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CHAPTER III After an arduous journey of four years from Venice to Shang-Tu near modern Peking, Marco Polo arrived in 1275 at the court of Kublai Khan, the Mongol emperor of China. He brought the emperor glass and jewelry produced by Venetian craftsmen and letters from the Doge of Venice and from Pope Gregory VIII in Rome. He also brought along something even more important to Kublai Khan, knowledge and professional skills, and for the next seventeen years Marco Polo worked for Kublai Khan as an adviser and emissary before returning to Venice in 1292. The story of Marco Polo illustrates the close relationship that has existed between trade in goods and trade in services throughout history. We could find similar reports in the clay tablets that have been unearthed from the ruins of the ancient cities of Sumer and Babylon. They have left us reports on the comings and goings of the merchants, craftsmen, storytellers, and ambassadors who carried out trade in goods and services between one city-state and another. In some ways not much has changed. Businessmen still travel from Europe to China bringing goods, messages, knowledge, and information as in the days of Marco Polo. What has changed is that modern technology has made it possible to transport goods and people from Europe to China in a matter of hours rather than years, in relative comfort rather than at great personal risk and discomfort, and at a fraction of the cost. Communication satellites and computers have made it possible to send long messages and large sums of money to remote parts of the world in seconds. Because it is so much easier and cheaper to move goods, money, people, and information from one country to another, the minuscule international flow of goods and services of Marco Polo's time has become so large that most people are affected by it either as consumers or as producers and the companies that supply the transportation, communications, and other international services have become large business enterprises employing hundreds of thousands of people. Increased economic importance has also brought growing influence on policy, and it has become increasingly difficult to treat international services as peripheral activities not worthy of the attention of trade policy officials. They deserve attention both because they are crucial for all international economic activity and because they are an important source of income and jobs. The same technological advances that have made it easier to move information from one country to another have also made the creation, processing, and distribution of information the source of new economic growth in the industrialized countries. The development of increasingly powerful -computers has led to an economic revolution as profound as the industrial revolution of the eighteenth century. Increasingly automated factories require fewer blue-collar workers on the production line, but more white-collar workers to program the computers, to design new products, and to process performance data. A growing demand for information-based business services and a new capability to transmit large amounts of information without a time lag. has thus created a new area of international trade. Labor-intensive processing of information can take place almost anywhere-across the street or at the other end of the world-and an increasing number of business enterprises are taking advantage of this possibility. A HISTORICAL PERSPECTIVE International trade in services has existed for as long as neighboring tribes, villages, or cities have traded with each other, visited each other, financed each other, or done business with each other. As people traveled, they carried skills, knowledge, information, and artistic talent from one country to another. Scientists, engineers, astronomers, and experts on many other subjects have traveled to other countries since time immemorial, offering their advice to foreign kings and merchant princes. Some of the earliest literature is based on an oral tradition preserved by wandering bards, who mesmerized their audiences with tales of foreign lands, spreading the fame of great heroes and kings. Artists, musicians, and actors have traveled far and wide in search of inspiration and patrons. Students traveled to attend foreign universities, to apprentice themselves to master craftsmen abroad, and to learn by seeing the world. The earliest traders had to provide their own transportation, find their own shelter, and cook their own food. As the international flow of goods, people, money, and information increased, more and more of the services that support international travel could be purchased from enterprises along the way. Further reductions in the real cost of travel have come as a result of new technologies-steamships, railroads, and jet aircraft, which made travel not only cheaper and faster but also easier. The growth in the market for services has created both very large companies that are able to take advantage of large economies of scale and many small companies that are better suited to meet the needs of narrow segments of the market. In both cases, specialization has added to the reduction in the cost of support services brought about by advances in technology. This in turn has stimulated a further expansion of international trade, international travel, international finance, and international information flows.
Today, most countries export a larger percentage of their total output and import a larger portion of what they consume than ever before. Travel to other countries has become commonplace. Vast sums of money move from one country to another in a matter of hours or even minutes. Information sometimes moves faster from Washington to London and hack than from one street to another within a city. Foreign markets have thus become more closely linked to local markets, and jobs and business profits are now tied much more closely to competition in the global marketplace. As international competition in the context of a global market has become more of a reality, corporate users have become much more sensitive to the cost of service inputs. In a world where expanded international competition has reduced margins and businesses succeed or fail on the basis of relatively small differences in costs, the cost and quality of available services can affect the profitability of a firm. Firms with large international operations have become far more vocal than in the past about the effect of foreign government policies on the availability and cost of services such as communications and transportation. This has led to a user-oriented focus to international trade discussions of such services as telecommunications, a somewhat startling concept to officials accustomed to a world of national telecommunications monopolies. International trade in services has also become big business. In the United States, many companies that supply international services-American Express (travel services), Citibank (financial services), Pan American (air transport services), Sea Land (ocean and land transport services), AIG (insurance), AT&T (communications), and EDS (data processing)-are among the largest companies in the country. These firms have become far more conscious than in the past of the advantage of influencing government policies that affect their ability to deliver services worldwide, and their rapid growth in recent years has given them the clout to get attention from the government. Both business executives and government officials are thus more inclined than in the past to look at barriers in services as key commercial issues. The rapid increase in international economic activity and the resulting growth of services made it inevitable that government officials responsible for trade policy would sooner or later pay more attention to policies that affect the delivery of services. THE INFORMATION REVOLUTION The crucial role of information-based business services to economic growth today and the tradeability of these services through modern communication and data processing facilities has convinced many governments that they should pay more attention to trade in services sooner rather than later. Services are at the heart of an economic revolution equivalent in influence to the industrial revolution that displaced artisans with factories in the eighteenth century. In the emerging economy the creation, processing, and distribution of information are displacing manufacturing as the primary economic activity of most workers. In fact, the creation, processing, and distribution of information are so central to the new economic revolution that it may well become known as the information revolution.1 The information revolution has fundamentally changed
the scope, character, and significance of trade in services. Old ideas
about the nature of services have become a hindrance to the efficiency
of government policies affecting the organization of services activities
in the world economy. Computers, factory robots, and completely automated factories are rapidly reducing the need for physical labor in manufacturing. At the same time, sophisticated agricultural machinery, fertilizers, pesticides, and biogenetic engineering are reducing the need for physical labor in growing food. In the new economy, more and more people are earning their living by working in services. The new service jobs fall into two categories: services directly provided to consumers and services provided to business. The people who hold jobs in the first category support our daily life: the legendary short-order cook at the local McDonald's, waiters at the local restaurant, taxicab drivers, the salesclerk at the comer store, the nurses and doctors at the local hospital, the teacher at your child's school, the plumber and the electrician, the TV repairman, the circus clown, and the preacher. The second category of service jobs are being created in response to the increasing demand by business enterprises for service inputs. A wide range of services are required to develop,
Table 3-1. U.S. Employment, by Sector.
program, install, operate, and maintain computers and factory robots. Increasingly complex products have to be planned, designed, engineered, tested, and advertised. At the same time, the growing complexity of the economy has substantially increased the demand for financial, legal, accounting, general managerial, and, of course, government services. Table 3-1 breaks down employment in the U.S. economy for the years 1975, 1980, and 1985. It shows the rapid growth of jobs in service industries in recent years. Table 3-2 shows the shift in the percentage distribution of gross national product in the United States from 1947 to 1977. The breakdown in this table is interesting because it highlights the distinction between services sold to consumers and services sold to business enterprises.
The Role of Information in the New Economy In the new economy that is emerging from the widespread application of computers, more and more of the jobs will be based on the application of specialized knowledge and the manipulation of information with computers. Most people will be earning their living by working with information-creating it, manipulating it, delivering it, managing its flow, applying it, or communicating information to others. The jobs that fall into this category include most office workers and managers, scientists and engineers, computer programmers and data entry clerks, teachers and preachers, lawyers and accountants, government , officials, poets and journalists, and architects and planners. It has been estimated that about half of U.S. workers in 1967 were in jobs that were in one way or another related to the production, processing, or dissemination of information. 2 In the service industries that produce service inputs for other businesses, most of the jobs involve work with information. In the service industries that produce services purchased by individual households, the percentage of jobs that involve work with information is smaller, but even in many of these industries more than half of the employees work in white-collar office jobs. The salesman in the local store, the doctor, the minister, the barber, the auto mechanic, the electrician, the plumber, and the mortician provide services that involve close interactions with consumers and their personal possessions. The establishments that provide these services, however, also employ a large number of clerks, computer programmers, accountants, secretaries, lawyers, and managers who are not in direct contact with customers. In one local department store chain, about a third of all employees are sales personnel and over a half work behind a desk as manager, buyers, bookkeepers, secretaries, telephone operators, computer programmers, advertising copywriters and artists, and lawyers. 3 Many of these employees do not have to be at the same geographic location as the customer. The Communications System as the During the eighteenth and nineteenth centuries the building of roads, canals, and railroads made it possible to centralize the production of goods in factories by providing efficient means for delivering raw materials to factories and delivering manufactured goods to markets. In the last part of the twentieth century, computers, optical fiber networks, communications satellites, and microwave networks are making it possible to centralize more of the information-based services activities by providing efficient means for delivering information from those who supply information to those who use information. Communications technology has progressed to the point where 1.5 billion bits of information can be transmitted through one circuit per second with complete reliability. In the very near future, computer-communication links are expected to operate at over 1.5 trillion bits per second. This tremendous increase in capacity has been accompanied by sharp decreases in the cost of transmission. The cost for a typical international voice or telex message was $3 per minute in 1970; today the cost is only a few cents. Moreover, a signal that is transmitted through a communications satellite can be sent to another location that is 3,000 miles away as cheaply as to a place that is a few hundred miles away.
Table 3-2. Percentage Distribution of Gross National
Product, 1947 1969 1977
How Trade in Business Services Has Altered the World Economy By making it possible to move large amounts of information efficiently, cheaply, and reliably over long distances, the information revolution has made many more information-based services tradeable. The production of services based on the creation or processing of information can now benefit from the same kind of international specialization that led to the rapid growth of trade in goods in the past. Take data processing services. Large computer centers
in New York, North Dakota, and Amsterdam now often serve clients from
many different parts of the world. Workers in Jamaica, Korea, and
Taiwan code and convert information into machine-readable form for
many multinational companies headquartered in the United States. Large
American construction At the same time, the information revolution is transforming the global organization of many manufacturing industries. Since it is now possible for managers in widely separated facilities to share the same information, there has been a sharp increase in international specialization in the production of the components and parts that go into finished products. The typical home computer contains parts manufactured in over a dozen countries. Other manufactured products that are now produced on a global basis, with inputs from many different countries, include automobiles, airplanes, television sets, automated machine tools, and boats. These globally produced goods inevitably incorporate service inputs from a number of different countries. Many of these globally produced goods finally compete in global markets, as perhaps best illustrated by airport shops around the world that display the same electronic gadgets, fashion apparel, and liquor. Overall, the information revolution is internationalizing markets to a far greater degree than before. Traders now have the ability to know the prices being charged at any one time in markets around the world, and they are able to determine with some precision the cost of shifting goods and services from one place to another. National markets are becoming much more closely linked to each other. The foreign exchange market and the Eurodollar market were perhaps the first markets to become highly integrated on an international basis.-As-time-passes, more stock exchanges are establishing direct linkages with each other, and traders in London can now buy and sell shares on the Singapore exchange after the London exchange has closed. Trading in any relatively homogeneous commodity now reflects price movement in other parts of the world. Needless to say, these global markets are supported by business services supplied on a global basis. International trade in business services has been central to the internationalization of economic activity. Behind the goods and services purchased by consumers from local retail establishments is an increasingly complex web of networks that tie together producers of specialized goods and services in many different countries. CENTRALIZATION OF BUSINESS SERVICES In order to understand fully the emergence of international trade in services as a key issue, we have to understand the economic forces that have affected the production, delivery, and role of business services, and the requirements of an increasingly integrated world economy
In the past, most services required to operate a manufacturing
business were produced within the firm itself. A typical firm employed
bookkeepers, accountants, engineers, experts in finance, marketing,
public relations, training, and personnel management, secretaries,
clerks, industrial designers; security guards, a cleaning and maintenance
crew, statistical analysts, computer programmers, and research scientists.
Most of these services were-produced in close proximity to the factory.
Business enterprises producing services also require a broad range
of service inputs, and these too were largely produced within the
enterprise in close proximity to the local bank, store, hospital,
or radio station. Since most support services in the past were tied to the local factory or the local service establishment, the possibility for specialization was quite limited. Depending on the scale of the local factory or services business, those responsible for individual activities had only a limited opportunity to hone their skills and to deepen their knowledge in a subset of their area of responsibility. Continuing improvements in communications and transportation facilities over the years gradually led to increased centralization and specialization in the production of business services. Manufacturing enterprises that had a number of factories at different locations or services firms with many retail outlets centralized the production of administrative services at corporate headquarters. This permitted functional specialists to develop greater skills and knowledge in narrower areas of activity. It also made it possible to take advantage of new economies of scale in processing data and to make better use of outside specialists. The trend toward greater centralization and specialization in the production of business services was accelerated by a growing demand for more specialized service inputs. As both products and the machinery used to produce such products became technologically more complex, manufacturing companies needed not only more engineers and research scientists, but also engineers and scientists with more highly specialized skills. At the same time, the growing demand by consumers for greater variety in both goods and services created a greater need for industrial designers, marketing experts, planners, and development staffs. The growing integration of both national and international markets has sharpened competition, and any firm that wants to survive has to acquire the best design, engineering, and marketing services available. High-quality service inputs, of course, are expensive, and the expense can be justified only if the scale of production is large enough. The growing centralization and specialization in the production of service inputs within business enterprises have had the interesting result that some manufacturing companies have become major suppliers of business services. Manufacturing companies that were able to cut the cost of their own service inputs through a process of centralization often found that they could profitably supply the same service inputs to other businesses. Manufacturing giants like Boeing, McDonnell Douglas, General Motors, General Electric, Mead Paper Company, and Montedison, for example, became major suppliers of data processing and information services. So did financial institutions like Citibank and Merrill Lynch. Companies that made a major investment in developing computer programs to facilitate various management and engineering tasks have similarly found that they can profitably sell these computer programs to others in the industry and thereby recoup the development costs. Of course, it does not make sense to centralize the production of all business services. Some business services require so many interactions and such a close working relationship with workers on the factory floor or with customers and sales personnel in retail outlets that it would not be practical to supply such services from a long distance. For example, detailed record keeping of materials used; hours worked, and available inventory is best carried out at the local level. On the other hand, aggregation of such data and analysis of the data might well be carried out more efficiently at corporate headquarters. Services that require extensive familiarity with the local environment are also best carried out at the local level, while services that require in-depth knowledge or services that can be produced much more cheaply in large volumes are best carried out on a centralized basis. The basic design of a factory producing paper or of a fast food outlet can be produced more efficiently at corporate headquarters, while the adaptation of the drawings to meet local building codes or zoning requirements might be done more efficiently by a local architect familiar with the regulations. Advertising and marketing of brand names is usually done more efficiently at the national corporate level, while arrangements for placing advertisements in local newspapers are best left to the manager of a local store. George Stigler (1956), an eminent economist at the University of Chicago, was one of the first theorists to draw our attention to this transformation of business services. A recent study by the Office of Technology Assessment has pulled together some recent data on shifts in the organization of service industries (1987, ch. 8); also see Stanback et al. (1981, chs. 3 and 5). Firms alter the distribution of service functions between the local level and regional, national, or international levels as the technology changes or as experience shows that a different distribution of functions leads to better results. How changes in technology can affect the distribution of functions is illustrated by developments in data processing departments. In the early days of mainframe computers, firms centralized a large number of data processing functions in one department. These centralized data processing departments, however, were often unresponsive to local needs, and the development of personal computers led to a new decentralization of many data processing functions in many companies. The last few years have seen a strong trend in many companies to using external sources for many business services. Even large corporations often do not have sufficient internal demand for many services to justify the development of internal staff expertise at a required level of professional competence. Corporate headquarters staff also tend to become unresponsive to needs in the field and tend to spend too much time coordinating with each other. By hiring an outside expert, a business manager can use as much or as little of that expert's time as may be required to meet current needs. Outside experts also tend to be more responsive to management needs or wishes since it is easier and cheaper to change outside consultants than in-house staff. Fortune magazine (February 2, 1987, pp. 47-50j predicted that over the next ten years most companies will significantly reduce the ranks of middle managers who provide most in-house services and replace them with independent suppliers of business services. Many companies have become too large to respond rapidly to shifts in markets and technology, and a reduction of corporate staff will tend to make such companies leaner and meaner and able to respond more decisively to changes in the environment. The major changes that have taken place in the production
of service inputs used by business have made it far more difficult
to interpret data on manufacturing and services employment. A INTERNATIONALIZATION OF BUSINESS SERVICES Many of the business services that can be produced in a corporate headquarters office-whether in a neighboring city or in a city across the country-can be produced just as efficiently in another country. Besides, any number of cities in Canada are closer to Portland, Maine, than Chicago or Los Angeles, and travel to and from a corporate headquarters in Montreal or Toronto would be less inconvenient than travel to and from Los Angeles. The same economic forces that lead to the growth of national firms and to the centralization of business services within countries have also led to the growth of international firms and to the centralization of some business services at an international level. Of course, national borders do matter. Some business services such as marketing, for example, require an intuitive grasp of the national-culture, and other business services may require an extensive knowledge of national laws and regulations. Government regulations may require that certain business services be performed within the country. In all such cases service inputs are produced within the same country where they are used. Multinational services companies with local branches in many countries can take advantage of international economies of scale by centralizing activities that do not require close physical proximity to users, while maintaining a local market presence for all activities that require close physical proximity to customers. A study carried out by the Organization
for Economic Cooperation and Development (OECD, 1983, pp. 11-12) showed
that multinational companies typically use centralized data processing
services to carry out the following functions: Increased international competition among global manufacturing enterprises has also boosted international trade in business services. Much as greater competition within countries made it essential that producers of goods acquire the best service inputs that were available nationally, intensified competition at an international level has made it essential that producers acquire the best service inputs available internationally. A company that wants to gain a competitive edge in the world market for cars, television sets, videotape recorders, or kitchen appliances must have world-class design, engineering, and marketing services, and if the services available at home are not of world standard, it must procure such services abroad. The internationalization of markets and growth of trade in business services are closely related. International trade in business services is a relatively recent phenomenon, at least in terms of volume. American banks, insurance companies, and consulting firms began expanding into international markets in the 1960s. It was not until the 1980s, however, that advances in information technology made it practical to centralize the production of such business services. The same advances in information technologies have now made it possible to centralize the in-house production of business services such as research and development, data processing, information systems, economic forecasting, marketing, advertising, accounting, personnel management, and planning. This does not mean that companies have universally centralized the production of all of these service inputs, but rather that they have centralized activities that require a high degree of specialization or activities that can be done much more cheaply in large volumes. Service inputs that require an extensive knowledge of the local environment or frequent interactions with local managers obviously are not good candidates for centralization at an international level.
Consumer services such as food services, health services, entertainment services, educational services, household insurance services, and retail banking services are produced where they are consumed, and they are therefore not tradeable. Food served in restaurants has to be cooked and served where it will he eaten. The doctor and patient both have to be present at the same location for a medical examination or an operation. The loan officer at the bank undoubtedly wants to have a personal interview before providing a personal loan. The insurance company needs a local claims adjuster to assess damages claimed by policy holders. Retail service establishments, like all other businesses, also need many service inputs that can be provided from a distance: accounting, data processing, finance, facilities design, planning, training, information services, and specialized professional advice. Many of these service inputs can be provided from a central corporate office in another city or in another country. Indeed, the advantages of economies of scale in retail services are demonstrated by the steady growth of multiestablishment firms in retail services, including the growth of international chains like Hertz, Baskin-Robbins, Kentucky Fried Chicken, Hospital Corporation of America, Berlitz, and Holiday Inns. Unfortunately, we have very little aggregate data that would tell us to what extent business has centralized the production of business services. Evidence derived from individual companies leads one to believe that companies have centralized many activities such as data processing, engineering, research and development, training, design, finance, and personnel. It is impossible to judge, at this stage, how far the process has gone. Under these circumstances it is possible to have differences of opinion among analysts, and such differences are reflected among the authors of the different volumes produced for the American Enterprise Institute on trade in services. It is highly probable that international trade in business services will continue to grow. Future advances in technology will continue to improve the quality and reduce the cost of communications. Individuals will become more comfortable with the use of personal computers, electronic mail, and teleconferencing in interacting with coworkers at more distant locations. Government regulations that now often impede the international flow of services will eventually break down in response to economic pressures and international negotiations. It is interesting to speculate, though difficult to predict, to what extent true international trade might emerge in consumer services such as banking, insurance, retailing, information, and entertainment services. The development of the personal computer has created a new system for delivering consumer services to the individual household, and a market that is not strictly tied to geographic location. Many people now do their personal banking and investing through an electronic hookup between a personal computer and a bank that could be hundreds of miles away. Electronic shopping through computer terminals is spreading rapidly, tracking the earlier rapid growth of mail order shopping. Is there any reason why the same technology could not lead to electronic hookups with banks, mail order outlets, or databases abroad?
International trade in services has become an important issue because international trade in services has become big business, and the enterprises that conduct this trade are counted among some of the largest corporations in the world. It has also become important because internationally traded business services are an increasingly strategic resource in the production of both goods and services. A third reason why international trade has become a more important issue is that new technology and an expansion of the market have opened up new opportunities for competition in service industries previously dominated completely by monopolies. As some countries have moved to deregulate significant segments of the telecommunications and transportation industries, issues that were previously addressed by domestic and international regulation now have to be addressed in terms familiar to trade policy officials-rules for market competition, distortions introduced by government restrictions, and interactions between competitive markets and monopolies. There are those who have attacked the proposition that services, and in particular trade in services, have become more significant to economic growth and welfare. They argue that manufacturing remains the core of the economy, and that the greater emphasis on trade in services will only serve to distract attention from improvements that need to be made in manufacturing and in trade rules affecting manufactured goods. These analysts, however, completely misunderstand or refuse to acknowledge the true nature of the economic revolution that is taking place. The issue is not services versus manufacturing, but the role of services in manufacturing. The fundamental change that has occurred in the modem
economy is how manufactured goods are produced. Manufacturing has
come to depend more and more on service inputs, and the quality of
manufacturing is increasingly a function of the quality of service
inputs. Manufacturing has also become more globally competitive, and
service inputs play an increasing role in that competitiveness. A country that produces high-quality service inputs for its manufacturing industries also is in a good position to take advantage of its strengths in these services to expand its exports of services. Again, this should be seen not as a question of a choice between services and manufacturing, but as a mutually reinforcing relationship. ------------------------------------------------- NOTES 1) The pioneering work in this area was done by Daniel
Bell, who first coined the phrase postindustrial society. See, for
example, Bell (1967). In terms of empirical work on the information
economy, the best work has been done by Marc Porat (1977) at the U.S.
Commerce Department. A 1987 study published by the Office of Technology
Assessment also contains a great deal of useful information (see OTA,
1987, chs. 5 and 8). One of the more thought-provoking studies published
recently on the new world information economy is the book by Albert
Bressand and Catherine Distler, Le Prochaine Monde. |