Conclusions and Some Broad Policy Suggestions

The services sector has become an important and continuously expanding provider of both output and employment among the ASEAN countries. During the period 2000–2007, this sector contributed more than 40% of total value added in Singapore, Malaysia, the Philippines, Thailand, Indonesia, Viet Nam, and Cambodia. In terms of employment, the sector represented more than 40% of total employment in Singapore, Indonesia, Malaysia, and the Philippines.

In terms of the contribution to value added by the major services subsectors in Singapore and Malaysia, their service sectors are dominated by finance, insurance, and business. For the rest of the countries except Brunei Darussalam, the services sector is largely concentrated in wholesale and retail trade. In terms of growth in value added, on average the fastest growing sector is finance in Brunei Darussalam, Malaysia, and Myanmar; wholesale and retail trade in Singapore; electricity, gas, and water in Cambodia, the Lao People's Democratic Republic (Lao PDR), and Viet Nam; and transport and communications in Indonesia, the Philippines, and Thailand. In terms of employment contribution, the most important services subsector is wholesale and retail trade in all countries except Singapore, where finance is the largest services subsector.

In terms of performance, labor productivity calculations highlight the following: first, for the overall services sector, a large and growing labor productivity gap exists between Singapore and the rest of the ASEAN countries; second, disparities in labor productivity also separate the ASEAN 4 countries from Viet Nam and Cambodia; third, Indonesia and the Philippines were characterized by strong labor productivity growth from the 1990s to the 2000s, with Viet Nam catching up as it showed marked signs of improvements in its growth; and finally, electricity, gas, and water; finance, insurance and business; and transport, storage, and communications exhibited the highest average labor productivity levels and growth during the two periods. These sectors are skill- and capital-intensive, and information and communications technology (ICT), producer and user subsectors.

Currently, except for Singapore, ASEAN countries remain protective of their services sectors. Discriminatory and market access barriers still characterize services in general. The remaining restrictions include foreign equity limitations along with domestic regulations affecting business operations which often favor state-owned companies. In the wholesale and retail trade subsector, Malaysia, Thailand, and Indonesia have been found to be the most restrictive. In the maritime transport subsector, the most restrictive countries are the Philippines, Indonesia, and Thailand (with Singapore being the least restrictive). In the postal services sector, monopoly rights have been removed only in Singapore. The empirical literature on the linkages between services liberalization and economic growth has shown that policy reforms geared to increase competition and improve regulatory oversight result in the improved performance of the services subsectors concerned. Except for Singapore, the overall, level of protection of services in ASEAN has remained high. Hence, the productivity gap in services between Singapore and the rest of ASEAN seems to have widened as indicated by the labor productivity calculations.

Chenery and Taylor (1968) point out that growth in the services sector and a decline in the agriculture sector are structural features of economic development. In Organisation for Economic Co-operation and Development (OECD) countries, services represent more than two thirds of economic activity (Fernandes 2007). As the preceding discussions of the structure and performance of the services sector suggest, there exists strong potential for services to drive future growth in the ASEAN region. However, these prospects are negatively affected by the current global crisis. After growing rapidly prior to the crisis, the services sectors in the ASEAN 5¹⁰ countries have since exhibited either contractions or slowdowns. Quarterly growth rates from first quarter 2008 to first quarter 2009 show that services growth has contracted in Singapore, Malaysia, and Thailand and slowed down in the Philippines and Indonesia. While the ASEAN countries have allocated the bulk of their fiscal stimulus packages to infrastructure spending, levels of expenditure are still generally considered to be insufficient to create a large impact on growth.

The growth rebalancing model, which places the services sector on center stage, is important for restoring the momentum of productivity growth in services, reducing the productivity gaps in the region, and boosting the prospects for the future growth of the region's services sectors. To realize these goals, much depends on a more efficient and competitive services sector. Increased productivity in services sectors is crucial for the long-term economic growth prospects of countries.

It is also important to note that a more efficient services sector would also have indirect effects on economic growth by improving efficiency in other sectors of the economy. In this way, a shift toward developing services could, in turn, lead to an increase in aggregate productivity. For example, insofar as many service sectors provide inputs for the manufacturing sector, a competitive and efficient services market would contribute to the development of a more competitive and efficient manufacturing sector. Moreover, high-quality services could also result in increasing the attractiveness of a location for foreign direct investment.

One major challenge in transforming the services sector into an engine of growth in the ASEAN region is the need to introduce more competition to foster firm competitiveness and increase sector productivity. By focusing on the provision of infrastructure and social services such as health and education, governments can address the large investment backlog in these sectors. Investment in education and health are crucial, particularly since skilled workers are of paramount importance not only to the growth of the services sector but also to the growth of other economic sectors.

As a result of the development of new technologies, some degree of competition has been introduced into sectors that were considered natural monopolies in the past, such as telecommunications and airlines. Thus, while most infrastructure projects have been financed by governments, some countries have implemented regulatory reforms that allow private sector participation in infrastructure projects. Changes in the regulatory environment and contractual requirements have facilitated the emergence of a variety of public-private partnerships geared toward the provision of infrastructure services such as energy and water services. To encourage and renew interest in infrastructure investment in the region, governments have an important role to play in creating an enabling environment, particularly in maintaining a competitive bidding process and a stable policy regime, and by pursuing appropriate risk allocation.

Some broad policy suggestions are outlined below:

1) Increase government spending on infrastructure, health, and education services

To increase the competitiveness of their services sectors, it is important for ASEAN governments to formulate government programs for infrastructure spending on constrained areas such as power, ports, roads, and mass transit, as well as for health and education services, to help boost private sector investment and strengthen the foundations of long-term productivity.

2) Provide government support to promote green industry for low carbon growth

ASEAN countries could take advantage of the opportunities arising from new growth areas by encouraging investments in green industry for low carbon growth. Government support could be provided by pursuing policies that encourage more research and development, strengthen mechanisms for the transfer of green technology, and promote greater private sector participation.

3) Pursue deregulation and liberalization to strengthen competition, especially in transportation, and continue reforms in sectors like telecommunications and wholesale and retail

Domestic regulations and discriminatory policies continue to create unnecessary costs for the supply of services. Given the extent of the restrictiveness of services policies and regulations, as discussed in the earlier section, there are substantial potential gains to be made from services deregulation and liberalization. To make markets more contestable it is important to liberalize policies and implement regulatory reforms by dismantling discriminatory and non-discriminatory restrictions against market access per se. When designing reforms, care must be exercised to determine their proper sequencing—should policymakers focus on domestic regulatory reforms first or the removal of discriminatory polices? What is the optimal mix of policies that could maximize gains from reforms? Hoekman (2006) pointed out that empirical evidence suggests that domestic regulatory reform needs to be put ahead of removing policies that discriminate against foreign firms, because the former is likely to generate larger welfare effects.

Apart from the removal of barriers to market entry in highly protected sectors like transport, continued liberalization should also be pursued in subsectors such as telecommunications. This would allow more information and communications technology penetration, which is crucial for improving the productivity of the services sector.

4) Pursue market reforms in tandem with well-functioning competition and regulatory agencies

To keep markets competitive, public intervention is required. For liberalization to be successful, effective implementation of competition law and policy is necessary. For recently deregulated or liberalized sectors such as energy or telecommunications, active competition policy is needed to prevent unfair practices such as the creation of cartels or the abuse of positions of dominance by ex-monopolies. Competitive pressure is also crucial to induce firms to adopt innovation, which is particularly important in the services sector, for example in wholesale and retail trade. Moreover, bringing in more competition is particularly crucial in sectors that are not internationally traded or are still sheltered through domestic regulation.

Reforms such as liberalization and deregulation also require substantial strengthening of domestic regulatory institutions. Regulation is needed in situations where competition is not workable, such as in services subsectors with natural monopoly segments like transport or electricity, gas, and water distribution. Services subsectors such as telecommunications, transport, and energy are important industries with network externalities. To ensure that markets remain contestable, an appropriate regulatory framework should be in place together with the capacity to implement it.

5) Formulate country level domestic reform and structural assistance agenda for services

A domestic reform agenda, incorporating a proper sequencing design, should be formulated, along with a competition and regulatory framework for the services sector. These initiatives should be accompanied by temporary incentive measures to assist firms with the adjustment from a protective to a more open regime. Without structural adjustment assistance, measures, and facilities, it will be difficult to restructure, particularly as there will be resistance from those set to lose from liberalization and deregulation. A well-designed structural adjustment program, which includes restructuring assistance and capacity building measures, could enable acceleration of the pace of reforms.

6) Strengthen services data collection

Given the paucity of data in relation to services, there is clearly a need to collect more services data at the subsector level and supplement the existing highly aggregated services subsector information. There is also a need for an inventory of regulatory policies in each subsector and an evaluation of the status of liberalization proceeding from either unilateral or preferential trade agreements.

7) Carry out more empirical work on services

The empirical literature on services is still thin. More research is needed, particularly to assess the impact of existing barriers to services on growth and to review the extent of liberalization carried out in the past and its effects. Studies are also needed to identify anti-competitive practices in the services sector and assess their impact. Studies such as these are also important inputs for creating a constituency for reforms.

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