International Provision of Trade Services, Trade, and Fragmentation

This paper examines the special role that trade liberalization in service industries can play in stimulating not only trade in services but also in goods. International trade in goods requires inputs from several services industries (trade services, such as transportation, insurance, and finance) in order to complete and facilitate international transactions. Restriction on the ability of national service providers to provide these services across borders and within foreign countries creates additional costs and barriers to international trade above those that would arise in otherwise comparable intranational exchange. As a result, trade liberalization in services can yield benefits, by facilitating trade in goods, that are larger than one might expect from analysis of the services trade alone. This paper explores this idea using simple theoretical models to specify the relationships between services trade and goods trade. The paper also notes the role of services trade in a model of international industrial fragmentation, where production processes can be separated across locations but at some cost in terms of additional service inputs. The incentives for such fragmentation can be larger across countries than within countries, owing to the greater differences in factor prices and technologies available. However, the service costs of international fragmentation can also be larger, especially if regulations and restrictions impede the international provision of services. As a result, trade liberalization in services can also stimulate fragmentation of production of both goods and services, thus increasing international trade and the gains from trade even further.