International Trade, Growth and Tourism Specialization

PROS OF SPECIALIZATION IN TOURISM

Diana Isabel Pabn Italo Ral Arbul February 9th, 2010

Tourism is an industry that in the last years has reached high importance due to its weigh in the global economy. It has an important share in the global income and production, and mobilizes many people around the world. UNWTO's Tourism 2020 Vision forecasts that international arrivals are expected to reach nearly 1.6 billion by the year 2020. Of these worldwide arrivals in 2020, 1.2 billion will be intraregional and 378 million will be longhaul travellers1. In other words, WTO forecasts that tourism will continue growing, furthermore, new tendencies and trends in tourism have been recently visible. Traditionally tourism realized by big and constantly growing tour operators was concentrated on sand, sun & sea destinations.

However, the time and space pattern of spending free time also has been changing. Potential tourists are better educated, have higher incomes, and their intellectual expectations connected with tourism are now going far beyond the beaches2. In this way, specialization has been a determinant factor of this tourism growing behaviour, but also those positive results has done that many destinations wants to specialize in some tourist products or services, because they have found that they can offer places, products or services in which people would be interested. It implies that if a destination wants to specialize in any product or service, it is needed to be competitive in this specific product or service. This new trend in tourism demand gives good chances for less developed countries to reach sustainable development based on tourism specialization in the sectors with comparative and competitive advantages.

1 Source: World Tourism Organization web page: http://www.unwto.org/facts/eng/vision.htm; access February 8th, 2010. 2 See Tyran, Ewa (2004). Specialization as a driving force of competitiveness in agritourism.

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THEORETICAL FRAMEWORK

Comparative advantage refers to the ability to produce a product most efficiently given all the other products that could be produced. According to Sahli (2006)3 the external competitiveness of a countrys tourism industry is the countrys competitive ability to retain or increase its market share of tourism export in terms of ground and travel components4, then, it will be competitive when it has a growing commitment to exporting (market share) and a high net performance (coverage ratio). For this reason, the competitiveness of an industry is a critical determinant of how well it performs in world markets (Crouch and Ritchie 1999; Ritchie and Crouch 2003). The potential for any countrys tourism industry to develop will depend substantially on its ability to maintain competitive advantage in its delivery of goods and services to tourists (Dwyer et al.2000)5.

Comparative advantage would help to explain the competitiveness of tourist destinations. It recognizes special variations in endowments of the factors of production. Then, it obeys to the behaviour of abandoning those activities with comparative disadvantage in order to concentrate in which with comparative advantages. If a country or a destination is specialized in tourism, it means that it has comparative advantage in this activity. Obviously, the specialization of a country depends highly on its own characteristics, and particularly, on the development of its tourist industry, and for these reason, it will be different in each country. In short, as explained by Sahli (2006)6 the variables that determine tourism specialization in a specific destination are: per capita income; real exchange rate; revealed comparative advantage in international passenger transport; the hotel function; and the tourism intensity rate.

Price competitiveness is highly important in specialization, and its determinant: the real exchange rate, too. It is because the depreciation has a positive impact on the countrys position in respect of tourism. As an illustration, according to the results of the Sahlis study for the United States case The strength of the dollar between 1980 and 1985 led to a collapse of the USAs position in the tourism market. Subsequently, however, when the dollar weakened, the countrys position strengthened considerably7. This can confirm the role of the holdings by tourists to undertake travel activities, because this amounts can response to changes in exchange rates (devaluation depreciation-; revaluation appreciation-).
3 Dwyer L. & Forsyth P. (2006). International Handbook on the Economics of Tourism. Chapter 20: Tourism destination specialization by Mondher Sahli. Edward Elgar Publishing Limited. 4 Page 436 5 Cited by Sahli M. in the International Handbook on Economics of Tourism. Chapter 20: Tourisms destination specialization, pp-436. 6 Ibid, pp-434. 7 Ibid. pp-446. The author found that this interaction applies to many other countries, including France, Italy, Spain, Switzerland, Austria, Australia, Turkey and Mexico.

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Therefore, the real exchange rate is one of the key determinants of competitiveness in tourism. But also, specialization in tourism responds to other factors, not only economic issues, cultural and social variables too, because the specialization can affect direct or indirectly the natural and cultural environment; the social structures and economic activities source of income of population. In this way, Sahli has found that specialization in tourism is related to a countrys economic structure, and the quality of dynamic of that specialization differ one country to the other, as previously we intuit. This means that tourism does not develop in the same way in all countries. As it was mentioned before, the specialization in tourism and its evolution depends on many factors: price competitiveness, the degree of progress in passenger transportation, the domestic demand in terms of tourist services, and the degree of maturity of the destination. But also it will depend on the policy decisions about running.

Now, is the specialization in tourism good for the economy and the welfare of a country? From the theoretical point of view we can find general models of international trade that can support the specialization in tourism.

The Ricardian model supposes difference in technology, perfect competition, homogeneous good, and affirms that being the labor the only constraint on the production process, the comparative advantage will be determinant in the specialization of the countries. A

country has comparative advantage in the production of a good or a service if the opportunity cost in the production of this product in terms of other goods is less in this country than in the other countries. In this way, and taking into account that the absolute advantage is important for determining differences in real wages across countries (because it refers to the ability of a party to produce a particular good at a lower absolute cost than another), is the comparative advantage that determines the direction of the trade. The

comparative advantage of an industry depends not only of its productivity in relation with the foreign industry, but also of the rate of wage in relation with the foreign rate of wage.

The Specific Factor model is similar to the Ricardian model in terms of its conclusions (specialization), but the difference is the existence of other factor of production besides labor. Labor is the mobile factor among sectors, and the other factor (capital) is specific (fixed), which can be used only in the production of determined goods.

The Heckscher-Ohlin model establishes that factors of production (labor and capital) can move between sectors and the differences in resources endowments is the driven force of trade flows. This model predicts that if a country has relative abundance of a factor (labor or capital), will have a comparative and competitive advantage in those goods that require Page 3

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more of that factor. This means that the countries tend to export the goods which are intensive in the factors that are abundantly endowed with (the idea of specialization holds). This model shows that the comparative advantage is influenced by the interaction between the resources of the nations (the relative abundance of the production factors) and the technology of production (which is the same for both countries). The same factors are used in the different sectors. Then, the exports of a capital-abundant country will be from capital-intensive industries, and labor-abundant countries will import such goods, exporting labor intensive goods in return, again it supports the specialization idea.

Finally the Standard Trade Model is built by four relations: 1) the relation between the frontiers of possibilities of production and the relative supply curve, 2) the relation between the relative prices and the demand, 3) the determination of the global equilibrium throughout the relative global demand and supply, and 4) the effect of the interchange relation over the national welfare. As it is possible to note, to difference of the previous models, this model include the demand, and let us ask how economic growth and transfers of income change the trading equilibrium. In this sense, the model affirms that a rise in terms of trade increases a countrys welfare, while a decline in the terms of trade reduces its welfare. The perverse case where productivity growth makes a country worse off is called immiserizing growth and only holds under very restrictive circumstances.

In summary, it is possible to say that the first three models are special cases of the standard trade model. With the four models is defensible the specialization in tourism because a country (destination) with comparative advantage in tourism may specialize in this, while another with comparative advantage in industry for example, specializes in it. Or, a region with abundance of labor factor could specialize in tourism, and other with abundance of capital factor could specialize in technology. Thus, countries benefit from foreign trade, since they specialize in those products where they have comparative advantage, or where they have abundant endowments of a specific factor of production.

Moreover we can find arguments in favor of specialization cited by Cap, Riera and Rossell (2007). First of all, income from this industry provides currency that can be used to import capital goods or basic inputs, which allows a greater production of goods and services and, therefore, greater economic growth (McKinnon1964). In second place, international tourism contributes to increasing income by increasing efficiency through competition between local enterprises and those in other destinations (Bhagwati and Srinivasan1979; Krueger1980). Lastly, specializing in tourism export allows local enterprises to exploit economies of scale (Helpman and Krugman 1985).

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EMPIRICAL FINDINGS

Specialization in the tourism industry has been a driving force in the development of the destinations as Balearic and Canary Islands as is demonstrated in Cap, Rieva and Rossell (2007)8. Also, the industry has provided very significant growth in the level of income. Literature has paid little attention to examining tourisms contributions to aggregate economic activity and, more specifically, the effects of specializing in it on the long-term growth in production in tourism economies9.

Besides, the significant impact of international tourism in stimulating economic growth is especially important from a policy perspective. For this reason, the relationship between international tourism and economic growth would seem to be an interesting empirical issue. In particular, if there is a causal link between international tourism demand and economic growth, then appropriate policy implications may be developed.

In resent empirical studies such as the one made by Chang (2009), the results showed that there exist a positive and significant relationship between economic growth and tourism in two regimes, the regime with the degree of tourism specialization lower than 14.97% (regime 1) and the regime with the degree of tourism specialization between 14.97% and 17.50% (regime 2). The magnitudes of the impact of tourism on economic growth in those two regimes are not the same, with the higher impact being found in regime 2. However, an insignificant relationship between economic growth and tourism is found in regime 3, in which the degree of tourism specialization is greater than 17.50%.

The empirical results suggested that tourism growth leaded by specialization has a positive impact on economic growth; however, this relationship is not constant. This means that specialization has a positive impact on growth but until a certain level in which more specialization does not lead to greater economic growth (diminishing returns). The policy lesson is that there is promise for tourism-led growth in developing countries but other economic activities must also be developed in order to carry the economy forward once the potential of tourism-led growth has been exhausted.

As Gomez et al. mentioned10, particularly in some small economies, with low possibilities of diversification tourism has become an opportunity for development and improvement of living standards. Some works as Balaguer and Cantavella-Jord, Lanza and Pligiaru,
Cap J., Riera A. & Rossell J. (2007). Tourism and long-term growth: A Spanish perspective. Annals of Tourism Research, Vol. 34, pp. 709-726. 9 Ibid, pp. 710. 10 Gmez Gmez, Carlos Mario; Lozano, Javier; Rey-Maquierira, Jaiver. Environmental policy and long-term welfare in a tourism economy
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Adams and Parmenter, or Copeland have explored from different points of view the role of tourism as an engine for economic growth.

Other authors like Brau (2003 & 2007) mentions that tourism specialization appears to be an independent determining factor for growth in small states. In this sense, the author suggests that smallness per se can be bad for growth, but the opposite is true when smallness goes together with a specialization in tourism.

Furthermore, Adamou mentioned that tourism requires relatively low levels of technology and basic labor skills. Countries at an early stage of development that have the required natural resources can relatively easily develop successful tourism sectors. Tourists usually demand four main types of goods and services: accommodation, food, transportation and entertainment. These services are mostly labor intensive; hence tourism leads to the creation of many jobs that are primarily low-skilled. The development of a tourism sector can thus lead to an increase in production, income and employment and push overall economic growth.

However, it seems reasonable to expect that diminishing returns will eventually set in, putting a limit to the extent that the tourism sector can contribute to the national wellbeing. As tourism country develops, wages rise and this will lead to an increase in the price of tourism services, which are mostly, labor intensive. Thus a country specializing in tourism will become less competitive as it becomes richer. The evolution of specialization is related with the level of income per capita. It is shown by Sahli (2006) with an econometrical study for three groups of countries 19 OCDE (Organization for Economic Co-operation and Development) countries11. The author found that one of the most important determinants of competitiveness is the real exchange rate, but in addition, he found that even if tourism remains to a large extent governed by the existence of certain resources (sea, sun, mountains and cultural heritage), other factors also play an important role. These include technological factors, which serve to differentiate the nature of tourism comparative advantages, as well as the social dimension, the destinations degree of maturity, the level of domestic demand for tourist, and the price competitiveness and dominance of the transport segment. Michel (2003) mentioned that governments should focus on the creation of economic and social opportunity in small communities through the development of clusters of complementary firms that can collectively deliver a bundle of attributes to make up a
11 International Handbook on Economics of Tourism. Chapter 20: Tourisms destination specialization Handbook pp. 459. Sahli M. found that this tendency is better for developed countries, but it does not mean that it is bad for developing countries

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specialized regional product. Micro-market clustering offers one alternative for enhancing regional economic growth, but it seems suited to tourism development when the regional product requires a combination of many services to deliver the single experience the tourist seeks.

Some authors as Lejarraja (2007) mention that one of developing tourism is that it offers as a means of diversification away from tradable goods that have lost competitiveness in world markets. While tourism can be an alternate sector for economic specialization, a different perspective is to view tourism as a potential channel for the discovery of new products and exports. Tourism creates a foreign, diversified source of demand within the borders of the host economy, breeding new supply opportunities for entrepreneurs. These opportunities may be captured locally or internationally, reflected in part by the extent of linkages generated between tourism and other productive sectors of the host economy. In meeting the demand of the tourism economy, a developing country finds itself not only discovering new goods it can produce, but also adapting to the higher quality standards and technical requirements that are intrinsic to international tourists preferences. An OECD tourist wants a good to be produced in a certain fashion, to have a pleasing appearance, to incorporate labeling and packaging requirements, and even to conform to environmental- and labor-friendly practices. Therefore, once local producers in the host country meet the standards that tourists demand, they will also comply with the technical requirements needed to export the product to OECD and other international markets. As a result, establishing productive linkages with the local economy can serve as a springboard to export diversification. The successful broadening and deepening of linkages, then, is an integral part of making tourism work for economic diversification. In the absence of sustainable linkages between the existing tourism demand and other productive sectors of the host economy, tourism will fail to foment a supply and discovery response from local entrepreneurship.

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ECONOMIC POLICY ISSUES The tourism industry is the leading segment of the services industries in small island developing states, however, there is also a need for these countries to improve their levels of investment for the development of the technological infrastructure (telecommunications technology), and more importantly to ensure that the economic gains from tourism are spread to the lower-income households.

As Craigwell (2007) mentioned, the main difficulties (from a macroeconomic perspective) of these countries were related to designing appropriate policies and strategies to enhance tourism competitiveness and, at the same time, reduce the exposure of their economies to external shocks related to tourism demand12.

Proena (2008) mentioned that the capacity of the national economy to benefit from tourism depends on the availability of investment to develop the necessary infrastructure, in addition to its capacity to supply the services that tourists require (accommodation, food, transportation facilities, entertainment and safety, among others). As a result, there are strong links between tourism and other economic sectors, including transport, retailing, wholesaling, manufacturing, agriculture, arts and crafts and other services. International capital is also involved in the tourism sector in the form of direct foreign investment in infrastructure and services (hotels, tour operators, transport).

In many cases the specialization in tourism has been triggered by the abundance of natural resources with tourism attractiveness. The tourism sector has a distinctive relationship with the environment. The natural environment is part of the tourism output, but tourism activity makes pressure on nature which may put in danger the tourism viability of the economy in the long-term. In this sense, tourism specialization should be well planned in order to avoid this risk.

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As tourism demand is highly volatile and countries that become dependent on it are susceptible to negative shocks that can have a severe impact on the entire economy.

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CONCLUDING REMARKS

From the above brief literature review, it is clear that tourism can play a valuable role in stimulating higher growth, reducing regional asymmetries, creating employment and bringing about positive externalities that affect (directly or indirectly) other economic activities. As was explained in the theoretical framework, the comparative advantage and the endowments of factors let to country or destination if it is in conditions to specialize in tourism, but this decision cannot take along, it is needed to take into account also the general conditions inside the country and also with respect to the rest of the world. In this sense, we can say that specialization in tourism has the following pros:

1) Specialization in tourism has many positive effects on economic growth, but it is important to recognize that specialization has diminishing returns on growth. It is

better for smaller destinations (countries), according to Brau et al (2003) the smaller the state, the higher the growth if the tourism business is a key for the economy. This is the case of the Balearic Island or the Canary Islands.

2) It can contribute to solve the increasing unemployment problem within the country because it has potential for creating jobs for workers displaced from manufacturing sectors (because after a crisis, many people may be unemployment). Also, tourism allows the inclusion of people from many professions in several activities, given the importance of the human factor in the delivery of tourist services.

As is explained by Sahli and Nowak (2007), the tourisms net benefit can be always positive if the tourism sector is relatively more labor intensive than the other sectors13. Then, with an expansion in inbound tourism, there is an increase in the standard of living of resident people, because the wage in the rural area is better and it produces a migration flow from the city toward the rural area, and as a consequence, a decrease of urban unemployment (in terms of rate and total numbers). It results in an expansion of tourism output and a reduction in agricultural production. Thus, there is an increase in national welfare.

3) Specialization implies technological innovation in sectors such as hotel and it is good for the labor market. Also, it motives the changes in the tourism production processes and in employment.

13 In this study, the model is developed with two regions: urban and rural regions; in the urban region there is manufacturing industry, and in the rural region we find the agriculture and the tourism sectors.

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4) Then, tourism is a generator of opportunities because it is a chain, because major innovations in production and marketing help to make the tourism industry more productive. Besides, the specialization in tourism increases its direct effect (the value added or factor remuneration directly associated with the tourist activities); its indirect effect (related with the extension to which business firms in the nation or region supply each other with goods); and its induced effect (produced by the more wages and profits, because it makes the consumer expenditure increases, and additional business turnover occurs and this generates income). 5) The broader and stronger the linkages of tourism are, the more important the economic growth that can be achieved by tourism specialization. There are two perspectives, as Michel (2003) mentioned, tourism specialization can lead to specialization in regional product (Micro-market clustering) that offers one alternative for enhancing regional economic growth. On the other hand, as Lejarraja (2007) mentioned, if the linkages are strong it could help to diversification of production in other sectors that can also enhance economic growth.

6) As an export, specialization in tourism provides currency that can be used to import capital goods or basic inputs. In this sense, it could have a greater production of goods and services and, therefore, greater economic growth. It is highly related with the relative prices, but the strength of this relationship is in function of the nature of the destination. 7) Specialization should be complemented with public policies that help to take advantage of the initial benefits from tourism specialization and enhance economic growth in a sustainable way.

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