gravity model approach, which relates the level of trade between countries to their physical and economic characteristics. Introducing a variable measuring the level of a country’s barriers to services trade into the gravity equation allows for a tariff equivalent of the barriers to be estimated. This set of estimates can then be used in further research.

The gravity approach has been applied to services trade before, yet this paper makes several contributions to the existing literature. Previous research has generally focused on total services trade; in this paper the application of the model is extended to four disaggregated service sectors (government, travel, transport and other commercial services). The econometric specification of the model is also improved by the application of the Hausman-Taylor estimator. This type of estimator is increasingly used to estimate gravity models of goods trade flows but it has never previously been applied to services.

1 For example, a commercial bank wishing to establish a branch in another country must satisfy the prudential and non-prudential regulations of that country. Many countries will only recognise medical qualifications from specific institutions or require doctors to be proficient in the language of the country.

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