Economic Modelling 35 (2013) 297–304

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Economic Modelling
journal homepage: www.elsevier.com/locate/ecmod

Modeling the effect of the domestic business environment on

services trade
Azmat Gani a,⁎, Michael D. Clemes b
a
Department of Economics and Finance, College of Commerce and Economics, Sultan Qaboos University, P. O. Box 20, Al Khod 123, Oman
b
Commerce Division, Lincoln University, P. O. Box 80, Canterbury, New Zealand

a r t i c l e i n f o a b s t r a c t

Article history: This paper models the effect of the indicators of the domestic business environment on services trade in a sample
Accepted 18 June 2013 of low, middle and high-income OECD countries. The findings reveal that the time required to enforce a contract
is strongly negatively correlated with the growth in services exports in the high-income OECD countries as well
JEL classifications:
as with the growth in services imports in the middle and high-income OECD countries. A strong inverse correla-
F13
tion of the time required to register a property with the growth in services imports is confirmed for the OECD and
L80
O24
middle-income countries and the growth in services exports for the low-income countries. Internet diffusion and
O50 the strength of legal rights are strongly positively correlated with services exports in the OECD countries while
the strength of legal rights is also strongly positively correlated with services imports in the middle and low-
Keywords: income countries. The growth of world income has a strong positive effect on the growth of services exports in
Business the OECD and middle-income countries while domestic income growth strongly impacts on the growth in ser-
Services vices imports across the three income category of countries. Finally, tariff is strongly negatively correlated with
Trade services exports for the middle-income group of countries.
Contract enforcement
© 2013 Elsevier B.V. All rights reserved.
Income
Internet and legal rights

1. Introduction
The services sector, traditionally deemed the residual tertiary sector
after the primary and secondary sectors, is a significant contributor to
the national output of many countries (Fig. 1). The volume of world
trade in services increased significantly over the last two decades. For
example, Dutta (2008, p. 510–511) notes that since the 1980s, services
have been playing a more important role in their sustained value added
to GDP across many countries. In a recent study, Park and Park (2011)
note that world trade in services increased from US$387 billion in
1980 to US$3730 billion in 2008 and such expansion has been a result
of innovations in information technology, deregulation by the public
sector and liberalization of capital flows. Das (2010) notes that the
growth and development of domestic manufacturing industries have
also increased the globalization of economic activities in many areas
(transportation, tourism, computers and information technology, and
finance) and this expansion has facilitated the emergence of a service-
dominated economy in many countries. An important factor assisting
the emergence of the services sector is the entrepreneurial capital that
has also aided the economic development of several countries (Acs
et al., 2008). Ayyagari et al. (2007) found that several dimensions of
⁎ Corresponding author. Tel.: +968 24142950; fax: +968 24414043.
E-mail addresses: azmat@squ.edu.om (A. Gani), Michael.clemes@lincoln.ac.nz
(M.D. Clemes).
the business environment were associated with the large size of the
small and medium enterprise sectors which are also engaged in service
related trade.
Generally, the activities of the services sector are broadly categorized
into market and non-market services. The market activities usually in-
clude producer services (for example, banking and finance); distribu-
tion services (for example, transport and storage); personal services
(for example, hotels and restaurants) and communications (for exam-
ple, the internet). Non-market services include social services (for ex-
ample, health, education and housing). According to the World Trade
Organization (WTO), services trade is addressed within a broad based
framework of the General Agreement on Trade in Services (GATS).
The services sector plays a crucial role in the economic development
of many nations, as services in general bind the other core sectors of
the economy such as manufacturing, primary resource based industries,
and transportation and communication.
The contribution of market and non-market services to national val-
ued added is recognized by several countries. However, it is the market
activities of the services sector that are making a strong impact outside
the borders of national economies, positively contributing to the pro-
cess of regional as well as global trade integration and national welfare
improvements. For example, Hoekman and Mattoo (2008) argued that
trade in services is expected to contribute significantly to economic
growth mainly through enhanced productivity as services are basic in-
puts or intermediates for industrial production. In addition, Adlung

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http://dx.doi.org/10.1016/j.econmod.2013.06.033
298 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304
Services Value Added
Percentage of gross
80
domestic product
70
60
50
40
30
20
10
0 in services to be important for many countries aiming for greater
Low income countries Middle income High income OECD
countries countries
Country Category
1990 2007
Fig. 1. Services value added in the low, middle and high-income OECD countries.
Source of data for Fig. 1: World Bank (2011a).
(2007) argued that trade in services helps reduce income disparities
within and between countries such as income transfers generated by
workers moving abroad or mobilization of private investment for social
policy implications.
Countries throughout the world are aiming to expand their trade
structure with the aim of greater integration and participation in the
global trading environment in order to achieve higher levels of national
development (Chang et al., 2009; Greenaway et al., 2002). For many
countries, the desire to achieve greater participation in, and reap the
benefits of the global trading environment, outward oriented trade
strategies that include services trade becomes essential. In attaining
this goal, the domestic business environment can play a crucial role in
terms of allowing national economies to trade without many con-
straints and additional costs borne by entrepreneurs.
The expansion of the trade in services is impacted by several factors,
one of which is likely to be the domestic business environment. When
the business environment is highly regulated and doing business is dif-
ficult, potential entrepreneurs may be deterred and seek other produc-
tion locations where the ease of doing business and trade favors them.
More liberalized economies tend to attract more investors. Recent liter-
ature has raised the consequences of business environment on trade
and growth as noted by Acemoglu et al. (2005), Acs et al. (2008),
Freund and Bolaky (2008) and Khan and Kalirajan (2011). For example,
secure property rights create incentives for using resources for efficient
production (Solakoglu, 2007); sound contract enforcement and a good
quality legal system enhance the export activities of firms (Yue et al.,
2010); and the lengthy resolution of simple business disputes can
work against the interest of entrepreneurs (Djankov et al., 2007).
Policymakers in countries around the globe have begun to respond
to the challenge of creating a favorable business environment by intro-
ducing policies and legislation pertaining to the business formation pro-
cess, contract enforcement, property registration, and investment
protection, among others. The Doing Business 2012 report of the World
Bank (2011b) notes that the governments in 125 out of 183 countries
surveyed implemented a total of 245 business regulatory reforms, ap-
proximately 13% more reforms than in 2010. The report also notes
that in sub-Saharan Africa, 36 of the 46 economies measured improved
their business regulations. In addition, over the past six years 163 econ-
omies have made their regulatory environment more business-friendly.
While the aforementioned series of reforms may be considered signif-
icant steps towards improving the business environment, whether or not
these reforms have helped to facilitate more trade in services is an impor-
tant empirical question. This issue is worth investigating given the emer-
gence of a growing services sector, particularly in the emerging markets
and the developing world. To date, few studies systematically and empir-
ically investigate this issue in an international context that provide a
comparative analysis in countries at different stages of development.
The purpose of this paper is to provide a comparative analysis of the
effect of the domestic business environment on trade in services in a
sample of low, middle and high-income OECD countries. The paper
adopts an empirical framework using six indicators of the domestic
business environment: the cost of doing business, the security to prop-
erty rights, contract enforcement, dispute resolution, the extent of inter-
net diffusion, and the strength of legal rights. The explanatory power of
these indicators is tested in terms of their ability to explain the growth
rate of services exports and imports using cross-country data. We con-
sider the link between the domestic business environment and trade
trade integration. This study makes a new and valuable contribution
given that the empirical research in this area is almost non-existent.
The remainder of the paper is structured as follows. Section 2 pre-
sents the analytical framework and develops a structural model that
forms the basis of testing the effects of the domestic business environ-
ment on the trade in services. Section 3 presents a theoretical justifica-
tion of business environment and trade control variables. Section 4
discusses the estimation procedure, presents the empirical findings
and discusses the results. Section 5 concludes.
2. The analytical framework
The theoretical developments pertaining to international trade so far
provide logical arguments that international trade is welfare enhancing.
The literature demonstrates that national economic progress is deter-
mined by factors that are internal as well as external to a nation. Inter-
national trade in goods and services is one of the major external
contributors and its positive impact on the long-term economic growth
and development has been well documented, for example, Edwards
(1993), Yanikkaya (2003), Santos-Paulino and Thirlwall (2004),
Kneller et al. (2008), Chang et al. (2009), Bas (2012) and Berg et al.
(2012). Nobel Laureate, Amartya Sen (Sen, 2002) has emphasized that
“the importance of global contact and interaction applies to economic
relations among others and that there is much evidence that the global
economy has brought prosperity to many different areas of the globe
and in overcoming pervasive poverty, both modern technology and eco-
nomic interrelations have been influential.” Das (2010) has argued for
the importance of globalization noting that much of Asia, including
India and China, has benefited immensely from economic and financial
globalization.
Trade provides access for a country to the advances of the technolog-
ical knowledge of its trading partners, allows producers to access bigger
markets, encourages research and development, and provides access to
investment and intermediate goods (Yanikkaya, 2003). The studies
noted above provide evidence to indicate that national economies can-
not prosper unless they are open and integrated into the world econo-
my and that trade does appear to positively impact growth. At the same
time, it has also been shown that increase in trade restrictions can slow
down economic growth (for example, Marrewijk and Berden, 2007).
However, trade may not always have a direct positive effect on growth.
For example, in his study of the five largest Latin American economies
over 105 years, Astorga's (2010) findings revealed overall negative con-
ditional correlation between trade openness and GDP per head growth.
A less restrictive business environment can also be argued to be criti-
cal to enhance trade. Easing the process of business formation helps es-
tablish more businesses involved in exports and imports. Making the
business formation process simple, easier, less costly and ensuring that
the legal institutions (courts and judiciary) are effective in the protection
of investment is important. The development of enforcement mecha-
nisms for business contracts, and legal protection of investors are crucial
for traders. Thus, we posit that an easy domestic environment for doing
business (among other factors) can promote trade in services.
Our analytical model is framed on the basis of our argument that the
trade performance in services of a country is primarily dependent on its
international competitiveness and the extent of the global demand for
its output. We follow the structural model of Santos-Paulino and
Thirlwall (2004) and Santos-Paulino (2005) who refer to the interna-
tional competitiveness as the price of country's exports relative to the

foreign price of related goods expressed in a common currency. As-
suming that prices and income elasticity's of the demand are con-
stant, services exports can be expressed as:
!λ
d
Services P τ
EX i;t ¼K WY i;t
Pf i;t
where: EX is the level of exports; K is a constant; P /P is the relative
domestic prices and foreign prices measured in a common currency
(US dollars in this study); WY is the level of world income; λ is the
price elasticity of the demand for services exports (expected to be
less than 0); and τ is the income elasticity of the demand for exports
(expected to be greater than 0), i is the country and t is the time. Dif-
ferentiating Eq. (1) with respect to time gives:
 
services
exi;t ¼ λ pd −p f þ τ ðwyt Þ:
i;t
Eq. (2) is a basic structural model where the responsiveness of ser-
vices exports to changes in prices and incomes can be analyzed. With
some modifications, the structural representation of exports of services
model as shown in Eq. (2) can be used for econometric estimations to
capture the effects of changes in prices and incomes among others.
Eq. (2) can be modified assuming that there is no instantaneous adjust-
ment to the export demand for services to changes in prices and in-
comes. Thus, the modified specification of Eq. (2) takes the form of:
services services
exi;t ¼ α 0 þα 1 ðpexÞi;t þ α 2 wyi;t þ α 3 ext−1
where: pex is the rate of change of relative prices; wy is the world in-
come growth; exservices
t − 1 is the lagged services export growth, and μ is
the error term. Our sample of countries includes several economies
that have obtained membership to the World Trade Organization
(WTO). One of the operating principles of WTO is that member coun-
tries have to engage in trade liberalization measures. Therefore, we
also capture the effects of trade liberalization (tl), measured by the tariff
rates. In addition, the costs of exports (x-costs) can also impact on
traders as rising costs can hinder exports and falling costs can enhance
exports (for example, Kalirajan, 2007, 2010; Khan and Kalirajan,
2011). Including tl and ex-costs gives Eq. (4).
services services
exi;t ¼ α 0 þα 1 ðpexÞi;t þ α 2 wyi;t þ α 3 ext−1 þ α 4 tli;t þ α 5 ex− costsi;t þ μ i;t :
In Eq. (4), the a priori expectation for tl and ex-costs is negative. In
our empirical estimations, we exclude ex-costs as services trade usually
does not include the shipment of merchandise from one location to an-
other that adds to trade costs. Our core variables of interest are the indi-
cators of the domestic business environment. The strategy employed to
assess the impact of the domestic business environment on trade in ser-
vices includes testing a set of indicators of the domestic business envi-
ronment (DBE). Including the fixed country effect (αi, due to panel
data estimation) and the vector of DBE gives an augmented estimating
equation of the form expressed in Eq. (5).
services services
exi;t ¼ α i þα 1 ðpexÞi;t þ α 2 wyi;t þ α 3 ext−1 þ α 4 tli;t þ α 5 ex− costsi;t þ ΩDBEi;t þ μ i;t :
The DBE vector of variables in Eq. (5) is (i) the costs of doing business
(cdb); (ii) contract enforcement (ce); (iii) the protection of property
rights (pr); (iv) dispute resolution (dr); (v) the extent of internet diffu-
sion (int-d); and (vi) the strength of legal rights (lr). The expected signs
on the variables in Eq. (5) are: pex (−); wy (+); ext − 1 (+); tl (−); ex-
costs (−); (−) for cdb; ce; pr; dr; and (+) for int-d and lr.
The effect of domestic business environment on the import of ser-
vices is modeled using the same approach as discussed earlier for the
A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304 299
export equation. The import growth equation takes the following
form:
services services
imi;t ¼ β i þβ1 ðpimÞi;t þ β 2 dyi;t þ β 3 imt−1 þ β4 tli;t þ β 5 im− costsi;t þ ΦDBEi;t þ μ i;t
ð6Þ
ð1Þ
where: im is the growth rate of services imports, pim is the relative price
d f change in imports, dy is the growth rate of domestic income, imt − 1 is
the lagged growth rate of services imports, tl is the trade liberalization,
im-costs is the cost of imports, and the vector of DBE is the same vari-
ables as defined in Eq. (5). The expected signs on the variables are:
pim (−); dy (+); imt − 1 (+); tl (−); im-costs (−); (−) for cdb; ce;
pr; dr; and (+) for int-d and lr. The theoretical justification of the
right hand side variables and their measures in Eqs. (5) and (6) is
discussed in Section 3.
ð2Þ Our choice of sample countries is based on the levels of development
measured by their per capita incomes. We follow the World Bank classi-
fication of countries and choose our sample countries from the low, mid-
dle and high-income categories to allow us to gauge the effect of the
domestic business environment in countries at different levels of eco-
nomic achievement. An additional advantage of this approach is that es-
timating a sample of countries with similar levels of development, and
more specifically achievements in services trade, minimizes the prob-
lems related to econometric estimations such as heteroskedasticity.
Thus, countries entering Eqs. (5) and (6) on the basis of our aforemen-
tioned concerns were also determined by the availability of time consis-
tent, published data on the variables identified. While a consistent set of
þ μ i;t ð3Þ data for the chosen time period (2004 to 2010) is available for most of
the high-income OECD countries, this was not the case for the low and
middle-income countries where the sample years are 2005 to 2010.
The low-income category of countries is mainly the low-income
sub-Saharan African countries. These are Burundi, The Gambia, Malawi,
Togo, and Uganda. Other countries under the low-income categories are
not included due to the absence of variable measures that are consistent
across time and country. While we recognize that our sample size for
the low-income category of countries is small, we still estimate the ser-
vices export and import equations for this small sample of low-income
countries in order to get a comparative feel of the effects of the right
hand side variables across the three income categories of countries
that we test. We expect to expand this analysis in the future by involv-
ing more low-income countries once published data on variables of in-
terest becomes available.
ð4Þ The middle-income category of countries are: Belize, Bolivia, Camer-
oon, Chile, China, Colombia, Cote d'Ivoire, Dominican Republic, Ecuador,
Fiji Guyana, India, Lesotho, Morocco, Nicaragua, Nigeria, Pakistan, Papua
New Guinea, Paraguay, Philippines, Solomon Islands, Grenada; Malay-
sia, Romania; Russian Federation, South Africa, St. Lucia; Uruguay, and
the Republic of Venezuela.
The high-income OECD category of countries are Australia, Austria,
Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany,
Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Luxembourg,
Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic,
Spain, Sweden, Switzerland, the United Kingdom, and the United States
of America.
The source of data for the vector of DBE variables is the World Bank
(2011b). The source of data for tl is the World Bank (2011b) and United
ð5Þ Nations Conference on Trade and Development, UNCTAD (www.
unctad.org) while the source of the remaining data is the World Bank
(2011b).
3. Theoretical justification of the explanatory variables
3.1. Trade control variables
In Eqs. (5) and (6) the real exchange rate is included as it is a useful
general indicator of a country's international price competitiveness
300 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304
(Pugel, 2004). International price competitiveness is regarded as a key
determinant of a country's international trade in goods and services. If
the price of foreign goods and services relative to the price of the do-
mestic economy's goods and services is higher, domestic demand for
imports tends to be lower and foreign demand for domestic goods
and services tends to be higher. If competitiveness improves, exports in-
crease and imports decline. The measure of the relative price is the real
effective exchange rate index (2005 = 100).
The world income (wy) is included in Eq. (5) because an improve-
ment and expansion of exports are determined by a growing world
economy, indicating that economic conditions in the global environ-
ment are robust and likely to increase demand. Exporters are likely to
respond to increased demand by increasing their production for ex-
ports. The variable wy is measured by the world gross domestic product
(GDP) growth rate (annual percentage).
The domestic income (dy) growth matters for importers Eq. (6). A
growing domestic economy indicates that the domestic economic envi-
ronment is suitable for investment, production and sales and is likely to
encourage imports. A growing economy also indicates the extent to
which domestic factors favor trade (correct economic policies, rising in-
comes, price stability and so on). An economy, whose economic infra-
structure favors production encourages individuals to engage in the
creation and transaction of goods and services, contributes to imports
of goods and services and enhances trade. An economy in which domes-
tic income growth remains stagnant may discourage imports. The
variable dy is measured by the domestic GDP growth rate (annual
percentage).
Trade liberalization (tl) can determine the degree of a country's out-
ward or inward orientation (Kneller et al., 2008). An outward oriented
trade strategy is one in which trade and policies do not discriminate be-
tween production for domestic and export markets, or between pur-
chases of domestic goods and foreign goods. By contrast, an inward
oriented strategy is one in which trade and industrial incentives are bi-
ased in favor of production for the domestic over the export market.
Available evidence suggests that outward oriented trade policies have
been more successful than inward oriented trade policies (Edwards,
1993). As part of its broader economic reform program, most WTO
member countries have embarked on policy liberalization in a range
of areas including trade by gradually reducing applied tariff rates with
the aim of shaping an outward-looking economy. This policy shift is
likely to be welfare enhancing. For example, Asafu-Adjaye (2008)
found that unilateral trade liberalization increases real output, real na-
tional welfare and non-agricultural exports in the medium term. In a
further study on regional trade agreements versus global trade liberali-
zation using Fiji as a case study, Asafu-Adjaye and Mahadevan (2008)
found that full trade liberalization involving the removal of tariff and
non-tariff barriers provides the greatest benefits in terms of real output.
In this study, tl is measured by the applied tariff rate (simple mean, all
products, in percentage).
3.2. The domestic business environment variables
Freund and Bolaky (2008) have shown that business regulation is an
important complementary policy to trade liberalization. We argue that
if countries are engaged in easing the process of business formation, it
will lead to establishment of more trade oriented services sector.
While theoretical arguments in the extant economic literature relating
business environment directly with services trade are rare, we draw
on the theoretical literature from the more general business environ-
ment perspective and attempt to link it with trade in services as
discussed below.
3.2.1. Cost of doing business (cdb)
The cost of doing business is fundamental for traders as they prefer
lower to higher costs. Business costs are wide and varied and include
all the costs an entrepreneur must cover from establishing to finally
operating a commercial business. Business establishment costs may in-
clude costs related to obtaining all necessary licenses and permits and
completing any required notifications and verifications or inscriptions
for the company and employees with relevant authorities (World
Bank, 2011b). Thus, potential investors willing to engage in export or
import related business are attracted to locations where the costs of
doing the entire business are low. High and rising costs of doing busi-
ness attract potential investors to low cost production locations. Our
measure to capture the cost of doing business is the cost of business
start-up procedures and includes the costs to register a business nor-
malized by presenting it as a percentage of gross national income per
capita (World Bank, 2011a).
3.2.2. Contract enforcement (ce)
Contract enforcement reflects the extent of compliance and it has an
impact on services trade. Dabla-Norris and Freeman (2004) present a
simple model of the interconnectedness of underdevelopment and ex-
propriation and find that the lack of enforcements discourages econom-
ic activity. Absence of enforcement mechanisms may mean that
businesses partners do not comply with the provisions of a contract
and this can have a regressive effect on services trade. Rodrik (2002)
notes that the main impediment to international trade may indeed be
the problem of contract enforcement. When contracts can be efficiently
and cheaply enforced, businesses can expand their trade networks. For
example, Yue et al. (2010) find that sound contract enforcement and a
good quality legal system enhances the export activities of firms. In
this current study, contract enforcement is measured by the time re-
quired to enforce a contract. The variable is the number of calendar
days from filing of the lawsuit in a court until the final determination
and in appropriate cases, payment (World Bank, 2011a, 2011b).
3.2.3. Protection of property rights (pr)
One of the key variables indicating an improved business environ-
ment is the creation of property rights. Formal property titles give entre-
preneurs access to the services of markets such as credits and can
encourage investments in the service based industries, whereas infor-
mal titles cannot be used as a security and constrain financing for inves-
tors intending to create trade in services. Past studies provide evidence
that the protection of property rights matters strongly for investment
and increased economic activity. For example, Acemoglu et al. (2005)
note that security and protection of property rights help facilitate eco-
nomic growth. In addition, Nystrom (2008) revealed that better legal
structure and security to property rights, among others, tend to increase
entrepreneurship. Further, Bellos and Subasat (2012) have argued that
weak property rights may increase risks and reduce investment. Protec-
tion of property rights in this study is measured by the time required to
register a property and it is the number of calendar days needed for
businesses to secure rights to property (World Bank, 2011a).
3.2.4. Dispute resolution
In terms of dispute resolution, the theoretical argument here is that
the speedy and effective resolution of business related disputes can
matter in terms of costs and the expansion of trade in services. Disputes
in services trade may arise but mechanisms to efficiently resolve them
may not be present. Courts are the institutions in many countries that
resolve business related disputes formally and legally. Informal resolu-
tions based on networks and relationships also exist as noted by
Dhillon and Rigolini (2011) but may not always work in favor of the
parties affected. A delay by formal (judiciary) and informal (relation-
ships) means of resolving a dispute might lead to enormous costs and
may even lead to business losses or failures and so trade can be
disrupted. Thus, effective resolution of disputes in the production of ser-
vices is fundamental. In fact, Djankov et al.'s (2007) findings reveal that
simple disputes (such as how a plaintiff can use an official court to evict
a nonpaying tenant and to collect a bounced check) are resolved ex-
tremely slowly by courts in most countries, taking an average of over
 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304 301

200 days, thus dispute resolution may be inefficient in these countries.
Djankov et al. (2003) note that in reality, all legal systems heavily regu-
late dispute resolution: they rely on lawyers and professional judges,
regiment the steps that the disputants must follow, regulate the collec-
tion and presentation of the evidence, insist on legal justification of
claims and judges' decisions, give predominance to written submissions
and so on. Our measure of dispute resolution is captured by the time
taken to resolve a dispute. It is the number of years from the filing for
insolvency in court until the resolution of distressed asset.
3.2.5. The strength of legal rights (lr)
The strength of legal rights of business entities can matter for ser-
vices trade. The absence of a legal mechanism for enforcing business
contracts can lead to fewer as well as costly business transactions. Busi-
ness transaction costs can increase in countries where the legal appara-
tus is ineffective and this may work against the expansion of trade in
services. With regard to the financial services sector, Levine et al.
(2000) note that those legal and accounting reforms that strengthen
creditor rights, contract enforcement and accounting practices can
boost financial development and accelerate economic growth. In a fur-
ther study, Beck and Levine (2002) argue that the legal systems that
protect outside investors by enforcing contracts effectively boost finan-
cial development. Demirguc-Kunt et al. (2006) find that businesses are
more likely to choose the corporate form in countries with developed fi-
nancial sectors and efficient legal and corporate taxes and efficient
bankruptcy processes. Our measure to capture the strength of legal
rights is the strength of the legal rights index that measures the degree
to which collateral and bankruptcy laws protect the right of the bor-
rowers and lenders and thus facilitate lending (World Bank, 2011a).
The index ranges from 0 to 10, with higher scores indicating that
these laws are better desired to expand access to credit.
3.2.6. Internet diffusion (int-d)
We include the extent of internet diffusion as a measure of soft tech-
nology as it can influence services trade. The theoretical arguments re-
lating to soft technology can be traced from the economic growth
literature. Solow (1956) clarifies the role of the accumulation of physical
capital and emphasizes the importance of technological progress as the
ultimate driving-force behind productivity gains and sustained eco-
nomic growth. The argument here is that the advances in the digital in-
formation technology are likely to have a profound impact on the
here confirm with much certainty that in the high-income OECD coun-
tries all variables except ex, im, dy and tl are stationary in levels and that
variables ex, im, dy and tl are stationary in their first differences, that is,
an integrated of order one. In the middle-income countries, all variables
except ex are stationary in levels while ex is stationary in its first differ-
ence and integrated of order one. In the low income countries, several
variables are stationary in their first differences indicating that pex, tl,
cdb, dr, ce, int-d and lr are integrated of order one. In the estimation
phase, the stationary variables are tested in their levels while the non-
stationary variables are tested in their first differences.
Following the unit root test, the explanatory variables were also
checked for any overlapping effects. This study utilizes six measures of
business environment and the presence of overlapping effects cannot
be ruled out. The test results based on the correlation matrix did not re-
veal any significant overlapping effects in the measures of the domestic
business environment in any of the three income categories of the
countries.
We adopt the panel data estimation procedure. This procedure com-
bines cross-country and time-series data involving five countries and
seven time periods (2004–2010) for the low-income category; twenty-
nine countries and six time periods (2005–2010) for the middle-
income category; and twenty-eight countries and six time periods
(2005–2010) for the high-income OECD countries. The model accounts
for the fixed and random effects. The Hausman (1978) test was used to
determine if there were significant differences between the fixed and
the random effect models. Based on the Hausman test results, the results
of the fixed effects estimation (Tables 2 and 3) were considered to be the
most robust and were selected for the discussion. The results reported
are White (1980) heteroskedastic consistent. The fit of the models are
satisfactory given the use of the pooled data. A number of variables pro-
duced statistically significant effects.
Table 2 reports the results of the services export equation Eq. (5) and
Table 3 reports the results of services imports (Eq. (6)). In columns 1 of
Tables 2 and 3, we show the results of the effects of variables, other than
the indicators of the domestic business environment, while in column 2
of Tables 2 and 3 we show the results of the full models.
Table 1
Panel unit root test results.
Variable High-income OECD Middle-income Low-income
countries countries countries

services sector: including the creation of new trading partner networks, No trend Trend No trend Trend No trend Trend
markets and speeding up of trade transactions. Our measure of technol- Levels
ogy is internet users (per 100 people). Internet users are people with ac- ex −2.048 −2.230 −2.257 −2.365 −4.173 −4.079
cess to the worldwide network. im −2.296 −2.674 −3.413 −3.618 −4.724 −4.436
pex −3.620 −3.996 −2.029 −6.157 −1.047 −1.297
dy −2.142 −2.259 −2.925 −3.366 −2.899 −2.833
4. Estimation, findings and discussion of results wy −5.601 −5.605 −5.603 −5.604 −5.533 −5.764
tl −1.156 −3.792 −4.425 −4.478 −1.003 −3.046
We begin our estimation procedure by testing the stationarity prop- cdb −4.102 −4.494 −5.065 −5.337 −2.307 −1.928
dr −4.412 −4.839 −4.679 −5.323 −1.105 −2.479
erties of the data set using the Im et al. (2003) unit root tests. This is to
ce −3.582 −4.307 −4.285 −4.313 −2.125 −1.750
ensure that incorrect inferences are not made due to spurious regres- pr −4.159 −3.513 −4.242 −4.671 −2.284 −1.829
sion. The Im et al. (2003) test is an acceptable and a powerful method int-d −2.255 −2.860 −3.894 −4.237 −0.061 −0.291
for the panel data unit root test as used in the empirical literature (Li lr −5.731 −5.728 −4.202 −4.230 −2.172 −1.033
and Liu, 2005). Im et al. (2003) also tabulate the critical values of the First differences
test statistics. The augmented Dickey–Fuller (ADF) test represented as ex −5.008 −4.992 −6.828 −6.797 … …
Δyit = αi + (ρi − 1)yi,t − 1 + ∑ pi Δyi,t − 1 + εit is a commonly used im −5.614 −5.622 … … … …
pex … … … … −16.024 −14.929
unit root test. The test for a unit root consists of a t-test of the coefficient
dy −5.943 −5.943 … … … …
on the lagged level. In testing the unit root across all individuals, Im et al. wy … … … … … …
(2003) take the average of the t-ratios (also known as the “t-bar test”) tl −10.522 −10.477 … … −3.231 −4.180
N
that can be represented as t NT ¼ N1 ∑i¼1 t iT where tiT is the t-ratio for cdb … … … … −4.498 −4.667
dr … … … … −4.762 −5.432
the individual i using all T time-series observation. ce … … … … −5.581 −5.417
This study uses the t-bar test of Im et al. (2003) for unit roots in the pr … … … … −3.089 −4.528
data and the results are presented in Table 1. The results in Table 1 show int-d −6.868 −6.852 … … −3.761 −4.418
that the test statistics of several variables are negative and greater than lr … … … … −3.250 −4.208

the Im et al. (2003) critical values in absolute terms. The unit root tests … indicates variable not tested. All results are authors' computations.
302 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304

Table 2
The effects of the business environment on services exports.

Variable High-income OECD countries Middle-income countries Low-income countries

1 2 1 2 1 2

ext − 1 −0.551 (8.254)⁎ −0.505 (8.955)⁎ −0.100 (1.369) −0.127 (1.913)⁎⁎ −0.366 (2.429)⁎ −0.239 (2.425)⁎⁎
pex −0.019 (0.254) −0.033 (0.481) 0.099 (2.063)⁎⁎ 0.132 (2.853)⁎ 0.945 (4.476)⁎ 0.923 (2.731)⁎
wy 2.203 (1.663)⁎⁎⁎ 2.217 (1.807)⁎⁎⁎ 6.332 (5.959)⁎ 6.056 (6.440)⁎ 3.901 (1.434) 2.763 (1.348)
tl −0.655 (1.247) −0.691 (1.582) −0.005 (2.478)⁎⁎ −0.012 (2.708)⁎ 0.069 (0.207) −0.335 (0.343)
cdb … 0.475 (3.676)⁎ … 0.006 (0.217) … 0.174 (2.455)⁎
dr … 1.399 (3.066)⁎ … −0.002 (0.466) … 3.180 (4.851)⁎
ce … −0.013 (3.703)⁎ … −0.0006 (0.132) … −0.047 (3.301)⁎
pr … 0.038 (2.639)⁎ … −0.015 (2.298)⁎⁎ … −0.121 (3.730)⁎
int-d … 0.092 (3.028)⁎ … −0.157 (1.866)⁎⁎⁎ … −1.434 (5.374)⁎
lr … 0.708 (1.884)⁎⁎⁎ … 0.016 (1.300) … 0.168 (4.753)⁎
N 168 168 174 174 30 30
F 21.0 16.1 174.7 46.4 19.3 24.1
Buse R2 0.38 0.49 0.68 0.63 0.71 0.85
LM heteroskedasticity 24.8 67.7 82.7 70.1 29.3 7.64
Breusch–Pagan 457.4 451.7 472.6 509.6 13.0 9.60
Akaike 0.173 1.09 0.17 1.06 1.20 1.43

Note: t-statistics are in parentheses.

… indicates variable not tested.
⁎ Indicates statistically significant at the 1 percent level.
⁎⁎ Indicates statistically significant at the 5 percent level.
⁎⁎⁎ Indicates statistically significant at the 10 percent level.

4.1. The effects of domestic business environment on services exports
Does the domestic business environment matter for services ex-
ports? The empirical evidence presented in Table 2 suggests that the do-
mestic business environment does matter for services exports across
the three income category of countries.
In the high-income OECD countries, the coefficient for contract en-
forcement (ce), is negative as expected and statistically significant at
the 1 percent level while the coefficients of internet diffusion (int-d)
and strength of legal rights (lr) are positive as expected and statistically
significant at the 1 and 10 percent levels respectively.
In the middle-income category of countries, our findings reveal that
the coefficients dispute resolution (dr), contract enforcement (ce) and
property rights (pr) have negative signs as per our a priori expectations.
Among these three variables, property rights are statistically significant
at the 5 percent level. The strength of the legal rights variable (lr) also
has the expected positive sign on its coefficient but is statistically
insignificant.
In the low-income sub-Saharan African countries, our results in
Table 2 show that the variables: contract enforcement (ce) and property
rights (pr) have the expected negative signs on their coefficients and are
statistically significant at the 1 percent level. At the same time, the
strength of the legal rights (lr) variable has the expected positive sign
on its coefficient and is statistically significant at the 1 percent level.
Our findings of the statistically significant inverse correlations of
contract enforcement in the high-income OECD countries lead us to
conclude that as the time required enforcing a contract increases, the
growth of services exports is likely to regress. At the same time, the sta-
tistically significant positive effect of internet diffusion suggests that
high levels of internet diffusion contribute to higher levels of services
exports. The OECD findings also lead to the suggestion that stronger
legal rights are fundamental to increase services exports.
In the middle-income category of countries, our statistically signifi-
cant findings for property rights (pr) indicate that as the time required
to register property rights increases, the growth of services exports is
likely to suffer significantly.
Like the OECD and the middle-income countries, contract enforce-
ment (ce) and property rights (pr) do have a significant regressive effect
on services exports in the low-income sub-Saharan African countries.
On the other hand, the strength of legal rights (stronger legal rights)
matters positively for increasing services exports in the low-income
sub-Saharan African countries.
The findings of the domestic business environment variables: con-
tract enforcement (in the OECD and low-income countries), property
rights (middle and low-income countries), internet diffusion (OECD
countries), and the strength of legal rights (all country categories)
make a new contribution to the literature on business–trade relation-
ships and illustrate how the domestic business environment can impact
on the growth of services exports in the high-income OECD, middle and
low-income category of countries. Our findings from the three different
income groups of countries lead us to suggest that a robust domestic
business environment can have beneficial payoffs in terms of facilitating
higher levels of services exports.
4.2. The effect of domestic business environment on services imports
Does the domestic business environment matter for services im-
ports? The empirical evidence presented in Table 3 suggests that some
elements of the domestic business environment do matter for services
imports across the three income categories of countries.
In the high-income OECD countries, the coefficients dispute resolu-
tion (dr), contract enforcement (ce), and property rights (pr) are as
expected, negative. The coefficient of property right (pr) is statistically
significant at the 1 percent level while the coefficients dispute resolu-
tion and contract enforcement are statistically insignificant. The
strength of legal rights, while having the expected positive coefficient,
is statistically insignificant.
In the middle-income category of countries, the findings of the do-
mestic business environment indicators are highly robust. Our findings
reveal that the coefficients for contract enforcement (ce) and property
rights (pr) are negative, as per our expectations and statistically signifi-
cant at the 1 percent level. The strength of legal rights (lr) also has the
expected positive coefficient and statistically significant at the 10 percent
level. The variables cost of doing business and dispute resolution also
have the expected negative coefficients but statistically insignificant.
In the low-income category of countries, our findings reveal that the
coefficient for contract enforcement (ce) is negative, as per our expecta-
tions and statistically significant at the 10 percent level. The strength of
legal rights (lr) also has the expected positive coefficient and statistical-
ly significant at the 10 percent level. Property rights (pr), while having
the expected sign on its coefficient, is statistically insignificant.
Our findings of the statistically significant inverse correlations of
variables contract enforcement (in middle and low-income countries)
and property rights (in the OECD and middle-income category of
 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304 303

Table 3
The effect of the business environment on services imports.

Variable High-income OECD countries Middle-income countries Low-income countries

1 2 1 2 1 2

imt − 1 −0.539 (8.636)⁎ −0.517 (9.378)⁎ −0.116 (1.509) −0.146 (2.120)⁎⁎ 0.177 (0.872) 0.108 (0.671)
pim 0.147 (1.712)⁎⁎⁎ 0.195 (2.315)⁎⁎ 0.027 (0.647) 0.055 (1.516) 0.544 (3.000)⁎ 0.256 (0.727)
dy 0.949 (4.523)⁎ 1.090 (5.387)⁎ 1.131 (5.116)⁎ 0.937 (4.623)⁎ 4.171 (2.224)⁎⁎ 5.513 (2.135)⁎⁎
tl −0.638 (1.332) −0.734 (1.594) −0.002 (0.618) −0.009 (2.311)⁎⁎ 0.258 (0.799) 1.299 (1.374)
cdb … 0.142 (1.070) … −0.009 (0.342) … 0.119 (1.358)
dr … −0.314 (0.757) … −0.003 (1.081) … 6.122 (2.447)⁎⁎
ce … −0.0003 (0.072) … −0.010 (2.801)⁎ … −0.026 (1.870)⁎⁎⁎
pr … −0.035 (2.445)⁎ … −0.021 (3.658)⁎ … −0.027 (0.748)
int-d … −0.012 (0.422) … −0.056 (0.926) … −0.577 (2.310)⁎⁎
lr … 0.282 (0.687) … 0.016 (1.844)⁎⁎⁎ … 0.094 (3.010)⁎
N 168 168 174 174 30 30
F 30.2 16.4 118.9 71.1 5.5 5.4
Buse R2 0.47 0.50 0.64 0.68 0.48 0.56
LM heteroskedasticity 52.9 49.2 142.7 141.6 11.5 10.8
Breusch–Pagan 461.2 454.8 488.4 487.6 9.32 13.4
Akaike 0.17 1.10 0.17 1.06 1.44 1.55

Note: t-statistics are in parentheses.

… indicates variable not tested.
⁎ Indicates statistically significant at the 1 percent level.
⁎⁎ Indicates statistically significant at the 5 percent level.
⁎⁎⁎ Indicates statistically significant at the 10 percent level.

countries) lead us to conclude that as the time required to enforce con-
tracts increases, the growth of services imports is likely to fall, and as the
time required in registration of a property increases, it is likely to con-
strain the growth of services imports. As in the export model, the find-
ings of the strength of the legal rights variable in the import model
indicate that the strength of legal rights matters quite strongly in in-
creasing services imports in the middle and low-income categories of
countries.
These findings for the domestic business environment variables on
growth in imports of services for the three income categories of coun-
tries again add a new dimension towards understanding how the local
business environment can matter in terms of services imports. Our find-
ings from the three income categories of countries lead to the conten-
tion that a robust domestic business environment can matter in terms
attracting services imports.
4.3. The effect of standard control variables on services exports and imports
Focusing on the variables other than the direct measures of the do-
mestic business environment, our findings indicate that the lagged ef-
fects of the growth in services exports and imports have no beneficial
effects in the OECD and middle-income countries. The coefficients of
lagged exports of service are negative and statistically significant across
these two income categories of countries. The coefficient for lagged im-
ports of growth of services is also negative and statistically significant in
the high-income OECD and middle-income countries. In the low-
income countries, while the coefficient for lagged imports is positive,
it is statistically insignificant.
The relative price effects were measured by the changes in the real
exchange rate in the export and import models. Our findings of the rel-
ative price effect variable in the export equation confirm a negative but
statistically insignificant effect in the OECD countries. In the import
model, the coefficient is positive. The results of the relative price effect
variable for the OECD countries provide only weak evidence that the de-
preciation of the exporter's currency is beneficial for services exports.
In terms of services exports, the coefficient world income growth is
as expected, positive across all three groups of countries. In the OECD
and middle-income category of countries, world income growth is
statistically significant at the 10 and 1 percent levels respectively. This
means that a rise in the growth of world income has the beneficial
effect of strongly increasing the demand for services produced in the
OECD and the middle-income category of countries, thereby raising
the exports of their services. In the low-income sub-Saharan African
countries, while the coefficient of world income growth is positive, it
is statistically insignificant and possibly reflects the low level of integra-
tion with other economies.
The growth rate of domestic income matters very strongly for ser-
vices imports across the three income categories of countries. The coef-
ficient domestic income growth is as expected, positive and statistically
significant at the 1 percent level in the OECD and middle-income coun-
tries and at the 5 percent level in the low-income sub-Saharan African
countries. The expected positive coefficient for this variable suggests
that as domestic income growth rises, the demand for services from
abroad also increases thereby raising the imports of services.
We obtain highly robust results for the trade liberalization variable
(tl), particularly in the exports of services for the middle-income
group of countries (Table 2). The coefficient tl is as expected negative
and is statistically significant at the 1 percent level. In the OECD and
the low-income sub-Saharan African countries, the coefficient of trade
liberalization is negative but statistically insignificant. The results
strongly suggests that falling tariffs have led to higher levels of growth
in services exports in the middle-income group of countries and that a
gradual trade liberalization through tariff reduction strongly facilitates
more exports of services.
5. Summary and conclusion
This paper examines the effect of the domestic business environ-
ment indicators (the cost of doing business, dispute resolution, contract
enforcement, protection of property rights, the extent of internet diffu-
sion and the strength of legal rights) on services trade in a sample of
low, middle and high-income OECD countries. In testing the effect of
business environment on services trade, the empirical procedure also
controlled for the effects of relative price changes, incomes, and trade
liberalization.
In terms of the domestic business environment indicators, our em-
pirical findings reveal that the time required to enforce a contract is
strongly negatively correlated with the growth in services exports in
the high-income OECD countries as well as with the growth in services
imports in the middle and high-income OECD countries. A statistically
significant inverse correlation of the time required to register a property
with growth in services imports is confirmed for the OECD and middle-
income countries and growth in services exports for the low-income
countries. Internet diffusion and the strength of legal rights are strongly
304 A. Gani, M.D. Clemes / Economic Modelling 35 (2013) 297–304
positively correlated with services exports in the OECD countries while
the strength of legal rights is also strongly positively correlated with ser-
vices import in the middle and low-income countries.
In terms of trade control variables, our findings of the relative price
effect variable in the export equation confirm a negative and statistically
significant effect in the middle and low income categories of countries,
thus providing very strong confirmation that the depreciation of the
exporter's currency is highly beneficial for services exports. The findings
also provide evidence that the growth of world income has a strong pos-
itive effect on the growth of services exports in the OECD and middle-
income countries while domestic income growth strongly matters for
growth in services imports across the three income categories of coun-
tries. Finally, trade liberalization is found to matter strongly in the
growth of services exports for the middle-income group of countries.
The empirical findings of this paper lead to the conclusion that the
domestic business environment does matter strongly for trade in ser-
vices. Strategically, it is important for the policy makers to continue im-
proving their overall domestic business environment as it plays a crucial
role in facilitating services trade. The findings in this study provide sup-
port to the fact that ongoing reforms will be an important component of
the business environment and having a competitive business environ-
ment that reduces producers and investors' transaction costs can lead
to significant gains in services trade.
Acknowledgment
We would like to thank two anonymous reviewers for their signifi-
cant useful comments that have substantially improved the paper
from an earlier draft.
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