KENNESAW, Ga. | Jun 11, 2024

The Research Brief

Most manufacturing activities use service inputs such as financial and business services. Dr. Xuepeng Liu’s paper[1] examines the implications of services development for the export performance of manufacturing sectors. They develop a methodology to quantify the indirect role of services in international trade in goods and construct new measures of revealed comparative advantage based on value-added exports. They show that the development of financial and business services enhances the revealed comparative advantage of manufacturing sectors that use these services intensively but not of other manufacturing sectors. They also find that a country can partially overcome the handicap of an underdeveloped domestic services sector by relying more on imported services inputs. Thus, lower services trade barriers in developing countries can help to promote their manufacturing exports.

The Main Hypothesis

On the face of it, services play a relatively small role in international trade. Conventional trade statistics show that services trade currently accounts for only one-fifth of cross-border trade. However, a significant part of goods trade includes trade in embodied services. In the United States, for example, more than a quarter of intermediate inputs purchased by manufacturers were from the services sector. For certain manufacturing sectors, such as computers and electronic products, this percentage — a measure of “services intensity” — is as high as 47.6 percent. The development of the domestic services sector, as well as access to imported services inputs, can, therefore, be expected to influence comparative advantage in manufacturing trade. Dr. Liu seeks to understand this indirect role of services development drawing upon new measures based on newly available data.

The impact of services development is not straightforward. On the one hand, as services are used as inputs in the production of manufactured goods, services development can help to increase manufacturing production. On the other hand, since services and manufacturing compete for resources, the development of the former can be at the expense of the latter. For example, it is evident that the development of the services sector has drawn resources away from manufacturing not just in developed countries like the United States and the United Kingdom, but also in developing countries like India and the Philippines, provoking “deindustrialization” concerns.

The first hypothesis is that, while the overall effect of services development on the performance of manufacturing sectors is ambiguous, the effect is more likely to be positive for manufacturing sectors that use the services inputs more intensively.

This paper focuses on two services sectors that are crucial for modern economic development:  financial services and business services. Both have emerged as skill-intensive, dynamic, internationally traded services. These two services sectors are often regarded as the pillars of modern economies. Services development is mainly measured by the share of a country’s services value-added in GDP. Dr. Liu and his coauthors develop a methodology to quantify the indirect role of services in international trade in goods. They use a suitably modified version of revealed comparative advantage (RCA) to measure the competitiveness of manufacturing sectors. They improve on the traditional Balassa (1965)[2] RCA and construct new measures of RCA based on value-added exports rather than gross exports. Their econometric analysis provides a strong support for the hypothesis.

Policy Implications

Industrial countries have been strong in exporting services, both directly and indirectly. For example, the U.S. is not only the largest direct exporter of business services in the world, but also the largest indirect exporter of business services (actually twice as large), suggesting an important role of business services in U.S.’ manufacturing activities. However, developing and emerging economies have significantly lagged behind, with India being the only exception as a significant direct exporter of business services. Services development in these latter countries would not only strengthen their service sectors but also promote manufacturing sectors.

Countries such as China that may be concerned with the durability of their manufacturing export success may consider building stronger service sectors as a way to upgrade their manufacturing sectors to an even higher level of sophistication. China’s business services exports in value-added terms, relative to its exports in gross terms, are less impressive. Miroudot and Cadestin (2017)[3] show that China is the only country in their sample which has a majority of the manufacturing firms (77 percent in 2013) selling only goods, with little bundling of goods and services, as seen with Apple iPhones/iPads and Apple Stores. To strengthen the manufacturing sector, countries may need to have a favorable business environment that facilitates services upgrading, including but not limited to R&D, marketing, advertising, inventory management, quality control, production scheduling, and after-sale customer services.

With significant improvement in transportation and communication technologies and increasing services outsourcing activities, some developing countries such as India have developed competitive services sectors. For developed countries that have the same strength in service sectors as India, this paper suggests that the manufacturing sectors that use these services intensively tend to have a strong revealed comparative advantage. However, different from most of the other countries, Indian gross exports of business services are actually larger than its total value-added exports, suggesting relatively little embodied business services in other sectors. There is a plenty of room left for India, Philippines and other similar countries to take advantage of their competitive services sectors during their industrialization process.

The Second Hypothesis

This paper also provides evidence for a bypass effect, that is, countries may bypass their inefficient domestic services sectors by making use of 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 the hope of protecting their inefficient domestic services sectors may hurt the competitiveness of their manufacturing sectors.

References

[1] Liu, Xuepeng, Aaditya Mattoo, Zhi Wang, and Shang-Jin Wei, 2020. "Services Development and Comparative Advantage in Manufacturing.” Journal of Development Economics 144(C). https://doi.org/10.1016/j.jdeveco.2019.102438

[2] Balassa, Bela, 1965. “Trade Liberalization and ‘Revealed’ Comparative Advantage.” Manchester School of Economic and Social Studies 33: 99-123.

[3] Miroudot, Sébastien, and Charles Cadestin, 2017. “Services In Global Value Chains: From Inputs to Value-Creating Activities.” OECD Trade Policy Papers, No. 197.