by Strategy&, part of the PwC network

Technology and trust should be the drivers of digital trade when distance matters

When China emerged as a trading force in the early 2000s, the distances that had always limited international trade suddenly seemed to melt away. Globalisation had entered a new and deeper phase, and influential voices even began to talk of the world becoming "flat". 

Nowhere did this new paradigm have more logic than with the trade in services, which now comprises almost one-quarter of overall international trade thanks largely to the internet and the increasingly dominant digital economy. 

Yet a recent study by PwC, the professional services firm, shows that distance not only affects trade of physical goods but it also weighs heavily on internationally traded services. 

"Distance does matter," says David Armstrong, Strategy& Partner and Head of International Development at PwC UK. "And it matters for services as much as it does for goods."

The findings have profound implications for the UK at a time when the fast-approaching deadline for Brexit is creating pressure to strengthen trading partnerships outside the European Union. They also carry important lessons for trade officials and heads of businesses around the world as they look to shape policies and develop strategies for exporting services in the digital age. 

The study, based on new, experimental dataset on UK services trade compiled by the government, found that distance between the UK and other countries - as well as the size of those countries' economies - explained between 50 and 60 percent of trade in the dataset. Doubling the distance between the UK and a trading partner, for example, would decrease trade in services by just under half. 

In financial services, where the UK is the world's biggest exporter, the study found that distance had a particularly high impact on exports. Meanwhile, manufacturing had the highest distance coefficient of the 12 service sectors studied. Of all of them, only travel had a negative distance coefficient. 

The findings are particularly relevant for the UK because services account for 47 per cent of total exports compared with 35 per cent in the US - and just 25 per cent, on average, for member nations of the Organisation for Economic Co-operation and Development (OECD). 

But they are also relevant for the rest of the world because of the growing importance of services as a proportion of total global trade. Richard Samans, Managing Director, and Head of Policy and Institutional Impact, at the World Economic Forum, argues that the digital economy is producing sweeping changes in manufacturing and other areas that are likely to boost exports of services even more. 

One example is the rise of 3D printing, in which suppliers now frequently send their clients digital files of products that can be printed remotely rather than the physical products themselves. "Trade that takes place in manufacturing is increasingly in the intangible," says Samans. "What crosses borders is the design." 

Samans argues that these sorts of changes are having such a fundamental effect on traditional trading relationships that they demand what he calls an updated operating system for globalisation. 

"The Fourth Industrial Revolution is challenging the way we organise our economies and societies, as well as cooperate internationally," he says. "To maximize the benefits and mitigate the risks of the latest technological advances, we will need to strengthen and modernize national and global policy frameworks."

One question hanging over the shift towards international trade in services in a world where distance still matters is, what can countries do to encourage trade in services with partners who are not geographically close? 

Armstrong says that one thing is to build trust. Personal ties, common language and cultural affinities, for example, could help explain why South Africa buys £2.2bn in UK services a year. By contrast, Japan, which is closer than Cape Town to London, and whose economy is 14 times the size, only buys three times more UK services than South Africa.  

"This sort of example shows that there are more factors in play than just distance and size," says Armstrong. “In digital trade technology is the enabler, but trust is the clincher.”

A second factor is to work at reducing or eliminating non-tariff barriers to trade in services, such as regulatory requirements and restrictions on data flows. "Trade policy often focuses on tariffs but this is only half the picture," says Armstrong. "The presence of 'behind the border barriers' is a reminder that full trade liberalisation remains a distant goal."

According to the UK government, removing all non-tariff barriers in the European Union (EU) would increase the bloc's gross domestic product (GDP) 14 per cent. 

There are myriad non-tariff barriers, each one of which throws up obstacles to services trade. But one of the most common is licensing, where professions are required to hold licenses to work and yet those qualifications are only valid for the country - or even state - in which the professional works. As a result, a UK-qualified doctor could take up to a decade to be able to practise in the US. 

With gravity pulling as hard on services trade as that of goods, Armstrong argues that these other factors such as building trust and tackling non-tariff barriers should become a bigger focus for facilitating international trade. As he puts it, "there are still plenty of opportunities to push the boundaries".

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