Less Developed Countries, Tourism Investments and Local Economic Development

• Published date: 01 February 2013
• DOI: http://doi.org/10.1111/rode.12012
• Date: 01 February 2013
• Author: Guido Candela,Rainer Andergassen

Less Developed Countries, Tourism Investments and

Local Economic Development

Rainer Andergassen and Guido Candela*

Abstract

This paper analyzes the forward linkages of a multinational’s investment in a resort that kicks off tourism

activity in a less developed country. We show that, under quite natural assumptions, overnight stays are

increasing in the number of differentiated tourism-related goods and services.These goods and services, if

supplied by the local community,represent forward linkages of FDI in tourism. We investigate the multina-

tional’s incentives to promote, reduce or eliminate these forward linkages and the effectiveness of some

policy instruments available to a local government to leverage on the presence of FDI and to stimulate

domestic entrepreneurship.

1. Introduction

Many policy-makers view foreign direct investments (FDI) as a way to further the

process of wealth creation in the host country and to jump-start the development

process in less developed countries (LDCs). In terms of economic policy this means

creating a favorable economic environment that can attract FDI, for example, with

special tax treatment, exemption from import duties or direct subsidies.1Academic lit-

erature studies the welfare effects of FDI on both the host and the home country,

unveiling potential channels of welfare gains as well as welfare losses.2

In this paper we study the effects of a multinational’s tourism investment on local

economic development. FDI is often considered to be one of the most effective means

for harnessing the development of capital, infrastructure and knowledge and for

gaining access to global marketing in tourism. Therefore, LDCs often view the attrac-

tion of these investments as a leading tourism and economic development strategy;

however, the theoretical and empirical implications of tourism FDI on the host

country have not been fully studied and understood.3

FDI, which is mostly concentrated in hotels and restaurants, is most important for

emerging tourism economies, while it is relatively less important for developed and

mature tourism markets. UNCTAD (2007) documents the strong impact of FDI on

consumer demand in new destinations. For example, FDI played a major role in the

tourism take-off in Tunisia in the 1970s, when investors such as Club Med invented

the beach resort concept. In a similar vein, despite investments in the 1970s by the

Dominican government aimed at creating a tourism industry, the real boom did not

begin until after the massive influx of FDI in the 1980s. UNCTAD (2007) also docu-

ments the cases of Bhutan and the United Republic of Tanzania where sharp

increases in tourist arrival numbers appear to be directly linked to FDI.

* Andergassen (corresponding author): Department of Economics,University of Bologna, P.zza Scaravilli,

2, 40126 Bologna, Italy; Tel:(+39) 0512098666; Fax: (+39) 0512098040; E-mail: rainer.andergassen@unibo.it.

Candela: University of Bologna, P.zza Scaravilli, 2, 40126 Bologna,Italy. The authors would like to thank

Roberto Cellini, Antonello Scorcu and an anonymous referee for helpful comments.

Review of Development Economics, 17(1), 16–33, 2013

DOI:10.1111/rode.12012

© 2013 Blackwell Publishing Ltd

The challenge for policy-makers is to leverage on FDIs to foster domestic entrepre-

neurship. Such policies consist of, for example, minimizing leakages,4improving the

tourism value chain and, more generally, boosting the net value of tourism by increas-

ing tourists’ length of stay.

The role of FDI is more nuanced in tourism than in some other sectors of the

economy, and it is of greater value because it can kick off the tourism industry;

however, it is also feared because of its impact on economic and cultural independ-

ence, and its potential damage to the communities and the environment. The host

country faces the risk of foreign domination such as enclaves and other strategies in

which the multinational limits the benefits for the host country, which is therefore

unable to capitalize on such investments. This is the case, for example, of Punta Cana,

a Dominican Republic island, where transnational corporations built small enclaves

equipped with their own essential services such as power, waste and water manage-

ment and access modes (UNCTAD, 2007). Brohman (1996) argues that foreign domi-

nation and external dependency often seriously reduce tourism’s potential for

generating broadly based growth. Brohman uses the Caribbean as an example, where

a spatial polarization within both the modern tourism industry, based on resort

enclaves in the most desirable coastal locations, and the older agricultural-based

economy emerged. Battilani (2002) documents the investment strategy of a pool of

entrepreneurs led by Karim Aga Khan IV in the untouched Costa Smeralda area of

Sardinia (Italy) during the 1960s, that held the region’s tourism and as well as eco-

nomic development under tight control by acquiring a monopolistic position on the

potentially usable land and controlling the region’s administration.

We consider a multinational that builds and owns a resort in a new destination in an

LDC and study its incentives to let the local community benefit from the tourism

development. We show that under quite natural assumptions, tourists’ overnight stays

are increasing in the degree of diversification of tourism-related products and services.

Therefore, the multinational’s profits are strictly related to the variety of tourism-

related goods and services supplied. As a consequence the multinational has an incen-

tive to control the degree of product differentiation. In particular, the multinational

faces two options. On the one hand,the multinational can try to control the variety of

goods and services supplied by local firms; on the other, it can create an enclave and

directly supply the preferred variety. In the former case, in which tourism is based on

culturally authentic goods and services, we assume that each differentiated product is

produced by a single firm, and hence the number of tourism related products supplied

is a proxy for the local economic development induced by the multinational’s invest-

ments. In the latter case, in which tourism is based on a fake but authentically staged

local variety, the local community does not benefit from the tourism activity.

Our analysis focuses on these forward linkages of FDI, that is, the creation of new

markets in an LDC through the tourism product, and we neglect backward linkages

created by the multinational’s activity, that is, the effects on suppliers of intermediate

consumption goods.

In section 2 we characterize the representative consumer’s demand function for

overnight stays, consumption of differentiated tourism related products and non-

tourism related products. We show how the multinational’s profits from overnight

stays and the supply of differentiated products are related and that there exists an

optimal degree of product diversification from the multinational’s viewpoint. There-

fore, if tourism products are supplied by the local community, where the local variety

is determined by a free entry condition, then there may be too many or too few prod-

ucts from the multinational’s viewpoint. As a consequence, the multinational may

LDC, TOURISM INVESTMENTS AND DEVELOPMENT 17

© 2013 Blackwell Publishing Ltd