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Barriers to trade in services have an impact on multinational production in the manufacturing sector

Multinational enterprises that produce goods rely on services to organise their value chain, so barriers to investment in services are likely to affect their production.

The column uses a new and comprehensive OECD database to measure the share of services in the exports of multinational enterprises, and also in the output of their foreign affiliates. The results suggest that policymakers may need to focus more on the services that support manufacturing industries.

Services have become increasingly important in all economies, with a rising share of services in GDP, employment, trade and investment. The services sector encompasses transportation, finance, tourism, distribution, health or education, but a significant number of services also support the activities of manufacturing firms.

In recent years, the concept of global value chain (Gereffi and Fernandez-Stark 2016) has emphasised that the manufacturing value chain is supported by services. They include research and development and the design of a product, the logistics and transport services to move inputs, the marketing, sales and distribution services to reach consumers, and also accounting, legal, engineering and IT services.

Multinational enterprises (MNEs) that produce goods rely on many services to organise their value chain. These services may be traded cross-border or provided by a local supplier. Since most services are intangible and non-storable, the supplier providing a service must often be in the same location as the buyer.

Manufacturing firms increasingly produce services themselves, either to source services inputs from their affiliates or to sell services as a complement to the goods they produce (Miroudot and Cadestin 2017). Therefore, we can assume that regulations and barriers affecting trade and investment in services affect the production of MNEs. Data on activities of MNEs are scarce, however, and there is little evidence on the role of services in multinational production.

Measuring the production of MNEs and foreign affiliates

To overcome some of the data challenges in analysing multinational production, the OECD has developed a new and comprehensive database on MNE activities across countries and industries. This uses the OECD database on Activities of Multinational Enterprises (AMNE), which contains the official data collected and published by National Statistical Offices.

The missing information was estimated using additional sources and various statistical methods. This means we have a full coverage of the output, value added, exports and imports of foreign affiliates and domestic companies in 43 countries, plus the ‘rest of the world’, across 43 industries from 2000 to 2014 (Cadestin et al. 2018). In addition, the AMNE information is used to split inter-country input-output tables according to ownership. This allows for a value-added analysis of the activities of foreign affiliates, similar to the analysis provided for trade in the context of trade in value-added (TiVA) statistics.

This dataset highlights that the output of foreign affiliates, as a share of total output, increased until the financial crisis and declined after it (Figure 1). The share has since then been stable, with foreign affiliates accounting for about 12% of total output in 2014. Figure 1 also shows that 43% of the production of foreign affiliates are services, often in relation to manufacturing activities.

Figure 1 Share of foreign affiliates in total output, manufacturing and services affiliates, 2000-2014

Source: OECD Analytical AMNE database.

Exports versus FDI

To access foreign markets, firms can either export their products to consumers or serve them through a foreign subsidiary producing in the host economy. This decision has been described in the economic literature as ‘exports versus FDI’ (Heplman et al. 2004). As the OECD analytical AMNE database covers both trade and the output of foreign affiliates, it can provide insight on the relative importance of these two strategies. In the case of services, exports and sales of foreign affiliates correspond to different ‘modes of supply’, as defined in the WTO General Agreement on Trade in Services (GATS). Cross-border trade in services corresponds to modes 1, 2 and 4, while trade through commercial presence is mode 3.

In a recent paper we are able to show that, in gross terms, exports and sales of foreign affiliates are roughly equivalent at the world level, each about $20 trillion in 2014 (Andrenelli et al. 2018). But we need to be careful when comparing the two concepts, because in value-added terms there is a difference between exports and sales of foreign affiliates when it comes to double-counting (in other words, when removing the value of intermediate inputs that may be counted several times from these gross concepts).

In the case of exports, only intermediate inputs travelling across borders lead to double-counting. In the output of foreign affiliates, inputs used during the production process, and the inputs used to create these inputs (and so on) are also double-counted as domestic sales. Therefore we can conclude that there is more value-added in trade than in the output of foreign affiliates (Figure 2).

Figure 2 Value-added and double-counting in gross exports and the output of foreign affiliates, 2014

Source: OECD Analytical AMNE database.

The value-added analysis allocates the income generated by services inputs in manufacturing output to the services sector instead of to the manufacturing sector. Importantly, this value-added analysis highlights the true share of services in multinational production. Services account for about 43% of the output of foreign affiliates, but their share in value-added is higher than 50%.

The impact of services trade barriers on the output of foreign affiliates

Since services are so important for manufacturing activities, we might expect that regulations and barriers affecting trade in services to have an impact on the sales of foreign affiliates in both the services sector and the manufacturing sector. There is a correlation between barriers to trade in services, and the output of foreign affiliates producing goods or services (Figure 3).

We use an average of the OECD Services Trade Restrictiveness Index (STRI), available for 22 sectors, as a proxy for the level of restrictiveness affecting services in the host economy. This index covers mode 3, and therefore the impediments to sales of services by foreign affiliates, as well as barriers affecting cross-border trade in services. These restrictions impose additional costs to the entry of foreign suppliers and make the services and manufacturing sector less efficient.

Figure 3 Foreign affiliates output and services trade restrictiveness

Source: OECD analytical AMNE database and STRI.

To confirm this result econometrically, we use a gravity model based on the theoretical framework developed by Bergstrand and Egger (2007), to which we add the STRI and host country-specific variables. When running the regression on the output of foreign affiliates producing services, we find a negative and strongly significant coefficient for the STRI, indicating that services trade restrictions are associated with a lower output of foreign affiliates in services.

We also find that services trade restrictions affect a firm’s choice over whether to use exports or FDI to serve foreign markets. High barriers to mode 3 trade in services (that is, to a commercial presence) are associated with a lower ratio of foreign affiliate output to cross-border trade. This suggests there is a substitution effect between local production and cross-border trade in the presence of barriers to establishment.

Services trade restrictions had an impact on the output of foreign affiliates producing goods. Coefficients were most significant in computer, transport and professional service sectors, the activities most needed by manufacturing firms. We also find that barriers to competition in services sectors are the ones that most affect the activities of manufacturing affiliates. This suggests that, when services sectors are regulated in a pro-competitive manner, foreign affiliates produce higher volumes of goods.

If you want manufacturing, prepare for services

Overall, our results demonstrate the intertwined nature of manufacturing and services activities. This has implications for trade and investment policies aimed at promoting the manufacturing sector. Policymakers may need to focus more on services industries to support their manufacturing industries, which would require an integrated approach to manufacturing and services in policy discussions.

-Koen De Backer, Sébastien Miroudot, Davide Rigo

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