Creating value in an interconnected world: The role of services

24 April 2014
ITC News
The OECD Secretary-General outlines the inherent worth of trade in services as well as the contributions service functions can make to global value chains and national export revenue.

Global trade is undergoing rapid change through a fragmentation of production processes and the integration of emerging economies into the global market. A key factor in the expansion of global value chains (GVCs) is the role played by services activities. There would be no GVCs if well-functioning transport, logistics, finance, insurance, communication and other business services did not move goods, people and knowledge along the value chain. It is through services that companies coordinate and link stages of production. The OECD-World Trade Organization database on Trade in Value Added reveals that services account for over 30% of the value created in manufacturing value chains.

Moreover, a growing number of services are also provided within international value chains. Activities such as research and development, banking, and computer services increasingly rely on knowledge centres located in a variety of countries. Because face-to-face contact with customers remains important, services are generally produced closer to the consumer. However, that does not prevent some important inputs from being offshored to locations where applicable skills and talents can be found. The offshoring of business services has created many opportunities for developing countries to join new services value chains and to participate in the digital economy.

As a consequence, the share of services value-added in trade has increased for all countries. With the addition of direct exports of domestic services; the services embodied in exports of domestic goods; and the foreign services used as inputs in exports, the overall services sector represents, on average, 45% of the value of trade in G20 economies (see figure). This is more than double the share previously measured in gross terms (20%). 

Increasing value addition through knowledge-based services

But there is more to the role of services in GVCs. Services are not just the glue in the value chain, linking one stage of production to another. They also have an important impact on business models and the definition of products. For example, knowledge-based services often help to differentiate products for specific markets and consumers, adding value in the process. Manufacturers of goods are also increasingly looking after the needs of their customers. For example, car manufacturers offer financial services to help their customers buy their products. They then provide after-sale maintenance and repair services.

Investment in knowledge-based capital (KBC) – and innovation more generally – has an important role to play in increasing services sector productivity and helping countries move up the value chain. Business investment in KBC has been increasing faster than investment in physical capital such as machinery and equipment in many countries. In the United States of America, for example, KBC represents about 15% of GDP and contributes around 20%-34% of average labour productivity growth. In some emerging economies, such as Brazil, business investment in KBC has been increasing as well, albeit not as fast as investment in tangible assets.

Well-functioning product and labour markets, and systems of debt and early-stage equity finance, are essential to encourage KBC investment. Bankruptcy laws that do not overly penalise failure are also important. Reducing the stringency of bankruptcy legislation from the highest to the average level in the OECD could raise capital flows to patenting firms by around 35%.

According to a recent study on what is called the servicification of the economy, services should no longer be regarded as supplementary, but as value-adding activities. This is particularly important in the context of developing economies since their participation in value chains cannot occur without putting a new emphasis on services.

Lessons for trade policy

Trade policy needs to reflect these new realities. GVCs oblige policymakers to adapt to a world in which ideas count as much as physical inputs and services are the enablers of value creation. A successful venture now requires not just competitive costs and market access, but also knowledge of foreign markets and customers, high levels of quality and reliability, and the achievement of global standards. To reach such standards, some of the required services have to be imported or provided by subsidiaries of locally established foreign firms. Open markets are therefore crucial. When services cannot be competitively delivered by local firms, the logic of the value chain is to rely on foreign sourcing. In this respect, imports of services are essential for exports of countries that have not yet developed a strong services sector.

For other key services, and in particular services relying on local network infrastructures, reforms will be needed to improve the domestic provision and make it as efficient as possible. Governments can support the development of local services providers by encouraging linkages with international firms, fostering their supply capacity and ability to innovate, and facilitating the adoption of global standards.

The message is clear: efficient services regulations are essential for increasing productivity not just in services sectors, but also in manufacturing sectors. Though unilateral services reforms make a lot of sense, even larger benefits can be expected from multilateral reforms, as all countries rely to varying degrees on access to foreign services providers.

Trade policy is a necessary, but not sufficient, tool to draw the benefits from GVCs for inclusive employment and income growth. In this respect, improving the business environment, combined with investments in people, infrastructure and innovation, as well as complementary labour market and social policies are also essential. Last but not least, Aid for Trade policies have an important role to play, particularly in helping the poorest countries integrate into GVCs.