International financial openness and manufacturing productivity: A services trade perspective

Non-Technical Summary

Trade in services can occur through direct cross-border exchange involving either provision over telecommunications networks and the internet or through inward foreign direct investment (FDI), with companies establishing a commercial presence abroad to serve the market. One important potential barrier to trade in services is restrictions on the ability of agents to make international payments for imports of services (invisibles in the balance of payments terminology) and policies that constrain the ability of foreign suppliers to purchase real and financial assets – i.e., transactions associated with inward FDI activities, mergers and acquisitions, and purchases of equity stakes in companies.

In this paper, we investigate the relationship between productivity in manufacturing sectors and restrictions affecting the ability to pay for cross-border imports of services and inward investment. We hypothesise that more restrictive international payment policies will have a disproportionately greater negative effect on the productivity performance of manufacturing sectors that use services inputs relatively more intensively. Manufacturing sectors make use of many services as inputs, ranging from professional services to transport to finance, with substantial variation across sectors in the intensity with which services are used. Both country studies and cross-country analyses have found that productivity in more services-intensive manufacturing sectors is more affected by national barriers to trade in services than in sectors that are relatively less services-intensive. The intuition for this is that higher services trade restrictions attenuate competition on domestic services markets, reducing variety and/or increasing the prices of domestically available services.

The policy measures used in our analysis cover 94 countries for the 1965-2018 period, a much longer time span than has been the focus of the recent scholarship investigating the economic effects of services trade policies. This research has been based on services trade restrictiveness indicators compiled by the OECD and the World Bank and WTO, which are limited to the post global financial crisis (2009) period. The absence of a valid and reliable time-series measure of services trade regulation for a large cross-section of countries has been a significant constraint on empirical analyses of the relationship between services trade policy and economic performance.

We find that lower restrictions on services trade and cross-border investment are associated with higher productivity in manufacturing industries that rely more intensely on service inputs. We also find that international restrictions on payment for services and inward investment are complements: manufacturing productivity is higher when both are simultaneously liberalised. The relationship between international payment restrictions and manufacturing sector performance is heterogeneous, varying across time and countries with differing per capita incomes and governance quality. We do not find evidence of complementarity in the first two decades of our sample, when levels of international economic integration and specialisation were lower. Moreover, the hypothesised relationship is much stronger for the high-income countries in the sample. This suggests complementarity is associated with the increase in cross-hauling of FDI and associated supply chain trade specialisation that characterises the more recent decades in our sample. This is consistent with the extensive literature on the relationship between FDI and trade, and research finding that global value chain production is influenced by the costs of contracting and the presence of high quality institutions.

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