direct and indirect channels for regulation … · direct and indirect channels for regulation to...
TRANSCRIPT
OECD Technical Workshop on Trade Barrier Assessment Methodology
Paris, 12 December 2008
DIRECT AND INDIRECT CHANNELS FOR
REGULATION TO AFFECT TRADE IN SERVICES – THE CASE OF BUSINESS
SERVICES, CONSTRUCTION AND TELECOMMUNICATIONS
by Margit Molnar, Kensuke Tanaka** and Mark van Duijn
OECD Trade and Agriculture Directorate
** Development Centre, OECD
2
TABLE OF CONTENTS
Executive summary ......................................................................................................................................... 3
Introduction ..................................................................................................................................................... 5 Services in general are not traded as much as goods are, but there is large disparity across the service
sector ........................................................................................................................................................ 5
How does regulation affect trade in services? – Some insights from theory ................................................... 7 Information plays a more central role in trade in services ....................................................................... 7 Stringent domestic regulation may, in some cases, increase trade in services ......................................... 8 Market structure is an important factor affecting the relationship between regulation and trade flows .. 8
How does regulation affect trade in services? – An empirical investigation................................................... 8 Services imports are affected by domestic regulations only indirectly .................................................... 9 Do regulations affect services exports directly? ..................................................................................... 13
Major lessons and further steps ..................................................................................................................... 17
References ..................................................................................................................................................... 18
Tables
Table 1. Economy-wide sectoral regulation affects import flows indirectly ................................................ 11 Table 2. Sector-specific regulation affects imports through demand elasticities (imports) ......................... 12 Table 3. Product market regulation in export markets boosts export potential ............................................ 14 Table 4. Regulation in export markets boosts exports while that in the exporter’s markets has no effect ... 14 Table 5. Sector-specific regulation increases the demand elasticities and conduct regulation directly
affects trade (exports) .................................................................................................................... 16
Figures
Figure 1. Services sector output as percentage of GDP in OECD Countries, 1971-2006 .............................. 5 Figure 2. Share of services in global trade, 1994-2006 .................................................................................. 6 Figure 3. Finance, construction, business services and transportation are major producers .......................... 6 Figure 4. Business services and transportation are more traded than other services ...................................... 7
3
DIRECT AND INDIRECT CHANNELS FOR REGULATION TO AFFECT TRADE IN
SERVICES – THE CASE OF BUSINESS SERVICES, CONSTRUCTION AND
TELECOMMUNICATIONS
Margit Molnar, Kensuke Tanaka
** and Mark van Duijn
***
Executive summary
This paper proposes an error correction framework to analyse the relationship between domestic
regulation and international trade taking into account dynamic and long-term relationships as well as
various channels - direct and indirect - through which regulation may affect trade. Economic theories
suggest an economic equilibrium between imports (exports), domestic (world) demand and
competitiveness, i.e. in statistical terms there is a co-integration relationship between them. In practice,
however, adjustment lags and unanticipated shocks entail deviation from such long-run paths. If such
deviation exists, forces tend to pull back the variables towards equilibrium. This basic framework is
augmented by indicators of product market regulation to investigate the impact of regulations on services
trade flows. In addition to checking the direct impact of regulation on trade flows, an extended framework
– by controlling for interactions between regulation and major variables of the model – allows for testing
several other possible channels through which regulation may affect trade such as (i) whether regulation
changes the demand elasticity of trade flows, (ii) whether regulation changes the price elasticity of demand
in the sector in which regulation takes place, and (iii) whether regulation changes the speed at which trade
in that sector is adjusted following changes in demand and competitiveness. The testing of such channels
would not be possible with the gravity model that has long prevailed as the dominant framework for
examining international trade issues.
The estimation results suggest that on the one hand, economy-wide regulation in the importing
country affects imports only indirectly, with greater levels of regulation increasing the demand elasticity of
imports and accelerated speed of import adjustment following demand and competitiveness shocks. More
extensive sector-specific regulation, on the other hand, affects imports only via its increasing of demand
elasticites. More extensive regulation in export markets at first appears to boost exports, though after
controlling for indirect channels of regulatory impact on exports, this is cancelled out. Economy-wide
regulation in export markets does not appear to have a bearing on exports, while sector-specific regulation
in export markets increases the demand elasticity for exports in all model specifications. Regulations
related to conduct and market structure in the export markets in addition to directly boosting exports,
increase export demand elasticities and decrease the speed at which exports react to changes in external
demand and competitiveness.
A major lesson learnt from the analyses is that simple correlations of regulation and trade may not
provide a full picture of their relationship, therefore a more nuanced approach is needed. The above error-
correction framework allowed for the examination of indirect channels through which regulations may
affect trade and the results proved the existence of such channels. Although domestic regulations are
Corresponding author, Senior Economist, Trade and Agriculture Directorate, OECD. T: +33 1 4524 8949. E-
mail: [email protected].
** Development Centre, OECD.
*** Trade and Agriculture Directorate, OECD.
4
usually adopted with other considerations than boosting international trade in services, having in mind their
potential indirect impact on international trade may be useful when formulating such regulations. A further
refinement of the variables and an extension to more sectors would provide further insight into the
relationship between regulation and trade.
5
Introduction
Trade policies in general have an important bearing on the formation of domestic prices and hence on
the decision to produce or invest. Such policies in service sectors comprise not only explicit trade policies,
but also many domestic regulations that affect trade. Industries that are protected by entry restrictions, for
instance, do not face competition, and therefore tend to orient their production toward the domestic market.
Producing for a protected market, in turn, will reduce pressure to upgrade skills or increase efficiency,
resulting in a loss of competitiveness.
To provide an environment facilitating trade, it is therefore important to adopt the appropriate
regulations. To do that, in turn, it is indispensable to better understand the relationship between domestic
regulation and international trade. Notwithstanding the importance of services for the economy, little
research has been done on the impact of domestic regulations on international trade in services. In lack of
such literature, this paper is based on the assumption that given the different purpose of domestic
regulations than impacting international trade, their impact may rather work through indirect channels.
Intuitively, domestic regulation, if excessively restrictive, reduces the degree of flexibility of the economy
and hence its ability to react to shocks. With this in mind, some possible indirect channels for regulation to
affect trade in services are checked. Trade in this paper is limited to cross-border transactions and other
modes - such as sales of foreign affiliates or a large part of services provided by natural persons - are not
covered (in this latter case, with the exception of services provided by natural persons that recorded in
Balance of Payments statistics).
This paper, after a snapshot of trade and output structures in OECD services industries, gives an
insight into theoretical issues characteristic in particular to services. The main part of the paper consists of
the analyses of various channels through which regulation affects trade. Finally, some ways to improve the
present analyses are suggested.
Services in general are not traded as much as goods are, but there is large disparity across the
service sector
While the service sector produces almost three quarters of GDP in OECD countries (Figure 1) and
roughly half in developing countries, its share in global trade flows is far less than the share for goods
(Figure 2). Comparing the trends, the contribution of services to output growth has been increasing (over
about 35 years its share increased 17 percentage points from about 56% to 73%), nevertheless the share of
services in total trade has been constant at around 20% over the past decade and a half in the OECD area.
Figure 5. Services sector output as percentage of GDP in OECD Countries, 1971-2006
Source: WDI.
55%
60%
65%
70%
75%
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
6
Figure 6. Share of services in global trade, 1994-2006
Source: OECD Trade in Services Database.
In addition, shares of services in both output and trade mask significant differences across the sector.
On the output side, construction has traditionally been the largest service industry in OECD economies and
has only recently been overtaken by financial services (Figure 3), a sector that tripled its share in the last
30 years. Alongside financial services, “other business activities” (category 74 under the ISIC Rev. 3
classification) have been the most rapidly growing services sector. Computer services have also expanded
rapidly, though from a very low base.
Figure 7. Finance, construction, business services and transportation are major producers
Percentage of sectoral output in total output, OECD average, 1970-2006
Source: OECD STAN Database.
On the trade side, transportation and business services are far the most traded (Figure 4). To maintain
their share in total services trade, both of these industries have rapidly increased trade recently. In the past
couple of years there has been acceleration in financial services trade, leading to an increase of this sector’s
share in total trade. Trade in communication services although doubled in the past decade, this rate of
growth only allowed for a slight increase in its share in total trade and the almost constant size of trade in
construction services led to a diminishing share of this sector in total services trade.
19%
20%
20%
21%
21%
22%
22%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
19
70
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
Construction Retail Trade Transport
Communications Finance Computer activities
Other business activities
7
Figure 8. Business services and transportation are more traded than other services
Share of services sectors in total services trade, OECD average 1994-2006
Source: OECD Trade in Services Database.
The findings from the joint examination of output and trade share of services suggests that (i) some
services that are of great importance for the economy, such as construction, are among the least traded,
while (ii) other services of great importance for the economy such as transportation or business services
also have a corresponding share in trade. There are also services like computer services that contribute to a
much lesser extent to output than for instance, construction, nevertheless their share in total services trade
is much higher than that of construction.
How does regulation affect trade in services? – Some insights from theory
While barriers to goods trade are preliminarily tariffs and quotas, barriers to trade in services
predominantly take the form of domestic regulations such as entry barriers to local markets, rules on
conduct and rules of competition. Although highly regulated environments imply higher costs in terms of
production and transactions, governments intervene in the market with the purpose of addressing market
failures related to externalities, information asymmetry, or other undesirable developments. .
Information plays a more central role in trade in services
From a theoretical point of view, trade in services has several distinct features, although it shares
many characteristics with trade in goods. One of the most distinct features is the role of information for
trade in services. Owing to the high degree of information asymmetry, the price of a service is not serving
as a device to infer the quality of the service, therefore consumers need more information to make a
decision. It may, however, be too costly for suppliers to communicate the necessary information to each
individual consumer.
In such cases, in addition to educating consumers on how to recognise service quality (which can be a
long process), an appropriate regulatory framework to encourage information disclosure may prove to be
effective. These measures can help consumers to access and process information as they make expenditure
decisions. At the same time, the existence of information asymmetry provides incentives for good firms to
reveal their quality and thus maintain their reputation. Such efforts by firms to provide signalling reduce
the regulatory costs of mitigating information asymmetry.
0%
5%
10%
15%
20%
25%
30%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Other business services Transportation Financial services
Computer & Information services Communication services Construction services
8
Stringent domestic regulation may, in some cases, increase trade in services
Although in services markets transactions may take place amid high degrees of information
asymmetry, dismantling of barriers may not always boost trade. Paradoxically, in some cases, stringent
regulations may even encourage cross-border transactions. Requirements to prove qualifications by a
certificate, for instance, reduce information asymmetry and hence also transaction costs. An environment
with lower transaction costs may spur demand and encourage foreigners to provide the service. Therefore,
instead of dismantling certificate requirements, a harmonisation of qualifications and mutual recognitions
may be the right measures to adopt to boost trade in certain services.
Market structure is an important factor affecting the relationship between regulation and trade flows
Potential gains from services trade liberalisation are tied closely to market structure. Depending on the
market structure, regulation may induce different impacts on trade flows. The effect of improving market
access depends on market structures that differ across services industries. Markets for standardised
products, where prices play an important signalling role, tend to be ceteris paribus more competitive than
services markets, where tailor-made products are more common.
In several services industries (e.g. legal services and consultancy services), owing to the prevalence of
customer-specific products, markets are highly segmented. In segmented markets, suppliers have a certain
degree of monopoly power due to switching costs that are manifest in discretionary price setting. Both
customers and suppliers have incentives to maintain the segmented state of markets: customers because of
switching costs and suppliers owing to reputation effects as reputation takes time to build.
Some service industries depend on networks (e.g. telecommunications, electricity, gas, railways)
involving large sunk and fixed costs while also delivering valuable network externalities. Although the
products are more standardised than in some other industries, the nature of the activity may inhibit the
development of competitive markets.
How does regulation affect trade in services? – An empirical investigation
Gravity models have long prevailed as the dominant framework for examining international trade
issues and with the emergence of the empirical literature on services trade, they have swiftly been adopted
for services. While gravity models are useful for certain purposes, they may be limited in their ability to
capture some important issues with respect to services. Domestic regulation is a case to the point as it is
considered to be the major impediment to services trade.
Economic theories suggest an economic equilibrium between imports (exports), domestic (world)
demand and competitiveness, i.e. in statistical terms there is a co-integration relationship between them. In
practice, however, adjustment lags and unanticipated shocks entail deviation from such long-run paths.
This deviation of the co-integrating linear combination from its long-run mean reflects the distance from
equilibrium and if such deviation exists, forces tend to pull the variables back toward equilibrium. This
basic framework is applied to investigate the impact of domestic regulations on services trade flows.
Indicators of product market regulation are used to augment otherwise conventional trade demand
relationships in which trade in a sector is related to demand, a measure of competitiveness and a sector-
specific time trend to allow for technical progress.1 Two sets of relationships are estimated for each model.
1. In standard models estimating goods imports/exports it is not always assumed that trade flows depend on
demand but not supply, given that imports, for instance, could arise because of domestic producers’ inability to
produce the exact good demanded by consumers. Therefore, to control for supply constraints, a capacity
utilisation variable is included. Such data, however, are not available for services sectors.
9
The first simply tests whether there is an association between regulation and trade after controlling for
demand and competitiveness. The second enables tests to check (i) whether regulation changes the demand
elasticity of trade flows, (ii) whether regulation changes the price elasticity of demand in the sector in
which regulation takes place, and (iii) whether regulation changes the speed at which trade in that sector is
adjusted following changes in demand and competitiveness.
Regulation is captured by the OECD product market regulation (PMR) indicators that contain general
regulatory policies for the entire economy and sector-specific policies for several services sectors including
network services, retail trade and professional services. Given the limited availability of PMR indicators in
time series, only certain series of PMR indicators are suitable to test long-term relationships between
regulation and trade flows. The sectoral PMR indicators are available from 1975 onwards for the seven
sectors of telecommunications, posts, electricity, gas, railways, airlines and roads and their sub-
components, therefore they are suitable for such tests. The general PMR is only available from 1998, (and
only for the three years of 1998, 2003 and 2007) therefore its components are suitable only for short-term
tests.2 While the sector-specific indicators related to the sectors covered in the study are readily available, it
is also useful to test the effect of more general regulatory measures. In lack of a readily available general
PMR in long time series, the average of the 7-industry (telecommunications, posts, electricity, gas,
railways, airlines and roads) sectoral indicator (the electricity, transport and communication regulatory
indicator or ETCR) is used to capture economy-wide regulation. Also the gas sector indicator is used as a
substitute for the average ETCR as the gas sector is among the latest liberalised network industries,
therefore this indicator may be useful to assess economy-wide regulation.
Services imports are affected by domestic regulations only indirectly
The conventional import demand equation - where the size of import flows depends on import
demand, competitiveness and a time trend to allow for technological progress – is augmented by regulatory
indicators as in equation (1):
∆𝑚𝑖,𝑡 = 𝛼0 + 𝛼1Δ𝑑𝑖,𝑡 + 𝛼2Δ𝑐𝑜𝑚𝑝𝑖,𝑡+
+𝛼3 𝑚𝑖,𝑡−1 + 𝜌1𝑑𝑖,𝑡−1 + 𝜌2𝑐𝑜𝑚𝑝𝑖,𝑡−1 + 𝜌3𝑃𝑀𝑅𝑖,𝑡−1+𝜌4𝑇 + 𝜀𝑖,𝑡 (1)
where ∆ indicates growth rates, m is imports, d is demand for imports, comp is the competitiveness
variable, all in logarithmic forms, T is the time trend and PMR is the product market regulation indicator.
The demand for imports is captured by domestic output3 and competitiveness by the three variables of
unit labour costs, hourly wages in the sector and the real effective exchange rate. Domestic output is
deflated by the sector-specific output deflator, both obtained from the OECD STAN database updated by
the EU KLEMS, the 60-industry database of the Groningen Growth and Development Centre and national
sources. Real effective exchange rates were obtained from the International Financial Statistics database of
the IMF, unit labour costs from the OECD Unit Labour Cost database and sector-specific hourly wages
were computed as the ratio of the sectoral wage bill to the hours worked in the sector, both obtained from
the OECD STAN database. Product market regulation is measured by the OECD PMR indicators, the
effect of both the sector-specific indicators and indicators attempting to capture economy-wide regulation
are examined.
2. The overall PMR and its components did not appear to affect trade flows in the short term.
3. Demand is usually defined as total aggregate demand, including exports, rather than GDP to allow for taking
into account the import content of exports. In the case of services, however, information on “processing
exports” is not available as readily as in the case of goods.
10
The basic setting of the model works relatively well given that the availability and quality of data for
service sectors in general is inferior to those for goods. The dynamic coefficient is always negative and
significant, indicating that there is indeed a co-integration relationship between the major variables of
interest. The demand variable is mostly significant in the long run, though not always in the short run. The
competitiveness variable, although measured by three variants, does not appear with a significant
coefficient, most likely owing to the fact that the relative prices may not be best captured by labour costs
even in services.
After controlling for demand and competitiveness, there does not seem to be a significant relationship
between regulation and import flows (results subtracted). This finding of a lack of direct impact of
regulation on import flows, however, does not mean that regulations have no impact on trade at all. To
investigate further possible channels through which regulation may impact trade, a series of hypotheses
were tested: (i) whether regulation changes the demand elasticity of imports (ii) whether regulation
changes the price elasticity of imports and (iii) whether regulation impacts on the speed at which imports
adjust following changes in demand and competitiveness. To check these hypotheses, the following
equation is estimated:
∆𝑚𝑖,𝑡 = 𝛼0 + 𝛼1Δ𝑑𝑖,𝑡 + 𝛼2Δ𝑐𝑜𝑚𝑝𝑖,𝑡 + 𝛼3 + 𝛾1𝑃𝑀𝑅𝑖,𝑡−1 𝑚𝑖,𝑡−1 + {𝜌1 + 𝛾2𝑃𝑀𝑅𝑖,𝑡−1}𝑑𝑖,𝑡−1 +
+{𝜌2+𝛾3𝑃𝑀𝑅𝑖,𝑡−1}𝑐𝑜𝑚𝑝𝑖,𝑡−1+𝜌3𝑃𝑀𝑅𝑖,𝑡−1+𝜌4𝑇+𝜀𝑖,𝑡 (2)
where ∆ indicates growth rates, m is imports, d is demand for imports, comp is the competitiveness
variable, all in logarithmic forms, T is the time trend and PMR is the product market regulation indicator.
Regulation appears indeed to have an impact on import flows, albeit not directly. This is not so
surprising given that domestic regulations were adopted for different purposes than controlling
international trade; nevertheless by making the economy less flexible, such regulations may have a bearing
on trade flows. The results show that domestic regulation increases the demand elasticity of imports
(Table 1). This effect may work through the increased rigidity of domestic production implied by
regulation and hence more responsiveness of imports to demand changes when the domestic market is
regulated. This finding is robust to model specification: it is confirmed in a model where regulation is
measured by the average ETCR (which includes 7 network industries) or regulation in the gas sector.
Furthermore, it is robust to different specifications of the competitiveness variable. In addition to its impact
on increasing demand elasticity, regulation also increases the speed at which imports adjust to changes in
demand or competitiveness. This finding may again be explained by the fact that regulation in general
implies less flexibility in domestic production, and due to this limited domestic flexibility, increased
domestic demand, for instance, needs to be met by increased imports rather than increased domestic
production. By the same token, imports adjust faster to changes in competitiveness owing to the rigidity of
domestic production as a result of regulation.
11
Table 6. Economy-wide sectoral regulation affects import flows indirectly
Note: ETCR is the average of PMR indicators in the seven network industries of telecommunications, posts, air, road and rail transport, electricity and gas. For the regulatory indicators an unpublished preliminary version of the 2008 PMR database is used. REER stands for real effective exchange rate, wage for sector-specific hourly wages and ULC for unit labour costs. For the estimation, an unbalanced dataset of OECD countries was used with data available from 1975.
Source: Authors’ estimation.
Not all types of regulations impact trade flows in the same way. As seen above, even regulations that
affect the entire economy, although do not appear to have a direct impact on imports, may impact trade
flows via increasing the elasticity of demand and accelerating the speed of adjustment. Regulations which
are specific to the sector, similarly, do not tend to impact imports in the sector directly, but via increasing
the elasticity of demand (Table 2). This finding is the same when regulation is captured by the highest-
level sectoral PMR, two variations of the entry component of the sectoral PMR and the sectoral market
structure/conduct component.
Although the coefficient on the short-run demand term is always positive and statistically significant,
its size is not very large, hovering around 0.3. This indicates that the “leaks” of demand shocks to trading
partners are not too large, i.e. they do not limit too much the stimulative impact of such shocks on domestic
activity. The long-run estimate is close to unitary elasticity. The time trend is positive and often significant,
implying that imports are increasingly controlling for demand and competitiveness. The time trend serves
as a proxy for variables that are difficult to quantify such as increasing openness and specialisation or the
growing influence of multinational firms.
reer wage ulc reer wage ulc
Long-run coefficients
Demand 0.829** 0.773* 0.721* 1.368** 1.28* 1.429**
(0.40) (0.41) (0.39) (0.69) (0.71) (0.72)
Competitiveness 1.297 0.141** -2.125 -0.302 0.196 -3.431
(2.22) (0.07) (1.99) (3.29) (0.15) (2.94)
Regulation (in import market) 1.362 0.145 0.412 -0.405 0.929 2.907
(2.58) (1.17) (1.18) (4.31) (2.75) (2.66)
Trend 0.082** 0.065* 0.089** 0.072 0.061 0.087
(0.03) (0.04) (0.04) (0.04) (0.04) (0.05)
Short-run coefficients
Demand 0.186 0.258 0.155 0.23* 0.254 0.194
(0.14) (0.19) (0.14) (0.14) (0.19) (0.14)
Competitiveness 0.001 0.002 -0.399 0.026 0.001 -0.405
(0.23) (0.004) (0.46) (0.23) (0.004) (0.46)
Dynamic coefficent -0.201*** -0.205*** -0.199*** -0.124*** -0.126*** -0.124***
(0.03) (0.04) (0.04) (0.04) (0.04) (0.04)
Interaction term coefficients
Regulation-import -0.022*** -0.026*** -0.021*** -0.043*** -0.047*** -0.042***
(0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
Regulation-demand 0.639*** 0.616*** 0.561*** 0.631*** 0.645*** 0.585***
(0.20) (0.19) (0.18) (0.19) (0.18) (0.17)
Regulation-competitiveness 0.295 -0.025 -0.571 0.707 -0.001 -0.348
(0.57) (0.02) (0.46) (0.55) (0.02) (0.40)
No. Obs. 1097 990 1085 1097 990 1085
R-sq 0.140 0.148 0.139 0.152 0.160 0.150
ETCR GAS
12
Table 7. Sector-specific regulation affects imports through demand elasticities (imports)
Note: Sectoral PMR is the sector-specific PMR indicator, sectoral PMR entry is the entry restriction component of this indicator, sectoral PMR entry 2 is a variant of it, sectoral PMR conduct is an indicator where either the component related to conduct or market structure is used in a given sector, depending on availability. For the regulatory indicators an unpublished preliminary version of the 2008 PMR database is used. REER stands for real effective exchange rate, wage for sector-specific hourly wages and ULC for unit labour costs. For the estimation, an unbalanced dataset of OECD countries was used with data available from 1975.
Source: Authors’ estimation.
reer wage ulc reer wage ulc reer wage ulc reer wage ulc
Long-run coefficients
Demand 0.857*** 0.858*** 0.868*** 0.882*** 0.918*** 0.854*** 0.881*** 0.919*** 0.853*** 0.861*** 0.81*** 0.85***
0.23 0.27 0.22 0.23 0.27 0.22 0.23 0.27 0.22 0.23 0.25 0.21
Competitiveness 1.332* -0.031 -1.708** 1.207 -0.007 -1.679*** 1.202 -0.007 -1.688*** 1.386* -0.024 -1.805***
0.79 0.05 0.67 0.76 0.03 0.64 0.76 0.03 0.64 0.8 0.05 0.67
Regulation (import market) 1.848 0.851 1.059 1.381 0.189 0.47 1.353 0.174 0.475 2.264* 0.176 0.533
1.43 0.95 0.83 1.3 0.83 0.59 1.27 0.76 0.57 1.3 0.74 0.64
Trend 0.019 0.005 0.042** 0.021 0.005 0.044** 0.021 0.005 0.044** 0.02 0.008 0.05**
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
Short-run coefficients
Demand 0.328** 0.346* 0.305** 0.334** 0.368* 0.299** 0.335** 0.368* 0.299** 0.333** 0.345* 0.305**
0.14 0.2 0.15 0.14 0.2 0.15 0.14 0.2 0.15 0.14 0.19 0.14
Competitiveness 0.044 -0.0005 -1.306** 0.029 -0.0003 -1.25** 0.029 -0.0003 -1.254** 0.046 -0.001 -1.159**
0.25 0.004 0.53 0.25 0.004 0.52 0.25 0.004 0.52 0.24 0.004 0.5
Dynamic coefficent -0.244*** -0.246*** -0.256*** -0.244*** -0.243*** -0.255*** -0.244*** -0.243*** -0.255*** -0.244*** -0.244*** -0.253***
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
Interaction term coefficients
Regulation-import 0.003 0.01 -0.003 -0.003 0.004 -0.004 -0.002 0.004 -0.003 0.005 0.003 -0.008
0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01
Regulation-demand 0.827*** 0.836*** 0.806*** 0.866*** 0.919*** 0.824*** 0.863*** 0.921*** 0.823*** 0.836*** 0.802*** 0.797***
0.22 0.27 0.2 0.22 0.26 0.2 0.22 0.26 0.2 0.22 0.24 0.19
Regulation-competitiveness 1.036 -0.017 -1.436** 0.908 -0.001 -1.443** 0.9 -0.003 -1.443** 0.905 -0.014 -1.462***
0.7 0.04 0.56 0.67 0.03 0.56 0.67 0.03 0.56 0.69 0.03 0.52
No. Obs. 1015 889 979 1032 904 996 1032 904 996 1043 919 1019
R-sq 0.124 0.117 0.129 0.124 0.116 0.128 0.124 0.116 0.128 0.124 0.117 0.128
Sectoral PMR Sectoral PMR entry Sectoral PMR entry 2 Sectoral PMR conduct
13
The joint estimations mask some sector-specific variation. The very different nature of construction,
telecommunications, computer and other business services suggests that they may react to the same
regulations in different manners. Indeed, regulation increases the speed of adjustment following demand
and competitiveness shocks in the computer services industry. Given that this industry is one of the least
regulated services industries, it is not surprising that increased regulation in the economy as a whole
induces swifter reaction by this flexible sector. This finding remains unchanged whether the average ETCR
or the gas-sector PMR are used to capture overall domestic regulation and when three different types of
competitiveness measures are applied.
Do regulations affect services exports directly?
The equation estimated for exports follows the structure of the equation for imports, where the size of
export flows depends on export demand, competitiveness and a time trend. This basic export demand
equation is augmented by regulatory indicators to examine their impact on export flows:
∆𝑥𝑖,𝑡 = 𝛼0 + 𝛼1Δ𝑑𝑖,𝑡 + 𝛼2Δ𝑐𝑜𝑚𝑝𝑖,𝑡+
+𝛼3 𝑚𝑖,𝑡−1 + 𝜌1𝑑𝑖,𝑡−1 + 𝜌2𝑐𝑜𝑚𝑝𝑖,𝑡−1 + 𝜌3𝑃𝑀𝑅𝑖,𝑡−1 + 𝜌4𝑇 + 𝜀𝑖 ,𝑡 (3)
where ∆ indicates growth rates, x is exports, d is demand for exports, comp is the competitiveness
variable, all in logarithmic forms, T is the time trend and PMR is the product market regulation indicator.
The demand for exports is usually captured by world output; however, given the lack of such data in
this case, it is proxied by output of the rest of OECD countries. For competitiveness, similarly to the import
demand equation, three variants are used: unit labour costs, sector-specific hourly wages and real effective
exchange rates. OECD output is deflated by the average of the sector-specific output deflator, both
obtained from the OECD STAN database. Real effective exchange rates were obtained from the
International Financial Statistics database of the IMF, unit labour costs from the OECD Unit Labour Cost
database, and sector-specific hourly wages were computed as the ratio of the sectoral wage bill to the hours
worked in the sector, both obtained from the OECD STAN database.
Just like the case of the import equation, the basic setting of the model seems to work relatively well
given the quality and availability of data for services. The dynamic coefficient is negative and statistically
highly significant in all model specifications, indicating a co-integrating relationship between the variables
of interest.
After controlling for export demand and competitiveness, sector-specific regulation, including the
overall sector-specific regulation and entry regulations captured by two different variables, in the export
markets has a positive impact on exports (Table 3). That is, if production is constrained by regulation in the
export markets, the exporter directly benefits from it through higher export demand. This finding is robust
to the specifications using the three variants of the competitiveness variable and remains unchanged with
the addition of the exporter’s product market regulatory indicator, which never appears significant
(Table 4).
14
Table 8. Product market regulation in export markets boosts export potential
Note: Sectoral PMR is the sector-specific PMR indicator, sectoral PMR entry is the entry restriction component of this indicator, sectoral PMR entry 2 is a variant of it. For the regulatory indicators an unpublished preliminary version of the 2008 PMR database is used. REER stands for real effective exchange rate, wage for sector-specific hourly wages and ULC for unit labour costs. For the estimation, an unbalanced dataset of OECD countries was used with data available from 1975.
Source: Authors’ estimation.
Table 9. Regulation in export markets boosts exports while that in the exporter’s markets has no effect
Note: Sectoral PMR is the sector-specific PMR indicator, sectoral PMR entry is the entry restriction component of this indicator, sectoral PMR entry 2 is a variant of it. For the regulatory indicators an unpublished preliminary version of the 2008 PMR database is used. REER stands for real effective exchange rate, wage for sector-specific hourly wages and ULC for unit labour costs. For the estimation, an unbalanced dataset of OECD countries was used with data available from 1975.
Source: Authors’ estimation.
reer wage ulc reer wage ulc reer wage ulc
Long-run coefficients
Demand 1.05*** 1.029*** 1.202*** 1.093*** 1.051*** 1.21*** 1.085*** 1.048*** 1.207***
0.29 0.22 0.250 0.302 0.228 0.258 0.298 0.225 0.256
Competitiveness 0.487 -0.018 -0.719 0.459 -0.019 -0.663** 0.463 -0.019 -0.656**
0.62 0.018 0.264 0.619 0.02 0.263 0.619 0.02 0.253
Regulation (in export market) 0.357*** 0.253** 0.434*** 0.275** 0.192** 0.321*** 0.270** 0.190** 0.314***
0.141 0.110 0.126 0.107 0.082 0.095 0.104 0.080 0.093
Trend 0.058*** 0.042*** 0.079*** 0.058*** 0.04*** 0.077*** 0.057*** 0.04*** 0.076***
0.01 0.01 0.02 0.01 0.01 0.02 0.01 0.01 0.02
Short-run coefficients
Demand -0.06** -0.095* -0.04 -0.06* -0.093* -0.037 -0.06* -0.1* -0.04
0.03 0.05 0.03 0.03 0.05 0.03 0.03 0.05 0.03
Competitiveness 0.276 -0.001 -0.207 0.284* -0.001 -0.157 0.283** -0.001 -0.193
0.17 0.003 0.357 0.17 0.003 0.35 0.17 0.003 0.354
Dynamic coefficent -0.177*** -0.256*** -0.192*** -0.176*** -0.255*** -0.190*** -0.175*** -0.255*** -0.190***
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
No. Obs. 1230 1056 1207 1245 1069 1222 1245 1069 1222
R-sq 0.108 0.156 0.113 0.107 0.156 0.112 0.108 0.16 0.112
Sectoral PMR Sectoral PMR entry Sectoral PMR entry 2
reer wage ulc reer wage ulc reer wage ulc
Long-run coefficients
Demand 1.05*** 1.038*** 1.201*** 1.092*** 1.054*** 1.214*** 1.085*** 1.052*** 1.204***
0.29 0.22 0.250 0.302 0.23 0.260 0.298 0.227 0.258
Competitiveness 0.477 -0.02 -0.734*** 0.462 -0.019 -0.657** 0.463 -0.02 -0.652**
0.62 0.018 0.26 0.621 0.02 0.266 0.221 0.018 0.266
Regulation (own) 0.038 0.036 0.036 -0.04 0.004 -0.008 -0.001 0.005 -0.005
0.101 0.082 0.097 0.053 0.040 0.052 0.052 0.040 0.051
Regulation (in export markets) 0.317* 0.217 0.401** 0.279** 0.188** 0.328*** 0.271** 0.185** 0.318***
0.176 0.136 0.156 0.119 0.089 0.106 0.112 0.087 0.103
Trend 0.058*** 0.042*** 0.079*** 0.055*** 0.04*** 0.077*** 0.057*** 0.04*** 0.076***
0.01 0.01 0.02 0.01 0.01 0.02 0.01 0.01 0.02
Short-run coefficients
Demand -0.06* -0.095* -0.04 -0.06* -0.093* -0.037 -0.06* -0.1* -0.04
0.03 0.05 0.03 0.03 0.05 0.03 0.03 0.05 0.03
Competitiveness 0.275 -0.001 -0.21 0.285* -0.001 -0.185 0.284 -0.001 -0.191
0.17 0.003 0.357 0.17 0.003 0.354 0.173 0.003 0.354
Dynamic coefficent -0.177*** -0.256*** -0.192*** -0.176*** -0.255*** -0.190*** -0.176*** -0.255*** -0.190***
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
No. Obs. 1230 1056 1207 1245 1069 1222 1245 1069 1222
R-sq 0.108 0.156 0.113 0.107 0.156 0.112 0.108 0.16 0.112
Sectoral PMR Sectoral PMR entry Sectoral PMR entry 2
15
Following the confirmation of the trade-boosting impact of product market regulation in export
markets, the next step in the analysis is to check whether in addition to this impact, regulations also affect
trade through other channels. To do so, the following equation is estimated:
∆𝑥𝑖,𝑡 = 𝛼0 + 𝛼1Δ𝑑𝑖,𝑡 + 𝛼2Δ𝑐𝑜𝑚𝑝𝑖,𝑡 + 𝛼4 + 𝛾1𝑃𝑀𝑅𝑖,𝑡−1 𝑚𝑖,𝑡−1 + {𝜌1 + 𝛾2𝑃𝑀𝑅𝑖,𝑡−1}𝑑𝑖,𝑡−1 +
{𝜌2+𝛾3𝑃𝑀𝑅𝑖,𝑡−1}𝑐𝑜𝑚𝑝𝑖,𝑡−1+𝜌3𝑃𝑀𝑅𝑖,𝑡−1+𝜌4𝑇+𝜀𝑖,𝑡 (4)
where ∆ indicates growth rates, x is exports, d is demand for exports, comp is the competitiveness
variable, all in logarithmic forms, T is the time trend and PMR is the product market regulation indicator.
The estimates show that the direct impact of regulation on exports that was confirmed previously,
fades out once the effect through other channels is controlled for (Table 5), with the exception of conduct
regulation (for which no significant effect was found earlier). In all model specifications regulation in
export markets increases the demand elasticity of exports. This works through the same logic as in the case
of imports: as regulation in a market decreases the flexibility of production in that market, changes in
demand will result in more exports by partners to this market. This is basically the only channel through
which sectoral regulation in export markets affects exports, with the exception that conduct regulation (in
export markets) also reinforces the direct (positive) impact of regulation in the export markets on exports.
In addition, sector specific conduct regulation decreases the speed at which exports change as a result to
changes in export demand and competitiveness. This may be related to more cumbersome procedures in
more regulated markets.
The finding that when controlling for indirect channels, the direct impact of regulation on exports
cancels out, has an important implication on the way the issue of regulation and trade flows needs to be
approached. First of all, the lack of a finding of any impact of regulation on trade in a setting without
controlling for indirect channels should not necessarily mean that regulation has no impact on trade. By the
same token, even if significant relationships are confirmed in a simple setting, they may be misleading as
important explanatory variables may be missing. Overall, the relationship between regulation and trade
should be treated in a more nuanced way, exploring various possible channels. This implication should not
be surprising given that domestic regulations are usually adopted for other purposes than to affect trade and
therefore their impact may work through other variables such as demand or competitiveness.
Estimation at the industry level shows that economy-wide regulation in export markets reduces
exports of professional services. This finding is robust whether the unit labour cost or the real effective
exchange rate is used as a measure of competitiveness and whether the average ETCR or the gas sector
ETCR is used as a measure of economy-wide regulation. This may be explained by the fact that the cross-
border provision of professional services usually involves the movement of natural persons that provide the
service and it may be more difficult for such suppliers to operate in more restrictive environments.
16
Table 10. Sector-specific regulation increases the demand elasticities and conduct regulation directly affects trade (exports)
Note: Sectoral PMR is the sector-specific PMR indicator, sectoral PMR entry is the entry restriction component of this indicator, sectoral PMR entry 2 is a variant of it, sectoral PMR conduct is an indicator where either the component related to conduct or market structure is used in a given sector, depending on availability. For the regulatory indicators an unpublished preliminary version of the 2008 PMR database is used. REER stands for real effective exchange rate, wage for sector-specific hourly wages and ULC for unit labour costs. For the estimation, an unbalanced dataset of OECD countries was used with data available from 1975.
Source: Authors’ estimation.
reer wage ulc reer wage ulc reer wage ulc reer wage ulc
Long-run coefficients
Demand 1.1*** 0.919*** 1.227*** 0.935** 0.839*** 1.023*** 0.916** 0.829*** 0.996*** 1.367*** 0.946*** 1.235***
0.42 0.32 0.4 0.41 0.3 0.38 0.4 0.3 0.38 0.42 0.33 0.4
Competitiveness 0.491 -0.037 -0.838 0.552 -0.03 -0.681 0.569 -0.031 -0.639 0.308 -0.03 -0.823
0.92 0.03 0.7 0.9 0.02 0.7 0.91 0.02 0.7 0.89 0.03 0.68
Regulation (in export market) 1.143 -0.75 1.675 -0.73 -1.924 -0.469 -0.813 -1.996 -0.635 3.91* 3.524* 4.858**
2.17 1.81 2.3 1.84 1.44 1.99 1.85 1.44 2 2.23 1.88 2.34
Trend 0.058*** 0.042*** 0.081*** 0.055*** 0.04*** 0.075*** 0.054*** 0.04*** 0.073*** 0.061*** 0.045*** 0.083***
0.01 0.01 0.02 0.01 0.01 0.02 0.01 0.01 0.02 0.01 0.01 0.02
Short-run coefficients
Demand -0.06** -0.098** -0.041 -0.06* -0.099* -0.041 -0.06** -0.1* -0.04 -0.058* -0.107** -0.048
0.03 0.05 0.03 0.03 0.05 0.03 0.03 0.05 0.03 0.03 0.05 0.03
Competitiveness 0.276 -0.001 -0.215 0.292* -0.001 -0.172 0.291** -0.001 -0.174 0.278 -0.002 -0.162
0.17 0.003 0.37 0.17 0.003 0.37 0.17 0.003 0.37 0.17 0.003 0.35
Dynamic coefficent -0.179*** -0.258*** -0.197*** -0.176*** -0.259*** -0.192*** -0.175*** -0.259*** -0.192*** -0.183*** -0.255*** -0.197***
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
Interaction term coefficients
Regulation-import 0.003 -0.005 0.006 -0.001 -0.01 0.002 -0.001 -0.01 0.002 0.01 0.031*** 0.019***
0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01
Regulation-demand 1.086*** 0.948*** 1.208*** 0.977*** 0.897*** 1.065*** 0.964*** 0.894*** 1.045*** 1.263*** 0.875*** 1.114***
0.37 0.27 0.35 0.36 0.26 0.34 0.36 0.25 0.33 0.37 0.31 0.37
Regulation-competitiveness 0.494 -0.027 -0.826 0.517 -0.023 -0.686 0.527 -0.023 -0.651 0.339 -0.029 -0.833
0.76 0.02 0.59 0.74 0.02 0.59 0.73 0.02 0.58 0.76 0.03 0.62
No. Obs. 1230 1056 1207 1245 1069 1222 1245 1069 1222 1256 1087 1248
R-sq 0.108 0.157 0.114 0.108 0.159 0.113 0.108 0.16 0.113 0.11 0.15 0.11
Sectoral PMR Sectoral PMR entry Sectoral PMR entry 2 Sectoral PMR conduct
17
Major lessons and further steps
This paper suggested an error-correction framework to analyse the relationship between domestic
product market regulation and international services trade. Apart from certain deficiencies related to data
availability, the model performs relatively well and provides insights into so far undiscovered aspects of
the relationship between regulation and services trade flows. The paper departs from the widely used
approach of gravity modeling as these models do not allow for testing long-term relationships or indirect
effects. To capture regulation, the OECD PMR indicators are used that are available for all OECD
countries and some series are sufficiently long to test long-term relationships. The impact of regulation on
both imports and exports was checked in separate frameworks.
The estimation results suggest that different types of regulations affect imports and exports in
different ways. On the one hand, economy-wide regulation in the importing country tends to affect imports
only indirectly, via increasing the demand elasticity of imports and accelerating the speed of import
adjustment following demand and competitiveness shocks. Sector-specific regulation, on the other hand,
tends to affect imports only via its increasing of demand elasticites. Regulation in export markets appears
to boost exports, though after controlling for indirect channels of regulatory impact on exports, this is
cancelled out. Economy-wide regulation in export markets does not appear to have a bearing on exports,
while sector-specific regulation in export markets tends to increase the demand elasticity for exports in all
model specifications. Regulations related to conduct and market structure in the export markets in addition
to directly boosting exports, tend to increase export demand elasticities and decrease the speed at which
exports react to changes in external demand and competitiveness.
A major lesson learnt from the analyses is that simple correlations of domestic regulation and
international trade may not provide a full picture of their relationship, therefore a more nuanced approach
is needed. The above error-correction framework allowed for the examination of indirect channels through
which regulations may affect trade and the results proved the existence of such channels. Although
domestic regulations are usually adopted with other considerations than boosting international trade in
services, having in mind their potential indirect impact on international trade may be useful when
formulating such regulations. A further refinement of the variables and an extension to more sectors would
provide further insights into the relationship between domestic regulation and international trade in
services.
18
REFERENCES
Deardorff, A.V. and R.M. Stern (2004), “Empirical Analysis of Barriers to International Services
Transactions and the Consequences of Liberalisation”, Research Seminar in International
Economics Discussion Paper No. 505, Gerald R. Ford School of Public Policy, The University of
Michigan.
Nguyen-Hong, D. (2005), “Techniques for estimating services barriers” in Dee, P. and M. Ferrantino (eds.)
Quantitative Methods for Assessing The Effects of Non-Tariff Measures and Trade Facilitation, Asia
Pacific Economic Cooperation, Committee on Trade and Investment.