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Email this citationThe Future of International Trade in Services
Center for International Relations
1. Introduction
The "Uruguay Round" concluded in 1994 has formulated new multilateral rules to trade in services to reduce present barriers. These rules have been embodied in the General Agreement on Trade in Services (or GATS), which seeks to create "a level playing field of a common set of rules of the game for services that will contribute to the growth and expansion of the services industries themselves as well as of the world economy that they serve. 1
To be sure, GATS has been adopted in spite of reservations by a number of developing countries, suspicious as they were of the reach of Western multinational corporations. But all in all, GATS has been welcomed by the international community at large, and by the majority of industry and economic sectors in most countries in particular. In general, restrictions on services trade are more pervasive, complex, and effective than those prevailing in merchandise trade. Their elimination was long overdue.
Service imports still face government impediments. There are more than one thousand obstacles to international trade in services listed by the Office of the US Trade Representative. In a number of countries, local users of banking, insurance and financial services, telecommunications and transportation have to rely exclusively on domestic supply. Restrictions on trade are largely responsible for the present low level of international transactions services. Service trade represents only about 8% of service production while goods trade equals 17-20% of goods production.
The majority of obstacles and barriers which GATS seeks to lower or eliminate still remain and will probably be there for a long time. For the most part, GATS rules will not effectively apply until countries make specific commitments on a sector by sector basis, and this may well take years of arduous negotiations. In addition, liberalization does not mean deregulation: many of the existing regulations amount to effective obstacles to trade. There are still significant barriers in terms of nationality and residence requirements. Certain services such as maritime transport have not been included. All the same, an irreversible and progressive process of liberalization has been initiated which sets a trend for the years to come.
Liberalization is meant to stimulate the output of services. As one GATT expert has recently said, "it is no exaggeration that the services agreement could open trillions of dollars of business to international competition of some 120 member countries, with more to follow." With the increase of trade, supply and demand structures of services will also undergo drastic changes.
Producer services are increasingly utilizing new production processes and have experienced an unprecedented demand. Two factors have played a major role: firstly, technological innovations, particularly in the fields of electronics and telecommunications, have permitted the emergence of new categories of knowledge-intensive, foreign-produced services; secondly, these categories of services have also provided new models of efficiency in the production process of manufactures. They have modified basic production patterns through a larger embodiment of services in that process. That evolution was being held back by present barriers and obstacles to trade.
The first impact of freer trade in services will likely result in a further concentration of production into those countries and cities where specific factor endowments and comparative advantages already exist. However, the future, a shift of production endowments, a stronger influence of cultural factors and increasing demands for services adapted to local, specific conditions will foster an eventual dispersion of supply. Ultimately there will be a more equal balance between exporters and importers of services in a world wide basis.
2. Demand, Supply and Trade Liberalization
1. Use of Services and Economic Growth
By the mid 1980s, services accounted for more than half of the GNP of all developed market economies, and they were also the single largest sector in most developing countries. 2 In the United States, the share of services in GDP is 70 per cent. Financial services alone constitutes more than 6 per cent of GDP. The rise in recent years has been dramatic: services were only 59 per cent of GDP in 1965, 63 per cent in 1980, 69 per cent in 1990. These figures are reflected also in terms of employment in services, which has progressed from 72 percent of the total in 1973 to 78 percent in 1990.
In other developed countries we find a similar general shift towards a more service oriented economy, although this trend is far from uniform. In 1965 the share of services in GDP ranged from a low of 16 per cent for Oman to a high of 73 per cent for Singapore.
Increase of production and use of services is correlated with advances in product innovation, productivity, in both goods and other services, and the transformation of the firms' structures and financing. A well known factor increasing the demand for services is the growth of per capita output and the high income elasticity of demand for some consumer services, particularly leisure, education, and tourism. Higher incomes would then be the cause underlying a larger demand for services.
The unprecedented increase of services in both developed and developing countries is due to a combination of developments. First, there has been a substantial change in government policies. In many countries, service activities at the domestic level have been de regulated. 3 At the same time, there has been a widespread liberalization of foreign direct investment (FDI) in services, which is the main channel of delivery of international services, particularly in the developed countries.
To be sure, for those service industries in which economies of scale are important and companies are big (for example, national airlines, railroad transportation, and public utilities), regulations typically still favor national companies. However, some industries (e.g. telecommunication services) have already been or are being privatized in many countries. Also, large firms have boosted the policy of privatization as they became aware of the productivity gains which could result from the use of the innovations that a more competitive market, mainly in electronics and telecommunications, was able to provide. Governments have been responsive to these claims.
More important than governmental deregulation as a factor contributing to enlarged demand has been the new role of services in improving productivity. The range of services which all economic sectors are now using is the result of an impressive technological revolution of the last two decades. Competition, and high tech, corporate dynamism have stimulated the manufacturing sector and service industries to enhance productivity gains in traditional products and to bring new products to the market. At the same time, technological innovations have developed as a result of both scientific discoveries (electronics, biotechonologies, transportation) and an increasing awareness of their possible contribution to production of goods and services. As a result, new productivity gains have occurred in services.
Services are now an increasing component of the production process of goods. The expansion of "service functions" in all types of economic activities is the hallmark of the modern "service economy". 4 Research and development, marketing, finance, and after sales support, for example, have been growing in importance as necessary complements of the manufacturing process.
Expenditure on producer services in manufacturing has risen as a percentage of the value of manufacturing output. In Germany, this share went from 12.8 % (1975) to 14.1% (1981). Rates of increase were similar in France (22.2 % in this last year), in Italy (16.1 %), in the UK (10.1%). In the United States a similar trend was observed. Employment patterns have followed suit.
Services have also contributed to product innovation and differentiation. The need to innovate has called for an increase of R&D, design, advertising, marketing and distribution functions of the production patterns of goods and services.
This has been complemented by a market trend towards increasing product differentiation as consumers become attracted to more stylized products, and as producers target special groups of consumers. 5 The production of customized goods in short series is replacing mass production runs and this in turn has accentuated the service component of goods production. Design, marketing and distribution have become increasingly important. Economies of scope are rising to rival economies of scale.
The need to innovate has brought about new financial requirements and, with them, complex national and international financial environments within which firms must operate. Companies now raise capital internationally and resist take-overs by foreign firms. The need for information and expertise that are simultaneously broader and deeper is thus expanding. This process calls for the use of more services.
The increasingly complex national and international environments within which firms must operate has made necessary the emergence of new strategies in finance, banking, legal, insurance, and other producer services. Banks not only lend money but also offer their customers new financial instruments. Insurance companies offer not only indemnities when a loss occurs but also risk control advisory services. The setting up of new intermediate markets for services (for example, in the Euromarket, including reinsurance, securitization, and new forms of data transmission) has encouraged this process and permitted the formulation of new strategies.
New marketing approaches have also played a role in increasing the use of services. Marketing, distribution and after sales servicing activities have grown in relation to the value of the physical product itself (for example, a copying machine, or an aircraft). Brand loyalty has declined in many consumer products, from food to computers. As a result, success in the marketing of brand names rests increasingly on the provision of information to potential buyers. 6
New services closely related to consumption of goods have emerged. The relation between computer hardware and software is also an example of this complementarity. Neither is able to function without its counterpart, but whereas some years ago software (service) accounted for 20 percent of the value of computer equipment, it is now 80 percent of the total bill. Hardware (manufacture) has experienced a corresponding decline. Engineering design or foreign construction work is often tied to the sale of machinery and equipment. 7
2. Demand and Liberalization
Demand for services often developed as a result of an imitative process of production patterns which prevailed in other countries, where knowledge intensive services were available.
The United Nations, the World Bank and other international agencies have concluded that a less restrictive policy on international services, particularly producer or intermediate services, could increase productivity of domestic industries. They have pressed a number of countries to open the borders to foreign services:
"If services are inefficient, producers and consumers of services do not derive the benefits they ought to gain from their use or consumption. In addition, producers and consumers tend to under use inefficient services. In situations where a lack of efficiency can clearly be identified it may be possible to estimate some of the resulting costs to the economy. For example, by holding on to shipments longer than they should, low productivity producers of trucking services increases users' costs by billing a larger amount of capital and labor per unit of transport than would be necessary and by increasing the cost of holding inventories..." 8
3. The Supply of Services
The production of services, particularly intermediate or producer services, is very unevenly distributed over the world. The location of consumer services, tends to follow the population distribution. But producer services are not located only where major population markets exist. 9
Initially production was meant to meet the needs of nearby customers, so that, as the level of development increased and carried with it the actual or potential use of financial, business and professional services, production of these services increased, too. Production progressively expanded afterwards to cater for the demand of other countries, but central business headquarters of R & D, and at least until recently production activities were kept in their original location. This is why service industries have largely concentrated in developed countries until now.
Major producer service activities and some subsectors are not only confined to given developed countries, but also, within these countries, to geographically narrow regions and urban areas. This is particularly the case of services connected with financial activities. Rimmer finds an enormous concentration of service activities in 32 first ranked cities. He also finds an evidence of an emerging category of 'superclass' service supplying cities. 10 "London, New York, Tokyo...tend to dominate lower order metropolis in peripheral locations...Cities in the core areas of North America and Europe are the headquarters location for 78 percent of the international banks with branch offices in South America..." 11
Over half the head offices of the 100 top service industries in the European Union are located in London, Paris or Frankfurt. A study published in 1978 examined the location of services in France during the 1960s and early 1970s and arrived at similar conclusions in respect of concentration. In the Canadian context, Toronto and Montreal account for approximately 90 percent of all major financial institutions.
Human capital and skills determine a country's comparative advantage in most service industries. A literate work force is essential, and quality of education is often the determining factor. Sagari has pondered at length the importance of skilled labor as a source of comparative advantage in financial services. 12 (He explains why countries best endowed with skilled labor are those which would see their trade expanded as a result of the liberalization process brought about by the Uruguay Round). Carter and Dickinson have suggested that the essential element in international trade in insurance "is a well educated labor force, including a whole range of professional expertise in financial, legal, and technical subjects". 13 Sapir and Lutz found also that human capital and scale economies are the factors that determine comparative advantage in insurance services. 14
Increasing returns, arising from specialization, even for initially similar countries, result in scale economies (unit costs of production falling as a result of mass production). In most producer service industries, where start up costs and initial investments are very large, marginal production costs are generally very low. The volume of business is an essential ingredient of total unit costs and thus of a competitiveness. Now, the volume of business is very often a matter of location. 15 The volume of business handled by firms mainly headquartered in international financial centers provides them with a competitive advantage. This is why economies of scale and localization are interrelated concepts. "Large transnational business consultancy firms, merchant and investment banks, and hotel chains can profit from differential factor costs...And nowhere are the advantages of spreading risks, which size and scope confer, better seen than in the insurance, reinsurance and investment banking industries". 16
Size, indeed, is almost a precondition for competitiveness. According to Kakabadse, "one of the implications (of size and scale) is that subsidiaries (of multinational corporations) in other countries will keep a large degree of advantage over local competitors...This goes some way to explain the fear and intransigence of a number of developing countries in the matter of liberalizing trade in services". 17
Quality is another factor "Quality is probably the single most important variable determining the competitiveness of service TNCs, more important, in many instances than price" 18 and so is reputation and hearsay advices: "Prepurchase advice or the experience of related services may guide consumer choice". 19
Political stability and a suitable regulatory framework are also factors of competitiveness. Services are generally regulation intensive. As a result, comparative advantages in services are determined by the ability of states to generate the best rules. A favorable regulatory framework offers an explanation of the successful progression of finance industries in countries and territories like Hong Kong and Singapore. (If in doubt, ask a Swiss banker what he/she thinks about the role played by the legislation governing secret numbered bank accounts in the competitiveness of the Swiss banking industry).
Secondly, a stable political and economic environment is also an important ingredient of international competitiveness. This condition includes political stability in the normal sense, as well as the assurance that government actions will be predictable and consistent from the regulatory side. Since not many countries fully meet this condition, this requirement has been a further determinant of geographical concentration. 20
Socioeconomic, political and cultural traditions often attach a premium to services of a particular origin. Developing countries sometimes attach prestige to the services imported from the former colonial power. The French example is mentioned by UNCTAD, 1988: "A variety of factors may have contributed to French success in producer service exports...The historical ties with French speaking African countries, as well as the links of services supply with technical cooperation projects, have served to expand the external markets for French producer services exports for the small and medium size service firms characteristic of the French economy". 21
In a number of other instances, the supply of certain services may enjoy competitive advantages just because of the reputation of their production location. Geographic origin and brand images are often associated with the concept of quality. Software from Silicon Valley, futures trading of Chicago, movies from Los Angeles or currency trading from London, these will have a reputation for quality. And whether or not this reputation is deserved, it means a competitive edge over other locations.
4. Factor Endowments and International Competitiveness
Are service industries located where relative factor endowments yield comparative advantages? To be sure, countries relatively well-endowed with skilled labor or technology attract more firms in labor or technology intensive service industries than less gifted countries. 22 However, the direction of causation is debatable: the question is whether the former countries were endowed with the necessary production factors which eventually permitted competitiveness or did an initial element of competitiveness stimulate the emergence of factor endowments?
The few authors who have addressed the subject (e.g. Hindley and Smith, Sapir and Lutz, Oulton, Riddle, and others) agree by and large that there is no reason why the Hecksher Ohlin model, as embedded in the neo classical theory and GATT's paradigm, cannot be extended to services. 23 Relative weights in traditional factor endowments help to do play a role in providing comparative advantages and explain the location of service industries.
However, this conclusion does not exclude that factors other than those examined in the previous section. An obvious observation is that tourism, for example, is heavily dependent on natural resource endowments, while financial services may depend on geographical location in particular international time zones. For the UK, recent changes in the stock exchange have made it possible to capitalize on geographical location more effectively. "By not being tied to a trading floor...an early broker dealer will be able to operate in the closing stages of the Far Eastern markets and still catch New York in the late afternoon, giving London the potential to be a 24 hour international financial center".
Other less contingent and geographical factors have also been singled out. H. Peter Gray pointed out that "Trade in services cannot be explained only by relative factor prices...Other variables such as technology differences or communications linkages are crucial to explain trade in services". 24
According to Kakabadse (1987), "It will be necessary to go beyond the country specific comparative advantages of traditional theory...and incorporate at least two other factors which play a major role: corporate strategies and new service infrastructures". The role of corporate strategies, he says, includes the efficient response to market needs; the building up of a clear identity (e.g. Club Med); and the adaptation to local conditions. Also, competitive advantage stems from the increasing dependence of services on new computer and communications technology. This permits data to be generated, stored, processed and sent anywhere in the world via electronic networks. "This opens up new trading opportunities in services that can be delivered electronically." 25
Some other analysts (e.g. Krugman) argue that the pattern of trade in services results mainly from large "technology gaps" and path dependence. Lloyd’s of London is likely to be more competitive than Assurances de Timbuctu not only because the presence in London of a larger pool of skills and capital, but because of the aftermath of historical imperial contingencies. There is in London a legal system and a pattern of judicial and financial supervision that guarantees fairness to the insurance contract and solvency of the insurance company. If the development of the insurance industry was just a matter of factor endowments, it could be expected that, if enough efforts were put up towards attracting them, competitive conditions could shift from London to Timbuctu one day or another. Historical contingencies and the concentration of business however, make this a difficult and slow process.
3. Foreign Direct Investment and Virtual Corporations
1. The Role of Foreign Direct Investment and of Transnational Corporations in the Service Industries
Traditional factor endowments do not themselves determine the structure of the markets and the location of service industries as they have developed. FDI and TNCs have a role of their own.
Transnational manufacturing corporations tend to buy production services emanating from transnational service corporations: in many instances, the structure of the service industry duplicates the structure of the manufacturing industry on which it strongly depends. Services thus became transnational in order to cater to the needs of the manufacturing plants spread around the world. This tendency does not only apply to the United States and other highly industrialized countries; "New India" insurance company set up branch offices in all places where Indian merchants and traders had settled down.
The increased magnitude of FDI is considerable. As reported by (UN CTC, 1989), by the mid 1980s, about 40 per cent of the world's total FDI stock of about $700 billion (about $300 billion) was in services, compared to approximately one quarter at the beginning of the 1970s and less than 20 per cent in the early 1950s. 26 During the first half of the 1980s, more than half of total investment flows of about $50 billion annually were in the services sector, of which no less than two thirds were in finance and trade related activities. All available indications point to the intensification of this trend. As reported in a recent UNCTAD study ("1994 World Investment Report"), multinational corporations have increased their lead in the globalization of trade and finance. 27 There has been a dramatic shift in such foreign direct investment to the dynamic economies of Asia and Latin America from the United States and other industrial nations.
Geographic concentration of transnational corporations leads to a corollary concentration of service industries. Of 304 service transnational corporations (TNCs), 45 per cent are headquartered in the United States, 22 per cent in Japan and 28 per cent in Western Europe, mainly in the United Kingdom, France and Germany. By the mid 1980s, these 304 TNCs had about 23,000 foreign affiliates. Japanese corporations account for a smaller portion of foreign affiliates, only 11 per cent, largely concentrated in the trade and banking industries. The United States and Europe account for 61% and 24%, respectively, of foreign affiliates. 28
Similarly, geographical concentration of supply is also the result of concentration of ownership between services and manufacturing firms. Both services and manufacturing units are now attempting to acquire ownership of a wide range of service operations in order to take advantage of economies of scale. Strategic planning and decision-making functions have thus become more concentrated in a few large metropolitan areas, thus promoting the concentration of other intermediate business and producer service activities in these centers as well.
2. The Role of New Corporate Pattern: The Virtual Corporation and Externalization of Services
The supply of services has also been transformed as the organization of the firm and of its production has changed. The progressive liberalization of trade in manufactures in the last two decades provided a major inducement for these structural changes. World markets were opened to new and aggressive competitors enjoying more flexible labor markets, lower wages and based on technological innovation. Traditional goods producers were confronted with the emergence of new marketing techniques and institutions (e.g. the Japanese 'sogo shosha'), mainly from newly industrialized countries in Asia and the Pacific. All that meant that the Fordist model of the past, characterized by the search for massive internal economies of scale based on process flow and assembly line methods, had to be abandoned.
Many manufacturing regions had to shift resources to the production of services, often to new categories of services. The necessity of reaching a critical production mass to obtain economies of scale dictated the export of local production. As Jaeger and Durrenberger point out, in a situation of industrial decline and shrinking domestic markets, "flourishing producer services firms are inevitably forced to operate in an international environment. 29 A good example is the financial sector in Britain". Other good examples are found in Catalonia, and in the London area and Southern England. New York City where, by the way, international legal offices are said to substitute for the apparel sector as the major foreign exchange earner in the area and the Lyon Grenoble region, are also examples.
In addition to cutting labor costs, firms started asking whether corporate structure and the value added process should be changed. The result was flexible production patterns permitting greater efficiency and rapid adjustment to changing economic circumstances.
Vertical Disintegration: Introduction of the Virtual Corporation
The hallmark of flexible production patterns is vertical disintegration where the corporation contracts out to other firms the production of parts and components, that are not strategic to the production process itself. A "virtual corporation" is thereby established. 30
The virtual corporation has coincided with a substitution of high technology embodied capital for labor. This has allowed management's attention to be shifted away from physical production, where processes are increasingly routinized, towards other areas which previously had been regarded as deserving only secondary priority: corporate and product planning, research and development, advertising and marketing areas of activity falling under the category of "services". In addition, technological change, has forced a growing number of firms to seek specialized help in fields such as information processing, industrial engineering, process design, and research.
Competition has led to relocation of production units for goods and services. Raw materials are shipped from one country to another for transformation, elaboration, processing, then transported to other places for storage and packing, finally then delivered to the consumers hundreds or thousand of miles away.
Vertical disintegration means that firms have to be concerned with the development and exploitation of foreign markets, the maintenance and administration of relations with foreign affiliates and trading partners, and the direction of offshore production and sales units.
Externalization
Externalization of services, i.e. purchasing services from separate specialist firms rather than providing them internally through the firm's own personnel, has been an inevitable outcome of vertical disintegration. Firms then concentrate on core functions, those that they accomplish better than other organizations, and for which only a small and highly focused pool of human resources is necessary. The remaining services are purchased externally.
There are many economic and organizational advantages in going outside for types of services, from legal assistance, to surveys, engineering, accounting, janitorial services or the hiring of executives. This strategy has become common practice in a number of sectors. External firms may be more efficient through specialization. Firms may also license or purchase technology to save on R&D costs or hire consultants to deal with new problems.
According to UNCTAD, in house technical limitations largely explain the increasing resort to external suppliers of services. Firms' capacity to develop the level of expertise required to provide the greater quantities of producer services they consume may be restricted by knowledge, personnel or cost. Externalization thus has resulted in a great deal of specialization of the service activities and hence a professionalization in their performance.
3. Innovation, Financing and Declining Transactions Costs
There has been a new development of market structures and concentration in the fields of:
| (i). technological innovations and their application to service activities, and |
| (ii). financing global networks. |
| The combination of these factors influences competitiveness and location as they determine (iii). transaction costs. |
To some degree the development of high technologies (electronics, telecommunications, and so on) tend to concentrate in restricted geographical spaces (Silicon Valley, Massachusetts, and so on). There may also be a similar development of industries depending on them. It is still not clear, however, whether there will be a similar concentration of service industries. There is no necessary geographical contiguity between where technology is developed and where services are produced. Instead, a necessary condition is a cultural and intellectual closeness between the two centers of production. Financial activities in New York are carried out miles away from new developments in data processing, and yet a close relationship (cultural, financial, educational) exists between the two centres.
Similarly, globalization of international financing runs parallel to concentration of financial services in large city centers. The concentration of international banking is related to the emergence of international financial and securities markets as the principal medium for cross border borrowing and lending, a development that has lent a new impetus to the influence exerted by financial city centers in a few developed countries. According to Moss and Brion (1991), "The increased presence of foreign banks in New York City and other major US cities illustrates how the globalization of the financial service industry affects urban functions... Communications and information technologies have strengthened a small number of world cities while weakening the traditional autonomy of many smaller cities..." 31
The agglomeration process has been stimulated by global electronic networks which allow information to be centralized and transmitted to branch offices around the world for further action (i.e. a one to many network). Daniels (1991) finds it ironic that information technology has proved to be an instrument reinforcing concentration, while economic activity has been spread geographically. 32 Telecommunications of course allows parties to communicate in real time almost irrespective of distance. In this sense there should be no reason why, say, the insurance industry should concentrate in particular locations. And there is evidence of regional and national redistribution of services within countries for reasons related to telecommunication flexibility.
The need to lower transaction costs also explains why service activities show the highest propensity to cluster and agglomerate in large urban areas and central business districts. Unlike goods, producer services do not generally involve transportation costs. In fact, one characteristic of services is that they cannot be transported or stored. But because of this, their supply requires frequent interpersonal "face to face" contact, the most expensive mode of communication, which would explain agglomeration of industries and spatial concentration. According to Bailly (1992), the propensity to agglomerate is precisely an outward sign of high communications costs. 33
The above bears out the opinion that "concentration begets concentration", namely that concentration, once established, feeds on its own momentum. 34 Daniels (1991) observes that, particularly in the areas of finance and telecommunications, concentration tends to be a self sustaining process. 35 But other factors are also at work. The term 'historical inertia' has been coined to describe the kind of this historically contingent evolution (the City of London, for instance, where people meet and contacts and contracts are organized especially in the fields of financing, shipping, insurance a legacy of the British Empire). 36 These contingencies have largely shaped the further concentration of services in specific centers.
Concentration of service industries will continue as a result of GATS. Trade liberalization usually results in strengthening centres which are already competitive. But it cannot be expected that factors of production alone, shifted to less endowed countries, would be able to overcome the resistance and weight of present limits in the trading of services. This explains the resistance of developing countries to full liberalization of trade in services.
However, despite the economic tendencies toward concentration, they may not prove as strong as in the past. Factor endowments are not permanent prerogatives of a given country or region. Along with the concentration of head offices of service industries, there has also been a proliferation of small independent service establishments which aim at maintaining close contacts with the final or intermediate users. Between the two (a centre and a series of satellite firms) a symbiotic spatial relationship often develops. To be sure, concentration is likely to continue and, in a number of subsectors, to strengthen, but this should be not taken for granted in all circumstances.
4. The Geographical Dispersion of Service Activities
It can be indeed expected that, present concentration in given territorial areas, though a formidable obstacle to the development of the service industries in countries left behind, may not continue. Countries may want custom tailored services which can only be provided at home.
Carlo Jaeger and Gregor Durrenberger (1991), while observing that producer services agglomerate in the big urban centers in highly developed countries, note that this trend has slowed down. 37 These authors quote Kirn who, has shown that producer services in the USA became spatially more evenly distributed during the 1960s and 1970s, as a substantial proportion of producer services filtered downwards through the urban size hierarchy. Gillespie and Green have drawn a somewhat similar picture for the UK. 38
Does this mean that service production is becoming less concentrated? What we see is an internal spread and a less concentrated urban pattern of service industries within countries. But there is little evidence of general inter country dispersion, and this makes difficult to make long term predictions. It is also difficult to know 'where' services are produced. They are neither tangible nor storable. The location of the production of an automobile, in contrast, coincides with investment in a physical plant. In comparison, it is relatively easy for service firms to separate the location of the investment from the location of service production. For instance, services titularly originating in tax havens or countries offering flags of convenience may only be nominally located there. Data on locations may therefore, be misleading.
The production of services is usually considered to be located where the coordination, control and the ownership of the firm are situated. The 'head office', is then an appropriate gauge to determine the country or the city where the service is produced, but most service activities are shared between head offices and subsidiaries. This blurs the production concept. Which entity is undertaking the insurance activities involved in a policy issued by Allstate (Switzerland) in Zurich? Although foreign banks provide competition for US banks, they do not sell services produced abroad; rather they produce services in the US with the aid of US workers, the US banking infrastructure and often US capital.
Thus, the concept of "production" in service industries should be thought of in terms of a chain extending from the head office of the firm through to the commercial presence or sales organization in contact with the customer. The various production points along the line would progressively add some value to the original product up to the final output. There is a flow of activities through different locations involving more than one country. Recent evidence points to the likelihood that the production chain becomes more regular and even all through its length, instead of concentrating at a point at the head of the line (the home office).
The trend is likely to be reinforced in the years to come. "Matrix structures" have been adopted by an increasing number of transnational corporations (with each unit of production reporting to a product group headquarters and a country headquarters). "American multinationals going global have discovered that...an office in, say, New York cannot...manage the company's Asian operations. Global strengths must be matched by a local feel..."
This trend, if confirmed, may result in a corresponding relocation of production internationally giving developing countries, a larger participation in the output of services and their international trade. Messerlin and Sauvant (1990) make the point that in some countries at a medium stage of development there is a substantial degree of efficiency in subsectors like banking, insurance, air transport, telecommunications, tourism, shipping, construction and professional services, including health care and software development. 39 This will have a bearing on location of service activities.
Export of services has now successfully been carried out by domestic firms and countries which had previously been traditional importers. More than that, some of these new firms and countries have extended their activities on an international level. The dominant position of South Korea in construction services is only one of many instances which could be cited. Both Hong Kong and Singapore have been for a long time leaders in "cashless shopping" and automated "easy pay" systems. 40 Because of their compact size and close cooperation from the banking community, they were in a position not only to refine such services but also to export the systems worldwide.
Multinational banking institutions with a developing country as home base, now comprise about 20 per cent of branches and 6 per cent of subsidiaries throughout the world. The main source of the growth of these banks has been their role in an expanding export business and in arranging foreign direct investment in their home country. Forty one banks from developing countries and territories were among the 300 largest banks in 1986, an increase from 22 banks in 1975. Indian insurance companies operate through subsidiary companies in thirty two nations.
Another example is international construction and engineering contractors. Thirty three of the 250 largest are from developing countries. The largest (construction) firms (in Mexico) compete successfully in the international markets against other international construction giants, in hydroelectric projects, pipelines, and water systems.
Three major factors explain this new competitiveness and suggest further development in the years to come. Firstly, labor resources and skills, have become a major factor endowment. There is no doubt that an educated labor force does provide a significant competitive advantage. Relative labor factor endowments are reflected in labor costs: Overall costs for a computer programmer or a systems analyst in Mexico are 58 percent of those prevailing in the United States; the corresponding figure for India is less than one tenth of labor costs in the US. 41
The second factor is that the increasingly diversified range of services requires narrower and deeper types of expertise. Similar to the well known situation in high Technology manufacturing, 42 vertical disintegration occurs through spin offs of key employees from existing service firms. 43 Thus, the producer service sector is characterized by high levels of new firm formation. There are a number of examples of former employees of transnational corporations who established new firms not necessarily located in the same place.
A third major and related factor concerns the complexity of services and the strong human and cultural content they embody. Cross border standardized services are giving way to those better adapted to local conditions. "Nowadays big firms seek local help not only to tailor ideas to local markets (McDonald's restaurants now serve Teriyaki burgers in Tokyo and wine in Lyons) but also to get access to local expertise". 44 In a sense, all services are provided on a "one-off" basis, that is, they are never replicated exactly. Regional business customers want varied and specific services tailored to local cultural and socio economic conditions.
Because many services are intangible and hence cannot be stored, they can be more easily delivered to foreign markets through foreign direct investment than through International trade. In time however, the application of data technology will increase the tradability of services, and the need for FDI may fall. For example, the number of foreign banking affiliates has virtually remained stable since the beginning of the 1980s, when data technologies were introduced on a large scale by transnational banks.
This raises the possibility of creating new markets increasingly amalgamating local firms supplying small scale and local demand, and local and foreign firms supplying the needs of large firms, TNCs and governments. Small and medium sized domestic firms already coexist side by side with transnational firms. In this sense, concentrated and diffused production locations are perfectly compatible.
4. Conclusion: The Liberalization Process and Structural Changes Capitalize
The distinctive feature of present production is the large spread of actual or potential demand for new, technologically advanced, producer services and the relative concentration of supply.
A substantial change of the rules of the game, like that in GATS, is not only the result of new market forces in a neo classical framework. It also stems from an interaction between factor endowments and resources combined with the political forces that these structures generally command.
The future pattern of service production will be like goods production in the past. Goods production initially served a local market, then was exported overseas. In time production in overseas markets (partly sustained through FDI) competed effectively with exports and production became more diversified, partly obviating the need for exports. In service industries, overseas markets have until recently been closed. Now that they are opening as a result of GATS, there will be large service exports from metropolitan countries to developing nations. In time, however, the service industries of the developing world will catch up and the production of services will be dispersed on a world wide basis.
Note 1: GATT, What it is, What it Does, (Geneva: GATT Centre William Rappard, 1992) Back.
Note 2: Mario A. Kakabadse, "International trade in services: Prospects for liberalization in the 1990s", Atlantic paper #64, (New York: Croom Helm, for the Atlantic Institute for International Affairs, 1987). Back.
Note 3: UN CTC (United Nations, Centre on Transnational Corporations), Foreign Direct Investment and Transnational Corporations in Services, (New York: United Nations, 1989). Back.
Note 4: Dorothy Riddle, Services-led Growth: The Role of the Service Sector in World Development, (New York: Praeger, 1986). Back.
Note 5: Bailly & Coffey & Paelink & Polese, Spatial Econometrics of Services, (Bookfield, VT: Ashgate Pub. Co., 1992). Back.
Note 6: The Economist, London, July, 2, 1994. Back.
Note 7: (Kakabadse, 1987) Back.
Note 8: UNCTAD (United Nations Conference on Trade and Development) and The World Bank, "Liberalizing international transactions in services: A handbook", (New York: United Nations, 1994). Back.
Note 9: Carlo Jaeger and Gregor Durrenberger, "Service and counterurbanization: the case of Central Europe", in: Daniels, ed. (New York: Routledge, 1991). Back.
Note 10: Peter J. Rimmer, "the global intelligence corps in world cities: engineering consultancies on the move", Services and Metropolitan Development: International Perspectives, P.W. Daniels, ed., (New York: Routledge, 1991). Back.
Note 11: P.W. Daniels, Service Sector Restructuring and Metropolitan Devlopment: International Perspectives, P.W. Daniels, ed., (New York: Routledge, 1991). Back.
Note 13: (Carter and Dickinson, 1979) Back.
Note 14: (Sapir and Lutz) Back.
Note 15: Ken Tucker and Mark Sundberg, Comparative Advantages and Service Intensity in Traded Goods, (Kuala Lumpur, Canberra: ASEAN-Australia Joint Research Project, 1986) Back.
Note 17: (Kakabadse, 1987) Back.
Note 19: (Bailly and others, 1992) Back.
Note 20: (Daniels, 1991) Back.
Note 21: UNCTAD (United Nations Conference on Trade and Development) Trade & Development Report, (New York: United Nations, 1988). Back.
Note 22: Patrick A. Messerlin & Karl P. Sauvant, ed., "the Uruguay Round: Services in the world economy," (Washington D.C.: The World Bank, 1990) Back.
Note 23: (Hindley and Smith, Sapir and Lutz, Oulton, Riddlem and others) Back.
Note 25: (Kakabadse, 1987) Back.
Note 29: (Jaeger and Durrenberger, 1991) Back.
Note 30: William S. Coffey & Antoine S. Bailly, "Producer Services and the Rise of Flexible Production Systems", Urban Studies #29, No. 2, August 1992. Back.
Note 30: Mitchell L. Moss & Joanne G. Brion, "Foreign banks, telecmmunications and the central city", Services and Metropolitan Development: International Perspectives, P.W. Daniels, ed., (New York: Routledge, 1991). Back.
Note 32: (Daniels, 1991) Back.
Note 33: (Bailly & others, 1992) Back.
Note 34: Paul Krugman, Geography and Trade, (Cambridge: MIT Press, 1991). Back.
Note 35: (Daniels, 1991) Back.
Note 36: (Jaeger and Durrenberger, 1991) Back.
Note 37: (Jaeger and Durrenberger, 1991) Back.
Note 38: (Gillespie and Green) Back.
Note 39: (Messerlin and Sauvant, 1990) Back.
Note 41: The Economist, London, July 30, 1994 Back.
Note 42: (Glasmeier, 1988) Back.
Note 43: (Marshall, 1988) Back.
Note 44: The Economist, London, July 30, 1994 Back.
References
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P.W. Daniels:
Service Sector Restructuring and Metropolitan Development: International Perspectives,
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Foreign Direct Investment and Transnational Corporations in Services, (New York: United
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UNCTAD (United Nations Conference on Trade and Development):
Trade & Development Report, (New York: United Nations, 1988).
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1994).
