OECD Experts Meeting on Construction Services

Paris, 11 December 2008

TRADE AND REGULATION: THE CASE

OF CONSTRUCTION SERVICES

by Massimo Geloso Grosso, Anna Jankowska and Frédéric Gonzales*

OECD Trade and Agriculture Directorate

*The authors wish to thank Eduard Eykelberg for helpful research assistance

2

TABLE OF CONTENTS

I. Introduction .......................................................................................................................................... 5 II. Characteristics of construction services ............................................................................................ 6 III. Trade patterns .................................................................................................................................... 9

The OECD services trade database ........................................................................................................ 10 OECD FATS statistics ........................................................................................................................... 12

IV. Regulation of construction services ................................................................................................ 13 Main types of regulatory measures ........................................................................................................ 13 Regulation in OECD countries ............................................................................................................... 15

V. The relationship between regulation and trade in construction services ......................................... 26 The Spearman rank correlations ............................................................................................................. 26 The regulatory heterogeneity indicator .................................................................................................. 28

VI. Conclusions ..................................................................................................................................... 30

REFERENCES .............................................................................................................................................. 32

ANNEX I. TOP INTERNATIONAL CONTRACTORS 2008 ..................................................................... 34

ANNEX II. METHODOLOGY FOR ESTIMATING THE GRAVITY MODEL ....................................... 35

ANNEX III. THE PMR STRUCTURE ......................................................................................................... 36

3

EXECUTIVE SUMMARY

This study provides a detailed analysis of construction services as part of the OECD project on

developing a services trade restrictiveness index (STRI). The primary objective is to identify the most

relevant regulations affecting trade in construction services, to be included in the STRI for the sector. The

analysis is based on four main elements: 1) a discussion of the economic importance and characteristics of

the sector, including through mini company case studies; 2) a description of trade patterns; 3) a detailed

analysis of regulations in these services; and 4) statistical and econometric estimates on the impact of

regulations on trade and investment flows.

Construction services have historically played a key role in the functioning of economies, providing

the infrastructure for other industries. These services account for a considerable share of GDP and

employment in OECD countries and generate significant economic activity through linkages with other

industries. The nature of the construction business requires local production which, coupled with its high

labour and material intensity, help to explain why the industry remains mainly oriented towards domestic

markets. The sector is characterised by a large number of small firms, with a few large-scale contractors

dominating the international market.

The local characteristics of the construction product imply that establishment abroad is the preferred

mode of supply in the sector, often a necessity to conduct trade in these services. The manner in which

construction firms enter a foreign market varies from the duration of a particular project to a more

permanent presence in overseas markets. It is likely that commercial presence and the movement of

natural persons are complementary in construction services. However, the importance of the latter may

vary depending on the entry strategy adopted, with generally more expatriates sent abroad in the case of

short-term establishment.

The modal nature of trade in the sector is reflected in trade statistics. In the OECD trade in services

by partner country (TiSP) database, the construction services sector represents an exception in that the

predominant mode of supply covered is establishment abroad, through short-term presence. The pattern of

trade over time appears in line with the cyclical nature of the construction industry. FATS statistics are

regarded as the closest proxy for more permanent commercial establishment. It is likely that the latter

represents the preferred entry strategy by contractors in OECD countries, as indicated by the trade data and

interviews with the private sector. However, further research is needed in this area.

Construction services trade is affected by a variety of regulations, including building and product

standards, specific restrictions on establishing a commercial presence and on the movement of personnel.

Government procurement is an important driver of demand for the sector, representing a considerable share

of construction activity in OECD countries. Procurement practices can thus have a significant impact on

trade in construction services. Public-private partnerships (PPPs), such as concessions, have also emerged

to facilitate private participation in infrastructure development and represent an increasingly important

component of the operations of international contractors.

Creating and updating the STRI over time requires periodic surveys of the main restrictions put in

place by members. The OECD Product Market Regulation (PMR) indicators are the obvious candidates

4

for this purpose. This study identifies other sources of information that could be used to complement

existing data for the development of the STRI. The analysis reveals considerable heterogeneity of

regulatory measures across OECD countries. Members have preferred to maintain regulatory flexibility in

the GATS context, though more progress in disciplining construction-related measures has been achieved

at the regional level and in the WTO Agreement on Government Procurement (GPA).

Although not originally designed for trade-related regulation, the PMR indicators include many

measures identified in the literature as the most significant restrictions to trade in the construction sector.

This is particularly the case for the latest version of the survey, to be released later this year. The empirical

analysis undertaken in this study supports the inclusion of these measures in the STRI when constructed

“bottom up”. Preliminary evidence is found that these regulations and their heterogeneity are negatively

associated with trade in construction services, particularly through long-term establishment. The results

hold for a number of more disaggregated measures of the PMR.

5

TRADE AND REGULATION: THE CASE OF CONSTRUCTION SERVICES

I. Introduction

1. As part of the broader project on developing a services trade restrictiveness index (STRI), this

paper presents a detailed analysis of the construction services sector. The objective is to develop in the

field of these services the initial steps outlined in the Road Map for work in this area presented to the Trade

Committee in June 2007 (OECD, 2007a) and a subsequent document presented to the first Services

Experts Meeting on the STRI in September of that year (OECD, 2007b). This study aims in particular at

identifying the most relevant regulatory measures affecting trade in construction services. These would

then be included in the STRI for these services.

2. The coverage of construction services is broadly comparable in international standard

classifications.1 The Extended Balance of Payments Services classification (EBOPS 249) covers site

preparation and general construction for buildings and other structures, construction work for civil

engineering, as well as installation and assembly work. It also includes repairs, renting services of

construction or demolition equipment with operator, and exterior cleaning work of buildings. Table 1

shows that the sector coverage is similar in the International Standard Industrial Classification (ISIC

Rev.3) and the WTO services sectoral classification list (W/120), which is based on the UN Provisional

Central Product Classification (CPC).

Table 1. Construction services in standard international classifications

51. Construction and related engineering services

512. General construction work for buildings

513. General construction work for civil engineering

514+516. Installation and assembly work

ISIC Rev. 3

45. Construction

Table 1. Construction services in standard international classifications

455. Renting of construction or demolition equipment with

operator

W/120 (Prov. CPC)

517. Bulding completion and finishing work

511+515+518. Other*

451. Site preparation

453. Building installation

454. Building completion

452. Bulding of complete constructions or parts thereof; civil

engineering

Note: * covers pre-erection work at construction sites; special trade construction work; and renting services related to equipment

for construction or demolition of buildings or civil engineering works, with operator.

1 The construction services sector is viewed as consisting of two sub-sectors: 1) architectural and engineering

design; and 2) construction and related engineering services, also termed “physical construction” (UNCTAD,

2000). This study focuses on the latter since architectural and engineering design services are regarded as

professional services. In the context of the STRI project, these services were already discussed in detail during

the Services Experts Meeting on Business Services held in June. This focus has modal implications, since mode

1 is less relevant for construction and related engineering services.

6

3. The next section of the paper discusses the economic importance and principal characteristics of

construction services and provides mini company case studies on the driving forces and main obstacles to

trade in the sector. Section III describes international trade patterns in construction services. Section IV

then discusses the range of regulatory measures potentially affecting trade in these services, and presents

and analyses available information on regulation in OECD countries. Section V provides statistical and

econometric estimates on the impact of regulations on trade and investment flows. The last section

concludes discussing the implications of the study for the development of the STRI for construction

services. Questions for further discussion are included at the end.

II. Characteristics of construction services

4. Construction services have historically played an important role in the functioning of economies,

providing the infrastructure for other industries. The industry has typically been considered as strategic in

light of its close links to public works and hence the implementation of fiscal policy. Increased spending

on infrastructure and non-residential development is probably the most important driving force for

construction activity in OECD countries (Butkeviciene, 2005). On the supply side, demographic changes

have recently been significantly affecting the industry. In particular, the aging population in OECD

countries represents a challenge for the sector, leading to increasing shortages of labour (KPMG, 2008).

5. The construction sector accounts for a considerable share of OECD economies and employment.

Table 2 indicates that the sector contributes between approximately 4 and 6% of GDP in some of the

largest OECD countries and between 6 and 9% of employment. The share of GDP has generally been

declining in the five OECD countries over the last two decades. This trend is consistent with work by

industry specialists which suggests that construction’s share of GDP first grows at an increasing rate and

then decreases with the level of economic development (Bon and Crosthwaite, 2000).

Table 2. Economic importance of construction services in selected OECD countries

1980 2005 1980 2005 1980 2005 1980 2005 1980 2005

Share of total value added

Construction 7.4% 3.9% 7.7% 5.8% 9.4% 6.2% 6.4% 4.6% 5.1% 5.1%

Manufacturing 29.7% 22.5% 24.7% 13.0% 28.2% 20.8% 24.5% 19.7% 23.7% 13.8%

Share of total employment

Construction 8.6% 5.6% 8.9% 6.4% 9.9% 8.8% 6.6% 5.5% 5.8% 6.1%

Manufacturing 30.6% 19.3% 22.9% 13.3% 23.3% 17.2% 23.8% 16.5% 19.6% 10.6%

Table 2. Economic importance of construction services in selected OECD countries

DEU FRA JPN SWE USA

Source: EU KLEMS database.

6. Construction generates significant economic activity in OECD countries through linkages with

other industries. Recent linkage analysis using OECD input-output tables shows that construction has one

of the highest backward linkages among all sectors in selected OECD economies, reflecting its importance

as a demander of inputs from other industries (Pietroforte and Gregory, 2003). Another trend shown in the

study is the transformation of construction technologies, with a decreasing share of manufacturing inputs

and growing services inputs. This could partly result from the increasing complexity of construction

processes, with modern construction firms outsourcing a growing number of knowledge-based services.

7. Construction services are a relatively labour-intensive sector (both skilled and un-skilled), which

is reflected in a higher share in employment than in GDP for all five countries shown in Table 2. In light

of the nature of construction activities, the potential for mechanisation and automation, and therefore

capital-intensive production, remains limited. The local characteristics of the construction product (see

below), and its high labour and material intensity, are also among the factors explaining why the industry

7

remains mainly oriented towards domestic markets (European Foundation for the Improvement of Living

and Working Conditions, 2005).

8. The sector is characterised by a large number of small firms generally specialising in certain

fields or operating in small geographic areas. According to the European Construction Industry Federation

(FIEC), for example, out of a total 2.9 million EU construction companies in 2007, 95% were SMEs with

fewer than 20 employees (FIEC, 2008). In value terms, companies with fewer than 50 employees

undertake around 60% of European construction work.2 Industry sources indicate a recent trend towards

consolidation and the creation of larger firms, providing the whole array of construction-relates activities.

Furthermore, the international market for these services remains mostly dominated by a few large

contractors and typically relates to large-scale projects (see Annex I).

9. For the most part, the nature of the construction business requires local production; it is the

production process that is exported, the final output must be totally constructed in the host country

(exceptions include off-shore oil platforms and some types of thermal plants). Establishment abroad is

therefore generally necessary to conduct trade in these services. The manner in which construction firms

enter a foreign market varies from the duration of a particular project to a more permanent presence in

overseas markets. Recent literature has attempted to shed light on evolving patterns of permanent versus

short-term commercial presence.

10. According to Chen (2008), from the 1990s there has been a tendency of market establishments

aiming at a more permanent presence in new markets and both entry strategies are now widely used. One

important difference between permanent and short-term entry is that in the former entrants tend to source

staff locally, while in short-term entry more expatriates are sent overseas. Hence, the significance of mode

4 may vary depending on the entry strategy used. Short versus long-term entry can also be differentiated

by whether an entrant has ownership in a permanent organisation (e.g. a joint venture company or a branch

office). The study finds empirical evidence indicating that when the host market entails high entry

restrictions, contractors are more likely to use short-term than permanent entry.

11. Construction services trade is affected by a variety of regulations, including building and product

standards, restrictions on establishment and on the movement of personnel (see Section IV). A prominent

source of market failure associated with their provision relates to externalities. Inappropriate performance

of contracts between sellers and buyers of these services can give rise to negative externalities to third

parties and society in general, e.g. the pollution of a river or of an open public space resulting from the

construction process. Asymmetric information represents a further potential concern. Purchasers of

construction services may roughly know what they aim to accomplish, but they have to rely on the

knowledge and experience of the builder to specify exactly what needs to be done (Myers, 2008).

12. Government procurement is an important driver of demand for the sector, representing a

considerable share of construction activity in OECD countries. In 2005, for example, it accounted for

around 35% in Germany and the UK and for almost 50% in the US3. Procurement practices can thus have

a significant impact on trade in construction services. Public-private partnerships (PPPs), such as

concessions and build-operate-transfer contracts, have also emerged to facilitate private participation in

infrastructure and service development and release pressure on governments’ budgets (see Box 1). PPPs

2 Figure reported by the EC DG Enterprise & Industry Construction Unit.

3 Government share of construction investment calculated from the EU KLEMS database. It refers to investment

in the public administration, defence, compulsory social security, education, and health sectors in non-

residential construction. For the latter two sectors the figures may include some private investment. The gross

fixed capital formation figures also include purchases of "second-hand” assets, which may have been built prior

to their acquisition.

8

differ from traditional procurement by linking private sector returns to long-term service provision and

maintenance of projects in contrast to traditional asset delivery (PriceWaterhouseCoopers, 2005).

Box 1. Driving forces and prominent obstacles to trade in construction services: private sector perspective

Skanska AB

Skanska AB ranked 3

rd among the Top International Contractors 2008 by the

Engineering News Record, with 75% of revenue coming from international sales. It builds a diverse array of structures with emphasis on the commercial

and infrastructure segments (see Figure 1), and is active in 13 markets in Europe, the US, and Latin America. The majority of its construction output is generated from European operations, but the US represents the largest single market by revenue share (see Figure 2). The firm’s focus is on long-term presence in the form of subsidiaries, since local knowledge and experience are viewed as important in facing heterogeneity of regulations across markets. Skanska reports that 39% of construction revenue comes from public clients. PPPs are also becoming a stronger component of operations, with the majority of project volume occurring in the UK, but increasing across Europe and in North America. The estimated value of PPP projects grew by almost 50% between 2006 and 2007, and Skanska foresees steady expansion in its Infrastructure Development segment.

Increased infrastructure investment is a prominent driver of demand for construction services, particularly in Europe. Skanska identifies diverse building codes and limitations on legal structure as key obstacles to international operations, including by limiting the transfer of technology and know-how across markets. Regulatory transparency was also noted as a critical factor in light of the importance of public procurement and related measures in the sector. Restrictions on the movement of persons represent an additional constraint, particularly in light of skilled labour shortages in the industry. Notably, the absence of these barriers within the EU, which allows for the free movement of capital and labour, is reported as a facilitating factor. Strabag SE

Strabag SE is one of the leading international contractors ranking 4

th on the

Engineering News Record Top International Contractor 2008 list, with 80% of output from international operations. Most of it (94%) is generated in Europe (see Figure 3) and a significant share is derived from transport infrastructure (see Figure 4). In addition, approximately 50% of output comes from public funding and this share may increase with growing utilisation of PPPs. Strabag currently has 19 PPPs across the world, representing a combined project volume of €6.5 billion, up from €4.3 billion in 2006. The firm’s market entry strategy tends to favour strategic mergers and acquisitions, which are reported to facilitate company operations by providing local knowledge, experience and materials.

Headquarters Stockholm

Employees 60,000

Revenue 2007 $18.5 billion

Headquarters Vienna

Employees 61,125

Output 2007 $15.8 billion

Commercial 57%

Civil, 35%

Residential, 4%

Other Services, 4%

Figure 1. Construction by segment

15%13%

32%

37%

3%

SWE Other Nordic Countries

Other European Countries

USA Latin America

Figure 2. Output by geographic location

9

Strabag’s success has been in part driven by strategic positioning in markets with growing infrastructure demand. This has been particularly the case in Eastern Europe, with the opportunities created by the EU Cohesion Fund, which is expected to total €177 billion by 2013. The firm’s international operations are influenced by several factors including physical distance and regulatory measures. Shortage of skilled labour and constraints on access to raw materials are highlighted as primary concerns; these are among the reasons leading to growing M&A activity and the development of a new training programme for staff members. Strabag highlighted lack of transparency in licensing and procurement procedures, as well as red tape and administrative bureaucracy as additional bottlenecks.

Source: Information contained in the companies’ websites and annual reports, complemented by information provided by the companies through semi-structured interviews.

13. According to Transparency International (2003), corruption in the construction sector is higher

than in any other sector of the economy. The industry is particularly prone to corruption due to the large

size of infrastructure projects allowing contractors to hide bribes and inflated claims. The uniqueness and

complexity of many projects, involving a range of participants in an elaborated contractual structure,

provide further opportunities for bribes at different stages of a project. These difficulties are compounded

by the fact that construction brings together a wide range of different stakeholders, and there is often no

single organisation overseeing the industry (Stansbury, 2005).

III. Trade patterns

14. The analysis is based on the OECD database on bilateral services trade flows and on Foreign

Affiliates Trade in Services (FATS) statistics recorded in the OECD Globalisation Indicators database.

The OECD services trade database includes trade flows as defined in EBOPS. Construction services

represent one exception in EBOPS in that the predominant mode of supply covered is mode 3 (and partly

mode 4), rather than mode 1.4 This results from the nature of the construction business discussed in the

previous section, which often entails a short-term presence for the duration of a specific project.

Technically, project work lasting up to one year is covered in the database (beyond that it becomes a

resident establishment so it is no longer captured in BOP statistics).

15. FATS statistics are regarded as the closest proxy for mode 3 and capture trade through

construction establishments continuing for over one year. FATS data are however more limited than cross-

border trade data. All OECD countries except Mexico and Switzerland report trade data on construction

services (EBOPS 249); only about 20 members report FATS statistics on these services (ISIC 45) and the

quality of the data is poorer, with only very few countries reporting a relatively long time series.

4 For a recent discussion on the coverage of services trade statistics in available datasets, see Miroudot and Lanz,

2008.

35%

20%

31%

8%6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

DEU AUT Central and Eastern Europe

Western Europe RoW

Figure 3. Revenue by geographic area

Tunneling services

6%

Transportation infrastructure

43%

Building construction

and engineering

services50%

Other

1%

Figure 4. Output by segment

10

The OECD services trade database

16. Figure 5 presents total exports and imports of construction services for OECD countries for

which data are available. The pattern of trade over time through short-term commercial presence appears

in line with the cyclical nature of the construction industry. The dip in 2000-2001 probably reflects the

economic slowdown during that period, which significantly hit some large OECD economies. Although an

important sector in most economies, construction services account for a small share of total services trade,

representing about 1.8% of OECD services exports and 1.4% of services imports in 2005. This supports

the finding in the previous section that the construction sector generally remains a local activity.

10000

15000

20000

25000

30000

35000

40000

Figure 5. OECD trade in construction services via short-term presence (USD millions)

Imports Exports

Note: OECD countries for which data are available. Source: OECD TiSP database.

17. Bearing in mind the country coverage of the data, figures 6 and 7 below indicate that the largest

OECD exporters and importers of construction services via short-term commercial establishment are

Germany and Japan. Construction services trade accounts for a significantly larger share of total services

trade than the OECD average in these two leading markets. In 2005, exports of construction services

represented roughly 5% and 6.5% of total services exports in Germany and Japan, respectively;

construction services imports accounted for about 3.2% of total services imports in Germany and over

3.5% in Japan in the same year. Surprisingly, the US does not have a prominent position, perhaps due to

the type of entry strategy covered by the data.

11

0

1000

2000

3000

4000

5000

6000

7000

8000Figure 6. OECD construction services exporters via short-term presence, 2003-2005 (USD millions)

Note: Latest year available between 2003 and 2005. Source: OECD TiSP database.

0

1000

2000

3000

4000

5000

6000

7000

Figure 7. OECD construction services importers via short-term presence, 2003-2005 (USD millions)

Note: Latest year available between 2003 and 2005. Source: OECD TiSP database.

12

OECD FATS statistics

18. Figures 8 and 9 present outward and inward sales of foreign affiliates in the construction sector

for the years 2003-2005. Keeping in mind the limited country coverage of the data, the two countries that

dominate exports through long-term establishment are Germany and the US, while imports are highest in

the US and UK. Inward sales in the US are more than twice larger than outward sales; as in the case of

trade via short-term presence, on the other hand, Germany and Japan are net exporters of construction

services through long-term commercial presence. FATS in the construction sector also represent a small

share of total FATS in the leading markets, at about 2% of Germany and the US outward and inward sales.

19. Comparing trade patterns through short versus long-term commercial presence, there is some

evidence that the latter is the preferred entry strategy of construction contractors in the OECD economies

covered in the analysis. This is particularly apparent for the US and Germany, especially in the case of

outward sales. However, there are exceptions and most notably Japan where trade through short-term

establishment appears to be considerably higher.

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

Figure 8. Outward FATS of construction services, 2003-2005 (USD millions)

Note: Latest year available between 2003 and 2005. Source: OECD Globalisation Indicators database.

13

0

5000

10000

15000

20000

25000

30000

35000

40000

Figure 9. Inward FATS of construction services, 2003-2005 (USD millions)

Note: Latest year available between 2003 and 2005. Source: OECD Globalisation Indicators database.

IV. Regulation of construction services

Main types of regulatory measures

20. The construction sector is subject to a wide range of regulatory measures. As seen earlier,

construction services are primarily supplied through the establishment of service suppliers abroad. Most of

the restrictions thus have a particularly strong impact on trade through commercial presence, be this on

entry of firms or their on-going operations. Some measures represent outright discrimination, while others

although non-discriminatory, are generally viewed to weigh more heavily on the ability of foreign firms to

compete for a national market. In addition to restrictions specific to construction services, several

measures applicable to all sectors of the economy are also relevant for the construction industry.

Health, safety, environmental and land planning

21. A first set of construction regulations relates to measures aimed at ensuring the safety of the

objects constructed, implementing urban and land use planning and preserving the environment

(Butkeviciene, 2005). The construction sector is characterised by the importance of building regulations

and technical requirements to meet these objectives. As construction companies depend on bringing their

capital equipment and materials to the project site, measures affecting the mobility of construction products

are also relevant to the sector. In addition, regulations often mandate regular inspections of plants and

machineries for conformity with technical specifications and standards.

22. Contractors and proprietors typically have to comply with multiple authorisation requirements

and procedures prior to service provision or pre-qualification requirements, such as past experience of

working in the country. Guarantee and liability insurance related to construction work also need to be

taken into account. Restrictions on land and real estate use or ownership are normally applied to all

14

sectors, but typically have direct bearing on the provision of construction services. For example, property

developers may not be able to own real estate under construction until completion of the project.

23. These regulations are generally applied on a non-discriminatory basis but may prevent foreign

construction companies from penetrating the domestic market; some technical standards or restrictions on

land ownership may also specifically target foreign providers. From a trade perspective, the main question

surrounding these measures relates to whether they are more burdensome than necessary to achieve their

objectives. The fundamental impediment here arises from the heterogeneity of standards, processes and

procedures faced by construction firms in different export markets.

Commercial presence and the movement of people

24. Another set of measures explicitly restricts trade through modes 3 and 4 (WTO, 1998). Foreign

ownership or equity measures (e.g. if only minority ownership is allowed for foreign providers) are often

not sector specific but may apply to construction services as part of the general investment legislation.

Quantitative restrictions can also be relevant for the construction sector and so are economic needs tests,

which include a wide range of criteria for allowing foreign provision from the perspective of how the local

community would benefit (e.g. when resources are not available domestically). Foreign contractors may

further be required to source personnel and products locally.

25. Other measures affecting commercial presence are restrictions on the types of legal entity

allowed. These can for example take the form of local incorporation requirements or prohibitions to

establish branches. Joint venture requirements can help foreign contractors overcome a number of

regulatory hurdles since local firms are accustomed to work in the domestic environment; but requirements

to do so can create a burden on foreign construction firms’ ability to make their decisions based on market

conditions. Similar issues arise with respect to regulations mandating foreign construction contractors to

use local agents.

26. Given its intensive use of labour and the recent industry trend of labour scarcity, construction can

be significantly affected by limitations on the movement of natural persons. Short-term presence, in

particular, requires frequent visits by managerial and professional staff, as well as longer stay for those

implementing the physical construction. The movement of foreign nationals may be subject to quotas,

nationality, residency or other staffing requirements, even for project-related work of short duration. Other

restrictions relate to labour market tests, which are sometimes referred to as economic needs tests, though

they focus on the likely impact of foreign providers on the local labour force.

27. Since the provision of construction services requires the movement of qualified personnel, non-

recognition of their qualifications emerges as another prominent constraint. Horizontal immigration and

labour legislation are also relevant for the construction industry. Visas and entry permits, as well as related

administrative procedures can affect the movement of natural persons at all skill levels. Regulations

extending minimum wages, rules on working hours of foreign workers employed temporarily at

construction sites, and requirements on foreigners to participate in social security systems can reduce the

cost advantage of foreign providers.

Government procurement and subsidies

28. In light of the importance of public procurement for construction services (see Section II),

regulations adopted in this area can significantly affect trade in the sector. The main restrictions relate to

discrimination towards foreign providers, inadequate procurement procedures (e.g. with respect to criteria

for awarding contracts and procedures for opening tenders) and lack of transparency throughout the

procurement process (from publication of conditions for suppliers’ qualifications to information on

15

contract award). Providing the opportunity for suppliers to challenge the due process of procurement

conduct is another important element. Many of these issues are also relevant for different kinds of PPPs.

29. Subsidies and tax incentives granted only to local providers of construction and related services

can further have a bearing on the international provision of these services. Such incentives are provided in

many countries to promote construction work or to encourage the development of the national industry.

Regulation in OECD countries

The OECD Product Market Regulation (PMR) indicators

30. The OECD Economics Department (ECO) PMR database represents an important source of

information on regulation in the services sector. It is compiled using information from official government

responses to the OECD Regulatory Indicators Questionnaire, which covers economy-wide as well as

sector-specific indicators (as defined in ISIC Rev. 3). The indicators are calculated using a methodology

which involves several steps (see Conway and Nicoletti, 2006). The country answer to each question is

coded and ordered in a scale ranging from 0 to 6, with lower scores corresponding to more liberal regimes.

Scores on individual regulatory items are aggregated into low-level indicators, mid-level indicators and

broader aggregates.5

31. Trade in construction services can be affected by generic regulation (see Section V below). In

addition, although construction is not covered as a separate sector, a number of specific questions for the

sector have been included in the indicators of economy-wide regulation. This is particularly the case in the

latest version of the questionnaire to be released towards the end of the year. The questionnaire is

structured around three main sections: 1) general policies; 2) regulatory and administrative policies; and 3)

administrative requirements for business start-ups. The questions on regulation relating specifically to

construction are contained in the first two parts, particularly under firm ownership, control and legal status,

and treatment of foreign parties (see Table 3).

5 Through 2003, the PMR was aggregated using principal component analysis; for the recent update equal

weights have been used instead.

16

Table 3. OECD questionnaire for construction services

Q 1.1.3 Q 2.2.3

If so: a) Q 2.2.4

Q 1.1.4

a)

b)

Q 1.1.5Q 2.2.7

a)

If so: b) Q 2.2.7

b)

Q 1.1.6

Q 1.1.7

Table 3. OECD questionnaire for construction services

1.1 Firm ownership, control and legal status 2.2 The treatment of foreign parties

Are potential new entrants permitted to freely enter

at least some markets in the construction sector?

Is the number of foreign firms in the construction

sector permitted to practice restricted by quotas,

economic needs tests or labour market tests?

Has your country engaged in Mutual Recognition

Agreements (MRAs) in the construction sector with

any other country?

Do national, state or provincial governments control

at least one firm in the construction sector?

What is the number of publicly-controlled firms in the

construction sector?

any legal or constitutional constraints to the sale of

the stakes held by government in these firms?

Is the number of foreign professionals permitted to

practice in the construction sector restricted by

quotas, economic needs tests or labour market

tests?

Do national, state or provincial governments have

special voting rights (e.g. golden shares) in any

construction firm?

when can these special rights be exercised? i)

merger with or acquisition by another company; ii)

change in controlling coalition; iii) acquisition of

equity by foreign investors; iv) choice of

management; v) strategic management decisions.

Are foreign suppliers in the construction sector

subject to: i) residency requirements; ii) differential

tax treatment and/or differential eligibility to

government subsidies as compared to domestic

suppliers; iii) other regulations which do not

recognise national treatment principles; iv) different

provisions concerning participation in public

procurement.

Q 2.2.5

Q 2.2.7

c)

any statutory or other legal limits to the number or

proportion of shares that can be acquired by foreign

investors in them?

Are there laws or regulations restricting, in at least

some markets, the number of competitors allowed to

operate a business in the construction sector?

Are there any specific provisions that require

regulators to recognise the equivalence of regulatory

measures in construction services in other

countries?

Are there any specific provisions that require

regulators to use internationally harmonised

standards and certification procedures in

construction services wherever possible and

appropriate?

If national, state or provincial governments control

any firm(s) in the construction sector are there:

The OECD FDI Regulatory Restrictiveness Index (FDI RRI)

32. The Directorate for Financial and Enterprise Affairs (DAFFE), in cooperation with ECO, has

developed indexes of FDI restrictiveness for OECD countries (Golub, 2003; and Koyama and Golub,

2006). The analysis includes construction services and is largely based on the OECD Code of

Liberalisation of Capital Movements. The methodology used for creating the indexes is a variant of the

one employed by Hardin and Holmes (1997). Restrictiveness is measured on a 0 to 1 scale, with the

former representing full openness and the latter a prohibition of FDI. Ownership restrictions (foreign

equity limits) receive a substantial weight in light of their perceived importance. The following FDI

regulatory measures are included in the restrictiveness indicators:

Foreign Direct Equity Investment Limits (from 0 to 99%).

Screening and Approval (subject to proving economic benefits, approval unless contrary to

national interest or notification).

Restrictions on Board of Directors/Managers (nationality, residency or licensing requirements).

17

Restrictions on the Movement of People (from no entry to three to four years).

Input and Operational Restrictions (domestic content of more than 50% or other).

33. Regulatory data on specific FDI measures are not publicly available. Nonetheless, composite

indicators for construction services are included in Golub (2003) for the period 1998/2000 and in Koyama

and Golub (2006) for 2005/2006. Figure 10 shows that the OECD countries with the highest levels of

regulatory restrictiveness in construction are Iceland, Mexico, Turkey, Canada, Australia and Austria.

Significant progress has been made in easing restrictions in some countries during the period covered by

the two studies; as pointed out by the authors, though, care must be exercised in comparing results from the

two years as they may be related to changes in information sources. In general, construction is one of the

least restricted services sectors, consistently below a simple average of all the other services sectors.

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

Figure 10. OECD FDI Regulatory Restrictiveness Index for construction services

1998/2000 2005/2006

Source: Golub, 2003; and Koyama and Golub, 2006.

The World Bank Doing Business

34. The Doing Business report, released annually by the World Bank, ranks countries according to

the ease of operating a business within the economy. Several topics are covered throughout the process

from starting to closing a business, including employing workers, registering property, paying taxes and

protecting investors. The index ranges between 1 and 181, with first place being the most business

friendly. It is calculated for each economy as the ranking of the simple average of the topics covered and

of the components for each topic.

35. One of the topics deals specifically with construction permits, by recording all procedures

required for an entrepreneur in the construction sector to build a warehouse. These components include

submitting project documents (e.g. building plans) to the authorities, obtaining all necessary licenses and

permits and receiving all necessary inspections. Procedures for obtaining utility connections (e.g.

18

electricity and telephone) are also covered. The cost and time to complete each procedure are calculated,

including all official fees associated with legally completing the procedures. The time is recorded in

calendar days and the costs are estimated as a share of GDP per capita.

36. Figures 11 and 12 below present the time and costs involved in obtaining construction permits in

OECD countries, indicating that these vary substantially. The OECD average required length of time is

161 days, but ranges from 328 days in Portugal to 34 days in Korea. Similarly, the average OECD costs

amount to 57% of GDP per capita, but the share is over twice as much for Korea, Italy and Finland, and

considerably lower for Hungary and the US.

0

50

100

150

200

250

300

350

Days

Figure 11. Time for construction permits in OECD countries, 2008

Source: World Bank Doing Business.

19

0

20

40

60

80

100

120

140

160

180

Sh

are

pf G

DP

per cap

ita

Figure 12. Cost of construction permits in OECD countries, 2008

Source: World Bank Doing Business.

The WTO Trade Policy Reviews (TPRs)

37. The TPRs contain detailed information on actual regulation in a wide range of services sectors

well beyond OECD membership and over time. The information collected during the reviews is coupled

with data from other sources such as international organisations and academic research papers and its

factual accuracy has been checked by the country under review. However, the construction sector is not

thoroughly covered in OECD countries, with only the TPRs of Japan (1998), Korea (1996) and

Switzerland (1996) presenting specific information on construction services (see Box 2). Other

information can be found in the horizontal part of the reports for specific measures (e.g. government

procurement), at times with explicit reference to construction.

Box 2. Construction services in the TPRs of selected OECD countries

Japan’s main requirement governing access to the construction market relates to obtaining permission from either the

Ministry of Construction or prefectural government, which entails mandatory commercial presence in the form of a branch or local subsidiary. Construction firms subcontracting above a certain threshold have to apply for a separate permit. Construction companies are also required to have: 1) a sound financial base; 2) at least one of the board members with five years experience in the relevant type of construction business; 3) at least one employee with a certain educational background at each branch or local subsidiary; and 4) employment of a certain type of engineer in each office. Far-reaching mode 4 regulations stemming from the Immigration Control and Refugee Recognition Law apply to construction-related labour. In particular, different categories of construction work require entry permits granted on the basis of detailed criteria. In Korea, possession of a license for general construction work is required to access the market, for which a

commercial presence in the form of a branch or local subsidiary is mandatory. General construction companies are also submitted to a compulsory subcontracting system, requiring them to subcontract at least 30% of the contract value to special construction companies. Construction entities have to further comply with minimum capital requirements and employ at least four domestically qualified engineers. A variety of Switzerland’s construction activities require permits or authorisations. For example, for electrical work

authorisation is given to companies having among their staff a qualified member of the profession (one “personne de

20

métier” per 20 workers); or to persons having diplomas recognised by the competent authorities and two years of professional experience. Property purchases by non-residents is restricted, posing difficulties for foreign property developers as it is common practice to own apartments under construction until completion. In general, approval procedures for infrastructure projects (e.g. roads), where environmental and general land use considerations play a role, are seen as lengthy. National construction standards set by the Swiss Society of Engineers and Architects are also described as strict and costly. Detailed labour market regulations further apply to the construction sector, where about two-thirds of all Swiss employees are foreigners. There is a global quota of permits distributed to cantons with allocation by firms made on a historical basis. Foreign construction companies have to obtain a temporary permit for each “imported” worker, generally only valid in sites for which they have been delivered. In some cantons, prior to delivery of permits, established firms are submitted to consultations by tripartite commissions comprising employers, workers and government representatives.

Note: The regulations may have been changed since the time of the reviews. Source: WTO, 1998b; WTO, 1996a; and WTO, 1996b.

WTO commitments

38. WTO commitments resulting from the Uruguay Round provide an additional source of

information on regulation in construction services by country. The shortcomings of this information are

widely acknowledged. The documents are now quite old and in any event they may have not reflected the

regulatory stance of a country even back in 1994 when they were largely compiled. This is because

countries may choose to bind at less than the status quo to allow for regulatory flexibility. In addition, care

must be taken in comparing schedules for analytical purposes. Lack of restrictions in a particular sector

may reflect no commitments in that sector or a related subsector, rather than a liberal regime.

39. Nevertheless, it seems useful to review this information by way of background to get a sense of

what member countries have bound in the area of construction services. The analysis includes regulations

which are mostly considered as domestic regulatory measures under the GATS and do not generally need

to be scheduled (e.g. licensing and qualification requirements). Similarly, the review covers procurement

measures although they are currently outside the scope of the agreement. Some countries have included

these regulations in their schedules either for transparency purposes or in the additional commitments

column (relating to GATS Article 18).

40. Table 4 shows that, although members are not always required to schedule them, licensing and

qualification requirements are quite common in the construction sector. Licensing and registration

requirements include liability insurance, exclusive rights to perform certain activities (e.g. maintenance and

management of highways) and membership in a professional body. Residency requirements are also often

scheduled, indicating that countries have preferred to maintain flexibility to use these measures. Similarly,

FDI restrictions, controls on land and real estate and labour market tests for natural persons are not

infrequent and are generally scheduled as horizontal limitations. For the construction of the STRI, this

underlines the need to consider services regulations in a holistic manner.

21

Table 4. Measures contained in OECD countries’ GATS schedules

AU

S

AU

T

BE

L

CA

N

CZ

E

DN

K

FIN

FR

A

DE

U

GR

C

HU

N

ISL

IRL

ITA

JP

N

KO

R

LU

X

ME

X

NLD

NZ

L

NO

R

PO

L

PR

T

SV

K

ES

P

SW

E

CH

E

TU

R

GB

R

US

A

Construction (UN Provisional CPC 512-518)

FDI/ownership restrictions H H H X H H H H

Restrictions on legal entity HX √ H X H H

Nationality requirements H X H H

Residency requirements H H H√ H H HX H H H X

Quotas/economic needs tests X H H X

Labour market tests H H H H H

Qualification requirements X X X X X X X

Licensing/permits and registration requirements √ X X X X X X

Controls on land use/real estate H H H √ H H H H H H H H √

Discriminatory procurement √ X

Discriminatory subsidies and taxes H X H H H

Table 4. Measures contained in OECD countries' GATS schedules

Note: X indicates that a sectoral measure exists; √ a sectoral measure is applied only in some states or provinces within a country with a federal system; H a horizontal measure exists. Source: OECD based on GATS schedules.

22

The WTO Government Procurement Agreement (GPA)

41. Most OECD countries have adopted disciplines on procurement regulations as parties to the

WTO GPA. The agreement prohibits the use of measures discriminating against foreign providers and

addresses various aspects of procurement procedures. This includes criteria for the qualification of

suppliers and technical specifications of products and services; and the whole array of tendering

procedures, from invitations to participate in a given procurement to opening of tenders and award of

contracts. There are also provisions for transparency at all stages of the procurement process and

concerning the opportunity of aggrieved private bidders to challenge procurement decisions and obtain

redress. Yet, divergence in procurement and related measures among OECD countries could result from

the following:

Australia, Mexico, New Zealand and Turkey are not parties to the agreement (though Australia,

New Zealand and Turkey are observers).

The disciplines apply only above a certain threshold, which for construction is generally set at 5

million SDRs (currently around USD 8 millions).

While all procurement of goods is covered, for services and construction services only those

specified in positive lists are covered. All OECD countries cover construction services (UN

Provisional CPC 511-518).6 However, in varying degrees infrastructure services such as

transport and energy are excluded in many OECD countries.

Positive listing also applies to entities and not all GPA parties cover sub-central entities. Most

OECD countries have also committed on the basis of reciprocity considerations.

PPPs’ practices have similarities with traditional procurement measures, but may be outside the

scope of the agreement.

Regional Trade Agreements (RTAs)

42. Regional preferences represent an increasingly important feature of trade in the construction

sector. Several regulatory spheres relevant to construction services are addressed in the growing number of

RTAs featuring disciplines on trade and investment in services (see Table 5 below). In the area of mode 3,

discriminatory establishment measures have been prohibited in several groupings, including local content

and nationality requirements. Quantitative restrictions and labour market tests for some, generally highly-

skilled categories of service providers have also been removed. Although visa requirements remain largely

in place, rules limiting related processing fees have been adopted.

43. The approach taken with respect to qualification and licensing requirements is broadly similar

across RTAs. Members should ensure that such measures do not constitute unnecessary barriers to trade

(e.g. they are objective and transparent), and mutual recognition agreements by the accredited professions

are to be encouraged. NAFTA and agreements modelled on it (e.g. the Australia-US FTA) have eliminated

citizenship and permanent residency requirements for the licensing and certification of professionals. The

EU, as part of its process of deep integration, has adopted a system of mutual recognition of professional

qualifications and is harmonising standards for buildings and construction products.

6 The only exception is Korea which excludes renting services related to equipment for construction or demolition

of buildings or civil engineering works (518).

23

44. Procurement provisions in the RTAs reviewed share many common elements with those

contained in the WTO GPA, prohibiting discriminatory treatment and requiring the establishment of

objective and transparent procurement procedures. The thresholds are also broadly similar, in the range of

USD 6-8 millions. The only significant variation across RTAs relates to the coverage of procuring entities;

the EU and the Australia-New Zealand Government Procurement Agreement (ANZGPA) generally cover

all entities, while the other agreements adopt a positive list approach whereby only listed entities are

covered. Regional progress on limiting subsidies for services in general remains limited.

24

EU NAFTA ANZCERTA Australia-US Japan-Mexico EU-Mexico

Mode

3/investment

The EC Treaty prohibits

restrictions on the freedom of

establishment and on the free

movement of capital.

Prohibits discriminatory

investment measures and

commits parties to make

transparent and to best

endeavour to dismantle (non-

discriminatory) quantitative

restrictions. Parties also agree

not to impose performance

requirements (e.g. local content)

and limit scope for nationality

requirements for senior

management and board of

directors.

Prohibits discriminatory

establishment measures and (non-

discriminatory) quantitative

restrictions. Parties also

exchange the right to select their

preferred form of commercial

presence.

Prohibits discriminatory

investment measures and

commits parties to make

transparent and to best

endeavour to dismantle (non-

discriminatory) quantitative

restrictions. Parties also agree

not to impose performance

requirements (e.g. local content)

and limit scope for nationality

requirements for senior

management and board of

directors.

Prohibits discriminatory

investment measures and

commits parties to make

transparent and to best

endeavour to dismantle (non-

discriminatory) quantitative

restrictions. Parties also agree

not to impose performance

requirements (e.g. local content)

and limit scope for nationality

requirements for senior

management and board of

directors.

Prohibits discriminatory

establishment measures and

pursues a GATS-like positive list

approach for (non-discriminatory)

quantitative restrictions.

Labour

mobility

Provides for the broad right to

labour mobility: EU citizens can

move and reside freely within the

territory of members. Treaty

provisions also apply to

movement of workers, including

through access to employment in

other members, right to work as a

self-employed person and the

freedom to provide services under

the same conditions of nationals.

No visas or work permits are

required.

Access is limited to temporary

entry and to four higher-skilled

categories: traders and investors,

intra-company transferees,

business visitors and

professionals. Labour

certification/market tests are

removed for all four groups and

work permits have been lifted for

business visitors. Visas are still

required but there are rules on

limiting processing fees.

Does not cover explicitly labour

mobility but the agreement covers

all service suppliers, without

distinguishing between different

modes of delivery. In addition,

under the Trans-Tasman

Arrangement (although not part of

ANZCERTA) citizens are free to

live and work in each other's

countries for an indefinite period.

No specific disciplines. Access is limited to temporary

entry and to four higher-skilled

categories: business visitors, intra-

company transferees, investors

and professionals. Approval

procedures and quantitative

restrictions are removed for all

four groups. Visas may still be

required but processing fees have

to take into consideration the

administrative costs involved.

The presence of natural persons

is explicitly mentioned as one of

the modes of service delivery, so

disciplines on services are

extended to mode 4. The

Agreement is not intended to

cover movement beyond service

suppliers under the GATS and

excludes access to the labour

market.

Qualification,

licensing and

standards

Members have adopted a system

of recognition whereby they

recognise the comparability of

higher education diplomas for

granting authorisation for exercise

a regulated profession. Under the

Construction Products Directive,

members are also implementing

harmonised technical standards

for construction products. In

addition, the EU is working

towards the implementation of

Euro codes, harmonised building

design codes which stipulate

structural safety and material

content. They will become

mandatory for all publicly

procured contracts in 2010.

Members are to ensure that

licensing and certification do not

constitute unnecessary barriers to

trade and agree to eliminate

citizenship and permanent

residency requirements. They are

also to encourage the accredited

professions to conclude

agreements on mutual recognition

of licensing and certification

requirements.

Members endeavour to ensure

that licensing and certification

measures are not discriminatory

and do not restrain market access

of persons. Each member is also

to encourage the recognition of

qualifications obtained in the other

member for the purpose of

licensing and certification

requirements.

Members are to ensure that

qualification requirements and

procedures, technical standards

and licensing requirements do not

constitute unnecessary barriers to

trade. They are also to encourage

the accredited professions to

conclude agreements on mutual

recognition of licensing and

certification requirements.

Additional transparency provisions

apply to regulations in general

(e.g. on advance notice and

opportunity to comment by

interested parties).

Members are to ensure that

licensing, certification or technical

standards of service suppliers do

not constitute unnecessary

barriers to trade.

Parties undertake that, in principle

no later than three years following

the entry into force of this

decision, the Joint Council is to

establish the necessary steps for

the negotiation of agreements

providing for the mutual

recognition of requirements,

qualifications, licensing and other

regulations.

Table 5. RTAs among OECD countries with provisions relevant to construction services

25

EU NAFTA ANZCERTA Australia-US Japan-Mexico EU-Mexico

Government

procurement

Public procurement of supplies,

works and services (including in

the water, energy, transport and

telecoms) is subject to rules

providing for non-discrimination

(whether or not of EU origin),

procurement procedures and

transparency. All entities at the

State, regional and local level are

covered.

Public procurement of goods and

services (including construction)

is subject to rules providing for

non-discrimination, procurement

procedures and transparency.

The agreement adopts a positive

list approach to covered entities

(though a negative list approach

to the coverage of services

procured by listed entities).

Under the ANZGPA, the parties

have adopted rules on non-

discrimination, transparency and

due process (through mutually

agreeable outcomes). With some

exceptions, the agreement covers

all goods, services and

construction activities, as well as

all contracting entities, unless

specifically exempted (negative

list).

Public procurement of goods and

services (including construction)

is subject to rules providing for

non-discrimination, procurement

procedures and transparency.

The agreement adopts a positive

list approach to covered entities

(though a negative list approach

to the coverage of services

procured by listed entities).

Public procurement of goods,

services and construction is

subject to rules on non-

discrimination, procurement

procedures and transparency. A

positive list approach is adopted

for both entities and services.

Public procurement of goods,

services and construction is

subject to rules on non-

discrimination, procurement

procedures and transparency

(Mexico adopts NAFTA's rules

and the GPA provisions are

applicable to the EU). A positive

list approach is adopted for both

entities and services and

thresholds correspond to those of

NAFTA for contracts awarded in

Mexico and to those of the GPA

for contracts awarded in the EU.

Subsides Prohibits members from granting

state aid that distorts competition

affecting trade flows.

No specific disciplines Prohibits members from

introducing new or expanding

existing export subsidies,

incentives and other assistance

measures having a direct

distorting effect on trade between

them. Members are also to work

towards the elimination of any

such measures by 30 June 1990.

No specific disciplines No specific disciplines No specific disciplines

26

V. The relationship between regulation and trade in construction services

45. This section applies statistical and econometric techniques in order to explore the linkages

between regulation and bilateral trade flows in the construction sector. The focus is on mode 3 (and partly

mode 4) which as seen earlier is the preferred mode of supply in these services and is sufficiently covered

by trade and investment data in the sector. The interest in this study is primarily on finding answers to the

following questions:

To what extent do particular types of regulation inhibit trade?

Do regulatory impacts differ across entry strategy (i.e. short-term versus more permanent entry)?

46. Two instruments are employed in the analysis: Spearman rank correlations between different

types of regulatory measures and trade and investment flows; and the gravity model, which explains

bilateral flows as a function of the market size of trading partners, the distance between them and other

geographical and institutional variables. The study focuses on the OECD PMR indicators as these are

among the few indexes of regulations for which comparable data are readily available for statistical

analysis. It is envisaged to expand the analysis to cover the FDI RRI and the World Bank Doing Business

index at a later stage.7

47. In estimating the now standard gravity equation derived by Anderson and Van Wincoop (2003)

with fixed effects, the PMR indicators could not be retained as they do not vary across partner countries

(see Annex II for the details on the methodology used in this study). To address this issue, this study

employs measures of the bilateral heterogeneity of these indicators.8 In an attempt to capture the potential

importance of regional preferences, an indicator is also constructed which is equal to one if the exporting

and importing countries both belong to one of the following: EU, NAFTA or ANZCERTA.

48. Data on short-term commercial presence are from the OECD TiSP database (see Section III).

Since FATS data on construction services on a cross-country basis are currently limited, stocks of foreign

direct investment estimated from the OECD FDI database are used as a proxy for more permanent

commercial presence. It is likely that capital stocks and sales volumes move together but this and broader

trade data limitations for the sector both in terms of scarcity and quality need to be borne in mind. GDP

data are from the World Bank World Development Indicators. Data for distance and other geographical

and historical variables are from CEPII.

The Spearman rank correlations

Table 6 below presents Spearman rank correlations between the PMR regulatory hierarchy and

imports (EBOPS 249) and inward FDI stocks (ISIC 45) of construction services. The correlations include

the aggregate PMR and the 20 types of measures in its five levels of disaggregation (see Annex III); and a

7 Initial work was conducted using the FDI RRI and the impact of restrictions resulted often insignificant and not

robust to different specifications. These results will require further work but they could be related to the nature

of measures contained in the FDI RRI, which fall short to include issues related to their implementation.

8 This indicator, developed by Kox and Lejour (2004 and 2005), is based on detailed comparisons between

individual country pairs for the PMR. These yield binary information per policy item (from a total of around

130 items) equal to one if two countries have a different policy in place and zero if otherwise. The scores per

country pair are averaged to generate an average policy heterogeneity indicator for each pair. The value of the

average indicator ranges between one in case of complete dissimilarity and zero in case of identical regulations.

27

construction-specific PMR indicator newly created by aggregating the measures contained in Table 3.9

Correlation analysis needs to be interpreted with caution since it does not imply causality and it is not

possible to conclude from the results that the indicators included in the table restrict trade. Nevertheless, it

can point to candidate measures for further investigation of whether they may have a negative impact. It

should also be noted that although the indicators included in Table 7 are statistically significant, they are

quite small, in absolute value generally below 0.3.

With this in mind, a result immediately apparent is that regulations seem to affect permanent

establishment considerably more than short-term presence. This finding is consistent with business

strategies by international construction contractors favouring short-term commercial presence when entry

restrictions are high in the host country (see Section II). Inward oriented policies relating to state control

and public ownership are negatively and significantly related to short-term presence; while outward

oriented policies under which barriers to trade and investment fall, as well as the construction specific

indicator do not have a negative impact. By contrast, inward, outward oriented and sector-specific

regulations are negatively associated with FDI in construction services.

Level Indicator EBOPS 249 ISIC 45

1 PMR x

2 PMR inward x

PMR outward x

3 State control x x

Barriers to entrepreneurship x

Barriers to trade and investment x

4 Public ownership x x

Government involvement in business operations x

Administrative burdens on start-ups x

Barriers to competition

Explicit barriers to trade and investment x

Other barriers x

5 Direct control of business enterprises x x

Size of public enterprise sector x

Scope of public enterprise sector x x

Communication and simplification of rules and procedures x

Use of command and control regulation x

Administrative burdens for corporations x

Administrative burdens for sole proprietor firms x

Discriminatory procedures x

Foreign ownership barriers x

Regulatory barriers x x

PMR construction x

Table 6. Regulatory measures negatively and significantly associated with commercial presence

(1998, 2003 and 2007)

Note: The latest year available for data on imports is 2006 and on inward FDI stocks is 2005.

9 The indicator is calculated as the simple average of the country answers to the questions for construction

services listed in the latest PMR questionnaire.

28

The regulatory heterogeneity indicator

49. Gravity estimates on the impact of regulatory heterogeneity on FDI stocks are shown in Table 7

below. The results suggest that for long-term investment decisions, having a common language is more

important than sharing a border. The estimations produced an insignificant effect of membership in an

RTA.10

The aggregate indicator of regulatory heterogeneity, measures relating to government involvement

in business operations, barriers to competition and explicit barriers to trade and investment have a negative

and statistically significant impact on FDI stocks. The model predicts that an increase in regulatory

heterogeneity from the 25th

percentile (HG_PMR = 0.35) to the 75th

percentile (HG_PMR = 0.43) would

reduce inward FDI by more than 27%.

50. Regulatory heterogeneity does not seem to be negatively correlated with trade through short-term

commercial presence. In estimates from the gravity model using different specifications, the regulatory

heterogeneity indicator does not have a statistically significant negative impact on trade via this entry

strategy.11

Since regulatory heterogeneity is explicitly mentioned by the private sector and industry experts

as a source of trade restriction, this result will require further investigation.

10

To check the robustness of the results, the regressions were estimated without fixed effects and in some cases

the RTA dummy is negative and significant. This result is puzzling and will require more research to

investigate the underlying reasons. One possibility is that the regional indicator currently used does not

adequately capture trade and FDI preferences between trading partners.

11 In OLS and Poisson pseudo maximum likelihood estimates, with and without fixed effects, the indicators of

regulatory heterogeneity at the aggregated and disaggregated levels are not significant.

29

Log distance -0.658*** -0.549*** -0.659*** -0.670*** -0.541*** -0.529*** -0.679*** -0.657*** -0.672*** -0.642***

(0.170) (0.155) (0.171) (0.171) (0.154) (0.153) (0.172) (0.169) (0.171) (0.171)

Contiguity 0.0620 0.198 0.0793 0.0578 0.203 0.213 0.0629 0.100 0.112 0.104

(0.355) (0.354) (0.356) (0.356) (0.352) (0.348) (0.358) (0.353) (0.358) (0.355)

Common language 0.843** 1.162*** 0.879** 0.822** 1.167*** 1.209*** 0.864** 0.844** 0.897** 0.924**

(0.393) (0.367) (0.394) (0.395) (0.367) (0.364) (0.395) (0.391) (0.395) (0.394)

Colony 0.161 0.0533 0.161 0.127 0.0630 0.198 0.103 0.196 0.114 0.140

(0.399) (0.388) (0.401) (0.400) (0.387) (0.387) (0.401) (0.398) (0.401) (0.400)

RTA -0.0356 -0.0288 0.0259 -0.00594 -0.0715 -0.0635 -0.00786 0.000901 0.0223 -0.0871

(0.387) (0.355) (0.388) (0.388) (0.351) (0.345) (0.391) (0.385) (0.388) (0.392)

HG_PMR -3.372**

(1.512)

HG_BE 0.382

(1.152)

HG_BT -1.266

(0.972)

HG_SC -1.927

(1.275)

HG_PO -0.436

(0.859)

HG_IBO -1.560**

(0.639)

HG_ABS -0.383

(0.553)

HG_BC -2.893***

(1.050)

HG_RAO 0.653

(0.701)

HG_EBT -1.267*

(0.698)

Observations 452 325 452 452 325 325 452 452 452 452

R-squared 0.548 0.578 0.544 0.545 0.579 0.587 0.543 0.551 0.546 0.543

Table 7. The effects of regulatory heterogeneity on FDI stocks, OLS reporter, partner and time fixed effects (1999 and 2003)

Dependent variable: Log inward FDI stocks. Statistical significance indicated as follows: *** (1%), ** (5%), and * (10%). BE indicates barriers to entrepreneurship; BT barriers to trade and investment; SC state control; PO public ownership; IBO government involvement in business operations; ABS administrative burdens on start-ups; BC barriers to competition; RAO regulatory and administrative capacity; and EBT explicit barriers to trade and investment.

30

VI. Conclusions

51. This study has sought to prepare the ground for the development of the STRI for construction

services. The industry plays an important role in the functioning of economies and accounts for a

significant share of GDP and employment in OECD countries. The main implications of this report for the

STRI include:

Establishment abroad is the preferred mode of supplying construction services, often a necessity

for trade to take place. This can take the form of short-term commercial presence usually for the

duration of a given project, or more permanent presence in overseas markets. It is likely that the

latter represents the preferred entry strategy by contractors in OECD countries, as indicated by

the trade data and interviews with the private sector. However, further research is needed in this

area.

Construction services trade and investment are affected by a wide range of regulatory measures,

which can have a different impact on business strategies and operations. Creating and updating

the STRI over time requires reliable and periodic surveys of the main trade restrictions put in

place by member countries. The PMR indicators are the obvious candidates for this purpose. In

addition, this study identifies other sources of information that could be used to complement

existing data for the construction of the STRI.

Although not originally designed for trade-related regulation, the PMR indicators include many

measures identified in the literature as the most significant restrictions to trade in the construction

sector. The empirical analysis undertaken in this study supports the inclusion of these measures

in the STRI when constructed “bottom up”. Initial evidence is found that these regulations and

their heterogeneity are negatively associated with trade in construction services, particularly

through long-term establishment. The results hold for a number of more detailed measures.

It is likely that commercial presence and the movement of natural persons are complementary in

construction services. However, the importance of the latter may vary depending on the entry

strategy adopted, with generally more expatriates sent abroad in the case of short-term

establishment. The modal focus of trade restrictiveness for this sector should thus be on mode 3.

The ability to bring in personnel at different skill levels, though, may be part of the binding

restrictions to this mode of supply.

Questions for further discussion:

What are the major driving forces for trade in construction services? How significantly is the

recent trend of labour scarcity affecting the industry?

What is the preferred entry strategy by international contractors? How have patterns of short

versus longer-term establishment evolved over time?

Are the regulations affecting trade in construction services identified in Section IV appropriate?

Are some of the measures discussed no longer relevant for construction services?

Are there information sources, in addition to those presented in this paper, which could be used to

assemble data on construction services regulations in OECD countries?

31

To what extent is the growing utilisation of PPPs creating new regulatory challenges? Have there

been recent discussions clarifying the scope of international agreements in relation to PPPs?

The empirical results in this study support the view of industry specialists that regulations seem to

affect longer-term commercial presence to a higher degree. What is the institutional, legal form

generally required to establish abroad for short-term project work?

32

REFERENCES

Anderson J.E. and E. Van Wincoop (2003), “Gravity with Gravitas: A Solution to the Border Puzzle”, The

American Economic Review, 93(1), 170-192.

Bon, R. and D. Croswaithe (2000), “The Future of International Construction”, American Society of Civil

Engineers, Thomas Telford.

Butkeviciene, J. (2005), “Managing Request-Offer Negotiations Under GATS: The Case of Construction

and Related Engineering Services,” UNCTAD, Geneva, Switzerland.

Chen, C. (2008) “Entry mode selection for international construction markets: the influence of host country

related factors” Construction Management and Economics 26(3), 303-314.

Conway, P. and G. Nicoletti (2006), “Product Market Regulation in the Non-Manufacturing Sectors of

OECD Countries: Measurements and Highlights”, Economics Department Working Paper No. 530,

OECD.

Engineering News Record (2008), “Top 225 International Contractors 2008”, August 18, 2008.

European Foundation for the Improvement of Living and Working Conditions (2005), “Trends and Drivers

of Change in the European Construction Sector: Mapping Report”, available at:

http://www.eurofound.europa.eu/emcc/publications/2005/ef04149en.pdf.

FIEC (2008), “Key Figures: Construction in Europe 2007”, available at:

(http://www.fiec.org/Content/Default.asp?PageID=5).

Golub, S.S. (2003), “Measures of Restrictiveness of Inward Foreign Direct Investment for OECD

Countries”, OECD Economics Department Working Paper No. 357.

Hardin, A. and J. Holmes (1997), “Service Trade and Foreign Direct Investment: Australian Productivity

Commission”, available at: (www.pc.gov.au/ic/research/information/servtrad/index.html).

Kox, H., A. Lejour and R. Montizaan (2004), "The Free Movement of Services within the EU", CPB

Document 69, The Hague,

available at: (http://www.cpb.nl/eng/pub/cpbreeksen/document/69/doc69.pdf).

Kox, H. and A. Lejour (2005), “Regulatory Heterogeneity as an Obstacle for International Services Trade”,

CPB Discussion Paper No. 49.

Koyama, T. and S.S. Golub (2006), “OECD’s FDI Regulatory Restrictiveness Index: Revision and

Extension to More Economies”, OECD Economics Working Department Paper No. 525.

33

KPMG (2008) “Embracing Change? Global Construction Survey 2008”, available at:

http://www.kpmg.com/SiteCollectionDocuments/Global_Construction_Survey_2008.pdf.

Miroudot, S. and R. Lanz (2008), “Measuring Bilateral Trade in Services: A note on the Data Collected

and Estimated for the Services Trade Restrictiveness Index”, OECD TAD/TC/SXM(2008)2.

Myers, D. (2008), “Construction Economics: A New Approach” Taylor and Francis, New York, USA.

OECD (2007a), “Towards a Services Trade Restrictiveness Index (STRI): A Proposal for a Road Map for

Future Trade Committee Work on Services”, TAD/TC(2007)4.

OECD (2007b), “The Services Trade Restrictiveness Index: Issues and Challenges in its Design”, Meeting

of Services Experts on the STRI, TAD/TC/SXM(2007)2.

Pietroforte, R. and T. Gregori (2003), “An Input-output Analysis of the Construction Sector in Highly

Developed countries”, Construction Management and Economics (2003) 21, 319-327.

PriceWaterhouseCoopers (2005) “Delivering the PPP Promise: A Review of PPP Issues and Activity”,

http://www.pwc.com/extweb/pwcpublications.nsf/docid/5D37E0E325CF5D71852570DC0009C39B

.

Stansbury, N. (2005) “Exposing the Foundations of Corruption in Construction”, Transparency

International, available at:

http://www.transparency.org/publications/gcr/download_gcr/download_gcr_2005.

Transparency International (2003),“Preventing Corruption on Construction Projects”, available at:

(www.transparency.org).

UNCTAD (2002), “Regulation and Liberalisation in the Construction Services Sector and its Contribution

to the Development of Developing Countries”, TD/B/COM.1/EM.12/2.

World Bank (2008), “Doing Business Report 2009”, available at:

(http://www.doingbusiness.org/Documents/RegionalReports/DB09_OECD.pdf).

WTO (1996a) “Trade Policy Review of Switzerland”, report by the Secretariat, WT/TPR/S/13.

WTO (1996b) ) “Trade Policy Review of the Republic of Korea”, report by the Secretariat, WT/TPR/S/19.

WTO (1998) “Construction and Related Engineering Services: Background Note by the Secretariat”,

S/C/W/38.

WTO (1998b) “Trade Policy Review of Japan”, report by the Secretariat, WT/TPR/S/32.

34

ANNEX I. TOP INTERNATIONAL CONTRACTORS 2008

Rank Firm Headquarters Revenue (USD

millions)

% Intl

1 Hochtief AG Germany 23861 89%

2 VINCI France 41716 35%

3 Skanska AB Sweden 18547 75%

4 Strabag SE Austria 15797 80%

5 Bouygues France 32062 38%

6 Bechtel USA 17696 66%

7 Saipem Italy 11757 96%

8 Technip France 10004 98%

9 Bilfinger Berger AG Germany 12642 67%

10 Bovis Lend Lease Australia 9649 83%

Source: Engineering News Record, 2008.

35

ANNEX II. METHODOLOGY FOR ESTIMATING THE GRAVITY MODEL

The gravity model used in this paper is based on the now standard gravity equation derived by Anderson

and Van Wincoop (2003) where the “multilateral resistance term” is taken into account by augmenting the

model with country and time fixed effects. Thus, the basic empirical specification of the gravity equation

estimated in this study is the following:

Log Iijt = 0 + 1 log distance + 2 contiguity + 3 common language + 4 colony + 5 RTA

+ HG_PMRij + i + j + t + ijt

Iijt refers to imports or inward FDI stocks in construction services to country i from country j in time period

t. Distance, contiguity, common language and colony are geographical variables commonly used in gravity

regressions. They capture respectively bilateral distance, geographical contiguity, a common official

language, and a past colonial connection. RTA is a dummy variable equal to unity only if the exporting and

importing country belong to the same regional trading arrangement. Due to incomplete data on the

provisions of such agreements affecting construction services, RTA at this stage only captures joint

membership in the EU, NAFTA, or ANZCERTA.

HG_PMR is a bilateral variable which measures the regulation heterogeneity between two trading

countries i and j at different levels of the PMR regulatory hierarchy (as presented in Annex III). I, j and

t denote reporter, partner and time fixed effects respectively. Country-specific variables which do not

vary across partner countries have to be dropped from the estimating equation as these are accounted for in

the respective fixed effects.

36

ANNEX III. THE PMR STRUCTURE

The 2003 aggregation system

Product market regulation

Inward-oriented policies Outward-oriented policies

State control Barriers to Entrepreneurship

Explicit barriers to trade and investment

Public ownership Involvement in business operation

Administrative burdens on

startups

Regulatory and admisnitrative

opacity

Barriers to competition

Other barriers

Barriers to trade and investment

Scope of public enterprise

Size of public sector

Direct control over business enterprises

Price controls

Use of command and control regulation

Licenses and permits system

Communication and simplification

of rules and procedures

Administrative burdens for corporation

Administrative burdens for sole proprietor firms

Sector specificadministrative

burdens

Legal barriers

Antitrust exemption

Foreignownership

barriers

Discriminatoryprocedures

Tariffs

Regulatoryprocedures

Source: OECD International Regulation Database.

37

The 2007 aggregation system

Product market regulation

State control Barriers to Entrepreneurship

Explicit barriers to trade and investment

Public ownership Involvement in business operation

Administrative burdens on

startups

Regulatory and admisnitrative

opacity

Barriers to competition

Other barriers

Barriers to trade and investment

Scope of public enterprise

Direct control over business enterprises

Governmentinvolvement in

network sectors

Price controls

Use of command and control regulation

Licenses and permits system

Communication and simplification

of rules and procedures

Administrative burdens for corporation

Administrative burdens for sole proprietor firms

Sector specificadministrative

burdens

Legal barriers

Antitrust exemption

Barriers in network sectors

Barriers in services

Barriers to FDI

Tariffs

Discriminatoryprocedures

Regulatorybarriers

Source: OECD International Regulation Database.