Does Service Trade Help Goods Trade?

Joy Mazumdar, Emory University

Usha Nair-Reichert, Georgia Institute of Technology

Producer services such as transportation, management consulting, engineering

consulting, banking, insurance, marketing and financial services have become increasingly important in recent years, both in their role in the domestic economy and in international trade. In addition to their use as intermediate inputs in the production of the final goods, certain producer services are also useful in facilitating goods trade between countries. Deardorff (2000) argues that if service providers of trade services are not allowed to operate across borders then trade itself is likely to be more costly, if it occurs. The main purpose of this paper is to examine the question: does liberalization of trade in services contribute to increased trade in goods, and if so, what are the channels through which service trade liberalization impacts goods trade?

We develop a monopolistic competition model to analyze the impact of trade in services on goods trade. We assume that goods can be made available for sale in the foreign country with the help of either domestic services (provided by domestic skilled labor) or foreign services provided by foreign skilled labor. We also assume that domestic skilled labor is more efficient in the provision of domestic varieties. However, if service exports are not allowed then domestic firm will have to use foreign services when exporting. This will imply that the price of the export will be higher than when the same good is sold on the domestic market. In the case of identical countries, the volume of goods exports is lower and the share of exports in output is smaller where there are restrictions to service trade, as compared to the free trade in services case. We also find that the reduction in both exports and the share of exports in output is larger (in absolute value) if provision of the goods is more intensive in services.

We empirically test this model by using data on bilateral trade flows to the US from various partner countries at the 4-digit SITC level for the period 1989 to 1998. The data on US imports of services and the service sales of foreign affiliates in the US is from the Bureau of Economic Analysis. The service intensities for various commodity categories are from the US input output tables. The hypothesis suggested by our model is that that imports of goods that use services intensively would increase the most as a result of liberalization service trade. We use the gravity model to estimate the impact of trade liberalization in services on trade in goods. The empirical results provide conditional support for our hypothesis.

Address for correspondence: Usha Nair-Reichert, School of Economics, Georgia Institute of Technology, Atlanta, GA 30332-0615; Tel: (404) 894-4903; Fax: (404) 894-1890; E-mail: usha.nair@econ.gatech.edu