Are services different

Updated: Jan 18 2013, 09:26am hrs
The effect of the real exchange rate is even stronger for exports of services than exports of goods; yet it needs to be accompanied by strong institutions, sound macroeconomics, a disciplined labour force and high savings rate to be successful

poonam gupta & Barry Eichengreen

It is fair to say that there is now a broad consensus among economists that policies encouraging exports can have a positive impact on growth. The marginal product of labour tends to be higher in the production of exports than other activities. Reflecting this productivity differential, export-oriented industries pay higher wages than other sectors. Exports tend to be labour intensive in developing countries, consistent with the comparative advantage implicit in factor endowments.

Exports relax the balance-of-payments constraint on growth, facilitating imports of capital goods and technologies. Export industries are centres of learning by doing and sources of externalities that raise the productivity of other sectors. These and related observations have spawned a large literature concerned with the policies and circumstances conducive to export growth.

The new frontier today, including in developing countries, is trade in services. The exports of services have grown by about 10% annually worldwide between 2001 and 2010. Since the mid-1990s, exports of services have grown by at least 15% annually in 20 developing countries. The share of developing countries in global trade in services rose from 14% to 21% between 1990 and 2008 (Goswami, Mattoo and Saez 2012). Exports of engineering, health, legal, accounting and management services, constituents of the modern or non-traditional category, have been the fastest growing component of service exports in recent years. All this points to the question of whether the same policies and circumstances that are conducive to the growth of exports of merchandise are similarly conducive to the growth of exports of services.

In earlier papers we considered the determinants of the size of the service sector. In this one we focus on service exports, distinguishing between modern and traditional services.

Traditional services include trade and transport, tourism, financial services and insurance. Modern services include communications, computer, information and other related services. We consider both the growth of export volumes and so-called export surgesperiods of unusually rapid sustained growth.

Freund and Pierola find that large sustained depreciations of the real exchange rate, implying improvements in competitiveness, typically precede surges of merchandise exports. In some of their specifications they find that low levels of exchange rate volatility and high levels of economic openness significantly predict export surges. Other variables associated with the level of exports, such as inflation and the incidence of financial crises, are not associated with surges of merchandise exports. The first question we ask in this paper is whether similar results are found for surges of service exports.

The literature points to additional variables that could be especially important for exports of services, some of which we consider in our own work. These include skills (human capital), English language facility, trade liberalisation, foreign direct investment (FDI) and the existence of an overseas diaspora. The role of human capital is self-evident, given the skilled-labour intensity of major trade able services. Goswami, Mattoo and Saez (2012) observe that exports of services are more information intensive than exports of merchandise; it follows that interventions limiting information asymmetries (such as regulatory requirements and measures strengthening contract enforcement) may be important in this context. Other authors have pointed to the importance of a well-developed communications infrastructure. There is an obvious link between access to the internet and modern communications on the one hand and the provision of computer and back-office services on the other.

Our results confirm the importance of the real exchange rate for export growth. In addition,we find that the effect of the real exchange rate is even stronger for exports of services than exports of merchandise. It is especially large for exports of modern services, as opposed to traditional varieties. The evidence for differential effects between advanced and developing countries, in contrast, is weaker. Still, this suggests that as developing countries shift from exporting primarily commodities and merchandise to exporting traditional and modern services,appropriate policies toward the real exchange rate become even more important. In sum, we find that real exchange rate changes affect exports of merchandise and traditional services in broadly similar ways, but that the effect on modern services is 30-50% larger.

Just why the real exchange rate impacts exports of services so powerfully is, at this point, a matter of conjecture. It could be that services, and especially modern services, use fewer imported imports. It could be that these sectors have lower fixed costs of entry, making for a more elastic supply response. It could be that demand for these exports is more price elastic. Or it could be a combination of the above.

Export surges

Export surges seem to be preceded by an increase in the saving rate, especially in developing countries. Surges in exports of modern services, especially in developed countries, are accompanied by and preceded by a sharp increase in the internet penetration. Even though we do not look at the effects of export surges in this paper, we see a remarkable acceleration in per capita income growth during an export surge in services. The acceleration is short lived in traditional services surges, but lasts longer for surges in modern services.

Experiencing a currency crisis in the recent past does not affect the probability of an export surge one way or the other but its effect is positive and marginally significant for the export surge in traditional services. This finding is somewhat consistent with the pattern observed by Borchert and Mattoo (2009). It also seems to be a promising area for future research. An English-speaking population increases the probability of an export surge in modern services, which is intuitive. Higher FDI inflows and a higher savings rate are associated with a greater likelihood of a surge of exports of traditional services and merchandise.

We do not find consistent evidence of differential effects across advanced and developing countries. Nonetheless, as less-advanced countries shift in the course of development from exporting primarily commodities and merchandise to exporting traditional and modern services, these findings suggest that appropriate policies toward the real exchange rate become, if anything, even more important.

This said, relying on an undervalued exchange rate to encourage the growth of exports of services, as of merchandise, has its limitations. To put it another way, limiting the natural tendency for the real exchange rate to appreciate as an economy develops can have costs as well as benefits. Eichengreen (2008) and Haddad and Pancaro (2010) caution that depreciation/undervaluation can be deployed as a policy tool to spur growth only in the short term because a country cannot maintain a depreciated real exchange rate indefinitely. Potential costs include tensions with other countries, accumulation of foreign exchange reserves on which capital losses may occur, and the fact that adjustment, when it occurs, may come in the form of inflation.

For a competitive real exchange rate to succeed in boosting exports it will have to be accompanied by strong institutions, sound macroeconomic policies, a disciplined labour force, high savings rates or other policies conducive to attracting foreign capital. Finally, for the benefits of the policy to exceed the costs, countries using real exchange rate depreciation to jump-start exports and growth should have an exit strategy in mind and, ideally, in place.

This piece is excerpted from the NIPFP paper The Real Exchange Rate and Export Growth: Are Services Different