International trade, tourism and the environment

Literature review: Inbound tourism and national welfare

Italo Ral Arbul Julio Estanislao Cuc Diana Isabel Pabn Mara Laura Rodrguez

Introduction

Tourism has become during the last few decades in one of the most important industries of the world, with growing annual rates of 4% according to the World Tourism Organization. That is the main reason why the relationship between that growth and the national welfare has been the field of research of several authors. Then, our objective is to review the literature about inbound tourism and national welfare, in order to find out how the empirical and conceptual works have been conducted and which are the gaps or the research areas that should be deepen.

1. Theoretical approach

Many authors have studied the relationship between national welfare and economic growth, but only in the last few decades there has been a growing interest in the explicit effects of tourism over the welfare. Copeland (1991) was among the first authors to deal with this subject. He studied the economic effects of an increase in tourism in a small open economy, using a general equilibrium international trade model with three sectors (agriculture, manufacturing and services). He found that in the absence of taxation, distortions and foreign ownership, an increase of the inbound tourism benefits the host country only through the increase of non-tradable prices and the improvement of the terms of trade.

The author also analyzed that in the presence of factor mobility, the price of nontradable is less responsive to demand shocks, then the benefits from a tourist boom are smaller. Also, in presence of foreign ownership of immobile factors, such as land, an increase in tourism can reduce welfare if the flow of repatriated earnings is sufficiently large. For the contrary, he found that the presence of domestic commodity taxes increases the benefits of tourism because they allow the extraction of rents from unpriced natural amenities. Copeland recognized that tourism can also have undesirable effects on income distribution, negative externalities (such as crowding) and deindustrialization due to the increased demand for non-tradable and the consequent attraction of domestic factors from tradable sector to non-tradable.

A different perspective was shown by Hazari and Ng (1993) using the dependency model of trade from Hazari, Sgro and Suh (1981). They found that tourists consumption of non-traded goods and services affects the relative price and availability of them and may affect domestic consumers by reducing their welfare. The same result is in Hazari and Kaur (1995), where the presence of monopoly production of the nontraded good conduct to a probably fall in domestic welfare and in the price of the nontraded good. That fall would occur depending on how the demand curve is shifted. The fall in the price of non-traded good represents an adverse movement in the terms of trade, hence the welfare of the domestic residents falls as a result of the expansion of tourism (Hazari and Kaur, 1995: 176). 2

However, there is no consensus around the last statement. Clarke and Ng (1995) criticizes Hazari and Ng saying that their result is inconsistent with general trade theory and with other specific literature (Clarke and Ng, 1995:305). They argue that the correct conclusion is the following: without introducing distortions, increased trade in any type of good or service (traded or non-traded) cannot inflict potential Pareto losses on residents. If the relative price of non-tradable rises with such demands there are strict welfare gains (Clarke and Ng, 1995:306).

They discuss that Hazari and Ng (HN) suggest that tourists demand a good so keenly (or inelastically) sought by residents that consumption-losses more than offset any income gains they may derive from being able to sell to a larger market. But Clarke and Ng sustain that this is questionable because if the good is keenly sought by residents, the price at which it is sold to tourists will reflect this strong preference. Tourism can only make residents worse-off if tourists can force residents to sell the non-traded good against their wishes. Thus, even if residents consume less of a strongly-preferred nontradeable because of tourism demands for that good they will still always be better-off if the goods price rises in the face of such demand increases due to the increased income received from tourists for the good (Clarke and Ng, 1995:308). The authors also sustain that the reasons why tourism can make residents worse-off are related with income distribution effects, unpriced external costs, pollution, littering, tourism-induced xenophobia and foreign ownership of fixed factors.

Furthermore, Nowak, Sahli and Sgro (2003) investigated the interdependence between tourism and the rest of the economy, particularly focused in agriculture and manufacturing. Their analysis is based on the RicardoVinerJones (RVJ) and HeckscherOhlin (HO) models under full employment assumption. Their model had three sectors: non-traded good sector of production, an agricultural sector of production and export and a manufacturing sector of production and import. Then, through a general equilibrium analysis they found that if there is an increase in tourism, irrespective of the labor intensity of the non-traded goods sector, the price and output of this sector always increase and the output of the agricultural sector falls (Nowak, Sahli and Sgro, 2003:254). But the results on the other key variables depend on the labor intensity of the non-traded goods sector: 3

If this sector is labor-intensive, the wage rate increases and both the rental on land and capital fall. Then, the output of the manufacturing sector falls, because the tourist expansion becomes a cost for the manufacturing sector. This situation worsens the welfare loss, because at initial level manufacturing output is suboptimal. This welfare loss can outweigh the welfare gain because of the termsof-trade effect (non-traded prices>0). In this way, resident welfare (income) may fall as a result of the increase in tourism (Nowak, Sahli and Sgro, 2003:254).

If the non-traded sector is land-intensive, the wage rate falls, the rental on capital and land rises and the outputs of both manufacturing and non-traded sector rise. Therefore, the expansion in tourism helps the development of the manufacturing sector. If those effects are positive, resident welfare (income) rises (Nowak, Sahli and Sgro, 2003:254).

Of the first scenery, can be induced the immiserizing growth case. Because the increase in tourism induces an increase in the price of non-traded and, supposing that residents do not consume this kind of goods, the rate of wage increases at the expense of the rental rates on land. Then, the manufacturing sector reduces its demand for labor, leading an increase in labor supply and unemployment. This increase in the welfare loss outweighs the increase in income from the terms-of-trade effect (Nowak, Sahli and Sgro, 2003:255). Then, as we shown, a tourism boom may provoke an immiserizing of the resident community. On the other hand, Chao, Hazari and Sgro (2004), presented a general equilibrium model to study the contribution of tourism to resident welfare in small and imperfect economy, with the same three sectors. Then, after applying the outcomes of the proposed model, and differentiating the indirect utility function of residents which represents their welfare, they found that there are three channels that affect domestic welfare by tourism:

Social externality of tourism, which is positive in the first levels, but becomes negative when the inbound tourism demand is high growth. After time, the

beneficial impact of culture and lifestyle of foreign visitors begins to decline due to consumption congestion.

The terms of trade effect via rises in the non-tradeable prices, because nontradable are made tradable by tourism, then a change in their price has a termsof-trade effect. Nevertheless, the gain from tourism occurs only when the price of non-tradable good rises (Chao, Hazari and Sgro 2004: 147).

The resource movement effect to the manufacturing sector, because the change in the prices of non-tradable goods, causes resource movements and changes in the production of manufacturing goods. If resource reallocation expands this production and hence shrinks the monopoly distortion, domestic welfare will be positively affected. Additionally, they found that the optimal levels of tourism occur when tourists bring negative social externalities to the economy due to the positive terms-of-trade effect and/or the benecial resource movement effect. That is, to maximize resident welfare, a trade-off between social externalities and economic development occurs. Respect to last outcome, they invite to do further investigations.

1.1. De-industrialization and Dutch Disease

Following what Copeland mentioned about de-industrialization, Chao et al (2006) examined the effects of an expansion in tourism on capital accumulation, sectoral output and resident welfare in an open economy with an externality in the traded good sector. Using a dynamic framework and assuming that foreign tourists consume the local nontraded good only, an expansion of tourism leads to higher prices of the non-traded good. Since tourism turns the non-traded into an exportable good, the rise in the good price is equivalent to terms of trade improvement and yields a gain in revenue.

However, the authors found that the increase in the relative price of non-traded goods results in a lowering of the demand for capital used in the traded sector. Then, it can lead to a de-industrialization in the traded good sector, what is also known as Dutch

Disease that may lower the resident welfare. This result was supported in their study by numerical simulations.

1.2. Environmental relationships

Over the recent years there has been a growing interest in the study of the relations between tourism and environment, which also has welfare consequences for the host country. Cerina (2007) presented a dynamic general equilibrium model of a small open economy, specialized in tourism based on environmental resources. In the model, the country chooses the number of tourists to be hosted, the level of consumption and the fraction of income to be devoted to abatement efforts which maximizes the long-run welfare of its residents. Such a choice will take into account a series of dynamic tradeoffs. Firstly, the number of incoming tourists has an ambiguous effect on welfare: on the one hand, visitors increase tourism revenues and consumption possibilities; on the other, by reducing the stock of environmental resources, they also have an indirect negative feedback on both residents and tourists preferences. Secondly, public abatement expenditures reduce residents consumption possibilities but, by reducing the marginal impact of tourists on the environment, they also have a positive effect on welfare by allowing for a higher (and, in some cases, increasing) number of tourists in equilibrium, and ultimately higher tourism revenues (Cerina, 2007:554).

Other model related with the environment is the one of Giannoni (2009), who built a standard model of optimal growth, with exogenous population growth and technical change, for an economy specialized in tourism. Assuming that the production of tourism is pollution generating and that tourists are pollution adverse, he establishes propositions regarding long-term growth and sustainability of tourism. He showed that mass tourism only is associated with high growth rates and but mass tourism seems not sustainable. Residents utility would be non-decreasing in the long run if and only if their environmental preferences are low enough. This fits the idea that environmentally friendly tourism is easier to sustain. But this does not exist yet to our knowledge (Giannoni, 2009:58).

Lane (2005) found that ideas behind sustainable tourism strategies are frequently denigrated by people in a hurry. They are sometimes attacked by developers seeking 6

rapid, short-term returns on their investments. Other regions may follow conventional short-term plans, and gain more jobs and more visitors and more investment.

1.3. Tourism, welfare and migration

Chesney and Hazari (2003) found that many countries receive illegal migrants that work in the service sector. Then, by paying illegal migrants less than local workers, the relative price of the non-traded goods is shown to be lower than it would be in the absence of such workers. An expansion in tourist trade, under certain intensity conditions, necessarily raises resident welfare and employment. A tourist boom necessarily lowers the welfare of the illegal migrants. It is established that an increase in tourism, in spite of a wage distortion, is welfare increasing for domestic residents. However, the authors found that this is not always the case for illegal migrants, whose welfare falls as a result of expansion in tourist trade their wages fall, and illegal migration increases. Then they conclude that under certain conditions illegal migrants do help the tourist trade.

According to Clarke and Ng (1993) tourist flows at a certain rate must be even more beneficial to the local economy than a comparable increase in population due to immigration. Specifically, a countrys residents derive gains from trade

advantages from either having a million tourists on average visiting or from having a million permanent new immigrant settlers. It is argued here, however, that these gains will be greater for tourists than immigrants because of their lower demands on the public coffers (Clarke and Ng, 1993:630).

1.4. Taxing tourism and welfare

Some authors studied the effects of taxing in tourism and its impacts on the national welfare. Among them Clarke and Ng (1993) sustained that, under perfect conditions, in economical terms residents are not worse-off when there is an increase in the tourists flow. This happens because it is assumed that tourists pay for all costs they generate, therefore there are no un-priced externalities associated with the purchase of goods and services by tourists. In this way, tourist-induced growth can never been immiserizing or welfare-reducing. According to the authors without un-priced external costs, 7

residents derive economic advantage from a relatively open door tourism policy and from having low financial, and other, visa restrictions imposed on tourists. This is truly regardless of whether optimal commodity taxes are imposed on foreign tourist consumption. Such taxes will increase the benefits accruing to residents but is unnecessary to ensure net gains. This finding is, however, conditional on efficient pricing or other types of regulatory policies, being used to offset the externalities associated with growth in foreign tourism demands. Following this idea, they affirm that with increased tourism, the gains from switching to policies such as efficient pricing are increased. Equivalently, there are increased costs in not doing so. Implementation of such policies guarantees that tourism will generate potential Pareto gains for residents.

Additionally, Sheng and Tsui (2009b) showed, through a general equilibrium model, that taxing tourism may increase or decrease economic benefit depending on the destinations market power. Taxing tourism is welfare-enhancing, as even though taxing tourism seems to reduce a destinations benefit in pure accounting terms (e.g. lower GDP), the total welfare of the destination can still increase. However, from the perspective of political economy, the actual taxation policy may diverge from the one conducive to sustainable tourism because the interests of certain social groups can override those of others in the absence of a well-functioning democratic decisionmaking mechanism (Sheng and Tsui, 2009b: 633).

Gmez, Lozano and Rey (2007) presented a dynamic general equilibrium model for a small, fully specialized in tourism, open economy and tested if a tourism tax was a relevant policy to increase local income and welfare by reducing congestion, improving the environment and increasing the output quality. They found that a marginal increase in the tourism tax always improves both the environmental quality and the terms of trade of the economy and it may result in higher consumption, and thus local welfare, in the long-term. It also increases tourism revenue, capital and consumption provided that the elasticity of tourism revenue with respect to accommodation capacity is negative.

2. Empirical works

The aim of this section is to analyze on the one hand the main empirical tools used by researchers and, on the other hand, the main results. This will help us to understand the main gaps that the empirical work has not covered from the theory and the strengths and weaknesses of every method.

Chen and Devereux (1999) formulated the question Tourism exports are welfare improving for the developing economies in general and for Sub-Saharan economies in particular? And their answer for most developing economies was yes, as tourism increased welfare with imports restrictions and exports subsidies. Moreover they showed that results holds with quantitative restrictions and foreign investment in tourism. However, they consider that under certain circumstances tourism may reduce welfare. That occurs when tourism worsens the trade distortions associated with exports restrictions and imports subsidies that dominate the trade regimes of those economies.

Reeder and Brown (2005) identified that recreation and tourism development has potential advantages and disadvantages for rural communities. Among the advantages, recreation and tourism can add to business growth and profitability. Landowners can benefit from rising land values. Growth can create jobs for those who are unemployed or underemployed, and this can help raise some of them out of poverty.

Recreation and tourism can help diversify an economy, making the economy less cyclical and less dependent on the ups and downs of one or two industries. Furthermore, it may be easier to diversify compared to other kinds of development such as high-tech development because it does not require a highly educated workforce. In their study they found that the unemployment, poverty, high rate of education, health conditions of population are positively and significantly for the communities on the other hand the indicators of rate of crime, earnings, population growth and cost living has a negative impact on the communities.

Kumar (2004) used computable general equilibrium (CGE) models to measure the economic impact of tourism in Fijis economy. Among the key results, it was found that 9

the growth in total exports exceeds that of total imports, leading to a balance of payments surplus. Together with an increase in real private investment, real GDP grew and the real national welfare also improved.

Furthermore, the results also reveal that, with an increase in tourist expenditure in Fiji, the traditional export sectors experience a decline in real output and exports. The authors attributed this finding to the appreciation of the exchange rate, induced by the expansion of tourism, which harmed the competitiveness of these sectors. The decline in traditional exports, however, was outweighed by the increase in tourism and nontraditional exports.

Gooroochurn and Blake (2005) also used a CGE model (the model is static with the conventional neo-classical assumptions) using Mauritius as a case study (considered as a small open economy and tourism is the only export sector for which the world price is not fixed). It was found that a tourism boom with increasing returns to scale in the export-oriented sectors leads to lower welfare gain and can be immiserizing. On the other hand, increasing returns in the tourism-related sectors and non-tradeables leads to higher welfare increase following the tourism boom.

The outcomes of the tourism boom simulation under different trade regimes are more complicated. Tourism boom under the assumption of pre-existing import taxes/subsidies on final demand, leads to higher welfare gain with higher import tariffs. On the other hand, the presence of import subsidies leads to immiserizing growth. However, if import subsidies are levied on both final and intermediate demand, a tourism boom can increase welfare. It is also found that a tourism boom tend to improve income distribution. Other methodology related to empirical studies on economic development related to tourism is the one made by Balaguer and Cantavella-Jord (2002) that investigated if whether and, if so, to what extent Spanish economic growth responds to the evolution of external tourist activity during the 1975-1997 period.

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The Johansen technique was applied; this methodology allowed obtaining a cointegrating relationship among the variables. These variables represent indicators of Spanish economic growth, international tourism income and external competitivity1.

The cointegration results provide evidence of the existence of a unique cointegrating vector. The analysis showed, then, that a long-run stable relationship between economic growth and tourism expansion exists. The strong impact of tourist activity, according to the magnitude of the estimated parameter would reveal the existence of important longrun multiplier effects. Contrary to what the traditional export-led growth literature predicts, tourism-led growth is not specific of developing countries, which base their foreign exchange earnings on the existence of a comparative advantage in certain sectors of the economy.

On the other hand, it seems like possible effects that reduce welfare from an increase of domestic prices (Hazari and Ng, 1993) would be more than compensated through positive effects on the countrys overall welfare.

Dritsakis (2004) goes beyond the previous work and examines empirically the tourism impact on the long-run economic growth of Greece by using a multivariate autoregressive VAR model in order to get a causality analysis among real gross domestic product, real effective exchange rate2 and international tourism earnings.

The results of cointegration analysis suggested that there is one cointegrated vector among real gross domestic product, real effective exchange rate and international tourism earnings. The error correction model (ECM) was used to investigate the causal relationships among the variables real gross domestic product, international tourism earnings and the effective real exchange rate (GDP, ITR, EXR). Such analysis provides the short run dynamic adjustment towards the long run equilibrium.

Granger causality tests based on error correction models (ECM), have indicated that there is a strong Granger causal relation between international tourism earnings and economic growth, there is a strong causal relation between real exchange rate and
1 2

Real effective exchange rate was used as a proxy. Proxy of competitiveness.

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economic growth, while the relation between economic growth and international tourism earnings is simply a causal relation and lastly the relation between real exchange rate and international tourism earnings is simply a causal relation as well3.

However, there is still more issues to be investigated on the fiscal sector of tourism. As Reeder and Brown (2005) mentioned, rural communities can benefit from growing tax revenues and local governments may be able to improve public services.

However, few investigations have been done in order to understand which the best taxing rate for tourism is. The main results from this kind of investigations are related to pigouvian taxes such as the study of Palmer, Riera and Rossell (2005) that evaluated the situation of Rental Cars in Mallorca and proposed the implementation of a tax to internalize the congestion costs generated by the use of hire cars, this is a mechanism that partially internalizes the external costs of transport and the externalities of tourism, since transport is one of the activities that characterizes a tourist experience.

Furthermore, given that tourism product is related to public infrastructure and local resources, there is also little investigation on the fiscal cost of tourism.

There is strong causal relation if it is through both channel 1 (short-run) and channel 2 (long-run) and simply a causal relation if it is through either channel 1 or channel 2.

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3. Summary and further research

After the previous literature review, it is clear that the relationship between tourism and national welfare depends on many factors and it can be different in each economy. Taxation, market distortions, foreign ownership of the factors, monopoly, intensity of the factors, preferences of the society and market power are among the situations that could determine if an increase in inbound tourism would be welfare improving for a nation or region or not.

From the empirical analysis it can be said that tourism is welfare improving in many cases, but further research should be made in order to have conclusive answers for the effects of tourism each of the cases mentioned above. In the next paragraphs it can be found some limitations of the methods used and possible research to be done.

3.1. Computational General Equilibrium Models

One limitation of this study is that tourism is modeled exogenously. There is a need to model tourism endogenously so as to capture the determinants of tourism for a particular country. This is important because it will ensure a complete modeling of the determinants of tourism, and hence will provide more reliable and detailed results.

A complete tourism demand model in a CGE, for instance, will enable analysis of the impact of tourism prices (such as hotel costs), transport costs, marketing expenditure and foreign income. This will mean that disaggregated shocks to tourism can be applied and more in-depth knowledge of the industry can be derived.

3.2. Long and short run relationships

Cointegration analysis error correction models (ECM) are very useful methodologies to understand causality issues, however, there is still further investigation needed in order to evaluate the pathways and mechanisms through which this effects are transmitted. This is a very important issue to develop in order to understand the how certain factors influence on welfare and how public policy can improve tourism benefits. 13

Furthermore, when competitiveness is used as a determinant of welfare it is always approximated by using the real exchange rate. In this sense, the results are not totally accurate. It is recommended to develop and use specific variables on tourism competitiveness. This should be a necessary development for statistical agencies. In this sense, further investigation should be made in order to understand better the main differences in determinants of economic development related to tourism.

3.3. About Labor

In the cases where the expansion of tourism harms the competitiveness of exporting sectors an important question for policy makers is whether the tourism industry and the non-traditional sectors can absorb the redundant labour from the traditional export sectors. It seems likely that tourism, depending on the extent of its growth, will be able to employ some of the surplus labour, for tourism is a less skill-intensive industry. As to whether non-traditional export sectors can absorb the remaining surplus labour, this needs further investigation. This should be related also to further investigation over the impacts of tourism and migration.

3.4. About Taxes

There is still a gap in the empirical studies in order to find the best taxing policies for developing and developed destinations. Actual investigation is focused on pigouvian taxes. To diminishing the externalities the taxing is very difficult to apply because depend of the political policy and the resources could not be used for to improve the welfare of the country, and could be affect negatively the competitiveness and the investment on the country.

3.5. About public services

In many investigations it is common to read that one of the main benefits that local residents may gain from tourism is the access to a broader array of private sector goods and services, such as medical care, shopping, and entertainment. However, there is no

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measure about how the increase of tourism inflows has affected the quality of public services.

3.6. About social impacts

As we found in the empirical studies the tourism can have positive impacts on the society such as: employment, health and security services, education, but also negative impacts like as: increase of the rate of crime, traffic congestion and cost of living, but these impacts could not be just related to tourism, because the countries regularly have other sector when not are specialized in tourism, this assumption could be true for small open economies with a high grade of specialization in tourism.

3.7. About the environment

Actually with the increase of tourism flows to the natural resources related to tourism activities such as: ecotourism and outdoor activities have negative impacts on the environment with a high weakness for lose the natural resource for the erosion, contamination and mass tourism. For many countries that have richness in natural resources the ecotourism has been the strategy for develop the tourism industry but is necessary to formulate environmental policy for protected those resources.

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