CHAPTER 4

THE ECONOMIC
OF TOURISM
 Learning Objectives:
To explain the role of tourism in economic development.
To analyze the economic impact of tourism on a
destination area.
To differentiate the direct effects from the secondary
effects of tourists expenditures on the company on the
economy of the host area.
To elucidate the meaning of tourism multiplier and its
effect on the economy of the host country.
To describe the undesirable effects of the economic
aspects of tourism.
To identify the strategies which can maximize the
economic effects of tourism.
The Role of Tourism in Economic
Development

Several developing countries have used

tourism development as an alternative to help
economic. The reasons for this are: First,
there is a continuous demand for international
travel in developed countries increases, the
demand for tourism also increases at a faster
rate. Third, developing countries need foreign
exchange to aid their economic development.
 The Organization for Economic
Cooperation and Development (OECD) his
concluded that tourism provides a major
opportunity for growth for countries that are at
the intermediate stage of economic
development and require more foreign
exchange earnings.
 Tourism is an invisible export, which differs
from international trade in many ways.
1. In tourism, the consumer collects the product from the
exporting country, thereby eliminating the freight costs
for the exporter, except in cases in which the airline used
are those of the tourist receiving country.

2. The demand for pleasure travel is largerly dependent on

non-economic factors, such as local disturbances, political
unrest, and changes in the fashionability of resorts /
countries created mostly by media coverage. At the same
time, international tourism is both price elastic and
income elastic. This means that changes in price and
income will also change the demand for pleasure travel.
3. By using specific fiscal measures, the exporting
or tourist receiving country can manipulate
exchange rates so that those for tourists are higher
or lower (normally the latter is implemented in
order to attract large number of tourists than those
in other foreign trade markets. Also, tourists are
allowed to buy in domestic markets at the same
prices as the local residents (the exceptions are the
duty – free tourist shops operated in many
Caribbean islands and elsewhere).
4. Tourism is a multifaceted industry that directly
that directly affects several sectors in the
economy, such as hotels, shops, restaurants, local
transport firms, entertainment establishments,
handicrafts producers, and indirectly affects many
others, such as equipment manufactures and
utilities.

5. Tourism brings many more non-monetary

benefits and costs than other export industries,
such as social, cultural and environmental
benefits, and costs.
 Economic Impact
When travelers outside the destination are spend on
goods and services within the destination, tourism acts
as an export industry by bringing in revenues from
outside sources. Tourist expenditures also increase the
level of economic activity in the host area directly.
Many countries have utilized tourism as a means to
increase foreign exchange earnings to produce
investment necessary to finance economic growth.

Tourism economic impact on a destination area can

be immense since it provides a source of income,
employment, and foreign exchange.
 Direct and Secondary Effects
In order to measure the economic impact of tourism
on the destination area, it is important to know the direct
and secondary effects of visitor expenditures on the
economy of the area. Tourists expenditures received as
income by businesses such as hotels, restaurants, car
rentals, tour operators, and retail shops serving tourists
have a direct effect on the economy of the host area. The
term direct means the income is received directly.
Indirect or secondary effects mean that the money paid
by tourists to businesses are in turn used to pay for
supplies, wages of workers, and other items used in
producing the products or direct services bought by
tourists.
 Tourism Multiplier
The term multiplier is used to describe the total
effect, both direct and secondary, of an external
source of income introduced into the economy.

Tourism multiplier or multiplier effect is used to

estimate the direct and secondary effects of tourist
expenditures on the economy of a country. The
multiplier effect is illustrated in figure 3.
 A tourist makes an initial expenditure into the
destination. This expenditure is received as income by
local tour operators, handicrafts store owners,
hoteliers, may use some of the money received to buy
some supplies, pay some wages, and retain some
profits. The income in the second round may be spent
or saved, while the employee who has received
payment for services rendered may spend some of it on
rent and some on food, and may put some into savings.
The money spent on supplies in the third round of
spending goes for such things as seed, fertilizers, and
imported raw materials.
Any income spent on imports has leaked out of the
local economy. This process continues until the
additional income generated by a new round of
spending essentially becomes zero. Leakage is the
value of goods and services that must be imported
to service the needs of tourism. To estimate the
total economic impact on an area, imports must be
subtracted from the income generated by visitors.
 THE FORMULA FOR TOURISM MULTIPLIER IS:

The size of the multiplier depends on the extent to which the

various sectors of the economy are linked to one another.
When the tourism sectors buy heavily from other local
economic sectors for goods and services, there will be a
smaller tendency to import and the multiplier will be greater
than if the reverse were true.
Most developing economies have an income multiplier
range between 0.6 and 1.2, while developed economies
have a range between 1.7 and 2.0.
 Cost – benefits Ratio

Those concerned with developing the tourism

industry, whether a government or a private
individual, would like to know the extent of potential
benefits and their costs. Benefits divided by costs
equal the cost – benefit ratio. To arrive at these ratios,
the following procedures are used:

1.Determine where the tourist dollar is spent;

2.Determine what percentage of each expenditure
leaves the local economy;
3.Derive a “multiplier effect”, a ratio applied to
income that reflects multiple spending within
an economy;
4.Apply the multiplier effect to the tourist
expenditures to arrive at the total benefit
tourist expenditures in dollars;
5.Derive a cost-benefit ratio expressed as
dollars received/dollars spent;
6.Apply the cost-benefit ratios to tourist
expenditures to provide estimates of income
and costs of tourist business to a community,
for both the private and public sectors.
 
Undesirable Economic Aspect of Tourism
Some undesirable economic aspects of tourism are
higher prices and economic instability. Because of
additional demand and / or increased imports, tourist
purchases may result in higher prices in a destination
area. This would mean that local residents would also
have to pay more for products and services.

Since pleasure travel is a discretionary item, it is

subject to changes in prices and income. These
fluctuations may result in economic instability.
 
How to Maximize the Economic Effect of Tourism
A. Growth Theories
Some economic growth theories have been proposed to
maximize the economic effect of tourism within a
destination area. These are the theory of balanced
growth and the theory of unbalanced growth.
 
Proponents of the theory of balanced growth
suggest that tourism should be viewed as an important
part of a broad-based economy. This theory stresses that
tourism needs the support to other industries. Its
objective is to integrate tourism with other economic
activities. To obtain maximum economic benefit,
tourism goods and services should be locally produced.
 
 Supporters of the theory of unbalanced growth
see tourism as the spark to economic growth.
While the proponents of the theory of balanced
growth stress the development of supply,
supporter of the theory of unbalanced growth
emphasize the need to expand demand. As
demand is increased through the vigorous
development of tourism, other industries will
move to provide products and services locally.
 
 B. Economic Strategies

The key to maximizing the economic effects of

tourism is to maximize the amount of revenue and
jobs developed within the region. To attain this
objective, some economic strategies have been
adopted, such as import substitution, incentives, and
foreign exchange.
C. Import Substitution
It imposes quotas or tariffs on the importation of
goods, which can be developed locally. It also grants
subsides, grants, or loans to local industries to
encourage the use of local materials. Its objective to
minimize the leakage of money.
 D. Incentives

The wise use of incentives can encourage the influx

of capital, both local and foreign, necessary to
develop tourism supply. The most common forms
of incentives are:
1.Tax exemptions/ reductions on imported
machinery, materials, etc;
2.Reduction in company taxation by means of
favorable depreciation allowances on investment,
or special treatment in relation to excise taxes,
sales taxes, income taxes, turnover taxes, profit
taxes, or property taxes;
3.Tax holidays (limited period)
4.Guarantee of stabilization of tax conditions(for up
to 20 years);
5.Grants (for up to 30 percent of total capital costs);
6.Subsidies (guaranteeing minimum level of profit,
occupancy, etc.);
7.Loans at low rates of interest;
8.Provision of land freehold at nominal or little cost
or at low rents;
9.Free and unrestricted repatriation of all or part of
invested capital profits, dividends, and interest
subject to tax provisions; and
10.Guarantees against nationalization or
appropriation.
Before implementing an incentive strategy a
destination should:

1.Examine the performance of the schemes of

other countries in the light of their resources
and development of objectives;
2.Research the actual needs of investors;
3.Design codes of investments concessions
related to specific development objectives
with precise requirements of investors; and
4.Establish targets of achievements and
periodically monitor and assess the level of
realization of such targets.
 E. Foreign Exchange
Many countries have placed restrictions on
spending in order to maximize foreign exchange
earnings. They have limited the amount of their
own currency that tourists can bring in and take out
of the destination to ensure that foreign currency is
used to pay bills in the host region. Tourists may be
required to pay hotel bills in foreign currency.
Visitors may be required to show that they have
enough money for their stay before they are
permitted to enter the country or they may even be
required to enter with a specified amount of foreign
currency for the duration of their visit.