How free trade in services could boost the world economy

Hamish McRae on EU calls for a new round of global talks

ENCOURAGING greater freedom in international trade is like rising a bicycle: you have to keep moving forward or you start to wobble. Thus a small, little-noticed item of news yesterday - that European trade ministers have agreed that the European Union (EU) will call for a new round of global trade talks at the next World Trade Organisation (WTO) meeting in May - deserves a particular welcome.

Since the end of the Second World War the gradual liberalisation of trade has been the great engine of growth in the world economy, with cross-border trade rising at about four times the rate of growth of the world economy as a whole. As a result, world trade is now a higher proportion of world output than at any previous stage of our history: higher even than it was at the end of the last century.

This momentum has been sustained by successive GATT rounds, the trade liberalisation talks under the umbrella of the WTO's predecessor, the General Agreement on Tariffs and Trade. The most recent of these, the Uruguay Round, extended the liberalisation of trade from being principally in goods to trade in services.

This was enormously important for two main reasons. First, the production of goods has become a smaller and smaller proportion of the total output of developed countries, as their output shifts to services.

Typically, production of goods are now only 20-25 per cent of the total, in some countries even less. So liberalising physical trade, however desirable, acts on a smaller and smaller portion of the economy. The engine of wealth creation continues, but it acts on a smaller and smaller base.

Second, growth in trade in services has recently been relatively disappointing. In the 1980s it was tending to grow faster than growth in goods, but that momentum - despite the Uruguay Round - seems to have tailed off.

The graphs show what has been happening to the export earnings of the US and UK since the end of the last decade (we don't yet have full 1997 figures, so I am showing 1996). In both countries the total invisible earnings - that is earnings from exports of services and foreign investment income - has fallen since 1989. Back then, UK earnings from invisibles were actually larger than from physical exports; now they are smaller.

In one sense you could say that this is a considerable tribute to the physical exporters in both the US and the UK, and that is true enough. It is also true that some services will never be internationally traded: government services for example.

It would be very nice were citizens of one country free to pay their taxes to another country and get their social services from them: it would certainly put a bomb under the backside of sloppy governments if people could take their business elsewhere. But somehow I cannot see that happening.

And there are cultural barriers to trade in services which do not exist in trade in goods: people here are happy to buy a Japanese car, but would we really want to be treated by a Japanese doctor? Even within the EU, where trade in goods is now pretty well free from barriers, there are great hurdles facing traders in services.

Nevertheless, while service industries will not, in the foreseeable, future become as international as manufacturers, there are powerful reasons to want to encourage the growth of international trade in services.

If a country has a comparative advantage in producing goods the world can benefit; why should the world not benefit if it has a similar advantage in producing services? And at some stage there will be no more significant gains to be made by greater internationalisation of physical trade, and then the only way of getting the benefits from trade will be to boost trade in services.

The is where the successor to the Uruguay Round comes in. It would be unfair to brand that last round a failure, because it did start the process of services liberalisation. But the fact remains that the last decade has been characterised by rapid growth in "conventional" trade, particularly in growth of exports by East Asian countries, rather than growth in service trade. In that sense it has had only limited success.

So what is to be done? There are at least three big barriers to growth of trade in services: regulation, information and culture.

A new trade round ought to be able to do something about the first. Much regulation is well-meaning, and it could certainly be argued that consumers should expect a higher level of regulation with services than they should expect with products.

It is more damaging to buyers if the company providing their pensions goes bust than if the cars they have bought keep breaking down. But regulation is often covert protection for local producers, and this is something that the next trade round needs to tackle more vigorously.

Information, I think, will tend to take care of itself. It has been a great barrier, and a greater barrier than in trade in goods, because of the complexity of the service world. When buying goods, it is relatively easy to find out which products are swans and which are turkeys.

With services it is vastly more difficult for buyers to make a judgement. It is hard enough to work out which domestic bank offers the best savings account or credit card deal, so what hope have we in sorting out the global providers?

However, the growth of the internet and related technologies is already providing better access and as these develop I think it will be easier for people to inform themselves about the quality of the service products on offer.

For some such products, software and entertainment, the internet will provide a distribution channel as well as a source of information.

Finally, culture. It is probably inevitable that some cultural barriers will remain. But these will tend to diminish with better information and greater familiarity with foreign cultures. Besides, producers will become better at adjusting their output to suit local culture, a trick which global advertising agency groups are beginning to learn.

But this process needs support. A new trade round is not an end in itself, but it is an essential underpinning to the next stage of the world's economic progress, a truly free market in as much as possible of the 70 per cent plus of world output in the service sector.