Europe needs service-market liberalisation

Written by John Springford [1], 20 September 2012
From The Wall Street Journal

In exchange for sharing southern Europe's debt burden, Germany is demanding liberal economic reforms in those countries. Yet Germany is not following its own advice. Its services markets are heavily regulated. Diplomas are required by law for people to work as wooden boat builders, painters and decorators, or ski instructors. Pharmacists are only allowed to own four shops. Lawyers' fees for most civil and criminal cases are set by a centrally-determined scale, not the market.

Germany's strategy for Europe's economic future hardly includes services. The German government believes that the pre-requisite for growth is more flexible labor, with competitive wages, producing manufactured goods for sale abroad: hence its call for southern Europe to deflate and shift towards exports. But even in Germany, the manufacturing sector only accounts for 20% of GDP. And since European countries mostly trade with each other, they cannot all move into external surplus at once.

That's why productivity growth in services—which make up the majority of European output—must be at the heart of any long-term growth plan. This has been anaemic in the European Union, where productivity gains averaged only 1.2% per year between 1995 and 2009. In that same period, the U.S. managed 3% average annual productivity growth.

Poorly designed national regulations have played their part in the stagnation of European productivity. But the European Union has also failed to integrate national services markets. Europeans still buy nine-tenths of their services from firms established in their home countries. Small, national markets do not generate the levels of competition necessary to drive innovation and with it, faster productivity growth.

The European Commission argues that the EU's 2006 Services Directive would open up services markets, if only the national-regulatory laggards would finally implement it. The directive made member countries review their services regulations and scrap any rules that constrained foreign firms' ability to set up or sell services from abroad.

Whether a rule inhibits establishment is, however, open to interpretation. Some national governments insist that travel agencies have a minimum number of staff, but does this constitute a barrier for a foreign firm to enter? In many cases, the EU Services Directive let member states decide such questions for themselves. Perhaps unsurprisingly, many erred towards the status quo and most national barriers to market entry remain on the books.

The EU needs a plan to open up services markets more fully, so that more productive firms in one country can move into another and take market share. Mutual recognition—where one country allows a foreign firm free access to its market, while it is regulated by its home country—would be most effective. Companies would not have to sign up to new rules, reorganize their insurance, find workers with the right diplomas, or change their ownership structure to enter a new market.

The EU's original draft for the services directive included mutual recognition for firms that were temporarily selling services abroad. But the mutual recognition clause was removed by the European Parliament, under pressure from France, Belgium, Germany and from national trade unions. The directive failed because it was too sweeping, trying to free up all markets at once. The parliament balked at the notion of Bulgarian legal firms offering advice to Belgians without oversight by Belgian regulators.

The solution is to move sector by sector. Where consumers are buying expert advice, as in law or health care, they find it difficult to appraise the quality of the advice before purchase and so are used to relying on national regulators and standards boards.

But other markets are less troublesome: If a consumer buys shoes from one shop and they break, he can go to another with a reputation for better shoes. Retail, construction, tourism, cultural content, design, and logistics are all services where buyers find it easy to appraise the quality of service, or where they can use rating websites like Tripadvisor to help. Even business consultancy could be freely delivered across the EU, as the firms that buy their services have enough information to go by (and if they don't: caveat emptor).

The EU should take a staged approach to services liberalization, starting with the paths of least resistance. It should start with mutual recognition in construction and retail markets and then move on to more heavily regulated sectors. It should also start with one-off sale of services, and then move on to permanent establishment.

Germany is right that southern Europe needs more economic liberalization—but so does Germany and the rest of the EU. With Germany on board for service-sector liberalization, a large majority of EU governments would favour reform, helping to push it through. Italy, Spain and Portugal have already made some ambitious—and politically costly—changes to their labor markets. Earlier this year, Italian prime minister Mario Monti coralled eleven other leaders to sign a letter supporting more single-market integration. Perhaps Chancellor Merkel could provide the 13th signature?