Global Trends by Martin Khor

Monday 20 Feb 2006

Don’t rush to open up services sector

A United Nations agency has warned that opening up the service sectors to foreign firms may not be beneficial unless the developing countries are prepared through flanking policies and regulatory frameworks.  This warning is timely as countries are pressurized through the World Trade Organisation or bilateral trade agreements to open up quickly.


A United Nations agency has warned that developing countries should not just rush into opening up their services sectors to foreign enterprises. 

Doing so does not necessarily lead to growth.  And there are costs involved, including the displacement of local firms, job losses and adverse effects on social services and on culture.

The report by the UN Conference on Trade and Development (UNCTAD) is timely as developing countries are now being pressed at the World Trade Organisation to make commitments to liberalise more deeply in various service sectors such as finance, telecommunications, wholesale and retail trade, construction, and professional services.

Bilateral free trade agreements are also being used, especially by developed countries such as the United States and Japan, to get the developing countries to open up quickly.

Many developing countries have already increasingly opened up to foreign participation as part of national policy.  But they are reluctant to make legally-binding commitments on liberalization at the WTO because once these are made, it would not be possible to reverse the policies, unless the country is willing to compensate the countries affected.

Policy makers often prefer to take new measures (for example, allowing foreign finance firms to enter and engage in a certain activity) and retain the ability to reverse certain policies if circumstances change (for example, to curb speculative activities to prevent or to deal with a financial crisis).

There is also the understandable fear of local players that if foreigners are allowed to enter the market, they will lose their business entirely or at least their market share. 

A balance has thus to be struck between allowing foreign firms to enter and give the consumer more choice, and affording some protection to local service providers, so that they are not altogether subject to the full winds of foreign competition.

Some of these concerns are dealt with in the UNCTAD paper, Trade in Services and Development Implications, which was presented on 9 February at the agency’s Commission on Trade in Geneva.

Its main conclusion is that liberalisation does not automatically led to services growth in developing countries, and there is a need to establish necessary preconditions such as flanking policies and regulatory frameworks for liberalization to yield development-oriented results.

The paper, which is based on country studies, highlighted concerns on the effect of services liberalization.  They include displacement of local firms by foreign services providers, the loss of jobs, reduced access of the public to essential services, effects on social goals in education, health and culture, and effects of foreign investment on development.

It advises developing countries to conduct an analysis of the costs and benefits when planning reforms in the services sector.  Reforms should be undertaken at a suitable pace and with proper sequencing.  In particular, whether regulatory frameworks are in place will affect whether the liberalization exercise results in development gains.

Says the paper: “There is widespread recognition that the gains from reform will not materialize or will be seriously undermined if a competitive environment is not assured. A strengthened regulatory framework and the institutional development of competition and other regulatory authorities often represent preconditions for meaningful liberalization.”

It adds that each country should carefully assess the costs and benefits associated with liberalization, which could result in employment displacement versus employment creation, skill transfer and transfer of technology; efficiency gains versus effects on the informal sector and employment; local sourcing versus imports and effects on the balance of payments; and positive and negative effects of foreign investment. 

Studies of sectors and countries found the following:

CONSTRUCTION:   This sector is high-risk, and 50% more volatile than manufacturing. Small and medium firms play an important role and developing countries are striving to build their capacity, with government procurement having an important role.

A study on Jordan found many problems.  Foreign firms do not have any interest in developing local expertise; property prices increased;  foreign participation did not lead to technological capacity building;  there was a rising he number of local construction contracting firms forced out of the market; and foreign companies employing foreign workers are paying less than the national average, which forces Jordanian workers out of the job market.

TELECOMMUNICATIONS:  Liberalization and privatization of this sector have to be carefully managed to prevent anti-competitive behaviour, ensure universal coverage and affordable pricing, and widen access to all types of services.

A study in Kenya shows how the expected immediate negative impact on employment has made reforming the sector particularly difficult.

Policies need to be put in place, including: development of infrastructure; establishing a fund for extending telecom services to rural areas; improving the business environment; human resource development, and establishing policy and legislative frameworks.

TOURISM:   Benefits from liberalization of tourism depend on the degree of integration of domestic sector tourism, global business practices, competitive conditions in foreign markets, access to distribution networks, and the degree of “leakage” (how much of the tourist dollar is spent on imports). 

An Indonesian case study showed concerns of  excessive ownership of land and buildings by foreign investors, which can displace local players from potential tourist destinations, and monopolistic practices applied by large foreign suppliers.

For liberalization to proceed successfully, complementary policies are needed to help domestic firms to compete, to promote competition and minimize the costs to local people whose land, assets and jobs are displaced.

DISTRIBUTION SERVICES:  Modernisation of distribution services and the entry of foreign firms can increase productivity, lower prices, and a provide consumers with more choice of products.  However it also displaces small local retailers, with job losses. 

Developing countries are also concerned with the leading position of global retailers on the domestic market, who may acquire dominant market and buyer's power.

A situation to avoid is when the product or service of several sellers is sought by only one buyer – as happened in Ecuador’s wholesale trade.  In such cases, liberalization would mean a domestic monopoly provider would be replaced by a foreign one.