Discussion Note

Services trade and priorities for future negotiations

Published 18 November 2024

This roundtable was convened jointly by the Centre for Inclusive Trade Policy and Resolution Foundation. The event was held under the Chatham House Rule and took place on 15 October 2024.

Background

The UK is primarily a services economy, which accounts for 81% of economic output (Gross Value Added) and 83% of employment. The environment surrounding UK services is rapidly changing. Emerging technologies are driving the digitisation of trade, making almost 80% of the UK’s exports potentially digitally deliverable. Artificial Intelligence (AI) is shaping many aspects of service industries, from employment to supply chains. At the international level, global policies and regulations relating to climate change, national security concerns, and other non-trade objectives are impacting on both the manufacturing and services sectors. Furthermore, domestically, while the London-centred services ecosystem has a strong comparative advantage in producing and trading services, there is an issue of geographic imbalances within the UK.

From a trade policy perspective, the post-Brexit services trade arrangements with the EU under the UK-EU Trade and Cooperation Agreement (TCA) created new barriers for businesses compared to Single Market access. The UK has concluded about 40 trade agreements,1 some of them include innovative digital trade chapters, others are a new form of Digital Economy Agreement, such as the one with Singapore. However, at the multilateral level, little progress has been made since the General Agreement in Trade in Services (GATS) was created in 1995.

Against this background, the roundtable discussed priorities for the new UK Government’s services trade policy and negotiations at the bilateral, plurilateral and multilateral levels. The discussion was wide-ranging, yet certain themes clearly emerged. This summary is not intended to suggest that there was a consensus of views but instead provides an overview of the key issues raised, some important unanswered questions, and possible recommendations for inclusion in the UK Government’s forthcoming trade strategy.

Overview of UK services trade

One participant explained that similarly to the OECD as a whole, UK services exports have risen more sharply than goods exports since the Covid-19 pandemic. Between 2019 and 2022, the primary driver of the increase in UK services exports was the growth in international demand, as opposed to changes in the structure of UK exports. There is some evidence that the UK’s comparative advantage over the last decade has been high and growing in international business services, and growing also in intellectual property services, while declining in telecommunications, and in more recent years in financial services.

The way in which services are being traded internationally, and not just by the UK, appears to be changing. This phenomenon is sometimes described as “mode switching”2. This enables more services to be delivered electronically (Mode 1) as opposed to other modes of supply, e.g. through commercial presence (Mode 3) or the movement of natural persons as service suppliers (Mode 4). Factors such as digitalisation, remote working regulations, or firms' decisions to avoid higher trade barriers have contributed to this trend.

UK services exports to the EU now rely more both on Mode 1 but also Mode 3, as for some businesses, local establishment better suits the post-Brexit regulatory environment. There has also been some switch from Mode 4 (temporary movement of natural persons) to Mode 1. Participants observed that the UK economy will continue reorienting in response to the UK-EU TCA and other trade policies. Some showed concern that a decline in services trade, particularly with the EU, is likely to happen in the near future. Participants shared the view that understanding the decisions taken by British firms in the new business environment is crucial for developing better policies.

The importance of attracting foreign direct investment by leveraging the UK’s competitive advantage in services was discussed, as well as the challenges that leaving the EU has created in this regard. The point was made that services trade is enhanced by a clear legal framework that provides certainty for firms across sectors (financial, insurance, education, IT, professional services). One participant specifically highlighted the importance of the role of manufacturing firms as two-thirds of service exports from manufacturing firms involve foreign-owned companies. This highlights the crucial role of foreign direct investment in driving UK services trade.

The UK-EU relationship

In addition to the issues outlined above with regard to mode-switching, the discussion noted that while the UK holds a comparative advantage in high-skill services, stricter migration policies for highly skilled workers may negatively affect services, especially those in the category of “Other Business Services”, the largest UK services export item. Additionally, leaving the EU has reduced European demand for UK education services, which could potentially influence the highly skilled labour market and affect professional mobility. The UK-EU TCA contains a clause allowing for the negotiation of mutual recognition of professional qualifications between the two parties. In this context, one participant emphasised the importance of discussing more flexible labour mobility measures under the UK-EU TCA to strengthen the UK's comparative advantage in offering highly skilled services, especially in the professional services sector.

The benefits and limitations of Free Trade Agreements (FTAs)

In general, FTAs have been beneficial for international trade even if they have not offered better market access conditions. As empirical research has demonstrated, FTAs have lock-in effects and eliminate uncertainty as signatories bind domestic regulations impacting on market access and the non-discrimination principle of national treatment.

However, one participant was concerned that exemptions in FTAs related to public policy, national security, and the financial sector (e.g. prudential carve-outs) limit the effectiveness of services trade liberalisation. Another participant noted that highly developed countries are introducing new regulations and regressing on services trade liberalisation while developing countries are still liberalising. Participants shared the view that a key challenge is evidencing to policymakers the benefits of liberalising services in an era of government intervention.

While there has been generically a shift towards Mode 1 (cross-border trade), Mode 3 (commercial presence) still plays a role. There are many investment-related regulations in practice. These can diminish the effectiveness of FTAs. One participant addressed the issue of “liability mismatch”: Whereas corporate accountability is crucial, identifying to what extent stakeholders have responsibilities to meet governments’ regulatory requirements, such as digital trade related regulations, is challenging.

Some participants expressed the view that no substantial trade shift from the EU to non-EU trade partners is expected. Although the UK-India negotiations are ongoing, the UK services sector can probably expect little from it. The FTAs with countries like Switzerland, South Korea, and Turkey are also unlikely to have a major impact on UK services trade policy. Looking at UK-US relations, a future UK-US FTA appears extremely unlikely. FTAs with developing trade partners (for example: African countries) could be explored.

In order to liberalise services trade, it was suggested that other policy tools such as sectoral agreements could be more effective than FTAs. In addition, regulatory arrangements, such as Mutual Recognition Agreements (MRAs) with countries with similar regulatory practices (e.g. Australia and the US) could be explored. However, it was noted that promoting regulatory coherence/convergence differs across professions. For example, promoting MRAs for architects and for engineers may be easier than achieving the same for lawyers.

Data and digital trade

Participants shared the view that designing data, digital trade, and artificial intelligence policy is becoming more important for services trade policy. One participant argued that the relation between free data flows and data localisation requirements, and requirements to access source code provisions will become increasingly important, in part because these measures have a big impact on businesses. The US Government has withdrawn its support for restricting the prohibition of data localisation and source code requirements at the World Trade Organization (WTO) Joint Statement Initiative on e-commerce negotiations. It is important to consider the implications this will have for the UK’s digital trade policy and future digital trade negotiations at the bilateral, plurilateral and multilateral levels.

Regarding the WTO Joint Statement Initiative negotiations on e-commerce, it was noted that while the agreement was ‘stabilised’, there is a lack of clarity on implementation, and there remain a number of unresolved issues. For example, a significant challenge remains in terms of the substance of the e-commerce agreement and implementation, as well as the complications arising from the US not joining the agreement. The US’s concerns - such as national security exemptions, free data flows and its relation with localisation requirements and source code requirements - are closely related to geopolitics. One possible way forward would be to discuss these issues in de-politicised environments outside of the WTO.

While extending the moratorium on imposing customs duties on electronic transmissions is extremely important for business, there was pessimism with regard to a long-term sustainable solution.

One participant expressed a concern that the 'EU AI Act,' which aims to establish a global standard for AI regulation, could deter new investors due to its stringent requirements. Another participant stressed the importance of policy instruments to promote interoperability outside trade agreements such as adequacy decisions on data privacy.

Impacts of national security/economic security policies

Many participants expressed concerns that national security significantly impacts services trade policy. Protectionism and measures introduced on the grounds of national security concerns (e.g. the US’s restrictions on hardware and automobiles) undermine liberalisation commitments under international agreements. One participant stressed the importance of discussing the relation between national/economic security and trade policy together with security experts as the trade policy circle and the national security/economic security circle are segmented and look at the issue from completely different policy objectives.

Challenges to empirical research

Participants stressed that explaining the importance of creating a services trade strategy and negotiating priorities is difficult given that services trade is intangible, unlike goods trade. Limitations in data access and quality of data significantly impact the understanding of business priorities. This poses a major challenge for researchers and the civil service in their attempts to provide policy recommendations based on empirical research. Issues such as the difficulty in tracking labour productivity across the UK, challenges in analysing firm-level data on tax records and trade transactions, and the lack of more granular data on services exports are key concerns.

Recommendations for the UK Government

  1. Prioritise policies that promote productivity (growth) and investment in services sectors as these account for a large share of value added and employment. To this end, the new Government’s industrial strategy should focus on key services sectors such as professional services and creative industries. Developing workforce skills is fundamental. The strategy should also consider the involvement of key stakeholders such as businesses that export services, potentially alongside manufacturing goods.
  2. The regulatory environment should facilitate the private sector’s optimal choice of services delivery, be that cross-border trade (Mode 1), local establishment (Mode 3), mobility of service professionals (Mode 4), or a preferred combination of these modes.
  3. The UK Government and EU should also re-evaluate the restrictions that limit education services and work towards facilitating professional mobility.
  4. Pursuing mutual recognition agreements (MRAs) for professional qualifications may offer a quicker and more feasible approach to facilitate services trade in certain professions than fully-fledged trade agreements.
  5. The UK Government should consider regulatory dialogue, concrete regulatory cooperation between agencies with comparable remits, and the use of MRAs with countries that have similar cultural and regulatory backgrounds and sectoral agreements (especially with the EU) as a way forward.
  6. Rapid advances in technology as well as the rise in geopolitical frictions imply that the direction of travel is likely towards more regulation rather than less. Therefore, ensuring the coherence of trade policy and its implementation is critical, which entails consistency of provisions not only across the UK’s many trade agreements but also with domestic policies that have clear trade implications, such as copyright regulation or AI governance.
  7. To establish a coherent policy position across all trading partners, the UK Government should review key provisions in UK trade agreements (and DEAs) including (i) the provisions regarding free data flows and restrictions of data localisation requirements, (ii) restrictions of source code requirements, and (iii) national security exemptions.
  8. On the multilateral stage, the UK should provide international leadership in digital trade negotiations since digital trade influences all services sectors. In particular, extending the moratorium on imposing customs duties at the WTO should be set as a priority for businesses. These initiatives will help the UK fully exploit its comparative advantage in producing and exporting digitally deliverable services.
  9. Make efforts to improve the momentum of services trade negotiations. For example, establishing new plurilateral negotiations on cross-sectoral issues, such as trade facilitation (particularly logistics delivery), environment services and investment facilitation, could be considered.
  10. For the benefit of evidence-based policy advice, improve the quality of, and timely access to, sufficiently detailed services trade data for civil service analysts, academic researchers, and other stakeholders.

CITP Trade Roundtables

The new UK Government, elected in June 2024, has promised to produce both an industrial strategy and, closely connected, a trade strategy. The CITP convened a series of roundtables with various partners – Chatham House, The CBI, Resolution Foundation, and Fieldfisher LLP – each aimed at specific issues or an area of policy that the new trade strategy will need to address.

Each roundtable convened a high-level discussion between policymakers from the UK and beyond, business representatives, experts and academics to identify core challenges and policy recommendations in each topic area: a) trade and economic security; (b) trade policymaking within the UK; (c) Services trade and priorities for future negotiations; (d) SMEs, export support and UK competitiveness; and (e) agriculture, environment and food standards. A Discussion Note will be published summarising each roundtable.

Footnotes

  1. UK trade agreements in effect - GOV.UK (www.gov.uk)
  2. General Agreements in Services Trade (GATS) covers four services definitions of modes of supply: (i) Cross-border supply (Mode 1), consumption abroad (Mode 2), commercial presence (Mode 3), and temporally movement of natural persons (Mode 4). “Mode switching” means that services suppliers change a mode of services supply responding to changes in business environment. For example, a firm which used to invest abroad and supply services from a commercial presence there (Mode 3) switches to exporting services from the UK to abroad (Mode 1).