Does Services Liberalization Benefit Manufacturing Firms?
Evidence from the Czech Republic
Jens Arnold
*
Beata S. Javorcik
**
Aaditya Mattoo
***
Abstract
While there is considerable empirical evidence on the impact of liberalizing trade in goods, the
effects of services liberalization have not been empirically established. This study examines the
link between services sector reforms and the productivity of manufacturing industries relying on
services inputs. Several aspects of services liberalization are considered, namely, the presence of
foreign providers, privatization and the level of competition. The results, based on firm-level
data from the Czech Republic, show a positive relationship between services sector reform and
the performance of domestic firms in downstream manufacturing sectors. Allowing foreign entry
into services industries appears to be the key channel through which services liberalization
contributes to improved performance of manufacturing sectors. This finding is supported by
evidence that foreign acquisitions of Czech services providers result in profound changes in the
labor productivity and sales of acquired firms. As most barriers to foreign investment today are
not in goods but in services sectors, the findings of this study may strengthen the argument for
reform in this area.
Keywords: services liberalization, productivity, foreign direct investment, privatizations, foreign
acquisitions
JEL Codes: L8, F2, D24
_________________________
* OECD Economics Department, 2 rue André Pascal, 75116 Paris, France. Email: jens.arnold@oecd.org.
** Department of Economics, University of Oxford and CEPR, Manor Road Building, Manor Road, Oxford OX1
3UQ, United Kingdom. Email: beata.javorcik@economics.ox.ac.uk. *** World Bank, 1818 H Street, NW; MSN
MC3-303; Washington, DC, 20433. Email: amattoo@worldbank.org. This paper is part of the World Bank’s
research program on trade in services, which is supported in part by the United Kingdom’s Department for
International Development. We thank Andrew Bernard, Bruce Blonigen, Ann Harrison, Balázs Muraközy, Clinton
Shiells, Dan Trefler, an anonymous reviewer and seminar participants at the World Bank, the European Bank for
Reconstruction and Development, the European Central Bank, the London School of Economics, the Tuck Business
School at Dartmouth, the Joint Vienna Institute, the University of Michigan, the George Washington University,
University of Oxford, the NBER Summer Institute 2006, the NBER Universities Research Conference, the Third
CEPR Conference on "Trade, Industrialisation and Development" in Chianti, and the Empirical Investigations in
International Economics Conference in Isola for helpful comments. The views expressed in the paper are those of
the authors and should not be attributed to the World Bank, its Executive Directors or the countries they represent,
or to the OECD or its member countries.
1
1 Introduction
Services liberalization is a controversial subject, as is evident from recent policy debates
in the European Union and the World Trade Organization. The scope for controversy is great
because—in contrast to the large body of empirical research on the impact of trade liberalization
in goods—little is known about the effects of allowing greater foreign entry in services
industries. Since a wide range of manufacturing and services industries rely on services inputs, it
seems reasonable to presume that large gains could be achieved through the liberalization of
services sectors.
To the best of our knowledge, this is the first study that provides empirical evidence on
the link between reforms in services sectors and the performance of downstream manufacturing
industries.
1
Liberalization of services industries can involve the abolition of monopolies, the
privatization of state-owned enterprises and the elimination of barriers to entry. As a result, new
domestic and foreign providers are likely to enter the market and hence increase the choice of
providers for downstream users of services. Greater choice of services providers may in turn
affect the performance of manufacturing sectors in three ways.
Our analysis focuses on the Czech Republic which introduced far reaching reforms
of services industries during the 1990s, including opening services sectors to foreign investors, in
the context of its accession to the European Union (EU). The results, based on firm-level data for
the period 1998–2003, suggest a positive association between liberalization in services industries
and the productivity of manufacturing firms using services inputs. Allowing entry of foreign
services providers appears to be the key channel through which services liberalization benefits
the manufacturing sector.
1
The most closely related studies by Rajan and Zingales (1998) and Fernald (1999) are discussed in the next section. Recent efforts to estimate
the economy-wide benefits of services reform using computable general equilibrium models (Rutherford and Tarr 2008) assume downstream
productivity effects of foreign entry into services markets. This paper is seeking to establish the existence of these effects.
2
First, new services may become available through the entry of more technologically
advanced services providers. Examples include new financial instruments and cash flow
management tools, multi-modal transport services, or digital value-added services in
telecommunications. Availability of such services may allow manufacturers to introduce
productivity enhancing changes to their operations, such as receiving production orders on line
or setting up on-line bidding systems for suppliers. Ethier (1982) provides theoretical and Amiti
and Konings (2007) provide empirical support for the argument that access to a greater variety of
inputs can result in higher productivity of downstream industries. This argument in favor of
liberalization of trade in goods is equally valid in the context of services liberalization.
Second, services liberalization may also lead to a wider availability of services that were
formerly restricted to certain groups of users, such as internet coverage in rural areas or an
improved availability of business consulting services to smaller firms. The improved access may
lead to enhanced performance of smaller or remotely located enterprises.
2
Third, the reliability of existing services may improve as a result of privatization,
competition and the entry of internationally successful players. For instance, telephone
communications or electricity provision may become more reliable due to investments in
infrastructure by new domestic or foreign owners, or credit decisions may be made faster as
competition among banks increases. These improvements will in turn limit disruptions to
production and reduce operating costs in downstream manufacturing sectors.
The entry of foreign providers may play a particularly important role in realizing these
benefits. Foreign providers may bring know-how and knowledge about new products and
2
In a case study of Mexican detergent industry, Javorcik, Keller and Tybout (2008) find that the entry of Wal-Mart reduced the distribution cost
for detergent manufacturers. While in the past manufacturers used to deliver their products to individual supermarkets, Wal-Mart instituted a
system of deliveries to a central warehouse. Moreover, the expansion of Wal-Mart into many regions of the country gave producers an
opportunity to expand the reach of their products without having to engage in costly transactions with small wholesalers and retailers. This was
particularly valuable for smaller producers whose reach into other regions had been hindered by prohibitive transport and transaction costs.
3
international best practices into the country. By setting a higher standard and introducing new
products, they may also put pressure on domestic suppliers to make similar improvements.
3
To examine the link between services sector reforms and the performance of services
users, we rely on firm-level data from Amadeus, a commercial data base including financial
statements and ownership information for approximately ten thousand Czech companies for the
1998-2003 period. We regress the total factor productivity of manufacturing firms on the state of
liberalization in services sectors weighted by the respective manufacturing sector’s reliance on
inputs from each services sector. To take into account the possible simultaneity between
productivity shocks and input selection, we estimate the total factor productivity using the
methodology proposed by Olley and Pakes (2003). Our identifying assumption is that the effect
of services reform should be more pronounced in manufacturing sectors relying more heavily on
services inputs. Our measures of the state of liberalization in services sectors are time varying.
The reliance of manufacturing sectors on services inputs is assessed based on the national input-
output matrix. We control for other aspects of openness, namely tariffs both on output and on
intermediate inputs, and the presence of foreign direct investment (FDI) both in the same sector
as well as in industries supplying intermediates. All explanatory variables are lagged one period.
The estimated model also includes firm and year fixed effects. Standard errors are clustered on
industry-year combinations.
Given the limited scope for cross-border trade in services inputs, we would expect the
performance of downstream sectors to be tied more closely to the quality and availability of
services supplied by providers operating domestically than is the case for physical intermediate
inputs.
3
Javorcik, Keller and Tybout (2008) report that the centralized system of deliveries instituted by Wal-Mart in Mexico was later adopted by
national supermarket chains.
4
Identifying the impact of a policy reform, such as increasing openness of services sectors
to new domestic and foreign entrants, is often complicated by the fact that exogeneity of such a
reform is difficult to establish. If a policy is endogenous to changes in the overall economic
conditions or to developments in politically influential parts of the economy, the causality
between the policy and performance may run in both directions. This paper argues that the Czech
Republic’s efforts to join the EU and the close supervision of reform progress by Brussels
bureaucrats present a rare example of a largely exogenous policy reform leading to profound
changes in the structure of services industries and large FDI inflows into services.
Several measures are used to capture the extent of reform in services sectors. The first is
a set of policy reform indices published by the European Bank for Reconstruction and
Development (EBRD). Sector-specific time-varying indices are available for banking,
telecommunications, electric power, railway transport, road transport, and water distribution. The
indices reflect the overall state of policy reform in a given services industry. Three additional
measures capture a particular aspect of liberalization: (i) the extent to which foreign investors
have entered Czech services industries, which is proxied by the share of an industry’s output
produced by foreign-owned companies; (ii) the progress of privatization in services industries,
which is captured by the share of an industry’s output produced by private companies; (iii) the
level of competition in services industries, which is measured by the market share of the four
largest providers.
Our main finding is a positive correlation between liberalization in services sectors and
the productivity of downstream manufacturing firms. When each measure of reform is
considered in isolation, a positive and statistically significant relationship is found for the overall
progress in policy reform, the presence of foreign providers in services sectors and the extent of
privatization in services industries. No statistically significant relationship is detected for the
