Special Report: Economy

The Future of China's Service Sector

China will benefit greatly by fully removing the remaining impediments to services trade and investment

by Erik Britton and Vanessa Rossi

The service sector is emerging as a key engine of the Chinese economy, and China's implementation of its World Trade Organization (WTO) service commitments is yielding significant benefits for the country. Even more substantial gains would be possible, however, if China were to fully remove the remaining market barriers in its service sector.

From farm to factory—and then to services

The dramatic growth of the Chinese economy has been associated with equally dramatic changes in the country's industrial structure, as a largely agricultural economy transformed into one increasingly dominated by industry. This transformation has followed the same pattern already experienced by many other economies that are now further down the path of economic development.

Historically, in all economies, the period of rapid industrialization generally is just the first phase of economic development. The next phase involves the shift out of manufacturing industries toward service industries. This second phase is already fairly advanced in most developed economies, is about to get under way in intermediate economies like South Korea, and may be still a decade or more into the future for emerging economies such as China.

Despite recent changes in the composition of employment—viewed in terms of the shares of the agriculture, forestry, fishing, and mining industries (primary sector); the manufacturing and construction industries (secondary sector); and the service industry (tertiary sector), Chinese employment remains heavily concentrated in primary industries, largely agriculture. This is a predictable pattern for countries at China's stage of industrialization. Because of the relatively low productivity of the primary sector, the primary share of employment in developing economies tends to be much larger than the primary share of GDP.

In China's case, manufacturing accounts for almost half of economic output, and the service sector share has surpassed agriculture. In December 2005, the PRC National Bureau of Statistics (NBS) revised the 2004 GDP estimate upward by 16.8 percent after preliminary input from the 2004 economic census. NBS reported that ¥2.3 trillion ($277.8 billion) had been added to the 2004 GDP figures, bringing the total to ¥15.99 trillion ($1.93 trillion). The first national economic census revealed many economic activities, mostly in the service sector, that had been previously underreported.

Upward revisions to service sector output accounted for more than 91 percent of the GDP change—¥2.1 trillion ($253.6 billion) out of the increase of ¥2.3 trillion—implying that the composition of GDP had also changed. After the revision, the service sector's contribution to GDP increased to 40.7 percent from the previous estimate of 31.9 percent. Correspondingly, manufacturing's share of GDP declined from 52.9 percent to 46.2 percent. The share of agriculture and related activities fell to 13.1 percent of GDP from 15.2 percent.

Four sub-sectors of the service sector—transport and storage; post and communications; wholesale, retail, and catering trade; and real estate—together accounted for 70 percent of the increase in value added of the service sector. This implies that within the service sector, the composition of output also has been revised. Figure 1shows the revised composition of the service sector based on Oxford Economics Ltd. estimates for the shares of all the sub-sectors within services. The share of the transport and storage and the post and communications segments within the service sector has nearly quadrupled. The wholesale, retail, and catering trade sector now contributes 26 percent of services output, rather than the previous estimate of 7.6 percent. The contribution of real estate services also has more than tripled.

Using new findings of the first national economic census, NBS revised the level and composition of historical GDP data going back to 1993. Service sector output is significantly larger—and growing significantly faster—than previously estimated(see Figures 2 and 3). The Chinese service sector is growing far more rapidly than its counterpart in the United States (approximately 10 percent per year compared to 4 percent), but China's service sector remains merely a fraction (about one-ninth) of the US service sector.

Services trade and investment

The growth in service sector output in China has accompanied even more rapid growth in flows of services into and out of China via international trade. Both exports and imports of services have been growing at around 20-30 percent over the last few years in dollar terms, far outperforming the growth of service sector output (about 10 percent). Together, in 2004, service sector imports and exports were worth $134 billion, or 17 percent of service sector output in China, up from 11 percent in 1993. These figures show the increasing importance of trade in China's service sector as well as growing opportunities for services exporters in the United States and other economies.

China's services trade with the United States

China is running a substantial surplus on the current account of its balance of payments, including trade in both goods and services. But China is in deficit on its services trade account with all economies, to the tune of $9.5 billion in 2004. China also had a $2.6 billion deficit on its bilateral services trade account with the United States in 2005.

China's service sector exports to the United States are growing rapidly as the Chinese market opens up and the country becomes a more attractive destination for tourists and business visitors. The average annual growth rate is 14.5 percent in dollars at current prices. In 2005, Chinese service sector exports to the United States were $6.5 billion, compared to $1.5 billion in 1994. But Chinese service sector imports from the United States were $9.1 billion in 2005, up from $2.1 billion in 1994, an average annual growth rate once again of 14.5 percent over that period— and from a higher starting level than exports. China's bilateral service trade deficit with the United States has increased by almost $2 billion over that period, and China's service sector imports from the United States were more than 14 percent of its total service sector imports in 2004.

Most Chinese service sector exports to the United States are in the travel and transportation sectors, with a small residual of other commercial services. In contrast, 43 percent of US service sector exports to China consist of "other commercial services" (see Figures 4 and 5). Breaking down this category into its subcomponents reveals that the share of "education" services was the largest, followed by "business, professional, and technical," "financial," "telecommunications," and "insurance" services (see Figures 6 and 7).

US investment in the Chinese market

US companies are also investing in China's service sector. They are setting up operations in China to sell express delivery, financial, business, and other high-skill services directly to Chinese customers. The investments and sales of US operations in China are not reflected in bilateral trade figures, but they are an important element of the commercial relationship.

The US Department of Commerce's Bureau of Economic Analysis produces data on US foreign direct investment (FDI) flows to China, broken down by sector (see Figure 8). US FDI flows to China between 2001 and 2005 reached $16.8 billion, of which roughly $3 billion, or 19 percent, was in service industries. Between 1996 and 2005, the service sector share of those investment flows increased. In 2005, service sector FDI accounted for 54 percent of the total. (Note that this picture of how US direct investment flows to China refers only to the flows that go directly from the United States to China. It does not capture any flows that might be routed through Hong Kong or other economies. To include these funds would probably more than double the quantity of US direct investment into China.)

Impacts on China's economy

Benefits to date

Chinese industry is growing rapidly in part because of strong imports of knowledge services, network services (transport, communication, and information technology) and financial services from developed economies. Oxford Economics estimates that the increase in China's service sector imports after 2001 resulted in higher average labor productivity of 0.3 percent. This productivity increase equates to a $6.5 billion increase in Chinese GDP in 2005, of which roughly $650 million is attributable to service sector imports from the United States.

FDI in the service sector has also benefited China. In particular, inflows of service sector investment from the United States were worth around $3 billion between 1996 and 2005. Assuming that between half and three-quarters of US FDI outflows to Hong Kong during that period were ultimately destined for China, then inflows from the United States were around $6.1 billion. This addition to the capital stock contributed some $1.6 billion, or 0.1 percent, to Chinese GDP in 2005, via higher productivity.

Baseline forecast:
Implementation of WTO commitments

China's implementation of all of its WTO commitments will continue to translate into substantial benefits in the future. Oxford Economics estimates that under this scenario, the share of service sector imports in China's GDP will increase from 4.1 percent in 2006 to 5.4 percent in 2015. US service sector exports to China are slated to increase in proportion to Chinese service sector imports. Moreover, inflows of service sector FDI from the United States will also increase over the forecast period, by an average of around 5 percent per year.

China's commitment to remove and relax these constraints will have a significant positive impact on China's GDP by the end of 2015. If the share of China's service sector imports were to remain at pre-2001 levels until 2015, there would be a substantial impact on whole-economy productivity: By 2015, Chinese GDP would be around 1.2 percent, or $66 billion (in 2006 prices), lower. Of that shortfall, around one-tenth, or $6.6 billion, would be attributed to lower service sector imports and smaller inflows of service sector FDI from the United States.

Alternative scenario:
Removing all remaining service sector restrictions

In the baseline forecast, the gradual removal of constraints on service sector imports and on inflows of investment has a significant positive impact on productivity and GDP growth in China. But if remaining constraints were to be removed, the impacts on China's GDP and productivity growth would be even more substantial. Figure 9 compares the baseline forecast to an alternative scenario under which all the existing constraints on service sector imports and FDI inflows from all countries are removed by 2015. In the alternative scenario, the benefits to China's GDP would more than double by 2015 and reach almost 2.5 percent of GDP or $138 billion in 2006 prices. This would make the average Chinese household better off by $300-$400, or ¥2,300-¥3,100, per year. In comparison, average household income in China was around ¥30,000 ($3,700) in 2005. Service sector trade and investment flows with the United States would generate one-tenth of these gains.

The benefits also extend to job creation. The baseline forecast, which assumes existing WTO commitments are honored, projects employment in all foreign majority-owned service companies in China to increase to around 5 million by 2015, of which around 400,000 jobs would be in US majority-owned companies. In the alternative scenario, service sector employment in these companies would be nearly 7 million, of which 550,000 would be in US majority-owned companies. Thus, the growth in service sector trade and investment by 2015 would create up to an extra 7 million jobs in China—jobs in relatively high-paying, high-productivity service industries. This figure is almost equivalent to the entire population of Xi'an, Shaanxi.

Realizing these benefits

Greater benefits would be realized if PRC regulations, implementing rules, and license approvals were adjusted to increase the pace and scope of service sector reform.

Fully implementing China's WTO commitments is an essential first step to maximizing the advantages for the Chinese economy, but greater benefits would be realized if PRC regulations, implementing rules, and license approvals were adjusted to increase the pace and scope of service sector reform. In practice, this would entail the following:

Increasing the transparency of the regulatory environment for foreign service providers, through early publication of proposed regulations, consultation with foreign and domestic industry, participation in international service sector forums, and adoption of international standards and norms;
Progressively deregulating markets for the provision of services to encourage the growth of those services;
Addressing current restrictions on market access and expansion (including foreign ownership, industry, and geographic limitations) so that foreign expertise in the service sector can become another tool to further China's economic development;
Creating a level playing field by reducing government support for domestic enterprises in the services markets; and
Continuing to gather and publicize sectoral data about the performance of the Chinese economy, to enable all participants in the economy to understand more clearly how quickly the various service sectors in China are growing and what their future growth prospects might be.

Adopting such measures would generate significant benefits for China and help the country to move more quickly and effectively to achieve its economic development goals.

Taking it to the next level

In China, the service sector is growing, contributing to economic development and a rise in living standards by boosting the productivity of industrial enterprises. The expanding market for service-based jobs is vital to China's ability to absorb the large numbers of young workers and college graduates entering the job market each year. Historically, the growth of a service sector is also seen as a significant step in the evolution of a nation's economy.

The expanding market for service-based jobs is vital to China's ability to absorb the large numbers of young workers and college graduates entering the job market each year.

From a broader perspective, the expansion of China's services infrastructure is essential to the country's integration into the global economy and continued economic development. For example, the establishment of a modern capital market will help China move toward a market-driven exchange rate. Market-based lending will help level the playing field between US and Chinese competitors. China's ability to provide pension and health care insurance to its citizens will enhance social stability and unlock capital resources tied up in precautionary savings. Improving the regulatory framework for services will help Chinese manufacturers and commercial firms to continue to move up the value chain in all areas, from transportation, professional and financial services, and information technology, to retail, tourism, and hospitality, to name a few.

China's initial implementation of its WTO commitments in services already benefits the Chinese economy. But even complete implementation of these WTO commitments will leave in place a range of impediments to the growth of China's service sector, as well as service trade and foreign investment. By removing these constraints, China will realize the full potential economic benefits of trade and investment in services.

US Economy Benefits from Services Trade and Investment with China

The United States is the world's largest exporter of services and is well positioned to benefit from China's rapidly growing demand for services. US service sector exports to China grew more than twice as fast as US total service sector exports between 1992 and 2005, at an average annual rate of 14.5 percent (in current prices). That growth was faster than the growth of service sector exports to any other major economy over that period (including India, at 12.7 percent per year). As a result, US service sector exports to China, at $9.1 billion in 2005, now account for 2.4 percent of US service sector exports, up from 1.0 percent in 1992. China is already one of the top ten destinations for US private service sector exports, and the United States is already a net exporter of a broad range of services to China: The United States had a services trade surplus with China of $2.6 billion in 2005.

Both trade and investment flows between the United States and China in service industries have an impact on the current account of the balance of payments and, as a result, on US GDP. In 2005, in addition to the bilateral services trade surplus of $2.6 billion, US affiliates in China repatriated profits worth $3.3 billion. Of that, around 17 percent, or $560 million, is attributable to service sector affiliates in China. Together, service exports to China, along with repatriated service sector profits from China, contributed a net $3.1 billion to US GDP in 2005, slightly reducing the bilateral current account deficit with China.

US net exports of services to China make a direct contribution to US GDP in the short term via the current account of the balance of payments. In the long run, the overall net trade position is determined by such factors as the appetite for savings in the United States, compared to other countries, and its magnitude will not be affected by bilateral trade flows with any single country. There is, however, another way in which US service sector net exports to China can make a permanent contribution to US GDP. Indeed, service sector net exports to China support employment in relatively high-productivity and high-wage sectors of the US economy. According to Oxford Economics Ltd. estimates for 2005, net exports of "other private services" to China support a net number of roughly 37,000 high-productivity jobs in the United States. This provides a permanent boost to US GDP, worth around $460 million in 2005.

Maximizing the benefits

China's implementation of its World Trade Organization (WTO) commitments will continue to benefit the United States in the future. In the baseline forecast, in which China honors all of its WTO service commitments, US service sector exports to China will increase to $45 billion by 2015, while the US surplus on services trade with China will increase to $15 billion, or 0.1 percent of US GDP. On top of that, inflows of net income from US service sector affiliates in China will increase to around $1.5 billion by 2015. And the impacts on US productivity will also increase, as service sector trade and investment in China contribute a projected $2.5 billion to US GDP in 2015. The growth in service sector net trade with China and inflows of profits from service sector investments in China together will also support more rapid growth in service sector employment in the United States. In the baseline forecast, these effects combine to create an additional 60,000 service sector jobs in the United States by 2015.

If the outstanding impediments to service sector growth in China were fully removed, the bilateral services trade surplus with China would increase to around $60 billion by 2015, supplemented by extra income derived from US service-related investments in China worth $7 billion. This would boost US GDP in the short term by about 0.3 percent. The average US household would be better off by about $500 per year in 2010 as a result of this growth in services trade with China. The removal of all impediments to growth in services trade and investment with China would also create up to 240,000 high-paying US service sector jobs by 2015, accounting for 1.5 percent of the growth in US service sector employment between 2005 and 2015.

The effects in 2015 do not capture the long-run impact of services trade and investment with China on the US economy. The Chinese market for services will have grown substantially by 2015, but the real focus of US service providers should be on a longer horizon, one that spans the decades to come. By 2050, US service sector exports to China could reach between 1.5 percent and 3.5 percent of US GDP. By then, of course, China's service sector exports will also have grown, but the US surplus on service sector trade with China still could be worth around 1 percent of US GDP, while inflows of profits from US service sector FDI in China could contribute a further 0.5 percent of GDP to the US current account of the balance of payments.

Net services trade with China supports relatively high-productivity jobs in the United States, and the impact of this trade on the composition of US employment leads to higher average productivity and, therefore, higher GDP in the long run. The impact on US productivity via this channel could be worth 0.1 percent to 0.2 percent of US GDP in the long run: a substantial effect. This scenario clearly projects long-run benefits for the United States. For these benefits to develop fully, however, the market barriers in China's service sector must be dismantled completely.

—Erik Britton and Vanessa Rossi

Erik Britton's director of Economics, and Vanessa Rossi is director of International Economics, at Oxford Economics Ltd. They are based in Philadelphia, PA, and Oxford, the United Kingdom, respectively.

This article is adapted from the December 2006 China Business Forum report, The Prospects for US-China Services Trade and Investment. The China Business Forum (www.chinabusinessforum.org) is the educational and research arm of the US-China Business Council, publisher of the CBR.

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	Print Article Special Report: Economy The Future of China's Service Sector China will benefit greatly by fully removing the remaining impediments to services trade and investment by Erik Britton and Vanessa Rossi The service sector is emerging as a key engine of the Chinese economy, and China's implementation of its World Trade Organization (WTO) service commitments is yielding significant benefits for the country. Even more substantial gains would be possible, however, if China were to fully remove the remaining market barriers in its service sector. From farm to factory—and then to services The dramatic growth of the Chinese economy has been associated with equally dramatic changes in the country's industrial structure, as a largely agricultural economy transformed into one increasingly dominated by industry. This transformation has followed the same pattern already experienced by many other economies that are now further down the path of economic development. Historically, in all economies, the period of rapid industrialization generally is just the first phase of economic development. The next phase involves the shift out of manufacturing industries toward service industries. This second phase is already fairly advanced in most developed economies, is about to get under way in intermediate economies like South Korea, and may be still a decade or more into the future for emerging economies such as China. Despite recent changes in the composition of employment—viewed in terms of the shares of the agriculture, forestry, fishing, and mining industries (primary sector); the manufacturing and construction industries (secondary sector); and the service industry (tertiary sector), Chinese employment remains heavily concentrated in primary industries, largely agriculture. This is a predictable pattern for countries at China's stage of industrialization. Because of the relatively low productivity of the primary sector, the primary share of employment in developing economies tends to be much larger than the primary share of GDP. In China's case, manufacturing accounts for almost half of economic output, and the service sector share has surpassed agriculture. In December 2005, the PRC National Bureau of Statistics (NBS) revised the 2004 GDP estimate upward by 16.8 percent after preliminary input from the 2004 economic census. NBS reported that ¥2.3 trillion ($277.8 billion) had been added to the 2004 GDP figures, bringing the total to ¥15.99 trillion ($1.93 trillion). The first national economic census revealed many economic activities, mostly in the service sector, that had been previously underreported. Upward revisions to service sector output accounted for more than 91 percent of the GDP change—¥2.1 trillion ($253.6 billion) out of the increase of ¥2.3 trillion—implying that the composition of GDP had also changed. After the revision, the service sector's contribution to GDP increased to 40.7 percent from the previous estimate of 31.9 percent. Correspondingly, manufacturing's share of GDP declined from 52.9 percent to 46.2 percent. The share of agriculture and related activities fell to 13.1 percent of GDP from 15.2 percent. Four sub-sectors of the service sector—transport and storage; post and communications; wholesale, retail, and catering trade; and real estate—together accounted for 70 percent of the increase in value added of the service sector. This implies that within the service sector, the composition of output also has been revised. Figure 1shows the revised composition of the service sector based on Oxford Economics Ltd. estimates for the shares of all the sub-sectors within services. The share of the transport and storage and the post and communications segments within the service sector has nearly quadrupled. The wholesale, retail, and catering trade sector now contributes 26 percent of services output, rather than the previous estimate of 7.6 percent. The contribution of real estate services also has more than tripled. Using new findings of the first national economic census, NBS revised the level and composition of historical GDP data going back to 1993. Service sector output is significantly larger—and growing significantly faster—than previously estimated(see Figures 2 and 3). The Chinese service sector is growing far more rapidly than its counterpart in the United States (approximately 10 percent per year compared to 4 percent), but China's service sector remains merely a fraction (about one-ninth) of the US service sector. Services trade and investment The growth in service sector output in China has accompanied even more rapid growth in flows of services into and out of China via international trade. Both exports and imports of services have been growing at around 20-30 percent over the last few years in dollar terms, far outperforming the growth of service sector output (about 10 percent). Together, in 2004, service sector imports and exports were worth $134 billion, or 17 percent of service sector output in China, up from 11 percent in 1993. These figures show the increasing importance of trade in China's service sector as well as growing opportunities for services exporters in the United States and other economies. China's services trade with the United States China is running a substantial surplus on the current account of its balance of payments, including trade in both goods and services. But China is in deficit on its services trade account with all economies, to the tune of $9.5 billion in 2004. China also had a $2.6 billion deficit on its bilateral services trade account with the United States in 2005. China's service sector exports to the United States are growing rapidly as the Chinese market opens up and the country becomes a more attractive destination for tourists and business visitors. The average annual growth rate is 14.5 percent in dollars at current prices. In 2005, Chinese service sector exports to the United States were $6.5 billion, compared to $1.5 billion in 1994. But Chinese service sector imports from the United States were $9.1 billion in 2005, up from $2.1 billion in 1994, an average annual growth rate once again of 14.5 percent over that period— and from a higher starting level than exports. China's bilateral service trade deficit with the United States has increased by almost $2 billion over that period, and China's service sector imports from the United States were more than 14 percent of its total service sector imports in 2004. Most Chinese service sector exports to the United States are in the travel and transportation sectors, with a small residual of other commercial services. In contrast, 43 percent of US service sector exports to China consist of "other commercial services" (see Figures 4 and 5). Breaking down this category into its subcomponents reveals that the share of "education" services was the largest, followed by "business, professional, and technical," "financial," "telecommunications," and "insurance" services (see Figures 6 and 7). US investment in the Chinese market US companies are also investing in China's service sector. They are setting up operations in China to sell express delivery, financial, business, and other high-skill services directly to Chinese customers. The investments and sales of US operations in China are not reflected in bilateral trade figures, but they are an important element of the commercial relationship. The US Department of Commerce's Bureau of Economic Analysis produces data on US foreign direct investment (FDI) flows to China, broken down by sector (see Figure 8). US FDI flows to China between 2001 and 2005 reached $16.8 billion, of which roughly $3 billion, or 19 percent, was in service industries. Between 1996 and 2005, the service sector share of those investment flows increased. In 2005, service sector FDI accounted for 54 percent of the total. (Note that this picture of how US direct investment flows to China refers only to the flows that go directly from the United States to China. It does not capture any flows that might be routed through Hong Kong or other economies. To include these funds would probably more than double the quantity of US direct investment into China.) Impacts on China's economy Benefits to date Chinese industry is growing rapidly in part because of strong imports of knowledge services, network services (transport, communication, and information technology) and financial services from developed economies. Oxford Economics estimates that the increase in China's service sector imports after 2001 resulted in higher average labor productivity of 0.3 percent. This productivity increase equates to a $6.5 billion increase in Chinese GDP in 2005, of which roughly $650 million is attributable to service sector imports from the United States. FDI in the service sector has also benefited China. In particular, inflows of service sector investment from the United States were worth around $3 billion between 1996 and 2005. Assuming that between half and three-quarters of US FDI outflows to Hong Kong during that period were ultimately destined for China, then inflows from the United States were around $6.1 billion. This addition to the capital stock contributed some $1.6 billion, or 0.1 percent, to Chinese GDP in 2005, via higher productivity. Baseline forecast: Implementation of WTO commitments China's implementation of all of its WTO commitments will continue to translate into substantial benefits in the future. Oxford Economics estimates that under this scenario, the share of service sector imports in China's GDP will increase from 4.1 percent in 2006 to 5.4 percent in 2015. US service sector exports to China are slated to increase in proportion to Chinese service sector imports. Moreover, inflows of service sector FDI from the United States will also increase over the forecast period, by an average of around 5 percent per year. China's commitment to remove and relax these constraints will have a significant positive impact on China's GDP by the end of 2015. If the share of China's service sector imports were to remain at pre-2001 levels until 2015, there would be a substantial impact on whole-economy productivity: By 2015, Chinese GDP would be around 1.2 percent, or $66 billion (in 2006 prices), lower. Of that shortfall, around one-tenth, or $6.6 billion, would be attributed to lower service sector imports and smaller inflows of service sector FDI from the United States. Alternative scenario: Removing all remaining service sector restrictions In the baseline forecast, the gradual removal of constraints on service sector imports and on inflows of investment has a significant positive impact on productivity and GDP growth in China. But if remaining constraints were to be removed, the impacts on China's GDP and productivity growth would be even more substantial. Figure 9 compares the baseline forecast to an alternative scenario under which all the existing constraints on service sector imports and FDI inflows from all countries are removed by 2015. In the alternative scenario, the benefits to China's GDP would more than double by 2015 and reach almost 2.5 percent of GDP or $138 billion in 2006 prices. This would make the average Chinese household better off by $300-$400, or ¥2,300-¥3,100, per year. In comparison, average household income in China was around ¥30,000 ($3,700) in 2005. Service sector trade and investment flows with the United States would generate one-tenth of these gains. The benefits also extend to job creation. The baseline forecast, which assumes existing WTO commitments are honored, projects employment in all foreign majority-owned service companies in China to increase to around 5 million by 2015, of which around 400,000 jobs would be in US majority-owned companies. In the alternative scenario, service sector employment in these companies would be nearly 7 million, of which 550,000 would be in US majority-owned companies. Thus, the growth in service sector trade and investment by 2015 would create up to an extra 7 million jobs in China—jobs in relatively high-paying, high-productivity service industries. This figure is almost equivalent to the entire population of Xi'an, Shaanxi. Realizing these benefits Greater benefits would be realized if PRC regulations, implementing rules, and license approvals were adjusted to increase the pace and scope of service sector reform. Fully implementing China's WTO commitments is an essential first step to maximizing the advantages for the Chinese economy, but greater benefits would be realized if PRC regulations, implementing rules, and license approvals were adjusted to increase the pace and scope of service sector reform. In practice, this would entail the following: Increasing the transparency of the regulatory environment for foreign service providers, through early publication of proposed regulations, consultation with foreign and domestic industry, participation in international service sector forums, and adoption of international standards and norms; Progressively deregulating markets for the provision of services to encourage the growth of those services; Addressing current restrictions on market access and expansion (including foreign ownership, industry, and geographic limitations) so that foreign expertise in the service sector can become another tool to further China's economic development; Creating a level playing field by reducing government support for domestic enterprises in the services markets; and Continuing to gather and publicize sectoral data about the performance of the Chinese economy, to enable all participants in the economy to understand more clearly how quickly the various service sectors in China are growing and what their future growth prospects might be. Adopting such measures would generate significant benefits for China and help the country to move more quickly and effectively to achieve its economic development goals. Taking it to the next level In China, the service sector is growing, contributing to economic development and a rise in living standards by boosting the productivity of industrial enterprises. The expanding market for service-based jobs is vital to China's ability to absorb the large numbers of young workers and college graduates entering the job market each year. Historically, the growth of a service sector is also seen as a significant step in the evolution of a nation's economy. The expanding market for service-based jobs is vital to China's ability to absorb the large numbers of young workers and college graduates entering the job market each year. From a broader perspective, the expansion of China's services infrastructure is essential to the country's integration into the global economy and continued economic development. For example, the establishment of a modern capital market will help China move toward a market-driven exchange rate. Market-based lending will help level the playing field between US and Chinese competitors. China's ability to provide pension and health care insurance to its citizens will enhance social stability and unlock capital resources tied up in precautionary savings. Improving the regulatory framework for services will help Chinese manufacturers and commercial firms to continue to move up the value chain in all areas, from transportation, professional and financial services, and information technology, to retail, tourism, and hospitality, to name a few. China's initial implementation of its WTO commitments in services already benefits the Chinese economy. But even complete implementation of these WTO commitments will leave in place a range of impediments to the growth of China's service sector, as well as service trade and foreign investment. By removing these constraints, China will realize the full potential economic benefits of trade and investment in services. US Economy Benefits from Services Trade and Investment with China The United States is the world's largest exporter of services and is well positioned to benefit from China's rapidly growing demand for services. US service sector exports to China grew more than twice as fast as US total service sector exports between 1992 and 2005, at an average annual rate of 14.5 percent (in current prices). That growth was faster than the growth of service sector exports to any other major economy over that period (including India, at 12.7 percent per year). As a result, US service sector exports to China, at $9.1 billion in 2005, now account for 2.4 percent of US service sector exports, up from 1.0 percent in 1992. China is already one of the top ten destinations for US private service sector exports, and the United States is already a net exporter of a broad range of services to China: The United States had a services trade surplus with China of $2.6 billion in 2005. Both trade and investment flows between the United States and China in service industries have an impact on the current account of the balance of payments and, as a result, on US GDP. In 2005, in addition to the bilateral services trade surplus of $2.6 billion, US affiliates in China repatriated profits worth $3.3 billion. Of that, around 17 percent, or $560 million, is attributable to service sector affiliates in China. Together, service exports to China, along with repatriated service sector profits from China, contributed a net $3.1 billion to US GDP in 2005, slightly reducing the bilateral current account deficit with China. US net exports of services to China make a direct contribution to US GDP in the short term via the current account of the balance of payments. In the long run, the overall net trade position is determined by such factors as the appetite for savings in the United States, compared to other countries, and its magnitude will not be affected by bilateral trade flows with any single country. There is, however, another way in which US service sector net exports to China can make a permanent contribution to US GDP. Indeed, service sector net exports to China support employment in relatively high-productivity and high-wage sectors of the US economy. According to Oxford Economics Ltd. estimates for 2005, net exports of "other private services" to China support a net number of roughly 37,000 high-productivity jobs in the United States. This provides a permanent boost to US GDP, worth around $460 million in 2005. Maximizing the benefits China's implementation of its World Trade Organization (WTO) commitments will continue to benefit the United States in the future. In the baseline forecast, in which China honors all of its WTO service commitments, US service sector exports to China will increase to $45 billion by 2015, while the US surplus on services trade with China will increase to $15 billion, or 0.1 percent of US GDP. On top of that, inflows of net income from US service sector affiliates in China will increase to around $1.5 billion by 2015. And the impacts on US productivity will also increase, as service sector trade and investment in China contribute a projected $2.5 billion to US GDP in 2015. The growth in service sector net trade with China and inflows of profits from service sector investments in China together will also support more rapid growth in service sector employment in the United States. In the baseline forecast, these effects combine to create an additional 60,000 service sector jobs in the United States by 2015. If the outstanding impediments to service sector growth in China were fully removed, the bilateral services trade surplus with China would increase to around $60 billion by 2015, supplemented by extra income derived from US service-related investments in China worth $7 billion. This would boost US GDP in the short term by about 0.3 percent. The average US household would be better off by about $500 per year in 2010 as a result of this growth in services trade with China. The removal of all impediments to growth in services trade and investment with China would also create up to 240,000 high-paying US service sector jobs by 2015, accounting for 1.5 percent of the growth in US service sector employment between 2005 and 2015. The effects in 2015 do not capture the long-run impact of services trade and investment with China on the US economy. The Chinese market for services will have grown substantially by 2015, but the real focus of US service providers should be on a longer horizon, one that spans the decades to come. By 2050, US service sector exports to China could reach between 1.5 percent and 3.5 percent of US GDP. By then, of course, China's service sector exports will also have grown, but the US surplus on service sector trade with China still could be worth around 1 percent of US GDP, while inflows of profits from US service sector FDI in China could contribute a further 0.5 percent of GDP to the US current account of the balance of payments. Net services trade with China supports relatively high-productivity jobs in the United States, and the impact of this trade on the composition of US employment leads to higher average productivity and, therefore, higher GDP in the long run. The impact on US productivity via this channel could be worth 0.1 percent to 0.2 percent of US GDP in the long run: a substantial effect. This scenario clearly projects long-run benefits for the United States. For these benefits to develop fully, however, the market barriers in China's service sector must be dismantled completely. —Erik Britton and Vanessa Rossi Erik Britton's director of Economics, and Vanessa Rossi is director of International Economics, at Oxford Economics Ltd. They are based in Philadelphia, PA, and Oxford, the United Kingdom, respectively. This article is adapted from the December 2006 China Business Forum report, The Prospects for US-China Services Trade and Investment. The China Business Forum (www.chinabusinessforum.org) is the educational and research arm of the US-China Business Council, publisher of the CBR. Further Reading The China Effect Hospitality, Chinese Style Banking on Reform Life Insurance Industry Heats Up The Sources of China's Economic Growth Copyright 2007 US-China Business Council Top of Page Table of Contents
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