There’s a whole other side of trade. A side of trade that typically doesn’t garner the headlines because its complicated, boring, and much more difficult for politicians to be photographed standing in front of. A side of trade you hear mentioned briefly as important, to much somber nodding of heads, before everyone invariably goes back to arguing about tariffs and containers.

Trade nerds can have a little services chat, as a treat… THEN BACK TO THE BOXES.

So how do you deal with something that isn’t a thing, but still crosses a border? – Well that’s services trade. It’s one of the most complex areas of trade policy so for this blog, I’ve teamed up with George Riddell, the dark master of all things services, to try to make it as simple as possible. He also has stories about my first week as a WTO delegate, which is where we first met, but provided I keep making my payments on schedule and don’t involve the authorities, he has promised not to share them.

Our strategy for cutting through the fog around services trade is twofold:

To avoid bogging down every sentence with multiple caveats, we’ll deal with exceptions at the end, rather than as we go along; and
We’re going to illustrate every point with examples from the real world so it doesn’t all become hideously abstract.

Strap in, it’s going to get servicy.

What is services trade?

Services trade consists of transactions between sellers of one country and buyers of another, over something which isn’t a tangible good.

Examples include:

A business in France hiring a graphic designer in Sri Lanka to design a logo;
An Italian tourist eating at a restaurant while on holiday in Brazil;
A UK bank opening up a branch in Turkey to service customers there; and
An Israeli agriculture expert traveling to Barbados to consult on an irrigation project.

A good rule of thumb is to ask yourself if the foreign thing you’re paying for spent any time in a shipping container. If it didn’t, it’s probably a service. Unless of course you’re talking about the ship itself – that’s a transport service (Note: it took is about 8 lines to break our ‘no exceptions until the end’ rule).

How do governments mess with it?

As always when you’re talking about trade policy, the heart of the matter is how government decisions change things for buyers and sellers.

In goods trade, governments use a combination of taxes (tariffs) and rules (regulations) to control the flow of imports into their territory. For services, no tariffs apply, but the rules can be a lot wider and more intrusive.

Types of Service-Trade-Messing-With Regulations

Governments use three types of regulations to control services trade. These determine:

Which services foreign providers are allowed to sell into your market.
This is called market access.

Example: Is a foreign insurance company allowed to sell you a policy?
Compared to local competitors, how are foreign providers treated differently when selling services to our citizens?
This is called national treatment.

Example: Does a foreign bank have to maintain larger capital reserves than a local one, in order to be allowed to take deposits?
Are qualifications earned abroad recognized as equivalent?
This is called recognition.

Example: Can a foreign trained truck driver work in your country on their existing license?

The government uses these regulations to protect the public, protect local businesses from competition, or both. Often it pretends to be doing the former, while really being interested in the latter. This is sometimes referred to as regulatory capture, and if you whisper that three times in a mirror someone from the Cato Institute (if you’re in the US) or the IEA (in the UK) appears to lecture you about Hayek and free markets.

Targeting Regulations

Unlike a potato, which is pretty consistently a potato, services can be delivered in many different ways. Another good rule of thumb is governments like to target their regulations to ensure they’re only getting the services they want in the ways they want them.

This targeting is done through services ‘Modes’

George: “Hey Dmitry, George here. Shouldn’t we try and make this fun?”
Dmitry: “I’m concerned our definitions of fun do not align.”
George: “Nonsense. Everyone loves my tortured analogies. They are the melted chocolate poured atop the dry sticky pudding of an otherwise bland and lifeless day.”
Dmitry: “I regret this already.”

George: Hi everyone, so we’ve been talking about things and thumbs but why don’t we talk about Thing. You know, the disembodied hand from the Addams Family.

So to explain Modes of supply, let’s reframe those examples Dmitry mentioned earlier:

The Thing is paid to make a telephone call to someone overseas and advise them on how to make their homes spookier – that’s a Mode 1 service because neither The Thing, the Thing’s company, nor The Thing’s customer crosses a border.
If the Thing travels to Italy and gets a manicure – that’s a Mode 2 services export by the manicurist. The nail salon didn’t travel and neither did the nail technician, but their customer did. If it helps, basically everything you’ve ever done on holiday was the consumption of a services export. You just didn’t know it.

Pretty clear I should have outsourced making this to a Mode 1 services provider.

Now, if Thing decided that it wanted to expand its operations overseas but didn’t particularly want to go itself – then it could set up a subsidiary or franchise and hire local animated hands to provide spooky advisory services. This is called Mode 3, because neither the Thing nor the Thing’s potential customers crossed a border, but the Thing’s business did.
Finally, if the Thing decides that spookiness requires a hands on approach, he could travel to wherever spookiness is needed and sell it to the customer directly. This is Mode 4, because the service provider has to temporarily enter the buyer’s country to deliver it. This should not be confused with a permanent move abroad. It’s only a services export as long as the move is temporary, for the duration of service provision.

Combined, these four modes allow governments to restrict or impose conditions in a much more targeted way. Thus ends the analogy, which like the Addams Family it’s based on, really does not require a sequel ever again <click click>.

How do all these modes and types work in practice?

So let’s take the example of architectural services. The table below lists the types of restrictions a government might have on them, across each type and mode.

“Wow, that simple table really clears this whole thing up, thanks guys.” - No one ever.

In practice, the actual level of regulations vary massively. The vast majority of governments:

Regulate Mode 1 extensively for some services types, but not others;
Leave Mode 2 largely unregulated (something like Chinese exit visas are an exception);
Design their Mode 3 regulations to attract a controlled amount of foreign investment in the areas they’re comfortable being owned by foreign entities; and
Have incredibly strong barriers in Mode 4 they’re hugely reluctant to touch in free trade agreements.

How does all this play out in negotiations?

When governments negotiate on services trade, they’re really exchanging promises on regulations, and they’re using the types and modes to do it.

For example, a government might decide to offer market access and national treatment in Mode 3 legal services. This would actually be a commitment not to regulate against a law firm establishing a branch or subsidiary (Mode 3) in its territory (market access) and to treat that branch or subsidiary the same way it does any other law firm in town (national treatment).

However, because this commitment doesn’t extend to mode 4 or recognition, the law firm may not be able to send in its foreign lawyers to its new branch to work with their clients (Mode 4) and the government doesn’t commit to accepting foreign legal qualifications (recognition).

I heard most Free Trade Agreements don’t do much on services?

That’s partially true.

Most Free Trade Agreements:

Are hesitant to offer commitments on recognition of foreign qualifications, as this effectively outsources safety to foreign authorities;
Offer very little new market access in Mode 1 (selling remotely) or 4 (temporary entry) services, because these are complex regulatory areas and quite politically sensitive;
Do next to nothing on Mode 2 (tourism) services because is already largely unrestricted; and
Improve some aspects of Mode 3 (establishing businesses/investment) because governments generally like having foreign investors and firms open certain kinds of businesses on their territory, creating jobs and opportunities.

What FTAs do do is lock-in existing levels of openness and provide businesses with legal certainty that might not have been there before.

Even countries with multiple states or territories haven’t fully liberalized services trade. Many US states for example do not recognize licenses or qualifications issued in other states, let alone ones from abroad.

One exception to the above rule is the EU Single Market. It has made considerably more progress than most trade agreements in this regard, but this required unprecedented regional integration and decades of negotiations. Even today, entire swathes of services categories still remain less than completely liberalized.

Does that mean if I’m not an investor or an EU Member State, everything is hopeless?

Not at all.

First, as George and I can tell you first hand, a lot of the reason Free Trade Agreements don’t do more on services is that no one asks. The complexity of services trade rules puts many businesses and interest groups off really engaging, which means neither side has the political will to push the limits on what FTAs can do. You can break the cycle!

Second, just because governments aren’t willing to commit to permanent and binding liberalization through a trade agreement doesn’t mean they’re not willing to liberalize. FTAs can provide a forum for governments and their regulators to talk to each other, which can be important when new regulations are being considered and implemented. An agreement at the regulator level may not be as sexy as a binding Free Trade Agreement commitment, but it can have exactly the same effect while being significantly easier to negotiate and deliver.

Third, the rules governing services trade have always lagged behind their goods counterparts. We had the first multilateral rules governing goods trade in 1947, it took until 1994 to have corresponding ones for services. As economies become more focused on services and technology allows services exports that would have been unthinkable even a decade ago, trade rules are following. Services have already been a far larger part of the UK trade conversation than they’ve ever been in past trade debates elsewhere. The tide is turning, however slowly.

Getting traction on the aspects of services trade that matter to you is increasingly possible, but you need to ensure you’re asking for the right things, in the right way. Hopefully this article will help you navigate the lingo and surf the concepts.

You promised exceptions and caveats…

Believe it or not the above was the very simple version of trade in services. There’s a lot more nuance we skipped over for the sake of brevity and spooky analogies.

Embedded Services

If you look around you, most products are no longer just products. From the after-sale warranty on your oven to the updates needed to keep internet-connected fridges functioning and secure, increasingly services are embedded into the products themselves.

This kind of embedded service complicates the goods/services dichotomy, but at present governments have generally dealt with them by considering the price of the embedded services to be part of the good, while treating the services separately when it comes to rules and regulations.

So for example, if your wind turbine comes with servicing then the government might charge you taxes against a service inclusive price, but any technicians that came over to service it would need to be eligible to perform their duties according to your country’s Mode 4 rules and qualification recognition requirements.

Financial Services

Financial services have always been treated somewhat differently. While on the one hand, they have been some of the most liberalized types of services due to the importance they play in international trade – they are also one of the most heavily regulated sectors, for good reason. In WTO-speak there is something called the ‘Prudential Carve-out’ which allows governments and regulators to take any measures they deem necessary to regulate their domestic market to safeguard against financial crises.

In the EU, there are multiple ways that financial service providers can access the EU market depending on where they are based, and the EU regulators have varying levels of ability to scrutinize and withdraw such access. This is where we get into the passporting versus equivalence debate. But that’s for another time.

Cultural Services

Audio-visual services (basically anything to do with TV, movies or the media) are conversely one of the least liberalized sectors in international services trade. A number of EU member states have historically secured a carve-out of these types of services – to preserve their ability to discriminate against foreign media in favor of domestically produced ones.

In France, they have the CSA (Conseil superieur de l’audiovisuel) which is responsible ‘for ensuring the defence and illustration of the French language and culture in broadcasting’ – to you and me that means a quota of local content songs in French. Given their history the phrase ‘content is king’ might not be apt, but we’re going to just gloss over that.

Digital Only Goods

If I buy a Lizzo song from the Google Play store, that’s a good. If I pay for a Spotify subscription, which lets me listen to and even download that same Lizzo song, that’s a service. To make things even more confusing, World Trade Organization Members have for years repeatedly extended a moratorium on charging tariffs for digitally delivered goods – the bits and bytes that cross over a border, so even though the Google Play store Lizzo song is a good, governments can’t charge tariffs on it… as if it were a service.

If you can get your head around all that, you’re doing better than most of us trade professionals.

We hope you enjoyed this “simple” explanation of the very un-simple world of services trade. There’s a lot more we could have covered, from the limits imposed by the World Trade Organization’s General Agreement on Trade in Services through to the different scheduling approaches countries use to write their services obligations down.

We however, think you have suffered enough.

A big thank you to George Riddell for co-writing this piece with me, and a gentle reminder that if you like trade explained simply you should consider subscribing to these updates and ExplainTrade’s training offers.

Services Trade, Simply Explained - Co-Written by Guest Nerd George Riddell