GLOBAL ECONOMICS

Patrick Grady and Kathleen Macmillan
Second Crack at Services
from Seattle and Beyond: the WTO Millenium Round (1999), Chapter 4.

Trade in Services Booming

Although trade in services is only a fraction of trade in goods (one fifth for Canada), it has been growing much more rapidly. Between 1990 and 1997, exports of commercial services grew 8 per cent per year while merchandise exports only increased 6 per cent. By 1997, exports of commercial services had surpassed $US1.3 trillion, and accounted for almost one fifth of total exports. And there is still plenty of room for growth. Services are the mainstay of modern industrialized economies, accounting for almost two-thirds of output and more than two-thirds of employment.

Trade in services is important for the three main areas of the world. North America's share of world exports of services is almost 20 per cent; Europe's almost 46 per cent; and Asia's almost 23 per cent.

The most dynamic component of services trade is not the traditional transportation or travel services, but other services which includes fast-growing financial services, construction services, and computer and information services. Services are at the heart of the new information economy. It is these services that are key in raising productivity in the production of goods and in making an economy more competitive.

Services are not like goods, which cross borders in neatly-stacked boxes that can be inspected by customs officers and subjected to duties and other tax-like measures. Their flow is invisible. The barriers to trade in services are usually regulatory inside the border rather than border measures like tariffs and quotas. A trading regime for services has to be different from one for goods.

The GATS

By the time the Uruguay Round got underway in 1986, trade in services, like the camel in the tent, had become too important to be ignored any longer. Notwithstanding strong resistance at the outset from many developing countries, the General Agreement on Trade in Services, which was negotiated over this round, represents a first effort to establish multilateral, legally-enforceable rules for trade in services. Patterned on the GATT, it covers all services, except those provided in the exercise of governmental authority, and seeks to ensure transparency in regulations and inquiry points. It also specifies that regulations must be "administered in a reasonable, objective and impartial manner," and that international payments with respect to covered trade in services should normally be unrestricted.

Most fundamentally, the GATS seeks to implement the two key basic principles of Most-Favored Nation and national treatment, which are the core of the GATT. Unfortunately though, as for many copies, the original was much better. The MFN principle of non-discrimination allows exceptions and national treatment only applies in certain sectors depending on the country.

The GATS covers all four ways of providing an international service:

Because the GATS imposes obligations with respect to "commercial presence," it covers investment abroad. This makes it the first multinational investment agreement. And it was negotiated without all the muss and fuss of the MAI.

The MFN principle as applied to the GATS means that, if a country allows foreigners market access to a particular service sector, it must allow equal access for all members of the WTO. The qualification is that countries are permitted to list exceptions to MFN treatment in individual sectors. This was largely to temporarily accommodate members that already had preferential agreements covering services such as NAFTA and the EU. These exceptions could only be made at the time of the initial agreement, and no more can be added. By April 15, 1994 when the Final Act of the Uruguay Round was signed, 61 lists of such exceptions had been submitted. The exceptions are to be reviewed after five years and are to end after ten years. Countries are expected to remove the exceptions even sooner when other countries agree to reciprocal market access commitments such as has already occurred in basic telecommunications and financial services. The principle of MFN treatment should eventually become unqualified as it already is for the GATT (except of course for customs unions and free trade areas which are allowed under both agreements).

The GATS also imposes an obligation of national treatment. This means that foreigners and a country's own national must be given equal treatment under the regulations governing market access in the different service sectors. But there is a very big qualifier attached. The national treatment only applies when a country makes a positive commitment in its schedule. In contrast, the GATT brooks no exceptions. Once a good is admitted across the border, it can not be subjected to discriminatory taxes and quantitative regulations. If this was too ambitious for the countries negotiating, it would have been better, at a minimum, to have incorporated an obligation of national treatment in the GATS subject to specific listed exceptions in a schedule (the so-called negative list).

The situation is not quite as bad as it seems with respect to national treatment, however. Once a country makes a commitment with respect to a sector, national treatment applies to all services in the given sector unless the country enters a reservation. Hence another problem: these reservations tend to be very broad. An effort needs to be made to make the reservations as narrow as possible.

The schedule of commitments with respect to national treatment under the GATS serve the same role as the tariff schedules under the GATT. They are the focus of the negotiations to improve market access. A country will offer to accord national treatment in a specific sector in return for national treatment in the same or different sector from another country. These concessions are in turn "multilateralized" so that all parties to the negotiation can enjoy the benefit. Specific commitments are binding in the same way as tariff commitments are binding under the GATT. They provide a reasonable assurance of stability in market access and can only be withdrawn with compensation.

There are twelve broad sectors listed in the schedules, which follows the GATT Secretariat's classification scheme. Within this broad framework, commitments are specified by numerical references to the Central Product Classification System of the United Nations. By July of this year, there were 132 schedules of specific commitments submitted and agreed. Their sectoral distribution is shown in Table 1. The sector with by far the most commitments was tourism and travel related services. Even the least developed countries are keen on attracting foreign investment in tourism and travel. Financial services, business services and communication services also have relatively large number of commitments. In financial services and communication services, the number of commitments went up as a result of the Financial Services and the Basic Telecommunications Agreements reached after the conclusion of the Uruguay Round. Table 1

Table 1
Specific Commitments by Sector
01. Business Services89
02. Communication Services85
03. Construction and Related Engineering Services60
04. Distribution Services38
05. Educational Services32
06. Environmental Services40
07. Financial Services91
08. Health Related and Social Services34
09. Tourism and Travel Related Services114
10. Recreational, Cultural and Sporting Services49
11. Transport Services70
12. Other Services not Included Elsewhere9
Total711
Source: http:www.wto.org/wto/services/websum.htm dated 7/31/1999.

The industrialized countries with their more developed service sectors have been the ones most willing to make commitments for more sectors. Developing countries, particularly the least developed, have been the least willing. The European Union has made commitments with respect to all twelve sectors. The United States and Japan has made commitments with respect to eleven sectors including all sectors but the residual "other" category. Canada has only made commitments for eight sectors, leaving out educational services, health related and social services, and recreational, cultural and sporting services as well as the "other" category. This reflects Canada's traditional concerns about education and health, which is largely in the public sector, and worries about external, especially American, threats to Canadian culture.

The GATS allows governments to negotiate agreements to recognize qualifications for the purpose of authorizing, licensing or certifying service providers. But in order to prevent these mutual recognition agreements from being discriminatory and becoming additional barriers to trade, it requires that all WTO members be given an adequate opportunity to join them. WTO members are also required to work together to establish common international standards and criteria for the recognition and practice of the trades and professions involved in the international delivery of services.

The GATS is overseen by the Council for Trade in Services. This body, made up of representatives of all the member countries, serves the same function for the GATS as the Council for Trade in Goods serves for the GATT. Members must notify the Council for Trade in Services of any changes in regulations affecting services covered by specific commitments and of any recognition agreements for qualifications. Domestic regulations are the main form of barriers for service trade. That is why a Working Group on Regulation has been established.

Trade in services has aspects that make it unique. And some types of services are quite different from others. This is reflected in some of the GATS annexes:

Subsequent Negotiations

The Uruguay Round was not the end of service sector negotiations, but rather the beginning. Negotiations continued in four areas: basic telecommunication services; financial services; movement of natural persons; and maritime transport. Agreements were reached on basic telecommunication service and financial services by early 1997. Concerning movement of natural persons, guidelines and disciplines have been developed for the accountancy sector as a model for facilitating trade in professional services. More general talks to improve specific commitments in the movement of natural persons were completed in July 1995 without any concrete results. Negotiations on maritime transport, which had earlier proved difficult in the context of both the Canada-US Free Trade Agreement and GATT, were suspended in 1996.

Telecommunication Services

No commitments were made during the Uruguay Round on basic telecommunications services. The fact that basic telecommunication services were delivered by government monopolies in many countries, including those in Europe at the time of the completion of the round in 1994, made the liberalization of trade in this sector a tricky business. It was much easier to liberalize trade in some of the more value-added telecommunication services. Some commitments covering these services such as allowing third party supply of PBXs found their way into some of the original GATS schedules. But the big prize the $675 billion market for basic telecommunication services including local, long distance and international services for home and business was left for further negotiations.

A pathbreaking agreement was finally reached on February 15, 1997 liberalizing trade in basic telecommunication services. By the time the agreement came into force on February 5, 1998, 72 countries representing over 90 per cent of the market had submitted commitments on basic telecommunication services, including 59 countries that committed to a complete set of so-called reference rules for regulating the telecommunications sector. These rules require countries to open their market to foreign investment and competition, to establish an independent telecommunications regulator, to make interconnection guarantees, and to agree to WTO surveillance. Commitments made by most governments covered local and long-distance voice services, data transmission, cellular/mobile markets, leased circuits, and satellite services. Some of the commitments are subject to a phase-in period.

As a general rule, the benefits of the Telecommunications Agreement are extended to all WTO members on a MFN basis. But each signatory was given the option of filing an MFN exemption, which 9 countries actually submitted. This included an American exemption for one-way satellite transmission of Direct-to-Home (DTH) and Direct Broadcast Satellite (DBS) television services and digital audio services.

The liberalization of the market for telecommunication services before the agreement entered into force had already lead to dramatically lower phone rates in North America and Britain. In 1998, the Europeans were already moving to privatize state monopoly telecommunication companies and to liberalize the market for telecommunication services. The WTO Telecommunications Agreement will help them to secure the benefits of lower telephone rates and improved quality of services. The over 46 participating developing and transition economies with telecommunication rates that are 10 or 20 times those in North America will also benefit.

While Canada refused to allow majority foreign ownership of telecommunication companies, there were major changes here as well. Teleglobe Inc., which lost its monopoly on overseas calls for Canadian carriers, has managed to sell services to carriers world-wide. The Telesat monopoly on fixed satellites is scheduled to end in March 2000.

Financial Services

Even though many countries made specific commitments on market access and national treatment during the Uruguay Round, the offers were not considered sufficient to call an end to the negotiations by the time of the Marrakesh Ministerial Meeting in April 1994. Treatment was still based on reciprocity and broad exemptions to the MFN principle persisted. The negotiations in the financial sector were extended until June 1995, six months after the coming into force of the GATS. These negotiations, which resulted in a modest "interim agreement," also proved not to be enough. Again negotiations were resumed. Fortunately, these proved to be more fruitful.

The Asian financial crisis touched off by the devaluation of the Thai baht in July 1997 held the feet of some previously recalcitrant negotiators to the fire. This facilitated the negotiation of a new and improved set of financial services commitments under the GATS. The process culminated on December 12, 1997, when 71 countries agreed to the new Financial Services Agreement. This gave an important signal to the world that the Asian crisis was not going to be allowed to derail the move to more open global financial markets.

The new pact, which brought to 104 the number of countries with commitments in financial services, came into force on March 1, 1999. It covers more than 90 per cent of the enormous global market for financial services, which takes in $40 trillion in domestic bank lending, $20 trillion in securities trading, and over $2 trillion in insurance premiums.

The Financial Services Agreement lightens or scraps regulatory restrictions on foreign banks, securities firms, and insurance companies. The new commitments made included the elimination or relaxation of restrictions on foreign ownership, the juridical form of commercial presence, and the expansion of existing operations. WTO members have also undertaken to do something about measures that enforce the segmentation of banking, securities and insurance or that restrict geographical expansion. This is important in the United States where the Glass-Steagall Act and the McFadden Acts restrict opportunities for foreign financial institutions.

In the final agreement, the United States, India and Thailand withdrew their broad reciprocity-based MFN exemptions. Several other countries also curtailed the scope of their exemptions. The United States submitted a new MFN exemption in insurance, which was targeted at Malaysia but was made generally applicable to countries that force US insurance companies to divest.

Canada's new financial service commitment reaffirmed the Government's previously announced intention to permit foreign banks to directly open branches in Canada. It also allowed foreign bank subsidiaries operating in Canada to open branches. This was something that US and Mexican banks already could do under the NAFTA.

The United States, which was the driving force behind the financial service talks, expects to be the big winner as the agreement opens up global markets to the highly competitive US financial services industry. In spite of what four of Canada's six biggest banks said about the need to be bigger to survive when they were trying to justify mergers, Canada does have world class financial sector and can be a winner too. Moreover, in the end, everyone will gain from freer trade in financial services because of increased access to lower cost capital ushered in by the agreement.

Even though the financial services agreement marks a big step forward in opening up trade in financial services, many barriers remain. Countries with a comparative advantage in financial services like the United States and the United Kingdom can be expected to push for further liberalization in the Millennium Round.

Professional Services

As a first step towards imposing more disciplines on service sectors involving the professions, the accounting sector was picked as a pilot to develop rules to facilitate trade in these services. First, the WTO Council on Trade in Services adopted guidelines for the recognition of qualifications in the accountancy sector on May 29, 1997. These guidelines, which are non-binding, were prepared to make it easier for governments to conclude agreements on the mutual recognition of professional qualifications. Second, the WTO Council for Trade in Services adopted Disciplines on Domestic Regulation in the Accounting Sector on December 14, 1998. These disciplines, which apply to all countries with specific commitments for the accounting sector, cover the administration of licensing requirements, qualification requirements and procedures, technical standards, and transparency requirements. Under the disciplines, regulatory measures can't be more trade-restrictive than necessary to attain such legitimate objectives as protecting consumers, and ensuring the quality of the service and professional competence. These disciplines are to be integrated into the GATS and become legally binding at the end of the next round of service negotiations. In the meantime, WTO members agreed not to take any inconsistent measures. The work program for accountancy now needs to be extended to other professional services such as engineers, architects and legal consultants.

Maritime Transport

Although there are some commitments in GATS schedules with respect to ocean transport, port facilities and auxiliary services, maritime transport has proved a hard nut to crack for trade negotiators. Countries have many restrictions on maritime transport such as the Jones Act in the United States which limits foreign participation in domestic transport. Failing to reach any agreement during the Uruguay Round, an additional round of marine transport negotiations was scheduled to end in June 1996. All that the group could agree on by that deadline was to suspend the negotiations until the commencement of the next comprehensive service sector negotiations in the year 2000. The MFN obligations were also suspended, but at least a standstill was imposed on any new barriers. Maritime transport remains a sector where trade barriers abound. Liberalization in maritime transport should be an important objective of the Millennium Round.

The Service Agenda

The GATS (Article XIX:1) requires negotiations to begin by the year 2000 to increase the number and level of commitments in countries' schedules. This is a major part of the WTO's built-in agenda that has set the stage for the Millennium Round. Because many more barriers to trade exist in the service sector than in the goods sector and because they take the much more intractable form of regulatory obstacles, further liberalization of trade in services must be a key objective of the Millennium Round. The Uruguay Round was just a start in this direction. Much must be done before trade in services is as free as trade in goods.

An indication of the magnitude of the task needed to liberalize trade in services is provided by Table 1. The shortfall of the number of specific commitments from the number 135 reveals the number of WTO members that have not made commitments to liberalize in a specific sector. For instance, the 91 commitments in financial services means that 44 countries have not made commitments. And only 70 countries have signed the Financial Services Agreement, leaving 65 that have not. The cup may be either half empty or half full depending on your point of view. But one thing is clear; it's not full. In addition, only 38 WTO members have made commitments in distribution services, leaving 97 that have not. This is important because an open distribution system is important for providing access to goods. If your goods aren't on the shelves, they don't get sold. This has been a perennial problem in penetrating the Japanese market. It was the main complaint made by the United States before the WTO in the recent Fuji-Kodak challenge. In this 1997 case, the US argued unsuccessfully that Fuji kept Kodak out of distribution and retailing in Japan.

In subsectors within the sectors, the number that haven't made commitments is even higher because a commitment in any subsector counts as a sectoral commitment even if there are no commitments for other subsectors. For example, only 14 WTO members have made commitments in the audio-visual subsector of the communication sector. This is a particular sore point for the Americans who push US pop culture exports of action movies and rock music.

The differences between goods and services is becoming increasingly blurred. Manufacturing firms are providing financing and ongoing service support to sophisticated high-tech products and service firms are packaging technologically advanced products with their services. Firms can no longer be put in hermetically-sealed boxes to be governed by the GATS or the GATT.

Since the GATS is a separate agreement from the GATT, there is an issue of how to handle overlapping topics. For instance, does it make sense to have different rules for investment in service-producing industries than in goods-producing industries as currently exists? What about rules for movement of natural persons? These questions are even more complex for firms that produce goods as well as services. At a minimum the two agreements have to be consistent and the negotiations coordinated. An alternative would be to carve out the negotiations on the cross-cutting issues and place the disciplines concerning the treatment of enterprises under a separate agreement that would apply regardless of whether the enterprise produced services or goods.

Speaking before the World Services Congress in Washington last June, US Trade Representative Charlene Barshefsky proposed that the "request-offer" approach of the GATS be replaced by a better negotiating approach. She suggested that the "zero-for-zero" and formula approaches, which were used to negotiate tariffs for goods, could be applied to services. Under these approaches, negotiators could agree to get rid of all barriers in a sector or to reduce them to a certain negotiated level. Such a more aggressive approach appears to be more promising than the slow and painstaking process of waiting for countries to offer up the barriers themselves.

Another approach that appears promising is that pursued in the telecommunication negotiations. It involves developing a common regulatory framework for a sector, which would be accepted by all WTO members. This approach could be systematically applied sector by sector starting with the sectors such as maritime transport where the barriers are the greatest

Rules governing three areas of the GATS were left unfinished in the Uruguay Round: subsidies, safeguards, and government procurement. This was partly because time ran out and partly because it wasn't clear what, if anything, needed to be done. But commitments for future action were made. GATS Article XV requires members to enter into negotiations to develop disciplines for subsidies. GATS Article XIII promises further multilateral negotiations on government procurement in services.

Subsidies is probably the easiest area to deal in theory. The same kinds of disciplines that apply to subsidies on goods could be extended to subsidies for services. Disputes over service subsidies could be handled under the dispute settlement system. While export subsidies are not a big problem for services, domestic subsidies in such areas as transportation and telecommunications are very high. They are also extremely difficult to measure. The big problem would be convincing countries that make heavy use of subsidies to accept the disciplines. Special more lax rules would have to be made for certain sectors such as health, education, and pensions where subsidies are used to pursue sensitive social policy objectives.

Safeguards are measures that protect domestic industries from surges in imports. They are useful in convincing governments to go along with trade liberalization. On the bright side, traded services can't be stored and are thus less subject to surges than goods imports. Safeguards are consequently less necessary for service imports. But some countries will probably insist anyway on at least having this issue discussed in detail, even if it is unlikely that it will be possible to agree on any rules.

Given that government procurement of goods is not covered by the GATT, it should not be surprising that government procurement of services is not covered by the GATS. Procurement of services is more difficult to deal with than procurement of goods. Procurement of services is characterized by small contracts and difficult issues of determining quality. Nevertheless, there are services such as financial services, transportation, telecommunications, and construction that should be subject to disciplines. The most sensible approach would probably be to try to get all countries to join the plurilateral Government Procurement Agreement rather than establish a separate set of disciplines under GATS. But, regardless of what is done, there is still the issue of the definition of the government sector excluded under the GATS to be resolved.

The United States with its dynamic service sector is the champion of freer trade in services. Canada's service sector is not that far behind, especially in commercial services, and can use the competition to catch up. A dynamic and competitive service sector is essential for an economy's overall competitiveness. That's why the GATS negotiations are so critical for the success of the Millennium Round.