Embody, Disembody, and Gains for Everybody

7 January 2016

In their excellent survey of literature, Francois and Hoekman (2010) justifiably point to the ‘disembodiment’ literature to make the point that, because of technological advances, services became disembodied from goods where they were incorporated, and it is because of this disembodiment process that trade in services increased. Bhagwati (1984) should be credited with pioneering status in this area, whereas Sampson and Snape (1985) put it all in operative language and laid the foundations for what became the four modes of supply in GATS (General Agreement on Trade in Services).

It is not that services were not traded at all before. True, because services were traditionally viewed as requiring proximity between supplier and consumer (the ‘proximity burden’), they were often referred to as non-tradables. And yet, practically every good traded carried a services component with it. Furniture and clothing had to first be designed, and manufacturing firms always needed engineering advice and testing done by specialised services firms before selling a new product. So what was the world like before the disembodiment literature? Services were traded as goods, so no one thought seriously of providing a framework for services trade. This continued until, following technological evolutions, the Uruguay Round led to the establishment of the GATS. And the new rules went hand in hand with new technological developments and the growing role of services in global supply chains.

There is one aspect of the old world that looks worth revisiting, and this is what one of us, Cernat, aimed to capture in an earlier E15 blog post through his Mode 5 services concept, which builds on existing WTO rules. Mode 5 services are simply defined as "services in boxes", i.e. services exported not as such but as part of products. Assume Home designs cars or shoes, but, for sound economic reasons, the production process takes place in Foreign. According to one provision in the WTO Customs Valuation agreement (WTO CVA Art. 8b(4)), when Foreign exports cars or shoes back to Home, the good will pay customs duties, but the services component will not be burdened with duties when returning back Home. Both the original design service export transaction, Home to Foreign, and the re-import of design incorporated in cars will pass customs officials duty-free.

The logic on which this WTO rule seems to be built on is that it is simply unreasonable to impose customs duties on its own service producers, i.e. the design component of cars and/or shoes.

Is this provision of real value to firms? Well, yes. Existing jurisprudence clearly shows the importance of these provisions both for customs officials and importing companies. The anecdotal evidence on the implementation of the existing WTO mode 5 provisions does not suggest that administrative costs are more burdensome than other existing customs-related procedures. In fact mode 5 provisions may be less cumbersome than some existing preferential rules of origin regularly used in FTAs around the world.

Well, if there are some rules on mode 5 services already, why worry? The easy way out is of course to do nothing. After all, tariffs on goods are becoming immaterial, so we should not bother. Or should we? Well, first, there is still scope for tariff liberalisation as the recent ITA negotiations have shown. There is a substantial services component in many agricultural products as well, both in OECD and developing countries. Second, so far the existing WTO rules only apply to a small share of mode 5 services re-imports, but not on the much bigger value of mode 5 services exports. GATS and many bilateral trade agreements do not typically achieve sweeping liberalisation levels. Therefore new mode 5 rules that reduce tariffs proportionately to the value of services component could provide the trading community with substantial gains both for goods and services, and at a moment in time when the WTO came back from Nairobi with less to cheer about than when the Doha round was launched.

We do not possess exact figures on the gains from trade if something along these lines sees the light one day, but there is evidence that mode 5 services exports represent in many cases more than 30% of goods exports. On this basis, for many WTO members, mode 5 services exports appear economically more important than some GATS modes of supply. Therefore, intuitively, it seems to us that gains from new mode 5 services provisions will be substantial.

How could this be done? Multilaterally, the obvious starting point is to expand the coverage of the existing WTO mode 5 provisions. That would reduce the level of customs value of traded goods and would be equivalent to traditional tariff liberalisation carried out so far in previous multilateral rounds. Alternatively, it could be done in a separate protocol to this effect across like-minded WTO members. The rest of the membership could join on similar conditions.

The WTO machinery might have problems addressing non-tariff barriers but works better when it comes to tariff liberalisation. Here is an opportunity to exploit it.

Lucian Cernat is Chief Trade Economist at the European Commission. The views expressed herein are those of the author and do not necessarily reflect the views of the European Commission. 

Petros C. Mavroidis is Theme Leader of the E15 Task Force on Regulatory Coherence. He is Professor of Law at the University of Neuchatel, Switzerland, Columbia Law School, New York City, and the European University Institute, Florence.