Barriers to trade in services reduce multinational production

Barriers to trade in services impact on multinational production in the manufacturing sector

Koen De Backer, Sébastien Miroudot, Davide Rigo 19 April 2018

Multinational enterprises that produce goods depend on services to organise their value chain, so barriers to investment in services will probably affect their production. The column runs on the new and comprehensive OECD database to gauge the share of services in the exports of multinational enterprises, and in addition in the output of their foreign affiliates. The results claim that policymakers might need to focus more on the services that support manufacturing industries.

Related

Services have grown to be increasingly important in every economies, with a rising share of services in GDP, employment, trade and investment. The services sector encompasses transportation, finance, tourism, distribution, health or education, but a substantial number of services also support the actions of manufacturing firms.

Recently, the idea of global value chain (Gereffi and Fernandez-Stark 2016) has emphasised that the manufacturing value chain is supported by services. They include research and development and the look of something, the logistics and transport services to go inputs, the marketing, sales and distribution services to attain consumers, and in addition accounting, legal, engineering and IT services.

Multinational enterprises (MNEs) that produce goods depend on many services to organise their value chain. These services could be traded cross-border or supplied by an area supplier. Since most services are intangible and non-storable, the supplier providing something must often maintain the same location as the customer.

Manufacturing firms increasingly produce services themselves, either to source services inputs from their affiliates or even to sell services as a complement to the products they produce (Miroudot and Cadestin 2017). Therefore, we are able to assume that regulations and barriers affecting trade and investment in services affect the production of MNEs. Data on activities of MNEs are scarce, however, and there is little evidence on the role of services in multinational production.

Measuring the production of MNEs and foreign affiliates

To overcome a few of the data challenges in analysing multinational production, the OECD is rolling out a fresh and comprehensive database on MNE activities across countries and industries. This uses the OECD database on Activities of Multinational Enterprises (AMNE), which provides the official data collected and published by National Statistical Offices.

The missing information was estimated using additional sources and different statistical methods. This implies we have a complete coverage of the output, value added, exports and imports of foreign affiliates and domestic companies in 43 countries, in addition to the ‘rest of the world’, across 43 industries from 2000 to 2014 (Cadestin et al. 2018). Furthermore, the AMNE information can be used to split inter-country input-output tables according to ownership. This enables for a value-added analysis of the actions of foreign affiliates, like the analysis provided for trade in the context of trade in value-added (TiVA) statistics.

This dataset highlights that the output of foreign affiliates, as a share of total output, increased before financial meltdown and declined after it (Figure 1). The share has since that time been stable, with foreign affiliates accounting for approximately 12% of total output in 2014. Figure 1 also demonstrates 43% of the production of foreign affiliates are services, often with regards to manufacturing activities.

Figure 1 Share of foreign affiliates altogether output, manufacturing and services affiliates, 2000-2014

Source: OECD Analytical AMNE database.

Exports versus FDI

To gain access to foreign markets, firms can either export their products to consumers or serve them through a foreign subsidiary producing in the host economy. This decision has been described in the economic literature as ‘exports versus FDI’ (Heplman et al. 2004). As the OECD analytical AMNE database covers both trade and the output of foreign affiliates, it could provide insight on the relative need for these two strategies. Regarding services, exports and sales of foreign affiliates match different ‘modes of supply’, as defined in the WTO General Agreement on Trade in Services (GATS). Cross-border trade in services corresponds to modes 1, 2 and 4, while trade through commercial presence is mode 3.

In a recently available paper we’re able to show that, in gross terms, exports and sales of foreign affiliates are roughly equivalent at the world level, each about $20 trillion in 2014 (Andrenelli et al. 2018). But we have to be careful when you compare both concepts, because in value-added terms there exists a difference between exports and sales of foreign affiliates with regards to double-counting (put simply, when removing the worthiness of intermediate inputs which may be counted many times from these gross concepts).

Regarding exports, only intermediate inputs travelling across borders result in double-counting. In the output of foreign affiliates, inputs used through the production process, and the inputs used to create these inputs (and so forth) are also double-counted as domestic sales. Therefore we are able to conclude that there surely is more value-added in trade than in the output of foreign affiliates (Figure 2).

Figure 2 Value-added and double-counting in gross exports and the output of foreign affiliates, 2014

Source: OECD Analytical AMNE database.

The value-added analysis allocates the income generated by services inputs in manufacturing output to the services sector rather than to the manufacturing sector. Importantly, this value-added analysis highlights the real share of services in multinational production. Services take into account about 43% of the output of foreign affiliates, but their share in value-added is greater than 50%.

The impact of services trade barriers on the output of foreign affiliates

Since services are so very important to manufacturing activities, we may expect that regulations and barriers affecting trade in services with an effect on the sales of foreign affiliates in both services sector and the manufacturing sector. There exists a correlation between barriers to trade in services, and the output of foreign affiliates producing goods or services (Figure 3).

We use typically the OECD Services Trade Restrictiveness Index (STRI), designed for 22 sectors, as a proxy for the amount of restrictiveness affecting services in the host economy. This index covers mode 3, and then the impediments to sales of services by foreign affiliates, together with barriers affecting cross-border trade in services. These restrictions impose additional costs to the entry of foreign suppliers and make the services and manufacturing sector less efficient.

Figure 3 Foreign affiliates output and services trade restrictiveness

Source: OECD analytical AMNE database and STRI.

To verify this result econometrically, we use a gravity model predicated on the theoretical framework produced by Bergstrand and Egger (2007), to which we add the STRI and host country-specific variables. When running the regression on the output of foreign affiliates producing services, we look for a negative and strongly significant coefficient for the STRI, indicating that services trade restrictions are connected with less output of foreign affiliates in services.

We also find that services trade restrictions affect a firm’s choice over whether to use exports or FDI to serve foreign markets. High barriers to mode 3 trade in services (that’s, to a commercial presence) are connected with less ratio of foreign affiliate output to cross-border trade. This suggests you will find a substitution effect between local production and cross-border trade in the current presence of barriers to establishment.

Services trade restrictions had a direct effect on the output of foreign affiliates producing goods. Coefficients were most crucial in computer, transport and professional service sectors, the actions most needed by manufacturing firms. We also find that barriers to competition in services sectors will be the ones that a lot of affect the actions of manufacturing affiliates. This shows that, when services sectors are regulated in a pro-competitive manner, foreign affiliates produce higher volumes of goods.

If you wish manufacturing, plan services

Overall, our results demonstrate the intertwined nature of manufacturing and services activities. It has implications for trade and investment policies targeted at promoting the manufacturing sector. Policymakers might need to focus more on services industries to aid their manufacturing industries, which would require a built-in method of manufacturing and services in policy discussions.

References

Andrenelli, A, C Cadestin, K De Backer, S Miroudot, D Rigo, and M Ye (2018), “Multinational production and trade in services”, OECD Trade Policy Papers 212.

Bergstrand, J and P Egger (2007), “A knowledge-and-physical-capital style of international trade flows, foreign direct investment, and multinational enterprises”, Journal of International Economics, 73(2): 278-308.

Cadestin, C, K De Backer, I Desnoyers-James, S Miroudot, D Rigo, and M Ye (2018), “Multinational enterprises and global value chains: the OECD analytical AMNE database”, OECD Trade Policy Papers 211.

Gereffi, G and K Fernández-Stark (2016), “Global Value Chain Analysis: A Primer (2nd edition)”, Focus on Globalization, Governance & Competitiveness (CGGC), Duke University.

Helpman, E, M Melitz, and S Yeaple (2004), “Export versus FDI with Heterogeneous Firms”. The American Economic Review, 94(1): 300-316.

Miroudot, S and C Cadestin (2017), “Services In Global Value Chains: From Inputs to Value-Creating Activities”, OECD Trade Policy Papers 197.

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