Service industries in autarky, both in developed economies and less developed ones, have gained increasing stature in recent decades since the mass commercialization of advanced technologies in several service sectors. Not only has information technology, for example, revolutionized the telecommunications and computer-software for final consumer markets, but it has also directly impacted the operations of intermediate service providers (i.e., services purchased primarily by business and industry) such as financial services and professional & technical services. In terms of their share in the country's gross domestic product (GDP), services represent a large and increasing proportion e.g., 70% of U.S. GDP and employment in 1984 (OTA, 1986). When considering the international perspective of services, it is surprising that trade in services comprises only a small fraction of the total world trade transactions. This is the case because of the nature of tertiary services (services purchased by ultimate consumers) that is non-transportable, thus non-tradable. But, it is more interesting to learn that affiliate sales of services in overseas market as a result of foreign direct investment (FDI) contribute more to the balance of payments' invisible account in terms of investment income than direct export of services. In short, international service transactions are determined more by the investment flows than the trade flows. These patterns of services trade and investment lead to fundamental findings of and several implications for this study.

This study attempts to achieve two objectives: first, to adapt the conventional international trade theory developed during the last century and most recently to determine the factors of services provision; and second, to utilize the resultant assumptions to answer the topic question whether the less developed countries (LDCs) can use trade in services as their competitive advantage to improve their balance of payments vis-a-vis the developed countries (DCs), consisting of OECD and major EU countries. The first objective deals principally with the generalization of international trade in services that is extrapolated and relaxed from the usual assumptions given for international trade in merchandise. It also focuses on the competitive advantage of the nation resulted from the liberalization of trade and investment rather than on the comparative advantage which is based on the specialization of production. The second objective stresses on the consequences of the former in that international competitiveness in services is directly connected to the input productivity of the service factors, namely the skill-based human resources (H) and the knowledge-based technology (T), and the presence of non-tariff barriers to services trade. Both immediate- and long-term strategies for the LDCs to adopt in order to achieve and sustain their international competitive advantage position shall be discussed and recommended.

The organization of this study is divided into three sections. Section one explores the determinants of service factors based on the dynamic framework of trade in goods (i.e., changes in the availability of human resources and technological progress) and the relaxation of its assumptions. This part also incorporates the methodology from which service factors are derived. Section two seeks to explain how input productivity of service factors and non-tariff barriers affect the competitiveness of the country given its dynamic factor abundance and intensity. Some alternative trade and investment patterns for service industries in LDCs are also proposed and evaluated in this part. And finally, Section three provides some concluding remarks as well as recommendations for future research.

Determination of Service Factors Back to Top

Comparative Advantage vs. Competitive Advantage

Under the classical Ricardian trade theory and its contemporary variation such as the Heckscher-Ohlin (H-O) theorem, input factors for the production of commodities are derived from the static resource endowments that are abundant in each country. The abundance of one particular resource relative to the other provides the rational incentive for the country to specialize in and export the commodity in which it has comparative cost-advantage in its factor content, and to import the commodity in which its factor is scarce and more expensive (Salvatore, 1995). As the availability of resources expands through external factor mobility, international trade based on production specialization in the framework of comparative advantage is no longer valid as input factors will flow freely from the countries where factor prices are relatively cheaper to the countries where their prices are more expensive. Free flows of factors across national borders emerge from the pressures created when countries are competing with each other to attract their scarce resources from the resource-abundant countries by increasing international factor prices. This brings about the important different notions between production specialization on the one hand and trade and investment liberalization in the framework of competitive advantage on the other which forms the basis for today's multilateral economic transactions and relationships, especially in the realm of services.

To lay the foundation for service factor determinants, the usual assumptions for static trade model shall be modified to reflect the reality of external factor mobility as well as the dynamic nature of the input factors themselves. Two input factors are identified to embrace two different extremes of input-based services: skill-based human resources (H) and knowledge-based technology (T). These factors can be considered as the higher-order input factors of commodity ,i.e., labor (L) and capital (K) in that H represents human resource for services catered to the final (tertiary) market, whereas T is the major component of services provided in the intermediate market. The main distinctions between H and T are given in details in Exhibit 1. Definitions of both intermediate and tertiary service markets are provided in Terminology Section of Part IV. Succinctly defined, intermediate services are closely related to the knowledge-based technology whereby they can be directly exported, whereas tertiary services are tied with the skill-based human resources where consumers must personally come to the site to purchase the services; in other words, they are non-transportable. H-intensive services concentrated in the tertiary market include those in shipping and distribution of products, retail trade, health care, travel/recreation/entertainment, education, and other personal and social services including government. T-intensive services, on the other hand, which primarily serve business and industry include financial services, professional and technical services, and information-technology services. The detailed classification of services is given in Exhibit 2. Their dynamism not only includes external factor mobility, but also is resulted from the fast-paced development in both human skills and knowledge over time.

Exhibit 1
Knowledge-based Technology VS. Skill-based Human Resources

Knowledge-based Technology (T)	Skill-based Human Resources (H)
High-skill levels and relatively high pay, professional and para-professional jobs, continuous learning.	Low-skill levels and educational requirements, low pay, limited upward career mobility.
Technology affects quality of services, and enhance human skills.	Technology does not affect the nature of services, but replaces human skills.
Services are provided in intermediate market.	Services are provided in tertiary market.
Services involve substantial customization.	Services tend to be more standardized.

Source: Office of Technology Assessment, 1987.

 

 Exhibit 2
Classification of Services by Markets

Intermediate Markets	Tertiary Markets
Financial Services: - Banking, Investment, and Brokerage - Insurance - Leasing	Social & Government Services: - Postal and Courier Services - National and Public Security
Professional & Technical Services: - Technical Licensing - Design, Engineering, and Construction - Management Consulting - Legal Services - Accounting	Shipping & Distribution: - Ocean and Containerizing - Railway - Trucking - Air Freight - Warehousing and Wholesale
Information Services: - Computer Software - Telecommunications - Franchising - Marketing and Advertising - Research and Data Processing	Other Personal Services: - Property Maintenance and Repairs - Private Security
	Retail Trade
	Health Care
	Education and Training
	Travel, Recreation, Entertainment

Source: Office of Technology Assessment, 1987.

 

Less Restrictive Assumptions for Trade in Services

Four main assumptions have been extrapolated and relaxed from the classical and H-O theories to accommodate the reality in trade in services:

1. External factors mobility resulting from the present and trend in global liberalization of trade and investment in goods and services;
2. Two dynamic input factors H and T, as human-resource skills can be increased by the learning-curve effect through education and training while know-how and technology are advanced through the investment effect in research and development (R&D);
3. Two services: H-intensive and T-intensive, where the former are predominantly non-transportable except that the service providers are transported, and the latter exportable via telecommunications and licensing; and
4. Two markets for services i.e. intermediate and tertiary.

Other important auxiliary assumptions include:

1. Two economic blocs between DCs and LDCs where the former tend to have T-abundance and the latter H-abundance;
2. Heterogeneous demand as services contain higher degree of customization than merchandise dose;
3. Presence of non-tariff barriers to trade and investment in services that are relatively strong in many LDCs;
4. Parity relationship with relatively fixed currency exchange rates between DCs and LDCs;
5. Measurement of international service transactions that is based on foreign revenues balance (i.e., direct services balance plus net affiliate service transactions) rather than direct services balance as reported in the balance of payments alone.

Notice in the last assumption that the term trade in services does not capture the wholeness of worldwide flows of services if measured in terms of direct services balance. Instead, the term trade and investment in services should be used to account for the overseas operations of multinational service corporations in terms of affiliate service sales in host countries' markets. This terminology thus fully supports the assumption of external factor mobility that not only can the relatively inexpensive human resources flow from LDCs to DCs, but they attract capital from DCs to flow into LDCs as well.

Methodology: Hypotheses, Measurement, and Data Interpretation Back to Top

According to the assumptions given in Section 2, two input factors H and T are subject to testing for their validity and representativeness in the dynamic model of trade and investment in services. It is hypothesized that the line dividing between H- and T-intensive services is based on 1) the nature of services whether they are skill-related or knowledge-related, 2) the difference in markets in which the two service categories are provided namely the intermediate and tertiary markets, 3) the service orientation and degree of skill and knowledge intensity in domestic industries between the two economic blocs where LDCs are oriented more toward skill-based services and DCs more toward knowledge-based services.

In order to measure international competitiveness in service industries between DCs and LDCs, comparative economic data analysis is performed. The simple comparative methodology has been developed as follows. Both DCs and LDCs are sub-categorized into ten representative countries with corresponding economic data during the same period. Five countries that represent DCs are: the United States, Japan, the United Kingdom, Switzerland, and France; whereas five ASEAN (i.e., Association of Southeast-Asian Nations: a group of regionally integrated countries in the form of free trade area called Asian Free Trade Area or AFTA) member countries including Thailand, Singapore, the Philippines, Malaysia, and Indonesia are used as the sample for LDCs. Their economic data from 1977 to 1982 obtained from the Balance of Payments and International Financial Statistics of International Monetary Fund (1983) are presented in Appendix.

It is noteworthy that the BOPs' figures reflect only the direct services balance for each country which underestimate the true overall international service transactions. The Office of Technology Assessment (OTA) of the Congress of the United States, in its 99th and 100th Congressional Reports, indicated that the current system of reporting services in the BOPs was subject to large errors. Other principal findings of OTA included the magnitudes of errors, trade in services's positive contribution to the United States BOPs, sales of services by the overseas affiliates of American firms and their importance, ranking of services export industries, and the benefits of liberalization of trade and investment in services (OTA, 1986).

Skill-Based Human Resources and Knowledge-Based Technology

The classical and H-O theories of international trade assume that two countries have the same taste (identical demand conditions), use the same technology in production, face constant returns to scale (constant input productivity ratio), but differ in factor endowments (i.e., labor and capital) (Salvatore, 1990). These assumptions are totally violated under the assumptions given for the trade in services that both countries do not necessarily have the same demand patterns as services are largely customized and vary from country to country, that different technologies are utilized to obtain the same services depending on the skills and knowledge in each country, and that the input productivity increases (increasing return to scale) as skills and technologies change over time to provide more and better service outputs.

Skill-based human input factor prices can be cheaper in LDCs than in DCs given the same education and training background of labor force because of the following reasons. First, more human resources enter the service labor market in LDCs where their skills are used to substitute the more expensive service technologies which are more abundant in DCs. For instance, personal services in retail and travel & recreational industries in LDCs are more prevalent than in DCs where automation and self-services are not unusual. Second, in the absence of proprietary know-how in LDCs, violations of copyright and patent laws are evident, indicating that the intensity of knowledge-based services are lower in LDCs than in DCs. And third, the R&D investment in DCs surpasses that of LDCs in many industries in both goods production and services provision.

On the contrary, the abundant knowledge-based technological input prices are relatively less expensive in DCs than in LDCs. The vast experience and technological leadership of the Japanese construction industry, for example, as well as special skills in project management give Japanese firms a competitive advantage in international biddings. British banking and financial institutions are very competitive internationally, particularly when offering Eurocurrency deposits, merchant banking operations, financial derivatives and risk management, and other services they have pioneered. The United States information technology and telecommunication industries as well as management consulting services enjoy competitive edge in the innovations and marketing of such services worldwide. These firms sell their particular expertise overseas both via direct exports and through affiliate sales.

Service Factors in the World of Trade Liberation and Competition

While the classical theory of international trade focuses on the absolute and comparative factor-price advantage between nations, the H-O theorem postulates that the international difference in factor endowments alone can serve as a basis for and form mutual gains from international trade. Furthermore, international trade will equalize, though not perfectly, the pretrade factor prices (absolute and relative) among nations, according to the Heckscher-Ohlin-Samuelson (H-O-S) Factor-Price Equalization Theorem. These two important conclusions are valid under the highly restrictive assumptions, but are not yet proven effective under the more relaxed assumptions outlined in Section 2.

As mentioned earlier in Section 1 (Exhibits 1 and 2), there are strong associations between H and services provided in the tertiary market on the one hand, and between T and services marketed in the intermediate market. In terms of absolute advantage position, DCs are able to exploit both factors more efficiently than LDCs are, given their better-developed educational systems and more advanced technological development. However, given the greater rate of technological progress in DCs relative to LDCs, the former tend to have more comparative advantage in T than the latter and vice versa. Thus, it is implied under the classical and H-O theorem that DCs should specialize in and export T-intensive services to LDCs while importing H-intensive services from them. But under the relaxed assumptions based on the competitive advantage argument, both DCs and LDCs are free to specialize in either H- or T-intensive services as factors are internationally mobile and their prices equalized. International trade in services alone no longer determines comparative advantage of the nations nor influences their competitive advantages. The value of global service transactions is more or less governed by the foreign investments made by multinational corporations which generate investment income for their home countries more than exports of services. For any country to be internationally competitive in services, it is imperative that the country focus on direct foreign investment flows rather than direct trade flows.

There are strong restrictions to trade and investment in services in most LDCs in the form of non-tariff barriers (NTBs). These NTBs tend to obstruct the flows and divert the benefits of trade and investment in services. In order to effectively liberalize them, DCs especially the United States have sought, since the last GATT's Uruguay Round of multilateral trade negotiations, to gain from the LDCs' governments 1) the national treatment for foreign service industries i.e. the equal treatment for both national (domestic) and foreign-owned firms, 2) the transparency in regulations and barriers that affect services trade i.e. explicit rather than hidden rules, and 3) GATT/WTO procedures for resolving disputes concerning trade in services (OTA, 1987). The first requirement includes the reduction and/or elimination of restrictions on foreign direct investment that may distort trade flows e.g. performance requirements that make exporting and technology transfers the conditions for inbound FDI, and protection for intellectual property (knowledge-intensive). Clearly, as only knowledge-based factor can be directly traded, DCs are in a better position to gain from trade than LDCs can be. The only avenue for skill-based factor from LDCs to be able to enter the international service arena is through outbound FDI. Likewise, LDCs can improve their knowledge-based factor by effectively managing the inbound FDI to attract and retain as much technology and know-how as possible. The ways in which LDCs can manage both outbound and inbound FDIs to gain international competitiveness in services shall be discussed later in Part II, taking into account the rigid presence of NTBs. For the purpose of service factor determination, it is therefore concluded that H and T are considered two dominant inputs for both LDCs and DCs respectively.

Input Productivity and Long-term Competitiveness Back to Top

Measurement of Input Productivity

In this Section, the input productivity of H- and T-intensive services is explored in relation to the international competitiveness of both DCs and LDCs. The productivity of service factors is characterized by the speed for services provision, the level of investment to increase the speed of services provision, and the marginal cost of delivering (transporting) the services to the markets. For H-intensive services, standardization of output quality makes the process of services provision relatively faster than the T-intensive services whose outputs require more customization and lead-time for development. Fast-food franchises and hotel chains, to illustrate, have objective service quality to meet when operating nationwide or worldwide. Speed of services provision and delivery is a more important measure of input productivity for H-intensive services than for T-intensive ones. How to increase services speed without sacrificing the output quality is also essential to the competitiveness of both kinds of services.

The level of investment to increase the speed of services provision also indicates how productive the service factors are in terms of human capital improvement. Although T-intensive services require higher capital investment in R&D than H-intensive services do, it is not obvious that the R&D will improve the services speed. Rather, R&D will enhance human skills and thinking which shall indirectly make them provide services faster. Competitive pressure among services providers may expedite the services outputs as in the cases of computer software development and design & architecture. H-intensive services, on the other hand, have lower level of capital investment. Most of the investment goes into the education and training of skilled labor. As the process of learning is continuous, incremental investment in human capital for H-intensive services tends to be high. It is important to note that technology used in H-intensive services will replace human skills rather than enhance them. This is how technology displaces H-intensive services in many ways in DCs.

H-intensive services have one disadvantage compared with T-intensive services in that they are non-transportable. Either must the service receivers come to the location where services are provided or the service personnel are dispatched to meet the customers. The marginal cost of delivering H-intensive services is rather high when taking into account the cost of travel and transportation of people. It is more convenient, faster, and less costly for T-intensive services to be delivered to the markets. Advanced data communications and processing make it possible for the T-intensive services providers to directly exports their know-how and expertise in the most cost-effective manners.

Competitive Advantage Based on Input Productivity

Given the facts that H-intensive services offer more comparative advantage to LDCs, require lower capital investment, and are non-transportable, the only option for them to be internationally competitive is to increase foreign revenues from their overseas service operations. This can be done by investing more in the DCs' tertiary markets, exploiting the well-trained service personnel in those countries provided that the wages for high skill labor between DCs and LDCs are theoretically equalized, and emphasizing the unique cultural aspects in the personal services that can differentiate themselves from domestic services providers. The result is substantial increase in the economies of scale that extend the service capability frontier while reducing the overall costs of services provision and delivery for LDCs.

The mixture of outbound FDI and direct service exports can also be considered in light of lower transportation cost as a result of geographical proximity. Mexican and other Latin American H-intensive service firms, for example, can invest in the United States and Canada freely based on the North American Free Trade Agreement (NAFTA) while transporting their high-skilled labor to serve in the United States and Canada's tertiary markets. Many countries in Eastern Europe and Northern Africa can follow suit in the European Union's markets. It could be more costly for ASEAN countries to export H-intensive services to the United States and EU countries, but the possibility is open for them to do the same in the Japanese market. How well and effective LDCs can relocate their H-intensive services to DCs' market are the issues to be discussed in Section 9.

Competitive Advantage Based on Non-Tariff Barriers

It is difficult to assume that international trade and investment in services are transacted in the restrictions-free environment especially between DCs and LDCs. Although GATT/WTO is quite successful in reducing tariff barriers among the member countries, its attempts to set rules and procedures to reduce NTBs are still far from accomplishment. Given this NTBs environment, it is for the benefit of LDCs to exploit these rigid international trade and investment gaps. The requirements for inbound FDI of DCs to export their products and services while employing the host countries' natural resources and transferring proprietary technology to local human resources are still intact and used by the LDCs' governments to negotiate for other trade deals with DCs. Therefore, NTBs can be considered the sources of competitive advantage for LDCs to retain foreign inflows of capital and technology. The question is further asked whether LDCs will be able to attract inbound FDI from DCs in view of strong existence of NTBs. This question is addressed in the next Section.

Management of Outbound and Inbound FDIs for Long-term Viability

As pointed out before in Part I about the rationale and role of services factors in the countries' competitive advantage, LDCs can manage their policies on FDIs, both outbound and inbound, to improve their BOPs problem in light of current and foreseeable NTBs. Even though DCs are trying to push the issues of trade in services into the GATT/WTO multilateral trade negotiation agenda, their attempts seem to yield minimal progress as many LDCs, especially India and Brazil, have consistently opposed the inclusion of such issues (OTA, 1987). The opposition might be even stronger with the potential membership of the People's Republic of China (PRC) in GATT/WTO. With its huge skilled-labor force and its leaders' aspiration to unite Taiwan (T-abundant country) and Hong Kong (regional financial center) to become a Greater China, PRC could emerge as the largest H- and T- intensive services provider in the world.

At present, ASEAN member countries are promoting the development of high-skill labor forces in all tertiary service industries. Hotel industry in Thailand, for instance, has consecutively been ranked in the top five in terms of personal service quality for many years (e.g., the Oriental Hotel of Mandarin Chain and the Dusit Thani-Princess Hotel Group). Many international airlines in Asia such as Singapore Airlines, Thai International Airways, The Swirl Group's Cathey Pacific Airlines are highly praised for their exceptional standards in in-flight services by international travelers. Travel and tourism industry within the same region, as the consequence of the high recognition of hotel and airlines service industries, have become the top foreign-revenue earners for most LDCs in the Pacific Rim. Should PRC whose natural and human resources are rich for travel and tourism industry join other LDCs in the competition of international services aside from its stronger manufacturing sectors, LDCs' trade in services shall become the most important factor for their BOPs improvement.

The strategy for LDCs to adopt for the management of outbound FDI is through collaborative investment based upon the existing economic integration structure such as ASEAN and APEC. By pooling among themselves both capital and human resources into H-intensive services and by relocating these pooled investment abroad, LDCs will be able to generate substantial foreign revenues very effectively resulting from their accumulated domestic and regional input productivity. These service-oriented MNCs from LDCs will also have direct access not only to the well-educated human resources in DCs but also to the advanced technology and expertise available locally. Many laws governing foreign-owned service operations, such as the International Banking Act of 1978 and the upcoming legislature on immigration in the United States, are deregulated and facilitate international competition. This instance opens more opportunities for LDCs' service firms to develop their competitiveness in the T-intensive services as well in addition to the outbound collaborative FDI.

In terms of inbound FDI management, LDCs as a group can harmonize their policies concerning trade and investment in services by adopting the clearer, more specific, more transparent, and dynamic policy guidelines for foreign direct investors to follow. National, if not preferential, treatments can be granted to the more T-intensive service firms to access LDCs' local intermediate markets if the requirements for vital technology transfer are gradually met. Bilaterally cooperative and collaborative efforts between DCs and LDCs' governments as well as from GATT/WTO's initiatives shall foster to guarantee the free and fair competition among the MNCs from either economic bloc. In the long run, the NTBs created by host governments will be reduced to a certain minimum that are necessary to encourage the private service sector to compete effectively on the comparable grounds and to provide incentives for them to spill some technological development to other sectors in the economy. By pursuing this policy route, LDCs shall be able to manage the inbound FDI with high confidence and trustworthiness from DCs.

Balance of Payments Effects of Outbound and Inbound FDI Management

Due to the fact that direct exports of services do not contribute much in the countries' balance of trade, the effects of FDI on BOPs are considered greater in terms of foreign revenues generated by the sales of services by overseas affiliates. In order for BOPs to be improved, both balance of trade and balance of invisible accounts (consisting of investment incomes and direct services exports) must be positively increased. Through the use of outbound FDI, LDCs can increase their investment income generated abroad while also exporting their skilled human resources to deliver tertiary services to the final customers. At home, the effectively managed inbound FDI shall guarantee constant inflows of services technology in exchange of local intermediate market opening for DCs' MNCs. Although hampering the balance of payments in terms of intermediate services imports, the resultant benefits on long-term technological development in LDCs shall weight more than the costs incurred.

The actual benefits of these strategies on the BOPs are not yet examined and measured. Especially, the effectiveness of inbound FDI strategy is even harder to quantify since the benefits of technology transfer to local human resources can be greater or worse than expected depending upon the level of preparedness and appropriateness of the each recipient country. It is left for other researchers to conduct future empirical studies along this prediction, which should be contributive to the academic society and beneficial for the policy-makings.

Conclusion Back to Top

The invisible nature of services, whether they are for intermediate or tertiary markets, proves to have lent significant implications on the classical and modern theory of international trade. It also offers an alternative to trade in services that is the flows of service investment across countries. Service factors H and T are more mobile than before in the environment of trade liberalization under the GATT/WTO realm. In such environment, competitive advantage between nations can be gradually developed through the exploitation of dynamic input productivity whereby H and T are enhanceable by an increase in the level of education and training on the human resources side, and investment in research and development on the technology side. Given enough time and capital, experience curve and technology gap between nations will be matched and narrowed. Still, competitive advantage in services can be created from the structural non-tariff barriers. This advantage shall diminish when countries' governments attempt to harmonize their trade and investment policies reciprocal to each other.

For less developed countries to be able to sustain their competitive advantage in services in the long run, strategies to manage both outbound and inbound foreign direct investments must be adopted. These strategies include, for the outbound FDI strategy, the collaborative investment in and relocation of skill-based human resources in which the LDCs have comparative advantage over the DCs to penetrate into their tertiary service markets, and for the inbound FDI strategy, national and preferential treatments of foreign-owned service companies with transparent guidelines for technology transfer to attract and retain know-how and expertise. Within the context of global competition and collaboration in trade and investment in services, the balance of payments of the countries, especially of the LDCs, shall be substantially and sustainably improved.

Recommended Future Research Back to Top

Theory of international trade based on comparative advantage has now been challenged. As reality depicts, trade liberalization tends to overshadow the traditional thinking of trade by specialization in many aspects, services are ones just described. More and better refined assumptions for external factor mobility should be obtained, mathematically proven, and graphically modeled for future research and applications. When the United States Congress's Office of Technology Assessment declared that many service transactions have not been accounted for in the official reporting of the United States Balance of Payments, it is also of primary importance that these figures be corrected and reconciled, otherwise the results of future research in this context will be unrealistic and unreliable. Other areas of empirical study can be focused on the effectiveness of the FDI in services. Again, more accurate and reliable balance of payments information must be obtained first in order to measure and analyze the policy impacts correctly. These are some recommended subjects worthy of further exploration.