The lingering effect of Covid on services trade

While lockdowns imposed across the world in the wake of Covid-19 will be lifted eventually, social distancing, both voluntary and selective, is likely to stay for longer. This already has had — and will continue to have — a significant adverse impact on services transactions that require proximity between buyers and sellers. Trade in services is likely to take longer to recover, with knock-on effects on other sectors of economic activity, and the world could see more regulatory restrictions on services trade on health grounds.

The International Monetary Fund (IMF) and the World Trade Organization (WTO) have predicted massive losses in economic growth and international trade. The WTO expects a 13-32 per cent decline in trade, but these predictions are likely to be underestimates as they are only based on merchandise trade.

In gross terms, services trade accounts for a quarter of global trade; the share of services doubles in value-added terms (WTO, 2019). This emanates from the growing “servicification” of economic activity globally.

Services trade was shown to be more resilient to the 2008 global financial crisis than merchandise trade, given its low sensitivity to demand shocks and less dependence on supply finance. While Covid-19 has resulted in an immediate supply shock followed by a demand shock, what will matter more this time is the social distancing and contagion-related fears, which will have a bearing on services transactions that cannot be substituted or replaced by services traded over the internet.

There are four different ways in which services are traded across borders and three of these four “modes of services delivery” (in WTO GATS parlance) require proximity between buyers and sellers. These include Mode 2 (consumption abroad, e.g. health and education), Mode 3 (commercial presence or FDI in services, e.g banking services) and Mode 4 (movement of people, e.g. IT professionals). Mode 1 or “cross-border services trade” includes the entire range of services transacted over the internet, some of which at least continue to be delivered even in work-from-home scenarios.

The adverse effects of social distancing practices are going to be most evident for services transacted via Modes 2, 3 and 4. According to WTO data, the total value of global trade in commercial services in 2017 was $13.3 trillion, of which nearly 75 per cent was transacted via these three Modes.

According to UNCTAD’s World Investment Report for 2018, nearly half of the foreign direct investment (FDI) in 2017 was in the form of greenfield investment, with M&A activity accounting for the rest. This suggests that at least half of Mode 3 services trade may be completely stalled due to this pandemic, with significant adverse effects on the remaining half. Thus, services trade, worth nearly $7 trillion in value, easily stands compromised by Covid-19. And even this is likely to be an underestimate, given that several Mode 1 services are complementary inputs to manufacturing and other services, which have been affected by the lockdowns.

Some services sectors are going to get more severely affected and are likely to take longer to recover. These include education, tourism and restaurant services (which accounted for over 70 per cent of Mode 2 services exports in 2017) as well as air passenger transport; transport and distribution services, which are related to merchandise trade (and accounted for about a fifth of the global services exports in 2017, though two-thirds of these were delivered via Mode 1); and construction and other business services that require the movement of professionals across borders (and accounted for over a quarter of Mode 2, 3 and 4 services exports in 2017). In contrast, the effects of the pandemic on insurance, financial, telecoms and computer-related services are likely to be more limited as most of these services can still be delivered in work-from-home scenarios.  

This also has an implication for the effects of the pandemic on major services trading economies and their nature and speed of recovery, depending on the intensiveness of the underlying sectors in their gross domestic products. For instance, more than three-fourths of India’s (and global) IT services exports are now delivered online as opposed to on-site; IT services account for close to 40 per cent of India’s total services exports and along with management consultancy services, are one of the few sectors where the country exhibits a revealed comparative advantage.

In contrast, many of the Caribbean and small Pacific islands that rely mostly on tourism are likely to be severely affected and may take longer to recover given the physically proximate nature of such services. Keeping this in mind, the United Nations has already called for a global package of $2.5 trillion aimed primarily at such tourism-intensive economies.

Covid-19-induced delays in reigniting some of these sectors will also affect other areas of economic activity where these services serve as significant inputs. For instance, distribution and financial and transport services are major inputs across manufacturing sectors and total services value-added in manufacturing exports range from 30 to 33 per cent, according to OECD’s Trade in Value Added data. Services value-added also constitutes 90 per cent of services exports with greater reliance on inputs from within the same services sector.

In addition to the time it takes to revert to business-as-usual and a Sars-Cov-2 vaccine being developed for mass deployment, one major determinant of the recovery of global trade will be barriers that countries impose, which in the context of services trade are largely behind-the-border regulatory requirements. Existing studies have already demonstrated the adverse effects of regulatory incidence and differences in regulation on services trade.

The Great Depression and the inter-war period witnessed a rise in border tariffs on merchandise goods, the 1980s saw voluntary export restraints and the 2008 global financial crisis led countries to resort to state aid and subsidies. The need for social distancing and continued fear of the pandemic until a vaccine is available may result in countries imposing additional barriers to trade in services. Given the importance of services in general, countries would do well to ensure that such restrictions do not become prohibitive. This would be a crucial determinant of economic recovery in the aftermath of this pandemic.

The writer is senior fellow, ICRIER. These are excerpts 

from CEPR VoxEU column available at /article/services-trade-and-covid-19

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