A full understanding of the role of services in domestic economies and international trade and investment activities has yet to be developed. Consequently, present economic policies often do not take adequate account of the potential effect that service industries may have on growth, development and export expansion. While government intervention in the production of goods has been primarily through commercial policies, this has not been the case with services. Most services are intangible in nature and hence do not lend themselves to traditional border measures such as tariffs or quotas. Consequently, regulation of foreign investment becomes a particularly important element in government policy regarding the service sector. Foreign investment policies often take the form of measures relating both to initial establishment and to operations after establishment. In addition, government measures affecting services are often for reasons unrelated to trade and are not directed to the maintenance of internationally uncompetitive industries. This is due primarily to the nature of many service activities. For example, though national banking laws may directly affect a foreign bank's operation within a host country, the laws exist primarily for domestic reasons (such as protection of the consumer, protection against monopolies, and control over monetary policy). Regulations concerning the operations of insurance companies and investment management companies, for example, specifying the areas where they can invest their funds, are also for the purpose of protecting the consumer from undue risk. These regulations become trade/investment policies only when they treat foreign operations differently from domestic ones.
Governmental and non-governmental measures bearing upon international service operations are likely to affect a broad range of key economic variables: domestic prices, production and consumption of services; the volume of trade in services; allocation of resources; distribution of income; and social welfare. Governmental measures can, in particular, have a potential influence on patterns and structural change in the national and international services sector and on the choice made by transnational service firms between export, direct foreign investment and contractual arrangements with companies abroad. Restrictive business practices of transnational service firms can influence the formation of oligopolistic market structures, with adverse implications for global efficiency and welfare. Preferential trading arrangements among countries such as free-trade areas, customs unions and common markets, also affect transnational service activities and may lead to trade creation or trade diversion in the services sector which will either improve or worsen resource allocation and welfare. Government policies which affect the import of services or the inflow of foreign capital are other primary determinants of how enterprises provide their services to foreign markets. In certain instances a host country's policies may require local establishment for the provision of the service or local participation in the establishment. In other cases, host-governments may try to induce direct foreign investment through various subsidization schemes. This is illustrated by the recent trend to move film production abroad in order to benefit from financial incentives provided by host countries hoping to develop this sector in their domestic economy. Similarly, foreign investment decisions are influenced by tax considerations, including the practice of transfer pricing for the services provided. The licensing-investment choice will often depend on the transaction costs involved in transferring the proprietary advantage relative to the net profit which can be obtained from direct investment. It also depends on host country policies regarding foreign equity holdings. The trend in the international hotel sector towards management contracts to operate local properties is due, among other things, to the increasingly high construction and financing costs of hotel properties and to host government policies directed at a continued of foreign shareholdings.
Government policies affecting investment and trade in services therefore can have a significant impact on the manner in which a firm markets its services abroad. To the extent that investment policies deter the establishment of a foreign subsidiary, a firm will seek to pursue its export option. Where trade policies prevent the export of a service, the firm is likely to seek sales through direct investment in a foreign subsidiary. In cases where both policies are pursued, or where the firm has only one viable alternative, such policies may prevent the service from entering into the international market altogether.