Setting priorities for services trade reform
Approach
To establish whether services trade barriers are rent-creating or cost-escalating requires using more than one measure of economic performance. Specifically, it requires estimating both a profit function and a cost function, and determining the effects of trade barriers on both measures of performance. Only then can it be teased out whether the effects of trade barriers are operating through price-cost margins or marginal costs.
A second advantage to estimating profit and cost functions is that both are structural, and correct for output quantities. This will overcome the critique outlined earlier about the reduced form nature of most of the work to date.
Drawing on general economic theory, the appropriate specifications for cost and profit functions are:
Profit = f(output prices, variable input prices, fixed input quantities, policy controls)
Cost = f(output quantities, variable input prices, fixed input quantities, policy controls)
where the measures of economic performance are profit and cost, respectively, and where the policy controls include measures of barriers to services trade. The first formulation measures the impact of barriers on price-cost markups (including via induced effects on output levels), while the second formulation measures the effects of the same barriers on real resource costs (given output levels). The effects of trade barriers on price-cost margins for a given level of output could be estimated by using replacing output prices by output quantities in the profit function estimation. Either way, the estimation will be done using the same functional forms for the cost and profit functions.
The first research task will be to decide what the relevant inputs and outputs are for each sector in question. This will require a search of the existing literature. For example, Berger, Cummins and Weiss (1997) discuss the relevant inputs and outputs in insurance, and show how they can be measured (or proxied) using accounting data. Similarly, Mitchell and Onvural (1996) discuss the relevant inputs and outputs in banking services, and how to measure them. Betancourt and Gautschi (1988) do the same for distribution services, and Carrington, Coelli and Rao (2004) for education services.
Estimation will require datasets that provide data on prices and quantities separately. Only then can profit and cost functions be estimated. The Worldscope database provides consistent accounting data for over 50,000 companies from over 50 countries, with particularly good performance data for banking and insurance services. Until recently it was time-consuming and difficult to extract time-series data from Worldscope, but recent improvements in the product have alleviated this constraint.
Additional price data will be required to supplement the Worldscope data, so as to split accounting values into their price and quantity components. The International Financial Statistics of the IMF will provide data on asset returns (the prices of capital inputs), and the price indexes necessary to deflate nominal items to real ones. Wage data can be obtained from the ILO. For education services, the OECD’s education database (accessible from the OECD’s website) will provide an alternative source of performance data.
Finally, the project will require information on regulatory structures, and how these have evolved over time. Most of the sources that were used for the previous ARC-funded projects provide such information for a range of countries on an ongoing basis, and can be canvassed to develop the time-series dimension to the regulatory data. These sources include the Trade Policy Reviews of the WTO, the National Trade Estimates (NTE) Report on Foreign Trade Barriers from the United States Trade Representative, the APEC individual action plans available on the website of the APEC secretariat, the country analysis briefs of the US Energy Information Agency, and various reports of the International Telecommunications Union. The International Civil Aviation Organisation is about to release up-to-date information about the regulatory content of bilateral air services agreements.
The project will be organised as a series of sectoral studies. Most of these will look at the evolution of regulatory structures across countries over time, providing estimates of the ‘height’ and ‘type’ of barriers to services trade for each country and time period in the sample. As in the previous ARC-funded projects, it will be useful to develop the methodology for studying some sectors in an Australian context, for example by looking at the variation in regulatory regimes across Australian States and territories. Once the methodology has been refined for Australia, it can then be applied to a range of countries in the region.
Berger, A., Cummins, J.D. and Weiss, M. 1997, ‘The coexistence of multiple distribution systems for financial services: The case of property liability insurance’, The Journal of Business, 70(4), pp. 515–46.
Betancourt, R. and Gautschi, D. 1988, ‘The economics of retail firms’, Managerial and Decision Economics, 9(2), pp. 133–44.
Carrington, R., Coelli, T. and Rao, P. 2004, ‘Measuring the performance of Australian universities: Conceptual issues and initial results’, paper presented to Asia-Pacific Productivity Conference, University of Queensland, 14-16 July 2004.
Mitchell, K. and Onvural, N. 1996, ‘Economies of scale and scope at large commercial banks: evidence from the Fourier Flexible Functional Form’, Journal of Money, Credit and Banking, 28(2), pp. 178–99.
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