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Like a blind man describing an elephant, services are difficult to define, but you know them when you come across them. Services are commonly taken to be whatever part of the economy is left over, once the primary sector (agriculture, fishing, mining and forestry) and the manufacturing sector have been taken away. Hardly a firm enough definition on which to base an international agreement.

Just as there is the world of difference between the production of a cotton T-shirt and a semiconductor, so there are different types of services. Some are internationally tradable (forex sales) and other are non-tradable (hospital cleaning). Some services are high value added (LSE summer schools) and others are low value added (burger flipping). Some cannot exist without other economic activities and are said to be "coupled" (accountancy, management consulting) and others are de-coupled (haircuts).

What proportion of a developed economy do you think is typically accounted for by the production of services? An OECD country will typically have about two-thirds of its economy devoted to providing services, with 2-3% in primary sector production and the rest made up by manufacturing. Even developing countries tend to have services make up about half of their economy. The importance of service sector companies is illustrated by the list of the world's largest companies detailed in the following table.

Table 8.1 Business Week Global 1000. Top Companies by Market Value, Sales and Profits. (Figures in Billions of US Dollars)

Of the companies shown, only three of the top ten by market value are manufacturing companies, as are two of the top ten ranked by sales and half of those ranked by profits. Telecommunications and banking feature strongly, accounting for half of the top companies by market value and three of those ranked by profits. The list ranked by sales is dominated by six Japanese trading houses, or sogo shosha, whose core business is to act as an intermediary for a broad spectrum of traded goods. The two largest petroleum companies, Exxon and Royal Dutch/Shell appear in each of the three lists.

This is a further illustration of the size and importance of the service sector in the economy. Some of the largest employers and biggest companies come from the service sector. However, it is also true that service sector companies tend to be more domestically oriented than manufacturers.

Table 8.2 Most `International' Companies, 1993

With the exception of Canada's Thomson Corporation, whose business is mainly newspaper and magazine publishing, the list of the most international companies includes no service sector companies. The United Nations also ranks the top 100 transnational corporations according to the size of their foreign assets and that list reads: Royal Dutch/Shell, Exxon, IBM, General Motors, General Electric, Toyota, Ford, Hitachi, Sony and Mitsubishi Corporation. Only the last of the ten, Mitsubishi Corporation is clearly a service sector company.

So, although there are many large service sector companies, there are far fewer large international service sector companies. This is partly because the cross-border expansion of service sector companies has been more restricted than that of manufacturing firms, with for example, a state protecting its domestic telecommunications monopolist from foreign competition. It also reflects the non-tradable element of some service sector companies.

Liberalisation of services is seen as important in the world economy for several reasons. Firstly, sectors such as finance, airlines, telecommunications and biotechnology are some of the most exciting and fast-moving areas. An illustration is that trade in services is growing more quickly than that in manufactured products. In 1987 world trade in goods was worth $2415 billion, while services trade amounted to $670bn. By 1994 goods trade had reached $4095 billion (an average 7.8% annual growth) while services trade was $1194 billion (8.6% growth). At the same time flows of foreign direct investment, which are another manifestation of the internationalisation of services, were growing faster than trade.

In addition, services trade is still less liberalised than that of goods. Successive GATT rounds focused mainly on merchandise trade, and the attempts to bring services into the Uruguay Agreement were only partly successful. The implication is that once service sector trade is liberalised, there will be the scope for a similar boost to globalisation that accompanied the lowering of tariff barriers on goods.

It is typical for observers to bemoan the loss of manufacturing jobs and to see their replacement by service sector employment as a poor substitute. "We can't all just open doors for each other" illustrates a widespread belief that making things is somehow more important than providing a service.

The perception is that service sector jobs are low value-added and low paid, whereas dynamism in manufacturing will determine the success of an economy. The article by Brown and Julius highlights the faults of such an argument, with the key being not the sector involved, but the amount of value added in any given industry. Whether a country excels in automobiles or telecommunications is less important than whether it provides financial services or fast food restaurants.

As the list of the world's largest companies shows, most are service sector companies. The list also illustrates some of the problems in defining to which sector a company belongs. Is Exxon a mining company, as it extracts oil, is it in manufacturing, because it refines the crude, or is it a service sector company, due to its array of filling (gas) stations.

Consider for example, the difference between computer programming and pharmaceuticals. In both cases, the bulk of the cost of the product is in the research and training of the individuals engaged in providing the software or the drug. Although the cost of the physical components in a drug is usually a fraction of its price, it is a manufactured product. If a computer programmer spends a month writing software for a company it is a service. What happens if the same person puts the program on a disk and sells it more widely. Like drugs, the cost of the computer disk will be a fraction of the cost of the product, but is it now a manufactured product?

Similarly, if a security guard moves from being employed by Nippon Steel to go and do the same job for the advertising giant Dentsu, he stops being employed in the manufacturing sector and is now a service sector worker.

The point is that some of the distinctions drawn between services and manufactures are false ones. However, some services do have peculiarities which distinguish them from manufacturing firms. These can be summarised under three headings:

Low or zero marginal cost. Many services are characterised by high initial costs in terms of capital spending and employing the workforce, but very low or zero marginal costs. Consider an aeroplane flying across the Atlantic. Filling an empty seat with a passenger increases costs only marginally in terms of the extra fuel needed to carry him and his luggage, or to provide refreshments, but it brings in substantially more revenues. The same is true for hotels, most publishing, broadcasting, etc.

For the service provider this has implications in terms of marketing, pricing and any other area which will ensure that their facilities are used to the maximum extent. For governments it has implications in terms of competition. For example, the marginal costs of providing telecommunications services are very low, but the initial expenditure to create the network is extremely high, and the combination means that introducing competition is extremely complex.

Nature of Supply. The supply of services does differ from the supply of manufactures in some ways. Notably, there tends to be a greater degree of human contact with the supply of a service which means that the supplier must be proximate to the consumer. It also makes it more difficult to ensure a consistent standard of service - the treatment you receive when buying shoes in the same department store can vary greatly from week to week. Cultural factors also tend to be more important than in the provision of manufactures, due to the higher reliance on human capital - this can be a problem when service companies are internationalising.

This reliance on human capital makes it difficult to value service sector companies due to the large element of goodwill embodied in a service sector firm. The plunge in value of the old Saatchi & Saatchi stock price once its founders left and set up a rival business is a recent illustration of this. Another is the apparently high price paid by Swiss Bank Corporation and Merrill Lynch to buy S.G. Warburg and Smith New Court respectively only to see many of their acquisition's top employees resign in the following months.

Moreover, services are not storable. A hotel room may be empty one day, but guests are unlikely to be prepared to share that room the next night. This means that the excess cannot be stockpiled and it cannot be exported.

The supply of services is less likely to be determined by natural resources than other forms of economic activity. While the emergence of Chicago as a financial centre has its roots in agricultural commodity trading from the Mid-West and the success of Mauritius as a supplier of tourism services is dependent on its location, major service industries such as telecommunications or airlines do not rely on natural resources for their competitiveness.

Role as meta-technology. Some services are essential for an economy, not just because of the intrinsic value of that service, but in terms of their impact on many other forms of activity in an economy. For example, without an efficient financial industry economic transactions will be severely hampered (India has been a prime example of an economy hamstrung by inefficient banks). More fundamentally, without efficient telecommunications almost any form of business becomes more time-consuming and costly (imagine the City of London operating with the phone system that exists in the Philippines).

It is this second feature that has turned the attention of governments across the world towards the large service industries in their economy. As a 1994 UNCTAD report noted, "service sector growth is not just a result of growth in other sectors, but a precondition for growth elsewhere". Governments are coming to realise that due to this pervasive influence of services, their country might be able to prosper without a steel industry or an automobile sector, but without efficient telecommunications, power supply, transportation infrastructure and finance, all other forms of business will suffer.

The publicly-owned or heavily regulated part of the economy is typically biased towards the service sector. While some governments have owned strategic or economically sensitive industries, such as steel or automobiles, it is through ownership of health-care, transportation, power utilities and communications that the hand of the state is most frequently evident. Strict regulation of financial services is also commonplace.

As seen in earlier sections, liberalisation has usually concentrated on the service sector. As the technical and economic arguments in state provision of services have weakened over the past two decades, so liberalisation has proceeded.

Financial Services. It is worth reinforcing earlier statements that there is no single approved track towards liberalisation. Differing experiences with financial services provide a good illustration. Both the US and the UK saw the main bout of deregulation in a single "big bang". Since then the pace of change has been slower, although in the US there has been a gradual erosion of the Glass-Steagall Act (which separates commercial and investment banking) and the McFadden Act (which regulates interstate banking), although this is due more to financial innovation than to any positive action on the part of the regulators.

By contrast, in Japan the preference has been for steady, incremental deregulation which has included gradually lifting caps on interest rates, selling foreign firms seats on the Tokyo Stock Exchange, and first steps in abolishing Article 65, Japan's version of the Glass-Steagall Act. Tokyo's financial markets are still far more tightly regulated than those in London or New York - both officially and unofficially - but the pace of decline in regulation of Japanese finance has probably been faster than in the US or UK, given its heavily regulated starting point.

However, one feature of the globalisation of financial services is that for international financial institutions it is not the absolute level of regulation which matters so much as how it compares to the alternative locations. In recent years Japan has been moving towards becoming a large domestic financial centre, rather than a true international one. The number of foreign firms with a listing on the Tokyo Stock Exchange has been falling steadily from a peak of 127 in 1991 to below 80 currently, and several companies have moved their foreign exchange trading operations to Singapore. Only 88 foreign banks operate in Japan compared to more than 300 in rival financial centres such as London and New York.

In Europe, London has historically seen a lower level of regulation on financial services than in other major European financial centres such as Frankfurt or Paris. The result has been that, even after the waning of the international economic power that first gave the City of London dominance in financial matters, international financial institutions are more likely to locate in London than elsewhere in Europe. Just as with semiconductors in Silicon Valley, there tends to be a clustering of activity in financial services. The advantage of the leading centre is enduring - in the absence of negligent policy-making - once a location is established as pre-eminent, even if other locations (Paris, Frankfurt) then offer similar levels of regulation, the re-location costs and the costs of being separated from one's peer group will prevent firms from moving. Thus a government can establish a `first mover advantage' by being the first to liberalise its service sector. This does not only apply to financial services - airlines and telecommunications are other major examples.

As services have been liberalised, they have also tended to internationalise. So far, most service sector FDI is of the "coupled" variety, linked to other economic activity - 85% of service FDI is trade or finance related - so firms are investing abroad to follow the customer or the product that they service. This explains much of the motivation for banks, accountancy firms, management consultants and the like to develop a presence in all major economies in recent years.

The importance of being able to offer a global service is illustrated by the problems facing Daiwa Bank after it was forced to cut its New York operations facing a bond dealing scandal in 1995. Although its losses were not life-threatening, the potential loss of customers as a result of only being able to offer a partial global service was enough to force Daiwa into merger talks with Sumitomo Bank.

The Uruguay Round identified four types of trade in services. According to Part 1, Article I.2 of the General Agreement on Trade in Services, "trade in services is defined as the supply of a service:

Examples of each version are:

One feature of services trade that does not applied to manufacturing is that the buyer and seller must usually meet, and it is usually the seller which must travel. This makes restrictions on FDI essentially the same as restrictions on trade.

Many services could not internationalise without liberalisation. It is needed to provide firms with the authority to expand out of their home market, as well as the freedom to enter foreign markets (i.e. domestic and foreign liberalisation is necessary). Aside from legal or regulatory considerations, liberalisation also provides the incentive to move into new markets.

A domestic telecommunications or power utility which is under state ownership has little need to examine diversification into foreign markets. Even after privatisation, it would be quite understandable for a monopolist to concentrate on squeezing the most out of its domestic market and neglecting others. However, liberalisation of the domestic market changes the situation. Suddenly the monopolist can no longer rely on easy profits at home and it is forced out into foreign markets in an attempt to maintain profitability. This "push" effect has been particularly noticeable for American telecom and financial firms, but it has also affected a range of less high profile businesses, such as British Gas which

has become very involved in Kazakhstan or General Public Utilities of New Jersey and Cinergy of Cincinnati which bid for Midlands Electricity in the UK.

It is a mistake to believe that the liberalisation of services is an entirely different subject from that related to manufactures. However, there are some differences between the two sectors which can be important, not least in terms of how they supply their products to foreign markets. It is an area which is interesting not just because it contains some of the world's most exciting companies, but also because trade in services is still relatively tightly controlled. As it is liberalised the potential for further rapid growth will become evident.

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