Opening services markets within Europe: Modelling foreign establishments in a CGE framework

Abstract

In services the activities of foreign affiliates often exceed the value of cross-border trade. A complete analysis of services liberalisation therefore requires the modelling of FDI. This paper presents the treatment of FDI in our CGE model WorldScan based on the ideas of Petri (1997) and Markusen (2002). They assume that firms establishing affiliates abroad also transfer firmspecific knowledge. Consequently, capital and products differ from existing capital and products in the host country. As an illustration, we apply this model to assess the proposals of the European Commission to open up services markets. FDI in services could increase by 20% to 35%. However, the overall economic impact is limited. Our assessment suggests that GDP in the EU25 could increase up to 0.4%. These effects could be up to 0.8% higher if foreign capital also increases the overall productivity of the services sector.

CGE Modeling of Market Access in Services

“…Research on the potential gains from further integration of EU services markets confirms the findings of the work by Tarr and co-authors discussed above that what matters in welfare terms is to new entry by foreign firms (FDI). Lejour, Rojas-Romagosa, and Verweij (2008) conclude that although further integration of EU services markets rsulting from the revised directive will be beneficial, relative to initial GDP the increases will be limited (less than 1 percent of GDP) because they are unlikey to stimulate a significant net increase in investment as a result of the continued prevalence of country-specific regulation (i.e., differences in regulatory regimes will continue to create country-specific fixed costs of entry). Dee (2006) is representative of CGE analysis of shallower forms of regional integration of services markets than the EU.…”

“…FDI data are plagued by limited coverage, as well as by confidentiality constraints that imply that even if available they cannot legally be reported. As discussed below, FDI data compilation efforts have sometimes been linked to specific modeling projects, like FTAP (Hanslow et al, 2000), the Michigan model ) and the Worldscan model (Lejour, Rojas-Romagosa and Verweij, 2008). As an alternative, the French research institute CEPII has endeavored to follow the entropy and reverse gravity methods pioneered for merchandise trade flows to map out a picture of the geographic pattern of FDI refined enough for CGE modeling (Boumellassa, Gouel, and Laborde, 2007).…”

“…There are a number of papers in the literature that focus on the effects of domestic regulation as well as the impacts of discriminatory policies -e.g., Kox and Lejour (2006) and Lejour, Rojas-Romagosa and Verweij (2008), as well as much of the Australia-based research covered above. Doing more to accurately characterize both types of measures and the likely impacts of reform is important for work in this area to be policy-relevant.…”

“…Others have followed the example of the Dee and Hanslow/FTAP effort, including the Central Planning Bureau in the Hague, which extended its WorldScan model to include FDI in services (Lejour, Rojas-Romagosa and Verweij, 2008), and and Brown, Deardorff and Stern (2001), who extended the Michigan model to include FDI along Petri lines. A major limiting factor here is the lack of detailed bilateral FDI data by sector.…”

Reflections on the Economic Modelling of Free Trade Agreements

“…Nevertheless, attempts to model FDI, with different underlying motives and logic have been undertaken, with varying degrees of linkages to real data, see e.g. Ciuriak and Xiao (2014), Lai and Zhu (2006), Lejour et al (2008) and the literature cited therein and Tarr (2013). Fukui and Lakatos (2012) have added to the work in this area through an analysis of foreign affiliate statistics and the creation of such a database.…”