Module

6

Modal Structure of the GATS

ESTIMATED TIME: 3 hours

OBJECTIVES OF MODULE 6

  • Provide more information on the GATS framework for defining "trade in services";
  • discuss some of the challenges that are faced when determining which modes are actually involved in a service transaction; and
  • highlight the underlying rationale and economic importance of the four modes of supply of the GATS.

1

I.INTRODUCTION

The GATS covers all measures by governments affecting "trade in services". Examining this simple phrase, how should we understand the term "services"? And when will there be "trade" in these services? Although the term "services" is not specifically defined in the Agreement, it is understood to include the full range of intangible transactions commonly found in international service classifications. The notion of "trade in services", on the other hand, is specifically defined in the Agreement, and covers four different "modes" by which services are supplied to a consumer. The basic concept of modes of supply was explained in module 4. In this module, a more detailed explanation is given of each mode of supply as well as of its economic importance in services trade.

II.MODES OF SUPPLY

In some cases, a service can be transacted across a border without either the supplier or consumer being in the same place. Examples are the use of the Internet to provide online services like distance learning, ebanking, hotel reservations, telemedicine, as well as many other services conveyed electronically. Such transactions are conceptually similar to trade in goods under the GATT, where the exporter and importer are typically not located in the same country. However, in other instances, for technical reasons or simply out of convenience, the supplier and the consumer of a service may have to be present in the same place in order for the transaction to be conducted. An example of such a situation might be a haircut. Even with technological advances, it is today simply impossible to provide or obtain an on-line haircut. For that transaction to take place, the producer of the service has to move to the consumer, or the consumer to the producer.

In light of this special feature of services trade, the GATS defines four modes of supply. The first covers trade in services in which the supplier is not present in the same WTO Member's territory as the consumer. The other three cover trade in services in which the producer and the consumer of the service are present together within the same WTO Member. Module 4 has already explained modes of supply, but for a reminder see the box below:

Reminder
How Services Are Traded—The Four “Modes of Supply” in the GATS
The GATS does not define what "services" are, but specifies instead the four modes by which services may be supplied:
Mode 1 (Cross-Border Supply): from the territory of one Member into the territory of any other Member
This mode requires that only the "service" crosses the border from one Member to another. Neither the supplier nor the consumer of the service moves from their respective territories. Examples include services provided via the post or the Internet.
Mode 2 (Consumption Abroad): in the territory of one Member to the service consumer of any other Member
Under this mode, the service consumer of one Member will typically cross the border to where the supplier is located to purchase and consume a service. Examples include holidays abroad, foreign education, and overseas health care. Although the presence abroad of the consumer is often necessary, activities such as ship repair, where only the property of the consumer moves or is situated abroad, are also covered.
Mode 3 (Commercial Presence): by a service supplier of one Member, through commercial presence in the territory of any other Member
This mode covers any type of business or professional establishment including an affiliate, subsidiary, representative office or branch. Examples are foreign banks or telecommunications companies with subsidiaries in another territory. Typically, investment flows are involved.
Mode 4 (Presence of Natural Persons): by a service supplier of one Member, through presence of natural persons of a Member in the territory of any other Member.
This mode covers natural persons who are themselves service suppliers, as well as natural persons who are employees of service suppliers who are present in the host country. Schedules indicate that Members have generally used the following categories of mode 4 service suppliers: independent professionals; intra-corporate transferees; business visitors; and contractual service suppliers.

The above definitions of the four modes of supply are significantly broader than the balance of payments (BOP) concept of services trade. While the BOP focuses on residency rather than nationality (i.e., a service is being exported if it is traded between residents and non-residents) certain transactions falling under the GATS, in particular in the case of mode 3, typically involve only residents of the country concerned. Current BOP statistics would therefore not capture the value of the activities of mode 3 service suppliers (see section below on mode 3).

Which mode of supply accounts for most of trade in services?
Overall, in terms of commercial value, the share of individual modes in world services trade has been estimated at: 25-30 per cent for mode 1; 10-15 per cent for mode 2; 55-60 per cent for mode 3; and less than 5 per cent for mode 4 (Measuring GATS Mode 4 Trade Flows). Mode 3 trade, mostly combined with foreign direct investment (FDI), has been the most dynamic component in recent years. Even then current statistic significantly underestimate mode 3 trade since it does not appear in BOP statistics for the reasons explained above.

Sometimes a service transaction may, for practical or commercial reasons, require the use of more than one mode of supply. Relevant linkages may exist among all four modes of supply. For example, a foreign bank established under mode 3 in country A may employ nationals from country B (mode 4) and import advertising services from C (mode 1) to operate in its host market. Similarly, business visits into A (mode 4) may prove necessary to complement cross-border supplies into that country (mode 1) or to upgrade the capacity of a locally established office (mode 3). During the time spent in the country the business visitor cosumes services (mode 2), such as staying at a hotel. However, it is important to keep in mind that commitments are modespecific and, despite close economic linkages, cover only the transactions for which they have been inscribed. They do not imply a right for the supplier of a committed service to supply uncommitted services.

III.MODES 1 AND 2 (CROSS-BORDER TRADE AND CONSUMPTION ABROAD)

Until recently, mode 1, or "cross-border trade", has attracted little attention, in part because its practical and economic importance was rather limited. Attention focused principally on modes 3 and 4. However, as a result of technological developments, mode 1 has gained increasing importance. A number of services whose provision once required physical proximity between the consumer and the supplier can now be traded via the Internet or other networks. This includes, for example, e-banking, computer and IT services, many forms of professional and consultancy services, travel agency services, hotel bookings, and sales of air tickets, as well as many other consumer and producer services. Electronic delivery has thus added a new dimension to crossborder trade in services. It has created many business opportunities, in particular for developing countries, and has also opened new perspectives for small and medium-sized suppliers in all countries.

Over the last ten years and, more recently, the emergence of offshoring[1] activities have fuelled additional interest. Several developing countries host offshoring centres which offer new employment and important business prospects (see box below).

What is business process outsourcing?
One of the fastest growing offshoring activities has been Business Process Outsourcing (BPO), which includes a variety of business support functions, sometimes referred to as back office services. Using electronic means, such services can be obtained from locations in a different territory far from the head office or the final consumer. Many developing countries have realized success in BPO in recent years.
BPO services may include customer support or sales and marketing support and customer servicing (e.g. by means of call centres) for insurance, airline and many other industries. It also can include accounts, bookkeeping, payroll management, bill collection, and records transcription, to name a few examples. They often require language aptitudes and a degree of skills and training, but not necessarily at sophisticated levels, and can offer advantages such as lower costs and a 24 hour-service.
Offshore activities, such as BPO, often use the Internet, Internet-enabled technologies (such as VOIP networks for call centres), private corporate networks, satellite links or a combination of these to send and receive services.

While cross-border supply (mode 1) is most relevant, consumption abroad (mode 2) may also be involved in a service transaction using the Internet. There is uncertainty about how GATS modes of supply may apply to electronic delivery and, more generally, about how to distinguish between supply under modes 1 and 2 (see following section). As a result, commitments for both modes might prove relevant and should be consulted for such services.

III.A.HOW TO DISTINGUISH BETWEEN MODE 1 AND2?

As mentioned above, the "cross-border supply" of services (or "mode 1") is defined as "the supply of a service from the territory of one Member into the territory of any other Member" (ArticleI:2(a)). Examples of crossborder supply include international transport as well as services supplied through telecommunication or mail[2]. Electronic transactions also fall under mode 1 (see explanation on technological neutrality). Mode 2, or so-called "consumption abroad", on the other hand, is defined as the supply of a service "in the territory of one Member to the service consumer of any other Member" (ArticleI:2(b)).

Figure 1:"Cross-border supply" of services (or "mode 1")

Figure 2:"Consumption abroad" (or "mode 2")

Technological neutrality
The Uruguay Round agreements were concluded at a time when the Internet was just beginning and not used on a large scale by the business community. A few years later, the question arose among WTO Members whether electronic deliveries were covered by existing GATS modes of supply. In the discussions on electronic commerce which started in 1998 under the aegis of the General Council, there was a generally shared view among Members that the GATS was technologically neutral, in the sense that "it does not contain any provisions that distinguish between the different technological means through which a service may be supplied." This principle, referred to as "technological neutrality", means that specific commitments undertaken under mode 1 during the Uruguay Round, do cover Internet transactions. However, it must be pointed out that the WTO discussions on electronic commerce did not result in any formal conclusions by Members.
Nevertheless, the principle of technological neutrality has been endorsed by a panel ruling. In the United States – Gambling dispute, the Panel considered that the definition of mode 1 in ArticleI:2(a) "does not contain any indication as to the means that can be used to supply services cross-border. This indicates [...] that the GATS does not limit the various technologically neutral possible means of delivery under mode 1. [...] a market access commitment for mode 1 implies the right for other Members' suppliers to supply a service through all means of delivery, whether by mail, telephone, Internet, etc., unless otherwise specified in a Member's Schedule."

In theory, the main distinction between modes 1 and 2 is that for mode 1 the service is delivered within the territory of the Member taking the commitment concerned, while for mode 2 it is delivered and consumed outside its territory. However, electronic delivery blurs this distinction, with the two modes operating in tandem and the physical presence of the consumer is not necessarily a relevant criterion for determining the place of delivery or consumption of a service. The issue has arisen particularly in relation to financial services (see box below for some examples).

When is a financial service mode 1, and when is it mode 2?
Deposits: A bank account is opened abroad by a consumer of a Member. If the consumer travelled abroad to open the account, this may be mode 2 supply, while the absence of travel (opening of the account through mail order and bank transfer, or through electronic means) may imply mode 1. However, the services directly associated with this account (payment of interest, debiting and crediting of payments and transfers, offsetting of balances, etc.) can be delivered either abroad or in the consumer's home country at the request of the consumer.
Loan: A loan is made by a bank established abroad to a consumer of another Member. The loan can be delivered either within or outside the territory of the consumer's home country.
Insurance: The consumer of a Member concludes a property insurance contract with an insurer established abroad. It can be argued that if the insured property is located abroad, the service is also delivered abroad, since the protection provided by the insurance contract is "delivered" with respect to the property; therefore this belongs to mode 2. However, it can equally be argued that the insurance provides protection to the consumer in his or her home country, as the premiums are paid by the consumer, and in the event of an accident, the indemnity will be paid to the consumer in the home country; therefore this would come under mode 1.
Given the diversity and complexity of financial services, there may be an infinite number of such examples. For more information on modes 1 and 2 in financial services see S/L/92, Attachments 2 and 3.

So far, Members have not reached a clear understanding on how to make a clear distinction. The same problem potentially arises in all sectors where services can be supplied electronically and with the development of the Internet, the scope for controversial situations may have expanded as well. It has been suggested, as a practical matter, that mode 2 may relate to restrictions placed on the consumer, regardless of where the consumer is situated, and that mode 1 may relate to restrictions placed on the supplier. Of course, in practice an interpretative difficulty may only arise when, for a given sector, the levels of commitment are different for mode 1 and mode 2 (for instance, there is an "Unbound" for mode 1 and a "None" for mode 2). Pending an agreed solution, one approach may be for Members to inscribe similar commitments for both modes 1 and 2 in sectors.

III.B.HOW IMPORTANT ARE MODE 1/2 SERVICES TRADE?

The estimated share of cross border transactions in world trade is between 25-30 per cent. In developed economies, crossborder trade of services represented US$591 billion in 1995 and grew to US$1,119 billion in 2004. In developing countries, its share jumped from US$163 billion in 1995 to some US$302 billion in 2004. Worldwide, the annual average growth of cross-border transactions has been close to 8 per cent between 1995 and 2004. Sixty-nine per cent of the "export" transactions comes from developed countries (this figure does not take into account intra-EU 15 trade), 26 per cent comes from developing countries and 5 per cent from transition economies. Transportation represents 33 per cent of services "export" transactions, followed by "Other business" with 35 per cent, financial services (8 per cent), royalties and licence fees (8 per cent), computer and information (6 per cent), communications (4 per cent), insurance (4 per cent) and cultural and recreational services (2 per cent).

However, it is unclear how much of cross border transactions on a BOP basis may represent cross border trade as defined by GATS, and data on on-line supply and offshoring are extremely difficult to track. Not only are current statistical methods believed to underestimate cross border trade in many sectors, but, in addition, on-line cross border trade in services largely escapes most statistical gathering efforts. It should also be noted that none of the extensive intra-firm offshoring activities in developing economies, for example, BPO services, are reflected in the BOP figures

III.C.WHAT HAS BEEN COMMITTED?

Overall, mode 1 has attracted far fewer commitments than mode 3, for instance. Mode 1 has the largest share of "Unbound" of all modes of supply: more than 30 per cent, as compared to less than 10 per cent for mode 2 and less than 5 per cent for mode 3. However, such general patterns need to be interpreted with care since, for a given mode, there may be big variations from one sector to another.

Reasons for not binding cross border supply may vary. In general, commercial presence was a main focus of the Uruguay Round negotiations, at a time when many developing countries were favourable to seeking investors to enhance and develop national services industries. Also, in some sectors, Members did not consider it to be technically feasible for given sectors (which they sometimes explicitly indicated with an "Unbound*", see module 5 for more information on entries in schedules). Indeed, cross-border supply is irrelevant – and will remain so – for a number of activities which, by their very nature, require physical proximity between the consumer and the supplier (construction and hotel services, for instance), although firms in many sectors draw upon Internet or similar technologies for ancilliary services or administrative support, such as reservations systems and tracking, or related consulting activities, However, one should note that for services that are or have become information-oriented, the assumptions concerning the "technical feasibility" of trading services cross-border may have changed since the end of the Uruguay Round as a result of technological advances. For example, with technologies available today, a computer repair can be effected by remote techniques. A number of activities for which mode 1 was not feasible or was commercially insignificant (such as health and education services, but also gambling) can now be traded remotely on a large scale thanks to the internet. Uncertainties with regard to how to enforce regulatory measures with respect to suppliers situated abroad may also have contributed to a reticence of governments to make binding commitments on cross border supply.