Risk Sharing Across Countries: the Importance of Tourism Activity
Risk Sharing Across Countries: The Importance of Tourism Activity
Faruk Balli[1] / Hatice Ozer Balli[2] / Rosmy Jean Louis[3]Abstract
In this paper, we provide empirical evidence that international tourism receipts serve as an important channel through which risks are shared among many countries beyond the well-known channels found in the literature. Further investigation into the extent of risk sharing across countries shows that the concentration of tourist flows for particular countries/regions has a negative impact on the role of tourism receipts in providing insurance. However, the share of tourist flows from off-continent countries has a positive impact on the extent of the risk sharing via international tourist receipts. We also find that tourist flows originated form separate continents are more likely increase the gains from risk sharing.
JEL classification: F24, F41
Keywords: diversification, international tourism demand, risk sharing, tourism receipts
Introduction
In times of economic boom or depression, international tourism receipts represent a reliable source of external financing for many developing and developed countries. According to the World Tourism Barometer of the United Nations World Tourism Organization (UNWTO), international tourism receipts have surpassed the 1 trillion USD mark worldwide and have grown steadily in the last two decades, save, of course, for the period covering the recent global financial crises. At the aggregate level, UNWTO estimates that international passengers’ travel and transportation account for 30% of the world’s exports of services and 6% of overall exports of goods and services, thereby making tourism spending an important injection to domestic economies. This surge in international tourism activity has proven beneficial all around the globe, particularly in those countries facing weak domestic consumption as a result of fiscal austerity and monetary policy ineffectiveness.
As a key export and labour-intensive activity, international tourism serves as engine to balance the current account and stimulate growth in the long run. With the globalization of markets and advances in information technology, the internet has become a global space, with popular social media sites such as YouTube and Facebook playing a key role in the promotion of tourism destinations around the globe through informal sharing of pictures and videos between friends and families, and formally through marketing and advertising. Tourism has become the engine of growth for many regional economies and the most important economic sector for many countries. As a result, policy makers and industry stakeholders have allocated a sizable amount of domestic resources towards the creation, promotion and enhancement of tourist destinations across countries.
Consequently, at the academic level, the literature has benefited greatly from various contributions that focus on the economic impacts of tourism on domestic economies. These encompass the works of Tosun (2001), Balaguer and Jorda (2002), Dritsakis (2004), Durbarry (2004), Kim, Chen, and Cheng. (2006), Gunduz and Hatemi-J (2005), Proenca and Soukiazis (2005), Lee and Chang (2008), Cuñado and Garcia (2006), Ongan and Demiroz (2005), and He and Zheng (2011), among others. These authors have mostly studied the impact of international tourism on economic growth by focusing on either long- or short-run relationships, while applying different techniques and using different country samples, be they emerging markets or OECD (the Organisation for Economic Co-operation and Development). The results have been mixed; some have found a positive relationship between international tourism and economic growth, whereas others have found either a negative or no relationship at all, depending on the time interval or the country sample used. An earlier study by Chen and Devereux (1999) on the indirect effects of international tourism suggests that tourism can, in fact, reduce welfare in countries with restrictive trade measures (export taxes and import subsidies). It is worth noting that Song and Li (2008) have provided the tourism literature with a comprehensive review on the diversity of research topics, methodology, data, region and research themes used in tourism research for the post-2000 era, along with the diversity of findings. Reviews by Crouch (1994), Li, Song, and Witt (2005), Lim (1997 a & b and 1999), and Witt and Witt (1995) that cover studies published mostly during the period 1960-2000 are precursors to the review of Song and Li (2008).
However, despite the many contributions on the importance of tourism to economic growth, the literature has remained, by and large, silent on the ability of tourism as a channel of risk sharing across countries, i.e. the ability of tourism to act as insurance against economic downturns. To that end, knowledge of the cyclical nature of tourism in relation to the business cycle of the recipient country is summarily important. If international tourism receipts are counter-cyclical (or at least less than 100% correlated) with the domestic output shocks, countries or regions experimenting economic downturns may be likely to benefit from tourist flows originating from countries less affected by global crises or with economic abundance. In this vein, tourist expenditures possibly insulate the domestic economy by smoothing income and consumption. Alternatively, little, no or negative risk sharing can materialize if tourism revenues are pro-cyclical, given that tourism activity in domestic countries are positively linked to economic well-being in foreign countries.
There are at least two compelling reasons for exploring the extent of risk sharing underlying tourism flows across countries. As per the general risk sharing hypothesis documented in Athanasoulis and van Wincoop (2000), and Pallage and Robe (2003), excessive consumption fluctuations transmitted through output shocks— a feature of higher risk sharing—can have adverse effects on the accumulation of human and physical capital. The welfare gains from these risk sharings may exceed 100% of permanent consumption (Obstfeld 1994; van Wincoop 1994). From another standpoint, in line with the theory of optimum currency areas of Mundell (1961, 1973 a&b), if risk sharing emanating from tourism activity is indeed effective in smoothing output shocks, just like any inflows to the economy, international tourism receipts can be considered as a reliable channel to absorb the impact of asymmetric shocks to domestic economies, thereby satisfying the requisites of higher economic integration.
However, despite the growing importance of the risk sharing literature, the crucial aspect of international tourism receipts as a shock absorber has not been formally investigated. The few studies that come close to focusing on this issue empirically have only documented the role of external inflows in promoting risk sharing. For example, Balli and Balli (2011) and Balli, Basher, and Louis (2013) examine the contribution of remittance inflows; Balli, Basher, and Balli (2013), the income inflows from international portfolio holdings; and Sorensen and Yosha (1998), the impact of international transfers, exports and imports on risk sharing, among other factors. Motivated by the limited research in the area and the exceedingly important role international tourism receipts play in the overall macroeconomic stabilization of developing economies, this paper makes a contribution to the existing literature in filling this gap.
Using data for a sample of 87 countries over the period 1995–2010, we first measure the extent of risk sharing via international tourism receipts for each country in our sample. Our preliminary examination suggests that there is substantial cross-country variation in the estimated degree of risk sharing via tourism receipts, ranging from 44% for Benin to –16% for Moldova. In light of this notable gap, we further investigate the determinants of international tourism receipts to uncover the source of this variation. We find that the concentration of tourist inflows from limited number of countries is a leading explanation for the extent of risk sharing via tourist receipts: the higher the diversification of the tourists from different countries, the greater the amount of domestic output shocks buffered by the tourism receipts. Another important finding is the impact of distance on risk sharing via tourism receipts: the closer the country or region of origin of the tourists is to the tourist destinations geographically, the lower the amount of risk shared via tourism receipts. As can be seen easily, the further away that countries supplying tourists are from the tourist attraction centres, the more likely it is that the two regions are subjected to asynchronous business cycles, hence opening room for risk sharing to take place as financial resources flow to smooth income in the less fortunate countries. In addition, we find evidence that international tourism receipts originating from countries supplying tourists that are far away or in different continents from countries that are tourist destinations produce more risk sharing than countries that are close to each other or share the same continent. This is quite reassuring, since business cycles are typically more synchronized among regional and neighbouring economies, tourist inflows behave pro-cyclically with respect to domestic output, thus giving rise to little or even dis-smoothing of output shocks. Last but not least, we investigate whether the size of international tourism receipts as a ratio to gross domestic product (GDP) facilitates more risk sharing. The results show that tourism receipts exert a positively strong and statistically significant impact on risk sharing.
The rest of this paper is organized as follows: in Section 2, we present the underlying theory of risk sharing that anchors the empirical model specification. Section 3 describes the construction of the variables and the data sources, while Section 4 discusses the empirical findings in detail. Finally, Section 5 concludes the paper.
2 The Empirical Model
Risk sharing indicates that economic agents or countries can share risk with each other. In this section we briefly outline the basic ideas for endowment economies with one homogeneous tradable good. For a fuller discussion interested readers are referred to Obstfeld and Rogoff (1996).
Following the theories of the risk sharing, first Cochrane (1991) and Mace (1991) utilize consumer-level data to investigate the degree of risk sharing between individual and aggregate consumption. Subsequently, researchers have generally regressed idiosyncratic (domestic minus world) consumption growth rates (∆cti) on idiosyncratic output growth rates (∆yti) to estimate the magnitude of risk sharing empirically. In short, ∆cti=α+bΔyti+εt equation is used to test the risk sharing empirically. The slope coefficient, b, is equal to zero if there is perfect risk sharing, implying that idiosyncratic consumption is uncorrelated with idiosyncratic output. This equation used to test for full risk sharing at the country level, is studied by Obstfeld (1994), Canova and Ravn (1996), and in the literature, most notably Backus, Kehoe, and Kydland (1992), Baxter and Crucini (1995), and Stockman and Tesar (1995) examined the prediction that the correlation of consumption across countries should be equal to unity. From these studies, we have observed that the notion of perfect risk sharing does not seem to be present in the data. A more realistic approach is to quantify the extent of risk sharing between countries while identifying the channels through which risk is shared and in what magnitude. This line of research was not possible until the ground-breaking study of Asdrubali, Sorensen, and Yosha (1996) and Sørensen and Yosha (1998). These researchers developed a simple accounting methodology to quantify the relative contributions of various channels of risk sharing. Their method decomposes the cross-sectional variance of GDP into various components to capture both market (capital and credit) and non-market (fiscal) channels of risk sharing. Among various channels, Sørensen and Yosha (1998) show that income risk sharing occurs primarily through cross-border ownership of assets. The contribution of remittance inflows (Balli and Balli (2011) and Balli et al. (2013)) and the income inflows from international portfolio holdings (Balli, Basher, and Balli (2013)) on risk sharing has also been studied. However, the literature so far is silent on quantifying the extent of risk sharing via trade or tourism channels.
2.1 Risk Sharing via Tourism Receipts
In order to quantify risk sharing via international tourism receipts, we follow the methodology used by Sørensen and Yosha (1998) to uncover the role of international tourism in absorbing output shocks. The starting point is the national accounts identity:
GDP=C+I+G+X-M. (1)
Since, at the aggregate level, total output is equal to total income, it follows that output (GDP) equals savings (S) plus consumption and taxes (T), where consumption includes both private (C) and public (G) expenditure on goods and services. Algebraically:
GDP=C+S+T. (2)
Under the assumption that T=G for a balanced budget, by setting Equation (1) equal to Equation (2), we obtain
S= I + X – M, (3) where I stands for gross public and private investment, and X and M are exports and imports of goods and services, respectively. Equation (3) can now be used to perform risk sharing analysis by decomposing savings to bring to light the contribution of tourism receipts incorporated in exports, which is our focal point. The basic consumption risk sharing regression equation estimated by Sorensen and Yosha (1998) and Obstfeld (1996) can be written as follows:
∆C+Gt=constant+β* ∆GDPt, (4)
where β* measures the co-movement of consumption and GDP growth rates. As β approaches zero, there is perfect risk sharing. By contrast, β* equals 1 implies no risk sharing. Since β* measures co-movement, 1-β* measures the extent of risk sharing. Accordingly, we estimate the following regression to quantify the extent of total risk sharing, β:
∆GDPt- ∆C+Gt=a+ β ∆GDPt. (5) where β =1-β*. Setting T = G in Equation (2) and solving for (C + G) to substitute in Equation (5), we obtain an expression that can be used to decompose the total risk sharing into channels:
∆GDPt- ∆GDP-St=a+β ∆GDPt. (6)
As per Equation (3), S = I + X – M, we are able to measure risk sharing via different channels. Since the variable X contains international tourism receipts, further decomposition followed by substitution leads to the regression equation used to estimate the extent of the risk sharing via tourism receipts:
∆ GDPt-∆GDP-Tourism receiptst=αi+βi*∆ GDPt. (7)
In contrast to Equation (4), both variables are expressed as a percentage change in GDP per capita prices minus their worldwide counterparts. For example, ∆ GDPt stands for the natural logarithm of annual real GDP per capita growth rate for country i minus the world aggregate GDP per capita growth rate.[4] The slope coefficient, βi, measures the extent of differential output shocks buffered by international tourism receipts after discounting aggregate shocks on tourism receipts. Each time series regression is estimated via the feasible generalized least squares (FGLS) method to adjust for the serial correlation and heteroskedasticity among the error terms.[5]