Modes of Supply

19.There are four main ways in which services are internationally traded. They are defined as the ‘Four Modes of Supply’ by the World Trade Organization (WTO) under its General Agreement on Trade in Services (GATS), which provides the basis for global rules on services trade. These ‘modes’ are described in Table 1.
Table 1: Modes of Supply under the GATS

Mode 1: Cross-border Services
Services supplied from the territory of one country into the territory of another, without either the consumer or producer moving to the physical location of the other. An example would be a call centre in India providing services to a company in the UK.21

Mode 2: Consumption Abroad
Services which are consumed by the resident of another territory who moves to the location of the service provider, for example a French tourist visiting the UK.22

Mode 3: Commercial Presence
This refers to trade between a business resident in one country which controls an enterprise resident in another (referred to as ‘foreign controlled enterprises’, ‘foreign affiliates’, or ‘subsidiaries’). For example, UK-based retailers setting up branches in France. 23

Mode 4: Presence of Natural Person
This mode of trade occurs when a service professional moves to another territory temporarily to deliver their service directly to a consumer. For example a London-based management consultant going to Paris to deliver a presentation.24

Trade via modes 1 and 2

20.Trade via modes 1 and 2 is measured by the ONS in its annual Pink Book as part of a country’s Balance of Payments (which records its financial transactions with the rest of the world), and by the International Trade in Services survey (ITIS).25

21.Globally, in 2015, the UK exported more non-financial services under modes 1 and 2 than it imported, generating a surplus of £33 billion.26 The UK Trade Policy Observatory commented, in evidence to this inquiry, that the UK’s general trade surplus in all types of services revealed the UK’s “comparative advantage in services, both relative to the world as a whole and even relative to EU-27 economies”.27

22.As shown in Figure 2, although the UK’s global trade surplus in non-financial services is smaller than the surplus generated by financial services (which is in the order of £55 billion), it is still important in partially offsetting the UK’s very large trade deficit in goods. Moreover, there is a greater volume of trade in non-financial than financial services: exports of £161.8 billion versus £63.7 billion.28
Figure 2: Global trade balance in goods, services and financial services in 2015 (£ billions)

Source: Pink Book 2016 and calculations based on written evidence from the ONS (TAS0064)

23.The EU is a significant market for UK exports in non-financial services (39%). In 2015, the UK ran a surplus in its trade with the EU in professional business, digital and creative services (totalling £9.8 billion). However, this was outweighed by the extent of the UK’s deficit with the EU in tourism (recorded as ‘travel’, at £11.5 billion) and, to a lesser extent, transportation services (totalling £1.1 billion).29

24.Nonetheless, the UK Trade Policy Observatory said focusing on positive balances alone “misses the point of trade”, because “in terms of employment, the output from sectors in deficit requires labour and so generates jobs just as much as that from sectors in surplus”. Dr Angus Armstrong, Director of Macroeconomics, National Institute of Economic and Social Research (NIESR), added that trade was about the “allocation of resources, the efficiency and the wages and salaries you generate from this”. He said the UK could have a “zero [trade balance] but do a lot of trade between countries, and this would still be a good thing for us because it means we can specialise in what we are good at”, while importing those things the UK was less able to produce itself.30
Figure 3: UK-EU trade in non-financial services 2015 (£ billions)

Measuring modes 3 and 4

26.Dr Armstrong explained that it was “much more difficult” to measure the value or volume of trade occurring under modes 3 and 4, because the statistics had to be collected from outside the UK, and required “imputing and estimating” numbers based on other data available.31

27.The lack of data on mode 3 is particularly concerning, because this is the mode under which the largest volume of services trade occurs. Professor Catherine Barnard, Professor of European Law at the University of Cambridge, estimated trade via mode 3 to be worth “55% or 60%”32 of the world’s trade in services, while Professor Holger Breinlich, Professor of Global Economics, University of Nottingham, said that “as a rule of thumb”, it was “roughly twice as big as the other modes combined”. Professor Breinlich explained that mode 3 was not included in the Balance of Payments data, because “balance of payments is meant to measure transactions between residents and non-residents and, if there is a foreign company in the UK, that company would count as a resident and would not be part of the balance of payments”.33 Dr Armstrong said that, while there was a close correlation between data on Foreign Direct Investment and trade via mode 3, it was not exact. 34

28.The lack of data on trade via mode 4 is also problematic, and is linked to wider concerns about immigration. The UK Trade Policy Observatory said that mode 4 was “notoriously mis-measured”, thanks to the many different categories of persons working (either as ‘independent professionals’, ‘contractual services suppliers’ or ‘intra-corporate transferees’), and the difficulty of collecting data on professionals registering themselves abroad.35 Professor Breinlich explained: “If McKinsey has a consultant in Paris and in London and they work together, which is basically a services trade, it goes completely unrecorded.” In his opinion, “the figures we have are an underestimate of what is truly going on”, but “by how much, it is unclear”.36 The UK Trade Policy Observatory also said the movement of unskilled workers was “more likely to go unmeasured”.37

29.The UK Trade Policy Observatory concluded:
“The fact that investment flows and movement of services professionals figure less prominently should not be construed as indicating that these modes are of lesser economic significance.”38

30.The Pink Book, in excluding modes 3 and 4, also fails to capture the extent to which different modes of supply may be complementary or substitutable. The UK Trade Policy Observatory said it was “widely believed” that professional services (such as legal advice) required “a combination of (at least) modes 3 and 4”. For example, a law firm looking to trade its services in another territory would need to begin by “establishing partnerships or other contractual arrangements (mode 3)”; in addition, “the temporary exchange of staff (often on a project [or] case-related basis) would also be required”.39 Professor Breinlich developed this point, arguing that it was important, in any negotiations on a FTA, to “bear in mind that services can be provided through [these] different modes”.40
Measuring the ‘value added’ by the UK’s services trade

31.Professor Breinlich also told us that a service embedded within a good—referred to as the value added by UK service providers to exports—did “not show up in the service[s] statistics” found in the Pink Book.41 Dr Armstrong referred to this as the ‘fifth mode of supply’. For example, while “software counts as a mode 1 delivery under GATS”, if that software was “embedded in some manufactured goods” it was “count[ed] as a manufactured good”.42 The UK Trade Policy Observatory cited an estimate that in 2009 “nearly 35% of the EU-27 gross merchandise exports in fact represented services inputs, equivalent to over 300 billion Euro”.43 The Minister for Energy and Industry at the Department for Business, Energy and Industrial Strategy, Dr Jesse Norman MP, agreed that UK non-financial services businesses were “prominent in areas that have very high value added”.44

The usefulness of the data

32.The Rt Hon Matt Hancock MP, Minister of State for Digital and Culture at the Department for Culture, Media and Sport, told us the problems with the data did “not really matter much because we know from hard data that we do have, such as on employment and jobs, that Britain is really quite good at this digital stuff and our services and business services are excellent”. He concluded: “We know enough to know that that is important and therefore we know that it is important to get the freest possible trade in goods and services” between the UK and the EU.45