The services sector accounts for more than 70% of the economy world wide.  However, it only accounts for about 20% of world trade.  The reason is that most services are “non-tradable”.  It is pretty hard to import a taxi ride or a hair cut from overseas!  By contrast, most manufactured goods, agricultural products and natural resources are tradable, even if they are sometimes a bit bulky.

Things are changing however, and more and more services are becoming tradable.

The World Trade Organisation’s General Agreement on Trade in Services defines four “modes” by which services can be traded:

• services supplied from one country to another, just like normal merchandise trade (e.g. international telephone calls), officially known as "cross-border supply" (Mode 1);

• consumers from one country making use of a service in another country (e.g. tourism), officially known as "consumption abroad" (Mode 2);

• a company from one country setting up subsidiaries or branches to provide services in another country (e.g. a bank from one country setting up operations in another country), officially known as "commercial presence" (Mode 3); and

• individuals travelling from their own country to supply services in another (e.g. an actress or construction worker), officially known as "movement of natural persons" (Mode 4).

As reported by the OECD, international services trade statistics only include Modes 1 and 2.  On this basis, services have represented a fairly stable 20% of world trade over the past three decades.  Its composition has changed, however, with the share of transport declining thanks to economies of scale, while other services like computer and information services, financial services, insurance services, royalties and license fees, and cultural services have grown sharply.

Trade in services is still heavily dominated by developed countries.  In 2005, they accounted for 81% of world service exports versus 68% for goods.  It is in travel (29%), computer and information services (27%) and communication services (24%) that the share of developing countries is the largest.  In these new areas, India has managed to carve out substantial market shares, and now accounts for two-thirds of developing countries’ share of computer and information services.

This increase in India’s services exports may be nothing less than the beginning of a revolution in the tradability of Mode 1 service supply.  Most services were non-tradable in that buyers and sellers needed to be in the same place at the same time, like the taxi driver and the haircut.  In fact, many services do not require physical proximity.  And new information and communications technologies are dramatically changing the tradability of the information-centered set of services.

Developing countries are now exporting a bewildering range of services like:

. business services like back-office processes, customer interaction and technical support.  India is by far the largest exporter of such services, but others are entering the field.

. computer and related services including installation of computer hardware, software implementation, data processing, database services.  Ireland, India and Israel account for much of these exports of services.

. Internet-related services include the supply of telecommunication services, the supply of content, audiovisual services and computer and related services.  Latin American Internet companies have expanded to other countries in the region.  Hong Kong, Lebanon and Singapore are also exporters to their neighbours.

. financial services covering insurance and insurance-related services, as well as banking and other financial services, often through joint ventures with large multinational enterprises.  India is a major player here.

. professional services such as legal services, accounting, auditing, taxation, architectural and engineering services.  India and Singapore are active in this area.

This means that a whole range of services are now increasingly subject to the international division of labour, with each country specializing in the export of services for which they have a comparative advantage.  While we still have not yet seen the full effect of the outsourcing of services, some trends are very clear.  Internet and IT are having a quicker impact on the fragmentation of services than they did on manufacturing.  The offshoring of tradable services potentially affects firms in all sectors.  It affects mainly white collar workers rather than blue collar workers.

Alan Blinder has estimated that the fraction of jobs that can move offshore will rise as technology improves and also as India and China continue to modernize, prosper and educate their workforces.  There will be very large adjustments as between 22 and 29 per cent of all US jobs could become offshorable within a decade or two.  Even if not all these jobs are in fact offshored, they will be exposed to international competition.  Traditionally we thought of service jobs as being immune to foreign competition, but this will be less and less the case.  This new offshoring will be like a new industrial revolution.

There are many services which are difficult to outsource.  Not all services are electronically deliverable.  Face-to-face interaction is still necessary for many things.  Proximity to consumers can be important to gain knowledge of markets.  Confidentiality and sensitivity considerations may limit outsourcing, as may legal and human resource factors.

But it seems clear that we are in the midst of an explosion in the tradability of Mode 1 services.

We may also be in the midst of an explosion in Mode 2 services.  International trade in higher education and health are now taking off (we will look at this in an upcoming article).  And as the global middle class is expanding rapidly, thanks to the rapid growth of emerging economies, we are also seeing dramatic growth in international tourism.  Even Japan is now being inundated with Chinese tourists!

In short, the world is changing!

References:

GATS – Facts and Fiction.  World Trade Organisation.

http://www.wto.org/english/tratop_e/serv_e/gats_factfiction_e.htm

Globalisation in Services: From Measurement to Analysis.  OECD Statistics Working Paper.

http://www.olis.oecd.org/olis/2008doc.nsf/LinkTo/NT00000AFE/$FILE/JT03240281.PDF

World Investment report 2004: The Shift Towards Services.  UNCTAD

http://www.unctad.org/en/docs/wir2004_en.pdf

Alan Blinder, “How many US jobs might be offshorable ?”, March 2007

http://www.princeton.edu/~blinder/papers/07ceps142.pdf