Environmental policy and long-term welfare in a tourism economy

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A dynamic general equilibrium model of a small open economy specialized in producing tourism services is presented. The tourism package is a bundle of attributes provided by firms, the government and the natural environment. Investment in
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  Span Econ Rev (2008) 10:41–62DOI 10.1007/s10108-007-9028-0REGULAR ARTICLE Environmental policy and long-term welfarein a tourism economy Carlos Mario Gómez  ·  Javier Lozano  · Javier Rey-Maquieira Published online: 23 May 2007© Springer-Verlag 2007 Abstract  Adynamicgeneralequilibriummodelofasmallopeneconomyspecializedin producing tourism services is presented. The tourism package is a bundle of attri-butes provided by firms, the government and the natural environment. Investment inaccommodation increases the number of visitors but also congests public goods andreduces environmental quality. The model is used to determine the conditions for theexistence of a long-term double dividend. These conditions depend on both the initiallevel of environmental quality and the responsiveness of the tourism price to marginalchangesinenvironmentalandaccommodationqualityandcongestionofpublicgoods. Keywords  Double dividend · Dynamic general equilibrium model · Environmentalpolicy · Tourism policy · Tourism taxation JEL Classification  E13 · E62 · H21 · H23 · O13 · Q01 · Q56 Support from the Balearic Islands Government (PRIB-2004-10142) and helpful comments fromanonymous referees are gratefully thanked.C. M. Gómez ( B )Department of Economics, Universidad de Alcalá, Plaza de la Victoria s/n,Alcalá de Henares, 28802 Madrid, Spaine-mail: mario.gomez@uah.esJ. Lozano · J. Rey-MaquieiraDepartment of Applied Economics, University of the Balearic Islands,Edifici Jovellanos Campus de la UIB, Cra de Valldemossa, Km 7.5,07122 Palma de Mallorca, Spaine-mail: javier.lozano@uib.esJ. Rey-Maquieirae-mail: javier.rey@uib.es  1 3  42 C. M. Gómez et al. 1 Introduction For many small countries and many regions in larger economies, investment in thetourism industry has historically represented a real opportunity to increase privatebenefits and enhance long-term growth (Copeland 1991; Adams and Parmenter 1995; Lanza and Pigliaru 2000). In many cases, the pre-existence of a proper local environ-ment is a necessary first condition for the opportunity to develop a tourism industry.The environment must provide potential tourists such offerings as sunny and reliableweather, some number of high-quality beaches, sea or mountain recreation oppor-tunities, peace, pleasant landscapes and other distinctive recreational opportunities.If these environmental capabilities exist, private firms have the incentive to buildhotels, restaurants and other privately provided infrastructures for the tourism indus-try. In fact, the specialization in tourism has been fostered by the opportunity forlocal firms to profit from the rents associated with the presence of local environ-mental assets; to acquire these rents local private firms sell tourism packages andinvest in tourism accommodation facilities. For tourism to be a real growth alterna-tive, a second important condition is the capability of the government to providesome public goods perceived as essential by potential tourists (such as personalsafety, health assistance, information, etc.), collective goods to make the locationand its environment accessible (such as airports, havens, road networks, etc.), andlocal public goods (such as beach cleansing, gardens, pathways, public parks, parkingfacilities).Thus the kind of output offered by the tourism industry is a package of differentattributes including privately provided services, services provided by the environmentand collective goods provided by government. The growth process of a tourism econ-omy is characterised by a complex interaction between capital accumulation by pri-vate firms, government provision of public goods and degradation of the environment(Tisdell 2001; Davies and Cahill 2000). For this reason economic growth in a tourism economy must be balanced to produce the optimal combination of the many attributesincludedinthetourismpackage.Furthermore,marketandgovernmentdecisionsmustbe coordinated to maximize local welfare.If investment in tourist accommodation services results in acquisition of environ-mentalrents,andifenvironmentalservicesandcollectivegoodsaresubjecttoconges-tionanddegradation,competitionandprivateincentivesmayleadfirmstoaccumulateexcessivecapitalintheformofaccommodationcapacitywhilebothtourismoutputandlocal income dip to suboptimal levels. As a result, in some mass tourism destinations,policies have shifted from quickly and quantitatively developing tourism to correctingenvironmental externalities and improving product quality (Ivars 2003; OECD 2004, pp. 26–28). In this case environmental taxation of tourism activity becomes a naturalinstrument to increase long-term welfare both by reducing externalities and by col-lecting revenues to finance the local and public goods needed to increase the value of the tourism output.Inthispaperwefocusontourismtaxationasaninstrumenttocollectpublicrevenueto finance tourism-related public expenditures, internalise environmental impacts andincrease long-term welfare. Thus, this paper contributes to the scarce literature thatexplores the use of tourism taxation as an environmental policy instrument (Piga 2003  1 3  Environment, tourism and growth 43 is an outstanding case). With this aim we develop a dynamic general equilibriummodel for a small open economy where capital accumulation in the tourism industryis the engine of growth, and where the quality of the environment affects local welfarebothdirectly,throughtheenjoymentofenvironmentalservices,andindirectly,throughits effect on tourism revenues. This model is related to a body of the literature thatextendstheeconomicgrowththeorytoincludeenvironmentalvariables(Barbier1999;Stokey 1998; Hettich 1998; Schou 2000 among others). However, to our knowledge no one has already dealt with the relationship between tourism and the environmentin a dynamic general equilibrium model.In the context of a green tax reform, the model allows us to explore the conditionsfor a double dividend of an overnight stay tax. A large body of the literature onpublic policy analyzes the conditions for a double dividend (Bovenberg and de Mooij1994; Goulder 1995 among others) that is, the situation where environmental taxes not only improve welfare through the betterment of environmental conditions (envi-ronmental welfare) but also through the increase in consumption possibilities (non-environmentalwelfare).However,fewpaperssettheanalysisinadynamicframework[BovenberganddeMooij(1994)andChiroleu-AssoulineandFodha(2006)areexcep- tions] and none to date have analysed the interactions between tourism growth and theenvironment.Like Chiroleu-Assouline and Fodha (2006) we focus on the long-term double dividend and therefore only analyze the impact of policy changes on the steadystate. Given the complexity of analyzing the intertemporal double dividend, thatis, the improvement of the discounted sum of both environmental and non-environmental welfare, such a discussion is out of the scope of this paper. We be-lieve that, given the long-term nature of the topics investigated, an analysis of thesteady state equilibrium is interesting in itself. Moreover, as Chiroleu-Assouline andFodha (2006) state, our results on the long-term double dividend contribute to the analysis of the conditions for an intertemporal double dividend: for rates of time pref-erence low enough the long-term double dividend guarantees an intertemporal doubledividend.The rest of the paper is organized as follows. Section 2 presents the model as astylized characterization of economies highly specialized in tourism that participatein a competitive international market. Following Rosen (1974) the complexities of  the international tourism market are summarized in a hedonic price function. Thearguments of this function have been selected to include private and public goodsand services (in the legal and economic sense) and local and non-local goods andservices that, as has been argued before, are essential parts of the tourism packagefor many tourism destinations. Section 3 explores the long-term effects of an over-night stay tax, with special attention to the conditions for the existence of a dou-ble dividend. It turns out that the existence of a long-term double dividend, in thestrong version, depends on the elasticity of tourism revenues (or national income)with respect to accommodation capacity. The model also shows that this result doesnot necessarily depend on the reduction of distortionary taxation. What is more,in situations of very low environmental quality it is better, from a long-term per-spective, to rebate the additional revenues in a lump sum way. Finally, Sect. 4concludes.  1 3  44 C. M. Gómez et al. 2 The model We consider the case of a small open economy that is fully specialized in providingtourism services to foreigners. The particular good offered by the economy may becalled a tourism package and is a bundle of three kinds of attributes: accommodationservices provided by the market, local and non-local public goods provided by thegovernment, and environmental services resulting from a given endowment of naturalassets.2.1 The tourism marketIn the global tourism market, to which our small economy belongs, there are manytourism economies offering a wide variety of differentiated tourism packages. Moreformally, we may assume a market formed by many tourism economies or regions(indexed by  j  ∈  J  ), each of which contains many different locations (indexed by i  ∈  I  ). This way the world tourism market is formed by a number of diverse tourismpackages (indexed by  ij  ∈  I   ×  J  ).On the demand side, there are many different consumers differentiated by theirtastes and ability to purchase various tourism packages. As the hedonic hypothesisclaims, in this kind of market there may exist not a single equilibrium price but a locusof the many equilibrium prices that depend on the characteristics of the tourism pack-age (Rosen 1974). This locus may be called the hedonic price function of the tourismmarket. Among tourism price-taking firms there is competition in the characteristicsspace and zero profits equilibrium is guaranteed by the existence of countably manydifferent locations around the world (e.g., Ellickson 1993).Few empirical hedonic price studies of tourism are available to guide the choice of arguments for our hedonic price function (Papatheodorou 2002; Espinet et al. 2003; Mangion et al. 2005). Extant models typically explain the brochure price of the tour-ism package in terms of category of accommodation, private services offered by theaccommodationfacilitiesanddummyvariablesfordestinations.Thelattermayreflect,among other things, differences in public goods and services offered in destinations,either natural or provided by the public sector. Mangion et al. (2005) also explicitly include variables that reflect the availability of services provided by the public sec-tor (proximity to public transport and main roads) and of environmental and naturalresources (proximity to the beach and to natural parks).In our stylized model, we assume that each tourism package is a bundle of thefollowing four attributes to be included in the hedonic price function:First,theprivatelyprovidedservicesthatwelooselycallaccommodation,butwhichmay include other complementary services provided by the tourism firm. The supplyof these services may be measured by the number of tourists that can be lodged over-night in the local economy  ( T  ) . Without loss in generality we may assume that in anylocation  i  there is a single firm. Each firm  ( i )  in the economy  (  j )  invests a certainquantity of capital  ( K  ij )  and supplies a given number of accommodation units  ( T  ij ) .The quality of tourism services offered by the firm increases with capital and maybe measured by the amount of capital invested per unit of accommodation  ( K  ij / T  ij ) .We use the concept “quality” in a broad sense to also include the number of services  1 3  Environment, tourism and growth 45 available to the tourist. Therefore, with the same amount of capital any firm maychoosetooffermanysmalllowqualityrooms(low  K  ij / T  ij ) orfewhighqualitysuites(high  K  ij / T  ij )  or any other intermediate alternative. Moreover, for a given level of capacity, the firm may supply only the bare accommodation service (low  K  ij / T  ij ) or other services like swimming pool, sport facilities, etc. (higher  K  ij / T  ij ) . The firstcharacteristic of the tourism package is, thus, the quality of the accommodation andit can be measured by the index  ( K  ij / T  ij )  [for example: Skalpe and Sandvik (2002) show for a sample of hotels in the USA that the amount of capital invested has apositive impact on the perceived quality].Second, non-local public goods such as personal security, health service access,food safety, etc. In this category of goods and services we may also include infra-structures such as an international airport or a harbour in a tropical island that maybe essential in tourism economies. For the tourism activity to exist in the local econ-omy, these goods must be provided at some minimum quantity. Above this minimumthreshold the availability of “public goods” enhances the perceived quality of a tour-ism package. The quantity of non-local public goods is denoted by  G  Aj . These goodsare subject to congestion and their availability for a single consumer may be indexedby  ( G  Aj / T   j ) , where:  T   j  =   I  T  ij .Third, the quantity of local public goods in any of the different locations within thetourismeconomy.Incontrasttootherpublicgoods,thesemaybeunevenly distributedin the local economy, and are represented by public parks, pathways, parking lots andsimilaramenitiesavailableatareasonablecostonlytotouristshostedinhotelslocatedin close proximity. Let us call these local goods  G  Bij  ; their quality may be measuredby  ( G  Bij / T  ij ) .Fourth and finally, the services provided by the environmental quality of the tour-ism destination. We consider that environmental quality is represented by a singlevariable called  N   j . As we will see below, environmental quality is not an asset thatmay be accumulated and depends primarily on the number of tourists coming to thelocal economy.Thehedonicpricefunctionorequilibriumpricefunctionoftheinternationaltourismmarket may then be represented as: P ij  =  P  K  ij T  ij , G  Aj T   j , G  B ij T  ij ,  N   j  where  P ij  is the unitary price of the tourism package (per overnight stay in the loca-tion/hotel  i  in the country  j ). From first principles we can assume that the equilibriumprice function is nonlinear and increasing at a decreasing rate in each of the attributesof the tourism package. For simplicity we use a Cobb-Douglas form of the tourismpackage hedonic price function: P ij  =  K  ij T  ij  α  G  Bij T  ij  β  G  Aj T   j  γ   N  µ  j  (1)where  α,β,γ   ∈ (0,1);  µ >  0 ; α  + β  + γ <  1  1 3
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