IMPACT OF FOREIGN DIRECT INVESTMENT IN TOURISM ON ECONOMIC GROWTH IN DEVELOPING COUTRIES

7/27/2019 IMPACT OF FOREIGN DIRECT INVESTMENT IN TOURISM ON ECONOMIC GROWTH IN DEVELOPING COUTRIES

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JOE PERI, Ph.D., Full ProfessorMAJA NIKI RADI, B.Sc., Assistent

Faculty of Tourism and Hospitality Management, University of Rijeka

IMPACT OF FOREIGN DIRECT INVESTMENT IN TOURISM

ON ECONOMIC GROWTH IN DEVELOPING COUTRIES

The share of services in world trade and investment has been increasing. Over the past twodecades, the service sector has expanded rapidly and has come to play an increasinglyimportant role in national economies and in the international economy. The structure offoreign direct investment worldwide has also shifted towards services. In the context of thiswork it is necessary to emphasize that tourism is major service industry. Many developingcountries are looking to tourism and tourism foreign direct investment as a promising av-enue for economic and human sustainable development. But, it must be kept in mind thatFDI in tourism, as well as in every other sector, has two sides, positive and negative.

Key words: service sector, foreign direct investment, foreign direct investment in tourism,economic growth

INTRODUCTION

It is generally recognized that foreign direct investment plays a significant rolein economic development because it is accepted as an important vehicle for the transferof technology, especially for developing countries. It is possible to say that foreigndirect investment is as an engine of economic growth and development. A largenumber of developing countries have placed the attraction of FDI as one of their top

economic priorities. The structure of foreign direct investment worldwide has shiftedtowards services. In the context of this work it is necessary to emphasize that tourism ismajor service industry and it is a priority sector in an increasing number of developingcountries economic strategies. In spite of the growing internationalization of services,there exists very limited literature on the conceptual framework for FDI in services;especially FDI is tourism, and its implications for the developing counties. Accordingto this, the main objective of this paper is to provide some conceptual issues about FDIin tourism and their impact on the developing counties.


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1. SIGNIFICANCE OF FOREIGN DIRECT INVESTMENT

Foreign direct investments have an important and essential role in thedevelopment of the world and individual national economies. The importance of FDIfor development has dramatically increased in recent years. FDI is now considered to

be an instrument through which economies are being integrated at the level ofproduction into the globalizing world economy by bringing a package of assets,including capital, technology, managerial capacities and skills, and access to foreignmarkets.1 FDI is considered a vehicle through which new ideas, advanced techniques,technology and skills are transferred across borders hence provide substantial spillovereffects.

The idea to produce abroad goes back a long way. Several activities similar tonowadays FDI took place in the past. But the real evolution of world FDI inflows

began with the second half of 20th century.FDI inflows grew due to the following factors:2

removal of trade barriers in the last three decades; dramatic political and economic changes in many developing countries; globalization.

Figure 1: FDI inflows, global and by group of countries, 19802009 (Billions ofdollars)

Source: World Investment Report 2009

1A Partnership for Growth and Development, UNCTAD, 1996., p. 14

2 Peri, J.,Europska unija i izravna strana ulaganja: trendovi, odnosi, uinci, Fintrade & Tours: "Adami",Rijeka, 1999, p. 65


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Global FDI inflows record a significant growth during the period 1980-2008.FDI began it strong growth in 1980 and intensified it till the end of 20th century. Afteruninterrupted growth in FDI activity till 2000, global FDI inflows fell in the period20012004. FDI inflows begins its growth again 2005th and since then recorded aconstant growth.

1.1. Sectoral composition of FDI

Just as there is a distinct geographical concentration of the countries supplyingand receiving FDI, so is there a marked difference in the sectoral composition in whichFDI entering. Nations rich in natural resources, but will small populations (like Canada,Australia, Middle Eastern and some African countries), tend to attract a higher

percentage of inward investment in the primary sector. Industrial or industrialisingcountries (Germany, Japan, South Korea, Singapore, China and Mexico) attract anabove-average share of inward investment in secondary sector. The US, the UK,France, Switzerland, Hong Kong (China) and Fiji record the highest share of tertiaryinvestments.3

FDI has grown over time in all three economic sectors primary,manufacturing and services. But the sectoral composition has shifted towards services.According to Figure, it is obviously that FDI is increasingly shifting towards servicesin all the countries. The global stock of both inward and outward FDI in the primarysector more than doubled between 1990 and 2002.4 The primary sectors share in worldFDI stock decreased noticeably from 9% in 1990 to 6% in 2002.5Stated result fromslower FDI growth in primary sector than in manufacturing and services. Themanufacturing share in world FDI stock rose nearly threefold during the period 1990

2002.6Its share in global FDI stock worldwide fell from 42% in 1990 to 34% in 2002.In the services sector, the global FDI stock more than quadrupled during the period1990-2002.7As a result of more rapid growth in this sector than in the other sectors,services accounted for about 60% of the global stock of inward FDI in 2002, comparedto less than 50% in 1990.

3 Dunning, J. H., Lundan, M., Multinational Enterprises and the Global Economy, Second Edition, EdwardElgar Publishing Limited, UK, 2008, p. 344 UNCTAD, World Investment Report 2004, p. 295 Ibidem6 Ibidem7 Ibidem, p. 31


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Figure 2: Sectoral distribution of FDI stock in the world, developed and developingcountries, 1990, 2002

Source: UNCTAD, World Investment Report 2004, p. 30

1.2. Foreign direct investment in services

The production of services typically accounts for the largest share of economicactivity in developed countries. The growth of an economys service sector is an


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important aspect of its development and is strongly associated with productspecialisation, income growth and economic modernisation. The importance ofservices to an economy is even greater than that reflected in direct sectoral shares ofGDP because services are inputs for all aspects of processing and production.8

As part of the Uruguay Round of global trade negotiations, contracting partiesto the General Agreement on Trade and Tariffs (GATT) signed the General Agreementon Trade in Services (GATS). The GATS is the first binding multilateral agreementcovering trade in services. The World Trade Organisation (WTO) administers theagreement. Trade in services rules are an important way in which WTO membershipmay enhance trade performance through their potential effects on inward FDI. TheGATT/WTO included for the first time in 1995 commitments on treatment of foreign

providers of services in the General Agreement of Trade in Services (GATS). Therange of services covered by the General Agreement on Trade in Services (GATS) is:

1. Business services2. Communication services3. Construction services4. Distribution services5. Educational services6. Environmental services7. Financial services8. Health-related and social services9. Tourism and travel-related services10. Recreational, cultural, and sporting services11. Transport services12. Other services not elsewhere included

GATS commitments in the tourism sector (sector 9) can be divided into foursub sectors:

A. Hotels and Restaurants (including Catering)B. Travel Operators and Tour OperatorsC. Tourist Guide ServicesD. Other.

Countries can commit any of around 160 sub-sectors and four modes. Fourpossible modes of service delivery are defined in the GATS. Crossborder supply iswhere the supplier and consumer are located in different countries, as with overseastelephone services. Consumption abroadinvolvesthe consumer moving to the foreignsupplier, as in tourism or education . Temporary movement of people involves thesupplier moving temporarily to the consumer, as in consulting services. Commercial

presence is where thesupplier establishes a commercial presence, often through FDI,to deliver theservice in a foreign country.Commercial presence in particular relates tothe conditions under which foreign firms have access to particular services sectors, andwhich conditions apply after their establishment.

8 Hardin, A., Holmes, L.: Service Trade and Foreign Direct Investment, Australian Government ProductivityCommission, Industry Commission Staff Research Paper, November 1997, p. 3


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FDI plays a key role in services trade. Restrictions on FDI can thereforepotentially have significant implications for services trade. In theory, it is possible toidentify three types of GATS effects on inward FDI:9

First, countries can offer market access to foreign providers of services,though in practice GATS commitments have gone little beyond existingliberalisation. Hence, GATS is scarcely used as a liberalising tool.

Second, the set of trade rules contained in GATS (especially mode 3 oninvestment) provides for a transparent framework conducive to private sectoractivities, reducing uncertainty and encouraging investment. Uncertainty canhave significant negative effects on investment, when investment involveslarge sunk and irreversible costs and there is the option to delay the decision tomake the investment until further information becomes available.

Signalling is the third effect. Countries that make offers and requests to GATSare willing to seriously consider development of the services sectors, sending

positive signals to potential investors.Establishing a commercial presence in a country, often through FDI, is an

important mode of delivery for some services, particularly where ongoing contact withconsumers is important or the nature of the services means that other modes of supplyare not feasible or viable.

FDI growth is expected to be led by services in computing and ICT, publicutilities (such as the generation and distribution of electricity, water and gas),transportation, followed by tourism, hotels and restaurants, construction, banking andinsurance, retail and wholesale and business services, all of which were noted by morethan 40% of both IPAs and experts.

9 Te Velde, D. W., Nair, S.: Foreign Direct Investment, Services Trade Negotiations and Development: TheCase of Tourism in the Caribbean, Overseas Development Institute, November 2005, p. 2


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Figure 3: Global FDI prospects in services sector, 2005-2006

Source:Prospects for Foreign Direct Investment and the Strategies of Transnational Corporations, 2005 2008, UNCTAD, 2005, p. 15


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2. DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN

SERVICES

It is clear that nowadays services, and particular tourism, have become themajor area of economic activity in developed countries. The growth of services reflectsa combination of both demand and supply driven factors such as the following:10

1. The growth of per capita output and high income elasticity of demand forsome consumer services in industrialized countries;

2. The increasing role of producer services in the value-added process;

3. The increasing tendency of firms in non-service sectors to externalize lessproductive service activities;

4. The growing importance of marketing, distribution and aftersales maintenanceand servicing activities to the value of a physical product;

5. The growth of finance, banking, legal, insurance, transport, and other supportservices;

6. The emergence of new intermediate markets for services;7. The liberalization of markets for several services, notably insurance and

financial services.This has led to the growing internationalization of service firms. In conditions

of globalization, internationalization becomes imperative.Foreign direct investment iscrucial in the process of internationalization, which is becoming increasingly importantdeterminant of competitiveness.

The determinants of FDI in services can be categorized as follows:11marketsize, home country business presence/local customer base, host government

policies/openness, cultural distance, competitive advantages, tradability of services,global oligopolistic reaction and firm size.

(a) Market size

Market size is found to be the most important determinant of inward FDI ingoods. The impact of the host country market size on the inflow of FDI in services isfound to be a significant determinant for transnational banks, international advertisingagencies and transnational insurance firms. Although market size is an importantdeterminant for FDI in services, its importance is lower than for FDI in goods.

(b) Home country business presence/local customer base

Home business presence is one of the most important determinants for FDI inservices as this increases the number of informed customers in the host country, whoare aware of the services and therefore are more likely to create demand for theseservices. That is, producer service firms locate where they find a large customer base.

10 Dunning, J. H., Kundu, S. K.: The Internationalization of the hotel industry some new findings from afield study, Management International Review, April, 199511Banga, R.: Foreign Direct Investment in Services: Implications for Developing Countries, Asia-Pacific

Trade and Investment Review, Vol. 1, No. 2, November 2005, p. 61


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They therefore follow FDI by downstream firms from the same home country and onlylater become more responsive to local demand since they find it initially difficult toattract local customers.

(c) Host government policies/openness

Similar to FDI in goods, the rule of law is the major barrier to FDI inservices. Categorical refusal to permit FDI in selected services still exists in manycountries. However, post GATS, many countries, mainly developing countries, are nowchanging their policies and allowing FDI into selected service sectors althoughrestrictions on the extent of foreign ownership still exist. One of the most importantdeterminants of the location of FDI in services are government policies and regulations.

(d) Cultural distance

The various host countries have different cultures, tastes and needs, thus FDIin services needs to be adapted to the tastes of local customers. In this respect, culturaldistance is also found to be an important determinant of FDI in services.

(e) Competitive advantages

The competitive advantages of service firms have been elaborated in terms ofownership, location and internalization advantages by Dunning (1989). As internationalcompetition in services grow, competitive advantages become increasingly importantdeterminant of FDI in services. However, competitive advantages in services aredifficult to measure and also transfer, especially if they are culturally and institutionallyembedded. A countrys competitive advantage in a particular sector is revealed byeither higher exports from that sector or outbound FDI from that sector. It is found thatFDI in services is positively affected by the international competitiveness of the home

countrys service industry. However, when the impact of ICI is estimated for differentservices, it is found that it is not a significant determinant in the case of trade-relatedservices and business services. It has some effect on finance-related services.

(f) Tradability of services

The fact that services are largely intangible and non-storable implies that theinternational transaction in services can occur mainly by inward FDI or by anindigenous firm producing under a licensing arrangement with a foreign transnationalcorporation. However, the tradability of services has improved considerably with theadvances made by information technologies. This has led to an emergence of network-

based trade. Thus, the location boundedness of FDI has reduced. The higher thetradability of services is, the lower will be the chances of providing services throughthe FDI route.

(g) Global oligopolistic reaction

Oligopolistic reactions occur when firms are mutually interdependent. FDI inmanufacturing have been found to follow both their domestic and internationalcompetitors in setting up their units in the host countries as a defensive strategy.Terpstra and Yu (1988) test this for FDI in the advertising industry in the United Statesand find that such an oligopolist strategy does explain FDI in this service industry. Thisimplies that FDI in services also needs to compete on the basis of a global strategy.


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(h) Firm sizeInternational expansion is one of the major growth strategies of the firm.

Larger firms are more likely to become transnational than smaller firms. As in themanufacturing of goods, firm size also has been found to be a significant factor in theinternational behaviour of several service industries such as banking and advertising.With respect to the determinants of FDI in services, we observe that the determinantsthat are found to be significant for FDI in goods are also found to be significant for FDIin services. However, the importance of the determinants differs. Some of the mostimportant determinants for FDI in services are government regulations and policies,cultural distance and the tradability of services. For FDI in goods, the most importantdeterminants are market size, barriers to trade and cost differentials in production.

In the context of this work it is necessary to emphasize that tourism is major

service industry. Many developing countries are looking to tourism as a potentiallypromising avenue for economic and human development and FDI is one of the routesthrough which they can further developing tourism. FDI is often considered one of themost effective engines for harnessing capital, infrastructure, knowledge and access toglobal marketing and distribution chains. All of the above is a critical for the tourism. Itis also important to note that foreign investment can give rise to more investment intourism in total.12

3. TRENDS IN TOURISM-RELATED FOREIGN DIRECT

INVESTMENT

Tourism is a priority sector in an increasing number of developing countries

economic strategies. International tourism is an activity whose growing trade is linkedclosely to international investment. FDI plays a particularly important role in supply oftourism services. In particular, the degree of control and openness that a host countrymight adopt in relation to FDI is central.13 If they want to realize the expected growthof tourism, they must put a strong effort to attract foreign direct investment in it. It is

possible to distinguish three trends that characterize tourism-related foreign directinvestment in developing countries and economies in transition.14

Firstly, even though tourism is the largest industry in many countries, itappears to be one of the least globalized. Contrary to perceptions, FDI in tourism is stillrather low in developed as well as developing countries compared to the levels ofFDI in other economic activities, including other services industries. This is partly

because tourism-related FDI is concentrated in just a few of the many related activitiescovered by the definition of tourism, mostly hotels and restaurants, and car rentals.There is very little FDI in high-profile and important activities such as tour operations,reservations systems and airlines.

12 Forsyth, P., Dwyer, L.:Foreign Investment in Australian Tourism: A Framework for Analysis, TheJournal of Tourism Studies, Vol. 14, No. 1, May 2003., p. 7213 Juda, N., Richardson, S.,Preliminary Assessment of the Envuronmental & Social Effects of Liberalisationin Tourism Services,WWW International Discussion Paper, February 2001, p. 3314FDI in Tourism: The Development Dimension, UNCTAD, 2007, p. 13


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Table 1:FDI is concentrated in a subset of tourism activitiesTSA component Frequency with which FDI appears to

occur

Most frequent Occasional RareHotels and similar

Restaurants and similar

Second homes

Passenger transport rental

equipmentRailway passenger transport services

Air passenger transport services

Road passenger transport services

Water passenger transport services

Passenger transport supporting

services

Travel agencies and similar

Cultural services

Sports and other recreational

services

Source:FDI in Tourism: The Development Dimension, UNCTAD, 2007, p. 14

Secondly, tourism FDI is concentrated primarily in developed countries. Itappears that 85 90 per cent of TNC hotels are located in developed countries, withonly a small proportion in developing countries. Tourism appears to be an economicactivity in which domestic investors, including small and medium-sized enterprises(SMEs), dominate.

The third trend is that tourism related FDI to developing countries isincreasing. This growth can be expected to continue over the next five years, accordingto respondents to the UNCTAD survey of international hotel investors.

Figure 4: TNC expansion plans for hotels during the period 2006-2011


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Source: UNCTAD survey of TNCs in the hotel business with at least one hotel in a developing country, FDIin Tourism: The Development Dimension, UNCTAD, 2007, p. 28

All responded that they planned to increase, especially with respect to theareas in which they were already located. The highest percentage of expansion plans,over 80 per cent, were in South, East and South- East Asia, but even the lowest

proportion, for Central Asia, was well over 30 per cent. The percentage for Central andEastern Europe were almost 70 per cent.

According to these three trends, it is expected that foreign direct investment intourism should increase worldwide.

4. IMPACT OF TFDI ON ECONOMIC GROWTH IN DEVELOPING

COUNTRIES

Tourism is today world's largest industry. As stated earlier, many developingcountries are looking to tourism and tourism foreign direct investment as a promisingavenue for economic and human sustainable development. FDI in tourism are one ofthe key factors for increasing competitiveness of developing country on the domesticand international market.15 But, it must be kept in mind that FDI in tourism, as well asin every other sector, has two sides, positive and negative.

The main impacts of tourism FDI in developing countries, according toUNCTAD, are:16

Impact on demand patterns; Impact on capital, technology and skills formation; Impact on human resources; Impact on local firms; Balance-of-payment impacts.

Tourism related TNCs put host countries on the map, and foreign brandsfurther enhanced their image as tourist destinations. If an industry is potentiallyvolatile, TNCs can be more robust and stable than local firms and thus help ensure thestability of an economy. Furthermore, TNCs can maintain a countrys poor image as a

15 Blaevi, B.: Turizam u gospodarskom sustavu, Sveuilite u Rijeci, Fakultet za turistiki i hotelskimenadment, Opatija, 2007., p. 25416FDI in Tourism: The Development Dimension, UNCTAD, 2007, p. 51


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lowquality, mass-market destination. They are also occasionally unpredictable, they aremoving out partly or entirely on the basis of changing international tourism trends anddemand patterns.

The financial contribution of tourism-related TNCs is relatively small in mostdeveloping economies, especially because much of their involvement takes non-equityforms. Although some host governments expected their help in the development ofinfrastructure it does not come though. They can introduce a diverse range of newtechnologies and skills into an economy, including advanced management,environmental and financial systems. These improve the productivity and sustainabilityof the sector and economy and, potentially, lead to beneficial spillovers to other firmsand sectors. TNCs can help raise standards through advanced systems and qualitycontrol and can also help diversify the product in some destinations.

Tourism-related TNCs generate employment and, in some cases, they generate

proportionally more employment than local firms. TNCs often pay higher wages andoffer a better package to employees than local firms. In more mature destinations orthose with a history of public investment in training, these distinctions between TNCsand local firms are less marked or absent.

Tourism-related TNCs make an effort to establish linkages with local suppliersand distributors, sometimes to a greater degree than equivalent local firms, whichgenerates economic activity and business opportunities. TNCs can sometimes alsocrowding out local firms. TNCs can potentially provide positive impacts throughcompetitive and demonstration effects.

There was little evidence that tourism-related TNCs are more likely to have anegative impact on the balance of payments than local firms. Imports of foreign

produce seem to be more related to the market segment than ownership per se. TNCsdo repatriate profits, but at the same time they boost tourist arrivals and hence foreign

exchange earnings considerably. Expatriates repatriate some of their earnings, but arealso employed by local firms. A government can do much to ensure that any negative

balance-of-payments impact is minimized.From all of the aforementioned, it is possible to conclude that FDI in tourism

offers many opportunities but it can also lead to a number of costs.

5. CONCLUSION

Foreign direct investment is as an engine of economic growth anddevelopment and a large number of developing countries have placed the attraction ofFDI as one of their top economic priorities. FDI has grown over time in all threeeconomic sectors, primary, manufacturing and services, but the sectoral compositionhas shifted towards services.

Tourism is as a major service industry, but FDI in tourism is still rather low in developed as well as developing countries compared to the levels of FDI in othereconomic activities, including other services industries. This is partly because tourism-related FDI is concentrated in just a few of the many related activities covered by thedefinition of tourism, mostly hotels and restaurants, and car rentals. There is very littleFDI in high-profile and important activities such as tour operations, reservationssystems and airlines.


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For a developing country, FDI could play a significant role in its economicdevelopment in general and to tourism sector in particular by improving countrysinfrastructure such as airports, highways and hotels which are the keystones to tourismdevelopment.

In recent years many developing countries have become more open to FDI intourism. But if developing countries want to take full advantage of FDI in tourism, acoherent and integrated policy framework is need. Although in recent years manydeveloping countries have become more open to FDI in tourism, there is a surprisinglylittle information about the use of necessary policy framework, and it is an area forfurther research.

REFERENCE

Banga, R.: Foreign Direct Investment in Services: Implications for Developing Countries, Asia-Pacific Tradeand Investment Review, Vol. 1, No. 2, November 2005

Blaevi, B.: Turizam u gospodarskom sustavu, Sveuilite u Rijeci, Fakultet za turistiki i hotelskimenadment, Opatija, 2007.

Dunning, J. H., Kundu, S. K., The Internationalization of the hotel industry some new findings from a fieldstudy, Management International Review, April, 1995

Forsyth, P., Dwyer, L.,Foreign Investment in Australian Tourism: A Framework for Analysis, The Journal ofTourism Studies, Vol. 14, No. 1, May 2003

Hardin, A., Holmes, L., Service Trade and Foreign Direct Investment, Australian Government ProductivityCommission, Industry Commission Staff Research Paper, November 1997

Juda, N., Richardson, S., Preliminary Assessment of the Envuronmental & Social Effects of Liberalisation inTourism Services,WWW International Discussion Paper, February 2001

Peri, J., Europska unija i izravna strana ulaganja: trendovi, odnosi, uinci, Fintrade & Tours: "Adami",Rijeka, 1999.

Te Velde, D. W., Nair, S., Foreign Direct Investment, Services Trade Negotiations and Development: TheCase of Tourism in the Caribbean, Overseas Development Institute, November 2005

A Partnership for Growth and Development, UNCTAD, 1996

World Investment Report 2004, UNCTAD

Prospects for Foreign Direct Investment and the Strategies of Transnational Corporations, 2005 2008,UNCTAD, 2005

FDI in Tourism: The Development Dimension, UNCTAD, 2007

World Investment Report 2009, UNCTAD

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IMPACT OF FOREIGN DIRECT INVESTMENT IN TOURISM ON ECONOMIC GROWTH IN DEVELOPING COUTRIES