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International Symposium
Trade in Services: China and World
Institute of Finance and Trade
Chinese Academy of Social Sciences
Center for American Studies
Fudan University

 

Principles of Sound Regulation in Services:
The Key to Long Term Economic Growth in the New Global Economy

 

Geza Feketekuty
Former Senior Assistant USTR
Former Chair of OECD Trade Committee,
U.S. Trade Center for Trade and Commercial Diplomacy
Monterey Institute of International Studies,

 

Services are at the center of all economic activity in the modern economy.  Innovation and efficiency in the production of services have become crucial to economic growth.  One of the most important challenges for governments in today’s economy therefore is to assure that its regulations in the services sector support innovation and efficiency in the production of services. This does not imply the elimination of all regulation, but the reform of regulations that are not well targeted at clear and objective social goals, or seek to achieve such social goals in ways that hamper innovation and competition.  Regulatory reform and liberalization of trade in services have thus become important policy tools for stimulating economic growth in today’s economy.

China faces many challenges in developing and modernizing its economy.  Its government has correctly identified three linked objectives – the reform of the state enterprise sector, the banking system and the social welfare system - as the top priority.  At the same time, China will not be able to build a solid foundation for long term economic growth without creating an economically efficient services sector.  One of the essential prerequisites for an efficient services sector is a regulatory system that encourages rather than hinders competition and innovation in the production of services.  This will require major reforms of current regulations.

Regulatory reform in Services, like the rationalization of state enterprises, will create adjustment problems, not the least of which will be the added displacement of workers employed by enterprises protected from competition by current regulations.  While the reforms themselves can be expected to generate new jobs in the industry, there is an inevitable time lag and the displaced workers may not have the skills needed to fill the new jobs created by expanded competition in the industry.  The government therefore will need to pace the reforms that create additional job losses to a pace that is socially acceptable.  At the same time, the government should now set the targets and direction for reform.

This paper will examine these propositions ingreater depth, and explore a set of regulatory principles which can help assure that a government can both effectively achieve the social objectives of its choice and minimize the bottlenecks created by regulation to innovation and efficiency in the production of services.

These principles incorporate some of the best insights about good governance.  They have also been widely incorporated in international trade rules, and thus play an important role in the liberalization of trade in services.

 

Why Regulatory Reform in services is crucial to economic growth

 Services have become crucial to economic growth and prosperity for three reasons:

·         First, the key to success in the new manufacturing economy is innovative product design and engineering, innovative advances in production processes, innovative marketing and distribution, innovative customization, and innovative outsourcing and globalization strategies - all services activities.

·         Second, telecommunications, transportation, finance, insurance, distribution and information services are the central activities that underpin all forms of international trade and all aspects of global economic activity.  Innovation and increasing efficiency in these infrastructure services were at the foundation all the remarkable growth of trade and the accompanying high rates of economic growth in recent years.

·         Third, Electronic Commerce now promises to revolutionize distribution of goods and services worldwide by making world markets accessible to small businesses.  The expanded use of Electronic Commerce promises to unleash a new wave of entrepreneurial activity worldwide.

Since business services make up an increasing proportion of the cost of production, anything that adds to the cost of business services also substantially increases the cost of everything a country produces. Ineffective and excessively intrusive regulation of services, government protection of monopolies in services, and barriers to foreign trade and investment in services thus increase the cost ofproducing both manufactured goods and consumer services in the economy, and make such goods and services less competitive on world markets. Moreover, regulatory rigidities constrain the ability of firms to respond and adapt to changes in markets, and create infrastructure bottlenecks that stifle growth by putting a direct cap on the volume of economic activity.

Any time a government regulation is not well targeted at a clear social objective, or anytime it seeks to accomplish the identified social objective through more red tape and government intervention than is necessary to accomplish the objective, it introduces an unnecessary cost.  Any time a government regulation seeks to accomplish its objectives by requiring businesses to follow procedures and practices based on current technology or current inefficient business practices it prevents innovation and the search for greater efficiency in the production of the regulated services.  Anytime a regulation reduces or prevents competition and the entry of new suppliers in the production of services; it reduces innovation and the search for greater efficiency.

Poorly targeted and excessively intrusive regulations not only reduce growth and the competitiveness of national goods in global markets; they also frequently fail to achieve their desired social objective.  This was well illustrated by the recent Asian financial crisis. Contrary to popular belief, the crisis was not caused by the liberalization of regulatory controls. It is true that the removal of controls on capital inflows led to the massive flow of liquid capital into these economies, flows that stopped and were reversed at the onset of the crisis. The crisis, itself, however, was caused by a combination of inadequate regulatory supervision of the fiduciary performance of market participants on one hand and of insufficient liberalization of controls on investment opportunities on the other hand.

Most countries were focusing on the wrong things in their regulatory systems.  On one hand, the regulations provided inadequate controls and monitoring of the overall quality of the asset portfolio acquired by financial institutions, the level of risk assumed by these financial institutions, and conflicts of interest created by cozy relationships and a lack of public transparency of transactions, assets and obligations.  On the other hand, the regulations continued to restrict investment opportunities in these economies.  This created seeds for the crisis for two reasons.  First, the discretionary controls built into the regulations provided opportunities for bribery and corruption, and erosion of the already inadequate degree of fiduciary supervision provided by regulators. Second, the restrictions on investment opportunities created an imbalance between the liberalization of financial capital inflows and investment opportunities open to foreigners. This created a large pool of liquid capital and a shortage of qualified entrepreneurs and managers who could make the judgments necessary for sound long-term investment decisions.

Given the current stage of economic development of the Chinese economy, one might be tempted to argue that the growth of the manufacturing sector is a more important priority than the growth of the services sector.  If China has not fully entered into the industrial stage of development, why should it now worry about its position in the post-industrial, information-based economy of the future?  Moreover, if many unskilled or semi-skilled Chinese workers are employed in the services sector, wouldn’t reform of the services sector exacerbate the overall social adjustment problem associated with the reform of the state enterprises?

These questions have some validity, but need to be put into the context of a broader understanding of the role of trade in growth, and the transformation of the manufacturing process in the rest of the world.  Increasingly, services rather than unskilled manufacturing labor constitutes the most important input into manufacturing.  Services that serve as direct inputs into the manufacturing process or into the production of consumer services are therefore a key to both growth and global competitiveness of a nation’s goods and services.  Regulatory reform that is targeted at such business services need not cover many of the labor-intensive consumer services that employ large numbers of unskilled or semi-skilled workers.

China will undoubtedly be better off if it seeks to adjust its economy to current production technologies rather than the outdated technologies of the past.  Aside from what is best for China as an isolated economy, China must consider the role of trade in its economic growth strategy.  Trade has been the major driver of growth in recent years, and trade needs to be supported by an economically efficient and smoothly functioning services sector.  If China is to develop its own native capacity to develop globally competitive products and to market and distribute such products globally, it cannot delay the development of economically efficient and globally competitive services sector. These propositions are explored in greater depth in the next section.

 

The Role of Services in the New Information-Based Economy


The introduction of computers into every aspect of economic activity is transforming the industrial economy that emerged from the industrial revolution of the 18th century, It has transformed the nature of the production process and the possibilities for international specialization and trade. There are two sources of growth in this new economy: innovation and participation in global production systems.

The criteria for achieving a high rate of economic growth are quite different from what they were in the economy dominated by large-scale heavy industry.  In the recent industrial economy, success depended on the ability to produce standard goods cheaply by combining large amounts of cheap labor with large-scale production facilities dedicated to the production of specific goods.  In the new economy, success depends on constant innovation in products and production processes to take advantage of rapidly changing technologies and to meet the requirements of rapidly changing markets.

Services are at the heart of the new economic revolution, since they drive economic activities based on the new production paradigm. They provide the basis for the innovation in technology and design that is central to global competitiveness.

The new economic revolution affects everyone tied into the world economy. Effective participation in global trade and in globalized production systems depends increasingly on state-of-the-art information systems that provide access to timely information about markets, production schedules, and product designs.  The efficient production of services is key to participation in this new global economy because they provide the foundation for the global communication, transportation and financial linkages that enable a country to participate in global production and trade.

No country can be successful in its effort to adapt new technologies to its own needs, or to link itself to the broader global economy, without establishing the basis for a thriving, productive, and innovative services industry. Regulatory reform and liberalization of trade in services are crucial tools for achieving this objective, because over-regulation and restrictions on entry by foreign service providers inevitably result in low quality, high cost, and outdated services.

An indication of the economic benefits of regulatory reform can be seen from the U.S. experience in reducing the level of government regulation in key sectors. Regulatory reform in sectors such as telecommunications, transportation, financial services, and energy were followed by major bursts of growth in these industries and a substantial reduction incosts and prices in these sectors. Corroborative evidence comes from analyses of the economic impact of European efforts to remove regulatory barriers to trade in the context of the single market program. Negotiations on trade in services have to be seenas key catalyst in facilitating domestic reform of regulatory systems that block growth.

 

Key Drivers of Industrial Competitiveness

This section provides a brief but in depth overview of the technological revolution, and the critical role of trade in services. The key manifestations of the transformation of the production process are the automation of production, the mass customization of both goods and services, the shortening of product life cycles, the flattening out of industrial organizations, the tradability of services, and the globalization of production, firms and markets.

Automation of production. Computer control of industrial machinery has led to the increasing automation of production and the ability to produce customized goods on mass production lines. Automation not only reduces labor costs, but it also increases quality. This is because computers and machines do not get bored or lose attention like human beings, and can therefore produce to more exact tolerances and maintain a high level of accuracy over longer periods of time. Automation also makes it possible to produce a larger variety of goods as cheaply as it was previously possible to produce uniform goods, thus enabling producers to meet different consumer tastes. It also makes it easier and cheaper to reprogram production lines for new products, and thus to introduce new products more rapidly and more cheaply when consumer tastes shift.  One of the key industries where the automation of production has had a dramatic impact is the auto industry, where labor costs as a proportion of the total cost of production have fallen substantially, where the proportion of blue collar and white collar workers has been reversed, and total a much smaller number of workers produce a larger number of vehicles than 10 to 20 years ago.

Customization of Production. The ability to produce a greater variety of goods on a single production line increases the possibility for the increasing customization of products to meet the varied tastes of different niches inthe global market.  Computer driven advances in materials science, electronic controls, chemical and biogenetic engineering and software allow firms to design products with an increasing range of potential features and performance characteristics to meetconsumer needs.  At the same time, a convergence of costs and increased competition have raised the importance of customization to competitive success in the global market place. The more rapid diffusion of technology leads to a greater convergence of direct production costs and an increase in competitive pressures.  The greater customization of production has led to increasing variety in the features and options built into the consumer goods offered for sale.  It has also led to increasing emphasis in the identification of niche markets, and in the development of products for such markets.  Benetton’s targeting of the teenage market is a good example.

Shortening of Product Life Cycles. Competitive success in this new environment requires constant innovation and flexibility in adapting production to the requirements of the market place.  The need for constant innovation has been reinforced by the rapid decline in product life cycles, i.e., the average life of a product from the time it is designed to the time it is replaced by another product in the market place. The actual product life cycle differs from product to product, but virtually all products traded in international commerce have experienced a substantial increase in the pace of change and innovation. This phenomenon has contributed to a flattening of the organizational structure of firms because large and complex hierarchies tend to slow down decision making and the rate of innovation.  The industry where the shortening of product life cycles has had the most dramatic result is probably the computer industry, where new models and new components appear as often as every 4 to 6 months.

Crucial Role of Information Technology. In this new economy, there is a much greater likelihood that products will fail the market test if they are not well targeted at specific niches in the consumer market and not updated when consumer tastes shift.  In order to compete successfully in this new economic environment and to prosper economically, producers in each country have to be able to

·         develop information about what consumers want to buy;

·         acquire information about the best available technology to design and engineer the products;

·         find information about least cost methods of production;

·         exchange information among all facilities involved in the production chain to shorten the time it takes to respond to shifts in consumer tastes and minimize idle or unsaleable inventory;

·         distribute information about new products to potential buyers; and

·         establish an information system to closely track what goods and services are being sold, to whom, and where.

The key element in the achievement of these challenges is the efficient and timely acquisition, processing, and distribution of information.

The introduction of computer technology has also led to the automation and tradability of information-based services. It has vastly increased the amount of information that can be processed and transmitted from one location to another instantaneously. The use of ever-faster and more complex computers and software has brought down the cost of producing information intensive services, and the ability to transmit the resulting output over great distances virtually in real time.

Network Competition. The ability to collect, process, and transmit information in real time has increased the possibility of introducing competition in many network-based infrastructure services, such as telecommunications, energy and transportation. It has made it possible to separate the management of the physical infrastructures such as telephone lines, electric power grids, and pipelines from the services provided through those facilities. Different service providers can use the same infrastructure, yet compete with each other in supplying the services involved to consumers.

The increasing capacity to automatically collect and analyze information has created the basis for virtual networks, which are created by tying together telephone lines or modes of transport owned by different companies as if they were integrated systems, under a unified management. Overall, these changes have created the basis for competition in the provision of infrastructure services.

Monopolies are therefore no longer predominant in these industries.  This is best exemplified by the agreement negotiated in the World Trade Organization on basic telecommunication services.  This agreement establishes competition as the new global paradigm for regulating these services.

Globalization of Production. The increased capacity to process and transmit information, and the associated tradability of services, has led to the globalization of production in both goods and services. Firms are now able to locate the production of individual components and business services in geographically separated locationsand to carry out different stages in the processing or assembly of a product in different places. Enterprises can seek out the optimal global location for each production activity, and thus take advantage of the locational advantages each place has to offer.  At the same time, such global firms can maintain a high degree of control and coordination of all downstream and upstream production processes, thus preserving all the advantages that close control and coordination have to offer, including low inventories and rapid shifts in production schedules in response to changes in the market.

The impact of the globalization of production has been pervasive. Few products can be produced on a globally competitive basis today by using exclusively national inputs. No company drawing on purely national resources can possibly match the cost advantages enjoyed by a company that is able to take advantage of the cheapest inputs obtained globally.  The most obvious example of the globalization of production can be found in industries related to information technology – telecommunications, avionics, electronics, computers, etc.

Globalization of Firms. The globalization of production has lead to the increasing globalization of firms. Unlike the typical multinational of the 1960s and 70s, the new global corporation tends to be far more integrated on a global level in terms of product development and staff management responsibilities.  At the same time, the new technologies have facilitated the outsourcing of production activities that are not one of the core competencies of a firm, and managers are left to concentrate on those activities that are most crucial to the competitive success of the firm. This has reinforced the flattening out of organizational structures and enabled firms to increase the rate of innovation and their response to market signals. It also has expanded opportunities for international trade in business services.

The globalization of production, firms, and markets has created an increasing demand by firms for seamless global infrastructure services, thus creating pressures for the globalization of many infrastructure services. The global firms of today increasingly demand network operators that can tie together the globally distributed facilities of the firm through integrated network services. The creation of virtual networks based on computer-controlled linkages among physical networks and facilities has significantly facilitated the development of customized infrastructure solutions.  The demand for new global operators of network services has had the most dramatic impact in telecommunications, parcel post and express mail delivery, and more recently in the provision of intermodal transportation services.  Globally networked firms such as DHL, Federal Express, Sealand, American Express have gained significant market share.

The Internet and the Revolution in Electronic Commerce. The Internet is taking this global economic revolution from the level of large multinational companies to small businesses and individual consumers. Internet-based electronic commerce will multiply potential economic benefits of low cost global communications by enabling many more businesses and service providers to:

·         market their products to foreign consumers;

·         acquire information about products and prices available abroad; and

·         sell and buy directly over the wire in the case of information-based products and services. It also will increase the competitive burden imposed on domestic firms by inefficient and costly business services and by infrastructure bottlenecks.

The production of services and, in particular, the collection, processing, analysis, manipulation and distribution of information, is at the heart of every one of the features of the new economic paradigm. Inefficiencies in the production of services due to excessive regulation, government protection of monopolies, and barriers to foreign trade and investment translate themselves into excessive costs and a lack of innovation in business services. Since business services make upan increasing proportion of the cost of production, the increased cost of business services readily translates into increased costs for everything a country produces. Moreover, the regulatory rigidities constrain innovation and the ability of firms to respond and adapt to changes in market signals. Finally, the bottlenecks in telecommunication and transportation stifle growth by putting a direct cap on economic activity.

 

Relevance of New Economic Revolution to Developing Countries and China

Developing countries such as China might be inclined to question the relevance to them of many of these changes in the world economy, since an abundant supply of unskilled workers and a limited supply of capital restrict the prospects for automating production in their economies. Moreover, much of the economic development process in China involves the accumulation of enough capital to bring the country more fully into the industrial economy. This perspective, however, misses a fundamental point. The economic prosperity of developed as well as developing countries today are tied to world markets. What producers from any one country can sell in foreign markets is dictated by what producers from every other country are offering for sale.

Goods and services produced in China for sale in world markets have to meet the requirements of the new paradigm. Products have to meet current consumer tastes, and production has to adjust rapidly to shifts in consumer tastes to avoid wasteful inventory build-up and loss of market share. There is a niche for cheap, low quality, undifferentiated products, but that is a heavily populated niche. Such products also contain little value-added and therefore will not sustain the increases in real income, which China seeks.

In order to lift the living standard of its people, China must seek to move to higher value production. That, in turn, means producing parts and components, business services and other inputs used in the global production of high quality goods and services.

China has a large pool of educated and skilled workers who are well qualified to produce world-class professional services. However, they will not be able to do so unless they are given access to world quality support services, in particular, a modern telecommunication and transportation system. Analysts at the World Bank and the Asian Development Bank have identified the lack of adequate infrastructure investment as the major obstacle to sustained growth in many high growth developing country economies.

To produce goods competitively, China needs to have access to world quality business services that are competitively priced. Any producer who cannot get access to capital at competitive rates of interest, reasonably priced insurance, world quality marketing and advertising expertise, and cutting-edge engineering know-how will find it difficult to compete in world markets. Moreover, China’s budget is even more strained than developed country budgets, and has as much a reason as developed countries to deliver social services as efficiently as possible.

In summary, if China wants to take advantage of the opportunities created by the new economic revolution it must seek to reform its domestic regulations in services and liberalize barriers limiting its trade in services.  What China does to open up competition and improve economic efficiency in services by removing regulatory and other obstacles to the production of efficient services will increasingly determine its economic growth and prosperity.

   

The Policy Challenge - Regulatory Reform in Services


A typical characteristic of many services is that they are heavily regulated by governments to protect consumer interests -- to assure the quality and reliability of services, assure that all parts of the population are served, prevent price gauging by providers with some degree of monopoly, and assure network integrity. While such regulations serve an important social purpose, they often become the vehicles for protecting traditional suppliers from internal and external competition. Someof these protective devices are intentionally inserted in the regulations for protectionist purposes. In other cases, the protection results from a failure to adapt the regulations to changing technologies or to take advantage of new insights about economically efficient regulation.

The need for regulatory reform is driven by four developments:

n         Technological innovations that have expanded the potential for competition in infrastructure services.

n         Development of new products and services that do not fit current regulatory provisions.

n         New insights into the economics of regulation, which offer the possibility for designing more economically efficient regulations.

n         The globalization of production and markets, which has increased the cost of large national differences in regulatory standards.

These developments are explored in greater detail below.

First, technological advances have led to an explosion of new products or services. Regulations that are product or service specific tend to become increasingly distortive and they prevent the introduction of new services. Such product or service specific regulations also become increasingly ineffective as markets substitute unregulated products and services for the regulated products and services.

Second, many infrastructure services have traditionally been thought of as natural monopolies because the major cost in providing the service was in the construction and maintenance of infrastructure facilities, rather than in the marginal inputs required to serve individual customers. Modern technology has fundamentally changed the economics underlying the provision of such services.  It has reduced the cost of the infrastructure facilities relative to variable costs, enhanced the possibility of interconnecting independently provided services through computer inter-mediated systems, and (c) made it possible to track, monitor, and price network services supplied over a single network by different enterprises. The net result is that competition has not only become more viable,but has become essential for the introduction of more efficient and innovative infrastructure services. Regulations that stifle and limit competition increase the costs of businesses dependent on these networks.

Third, much has been learned about the incentive structures created by various techniques of regulation and their relative effectiveness in achieving desired social objectives. Much has also been learned about the advantages and techniques for focusing regulations more closely on the desired regulatory objective. Too often regulatory systems seek to achieve desired social objectives by controlling entry into the industry by new suppliers or the provision of new services by existing suppliers, when the real issue concerns the behavior of suppliers with respect particular regulatory objectives. Moreover, there is a tendency to regulate more of the activities of an enterprise than is really necessary to achieve a clear social objective. For example, in order to assure that the owners of telecommunication or power lines do not charge exorbitant prices or abuse their control over the basic distribution network, it is sufficient to regulate access to the network and the price charged for the use of the network. The market can be allowed to determine the types of services that might be offered over the network by competitive suppliers, and the prices charged for such services.

Fourth, the globalization of production has created pressures for harmonizing standards related to he provision of internationally integrated infrastructure networks. The globalization of production makes economic sense only where national regulations allow the adoption of the technologies, information systems, and standards across national frontiers. Large differences in national regulations that have a direct bearing on the operation of globally integrated networks or production systems add to the cost of doing business internationally.

The Internet is taking the need for regulatory reform one step further by opening up the possibility for the efficient global distribution of many services. Governments will need to rethink their role in the regulation of many services; the locus of responsibility for services produced abroad but purchased locally though the Internet, and the desired scope for international cooperation in creating a stable commercial environment for Internet transactions.  Already, many information services are provided competitively over the Internet, as are many financial services such as banking.

 

 

Principles for Regulatory Reform in Services

A number of principles can be identified which can guide governments in developing sound laws and regulations.  These principles can help assure that the laws and regulations are well targeted at desired social objectives and that they do not burden economic activity more than is necessary to achieve those objectives.  Application of these principles are designed to assure that the social objectives are effectively achieved, while minimizing the economic opportunity cost of achieving the desired objectives.

At their core, most of these principles are principles of good governance.  Many of them have been recognized as fundamental principles of a sound legal structure since the time of Hammurabi. Many of them have also become embeddedin international trade rules and agreements, including the General Agreement on Trade in Services which governs trade in services under the umbrella of the World Trade Organization.

 

Transparency of Laws and Regulations

The first and most important principle is transparency.  It holds that governments should publish all the laws, regulations and administrative proceedings that affect market participants and all changes in such laws, regulations and administrative procedures. There are two important dimensions to transparency.

First, everyone affected by laws and regulations should know what they are before they engage in economic activity that may be covered by such laws and regulations. This is not only a question of fairness in governance, but also are requirement for economic efficiency. Market participants cannot make informed decisions about production, marketing and investment decisions if they do not know how government laws and regulations will affect them.  A firm cannot plan and organize its activities efficiently if it does not know in advance what rules it will have to follow.  Moreover, it will not be able to make sound decisions on what to produce or trade unless it knows all the costs it will incur, including the costs of meeting regulatory requirements.

Second, all potential market participants must have equal knowledge about the relevant laws and regulations; otherwise, market outcomes will be distorted.  Success in the market place will be determined by privileged access to knowledge, rather than by superior economic performance.  Every time a firm with superior economic performance is disadvantaged, the overall growth of the economy suffers.

Transparency with respect to laws and regulations in general is one of the most fundamental requirements for good governance.

The principle of transparency is a core principle embedded in virtually at trade agreements.  It is incorporated in the General Agreement on Trade in Services (GATS), which sets out the rules of the World Trade Organization (WTO) for trade in services, in Article III.  The GATS provides a set of rules which countries belonging to the WTO must follow in adopting regulations that affect international trade in services.  While many of the rules incorporated in the GATS depend on national commitments that each country has negotiated, the one overarching rule that applies to all regulations that affect trade in services is Article I on transparency.

The key parts of the provision read as follows:  “Each Member shall publish promptly �ll relevant measures of general application which pertain to or affect the operation of this Agreement.  Each Member shall promptly and at least annually inform the Council for Trade in Services of the introduction of any new, or any changes to existing, laws, regulations or administrative guidelines which significantly affect trade in services covered by its specific commitments under this Agreement. “

Transparency is a fundamental requirement for the efficient functioning of a market economy, because all market participants need to have all the available information about laws and regulations to make the correct management decisions, and they all have to have equal access to such information in order to assure that their success in the market placeis determined by their performance rather than by their privileged access to information.

 

Due Process in Administration of Laws and Regulations

A second key principle is due process. This principle holds that firms affected by government laws and regulations should be given the opportunity

·         to consult the government on the interpretation and application of the regulations that affect them,

·         to appeal regulatory decisions to appropriate administrative or judicial bodies, and

·         to obtain a timely response to requests for regulatory decisions.

 

Due process is designed to assure that both market participants and officials have the information they need about the impact of laws and regulations on economic decisions, and that laws and regulations are administered in an impartial and objective manner.  The process of consultation is a two-way street.  On one hand, it helps assure that officials making regulatory decisions have the best possible knowledge of the impact of laws and regulations on economic activity.  On the other hand, it helps assure that market participants fully understand how to interpret and adapt the legal language to real world situations.

Due process also helps to minimize unforeseen but avoidable burdens on economic activity.  Changes in the interpretation or application of regulations can help to boost economic growth when such changes reduce costs or expand commercial opportunities without compromising the desired social objective.

Due process contributes to economic efficiency in three ways.  It helps assure that all market participants have the information they need to make sound decisions.  It helps assure that the economic cost of laws and regulations is minimized to what is necessary to achieve clearly identified social objectives.  It helps assure that the most economically efficient firms succeed in the market place.

Due process is incorporated in a number of the Articles of the GATS Agreement.  Two of the provisions apply to all services sectors, regardless of the specific national commitments each country has negotiated, while a third provision applies only to negotiated commitments. The key provisions are as follows:

·         (1) GATS Article III, para 4“Each member shall respond promptly to all requests for specific information on any of its measures of general application or international agreements…”

·         (2) GATS Article VI, para 2 (a). “Each member shall maintain or institute as soon as practicable judicial, arbitral or administrative tribunals or procedures which provide, at the request of an affected service supplier, for the prompt review of, and where appropriate remedies for, administrative decisions affecting trade in services. Where such procedures are not independent of the agency entrusted with the administrative decision concerned, the Member shall ensure that the procedures in fact provide for an objective and impartial review.”

·         (3)GATS Article VI, para 3.“Where authorization is required for the supply of a service on which a specific commitment has been made, the competent authorities of a Member shall, within a reasonable period of time after the submission of an application-nform the applicant of the decision…”

 

Predictability

A third key principle is predictability.  It holds that governments should not arbitrarily change laws and regulations, but should make such changes only when necessary to achieve stated social objectives and after proper notification and consultation.  It implies that laws and regulations should be promulgated only after careful thought has been given to their implementation and effects in the future.

The principle of predictability extends the principles of transparency and due process over time, and helps to assure that market participants can make sound long term decisions.  The establishment of a predictable legal and regulatory environment helps to lower risk for market participants, and thus lowers the risk premium entrepreneurs have to build into their investment decisions.  A lowering of the risk premium adds to economic growth by enabling market participants to increase their level of investment.

Predictability is built into trade agreements through negotiated national commitments on policy measures that could affect particular sectors or products. Of course, the negotiation of such commitments does not remove all elements of risk that the rules might change in the future. The rules give governments the flexibility to alter their commitments in the face of unforeseen events, or to adopt policies that affect the commitments under certain well-defined circumstances. However, the commitments provide businesses the assurances that the government involved will not change the rules arbitrarily and for less than compelling reasons.

Predictability under the GATS Agreement is provided in provisions set out in Part III, dealing with Specific Commitments, Part IV, dealing with Progressive Liberalization and the Modification of Schedules, and Article XIV dealing with General Exceptions.

 

Nondiscrimination

A fourth principle is non-discrimination. It means that governments should not discriminate in the application of laws and regulations to market participants, except in so far as there is an objective and explicit criterion for such discrimination. Discrimination might be appropriate if the circumstances differ, or if discrimination serves an objective policy purpose.  It contributes to economic growth and economic efficiency by assuring that the most effective firms are not disadvantages through arbitrary discrimination in the design or application of regulations.

Non-discrimination between firms or products originating from different foreign countries is referred to as the Most Favored Nation principles in trade parlance.  Non-discrimination between domestic and foreign firms and products is referred to as national treatment in trade parlance.  The application of the national treatment principle in the GATS agreement does not obligate governments to treat all domestic and foreign firms equally in all circumstances, but rather that any discrimination be clearly stated, be based on clearly established criteria, and serve desirable policy objectives.

The principle of non-discrimination is built into three key provisions of the GATS Agreement:

·         Article IV on Domestic Regulation, which holds that “Members shall ensure that all measures of general application affecting trade in services are administered in a reasonable, objective and impartial manner.”  This rule applies to all measures that affect trade in services, regardless of whether or not the country has negotiated a specific national commitment.

·         Article XVII on National Treatment, which holds that  “In the sectors inscribed in its Schedule, and subject to any conditions and qualifications set out therein, each Member shall accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favorable than that it accords to its own like services and service suppliers.”  This provision clearly applies only to measures or sectors on which a country has negotiated a national treatment commitment.

·         Article II on Most-Favored Nation Treatment, which holds that “With respect to any measure covered by this Agreement, each Member shall accord … any other Member treatment no less favorable than that it accords to like services and service suppliers of any other country.”  This provision applies to all measures and sectors in services, except in so far as a country has taken an exception in its national schedule at the time it adopted the GATS agreement.

 

Objective, Performance Based Criteria

In order to be effective, regulations ideally should establish objective, measurable, performance-based criteria for the supply of services.  This isa goal that is difficult to achieve fully in all cases.  Nevertheless, a regulatory system is more likely to achieve its desired social objective and is less likely to impose a burden on economic performance, if its provisions and enforcement are based onobjective, measurable, and performance-based criteria.  Objective and measurable criteria help assure that enforcement of the regulation is not based on arbitrary criteria or the whim of the regulator, but rather on a standard that is predictable and transparent and can be applied on a non-discriminatory basis to all market participants.  By closely linking the objective and measurable criteria to performance with respect to the desired social objective, the government can help assure that the regulation achieves what it is designed to do, namely to achieve the desired objective.  It also helps assure that the achievement of the desired social objective does not impose unnecessary costs or burdens on economic actors and by extension on economic performance overall.

By contrast, regulatory systems that leave a great deal of discretion to regulators are prone to corruption, to underachievement with respect to the desired social objectives, and to economic inefficiency.  Similarly, regulatory systems that seek to substitute controls on entry, on production, or on prices for performance based regulatory criteria, will neither effectively achieve the desired regulatory goals nor serve to support the economically efficient delivery of the service and the growth of the economy overall.

The GATS agreement establishes the desirability of basing domestic regulation on objective and transparent criteria, but only indirectly alludes to the desirability of basing such objective criteria on performance closely tied to the desired social objective. The key provision is found in Article VI, 4 (a) which tasks the Council for Trade in Services with the development of disciplines that shall aim to ensure that regulatory provisions are “based on objective and transparent criteria.”

 

Minimizing the Regulatory Burden

Another principle for good regulation is that the regulation should be designed so as to minimize the burden the achievement of the desired social objective imposes on economic activity.  This is obviously closely related to the last principle, namely that regulations should be based on objective, measurable, performance-based criteria.  It is only common sense to argue that it is desirable to minimize the cost of achieving any particular goal.

This principleon minimizing the regulatory burden is incorporated in Article VI, 4 (b) of the GATS agreement.  This provision tasks the Council for Trade in Services with the development of disciplines that shall aim to ensure that regulatory provisions are “not more burdensome than necessary to ensure the quality of the service.”

 

Transparency of Regulatory Objectives

The objective of minimizing the burden associated with the achievement of a regulatory objective can be enhanced through the adoption of a corollary principle on the transparency of regulatory objectives.  This principle holds that the social objective served by a particular law or regulation should be transparent, i.e. that it should be clearly stated at the time the regulation is adopted.   A clear statement of the desired social objective helps to remove possible confusion over the purpose of the regulation.  It also makes it a great deal easier to judge whether a regulation is the least burdensome necessary to accomplish the desired social objective.

This principle on the transparency of regulatory objective is contained in a draft agreement under consideration in the WTO on accountancy services, and it is likely that it may find wider application in the future.

 

Use of Market Mechanisms

 

 Another principle is that governments should use a market mechanism to promote desired social objectives, whenever that is feasible.  The use of across the board economic incentives and disincentives is an economically efficient method of accomplishing desiredsocial goals because it allows market forces to determine the most economically efficient manner of accomplishing the desired social goal.  A corollary of this principle is that scarce resources should be auctioned whenever possible rather allocated to incumbent firms on the basis of historic shares. An auction process is more likely to enable the most efficient firms to gain access to such resources, and is more likely to ensure that the opportunity cost of using the scarce resource is properly reflected in the cost of supplying the service and the prices charged to consumers.

Where regulations give existing producers or sellers preferential treatment in the allocation of scarce resources, they not only create domestic economic inefficiencies by discriminating against potentially more economically efficient new suppliers; they also distort international trade and competition. Moreover, there is a significant risk that the economic inefficiencies and trade distortions are magnified by political/interest group pressures and corruption.

 

Minimizing the Scope of Regulations

A principle closely related to the principle that governments should seek to minimize the regulatory burden is the principle that governments should minimize the scope of any regulation towhat is necessary to accomplish the desired social objective.  This principle holds that governments should only regulate activities directly related to the achievement of the regulatory objective.  Minimizing the scope of regulations to the minimum necessary to achieve the desired social objective helps to minimize the economic cost of such regulations.

The application of this principle is particularly relevant to the regulation of infrastructure services such as water, gas, electricity, telecommunications and rail transportation.  The tendency in the past has been for governments to regulate all aspects of economic activity in these sectors because the network for distributing these services often constituted a natural monopoly.  In more recent years many governments have recognized that they can more efficiently accomplish their objective of protecting consumers by separating the construction and operation of the distribution network from provision of services over that network.  By separating the production of these infrastructure services from their distribution through the monopoly network, the government can regulate access to and use of the network monopoly, while leaving the supply of the services involved open to market competition. Efforts to minimize the scope of regulations to the minimum necessary to achieve the desired social objective helps to minimize the economic cost of such regulations and the potential distortion of international trade and competition.

Conclusion

China has made tremendous strides in the past few years in modernizing its economy, and it has generated impress8ive growth rates.  These gains have come from releasing the energies of the Chinese people in a market context, and in more widely participating in the global economy.  The most important challenge at this stage, undoubtedly, is the rationalization of the large state enterprises, in order to relieve the banking system of the continuing burden of subsidizing them.  In order to rationalize the state enterprises, China, in turn, has to relieve the state enterprises of their social obligations by introducing a modern social welfare system.  These challenges are well understood, and the top leadership of the Chinese government has committed itself to achieve these goals in coming years

These high priority goals for the near future are not the subject of this paper, and are mentioned here only for three reasons. First, to recognize the importance of these near term challenges. Second, to acknowledge that far-reaching regulatory reforms in financial services will be difficult to achieve without progress in eliminating subsidies to state enterprises and putting the banking system on a sound financial basis. Third, to indicate that the next most important challenge Chinafaces is the reform of its regulatory system, particularly in services.  It will be impossible for China to sustain high growth rates over the long run without such reforms.

The most immediate challenges for China in the area of regulatory reform are the most simple ones, yet also perhaps the most difficult to accomplish – to establish transparency and predictability in its regulations.  The reform process in China rightly involves a great deal of local experimentation.  It should be possible, however, topreserve an element of pragmatic experimentation with greater transparency and predictability. Beyond these fundamentals, China needs to move from a system of entry and licensing controls to a regulatory system based on transparent, objective and measurable performance criteria.  Such a system will be more likely to accomplish legitimate social objectives, as well as allow market participants to search out the most effective and economically efficient methods of supplying the services needed by a high growth economy.

Opening up competition to services will be particularly important as China seeks to develop its own capacity to develop, design, finance, insure, and market goods and services for the world market.  As long as Chinese enterprises play the role of subcontractors, foreign firms operating in the competitive global market place can provide these services.  Chinese enterprises will not be able to go far in developing their own excellence in these areas without the opening up of competition inside China, and that will require a major reform of Chinese regulatory systems in services.

Reforming the regulatory systems in services, and opening up the market to wider domestic and international competition is thus very much in China’s domestic economic interest.  These reforms cannot be accomplished overnight, since both the regulators and the managers of affected firms require time to acquire the necessary knowledge and skills, and since all reforms are accompanied by economic dislocations that need to be stretched out to a socially acceptable pace of adjustment.  The need for a phased implementation of reforms, however, is not an argument for a delay in mapping out a long-term game plan for reform and to initiate the process of reform.  The establishment of long term reform targets and a phased plan for implementing reforms creates a more predictable environment for enterprises, encouraging risk taking.  It also allows market participants to anticipate reforms through investment and management decisions,thus easing the future adjustment process and accelerating the economic benefits of the subsequent reforms. The establishment of reform targets and plans for their implementation should also facilitate China’s entry into the World Trading System.

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