Services inputs, like engineering, design, banking, software and logistics, play an increasingly important role in global manufacturing as a direct contributor to the value-added incorporated in manufacturing products. Cross-border trade in services has been traditionally defined as services provided internationally. The different forms of supply envisaged in the WTO General Agreement on Trade in Services (GATS) and adopted widely as part of hundreds of bilateral free trade agreements (FTAs) are referred to as modes: Mode 1- cross-border services trade such as online transactions; Mode 2 – customers purchase services while abroad such as tourism; Mode 3 – a services company sets up a commercial presence abroad; Mode 4 – a worker crosses the border temporarily to provide a service
In recent years however, policy makers and academics alike have recognised that there are other forms of services supply that are becoming increasingly important in international trade but are not covered by the four traditional modes of supply. These are the services inputs that make up a part of manufactured goods and the growing importance of these services inputs has been referred to as the “servicification” of manufacturing. When services inputs are incorporated and traded internationally as part of an exported good, such services exports are not covered by the GATS four traditional modes mentioned above. In line with the existing GATS terminology, this new mode of supply has been labelled mode 5 services.
As indicated in a many research studies, mode 5 services have become an important feature of manufacturing exports and are bound to grow in importance in the future. Mode 5 services can be simply defined as the services content embodied in goods exports. Typical mode 5 services include, inter alia, design, engineering and software that are incorporated and traded as part of manufactured products.
Spurred by global supply chains and technological progress, the role of mode 5 services inputs as part of manufacturing exports has increased considerably in recent years, notably for a number of industrial sectors such as motor vehicles, electronics, but also many other more traditional sectors, such as processed food and textiles. The WTO database shows that between 2010 and 2019, for instance, the share of embedded services as a percentage of total manufactured exports has witnessed double digit growth, with a diverse set of countries such as Finland, United States, Turkey, Poland, and China witnessing the largest increases in their share of embedded services. For a large majority of countries, the share of embedded services represents around one third of the total value of their manufactured exports, with many OECD countries such as France, Germany, Belgium, Italy, and Spain having among the highest shares of embedded services in their manufactured exports in 2020.
Several authors have suggested that service inputs affect firms’ export capabilities positively and that buying-in more services is linked to higher firm-level export intensity as well as to total factor productivity growth, especially in the high-skilled intensive industries. Conceptually, the coverage of mode 5 services as used and further modelled in this paper reflects production services which are an inseparable part of the production process of a manufacturing good, before the good enters the importing country. Consequently, mode 5 represents a subset of servicification rather than servicification as a whole.
As an example, in order to produce a car there is a need for engineering, consulting and design services as well as electricity and logistics services in order to operate the car factory and to purchase necessary inputs. These are the services which form part of the value of the good before it is exported. Another simple rule of thumb to think about mode 5 services is through the lens of the GATT rules that are currently applicable to embedded services in merchandise trade: if the value-added of a service element is included in the value of a product that would be subject to customs duties, then that service can be considered a mode 5 service.
All countries and all sectors would have the potential to benefit from liberalisation of mode 5 services in an international agreement. Mode 5 services represent not only a growing share of global trade in goods but also an important economic activity that support tens of millions of jobs worldwide. For instance, the European Union estimated that over 8 million jobs in Europe which is 1 out of 4 jobs supported by trade, are actually mode 5 services jobs.
Several mode 5 services such as product design, Research and Development (R&D), engineering and IT services, are high-value added and intrinsically linked to technology. Their importance for securing a competitive advantage in manufacturing trade and especially in the context of global production networks is indisputable not just for advanced manufacturing but also for more traditional sectors, including primary sectors like agriculture or mining and processed food.
The importance of mode 5 services is paramount in the automotive sector. The car industry has been at the forefront of the global supply chain revolution, and this was noticed by policy makers early on. One clear illustration is offered by Robert Reich, a former United States Labour Secretary, with his Pontiac example. Robert Reich stated that when an American buys a Pontiac Le Mans from General Motors, for example, he or she engages unwittingly in an international transaction. Of the $20,000 paid to GM, about $6,000 goes to South Korea for routine labor and assembly operations, $3,500 to Japan for advanced components which includes engines, transaxles, and electronics, $1,500 to Germany for styling and design engineering, $8,000 to Taiwan, Singapore and Japan for small components, $500 to Britain for advertising and marketing services and about $100 to Ireland and Barbados for data processing.
CBS reported that the Chevy Volt model, another GM brand, was dubbed one of the most software- intensive manufactured products on earth, with 10 million lines of software codes and the value of its software and electronic components amounting to around 40% of the total value of the car, compared to some 5% in 1980s. Everything from the Volt’s usage of the electric battery to engine controls, power train and motion sensors, plus plenty of other features, all depended on software. Nowadays, just a few years later, Volt is part of a long history of automotive progress.
Today the headlines are made by Tesla, a newcomer in the automotive industry, which has recently surpassed Ford and GM to become the most valuable United States automaker despite having a tiny market share in the US market compared to its competitors. Bloomberg reported that industry analysts claim that one of the secrets for Tesla’s ascent lies in the value of its software and the synergies the company builds between traditional automotive engineering and the new embedded software-driven technological developments. Wall Street and business analysts alike believe the software of this Silicon Valley company will give it an upper hand against traditional companies. Software will have an even more critical role if, or rather when self-driving cars become a reality.
But mode 5 services do not make headlines just in the automotive industry. Take Caterpillar and the Internet of Things (IoT), for instance. In the case of Caterpillar, it is actually the internet of big, yellow things. Running earth-moving machines in remote, harsh environments is costly if such equipment breaks down often and in unpredictable ways, making the repair process long and difficult. Financial Times, reported that by introducing remote sensors and Internet of Things technology in its machines and by applying predictive software analytics, Caterpillar has managed to reduce the typical cost of 900 hours of downtime and $650,000 in repair costs to less than 24 hours and only $12,000.