Services Development and Comparative Advantage in Manufacturing. World Trade Organization April

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1 Services Development and Comparative Advantage in Manufacturing Xuepeng Liu, Kennesaw State University Aaditya Mattoo, The World Bank Zhi Wang, UIBE & George Mason Univ. Shang-Jin Wei, Columbia University World Trade Organization April

2 Impact of Services Development on Manufacturing Performance Not straightforward: v Services & manufacturing compete for resources à development of one can be at the expense of the other. v If services are used intensively as inputs à services development can help manufacturing production. We focus on financial & business services. 2

3 Why financial & business services? Both emerge as dynamic, internationally traded services. Well functioned financial services are critical in mobilizing resources, stimulating investment, and helping firms better managing risks. Intensive use of modern business services can help firms increase productivity, reduce costs, expand their choices, differentiate their products, strengthen their after-sale customer services, etc. They provoke de-industrialization concerns: The development of the services sector has drawn resources away from manufacturing not just in industrial countries like U.S. & U.K., but also in developing countries like India & Philippines. Often regarded as the pillars of modern economies: Corr(VA shares in GDP, income level) >0 3

4 Figure 1: Scatter plots of the shares of services value added in GDP against income level, log(gdp/capita) Financial Serives Value Added / GDP log(gdp/capita) Business Services Value Added / GDP log(gdp/capita)

5 Importance of Services Inputs in Manufacturing Exports Conventional trade statistics show that services trade accounts for only 20%. Loungani, Mishra, Papageorgiou, and Wang (2017) However, a significant part of goods trade includes trade in embodied services. In the U.S., for example, more than ¼ of inputs purchased by manufacturers were from the services sectors (USITC, 2013). For computers and electronic products, this percentage a measure of services intensity is as high as 47.6%. Miroudot and Cadestin (2017): services inputs account for about 37% of the value of manufacturing exports. 5

6 Financial Services (selected WIOD countries/regions) ctr gexp vaexp = dvaexp + indvaexp 10,116 11,897 5,624 6,273 1,597 1, , , , , , , , , TOTAL 30,300 46,293 16,070 30,223 Domestic services Development Services Access to foreign services Manufacture 6

7 Business Services (selected WIOD countries) ctr gexp tvaexp = dvaexp + indvaexp TOTAL Manuf needs servicification Premature industrialization 7

8 Literature Review Embodied services in goods, based on Leontief inverse, is not new. Based on national IO tables: no info on the origins of imported inputs Gruebel (1988): Canadian exports had a surplus in embodied services but deficit in direct service trade. Urata and Kiyota (2003): some Asian economies Francois and Woerz (2008): business service inputs in manufacture Francois etc (2012): VAX/gexp>1 Based on International IO tables: Stehrer, Foster, and Vries (2012): share of services in goods directly and indirectly linked to manufacture. Timmer et al. (2013): share of income and jobs in goods directly and indirectly linked to manufacture. 8

9 Literature Review The role of services in growth/productivity: Literature review by Hoekman and Mattoo (2008): Access to low-cost & high quality services can promote growth. Industry level evidence: Amiti & Wei (2009a,b): positive impact of service offshoring on manufacture productivity and domestic employment. Firm level evidence: Arnold, Javorcik, and Mattoo (2011): Czech firms Arnold et al. (2012): Indian firms Fernandes and Paunov (2012): Chilean firms Debaere et al. (2013): Ireland firms Lodefalk (2014): Swedish firms 9

10 Literature Review On financial services: Rajan and Zingales (1998) and follow-up studies: Industries that are dependent on financing grow relatively faster in countries with more developed financial markets. Ju and Wei (2011): For economies with low-quality institutions, finance is a key driver of the real economy and a source of CA. Manova (2008): financial development promotes increased exports of finance intensive industries. Buera et al. (2011): Sectors with more financing needs are disproportionately vulnerable to financial frictions. Amiti and Weinstein (2011): Access to external finance helps to increase firms export performance. 10

11 Literature Review Differences from Rajan & Zingales: We consider business services in addition to financial services. For most countries in our sample, business services as a share of GDP are generally on par with or greater than financial services. Different measure of financial services intensity: Their measure of financial dependence is about the amount of externally raised funds relative to total funding. In IO context, we look at value added contributed by F services. Financial services may facilitate an investment deal, but is different from investment Rubber and Plastics Chemicals Basic Metals Wood Pulp & Paper Mineral Electrical & Optical Transport Equipment Coke & Refined Petroleum Textiles Machinery, Nec Manufacturing, Nec Food, Beverages & Tob Financial Services Input Intensity Leather & Foo 11

12 Literature Review: Summary Estimation of embodied services & studies on how services sectors affect downstream manufacturing is not new, but the two are somewhat disconnected. The former estimates the embodied services, but does not examine empirically its linkage to services sector development and manufacturing performance. The latter uses some proxies of inter-sectoral linkage to examine the effects of service reforms/development on manufacturing sectors without quantifying precisely services input intensity. 12

13 Main Goals/Contributions of this paper This paper connects the two literatures by precisely measuring the indirect roles of services in trade of goods valued-added based measure of export competitiveness directly quantifying the effects of services development on manufacturing export performance, taking into account their services input intensity. 13

14 Main Hypothesis The effect of domestic services development (D) on manufacturing export competitiveness (RCA) is more positive for manufacturing sectors with higher services input intensity (SII). 14

15 Measurement of SII V i VBF method V i is the N 1 direct value-added coefficient vector. Each element of gives the ratio of direct domestic value-added to gross output (exports) for country i at sector level. This is equal to one minus the intermediate input share from all countries j (including i itself). B ij denotes the N N block Leontief inverse matrix, which is the total requirement matrix that gives the amount of gross outputs in producing country i required for a one-unit increase in final demand in destination country j. F jj is a Nx1 final demand (domestic & foreign) matrix for country j. 15

16 Measurement of SII 16 ú ú ú ú ú û ù ê ê ê ê ê ë é = ú ú ú ú ú û ù ê ê ê ê ê ë é ú ú ú ú û ù ê ê ê ê ë é ú ú ú ú ú û ù ê ê ê ê ê ë é = G GG G G G G G G G G G G GG G G G G G F B V F B V F B V F B V F B V F B V F B V F B V F B V F F F B B B B B B B B B V V V VB F! " # " "!!! " # " "!!! " # " "!!! " # " "!! ˆ Each element represents the VA from a source sector of a source country directly or indirectly used by an absorbing sector in a destination country's total final demand (domestic + foreign).

17 Measurement of SII Services Input Intensity (SII) = (embodied services / manufacture VA)!"" # $% = ' # $ ( ## $% ) # % /+, # % Should we use country s own SII? SII of a country with underdeveloped services sectors (e.g., financial repression) may not be able to capture the required services input intensity along the manufacturing PPF. 17

18 Countries own SII or U.S. SII? Use U.S. as the benchmark country: U.S. has the least services transaction costs and frictions. If inter-sectoral linkage is considered as a feature of the production technology, it should be the same across countries in the absence of services under-development. Alleviate endogeneity problem No impact from other countries RCA or D on U.S. SII. We will drop U.S. observations from our regressions to further alleviate the endogeneity problem. Data quality Rajan and Zingales (1998) measure industries dependence on external funds using only U.S. data for all countries. 18

19 Measures of Domestic Services Development (D) D = ratio of services value-added to GDP. Figure 1: positive relationship between income level and the shares of financial and business services in GDP. Alternative measure = average VA per worker Other measures of financial services development (Rajan and Zingales 1998): (Bank private credit) / GDP (Bank private credit + stock market capitalization) / GDP 19

20 Dependent Variable: RCA Traditional RCA: Balassa (1965) ( ) *!"# $ % = '. *,- ( * ) 0 * /,- (/. / 0 ( / *, country i, j = 1, 2,.G; sector k=1, 2,.K *,- Problems: It ignores both domestic production sharing and international production sharing (Koopman, Wang, and Wei 2014 & Wang, Wei, and Zhu 2013) A conceptually correct measure needs to include indirect exports of a sector s VA through other sectors exclude foreign-originated VA and pure double counted terms Following Wang, Wei, and Zhu (2013): RCA G i i DVAk i= 1 k N i N G å DVA k= 1 k åk= 1åi= 1 = å DVA DVA is domestic value added in gross exports i k DVA i k 20

21 World Input-Output Database (WIOD) 35 industries for 40 countries over The data for years after 2008 were dropped to avoid potential complications resulting from the 2008 global financial crisis. We consider all 14 manufacturing sectors. 21

22 EMPIRICAL STRATEGY & DATA!"# $%& = ( ) + ( +,-- %& + (. / $& + ( 0,-- % / $& $ + 4 % + 4 & + 5 $%& + Control variables (X): lrgdpch = log(gdp/capita) GVC participation index (forward-linkage; Wang et al. 2017) how a sector s intermediate goods exports strengthen its overall export performance? Socio-economic variables: TFP_dual = manufacture TFP estimated by the dual approach lemp = log(manufacture employment) skratio_comp = payment to high skill workers / payment to all workers klratio = capital/labor ratio in manufacture rwage_emp = average wage in a country / world average wage Fixed Effects: i + s + t or i*t + s*t Robust std errors clustered by country*sector 22

23 The effects of D on manufacturing export RCA Using U.S. SII (averaged over ) (1) (2) (3) (4) (5) (6) D f *** (1.733) D f *SII f *** *** (35.993) (37.762) D b (2.066) D b *SII b *** *** (12.895) (13.937) D fb ** (1.405) D fb *SII fb *** *** (6.695) (7.182) Country FEs Yes Yes Yes Sector FEs Yes Yes Yes Year FEs Yes Yes Yes Country*Year FEs Yes Yes Yes Sector*Year FEs Yes Yes Yes Observations 5,686 5,686 5,686 5,686 5,686 5,686 R-squared

24 24

25 Robustness check (1): alternative measure of D D = services VA per worker (1) (2) (3) (4) (5) (6) D f (0.001) D f *SII f 3.854** 3.992** (1.570) (1.948) D b (0.001) D b *SII b 1.310** 1.247** (0.554) (0.621) D fb (0.001) D fb *SII fb 1.209*** 1.160** (0.439) (0.504) Country FEs Yes Yes Yes Sector FEs Yes Yes Yes Year FEs Yes Yes Yes Country*Year FEs Yes Yes Yes Sector*Year FEs Yes Yes Yes Observations 6,220 6,220 6,220 6,220 6,220 6,220 R-squared

26 Robustness check (2): alternative measure of financial D (1) (2) (3) (4) D f ** (0.120) D f1 *SII f 7.724*** 7.668** (2.841) (3.065) D f *** (0.072) D f2 *SII f 4.962*** 5.121*** (1.662) (1.863) Country FEs Yes Yes Sector FEs Yes Yes Year FEs Yes Yes Country*Year FEs Yes Sector*Year FEs Yes Observations 5,758 5,678 5,758 5,678 R-squared Df1 = (Bank private credit) / GDP Df2 = (Bank private credit + stock market capitalization) / GDP 26

27 RCA against Bank Private Credit to GDP, year 2005 RCA_domvaexp Basic & Fabricated Metals (low SII) RCA_domvaexp Food, Beverages & Tobacco (high SII) (Bank Private Credit)/GDP (Bank Private Credit)/GDP 27

28 Robustness check (3): using alternative services input intensity measures, with country*year and sector*year fixed effects (1) (2) (3) Use U.S. SII time-varying Use own SII time-varying D fb *SII fb *** *** ** (6.546) (4.147) (14.332) TFP 0.064** 0.067** 0.067** (0.028) (0.029) (0.029) log(emp) 0.964*** 0.944*** 0.969*** (0.099) (0.095) (0.099) SKratio (0.818) (0.682) (0.687) K/L 0.070*** 0.075*** 0.070*** (0.026) (0.027) (0.025) rwage (0.009) (0.008) (0.008) GVC Participation 2.575*** 2.572*** 2.556*** (0.496) (0.499) (0.498) Country*Year FEs Yes Yes Yes Sector*Year FEs Yes Yes Yes Observations 5,686 5,855 5,714 R-squared Use U.K. s SII Averaged

29 Testing Hypothesis 2 (Bypass Effect) We consider not only domestic services development, but also access to foreign services as inputs. Share of foreign embodied services among the total embodied domestic and foreign services:.!"#$h & '( = * +,+-& / ' + 0 '( +&! ( & / * / ' + 0 '( ( +&! & H2: the effect of embodied foreign services inputs (forsh) on manufacturing export RCA is more positive in countries with lower levels of domestic services development (D), especially for manufacturing sectors with higher SII '7 = !"#$h +'7 + 8 ; < = < +7!"#$h +'7 +?@ + A + + A ' + A 7 + B +'

30 Manufacturing sector classification based on service input intensity WIOD sector Sector Description Average ratio of embodied domestic F&B services to total manufacturing VA for U.S. over Leather, Leather and Footwear Food, Beverages and Tobacco Transport Equipment Machinery, Nec Manufacturing, Nec; Recycling Textiles and Textile Products Electrical and Optical Equipment Chemicals and Chemical Products Pulp, Paper, Paper, Printing and Publishing Coke, Refined Petroleum and Nuclear Fuel Wood and Products of Wood and Cork Rubber and Plastics Other Non-Metallic Mineral Basic Metals and Fabricated Metal

31 Can foreign services help to bypass inefficient domestic services? for MORE services intensive manufacturing sectors (1) (2) (3) (4) (5) (6) D f (3.766) forsh f (0.499) (1.295) D f *forsh f ** (4.376) (22.928) D b *** (5.080) forsh b ** (0.660) (1.113) D b *forsh b *** *** (8.025) (15.308) D fb 6.959** (3.374) forsh fb ** (0.820) (1.548) D fb *forsh fb *** *** (4.499) (12.198) Country FEs Yes Yes Yes Sector FEs Yes Yes Yes Year FEs Yes Yes Yes Country*Year FEs Yes Yes Yes Sector*Year FEs Yes Yes Yes Observations 2,901 2,901 2,901 2,901 2,901 2,901 31

32 Can foreign services help to bypass inefficient domestic services? for LESS services intensive manufacturing sectors (1) (2) (3) (4) (5) (6) D f (4.761) forsh f (0.560) (1.549) D f *forsh f (9.165) (25.722) D b 9.509** (4.404) forsh b (0.589) (0.984) D b *forsh b * (7.452) (14.001) D fb (3.735) forsh fb (0.786) (1.844) D fb *forsh fb (5.555) (15.852) Country FEs Yes Yes Yes Sector FEs Yes Yes Yes Year FEs Yes Yes Yes Country*Year FEs Yes Yes Yes Sector*Year FEs Yes Yes Yes Observations 2,931 2,931 2,931 2,931 2,931 2,931 32

33 Conclusions & Policy Implications Direct trade pattern can be misleading. The indirect exports of F&B services through merchandized exports account for a large share among total value added exports in trade of goods. We also find that services development enhances competitiveness of manufacturing sectors that use services inputs intensively. à If a country s services sectors are not competitive enough to export services directly, their competitive manufacturing sectors can facilitate the indirect exports of services. 33

34 Conclusions & Policy Implications Bypass effect: countries may bypass their inefficient domestic services sectors by relying more on imported services inputs. This suggests that nations with under-developed services may take advantage of globalization in services. Countries that hesitate to liberalize their services sectors in hopes of protecting their inefficient domestic services sectors may hurt their manufacturing sectors. 34

35 Conclusions & Policy Implications We should avoid a silo approach with each policy area being addressed separately in piecemeal fashion. Hoekman and Jackson (2013) A more comprehensive approach with a big picture by taking into account the inter-sectoral linkages. 35

36 Thank You! 36

37 Summary We study embodied services in manufacturing exports. Two goals (contributions) of this paper: We develop a methodology to measure indirect roles of services in international trade of goods valued-added based RCA (a measure of export competitiveness) Investigate the connections between services development and manufacturing export RCA, taking into account their services input intensity. Main findings: 1. Services development can enhances the export competitiveness of manufacturing sectors which use services inputs intensively. 2. A country can bypass its own inefficient services sectors by importing services as inputs for its manufacturing sectors. 37

38 Embodied F service shares vs. embodied B service shares in all manufacture sectors for each WIOD country, year As we expect, U.S. embodied services ratios are among the highest for both financial and business services. ZOW Business Services Input Intensity 38

39 Corr(STRI, forsh) for textiles sector in year 2000 Source of SRTI: Borchert, Gootiiz and Mattoo (2012) Financial services trade restriction index 39

40 WIOD countries Code Country Code Country Code Country Code Country Australia Denmark Ireland Poland Austria Spain Italy Portugal Belgium Estonia Japan Romania Bulgaria Finland South Korea Russia Brazil France Lithuania Slovakia Canada UK Luxembourg Slovenia China Greece Latvia Sweden Cyprus Hungary Mexico Turkey Czech Rep. Indonesia Malta Taiwan Germany India Netherlands U.S. 40

41 Detailed ISIC sectors inside financial services 6511 Central banking 6519 Other monetary intermediation 6591 Financial leasing 6592 Other credit granting 6599 Other financial intermediation n.e.c Life insurance 6602 Pension funding 6603 Non life insurance 6711 Administration of financial markets 6712 Security dealing activities 6719 Activities auxiliary to financial intermediation n.e.c Activities auxiliary to insurance and pension funding 41

42 Detailed ISIC sectors inside business services 7111 Renting of land transport equipment 7112 Renting of water transport equipment 7113 Renting of air transport equipment 7121 Renting of agricultural machinery and equipment 7122 Renting of construction and civil engineering machinery and equipment 7123 Renting of office machinery and equipment (including computers) 7129 Renting of other machinery and equipment n.e.c Renting of personal and household goods n.e.c Hardware consultancy 7220 Software consultancy and supply 7230 Data processing 7240 Data base activities 7250 Maintenance and repair of office, accounting and computing machinery 7290 Other computer related activities 7310 Research and experimental development on natural sciences and engineering (NSE) 7320 Research and experimental development on social sciences and humanities (SSH) 7411 Legal activities 7412 Accounting, book-keeping and auditing activities; tax consultancy 7413 Market research and public opinion polling 7414 Business and management consultancy activities 7421 Architectural and engineering activities and related technical consultancy 7422 Technical testing and analysis 7430 Advertising 7491 Labour recruitment and provision of personnel 7492 Investigation and security activities 7493 Building-cleaning activities 7494 Photographic activities 7495 Packaging activities 7499 Other business activities n.e.c. 42

43 U.S. vs China/India in business services U.S. has not only largest direct business services exports but also largest indirect exports (twice as large), suggesting an important role of business services in U.S. manufacturing activities. By comparison, China s direct export of business services is only 9% of the U.S. s amount; its indirect exports is only 8% of the U.S. Miroudot and Cadestin (2017): Firms in many countries bundle manufacturing with services (but not China). iphone & Apple Stores China needs to focus not just on manufacturing production, but also on servicification to upgrade manufacture. India: gexp > VAX of business services à little embodied business services in other sectors. Plenty of room for India to take advantage of its competitive services sectors by exporting more services indirectly. 43

44 Evolution of GVCs and Comparative Advantages Financial Services Bottom left quadrant: Greece & Russia Underdeveloped financial services is reflected in the low share of direct exports and the low level of embodied exports à less competitive goods sectors (Russia) or more reliance on imported services (Greece), or both. Top left quadrant: China Uncompetitive to export financial services directly, but which do export a significant share indirectly à competitive goods sectors, or restrictions on cross-border services imports (which oblige goods producers to use domestically produced services) or both. Top right quadrant: Austria, Belgium, and Netherlands Developed financial services sector exports both directly and indirectly. Bottom right quadrant: U.S. Mature deindustrializers : Domestic tangible industries have shrunk in importance and financial services are mostly exported directly. 44

45 Evolution of GVCs and Comparative Advantages Business Services Given the greater cross-border tradability or openness to trade of business services, there is less scope for an intermediate stage (to populate the top left quadrant). When a country is not competitive in producing these services, it neither exports them nor do its goods sectors use them intensively (relying on imported services instead). When a country is competitive, it exports both directly and indirectly (only exception: India). Bottom right quadrant: India offers an example of premature deindustrialization. perhaps because of the relative weakness of goods sectors. 45

46 Evolution of GVCs and Comparative Advantages mature industrialization premature industrialization 46