BUS606: Operations and Supply Chain Management

This paper is related to at least two strands in the literature: one is on the estimation of services embodied in traded goods; the other is on the role of services in economic development. 

Research on services embodied in traded goods, based on the Leontief inverse, can be traced back to Grubel who examined Canadian exports in 1973 and 1983. He found that, over that decade, Canadian embodied services exports had increased substantially to the point where Canada enjoyed a surplus in embodied services trade but had a deficit in direct trade in services. Urata and Kiyota examined the embodied services in total gross trade for several major services categories of five Asian economies – China, Malaysia, the Philippines, Singapore, and Thailand − in 1990. They found that embodied services accounted for a large share of total services trade for each country. Francois and Woerz examined the role of services as inputs in manufacturing sectors. They found a significant and strong positive effect of increased business services openness (i.e. greater levels of imports) on some industries, supporting the notion that offshoring of business services may promote the competitiveness of the most skill and technology intensive industries in the OECD countries. Recently, Francois et al. demonstrated that the ratio of value added exports to gross exports is significantly higher than one in services sectors, suggesting an important role of services sectors in downstream sectors through forward inter-industrial linkages. Their studies cover many countries and provide some interesting insights. 

These early studies used single national input-output tables, rather than an international input-output table as in this paper, so they could not break down the inputs according to their origins or consider the mismeasurement in services inputs due to two-way trade in intermediate products. In addition, they can only consider how much a service sector's value-added is embodied in manufacturing exports regardless whether parts of the exported value-added return back to the exporting country or not. In the current paper, we make use of the newly constructed international input-output tables by the WIOD team to measure more precisely the embodied services and indirect trade through other sectors. With the multi-country input-output table and the information about the origins of inputs, we can study embodied domestic and foreign services and their interaction with domestic services development. Stehrer, Foster, and Vries and Timmer et al. also use a similar method and the WIOD data to estimate the shares of services, income and jobs in a country that are directly and indirectly related to the production of manufacturing goods, but their work is primarily descriptive without connecting embodied services to the performance of manufacturing sectors.

On the role of services in economic development, Hoekman and Mattoo review the literature, focusing on channels through which openness to trade in services may increase the productivity of a firm, an industry, and an economy as a whole. The existing studies show that access to low-cost and high-quality producer services can promote economic growth. Based on an industry-level analysis of the U.S., Amit and Wei find that services offshoring by high-income countries tends to raise their manufacturing sectors' productivity. While services offshoring has both positive and negative effects on domestic employment, Amiti and Wei show that, at least for the case of the United States, it tends to enhance domestic employment on average. Arnold, Javorcik, and Mattoo, using firm-level data from the Czech Republic for the period 1998-2003, find a positive effect of services sector reforms on the productivity of domestic firms in downstream manufacturing. The manufacturing-services linkage is measured using information on the degree to which manufacturing firms rely on intermediate inputs from services industries. Arnold et al. use a similar methodology to show that services reforms had significant and positive effects on the productivity of manufacturing firms in India. Fernandes and Paunov, using the annual manufacturing survey of Chilean firms, find a positive effect of substantial FDI inflows in producer services sectors on the total factor productivity (TFP) of Chilean manufacturing firms. Their findings also suggest that services FDI fosters innovation activities in manufacturing and offers opportunities for laggard firms to catch up with industry leaders. Debaere et al. find that greater availability of services increases manufacturing firms' foreign sourcing of materials, which may in turn enhance manufacturing productivity. Using Swedish firm-level data, Lodefalk shows that in-house and outsourced services help to increase export intensity measured by the share of merchandise exports in total sales. Finally, a recent paper by Bamieh et al. shows that more intensive use of producer services appears to be positively associated with resilience to greater import competition.

In this paper, we study particularly the roles of financial services and business services in manufacturing production. On financial services, Rajan and Zingales and a number of follow-up studies find that industries that are particularly dependent on financing grow relatively faster in countries with more developed financial markets. Our approach differs from Rajan and Zingales in two major ways. First, we consider modern business services sectors in addition to financial services. For most countries in our sample, business services as a share of GDP are generally on par with or greater than financial services. Second, even for financial services, we measure the intensity of its use in manufacturing sectors differently from Rajan and Zingales in order to maintain consistency with our measure of business services intensity. In particular, their measure of financial dependence is about the intrinsic needs for externally raised funds relative to total funding needs for long-term investment. In an input-output context, the financial services sector only provides financial services in value added terms, rather than the amount of external finance raised. Financial services may facilitate an investment deal, but it is different from investment. Therefore, their measures and ours reflect two different concepts, and the scatter plot in Figure 4 shows a weak correlation between the two measures.

Some more recent papers also examine the role of finance in the economy. Ju and Wei show in a general equilibrium model that, for economies with low-quality institutions, finance is a key driver of the real economy and a source of comparative advantage. Buera et al. demonstrate in a model that sectors with more financing needs are disproportionately vulnerable to financial fricti A growing recent literature on credit constraints demonstrates that access to external finance helps to increase firms' export performance (see, Amiti and Weinstein, 2011, among others). Business services cover a wide range of activities as listed in Appendix 3C. There are many case studies on how a certain type of business services promotes economic performance at the firm, state, or national level. However, comprehensive empirical analyses covering most of the major economies at a detailed industry level are rare, probably owing to the lack of detailed services data. 

In the existing literature, the estimation of embodied services and the recent empirical analyses on their linkage to manufacturing export performance are somewhat disconnected. The former estimates the embodied services but does not examine empirically how services input intensity affects the performance of downstream sectors. The latter, on the other hand, uses some proxies of inter-sectoral linkage or the direct inputs in gross output to examine the effects of services reforms on downstream manufacturing sectors without quantifying precisely services input intensity. The current paper connects the two literatures: we measure precisely services input intensity as the ratio of embodied services to manufacturing value-added, considering both direct and indirect input usages; then, we directly quantify the effect of services development on the export performance of manufacturing sectors. In addition, we also consider the interaction between embodied domestic services and embodied foreign services and how they affect manufacturing export performance, depending on countries' domestic services development and services input intensity. 

Finally, the second hypothesis in this paper considers how access to foreign services markets may help developing countries to bypass their possibly inefficient domestic services provision. By distinguishing domestic from foreign services input, we implicitly assume that they are incomplete substitutes. Such a bypass effect is also discussed in a theoretical model by Ju and Wei, which derives the conditions under which financial globalization can serve as a substitute for reforms of the domestic financial system. This is also broadly consistent with the theory of comparative advantage – countries with underdeveloped services sectors benefit from imported services, but our paper shows that these benefits may go beyond services sectors through intersectoral linkages.