What future for free trade in services?

Bulletin article
Simon Tilford
03 April 2006

The controversy that has engulfed the Commission’s draft services directive is hardly surprising: the establishment of a single EU market in services was always going to generate more opposition than the liberalisation of trade in goods. Central to the ‘Bolkestein directive’, named after the former internal market commissioner, Frits Bolkestein, was the ‘country of origin’ principle. This would have allowed service providers to do business anywhere in the EU under the rules and regulations of their home country. It would thus have required many member-states to deregulate service sectors significantly – at a time when popular resistance to economic reform is rising.

Charlie McCreevy, Bolkestein’s successor, has likened the original draft directive to a Picasso painting: very beautiful but divorced from reality. He may be right that the Bolkestein directive was too ambitious to stand a chance of being adopted. But the European Parliament’s amendments to the draft, and the Commission’s promise to accommodate them, are disappointing. The new version excludes a whole range of sectors, ranging from broadcasting to social services. And in those sectors that are still covered, member-states will be allowed to apply exemptions from the country of origin principle on various, vaguely defined grounds, such as public policy, health or security. Services account for two-thirds of EU GDP and a similar proportion of employment. If Europe wants to improve its economic performance, it must make its service sector more open and efficient. The amended directive will not do much to bring this about.

The free movement of services is one of the ‘four freedoms’ guaranteed by the Treaty of Rome (the others are the free movement of goods, capital and people). The abolition of most barriers to trade in goods spurred competition and productivity growth, and lowered product prices. A huge range of services, from construction to advertising, are traded internationally and there is no reason to believe that a true internal market in services would not deliver similar benefits. However, service sectors in most EU countries are highly regulated, which means that national markets are largely insulated from cross-border competition. Services account for just 20 per cent of intra-EU trade – a proportion that has fallen over the last five years.

Opponents of the country of origin principle fear that it would lead to ‘unfair’ competition and an erosion of social standards by allowing companies to register in member-states where wages are low and consumer, health and environmental protection are weak. Such fears are largely unfounded. Workers posted to other countries would still have to be employed under the terms and conditions of the host state. A Polish builder working for a Polish construction company in Germany would no doubt earn less than a German, but local rules on minimum wages and health and safety would still have to be respected. The country of origin principle would merely allow a company or individual to offer services in another member-state without having to obtain any additional licenses or permits.

Lowering barriers to entry in this way would require many EU countries to accept a significantly greater role for the market in guaranteeing quality. Liberalisation would certainly lower the prices of many services, but cheaper services need not mean inferior service. The removal of regulatory barriers that limit competition could just as easily force standards up across the EU, by leaving firms with no option but to develop better services and become more efficient. The result would be lower prices, higher real wages and an expansion of service sector employment.

Opponents of free trade in services have not demonstrated how it would constitute unfair competition. An analogy with the trade in goods is instructive. Workers in Polish factories are paid around a fifth as much as their British or German counterparts and work longer hours. Does this mean Poland has an ‘unfair’ advantage in the manufacture of consumer products and car components? Put another way, why should people working in the service sector enjoy protection from competition while benefiting from free trade in goods, and the lower prices and improved choice this has brought?

Similarly, why should countries that profit disproportionately from trade in goods be able to block a free market in services that would bring relatively greater benefits to others? For example, France and Germany are much less successful exporters of services than countries which favour their liberalisation, such as the Netherlands and the UK. Excluding revenues from tourism (which count as services exports), 25 per cent of UK and Dutch exports are generated by the service sector, compared with 14 per cent in France and just 11 per cent in Germany.

What strategies are open to EU governments that want to liberalise services? One would be to veto any revised directive that seriously dilutes the ‘country of origin’ principle and hope to gain a better agreement once the economic climate improves. This would be risky. The drive to open up the EU’s services market has now taken on a kind of totemic significance for those opposed to further economic liberalisation. It may not be any easier to reach a good agreement in a few years’ time.

A second, and probably more effective strategy, would be for the member-states which back free trade in services to adopt the directive in its original form. Such a group could potentially include the UK, Spain, the Netherlands, Denmark, Ireland as well as most of the new member-states. Obviously, a services market that initially excluded France, Germany and Italy would be far from ideal. However, it would still be preferable to a heavily watered-down directive that largely perpetuated the status quo.

Such ‘enhanced co-operation’ between a coalition of the willing would serve a number of purposes. First, it would expose those governments opposed to liberalisation as trying to implement the single market selectively. Second, it would enable members of the avant-garde to reap the efficiency gains that increased cross-border trade in services would bring. And third, it would put pressure on the remaining member-states to opt in or risk a steady loss of service sector competitiveness.

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