More than two years into the COVID-19 pandemic, digitization has clearly accelerated in many areas of the global economy. With technology at their fingertips, society, the productive system, and the state now have more ways than ever to take advantage of the opportunities of the internet age. The unprecedented advance of the online world has made hybrid jobs and flexible working hours a fact of life, along with new services that do not require physical contact.
Lockdowns and social distancing have fast-forwarded us into the future: we now see the doctors via videoconferencing, do our banking using apps, and even go to the gym without leaving home.
This digital-service explosion explains why many entrepreneurs believe that Latin America and the Caribbean (LAC) is heading toward a new growth model. The recent boom in startup investments and the exponential growth in the number of Latin American unicorns are clear signs that times are changing.
Nonetheless, the services sector is very diverse. In contrast to traditional services like tourism and transportation, knowledge-based services that rely on digitization and highly skilled human capital enjoy more dynamic global demand and drive greater spillover effects. The most striking examples in LAC range from business services to software development, biotechnology, and the creative industries such as audiovisual production or video games.
To sound out how the region is faring in this revolution, my colleague Cloe Ortiz de Mendívil and I gathered evidence on trends, costs, and trade policies relating to services. Our study highlights the importance of modernizing the region’s regulatory frameworks to make it more competitive in the global marketplace, and unleash a powerful development driver.
Rapid expansion
Services are becoming increasingly important in LAC economies. Even before the pandemic, value-added in the services sector (understood as the value generated through production, including the contributions of both labor and capital) accounted for 58% of gross domestic product (GDP). By 2019, the sector was employing 64% of the total workforce.
Between 2005 and 2019, trade in services (imports and exports) grew an average of 6.1% annually, outstripping the average for trade in goods. In 2019 alone, trade in services reached US$377 billion. Over the same period, the share of service exports in GDP doubled, growing from 1.9% to 3.8%.
Further evidence of the sector’s meteoric rise is that in 2019, global service exports came to represent around 15% of total LAC exports on average—a figure that conceals highs of over 40% in the Caribbean and Central America.
Challenges to global competitiveness
Although the sector’s performance was outstanding, it peaked below its potential. A closer look reveals that LAC still specializes in traditional services, such as travel (tourism) and transportation (freight), which account for about 60% of the total.
Exports of services by competitive segment in %, 2013–2018
The study reveals the competitiveness challenges that LAC is facing by breaking down service exports from 2013 to 2018 into four segments: strategic (growing market share in sectors where demand is dynamic), mature (growing market share in industries where demand is stable or contracting), untapped (falling market share in industries where demand is dynamic), and declining (falling market share in sectors where demand is low).
We found, for example, that LAC gained market share mainly in mature segments (50%), especially travel, and only expanded marginally (1%) in strategic segments such as intellectual property. It also lost market share in areas of the untapped segment (26%), including business services such as consulting, customer service, or human resource management.
The benefits of reducing trade costs
In order to make the most of the potential of global trade in services, the region urgently needs to reduce costs related to regulatory and external market access barriers.
According to our estimates, the total costs of trade in services (such as tariff equivalents, non-tariff barriers, and expenses relating to the provision of the service in question) are extremely high for the average service provider in LAC. Although costs dropped from 259% in 2005 to 251% in 2015, they remain higher than in Asia (203%), the European Union (192%), and the United States (151%). They also outstrip those associated with goods exports.
The OECD indices can be used to evaluate restrictions to trade in both general and digital services. They reflect obstacles related to regulatory transparency, competition, market access for firms and individuals, and specific regulations for digital trade that limit connectivity, electronic transactions, and intellectual property protection, to mention a few areas.
A comparison of LAC with global best practices highlights opportunities for reform, but also some success stories. For example, Costa Rica is the country with the least restrictions on e-commerce in the global sample.
These estimates have concrete implications for policy design. For example, empirical evidence shows that a 10% reduction in restrictions contributes to a decrease in trade costs of about 3% and growth in service exports of almost 5%.
Strategic priorities
To foster growth based on service exports, LAC needs to focus on four strategic areas:
- For starters, there is an urgent need to invest in creating a reliable, detailed, disaggregated information base on trade in services comparable across countries. This is essential to ensure that policymakers are not flying blind in a key sector to the region’s economic recovery.
- To have a significant impact on complex ecosystems in which services firms can thrive, trade, innovation, education, connectivity, and banking regulations -to name but a few- cannot operate in silos. Smart policy coordination is needed to bring down trade costs and position firms competitively in the global marketplace.
- The main factor shaping the competitiveness of services is people’s talent. Investing in training and human capital development according to the dynamic demand of firms is an utmost priority.
- The trend towards digitizing trade in services is rewriting the international rulebook. The region’s negotiators need to bupskill, and the regulatory architecture has to be updated through state-of-the-art international treaties that harness the potential of regional integration.
In short, trade in services is at the heart of the digital acceleration triggered by the pandemic. Latin American entrepreneurs are convinced they have what it takes to become global players, and venture capitalists are taking note of the region’s talent. It is now up to governments to design state-of-the-art public policies that reduce trade costs and unleash the potential of digitization. The IDB can provide operational best practices, business networks, and dedicated forums to support the region on this quest, which is key to post-pandemic recovery.
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