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Tourism and the environment
Resource and Energy Economics 31 (2009) 39–49
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Resource and Energy Economics journal homepage: www.elsevier.com/locate/ree
Tourism and the environment Hamid Beladi a,*, Chi-Chur Chao b, Bharat R. Hazari c, Jean-Pierre Laffargue d a
Department of Economics, College of Business, University of Texas at San Antonia, 6900 north loop 1604 west, San Antonio, TX 78249-0633, United States Department of Economics, Chinese University of Hong Kong, Shatin, Hong Kong c Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong d University of Paris I and CEPREMAP, Paris, France b
A R T I C L E I N F O
A B S T R A C T
Article history: Received 3 April 2006 Received in revised form 9 June 2008 Accepted 20 October 2008 Available online 5 November 2008
This paper examines the effects of pollution taxes on welfare and environment for a small open economy. In the presence of tourism, pollution taxes provide a double dividend of less pollution and improvements in the tourism terms of trade. The optimal pollution taxes are derived under exogenous and endogenous tourism, and they can be greater or less than the marginal damage of pollution perceived by the domestic residents. Numerical simulations show that the optimal tax rate is larger under exogenous tourism. ß 2008 Elsevier B.V.. All rights reserved.
Keywords: Endogenous tourism optimal pollution taxes
JEL classification: F11 Q38
1. Introduction A recent report issued by the World Tourism Organization (1998) entitled ‘‘Tourism: 2020 Vision’’ analyzed the future of tourism in the twenty-first century. It forecast that 1.5 billion tourists will visit foreign countries annually by the year 2020, spending approximately US$2 trillion per year. This figure represents about three times more tourists than the 663 million recorded in 1999. Tourism transforms locally non-traded goods and services into exports which benefits local communities.1 There are strong incentives to site hotels and build tourist facilities near hotspots to attract and accommodate
* Corresponding author. E-mail address: [email protected] (H. Beladi). 1 See Copeland (1991), Sinclair and Stabler (1997), Lanza et al. (2003), and Hazari and Sgro (2004) for a review of the literature on tourism. 0928-7655/$ – see front matter ß 2008 Elsevier B.V.. All rights reserved. doi:10.1016/j.reseneeco.2008.10.005
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tourists, regardless of the environmental damage that may result. Furthermore, tourism is not usually well-managed from the environmental perspective. Increasing visitor arrivals not only makes the local environment overcrowded, but also causes resources to be overexploited. Consequently, natural habitats are increasingly being destroyed, and more pollution is being generated. It is often questionable whether local communities get enough revenues and other benefits from tourists to outweigh the environmental costs incurred. Many studies have made these points. For example, the TED case studies for Oman found that ‘‘large influxes of tourists could seriously threaten the environment by stressing Oman’s delicate resources, such as water and land, too severely. There is also a cultural impact to consider as Western tourists interact with a Muslim society that had been isolated from the modern world until just 30 years ago. How to balance these tough decisions is what confronts Oman as it tries to develop its tourism sector while maintaining its natural surroundings’’2 (p. 2). This study also concluded that ‘‘the government’s policy then is to proceed slowly, limiting tourist numbers and cautiously adding to existing infrastructure all in an effort to minimize the environmental impact’’ (p. 4). The expansion of world tourism increasingly poses a threat to the environment – particularly if it is not well-planned and managed. If tourism ultimately destroys the environment of a country, then tourists will no longer have a reason to visit it. In this paper, we consider the user-pay principle for managing the environment in an economy with inbound tourism. As a related issue, we also study the policy-induced impact on the degree of tourism. To achieve this, we endogenize tourism by introducing a visiting or tourism criterion: foreign tourists will be attracted to a locale until their marginal utility of visiting becomes identical across all destinations. Nevertheless, discussions of endogenous tourism remain absent from the literature. The purpose of this paper is therefore to fill this gap by considering an important question: does the stricter regulation of pollution attract more tourists and hence improve the welfare of domestic residents? Other related issues are also discussed. The remainder of the paper is organized as follows. In Section 2, we employ a generalequilibrium model to investigate the welfare and environmental effects of pollution taxes under exogenous tourism, and the case of endogenous tourism is examined in Section 3. We derive and then compare the optimal pollution tax rates for both cases. Section 4 provides numerical simulations for the effects of pollution taxes on an economy with tourism, and Section 5 concludes the paper.
2. The model with exogenous tourism Consider a small open, perfectly competitive economy that produces two goods, conventional good X and services Y, where good X is internationally traded and good Y is non-traded in the absence of tourism. Let good X be the numeraire, and the relative price of good Y is denoted by p. It is assumed that good Y generates pollution through emissions Z, and it is further assumed that pollution is a byproduct and that one unit of production of good Y emits one unit of pollution Z.3 Because environmental pollution harms consumers, a pollution tax s, which is smaller than p, is imposed on producers. The after-tax revenue function is expressed by R(p, s) = max {X + pY sZ: (X, Y) 2 G(K)}, where K is the given input vector and G() denotes the technology set.4 Using the envelope property, we have Rp(p, s) = Y, representing the supply function of good Y and Rs(p, s) = Z, indicating the level of pollution emissions in the economy. The demand side of the economy is defined by the consumption level of both domestic residents and foreign tourists. The former’s demand for goods X and Y is denoted by CX and CY. Following Schou (2002) and Itaya (2008), the utility function of the domestic residents is represented by constant 2 All quotations are taken from Trade and Tourism in Oman, TED Case Studies, http://gurukul.ucc.american.edu/ted/ omantour.htm. 3 Another way to model pollution is to treat it as a productive factor. See, for example, Yohe (1979), Yu and Ingene (1982), Khan (1996), and Copeland and Taylor (2003). 4 The production structure of general-equilibrium models can be found in Jones (1996, 2003).
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1l ½ðCXa CYb Z r Þ
elasticity preferences: UðC X ; C Y ; ZÞ ¼ 1=ð1 lÞ, where l > 0, l 6¼ 1, r 0 and a + b = 1. Note that l is the elasticity of the marginal utility of consumption and r captures the strength of the disutility of pollution. For a given negative externality from pollution (i.e., UZ < 0),5 the resident expenditure function is E(p, Z, u) = min {CX + pCY: U(CX, CY, Z) = u}, where u is the level of utility. The compensated demand for good Y is Ep(p, Z, u) = CY,6 with Epp < 0 for the negatively sloped demand function. In addition, EZ = rE/Z > 0 represents the marginal damage from pollution as perceived by the residents, or, equivalently, their marginal willingness to pay for reductions in pollution.7 To compensate for the damage caused by pollution, the consumption of good Y must be increased, because EpZ (= @CY/@Z) = rCY/Y > 0. As CY Y for the non-traded good Y, we have EpZ < 1 for the weak externality of pollution (r < 1) and EpZ > 1 if the externality is sufficiently strong (r > Y/CY > 1). Following Copeland (1991) and Hazari and Sgro (2004, Ch. 4), tourists have demand for both conventional goods and non-traded services, which are denoted here by DX and DY, and their utility 1h b function is specified as U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ, where h > 0, h 6¼ 1 and g 0. Pollution Z negatively affects the tourist utility. Given a budget T that they plan to spend in the destination, tourists maximize their utility given the budget constraint, i.e., T = DX + pDY. This yields tourist demands DX = aT and DY = bT/p, and the associated indirect utility function is V*(p, Z, b g h a b T) = [(kTp Z )1 1]/(1 h), where k = a b . It is worth noting that tourism transforms formally non-traded services into exportable goods. An increase in tourism raises the price of these goods, and this results in a terms-of-trade effect on the export of tourism services. Although the destination economy is small in terms of the traditionally traded good, it has monopoly power over the trade of the services that are consumed by tourists. This yields a foreign distortion in the sense that the foreign rate of transformation (FRT) is not equal to the domestic rate of transformation (DRT).8 Utilizing the above information, the equilibrium of the economy under the given budget for tourist expenditures is Eð p; Z; uÞ ¼ Rð p; sÞ þ sZ;
(1)
E p ð p; Z; uÞ þ DY ð p; TÞ ¼ R p ð p; sÞ;
(2)
Rs ð p; sÞ ¼ Z:
(3)
Eq. (1) describes the budget constraint of the economy and shows that expenditure equals revenue adjusted for pollution taxes. Tax revenue, sZ, is refunded to residents in a lump-sum form. Eq. (2) is the market-clearing condition for the non-traded good Y,9 whereas Eq. (3) expresses the level of pollution emissions released in the production process of good Y. For given spending T by tourists, Eqs. (1)–(3) contain three unknowns, u, p and Z, with a tax instrument s. The key variable of interest is the change in the welfare of residents, which can be obtained by totally differentiating Eq. (1) as Eu du ¼ DY d p ðEZ sÞ dZ;
(4)
where Eu > 0 and is the inverse of the marginal utility of income. Two distortions on the right-hand side of Eq. (4) affect welfare: monopoly power over tourism services via the change in the nontradable price p and the pollution externality of the damage EZ. In addition, pollution brings revenue to the government through pollution tax s. Without tourism (DY = 0), the first-best policy for regulating 1r
5 The change in pollution disutility can be captured by U ZZ ¼ r2 ð1 þ 1=r lÞðCXa CYb Z r Þ =Z 2 and thus UZZ = 0 as l = 1 + 1/r. As pointed out in Itaya (2008, p. 1161), the utility function U(CX, CY, Z) does not need to be concave in Z1 (i.e., UZZ < 0) because pollution Z is not a choice variable for consumers. The case of UZZ < 0 is discussed in Michel and Rotillon (1995). r l 6 The resident expenditure function is E(p, Z, u) = (1/b)(a/b)ap1aZ [(1 l)u 1]1/(1 ) and the compensated demands of r l r l residents for goods X and Y are: CX = (a/b)1ap1aZ [(1 l)u 1]1/(1 ) and CY = (a/b)apaZ [(1 l)u 1]1/(1 ). 7 See Copeland (1991) and Hatzipanayotou et al. (2002) for related applications. 8 An offer curve explanation on this distortion is presented in Figure 4.2b of Hazari and Sgro (2004, p. 73). This phenomenon resembles the case of the large-country assumption that ‘‘a country can affect its terms of trade by altering its volume of trade’’ (Bhagwati et al., 1998, p. 289). A foreign distortion thus emerges because DRT 6¼ FRT. 9 Studies on non-traded goods in general-equilibrium settings can be found in Komiya (1967) and Batra (1973, 1984), among others.
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pollution is to set a tax that is equal to its marginal damage as perceived by residents. In the presence of tourism (DY 6¼ 0), however, monopoly power arises over tourism services in the home economy. By transforming non-traded services into exportable ones, tourism generates a terms-of-trade effect even for a small, open economy. Consequently, the traditional result for coping with the negative externality of pollution (i.e., s = EZ) needs to be modified. The terms-of-trade effect that arises from tourism exports in Eq. (4) can be obtained by totally differentiating Eq. (2) as @DY @DY R p p d p ¼ E pu du dT E pZ dZ þ R ps ds; Epp þ (5) p @T where Rpp > 0 for the positively sloped supply function, Epu > 0 because good Y is normal in consumption, and Rps (= @Y/@s) < 0, as the pollution tax raises the cost of producing good Y. Eq. (5) shows that the price of good Y is influenced by demand factors, such as domestic utility (real income) u, tourist spending T and pollution Z, and by supply factors via pollution tax s. We turn next to the change in pollution emissions. From Eq. (3), we obtain dZ ¼ Rs p d p Rss ds;
(6)
where Rss (= @Z/@s) > 0. Because pollution is considered to be a by-product of the production of good Y, a higher price results in more pollution emissions, as stated in the first term on the right-hand side of Eq. (6). In addition, a higher pollution tax lowers the production of good Y and hence less pollution is emitted. By solving the system of Eqs. (4)–(6), we obtain the total effect of the pollution tax on pollution emissions ½ðE p p þ @DY =@ pÞ þ mDY = p dZ ; ¼ Eu Rss J ds
(7)
where m (= pEpu/Eu), the marginal propensity of domestic residents to consume good Y, is between 0 and 1, and J < 0 by stability.10 An increase in the pollution tax directly lowers the production of good Y and hence reduces pollution emissions. However, a fall in the supply of good Y raises its price. This confers a favorable tourism terms-of-trade effect that indirectly increases pollution emissions via a higher level of demand for good Y, as stated in the second term of Eq. (7). These two conflicting forces make the change in pollution Z indeterminate. Nevertheless, due to the unitary price elasticity of tourist demand for good Y (i.e., @DY/@p = DY/p), we obtain dZ/ds = Eu[Epp + (1 m)(@DY/@p)]Rss/ J < 0. We can solve for the price effect of the pollution tax from the system of equations in (4)–(6) as follows ½ð1 E pZ Þ þ ðm= pÞðEZ sÞ dp ¼ Eu R ps : ds J There are production and income effects involved. With regard to the former, the pollution tax reduces the supply of good Y and hence less pollution is emitted. The production effect raises the price of good Y but the income effect lowers it. The reduction in pollution further reduces the damage to residents, but lowers the tax revenue from emissions. This income effect, which is pertinent to the marginal damage and tax revenue from pollution in Eq. (4), depends on the sizes of EZ and s. Nonetheless, by substituting the expressions of EZ = r(E/Z) and EpZ = r(CY/Y), the final solution for dp/ds can be obtained as dp ½C X þ ð p sÞC Y ¼ Eu R ps : ds EJ
(8)
10 Following Dei (1985), the adjustment for the non-tradable price of good Y is p˙ ¼ nGð pÞ, where the dot denotes a time derivative, n is the speed of adjustment and G is the excess demand for good Y, i.e., G = Ep(p, Z, u) + D(p, T) Rp(p, s). From Eqs. (1)–(3), we can solve for u and Z as functions of p for given T and s. A necessary and sufficient condition for stability is dG/ dp < 0. Utilizing Eqs. (4)–(6), we obtain dp/dG = Eu/J, where J = Eu(Epp + @DY/@p Rpp RspEpZ) + Epu[DY + Rsp(EZ s)]. Hence, for stability, we require J < 0.
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As p > s, we have dp/ds > 0. The increase in the pollution tax unambiguously raises the price of good Y. The pollution tax thus brings gains to the resident welfare in Eq. (4): it not only lowers emissions [dZ/ ds < 0 in Eq. (7)], but also confers a favorable terms-of-trade effect on the exports of tourism services [dp/ds > 0 in Eq. (8)]. Using Eqs. (4)–(6), the effect of the pollution tax on resident welfare can be derived as ½ðEZ sÞðE p p þ @DY =@ pÞ DY ð1 E pZ Þ du ¼ Rss : ds J
(9)
Depending on the sizes of EZ and s, the welfare effect of the pollution tax is in general ambiguous. By setting du/ds = 0,11 we find the optimal level of the pollution tax in the exogenous tourism case, as follows12 so ¼
EZ DY ð1 E pZ Þ ; E p p þ @DY =@ p
(10)
by recalling that EZ = rE/Z > 0, Epp < 0, @DY/@p < 0 and EpZ = rCY/Y = 1. The traditional result that is obtained by setting the optimal tax rate so to be equal to EZ for internalizing the pollution externality is valid only when tourism is absent (DY = 0). However, in the presence of tourism (DY > 0), the induced terms-of-trade effect needs to be taken into account. When the pollution tax rate increases, the favorable terms-of-trade effect rises because dp/ds > 0 by Eq. (8). This raises the return on tourism exports and, consequently, boosts the welfare of domestic residents. However, the higher price of the non-traded good increases its production and thus also the level of pollution. The first effect is stronger than the second if the pollution disutility is low enough (EpZ < 1). We then have so > EZ. If the pollution disutility is strong (EpZ > 1), in contrast, then we have so < EZ. Next consider the welfare effect of tourism expansion. By solving Eqs. (4)–(6), the effect of an increase in tourism on the price of good Y is dp ð@DY =@TÞ ¼ Eu > 0; dT J
(11)
where @DY/@T > 0. An increase in tourist expenditure immediately causes an up-shift in the demand for good Y and hence its relative price rises. This price effect has repercussions for the supply of good Y and leads to more emissions from pollution. This can be seen from Eq. (6): dZ dp ¼ Rs p > 0: (12) dT dT Using the terms-of-trade effect on tourism exports in Eq. (11) and the pollution externality effect in Eq. (12), the effect of tourism on the welfare of domestic residents is du dp dZ Eu ¼ DY ðEZ sÞ : (13) dT dT dT In Eq. (13), the terms-of-trade effect of tourism exports is always favorable to residents (Copeland, 1991; Hazari and Sgro, 2004). However, the pollution externality effect is ambiguous and depends on the size of the marginal damage and tax revenue from emissions. By substituting the expressions from Eqs. (11) and (12) into Eq. (13), we obtain du/dT = (@DY/@T)[DY + Rsp(EZ s)]/J. This gives du/ dT > (<) 0 when s + DY/Rpp> (<) EZ. If s > EZ, then the tax-revenue effect is strong. It reinforces the terms-of-trade effect on tourism exports, and thus the welfare gain from tourism expansion is greater. If the tax-revenue effect is not too weak (i.e., EZ DY/Rpp < s < EZ), then an expansion in tourism still improves the welfare of residents through gains in the terms of trade. However, if s < EZ DY/Rpp, then the tax revenue is too small and it provides an inadequate level of support to mitigate the damage 11 Because tourism represents the export of the non-traded goods and services, the home government makes its policy decisions by considering the welfare of residents only. 12 This optimal tax rate maximizes the welfare of residents. Following Neary (1993), the welfare expression in Eq. (4) can be written as Eu(du/ds) = (dZ/ds)(s so), where dZ/ds < 0. Hence, du/ds > (<) 0 when s < (>) so. This indicates that u is maximized at so.
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caused by pollution. In this case, if the environment is extremely mismanaged because of low taxes on emissions, then tourism expansion can decrease resident welfare.13 We summarize the main results obtained under the exogenous tourism scenario, as follows. Proposition 1. In a small, open economy with exogenous inbound tourism and production-generated pollution, a higher pollution tax raises the price of the non-traded good. This results in a favorable termsof-trade effect on the export of tourism services, but the higher non-tradable price has a detrimental impact on the environment. Depending on the weak or strong disutility of pollution, the optimal tax rate is larger or smaller than the marginal damage from pollution as perceived by the residents. In addition, the expansion of tourism can reduce resident welfare if the pollution tax is sufficiently low, but can raise it if the tax rate becomes large enough. 3. Endogenous tourism So far, we have followed the literature (Copeland, 1991; Hazari and Sgro, 2004) by assuming that the expenditure of tourists T is exogenously given. In this section, we relax this assumption by considering endogenous tourism. Specifically, tourists make choices in selecting destinations to visit and, in equilibrium, the marginal utility of the final spending in each destination must be identical and b g h is denoted by v. That is, @V*/@T = v, where V*(p, Z, T) = [(kTp Z )1 1]/(1 h) is the indirect utility function of tourists. This break-even condition of the destination choice gives 1h h
k
T
pbð1hÞ Z g ð1hÞ ¼ v:
(14)
It should be noted that if v can be interpreted as the ‘‘utility’’ of expenditure T, then tourists maximize the function V*(p, Z, T) vT over T to yield the first-order condition described in Eq. (14). Because we consider the local economy only, the reservation level v for visiting another destination is exogenously given. From Eq. (14), the change in tourist expenditure T is dT 1 dp dZ ¼ þg : (15) 1 b T p Z h The price elasticity of tourist spending can be measured by b(1/h 1) in Eq. (15).14 This suggests that the monopoly power of a country over tourism increases when price elasticity decreases. It should be noted that when h ! 1, the changes in environmental quality and the non-tradable price have no impact on tourist spending. The case of endogenous tourism then converges to that of exogenous tourism. Using Eqs. (4)–(6) and (15), the effect of the pollution tax on the price of good Y under the endogenous tourism scenario is fð1 E pZ Þ þ ðm= pÞðEZ sÞ þ Mg dp ¼ hEu R ps ; ds D
(16)
where D < 0 and M = b(T/pZ)g(1/h 1).15 A rise in the pollution tax directly reduces pollution emissions, thereby improving environmental quality. This then influences tourist spending by Eq. (15) and thus yields an additional income effect via term M on the price of the non-traded good in Eq. (16). Analogously, the impact of the pollution tax on pollution emissions can be obtained as E p p þ ð1 mÞð@DY=@ pÞ N dZ ¼ hEu Rss ; ds D 13
(17)
We thank a referee for pointing out this implication of the mismanagement of pollution taxes. 1h b The utility function of foreign tourists is U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ. Letting Dð¼ DaX DbY Þ be the composite h g index of the two goods, an increase in pollution affects tourists’ marginal utility of consumption by UDZ = g (1 h)D Z[1+ (1 h)] = 0 as h = 1. That is, as mentioned in Antoci et al. (2005) and Itaya (2008), goods consumption D and environmental quality Z1 are complements (substitutes) to tourists when h < (>) 1. 15 Note that D = J + Eu[(1 h)/h](@DY/@T){p(@DY/@p) + g(T/Z)Rs} < 0 for stability. 14
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where N = b(T/p2)b(1/h 1). If there is a lot of competition in tourism (i.e., a positive and large b(1/ h 1) in term N), then a greater reduction in pollution emissions is needed to attract tourists. We now consider the welfare effect of the pollution tax under endogenous tourism. From Eqs. (4)– (6) and (15), we have ðEZ sÞðE p p þ @DY =@ p NÞ DY ð1 E pZ þ MÞ du ¼ hRss ; ds D
(18)
Again, depending on the sizes of EZ and s, the welfare effect of the pollution tax in Eq. (18) is indeterminate. By setting du/ds = 0, the optimal level of the pollution tax under endogenous tourism is soo ¼ EZ DY
1 E pZ þ M : E p p þ @DY =@ p N
(19)
The values of soo depend on the magnitudes of b(1/h 1) and g. If tourists do not care about pollution (g = 0), then soo is inversely related to b(1/h 1) in term N and hence is an increasing function of the country’s tourism monopoly power of the country. When this monopoly power is large, the country can raise the pollution tax rates and have higher prices for the non-traded good. However, if g > 0, then the sensitivity of soo to the price elasticity of tourist spending b(1/h 1) is weakened. However, soo increases (decreases) with g when b(1/h 1) > (<) 0. The reason is that if there is a great deal of (less) competition in the tourism market, then the country will try to attract tourists who have a strong (weak) aversion for pollution by increasing (decreasing) the pollution tax. Nonetheless, the comparison between so and soo under the exogenous and endogenous tourism cases is cumbersome. We rely on simulations for this purpose. The above results can be stated as follows. Proposition 2. Under endogenous tourism, tourist expenditure depends on the price of non-traded services and environmental quality. The optimal pollution tax rates increase when the degree of monopoly power over tourism rises. Furthermore, to attract environmentally conscious tourists, then the optimal pollution tax can be higher even when the tourism market is competitive. Finally, from Eq. (15), we can derive the effect of the pollution tax on tourist expenditure dT 1 T dp T dZ ¼ þg : 1 b ds p ds Z ds h
(20)
Because dZ/ds < 0 in (17) for a positive b(1/h 1), better environmental quality gained via higher pollution taxes is indeed effective in attracting environmentally conscious tourists.16 However, this effect can be mitigated by the price effect in the first term of Eq. (20) because the higher price of good Y will have a negative impact on tourist expenditure. Due to the conflicting forces in (20), the overall effect of the pollution tax on tourist expenditure is, in general, ambiguous. Nonetheless, if tourists appreciate the environment with a larger g,17 then stricter pollution regulations can attract more of them. 4. Simulations In this section, we calibrate our results. The production functions are specified as X ¼ ALeX and d Y = B(L LX) , where LX is the labor employment in sector X and L is the labor endowment in the economy. The other production factors are normalized to unity. Note that A and B are the technology factors, and e and d denote the respective labor share in sectors X and Y. Accordingly, the emissions from pollution are given by Z (= Y). Given the goods price p and the pollution tax s, the wage equality yields the equilibrium allocation of labor between sectors: eALXe1 ¼ ð p sÞdBðL LX Þd1 . 1l On the demand side, the utility function of domestic residents is UðC X ; C Y ; ZÞ ¼ ½ðCXa CYb Z r Þ 1= ð1 lÞ, and the allocation of consumption goods gives CX/a = pCY/b. As for tourist demand, the utility 1 h b function of tourists is U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ with DX = aT and DY = bT/p. 16
The elasticity of the marginal utility of consumption by tourists is: ðUD =@DY ÞðDY =UD Þ ¼ h. In a recent survey by the Hong Kong Tourist Association, foreign tourists complained about the poor air quality in Hong Kong. 17
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H. Beladi et al. / Resource and Energy Economics 31 (2009) 39–49 h
h
b
h
g
h
The break-even condition for their destination choices is k1 T p (1 )Z (1 ) = v. Note that tourist expenditure T (= 1/v) is fixed when h ! 1. The model is closed by considering the market-clearing condition for the non-traded good Y and the budget constraint of the economy: CY + DY = Y and X + pY = CX + pCY. We start by setting the values of the parameters and the exogenous variables, which determine the reference equilibrium of the model: A = 1.390, B = 1.793, d = 0.7, e = 0.7, a = a = 1/3, b = b = 2/3, l = 0.9, h = 0.9, g = r = 0.01, L = 10, v = 0.620 and s = 0.3. We assume that tourists and residents have the same preferences. Then, we compute the values of the endogenous variables: X = 3, Y = Z = 7, LX = 3, CX = 4.033, CY = 6.205, p = 1.3, DX = 0.517, DY = 0.795 and T = 1.550.
Fig. 1. Welfare effects of pollution taxes and pollution distaste under exogenous tourism.
Fig. 2. Welfare effect of tourism. Note: To make the figure clearer, we substitute U by 100(U 1.789).
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Fig. 3. Pollution distaste, price sensitivity and optimal pollution taxes.
This simulation model is set up for the case of endogenous tourism. However, when h ! 1, the model converges to the case of exogenous tourism. Therefore, we simulate the model for h = 1. Fig. 1 depicts the effects of the pollution tax on the welfare of domestic residents for parameter g ¼ r, which measures the intensity of the aversion to pollution by tourists and domestic residents, ranging from 0 to 0.10, under T = 1.550. The welfare of domestic residents first rises and then declines with the pollution tax rate. This gives an optimal tax rate of so = 0.396 under exogenous tourism when g = r = 0.01. This optimal tax rate increases with the value of g = r (when this value becomes too high, the constraint s < p ceases to be satisfied). We also drew a series of graphs, not reproduced here, that
Fig. 4. Price sensitivity, reservation utility and optimal pollution taxes.
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show that for any given value of g = r, starting from zero, a rise in the pollution tax raises the goods price p but reduces pollution emissions Z. We turn next to the effect of changes in tourist spending T on the utility of domestic residents. In the case of a low pollution tax rate, as in Eq. (13), an expansion in tourism can be welfare-reducing. This result is confirmed in Fig. 2 by setting s = 0: tourism is immiserizing for low values of T, but becomes beneficial to domestic residents when T is larger. Fig. 3 illustrates the optimal rates of pollution tax soo under endogenous tourism in function of h and g (= r). The values of soo are an increasing function of g and h. This indicates that for h 1, the optimal pollution tax rates are higher when tourism is exogenous than when it is endogenous. For example, when g = r = 0.01, soo is 0.365 as h = 0.8 instead of so = 0.396 as h = 1. This simulation result confirms the outcome obtained in Eq. (19). Fig. 4 illustrates the optimal rates of pollution tax soo under endogenous tourism in function of h and v. The value of soo is still an increasing function of h and is also a decreasing function of the reservation level v. For a given value of h, tourist spending converges to zero when v increases indefinitely. Then, the optimal tax rate converges to the marginal damage from pollution, as perceived by domestic residents: s = EZ = r(CX + pCY)/Z. 5. Conclusions This paper has addressed the issues of pollution taxes, the environment and welfare for a small open economy that has a monopoly power over the trade of goods consumed by foreign tourists. Because tourism represents the export of services, an expansion in tourism brings a gain from the terms of trade. However, this expansion may also induce greater production of the non-traded good, which causes environmental damages. To preserve the environment and attract tourists, pollution regulations are necessary. A pollution tax not only reduces pollution emissions, but also causes a favorable terms-of-trade effect on the exports of tourism services. The optimal tax rates can be greater or less than the marginal damage perceived by residents, depending on the intensity of the pollution disutility. Furthermore, under endogenous tourism, the optimal tax rates increase when the degree of monopoly power over tourism rises. In addition, if a country is attempting to attract environmentally conscious tourists, then the optimal pollution tax can be higher even when the tourism market is competitive. Acknowledgements We thank two anonymous referees for useful comments and suggestions. The usual caveats apply. The work described in this paper was supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project no. CUHK 4603/05H). References Antoci, A., Galeotti, M., Russu, P., 2005. Consumption of private goods as substitutes for environmental goods in an economic growth model. Nonlinear Analysis: Modelling and Control 10, 3–34. Batra, R., 1973. Nontraded goods, factor market distortions, and the gains from trade. American Economic Review 63, 706–713. Batra, R., 1984. Nontraded goods and the metzler paradox: a comment. International Economic Review 25, 763–767. Bhagwati, J.N., Panagariya, A., Srinivasan, T.N., 1998. Lectures on International Trade. The MIT Press, Cambridge. Copeland, B.R., 1991. Tourism, welfare and de-industrialization in a small open economy. Economica 58, 515–529. Copeland, B.R., Taylor, M.S., 2003. Trade and the Environment. Princeton University Press, Princeton. Dei, F., 1985. Voluntary export restraints and foreign investment. Journal of International Economics 19, 305–312. Hatzipanayotou, P., Lahiri, S., Michael, M.S., 2002. Can cross-border pollution reduce pollution? Canadian Journal of Economics 35, 805–818. Hazari, B.R., Sgro, P.M., 2004. Tourism, Trade and National Welfare. Elsevier, Amsterdam. Itaya, J.I., 2008. Can environmental taxation stimulate growth? The role of indeterminancy in endogenous growth models with environmental externalities. Journal of Economic Dynamics and Control 22, 1156–1180. Jones, R.W., 1996. International trade, real wages, and technical progress: the specific-factors model. International Review of Economics and Finance 5, 113–124. Jones, R.W., 2003. Joint outputs and real wage rates. International Review of Economics and Finance 12, 513–516. Khan, M.A., 1996. Free trade and the environment. Journal of International Trade and Economic Development 5, 113–136. Komiya, R., 1967. Non-traded goods and the pure theory of international trade. International Economic Review 8, 132–152.
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Lanza, A., Temple, P., Urga, G., 2003. The implications of tourism specialization in the long run: an economic analysis for 13 OECD economies. Tourism Management 24, 315–321. Michel, P., Rotillon, G., 1995. Disutility of pollution and endogenous growth. Environmental and Resource Economics 6, 279–300. Neary, J.P., 1993. Welfare effects of tariffs and investment taxes. In: Ethier, W.J., et al. (Eds.), Theory, Policy and Dynamics in International Trade. Cambridge University Press, Cambridge. Schou, P., 2002. When environmental policy is superfluous: growth and polluting resources. Scandinavian Journal of Economics 104, 605–620. Sinclair, M.T., Stabler, M.J., 1997. The Economics of Tourism. Routledge, London. World Tourism Organization, 1998. Tourism: 2020 Vision. WTO, Madrid. Yohe, G.W., 1979. The backward incidence of pollution control: some comparative statics in general equilibrium. Journal of Environmental Economics and Management 6, 187–198. Yu, E.S.H., Ingene, C.A., 1982. The backward incidence of pollution control in a rigid-wage economy. Journal of Environmental Economics and Management 9, 304–310.
Contents lists available at ScienceDirect
Resource and Energy Economics journal homepage: www.elsevier.com/locate/ree
Tourism and the environment Hamid Beladi a,*, Chi-Chur Chao b, Bharat R. Hazari c, Jean-Pierre Laffargue d a
Department of Economics, College of Business, University of Texas at San Antonia, 6900 north loop 1604 west, San Antonio, TX 78249-0633, United States Department of Economics, Chinese University of Hong Kong, Shatin, Hong Kong c Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong d University of Paris I and CEPREMAP, Paris, France b
A R T I C L E I N F O
A B S T R A C T
Article history: Received 3 April 2006 Received in revised form 9 June 2008 Accepted 20 October 2008 Available online 5 November 2008
This paper examines the effects of pollution taxes on welfare and environment for a small open economy. In the presence of tourism, pollution taxes provide a double dividend of less pollution and improvements in the tourism terms of trade. The optimal pollution taxes are derived under exogenous and endogenous tourism, and they can be greater or less than the marginal damage of pollution perceived by the domestic residents. Numerical simulations show that the optimal tax rate is larger under exogenous tourism. ß 2008 Elsevier B.V.. All rights reserved.
Keywords: Endogenous tourism optimal pollution taxes
JEL classification: F11 Q38
1. Introduction A recent report issued by the World Tourism Organization (1998) entitled ‘‘Tourism: 2020 Vision’’ analyzed the future of tourism in the twenty-first century. It forecast that 1.5 billion tourists will visit foreign countries annually by the year 2020, spending approximately US$2 trillion per year. This figure represents about three times more tourists than the 663 million recorded in 1999. Tourism transforms locally non-traded goods and services into exports which benefits local communities.1 There are strong incentives to site hotels and build tourist facilities near hotspots to attract and accommodate
* Corresponding author. E-mail address: [email protected] (H. Beladi). 1 See Copeland (1991), Sinclair and Stabler (1997), Lanza et al. (2003), and Hazari and Sgro (2004) for a review of the literature on tourism. 0928-7655/$ – see front matter ß 2008 Elsevier B.V.. All rights reserved. doi:10.1016/j.reseneeco.2008.10.005
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tourists, regardless of the environmental damage that may result. Furthermore, tourism is not usually well-managed from the environmental perspective. Increasing visitor arrivals not only makes the local environment overcrowded, but also causes resources to be overexploited. Consequently, natural habitats are increasingly being destroyed, and more pollution is being generated. It is often questionable whether local communities get enough revenues and other benefits from tourists to outweigh the environmental costs incurred. Many studies have made these points. For example, the TED case studies for Oman found that ‘‘large influxes of tourists could seriously threaten the environment by stressing Oman’s delicate resources, such as water and land, too severely. There is also a cultural impact to consider as Western tourists interact with a Muslim society that had been isolated from the modern world until just 30 years ago. How to balance these tough decisions is what confronts Oman as it tries to develop its tourism sector while maintaining its natural surroundings’’2 (p. 2). This study also concluded that ‘‘the government’s policy then is to proceed slowly, limiting tourist numbers and cautiously adding to existing infrastructure all in an effort to minimize the environmental impact’’ (p. 4). The expansion of world tourism increasingly poses a threat to the environment – particularly if it is not well-planned and managed. If tourism ultimately destroys the environment of a country, then tourists will no longer have a reason to visit it. In this paper, we consider the user-pay principle for managing the environment in an economy with inbound tourism. As a related issue, we also study the policy-induced impact on the degree of tourism. To achieve this, we endogenize tourism by introducing a visiting or tourism criterion: foreign tourists will be attracted to a locale until their marginal utility of visiting becomes identical across all destinations. Nevertheless, discussions of endogenous tourism remain absent from the literature. The purpose of this paper is therefore to fill this gap by considering an important question: does the stricter regulation of pollution attract more tourists and hence improve the welfare of domestic residents? Other related issues are also discussed. The remainder of the paper is organized as follows. In Section 2, we employ a generalequilibrium model to investigate the welfare and environmental effects of pollution taxes under exogenous tourism, and the case of endogenous tourism is examined in Section 3. We derive and then compare the optimal pollution tax rates for both cases. Section 4 provides numerical simulations for the effects of pollution taxes on an economy with tourism, and Section 5 concludes the paper.
2. The model with exogenous tourism Consider a small open, perfectly competitive economy that produces two goods, conventional good X and services Y, where good X is internationally traded and good Y is non-traded in the absence of tourism. Let good X be the numeraire, and the relative price of good Y is denoted by p. It is assumed that good Y generates pollution through emissions Z, and it is further assumed that pollution is a byproduct and that one unit of production of good Y emits one unit of pollution Z.3 Because environmental pollution harms consumers, a pollution tax s, which is smaller than p, is imposed on producers. The after-tax revenue function is expressed by R(p, s) = max {X + pY sZ: (X, Y) 2 G(K)}, where K is the given input vector and G() denotes the technology set.4 Using the envelope property, we have Rp(p, s) = Y, representing the supply function of good Y and Rs(p, s) = Z, indicating the level of pollution emissions in the economy. The demand side of the economy is defined by the consumption level of both domestic residents and foreign tourists. The former’s demand for goods X and Y is denoted by CX and CY. Following Schou (2002) and Itaya (2008), the utility function of the domestic residents is represented by constant 2 All quotations are taken from Trade and Tourism in Oman, TED Case Studies, http://gurukul.ucc.american.edu/ted/ omantour.htm. 3 Another way to model pollution is to treat it as a productive factor. See, for example, Yohe (1979), Yu and Ingene (1982), Khan (1996), and Copeland and Taylor (2003). 4 The production structure of general-equilibrium models can be found in Jones (1996, 2003).
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1l ½ðCXa CYb Z r Þ
elasticity preferences: UðC X ; C Y ; ZÞ ¼ 1=ð1 lÞ, where l > 0, l 6¼ 1, r 0 and a + b = 1. Note that l is the elasticity of the marginal utility of consumption and r captures the strength of the disutility of pollution. For a given negative externality from pollution (i.e., UZ < 0),5 the resident expenditure function is E(p, Z, u) = min {CX + pCY: U(CX, CY, Z) = u}, where u is the level of utility. The compensated demand for good Y is Ep(p, Z, u) = CY,6 with Epp < 0 for the negatively sloped demand function. In addition, EZ = rE/Z > 0 represents the marginal damage from pollution as perceived by the residents, or, equivalently, their marginal willingness to pay for reductions in pollution.7 To compensate for the damage caused by pollution, the consumption of good Y must be increased, because EpZ (= @CY/@Z) = rCY/Y > 0. As CY Y for the non-traded good Y, we have EpZ < 1 for the weak externality of pollution (r < 1) and EpZ > 1 if the externality is sufficiently strong (r > Y/CY > 1). Following Copeland (1991) and Hazari and Sgro (2004, Ch. 4), tourists have demand for both conventional goods and non-traded services, which are denoted here by DX and DY, and their utility 1h b function is specified as U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ, where h > 0, h 6¼ 1 and g 0. Pollution Z negatively affects the tourist utility. Given a budget T that they plan to spend in the destination, tourists maximize their utility given the budget constraint, i.e., T = DX + pDY. This yields tourist demands DX = aT and DY = bT/p, and the associated indirect utility function is V*(p, Z, b g h a b T) = [(kTp Z )1 1]/(1 h), where k = a b . It is worth noting that tourism transforms formally non-traded services into exportable goods. An increase in tourism raises the price of these goods, and this results in a terms-of-trade effect on the export of tourism services. Although the destination economy is small in terms of the traditionally traded good, it has monopoly power over the trade of the services that are consumed by tourists. This yields a foreign distortion in the sense that the foreign rate of transformation (FRT) is not equal to the domestic rate of transformation (DRT).8 Utilizing the above information, the equilibrium of the economy under the given budget for tourist expenditures is Eð p; Z; uÞ ¼ Rð p; sÞ þ sZ;
(1)
E p ð p; Z; uÞ þ DY ð p; TÞ ¼ R p ð p; sÞ;
(2)
Rs ð p; sÞ ¼ Z:
(3)
Eq. (1) describes the budget constraint of the economy and shows that expenditure equals revenue adjusted for pollution taxes. Tax revenue, sZ, is refunded to residents in a lump-sum form. Eq. (2) is the market-clearing condition for the non-traded good Y,9 whereas Eq. (3) expresses the level of pollution emissions released in the production process of good Y. For given spending T by tourists, Eqs. (1)–(3) contain three unknowns, u, p and Z, with a tax instrument s. The key variable of interest is the change in the welfare of residents, which can be obtained by totally differentiating Eq. (1) as Eu du ¼ DY d p ðEZ sÞ dZ;
(4)
where Eu > 0 and is the inverse of the marginal utility of income. Two distortions on the right-hand side of Eq. (4) affect welfare: monopoly power over tourism services via the change in the nontradable price p and the pollution externality of the damage EZ. In addition, pollution brings revenue to the government through pollution tax s. Without tourism (DY = 0), the first-best policy for regulating 1r
5 The change in pollution disutility can be captured by U ZZ ¼ r2 ð1 þ 1=r lÞðCXa CYb Z r Þ =Z 2 and thus UZZ = 0 as l = 1 + 1/r. As pointed out in Itaya (2008, p. 1161), the utility function U(CX, CY, Z) does not need to be concave in Z1 (i.e., UZZ < 0) because pollution Z is not a choice variable for consumers. The case of UZZ < 0 is discussed in Michel and Rotillon (1995). r l 6 The resident expenditure function is E(p, Z, u) = (1/b)(a/b)ap1aZ [(1 l)u 1]1/(1 ) and the compensated demands of r l r l residents for goods X and Y are: CX = (a/b)1ap1aZ [(1 l)u 1]1/(1 ) and CY = (a/b)apaZ [(1 l)u 1]1/(1 ). 7 See Copeland (1991) and Hatzipanayotou et al. (2002) for related applications. 8 An offer curve explanation on this distortion is presented in Figure 4.2b of Hazari and Sgro (2004, p. 73). This phenomenon resembles the case of the large-country assumption that ‘‘a country can affect its terms of trade by altering its volume of trade’’ (Bhagwati et al., 1998, p. 289). A foreign distortion thus emerges because DRT 6¼ FRT. 9 Studies on non-traded goods in general-equilibrium settings can be found in Komiya (1967) and Batra (1973, 1984), among others.
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pollution is to set a tax that is equal to its marginal damage as perceived by residents. In the presence of tourism (DY 6¼ 0), however, monopoly power arises over tourism services in the home economy. By transforming non-traded services into exportable ones, tourism generates a terms-of-trade effect even for a small, open economy. Consequently, the traditional result for coping with the negative externality of pollution (i.e., s = EZ) needs to be modified. The terms-of-trade effect that arises from tourism exports in Eq. (4) can be obtained by totally differentiating Eq. (2) as @DY @DY R p p d p ¼ E pu du dT E pZ dZ þ R ps ds; Epp þ (5) p @T where Rpp > 0 for the positively sloped supply function, Epu > 0 because good Y is normal in consumption, and Rps (= @Y/@s) < 0, as the pollution tax raises the cost of producing good Y. Eq. (5) shows that the price of good Y is influenced by demand factors, such as domestic utility (real income) u, tourist spending T and pollution Z, and by supply factors via pollution tax s. We turn next to the change in pollution emissions. From Eq. (3), we obtain dZ ¼ Rs p d p Rss ds;
(6)
where Rss (= @Z/@s) > 0. Because pollution is considered to be a by-product of the production of good Y, a higher price results in more pollution emissions, as stated in the first term on the right-hand side of Eq. (6). In addition, a higher pollution tax lowers the production of good Y and hence less pollution is emitted. By solving the system of Eqs. (4)–(6), we obtain the total effect of the pollution tax on pollution emissions ½ðE p p þ @DY =@ pÞ þ mDY = p dZ ; ¼ Eu Rss J ds
(7)
where m (= pEpu/Eu), the marginal propensity of domestic residents to consume good Y, is between 0 and 1, and J < 0 by stability.10 An increase in the pollution tax directly lowers the production of good Y and hence reduces pollution emissions. However, a fall in the supply of good Y raises its price. This confers a favorable tourism terms-of-trade effect that indirectly increases pollution emissions via a higher level of demand for good Y, as stated in the second term of Eq. (7). These two conflicting forces make the change in pollution Z indeterminate. Nevertheless, due to the unitary price elasticity of tourist demand for good Y (i.e., @DY/@p = DY/p), we obtain dZ/ds = Eu[Epp + (1 m)(@DY/@p)]Rss/ J < 0. We can solve for the price effect of the pollution tax from the system of equations in (4)–(6) as follows ½ð1 E pZ Þ þ ðm= pÞðEZ sÞ dp ¼ Eu R ps : ds J There are production and income effects involved. With regard to the former, the pollution tax reduces the supply of good Y and hence less pollution is emitted. The production effect raises the price of good Y but the income effect lowers it. The reduction in pollution further reduces the damage to residents, but lowers the tax revenue from emissions. This income effect, which is pertinent to the marginal damage and tax revenue from pollution in Eq. (4), depends on the sizes of EZ and s. Nonetheless, by substituting the expressions of EZ = r(E/Z) and EpZ = r(CY/Y), the final solution for dp/ds can be obtained as dp ½C X þ ð p sÞC Y ¼ Eu R ps : ds EJ
(8)
10 Following Dei (1985), the adjustment for the non-tradable price of good Y is p˙ ¼ nGð pÞ, where the dot denotes a time derivative, n is the speed of adjustment and G is the excess demand for good Y, i.e., G = Ep(p, Z, u) + D(p, T) Rp(p, s). From Eqs. (1)–(3), we can solve for u and Z as functions of p for given T and s. A necessary and sufficient condition for stability is dG/ dp < 0. Utilizing Eqs. (4)–(6), we obtain dp/dG = Eu/J, where J = Eu(Epp + @DY/@p Rpp RspEpZ) + Epu[DY + Rsp(EZ s)]. Hence, for stability, we require J < 0.
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As p > s, we have dp/ds > 0. The increase in the pollution tax unambiguously raises the price of good Y. The pollution tax thus brings gains to the resident welfare in Eq. (4): it not only lowers emissions [dZ/ ds < 0 in Eq. (7)], but also confers a favorable terms-of-trade effect on the exports of tourism services [dp/ds > 0 in Eq. (8)]. Using Eqs. (4)–(6), the effect of the pollution tax on resident welfare can be derived as ½ðEZ sÞðE p p þ @DY =@ pÞ DY ð1 E pZ Þ du ¼ Rss : ds J
(9)
Depending on the sizes of EZ and s, the welfare effect of the pollution tax is in general ambiguous. By setting du/ds = 0,11 we find the optimal level of the pollution tax in the exogenous tourism case, as follows12 so ¼
EZ DY ð1 E pZ Þ ; E p p þ @DY =@ p
(10)
by recalling that EZ = rE/Z > 0, Epp < 0, @DY/@p < 0 and EpZ = rCY/Y = 1. The traditional result that is obtained by setting the optimal tax rate so to be equal to EZ for internalizing the pollution externality is valid only when tourism is absent (DY = 0). However, in the presence of tourism (DY > 0), the induced terms-of-trade effect needs to be taken into account. When the pollution tax rate increases, the favorable terms-of-trade effect rises because dp/ds > 0 by Eq. (8). This raises the return on tourism exports and, consequently, boosts the welfare of domestic residents. However, the higher price of the non-traded good increases its production and thus also the level of pollution. The first effect is stronger than the second if the pollution disutility is low enough (EpZ < 1). We then have so > EZ. If the pollution disutility is strong (EpZ > 1), in contrast, then we have so < EZ. Next consider the welfare effect of tourism expansion. By solving Eqs. (4)–(6), the effect of an increase in tourism on the price of good Y is dp ð@DY =@TÞ ¼ Eu > 0; dT J
(11)
where @DY/@T > 0. An increase in tourist expenditure immediately causes an up-shift in the demand for good Y and hence its relative price rises. This price effect has repercussions for the supply of good Y and leads to more emissions from pollution. This can be seen from Eq. (6): dZ dp ¼ Rs p > 0: (12) dT dT Using the terms-of-trade effect on tourism exports in Eq. (11) and the pollution externality effect in Eq. (12), the effect of tourism on the welfare of domestic residents is du dp dZ Eu ¼ DY ðEZ sÞ : (13) dT dT dT In Eq. (13), the terms-of-trade effect of tourism exports is always favorable to residents (Copeland, 1991; Hazari and Sgro, 2004). However, the pollution externality effect is ambiguous and depends on the size of the marginal damage and tax revenue from emissions. By substituting the expressions from Eqs. (11) and (12) into Eq. (13), we obtain du/dT = (@DY/@T)[DY + Rsp(EZ s)]/J. This gives du/ dT > (<) 0 when s + DY/Rpp> (<) EZ. If s > EZ, then the tax-revenue effect is strong. It reinforces the terms-of-trade effect on tourism exports, and thus the welfare gain from tourism expansion is greater. If the tax-revenue effect is not too weak (i.e., EZ DY/Rpp < s < EZ), then an expansion in tourism still improves the welfare of residents through gains in the terms of trade. However, if s < EZ DY/Rpp, then the tax revenue is too small and it provides an inadequate level of support to mitigate the damage 11 Because tourism represents the export of the non-traded goods and services, the home government makes its policy decisions by considering the welfare of residents only. 12 This optimal tax rate maximizes the welfare of residents. Following Neary (1993), the welfare expression in Eq. (4) can be written as Eu(du/ds) = (dZ/ds)(s so), where dZ/ds < 0. Hence, du/ds > (<) 0 when s < (>) so. This indicates that u is maximized at so.
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caused by pollution. In this case, if the environment is extremely mismanaged because of low taxes on emissions, then tourism expansion can decrease resident welfare.13 We summarize the main results obtained under the exogenous tourism scenario, as follows. Proposition 1. In a small, open economy with exogenous inbound tourism and production-generated pollution, a higher pollution tax raises the price of the non-traded good. This results in a favorable termsof-trade effect on the export of tourism services, but the higher non-tradable price has a detrimental impact on the environment. Depending on the weak or strong disutility of pollution, the optimal tax rate is larger or smaller than the marginal damage from pollution as perceived by the residents. In addition, the expansion of tourism can reduce resident welfare if the pollution tax is sufficiently low, but can raise it if the tax rate becomes large enough. 3. Endogenous tourism So far, we have followed the literature (Copeland, 1991; Hazari and Sgro, 2004) by assuming that the expenditure of tourists T is exogenously given. In this section, we relax this assumption by considering endogenous tourism. Specifically, tourists make choices in selecting destinations to visit and, in equilibrium, the marginal utility of the final spending in each destination must be identical and b g h is denoted by v. That is, @V*/@T = v, where V*(p, Z, T) = [(kTp Z )1 1]/(1 h) is the indirect utility function of tourists. This break-even condition of the destination choice gives 1h h
k
T
pbð1hÞ Z g ð1hÞ ¼ v:
(14)
It should be noted that if v can be interpreted as the ‘‘utility’’ of expenditure T, then tourists maximize the function V*(p, Z, T) vT over T to yield the first-order condition described in Eq. (14). Because we consider the local economy only, the reservation level v for visiting another destination is exogenously given. From Eq. (14), the change in tourist expenditure T is dT 1 dp dZ ¼ þg : (15) 1 b T p Z h The price elasticity of tourist spending can be measured by b(1/h 1) in Eq. (15).14 This suggests that the monopoly power of a country over tourism increases when price elasticity decreases. It should be noted that when h ! 1, the changes in environmental quality and the non-tradable price have no impact on tourist spending. The case of endogenous tourism then converges to that of exogenous tourism. Using Eqs. (4)–(6) and (15), the effect of the pollution tax on the price of good Y under the endogenous tourism scenario is fð1 E pZ Þ þ ðm= pÞðEZ sÞ þ Mg dp ¼ hEu R ps ; ds D
(16)
where D < 0 and M = b(T/pZ)g(1/h 1).15 A rise in the pollution tax directly reduces pollution emissions, thereby improving environmental quality. This then influences tourist spending by Eq. (15) and thus yields an additional income effect via term M on the price of the non-traded good in Eq. (16). Analogously, the impact of the pollution tax on pollution emissions can be obtained as E p p þ ð1 mÞð@DY=@ pÞ N dZ ¼ hEu Rss ; ds D 13
(17)
We thank a referee for pointing out this implication of the mismanagement of pollution taxes. 1h b The utility function of foreign tourists is U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ. Letting Dð¼ DaX DbY Þ be the composite h g index of the two goods, an increase in pollution affects tourists’ marginal utility of consumption by UDZ = g (1 h)D Z[1+ (1 h)] = 0 as h = 1. That is, as mentioned in Antoci et al. (2005) and Itaya (2008), goods consumption D and environmental quality Z1 are complements (substitutes) to tourists when h < (>) 1. 15 Note that D = J + Eu[(1 h)/h](@DY/@T){p(@DY/@p) + g(T/Z)Rs} < 0 for stability. 14
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where N = b(T/p2)b(1/h 1). If there is a lot of competition in tourism (i.e., a positive and large b(1/ h 1) in term N), then a greater reduction in pollution emissions is needed to attract tourists. We now consider the welfare effect of the pollution tax under endogenous tourism. From Eqs. (4)– (6) and (15), we have ðEZ sÞðE p p þ @DY =@ p NÞ DY ð1 E pZ þ MÞ du ¼ hRss ; ds D
(18)
Again, depending on the sizes of EZ and s, the welfare effect of the pollution tax in Eq. (18) is indeterminate. By setting du/ds = 0, the optimal level of the pollution tax under endogenous tourism is soo ¼ EZ DY
1 E pZ þ M : E p p þ @DY =@ p N
(19)
The values of soo depend on the magnitudes of b(1/h 1) and g. If tourists do not care about pollution (g = 0), then soo is inversely related to b(1/h 1) in term N and hence is an increasing function of the country’s tourism monopoly power of the country. When this monopoly power is large, the country can raise the pollution tax rates and have higher prices for the non-traded good. However, if g > 0, then the sensitivity of soo to the price elasticity of tourist spending b(1/h 1) is weakened. However, soo increases (decreases) with g when b(1/h 1) > (<) 0. The reason is that if there is a great deal of (less) competition in the tourism market, then the country will try to attract tourists who have a strong (weak) aversion for pollution by increasing (decreasing) the pollution tax. Nonetheless, the comparison between so and soo under the exogenous and endogenous tourism cases is cumbersome. We rely on simulations for this purpose. The above results can be stated as follows. Proposition 2. Under endogenous tourism, tourist expenditure depends on the price of non-traded services and environmental quality. The optimal pollution tax rates increase when the degree of monopoly power over tourism rises. Furthermore, to attract environmentally conscious tourists, then the optimal pollution tax can be higher even when the tourism market is competitive. Finally, from Eq. (15), we can derive the effect of the pollution tax on tourist expenditure dT 1 T dp T dZ ¼ þg : 1 b ds p ds Z ds h
(20)
Because dZ/ds < 0 in (17) for a positive b(1/h 1), better environmental quality gained via higher pollution taxes is indeed effective in attracting environmentally conscious tourists.16 However, this effect can be mitigated by the price effect in the first term of Eq. (20) because the higher price of good Y will have a negative impact on tourist expenditure. Due to the conflicting forces in (20), the overall effect of the pollution tax on tourist expenditure is, in general, ambiguous. Nonetheless, if tourists appreciate the environment with a larger g,17 then stricter pollution regulations can attract more of them. 4. Simulations In this section, we calibrate our results. The production functions are specified as X ¼ ALeX and d Y = B(L LX) , where LX is the labor employment in sector X and L is the labor endowment in the economy. The other production factors are normalized to unity. Note that A and B are the technology factors, and e and d denote the respective labor share in sectors X and Y. Accordingly, the emissions from pollution are given by Z (= Y). Given the goods price p and the pollution tax s, the wage equality yields the equilibrium allocation of labor between sectors: eALXe1 ¼ ð p sÞdBðL LX Þd1 . 1l On the demand side, the utility function of domestic residents is UðC X ; C Y ; ZÞ ¼ ½ðCXa CYb Z r Þ 1= ð1 lÞ, and the allocation of consumption goods gives CX/a = pCY/b. As for tourist demand, the utility 1 h b function of tourists is U ðDX ; DY ; ZÞ ¼ ½ðDaX DY Z g Þ 1=ð1 hÞ with DX = aT and DY = bT/p. 16
The elasticity of the marginal utility of consumption by tourists is: ðUD =@DY ÞðDY =UD Þ ¼ h. In a recent survey by the Hong Kong Tourist Association, foreign tourists complained about the poor air quality in Hong Kong. 17
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h
b
h
g
h
The break-even condition for their destination choices is k1 T p (1 )Z (1 ) = v. Note that tourist expenditure T (= 1/v) is fixed when h ! 1. The model is closed by considering the market-clearing condition for the non-traded good Y and the budget constraint of the economy: CY + DY = Y and X + pY = CX + pCY. We start by setting the values of the parameters and the exogenous variables, which determine the reference equilibrium of the model: A = 1.390, B = 1.793, d = 0.7, e = 0.7, a = a = 1/3, b = b = 2/3, l = 0.9, h = 0.9, g = r = 0.01, L = 10, v = 0.620 and s = 0.3. We assume that tourists and residents have the same preferences. Then, we compute the values of the endogenous variables: X = 3, Y = Z = 7, LX = 3, CX = 4.033, CY = 6.205, p = 1.3, DX = 0.517, DY = 0.795 and T = 1.550.
Fig. 1. Welfare effects of pollution taxes and pollution distaste under exogenous tourism.
Fig. 2. Welfare effect of tourism. Note: To make the figure clearer, we substitute U by 100(U 1.789).
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Fig. 3. Pollution distaste, price sensitivity and optimal pollution taxes.
This simulation model is set up for the case of endogenous tourism. However, when h ! 1, the model converges to the case of exogenous tourism. Therefore, we simulate the model for h = 1. Fig. 1 depicts the effects of the pollution tax on the welfare of domestic residents for parameter g ¼ r, which measures the intensity of the aversion to pollution by tourists and domestic residents, ranging from 0 to 0.10, under T = 1.550. The welfare of domestic residents first rises and then declines with the pollution tax rate. This gives an optimal tax rate of so = 0.396 under exogenous tourism when g = r = 0.01. This optimal tax rate increases with the value of g = r (when this value becomes too high, the constraint s < p ceases to be satisfied). We also drew a series of graphs, not reproduced here, that
Fig. 4. Price sensitivity, reservation utility and optimal pollution taxes.
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show that for any given value of g = r, starting from zero, a rise in the pollution tax raises the goods price p but reduces pollution emissions Z. We turn next to the effect of changes in tourist spending T on the utility of domestic residents. In the case of a low pollution tax rate, as in Eq. (13), an expansion in tourism can be welfare-reducing. This result is confirmed in Fig. 2 by setting s = 0: tourism is immiserizing for low values of T, but becomes beneficial to domestic residents when T is larger. Fig. 3 illustrates the optimal rates of pollution tax soo under endogenous tourism in function of h and g (= r). The values of soo are an increasing function of g and h. This indicates that for h 1, the optimal pollution tax rates are higher when tourism is exogenous than when it is endogenous. For example, when g = r = 0.01, soo is 0.365 as h = 0.8 instead of so = 0.396 as h = 1. This simulation result confirms the outcome obtained in Eq. (19). Fig. 4 illustrates the optimal rates of pollution tax soo under endogenous tourism in function of h and v. The value of soo is still an increasing function of h and is also a decreasing function of the reservation level v. For a given value of h, tourist spending converges to zero when v increases indefinitely. Then, the optimal tax rate converges to the marginal damage from pollution, as perceived by domestic residents: s = EZ = r(CX + pCY)/Z. 5. Conclusions This paper has addressed the issues of pollution taxes, the environment and welfare for a small open economy that has a monopoly power over the trade of goods consumed by foreign tourists. Because tourism represents the export of services, an expansion in tourism brings a gain from the terms of trade. However, this expansion may also induce greater production of the non-traded good, which causes environmental damages. To preserve the environment and attract tourists, pollution regulations are necessary. A pollution tax not only reduces pollution emissions, but also causes a favorable terms-of-trade effect on the exports of tourism services. The optimal tax rates can be greater or less than the marginal damage perceived by residents, depending on the intensity of the pollution disutility. Furthermore, under endogenous tourism, the optimal tax rates increase when the degree of monopoly power over tourism rises. In addition, if a country is attempting to attract environmentally conscious tourists, then the optimal pollution tax can be higher even when the tourism market is competitive. Acknowledgements We thank two anonymous referees for useful comments and suggestions. The usual caveats apply. The work described in this paper was supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project no. CUHK 4603/05H). References Antoci, A., Galeotti, M., Russu, P., 2005. Consumption of private goods as substitutes for environmental goods in an economic growth model. Nonlinear Analysis: Modelling and Control 10, 3–34. Batra, R., 1973. Nontraded goods, factor market distortions, and the gains from trade. American Economic Review 63, 706–713. Batra, R., 1984. Nontraded goods and the metzler paradox: a comment. International Economic Review 25, 763–767. Bhagwati, J.N., Panagariya, A., Srinivasan, T.N., 1998. Lectures on International Trade. The MIT Press, Cambridge. Copeland, B.R., 1991. Tourism, welfare and de-industrialization in a small open economy. Economica 58, 515–529. Copeland, B.R., Taylor, M.S., 2003. Trade and the Environment. Princeton University Press, Princeton. Dei, F., 1985. Voluntary export restraints and foreign investment. Journal of International Economics 19, 305–312. Hatzipanayotou, P., Lahiri, S., Michael, M.S., 2002. Can cross-border pollution reduce pollution? Canadian Journal of Economics 35, 805–818. Hazari, B.R., Sgro, P.M., 2004. Tourism, Trade and National Welfare. Elsevier, Amsterdam. Itaya, J.I., 2008. Can environmental taxation stimulate growth? The role of indeterminancy in endogenous growth models with environmental externalities. Journal of Economic Dynamics and Control 22, 1156–1180. Jones, R.W., 1996. International trade, real wages, and technical progress: the specific-factors model. International Review of Economics and Finance 5, 113–124. Jones, R.W., 2003. Joint outputs and real wage rates. International Review of Economics and Finance 12, 513–516. Khan, M.A., 1996. Free trade and the environment. Journal of International Trade and Economic Development 5, 113–136. Komiya, R., 1967. Non-traded goods and the pure theory of international trade. International Economic Review 8, 132–152.
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