Liberalizing Services: Key to Faster Global Growth and the Sustainability of the US Trade Deficit

Testimony before the Subcommittee on International Trade
Senate Finance Committee
United States Senate
Washington, DC

October 21, 1999

Liberalizing trade in services is key to faster global growth and the sustainability of the US trade deficit. As a country grows and matures, services tend to increase as a share of GDP, as does the share of services in US exports to the country. The United States has global comparative advantage in services, yet services remain highly protected abroad. Multilateral and broad-based negotiations on trade in services will help to ensure that US exporters have access to growing markets. In addition, liberalizing policies will enhance competition and efficiency and raise productivity and growth in all the world's economies. Such a "high performance" strategy offers a win-win negotiating platform.

Don't underestimate the rising importance of trade in services

for the US and the world.2

The importance of the service sector for the US economy, for our trade position, and for global trade should not be underestimated. Services exports account for about 30 percent of the total dollar value of US exports (up from 20 percent in 1975). On the import side, the share has been about stable at somewhat less than 20 percent. The trade surplus in services is about $80 billion as against a merchandise trade deficit of about $330 billion.3 As of 1997, the US accounted for about one-quarter of the whole world's trade in services.

The demand for high-quality services at home contributes to a global comparative advantage in the delivery of many different services industries and professional services. Studies by McKinsey Global Institute of selected service-sector industries suggest that labor productivity in the United States exceeds that of its major competitors (Germany, France, United Kingdom, and Japan) by 30 percent in airlines, 30 to 40 percent in retail banking, 20 to 50 percent in telecommunications, and 10 to 50 percent in retail selling. In part because the domestic market is so well developed, the United States is also the world's leading exporter of business and professional services.

The share of services in US exports should increase further as our trading partners grow, mature, and demand more services. For example, in the mature economies of Europe, the service share of GDP is about 70 percent and the share of services in US exports is about 35 percent. For middle-income countries in South and Central America, the service sector share of GDP is about 57 percent and the service share of US exports is 25 percent. But in low-income China and India, the service share of GDP is only 37 percent and the service share of US exports is only 18 percent. Opening markets abroad is crucial to ensure that net trade in services contributes positively to the overall US trade balance, even as we would also expect greater imports of some services. Yet, liberalization of services trade has barely begun, and many barriers face US exporters of services.4

Rising services could diminish the "asymmetry" in response of

trade to changes in income.5

Empirical analysis of the behavior of US trade suggests that there are systematic differences in how goods flows and services flows respond to changes in US and foreign income. Decades of empirical work show that when US and foreign incomes rise, the US tendency to spend additional income on imports is about one and one-half to two times the foreigners' tendency to spend their additional income on US exports. Therefore, when US and foreign economies have grown at the same rate, the US trade balance has tended to worsen.

Recent work suggests that this asymmetry is much smaller or even reversed for trade in services. That is, the US tendency to purchase service imports when our income increases is about the same as or is less than the foreigner's tendency to purchase US service exports when their income rises.6 Over time, as the share of services in total trade increases, the asymmetry of responsiveness of total trade to changes in income likely will diminish. Consequently, as other countries develop and demand more imports of services, the US surplus in services trade is likely to expand; but only if markets abroad are open and growing.

The case for services liberalization is dramatic for the US

and for the world.7

My analysis suggests that the constellation of consensus projections for economic growth here and abroad, of exchange rates and relative prices, and of standard estimates of the income asymmetries yields a trajectory for the US trade and current account deficits that will be unsustainable in two or three years and certainly are unsustainable in the longer term. An unsustainable trade deficit could mean abrupt changes in exchange rates and interest rates with deleterious effects on US and global growth.

An on-going program of service sector liberalization in trade and deregulation and competition in domestic markets here and abroad changes that picture dramatically. Together, faster growth and a more liberal environment for services trade keep the US external accounts from worsening, and indeed they start to narrow in the long-term (10 years out).

How could multilateral service-sector negotiations have such a big impact? First, the impact on global growth is substantial. Comprehensive liberalization of services could raise global GDP by 4 to 6 percentage points—twice that credited to the Uruguay Round—as well as raise the long-run global growth rate from 3.2 to 5.0 percent.8 Second, as a multilateral effort, the impact on US firms and workers would be broad-based. In 1998, service exports constituted 30 percent of US total exports, 55 percent of corporate profits, 75 percent of US real GDP, and 80 percent of nonagricultural payroll employment. No bilateral or sectoral trade negotiation will affect this share of US exports, nor this share of the US economy. For example, one of the most hard-fought market-opening negotiations was the US-Japan agreement on autos and auto parts. In 1997 these sectors accounted for only 6 percent of US total exports and less than half that as a share of real GDP. By ensuring that services exports grow as rapidly as they have been, the asymmetry in income elasticities is reduced enough to radically change the trend in the US trade deficit.

Liberalization of trade and of domestic markets go hand-in-hand, particularly for the services sector, but multilateral liberalization of services has barely begun.9 The United States must move quickly to launch and encourage wide participation in a new trade round with a clear focus on services.

A cautionary note: Services liberalization is not a short-run fix,

nor a long-run panacea.

The trade and current account deficits are large right now partly on account of the cyclical factors of global financial crises and robust US domestic demand; so, resumption of global growth is a necessary ingredient to narrowing the US external deficits in the near-term. However, in addition to the long-term impact of services liberalization, there are structural factors in the US economy that underpin the trend external deficits that need to be addressed, including the low US household savings rate and the insufficient preparedness of US workers for current and future jobs. All told, a combined agenda that emphasizes macroeconomic policies for global growth as well as longer-term services trade liberalization and domestic policy initiatives will reap great benefits for the US and the global economies.



1. This testimony draws extensively from my book, Is the US Trade Deficit Sustainable?, Washington: Institute for International Economics, September 1999.

2. This section draws on Chapter 3 of my book, "Has US Comparative Advantage Changed? Does This Affect Sustainability?".

3. Based on data for January-August 1999.

4. See "The Globalization of Services: What Has Happened? What Are the Implications?" by Gary Clyde Hufbauer and Tony Warren, IIE working paper no. 99-12, October 1999.

5. This section draws on Chapter 6, "Is the US Deficit Caused by Unfair Trade Practices" and Chapter 8, "Is the United States 'Living Beyond Its Means' or an 'Oasis of Prosperity'?".

6. See analysis in Simon Wren-Lewis and Rebecca Driver, Real Exchange Rates for the Year 2000, Policy Analyses in International Economics 54. Washington: Institute for International Economics, 1998; and "Forecasting US Trade in Services" by Alan V. Deardorf, Saul H. Hymans, Robert M. Stern, and Chong Xiang, University of Michigan: mimeograph, October 15, 1999.

7. This section draws on Chapter 10, "Is the US External Deficit Sustainable?"

8. See Hufbauer and Warren, op. cit. and OECD, The World in 2020: Towards a New Global Age, Paris:OECD, 1997.

9. For more on what needs to be done, see Jeffrey J. Schott, The World Trading System: Challenges Ahead, Washington: Institute for International Economics, 1996.