Liberalization of Trade in Services

The Bolkestein-Directive

1. Historical Background
2. Trade in Services
3. Bolkestein-Directive
4. Theoretical Analyses
5. Conclusion
6. References

Exam paper written by Eigner Franz

International Trade, SS06, August 2006
Université catholique de Louvain
International Trade: Bolkestein-Directive Eigner Franz, SS06

1. Historical Background

After the Second World War, industrial countries agreed with each other on the idea that
economic cooperation would be the basis for peace and an instrument to promote economic
growth and development worldwide. The GATT (General Agreement on Tariffs and Trade)
was established to diminish trade barriers as tariffs and non-tariff barriers. The main concept
used to decrease barriers was the so called ‘unconditional most favoured nation principle’.
This means that “conditions applied to the most favoured trading nation (i.e. the one with the
least restrictions) must apply to all trading nations.”1 However, only manufactured/industrial
goods were included in these agreements and not services, which were thought to be hardly
tradable. A start has been made at the 8th round of the GATT, in Uruguay from 1986 to 1994
which extended the multilateral trading system to services, ending in setting up GATS, which
entered into force in 1995. The GATS based roughly on the same concept as the ‘old’ GATT,
but for services instead of manufactured goods. However up to now there is only a small
progress in liberalization of services.
European countries themselves forced economic integration further after 45’ by harmonising
standards for producers and by restricting duties on imports and exports of (manufactured)
goods between the member countries of the EU. In 1979 economic integration was further
promoted by the Cassis-de-Dijon-decision, which said that each product, which was produced
in a member country of the EU on the basis of its laws, has to be accepted by all other
member countries, also when the product doesn’t fulfil domestic laws. However up to now a
single market, which means freedom of movement of all four factors of production (goods,
services, capital and labour) was only partly achieved. One further step towards a single
market is the liberalization of the service sector, which was tackled since the middle of the
90’s. The last attempt concerning this was the controversial suggestion of a new directive on
services in the internal market by the former EU Commissioner Frits Bolkestein in 2004.

1
www.wwlia.org/General-Agreement-on-Tariffs-and-Trade.htm, 11.08.2006

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International Trade: Bolkestein-Directive Eigner Franz, SS06

2. Trade in services

What are services?2

“A service is a good which can not be touched (like banking services, tourism services or
telecommunications), whereas a good is a tangible object (clothing, food, vehicles)”

Aspects of trade in services: 3

Trade in services “represents not more than 20 percent of total trade” up to now, but it is the
largest sector of economic production in the EU (70%) and of employment and represents
therefore an “important source of employment and employment creation”. Furthermore
services are typically labour intensive and can not be replaced so easily by machines, opposed
to labour in the industrial or farming sector.

Trade in services is a much more difficult concept than trade in goods. In the GATS 4 modes
of supply can be distinguished:4
o Mode 1: Cross-border trade: “trade that takes place from the territory of one country
into another”, for instance e-banking. Here only services crosses the
border, not persons which is similar to normal trade with goods
o Mode 2: Consumption abroad: “consumption of services in another country e.g.
tourism”
o Mode 3: Commercial presence: “establishment of a firm from one country in the
territory of another”, i.e. bank, communications, hotel group
o Mode 4: Movement of natural persons: the ability for nationals to work overseas for
a temporary period. (consultancy firm, hospital, construction company)
Most important one is Mode 3 for the GATS agreements. Most of the trades in services
require the presence of provider and consumer in the same place.

Why is trade in services more restricted than trade in (manufactured) goods?5

For a long time services have not been seen as tradable objects, more as domestic activities
being non-tradable for legal and institutional reasons. For instance the rail transport and
telecommunications “have been viewed as classical domains of government ownership and

2
DFID: Background briefing: Services and Developing Countries
3
Services: GATS. objectives, coverage and disciplines; and Wikipedia (GATS) on 11.08.2006
4
DFID: Background briefing: Services and Developing Countries
5
The development impact of trade liberalization under GATS

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International Trade: Bolkestein-Directive Eigner Franz, SS06

control.” Health, education and basic insurance systems are considered as governmental
responsibilities, “given their importance for social integration and regional cohesion”, which
‘requires’ regulation. Another problem existed in form of “economic and technical constraints
(need for simultaneous presence of producers and users).” However this view changed in the
beginning of the 90’s on the occasion of “new breakthroughs in information, communication
and transport technologies.” For instance “the emergence of the internet has helped to create a
range of international tradable product variants – from e-banking to tele-health and distance
learning.” 6

3. Bolkestein-Directive

In 2004 Frits Bolkestein, former president of the European Commission initiated the service
directive which should be a large step towards a single service market within the EU. It was
one of the most controversial initiatives of the last year for the EU and one of the main
reasons for the voting of Netherlands and France against the European constitution.
It was also seen as an instrument to reach the aims of the Lisbon 2010 Agenda by making
European countries more competitive by market liberal reforms. The service directive should
decrease service industry regulations of individual EU Member states, unless they are “non-
discriminatory; objectively justified on the grounds of public interest; and proportionate. “7

The main points are:8

o Freedom of Establishment
If a service provider wishes to provide the same service in another Member State,
there should be little administrative restrictions on them doing so, i.e. not more than
in his home country. “This requires Member States to respect service providers'
rights to provide a service in a Member State other than where they are established
and to ensure that they receive free access to and free exercise of a service activity
within its territory.”9
o Country of origin

6
Wikipedia (GATS) on 11.08.2006
http://en.wikipedia.org/wiki/General_Agreement_on_Trade_in_Services
7
Wikipedia, on 11.08.2006
en.wikipedia.org/wiki/Directive_on_services_in_the_internal_market,
8
as above
9
FAQ on the Commission's amended proposal for a Services

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International Trade: Bolkestein-Directive Eigner Franz, SS06

A company can provide services to consumer in another member state on the basis
of the laws of its country of establishment. As a result it “facilitates the free
movement of service providers on a temporary basis to encourage cross-border
competition”, “to encourage individuals or companies to test other markets without
first having to establish”. A popular example: a polish plumber could work in France
under Polish labour laws
o Mutual assistance
Mutual assistance between member states to strengthen economic integration. For
instance it is planned that “service providers will be able to obtain information and
complete administrative formalities through single points of contact in any member
state.”10

Benefits according to the European Commission:11

The European commission claims that these reforms help to “boost economic growth and
sustainable jobs”. Furthermore cross-border competition would bring down prices and
improve quality and choice for consumers. The reforms would “remove pointless red tape”
and “improve cooperation between national authorities in different member states to protect
and inform consumers” and would “replace the current wasteful duplication of national
regulations and controls.”

Critics:12
The directive was criticized mainly by unions, environmentalists and left winged politicians.
They claim that a forced (cross-border) competition between all member states means
offering companies the best conditions to the debit of the consumers, which will make high
pressure on social security, product quality and environmental standards. The ‘country of
origin principle’ implies that ‘high-cost (un)qualified’ workers (French plumbers) would have
to compete with ‘low-cost unqualified’ workers (polish plumbers), who can be engaged under
‘less’ strict laws of the country of origin. This ‘competition’ will lead to decreasing wages in
more regulated, higher income-countries, for instance France and Germany and end in a
system of social dumping. What is more, the directive allows service providers from a given
member state to work in another country, but still being controlled (concerning product
quality, environmental laws …) by the ‘country of origin’. Critics say incentives therefore are

10
as above
11
as above
12
Attac. Die EU-Dienstleistungsrichtlinie – der Bolkestein-Hammer

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International Trade: Bolkestein-Directive Eigner Franz, SS06

small because the performances of these companies have a positive influence on the balance
of trade of the ‘country of origin’. They in general claim for a stepwise adaptation of social,
environmental and quality standards on a high level between the member states.

Revised proposal of the European commission:13

On account of the annoyance of large parts of the population in Western Europe, the
commission was forced to make some compromises in order to find an acceptable solution,
which could also pass the European Parliament. These changes strongly weakened the
directive by excluding branches like health care services, audiovisual services, social services
relating to social housing, child care, public transport and public education. The new proposal
confirms again, that the “directive is limited to facilitating and simplifying the development of
services activities at EU level in those areas which are already open to competition” and it
would “not affect the freedom of the member states to define what they consider to be public
services”. The ‘country of origin principle’ was formally deleted and substituted by a more
vague law, called ‘freedom to provide services’. Labour law provisions like minimum wages
are not affected by the Directive anymore. Furthermore service providers have to be
controlled by the country of establishment, not by the country of origin anymore.
After the council found a common position about the new directive in the end of July, the next
stage will be the second reading in autumn in the European Parliament with the aim of
adopting a final text during the Finish Presidency in the second half of 2006.

4. Theoretical analyses

These analyses make use of simple theories of International Trade to explain distributive and
welfare effects of the service directive by changes in relative prices and terms of trade.
We first assume that 2 kinds of goods exist which differ in their factor intensity.
‘Sophisticated’ industrial goods, which are expected to be intensive in skilled labour and
which are traded before the reform (and afterwards) and ‘unsophisticated’ goods, these are
services, which are expected to be intensive in unskilled labour and are not traded before the
reform. The high-skilled labour abundant West (richer countries) is expected to have an
advantage in the production of industrial goods on account of its higher relative endowments,
whereas the low-skilled abundant East (poorer countries) is expected to have an advantage in

13
FAQ on the Commission's amended proposal for a Services

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International Trade: Bolkestein-Directive Eigner Franz, SS06

the production of services. We assume that technology differences in producing services

between the trading partners don’t exist. As a consequence trade in services is not motivated
by technology differences, but by differences in factor endowments between West and East.
The effects of trade under these circumstances are captured by the Heckscher-Ohlin model. It
says that competition due to economic integration will lead to factor price equalization, which
means that in an open economy relative factor prices (unskilled labour to skilled labour) will
converge. We can imagine trade in services as a substitute for trade in factors. Countries
(West) will export goods that are intensive in the factors, with which they are abundantly
supplied and in doing so they export indirectly their abundant production factor (skilled
labour) itself. On account of factor price equalization the return to the scarce factor (unskilled
labour) in an economy will fall, whereas the return to the abundant factor will increase.
In the West owners of ‘unskilled labour’, the service providers will suffer from real wage
losses after trade, if compensatory transfers are not feasible. The loss in real wages is large, if
labour mobility is more restricted, because then workers can not relocate to other occupations.
The real wage loss however may be softened by complete liberalization, which leads to
smaller prices for other imported services and has therefore positive income effects for skilled
and unskilled workers. In theory, the loss of real wages for the unskilled would be more than
compensated according to the Standard Trade Model – under the assumption of free and
costless labour mobility within a country - by more efficient factor allocation. As a
consequence total welfare of the West would increase, further forced by beneficial effects of
increasing returns to scale, which are not captured by the Standard Trade Model.
However the terms-of-trade effect favours the East and therefore increases its welfare,
because the newly traded goods (services) can be exported at higher relative prices. After
factor price equalization in the East service providers will profit from trade on account of
higher relative factor prices in form of higher real wages whereas producers of industrial
goods have to face a loss in real wages.
The service directive (especially the ‘Freedom of Establishment principle’) can be interpreted
as an instrument to widen the range of goods that are tradable in a country, such as plumbing
services rather than an instrument to reduce tariffs. This will lead to more competition in
production of the same good, which is assumed to force a more efficient allocation of factor
endowments. However under the context of the fact that labour markets in the West are more
regulated than the labour markets in the East and on account of negative terms of trade effects
for the West, it could be that wage losses of the unskilled in the West can not be compensated

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by higher efficiency, whereas welfare of the East should benefit from an integrated service
market, especially when it’s assumed that its labour market is less regulated.

5. Conclusion

The results of the theoretical analyses in this paper give us some explanations for the negative
reaction of Western Europe countries like France and Netherlands towards the reform, fearing
social dumping opposed to Eastern Europe, where even Hungary’s socialist minister of
European affairs, Etele Baráth claims that the “freezing of the service directive is unfair.”14
Most economists support the new Directive, pointing to the benefits of more efficiency in
factor allocation, which could be used to help ‘losers’ from trade on account of negative
distributive effects afterwards. Furthermore in general economists tend to represent the large,
but unorganized group of expected trade winners, because those who are expected to lose
from trade are generally much better organized and have no problems to make pressure on
politicians. Thus economists often act as a counterweight against this bias in political process.
Furthermore they claim that each change in a nation’s economy, for instance technological
progress or discovery of new resources has an impact on the distribution of wealth. However
according to them, too strict regulations which aim at softening the speed of such changes
would slow down economic progress.

6. References

Trade in Services:
www.wto.org/english/tratop_e/serv_e/gsliber_e.doc
WTO: The development impact of trade liberalization under GATS. June 99. Last access: 11.08.2006

www.dfid.gov.uk/pubs/files/tradebrief-services.pdf
DFID: background briefing: Services and Developing Countries
Department for International Development. March 2003. Last access: 11.08.2006

www.wto.org/english/tratop_e/serv_e/gatsqa_e.htm Last updated: 04.10.2005

SERVICES: GATS. The General Agreement on Trade in Services (GATS): objectives, coverage and disciplines.

Bolkestein-Directive:
http://ec.europa.eu/internal_market/services/index_en.htm
European Commission: Internal Market for services. Last access: 11.08.2006

www.delcyp.cec.eu.int/en/qa/MEMO-06-154_EN.pdf

14
www.euractiv.com/en/agenda2004/freezing-eu-services-directive-fair-hungarian-minister/article-136602

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Frequently Asked Questions (FAQs) on the Commission's amended proposal for a Services Directive.
Brussels, 4. April 2006.

http://idei.fr/doc/wp/2005/making_sense.pdf
Institut d'Economie Industrielle (IDEI): Analyses: Making sense of Bolkestein-Bashing. 27. Mai 2005

www.attac.de/bolkestein
Attac. Die EU-Dienstleistungsrichtlinie – der Bolkestein-Hammer. Last access: 11.08.2006

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