Regulatory heterogeneity as obstacle for international services trade

International trade in services is hampered by non-tariff barriers that originate from national regulations. Not only the level of regulation in home or export country matters, but also the inter-country differences in regulation for service markets. International trade in services is hampered by non-tariff barriers that originate from national regulations. Not only the level of regulation in home or export country matters, but also the inter-country differences in regulation for service markets.  Regulatory measures tend to affect fixed costs rather than variable costs. The fact that regulations often differ by market, means that the fixed costs of complying with regulations in an export market are in fact sunk market-entry costs. We prove that policy heterogeneity between countries has a negative impact on bilateral service trade. We develop a new index of bilateral policy heterogeneity, and apply it in a gravity model for explaining service trade among EU countries. The empirical results support our theoretical prediction: the degree of regulatory heterogeneity is inversely related to the level of bilateral service trade. Simulations for the EU show that if countries make more use of mutual recognition, bilateral trade in commercial services among EU countries could increase by 30% to 60%.