Very Preliminary, Please do not cite without authors consent.

Comments welcome

Demand for Tourism

W.F. Maloney and Gabriel V. Montes Rojas
The World Bank
August 21, 2001

Introduction
For many countries, including much of the Caribbean, tourist income constitutes a
large fraction of total export receipts can as a share in GDP can above 40% (See figure
1). Further, tourism is a growth industry globally. The arguments that suggest that
primary products will enjoy a decreasing share of world income apply exactly in reverse
as more higher incomes and more leisure time raise tourist expenditures, as any other
luxury good, proportionally more than income. This is suggested by Figure 2 which
shows annual growth rates in real global tourist expenditures of over 3.8% for the last 20
years.
However, the performance of the Caribbean in this environment has raised concerns.
First, tourist expenditures in Latin America have risen .51 % annually over the
comparable period, and the region has dramatically lost market share. Second, tourism
is seen as fickle and subject to sharp movements in tastes or real exchange rates. Third,
as figure 2 shows, the apparent expenditure per visitor appears to be declining over time.
A common parameter underlying all these concerns is the price elasticity of tourism
demandAt present, the only published estimates for the Caribbean are extremely high.
Rosensweig (1988), using a multi-level CES SUR model, finds very high intra-Caribbean
elasticities of substitutions of 1.33 to 2.45, 1.85 to 1.00 with Mexico and 1.7 with Europe
depending on whether the source country was restricted to the US or all countries. These
greater than unity imply that anything that makes an island more expensive relative to the
competition will lead to a substantial fall in total revenues which could explain all the
phenomena above: The emergence of cheaper new competitors, or real depreciation by
competitor areas would eat into market share and cause sharp movements in revenues. A
rise in real wages in other emerging sectors-export processing zones in the Dominican
Republic- will lead to sluggish growth in tourist receipts. Rosensweig concurrs that his
results suggest that countries have a strong incentive to devalue to gain market share.
Rosensweigs estimates are at the high end of the very few estimates of tourism.
Papatheodoru (1999) estimates a model in levels for the Mediterranean region for tourist
from France, UK and Germany and finds price elasticities greater than 1 and increasing
over time.

Garn-Muoz and Prez Amaral (2000) estimate a dynamic model in levels

and a non dynamic differences specification on the determinants of tourist flows to Spain

and obtain price elasticities of 0.30 and 0.25, and income elasticities of 0.97 and 0.91
respectively. Because we expect that their data is non-stationary, we are most confident
in the second specification. Song et al. (2000) working in an error correction framework
on single country data

obtains a

less than unity price elasticity for the principal

destination countries of English tourists. On the other hand, the income elasticities are the
largest on record with a value of 2. They conclude that tourism is a luxury item for UK
consumers.
This paper argues that the three concerns or stylized facts are to varying degrees
questionable and, consistent with this, the demand elasticities are substantially below
those previously reported. Using Arellano and Bonds methodology, we offer the first
dynamic panel estimates

and find price elasticities of perhaps 30% of those of

Rosensweig.
II. Data
The Caribbean Tourism Organization tabulates time series from 1984-1999 from
its member states on number of tourists from the principal destinations. These are
disaggregated into stay-over and cruise passengers and we focus on the former which is
the larger and more lucrative market. Detailed information of tourists origins is available
since 1990 for the principal sources: USA, Canada, UK, France, Germany, Netherlands,
Italy and Spain. Those countries represent more than the 75% of the Caribbean Tourism
market and often have historical and cultural ties to individual islands. While total
expenditures by type of tourist would be interesting, only aggregate numbers are
available for most countries.
For the real exchange rate we use the purchasing power parity measures from the
World Bank World Development Indicators (2001). The income data for OECD countries
has the same source, while the data for Caribbean countries is from CTO. We construct a
panel of pairs of destination and origin counties. That is, each observation is the log of
the flows of overnight tourists from a particular destination.

The permits the best

alignment of flows, income and relative price data. It also helps compensate for the lack
of reliable data on duration of stay. The sketchy available data suggests that the duration
of individual nationalities is reasonably constant over time implying that percentage
2

change in entrants is a reasonably proxy for change in tourist demand for services.
However, US tourists show substantially shorter spells than Europeans. Aggregate
estimations may therefore conceal compositional changes and hence true changes in
tourist demand.
III. The Stylized Facts:
Are Incomes per Tourist Falling in the Caribbean?
Has the Caribbean been increasing revenues by expanding number or tourists, or
by increasing the value of their product? Figure 2 offers the standard measure-total
income over total tourists, and suggests a very mixed answer. For Bermuda, Curacao,
and Barbados, inflation adjusted receipts per tourist have been stable or increasing, but in
Antigua and Barbuda, Bahamas, Aruba, and Martinique, the tendency over the last
decade has been downward.
Unfortunately, this measure may simply reflect a proportionally greater increase
in cruise passangers who, on average, spend substantially less, but on the otherhand
require far less in terms of infrastructure or lodging capacity. A relatively
straightforward way of trying to separate out these effects is to run a simple panel
regression of
S = 0 + oO + C C

or simply attempting to isolate the contribution of overnight visitors (0) vs cruise

passengers (C). In principal, equation 2 is an identity and so there should be a long run
cointegrative relationship among the three variables. However, it is also true that we
cannot reject non-stationarity of all three series at the 5% level and hence we also run the
specification in differences. Overall, the levels results appear more unstable across
specifications, particularly the coefficient on cruise passengers, and sometimes with
strikingly high parameter values and hence we lean toward the difference results as more
reliable.

Table 1 presents the results running the specification both in levels with fixed
effects and in differences.

Columns a and g run eq. 2 with the number of overnight

visitors, but not compensating for reported nights stayed, a variable culled from customs
entry documents and hence subject to measurement error. As expected, total spending
by those who stay longer is higher. What was somewhat unexpected, however, is that
once we attempt some approximate adjustments by reported nights stayed (columns b
and h), cruise passengers appear to spend somewhat more. This may imply simply that
people overstate their projected length of stay to avoid customs problems should they
decide to stay longer. The variable remains useful, however, if we believe that stated
duration is proportional to actual since in several countries, and duration may have fallen
over time. As a final alternative, the surveyed hotel occupancy rate times number of
hotel rooms is used and it raise overnight spending somewhat. Columns d, e, and f and
j, k and l next allow the contribution of each kind of tourist to vary over time. In all
specifications, spending per cruise passenger appears to have fallen, probably $15 per
year. The levels specification suggest modest rises in spending per night of overnight
visitors but the difference regressions suggest a negative but statistically insignificant
trend. Overall, our preferred estimate uses the occupancy variable and generates a
borderline significant rise of about 1% per year in overnight stays and an annual decline
in tour ship revenues of about 5.5%.
These declines or small gains could be due two factors. First, the rise of all
inclusive packages, while not necessarily decreasing the demand for goods and services
of the host, does give large tour operators greater bargaining power with local providers. 1
Competition from other destinations has also put downward pressure on prices. 2 These
effects are functions of the demand elasticity.

A study commissioned for the Caribbean Development Bank (1996) concluded that there was no
evidence that all inclusives consumer fewer local goods and services than any other stayover visitors.
Spending throuh one supplier, however gives a stronger position with subcontrators. Maybe same overall
impact but different distributional implications pg 52.
2

However, overall, we do not find tremendous gains in the value per tourist over time. This suggests that
islands are overall not very mobile in the quality of their product- Bermuda will continue to be at the high
end and Dominica at the low end. Further, it suggests that, without initiative to find other ways for tourists
to spend their money, the growth benefits will not be realized.

Is Tourism Fickle?
Table 2 presents the standard deviation of growth rates of export value for
several commodities that often complement tourism in, particularly island economies.
What drives volatility separates tourism from the other commodities. Where price
fluctuations are perhaps the larger concern for commodities, it is the sudden fall in tourist
arrivals due either to recession in the country of origin or increased attractiveness of
alternative destinations that causes more concern for tourism. But what is clear is that in
virtually every case, tourism revenues are the least volatile. Only in Trinidad and Tobago
do tourism revenues vary by more than the other commodities and, even then, by very
little.
IV. Dynamic Panel Modeling of Tourism Demand
We begin with a reasonably standard log linear autoregressive specification in which
tourist arrivals is a function of its lag, current and lagged real exchange rate (relative to
the tourist country), total tourist arrivals to Caribbean countries by country of origin (to
capture cyclical and scale effects), time varying levels effects, individual fixed effects
(to capture island effects and tourist preferences), and a random error term. Thus, our
base specification is:
n

tourijt = tour tourij (t 1) + rer ( t k ) rerij ( t k } + +Q Q jt + t + ij + ijt

k =0

where tour denotes tourist arrivals to island i from country j, rer i-j real exchange rate
defined in the two ways defined below, and a scaling measure, Q that can be either total
arrivals from country j to all Caribbean countries or measures of the income of the
country of origina (GDP per capita), ij and t are island/tourist- and year-specific effects,

and ijt is the regression error term. All variables are in logs so the coefficients are the
relevant elasticities.
Unfortunately, the standard OLS techniques for approaching the individual effects
(random or fixed effects estimators) are not consistent in this context. The assumption of
a lack of correlation between ij and the explanatory variables required for variable
effects estimators is not defensible in this context since both tourt and tourt-1 are a
function of ij. Further, the usual elimination of ij by subtracting off the time mean
induces a negative correlation between the transformed error and the lagged dependent
variables of order 1/T, which, in short panels such as those used here remains substantial.
If at least one of the explanatory variables is truly exogenous, Balestra and
Nerlove (1966) show that its lags can be used as instruments and will yield consistent
estimates. However, in the present case, it is difficult to assume that real exchange rates
are uncorrelated with ij. For instance, countries with a large dependence on a certain
nationality of tourist will affect the exchange rate with that country.
Following Anderson and Hsiao (1982), we therefore difference the data to
eliminate ij, yielding:
n

tourijt = tour tourijt 1 + rer ( t k ) rerij ( t k ) + + Q Q jt + t + it

k =0

where is a time-difference operator. Unless the idiosyncratic error followed a

random walk, this differencing necessarily gives the transformed error an MA(n)
structure that is correlated with the differenced lagged dependent variable (LDV). This
can be overcome by using instruments dated t-n and earlier. We follow Arellano and
Bonds (1991) employment of additional lags as instruments to improve the efficiency of
the estimates in a Generalized Method of Moments (GMM) context.
We construct two different real exchange rates. One, simply the RER of with the
single country whose flows we are modeling. This is the limiting case of the commonly
used trade weighted exchange rate. Though used by Garn-Muoz and Amaral above,
this has the disadvantage of not capturing the competition of alternative islands, only
destinations within the country of origin. We therefore construct a Real Exchange Rate
based on the weights of each destination country

in the country of origins

basket of destinations. Hence, the demand of the French for St. Martin would have a
6

heavy weight of the Martinique exchange rate. This second RER is obtained using this
formula:
RERij =

k =1

RERiUS
RERkUS * tourkj
I

tour
k =1

kj

where i denotes the island, j the country of origin and k={1,, i, I} is the set of
islands. The selection of the US as the base is arbitrary and unimportant.

IV. Empirical Findings

We find substantially lower elasticities than those found in the literature to date.
Using the country of origin exchange rate, we find elasticities of -.28. Using the
competition weighted rate, we find elasticities of between -.51 and -.6. We find these
more plausible that Rosensweigs for several reasons.
First, what determines the price responsiveness of tourism is product
differentiation. To date, the Caribbean islands have tended to offer a fairly differentiated
product. British tourists charmed by the Barbados air of little England are not likely
to visit Bob Marleys stomping grounds in Jamaica because of small movements in
prices. The French patronize their old Colonies Guadeloupe, Martinique and St. Martin,
the Dutch Curacao, and St. Martin and they are not likely to be drawn to Cancun for
modest changes in prices.
Second, accommodation prices are keyed to the external market and over the
medium term, changes in exchange rates or wages are likely to reflected more in profits
than in prices. Over the longer term, we may expect more hotel building in areas with
higher profit levels, such as Cuba. 3 This is probably not the case with large economies
such as Mexico or Brazil where a large share of what the tourist consumes is interior
and hence would be more affected by exchange rate changes.
Third, Rosensweig uses pair wise real exchange rates for selected Caribbean
countries. That model is incomplete in the sense that the exchange rate should be
3

I am grateful to Mr. Luther Miller of the CTO for this point.

different for each origin of tourist in order to use all information that concerns the
consumer of tourism services. Further, in our data we found evidence of non-stationarity
even in these ratios that may give rise to spurious correlations. The value of the long run
income elasticity calculated is 1.04, which is similar to the estimation of Garn-Muoz
and Amaral for Spain. This value suggest that, even if tourism overall is a luxury good,
Caribbean tourism is perhaps less so.

References:
Arellano, M. and S. Bond, 1991. Some Tests of Specification for Panel Data: Monte
Carlo Evidence and an Application to Employment Equations. Review of Economic
Studies 58: 277-297.
Balestra, P. and M. Nerlove. 1966. Pooling Cross-Section and Time-Series Data in the
Estimation of a Dynamic Economic Model: The Demand for Natural Gas.
Econometrica 34: 585-612.
Caribbean Development Bank. A Study to Asssess the Economic Impact of Tourism
on Selected CDB Borrowing Member Countries. 1996. KPMG Peat Marwick.
Garn-Muoz, T. And Perez Amaral, T. (2000) An econometric model for international
tourism flows to Spain Applied Economics , 7: 525-529.
Griliches, Z. and J. A. Hausman, 1986. Errors in Variables in Panel Data. Journal of
Econometrics 31: 93-118.
Holder, Jean S.(2001) Some ideals for Tourism Change in a Changing World.
Secretary General, Caribbean Tourism Organization.
Papatheodorou, A. (1999), The demand for international tourism in the Mediterranean
region, Applied Economics, 31, 619-630.
Rosensweig, J. (1988), Elasticities of Substitution in Caribbean Tourism, Journal of
Development Economics, 29, 89-100
Sevestre P. and A. Trognon (1996), Dynamic Linear Models in Matyas, L. and P
Sevestre, The Econometrics of Panel Data, (Boston: Kluwer Academic Publishers),
100-118.
Song, H., Romilly, P. and Liu, X. (2000), An empirical study of outbound tourism
demand in the UK, Applied Economics, 32, 611-624
Witt S. and Witt C. (1992), Modelling and Forecasting Demand in Tourism Academic
Press

Tourism 's share of exports and GDP

Venezuela, RB
Ecuador
Tourism receipts / GDP

Trinidad and Tobago

Tourism receipts / Total exports

Peru
Dominican Republic
Grenada
St. Kitts and Nevis
Antigua and Barbuda
St. Lucia
0%

10%

20%

30%

40%

50%

60%

70%

80%

10

LAC's share and Rates of Grow th

30%

13%

12%
20%
11%

Rat es of growt h : Wor ld and LAC

10%

10%
0%
1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

9%

8%

-10%
LAC's shar e in Tot al Tourism Receipt s

7%
- 20%
6%
- 30%
5%

4%

- 40%

Real tourism receipts per tourist-day

0.3

0.25

Anguilla

0.2

Ant igua and Bar buda

Aruba
Bahamas

0.15

Barbados
Bermuda
Curacao

0.1

Mar t inique

0.05

0
1

10

11

12

13

14

15

16

11

Table 1: Estimates of Spending per Tourist

Fixed Effects Regressions with time dummies
dep var. tourism recepits
Levels
a
b
c
d
e
f
g
h
arrivals
672.0
708.2
506.4
(32.47)
(11.86)
(8.54)
arrivals * stay
82.0
15.9
47.8
(23.34)
(1.56)
(5.44)
occupancy rate*rooms
166.8
126.9
(23.3)
(5.66)
cruise passenger
52.6 220.5 379.4 214.6 516.0 539.4 119.0 125.0
(1.66) (5.74) (8.37) (3.65) (7.95) (8.02) (1.44) (2.68)
t* arrivals
t* arrivals * stay
t* occupancy rate*rooms
t* cruise passenger

Time

constant

-2.0
-(.68)

Differences
I
j
673.4
(5.83)

71.7
(3.83)
57.4
53.4
(3.91)
(3.62)
192.3 254.3 330.3 368.4
(4.23) (2.48) (3.03) (3.48)
-19.2
-(1.75)

3.5
(6.88)

-2.7
-(1.44)

2.4
(1.79)
-9.0 -21.9 -12.3
-(2.61) -(6.38) -(3.42)

0.5
(1.61)
-13.9 -20.6 -18.2
-(1.47) (2.08) -(1.85)

1.0 -1.2
(.51) -(.54)

2.2
(.92)

62.0 68.5 127.3

23.0 153.0 131.9 -7.7
(4.44) (3.79) (5.78) (1.13) (6.17) (4.49) -(.71)
R-sq
0.89 0.81 0.79
0.91 0.82 0.80 0.37
Obs.
371
359 270
371
359
270 342
(t-values), regressions include a complete set of time dummies.

-6.9 11.5 -7.2 -6.3 18.0

-(.6) (.89) -(.67) -(.55) (1.13)
0.24 0.26 0.38 0.20 0.16
332 248
342
332
248

12

Table 2: Export Revenue Volatility (Standard Deviation of Growth Rate)

Petroleum
Country

Tourism

Sugar

Fruits

Coffee

& Gas

Barbados

0.08

0.17

0.33

0.96

Belize

0.36

0.11

0.21

0.69

Dominica

0.11

2.55

0.91

0.48

Dominican Republic

0.11

0.13

0.08

0.32

Grenada

0.17

2.39

0.49

0.27

Haiti

0.13

2.79

1.09

0.71

1.65

Jamaica

0.09

0.23

0.15

0.13

2.66

St Kitts and Nevis

0.11

0.37

0.91

1.82

0.94

St Lucia

0.09

1.13

0.29

0.37

St Vincent and Grenadines

0.17

0.30

0.47

Trinidad and Tobago

0.29

0.23

0.22

0.28

0.2378

0.4315

1.84

0.99

1.522

2.34

Average*

3.61

0.69

*includes all the countries

13

Arellano and Bond dynamic panel data estimator of Tourism Price Elasticities
Dependent variable: ln Tourist Arrivals
a
b
c
d
e
0.142
0.174
0.149
0.172
0.189
ln Tourt-1
(0.054)
(2.52)
(2.03)
(2.49)
(2.67)
0.114
0.109
0.192
0.220
0.271
ln RERt*
(0.99)
(0.93)
(1.95)
(2.20)
(2.66)
0.245
0.233
.247
0.267
0.212
ln RERt-1*
(2.58)
(2.42
(2.85)
(2.98)
(2.43)
0.057
0.093
.063
0.08
ln Total Tourt
(0.75)
(1.35)
(0.81)
(1.16)
0.171
0.135
ln Total Tourt-1
(2.61)
(2.06)
2.299
ln GDP per cap t
(2.29)
-1.455
ln GDP per cap t-1
(-2.43)
Constant
0.145
0.025
0.003
0.013
-0.003
(3.71)
(0.58)
(2.05)
(-0.28)
(2.21)
Obs.
Groups
Sargan test of
over-identifying
restrictions (p
value)
Wald Test (p
value)
Long Run Price
Elasticity
Long Run Income
Elasticity

1491
205

1491
205

1491
205

1491
205

1470
205

0.001

0.069

0.001

0.008

0.020

0.000

0.000

0.000

0.000

0.000

0.286

0.282

.512

.575

.595

0.199

0.159

1.041

Notes: * Regressions a and b : real exchange rate relative to the tourist country.
Regressions c and d: real exchange rate relative to the competitors weighted by
number of tourist arrivals by origin.

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