Reevaluating Openness to Trade: Estimating the True Potential Gains from the Service Industry

While many recent free trade agreements include stipulations for liberalizing manufacturing and services, little empirical data exists to measure the impact of liberalization. In addition, available statistics fail to account for variation across industries in how “tradable” a service is. In “The Tradability of Services: Geographic Concentration and Trade Costs,” Antoine Gervais and J. Bradford Jensen create a methodology to address this information gap and find that not only are many service industries as tradable as manufacturing, but the positive welfare impact of liberalizing services, or lowering their barriers to trade, is also likely highly underestimated. This finding has the potential to considerably weaken arguments against trade liberalization and is further evidence of the United States’ capacity to maintain global competitiveness due to its ability to produce at a lower cost in skill-intensive industries.

The service sector is expanding rapidly in developed countries and now accounts for 80 percent of employment in the US and 30 percent of US exports. However, most international trade statistics focus on manufacturing because data on trade in the service sector is harder to measure and is therefore less detailed and limited to aggregated values from bilateral trade. Further, services have historically been considered difficult, if not impossible, to actually trade between countries because of the need for face-to-face contact. This belief fails to capture technological changes and improvements in telecommunication that have “digitized” many services.

Gervais and Jensen find that there is considerable variation in how tradable a service is across industries. In particular, many business services, like accounting or administrative services, are as tradable as manufacturing industries. Without taking into account this inter-industry variation, trade statistics are not complex enough to capture the share of economic activity attributable to services that can actually be traded and thus cannot accurately estimate the potential economic impact of liberalizing the service industry.

The authors use geographic concentration of production to estimate tradability in both manufacturing and service industries in the US. They find that wide dispersion of an industry’s production indicates that the industry is less tradable both within and outside of the country because each region is more likely to have its own production. The authors’ procedure is an extension of previous work that uses production and demand estimates within a region to find where there is mismatch between regional supply and demand. If these quantities differ, it is an indicator that trade is occurring.

Since the service sector makes up such a large share of economic activity in the US and the business sector, in particular, is highly tradable, the authors estimate that liberalizing the service sector will likely have a welfare impact of the same magnitude as an equivalent liberalization of goods. In addition, because trade barriers (e.g. tariffs, quotas, etc.) are actually higher on average for services relative to goods, the service sector would likely create much higher gains from trade if both sectors were liberalized to the same degree.

Gervais and Jensen also conclude that higher average wages in tradable services, as compared to other less tradable service industries or the manufacturing sector, imply that these services are more skill-intensive and that lower barriers to trade would allow workers to specialize in these jobs. Therefore, closing the US to trade in an attempt to decrease dependence on foreign goods will significantly depress the economy and hurt the domestic labor market by blocking the economy’s ability to profit from exporting relatively lower-cost services and/or increase employment in these higher-skilled, higher-paid industries.

Despite the importance of accurate international trade estimates for crafting both domestic and international policy, service sector data lacks detail and fails to account for differences in tradability across service industries. Gervais and Jensen are able to use domestic production information to measure these factors, and they find that liberalizing the service industry has the potential to create significant welfare gains in developed countries such as the US, where service-sector employment is expanding rapidly. These preliminary results not only provide further support for reducing barriers to trade, but also highlight the necessity for more detailed information on the service sector’s economic impact.

Feature Photo: cc/(Mikado Player)