DEVELOPMENT AND INVESTMETN POLICY IN TOURISM

DEVELOPMENT AND
INVESTMENT POLICY
IN TOURISM

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 DEVELOPMENT AND INVESTMETN POLICY IN TOURISM

DEVELOPMENT AND INVESTMENT POLICY IN TOURISM

The volume of international travel and its importance in world trade flows, together with increasing
demands from the domestic population for leisure and recreation, make tourism an investment
opportunity that few countries can afford to ignore. For many governments, the roots of their tourism
policy lie in balance of payments considerations. The prize is the foreign tourist, who on average, stays
longer and spends several times more than his domestic counterpart, and is seen as a ready source of
foreign exchange. Most developing countries are pressured into earning foreign exchange in order to
service their debts. Faced with limitations in their traditional exports, the attractiveness of tourism as a
fast earner of foreign exchange is obvious.

Any decision as to the appropriate investment policy depends on the interested parties and the
prevailing economic philosophy. On the one hand, there is the private sector which may have been
reasons for investing in tourism, but in general must be concerned with the viability of the investment in
terms of generating adequate returns on capital employed or returns to owner’s equity. On the other
hand, the degree of involvement of the government sector in tourism will depend upon how society
decides on the dividing line between public and private provision. Those who argue for the market
mechanism as the sole arbiter in the allocation of resources for tourism are ignoring the lessons of
history and are grossly oversimplifying the nature of the product. In the United Kingdom, for example,
the growth of the seaside resorts during the nineteenth century was as a result of a partnership
between the public and private sectors. The local authorities invested in the promenades, piers,
gardens, and so on, while the private sector developed the revenue-earning activities which enhanced
the income of the area and in turn increased property tax receipts for the authorities.

Tourism is a multifaceted product: it includes accommodation, transport, restaurants, shopping

facilities, attractions, entertainment, public infrastructure support, and the general way of life of the
host community. Embodied in the tourist product are goods and services which are unlikely to be
provided in sufficient quantity by the market mechanism. These are known as public goods: items which
everyone can enjoy in common and are equally available to all. Their principal feature is that they are
non-exclusive. If the good or service is to be provided at all, it may be consumed by everybody without
exception, and usually without charge at the point of use. The single-minded pursuit of profit may be
self-defeating, as several Mediterranean resorts have found to their cost. The outcome may not be the
integrated tourism development which distils the essence of the country in its design, but rather
crowded, overbuilt and placeless environment with polluted beaches.

The major hotel developments that took in the resorts of southern Spain during the 1960s and early
1970s were completed under laissez-faire expansionism with little consideration given to planning or
control. In general, the public infrastructure was overloaded and this has only been put in the second
half of the 1980s. New moves are now taking place to refurbish the resort centers to give more ‘green’
space in the form of parks and gardens. What is clear is that the complex structure of the product lends
itself to the fact that in any tourism development program, there is often a marked difference between
private and social benefits and cost.

The precise nature of a country’s stance on tourism investment is determined by the kind of
development the government is looking for and what role it envisages for the private entrepreneur. In
the past, much of the emphasis of Eastern European countries was on social tourism which allowed the
population to benefit from subsidized holidays through workers’ organizations and central government

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provision. Currency movements were arranged on a country to country basis through the form of
bilateral swaps. The success criteria were based on visitor numbers, and most tourist facilities were
heavily subsidized. This is now changing, and the influx of Western visitors, as for example in Hungary,
has tended to price Eastern European tourists out of the market.

African countries have recognized the importance of tourism for conservation. By giving wildlife an
economic value, funds are generated to support game reserves, preserve endangered species, and help
eradicate poaching. Many Caribbean countries have strong views about the wisdom of developing
casinos for tourists – because of the possibility of criminal involvement and also on moral grounds.

BENEFITS

Generally speaking, economics form the basis of nearly all tourism development plans. Within the
economic framework, there are three themes which are continually given prominence:

 Foreign exchange: tourism is a ‘cash’ business and so is an activity which is a fast earner of
foreign exchange.
 Employment creation: the variety of tourist spending is seen to have important spill-over effects
which, through job creation, spread the benefit of tourism growth as widely as possible.
 Regional development: tourism has been made to work in areas where there are few
opportunities for alternative forms of employment.

IMPLEMENTATION

To achieve these benefits, governments have to put forward an investment policy which is inviting to
developers and investors. In situation where there is a clear commercial profit potential, the
government may only be required to demonstrate a commitment of tourism by:

 Marketing and promoting the region, particularly abroad.

 Giving advice and information to prospective developers.
 Simplifying planning procedures.
 Initiating liberal transport policies, especially air access.
 Easing frontier formalities.
 Giving guarantees on investment security, e.g. repatriation of capital and earnings.

Where the social rate of return to tourism projects is greater than the assigned public sector discount
rate, but private rates are inadequate, governments will need to give financial incentives to investors to
encourage the desired pattern of tourism development. The extreme cast is where governments
themselves set up a tourist development corporation and invest directly in revenue-earning activities
such as hotels which are traditionally regarded as the preserve of the private sector. Examples around
the world include New Zealand, Malaysia, India, Egypt and many African countries, but the rising trend
towards market economics during the 1980s led states increasingly to divest themselves of trading
operations which could be undertaken by the commercial sector. To counter this, there has been a
growing concern for the environment and the concept of sustainable tourism. Given that tourist

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movements will increase both nationally and internationally, there will be a need for more regulation
and improved management of tourism resources to prevent environmental degradation. Large enclave
‘resortscapes’ which meet most tourists’ wishes will, in the long run, prove to be the most
environmentally friendly.

FINANCIAL INCENTIVES

International competition to obtain foreign investment is such that countries can become trapped in a
bidding process to secure clients. As a consequence, the variety of financial incentives multiplies,
together with an escalation in the rates of benefit, without any true consideration of the cost to the
economy, and the need for them in relation to the quality of the natural resource elements of the
tourist product on offer. The result of this bidding-up incentives may be that too much money is given
away when all that is required is an answer to the question ‘Will this project not go ahead if financial
support or the equivalent benefits in kind are not forthcoming?’ The implication of this question is an
ideal situation where all incentives are discretionary and therefore offered selectively. The legislation
would be fairly general, empowering the ministry responsible for tourism to offer loans, grants, tax
exemptions, and equity investment as it saw fit. The granting of incentives to prospective developers
would be in accordance with ministerial guidance. The latter should be regularly reviewed in response to
the level of tourism activity. Such guidelines might include the following:

 Location of the project.

 Bias towards projects which lengthen the tourist season, e.g. all-weather pools.
 Preference for projects which enhance the overall tourist package offered by an area rather
than competing with existing operations.
 Reserving some kinds of projects for local investors.
 Favouring specific projects, e.g. holiday villages, farm tourism, theme parks, craft centers,
leisure complexes, and health spas.
 Appropriate ceilings on the level of financial benefits available.

To have only discretionary incentives, however, is a counsel of perfection. Competition for tourism
investment frequently requires countries to legislate for automatic financial help in order to attract
investors in the first instance. This financial help falls into two categories:

 Reduction of capital costs: these include capital grants or loans at preferential rates, interest
rate relief, a moratorium on capital repayments for a certain number of years, provision of
infrastructure, provision of land on concessional terms, tariff exemption on construction
materials, and equity participation.
 Reduction of operating costs: to improve operating viability, governments may grant tax
‘holidays’ (five to ten years), give a labor or training subsidy, offer tariff exemption on materials
and supplies, provide special depreciation allowances, and ensure that there is double taxation
or unilateral relief.

Some countries may legislate for all incentives outline above; others for a subset of them. The
appropriateness of the various financial incentives available depends on understanding the nature of the
business risk and the likely returns of the tourist industry, as well as the ability of the country to afford
them. Thus, developing countries may find themselves in no position to offer grants or cheap loans. It is

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well known that part of the business risk in tourism projects lies in the fact that services are non-
storable (a hotel bed unsold is lost forever) and in demand being generally seasonal. This implies that
peak demand determines capacity, so that the industry is always facing excess capacity at other times.

Not always apparent is the dominant cost structure in the industry. Typically, tourist projects have a high
operating leverage, i.e. a high level of fixed costs arising out of the initial capital investment and low
operating costs. This makes pricing difficult, because operating costs are no longer a reliable guide as to
what to charge, and also result in businesses which are very sensitive to variations in demand. The
problem is illustrated in Figure 1.

Revenue costs
R
C2

Profit
C1
BEP

Loss

Q1 Q2 Q3 Quantity

Figure 1. Effects of operating leverage

Two projects are assumed to have exactly the same revenue line (R) and break-even point (BEP).
However, one project has a high operating leverage as shown by the cost line C1, and the other a low
operating leverage represented by C2. The possible outcomes of these two projects are shown by Q1,
Q2, and Q3. Suppose Q3 sales are achieved, then it is clear that the project with the high operating
leverage makes substantial more profit (represented by the difference between the revenue and cost
schedules) than the other. On the other hand, if the outcome is Q1 sales, then the project with the cost
structure C1 will make large losses. Thus, a 1 percent variation in load factors on aircraft may be critical
to the profitability of tour operators, and when things do go wrong, the consequences are often
spectacular: the nightmare scenario for governments is where a major tour operator collapses, either
depriving its millions of customers of previously arranged holidays or leaving them stranded abroad.

In addition to the above, tourism at the destination end deals, perhaps more than any other industry,
with the development of real estate. But the non-transferability of assets such as hotels hinders their
worth as a property investment. The upshot of this is that tourism projects are known to be risky
investments and the preferred form of financial incentives are those which reduce capital costs. The
most common are grants and loans: grants have an immediate impact on the investment funding and
are relatively simple to administer. Loans require a more elaborate administrative structure and need to

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be long term, for in tourism a healthy trading profit does not necessarily mean ability to service the debt
structure of the enterprise. Thus, there is a requirement to consider creative forms of debt finance, for
example, ‘balloon’ loans in which the principal is paid back towards the end of the loan term so as to
give greater freedom of operation at the early stages of the project’s life.

NEGATIVE FACTORS

What follows can be taken as a matter of common sense, but when the actions of many governments
with regard to overseas investors are considered, it is surprising how uncommon sense tends to be. It is
taken as axiomatic that investment funds should be secure, but political turmoil in many countries
prohibits this. Disincentives to invest may be placed under the following headings:

 Administrative : these would include bureaucratic delays in receiving necessary permissions and
the benefits of incentive schemes, discrimination, complex custom procedures, and
inconsistency of treatment.
 Legal : deterrent effects may rise from frequent changes or modifications in commercial law,
petty regulations such as the requirement to hold numerous operating licenses, restrictive work
permit practices for key staff, employment protection laws, and inappropriate import licensing
design to protect local suppliers or save foreign exchange.
 Financial : typically this would refer to cost influences such as excessive or inappropriate
taxation designed t recover in the form of indirect taxation that which is given away through
direct taxation, high costs associated with labor, utilities, purchases, construction, and
marketing, and financial risks imposed by threats of non-convertibility or devaluation.
 Structural : such aspects cover the suitability of the economic and social organization of the
country for tourism development. For example, attitudes to foreign investors, limited capital
market, small domestic market, inadequate air access, poor and unreliable infrastructure and
support services, a lack of trained labor and training facilities, hostile attitudes to visitors and so
on.

CONCLUSION

A country’s investment policy with regard to tourism depends on the development objectives of the
government. The authorities should decide upon the structure of the industry they would like to see and
set policy instruments accordingly. The focus of investment incentives should be on the capital structure
of projects and on encouraging a secure economic and political climate for developers. Incentives to
reduce operating costs may be considered secondary in importance.

FOCUS ON SMALL BUSINESS

The investment legislation of many countries is aimed at attracting international investors, although it
may be equally applicable to the domestic market. Small, local businesses may be offered preferential
rates of benefit, particularly as they form the dominant economic unit in the industry.

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Raising commercial finance for small businesses is always difficult because their asset backing is limited
and they often lack managerial expertise. On the other hand, owner-managers frequently see the
enterprise as a way of life and are prepared to sacrifice returns to equity to insure that the operation
does not founder. The tourist authorities can play a key role: they may act as a catalyst by pump-priming
the project through cash grants, by expressing confidence in the project and in so doing stimulating the
flow of commercial funds, and by giving or obtaining expert advice and training. On the basis that the
authorities are acting as lenders of the last resort so as to maximize the leverage on public funds, i.e.
the ratio of private to public capital, grants are preferable to loans since by this stage the debt burden
on the small business is already likely to be severe.

By definition, individual disbursements to small operators will not be large. It is important, therefore,
that any grant as a percentage of the capital cost should not fall to a point where it is not worthwhile
putting in an application form. The threshold is considered to be around 20 percent. Further, because
the sums involved are relatively small, it is possible to streamline aid procedures and the
documentation.

REVIEW QUESTIONS

1. Who are the interested parties in the decision making of investment policy in tourism? How do
they affect the development in tourism?
2. What are the three (3) main economic benefits of tourism? Explain each.
3. How do the government demonstrate their commitment to tourism in order to attract
investors?
4. How do the government attract private investors? What are other possible financial help they
can give to the investors?

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