Tourism Development, Capital Inflow and Pollution Tax in a Small Open Tourism Economy: A Theoretical Analysis

We develop a three-sector small, open tourism economy: agricultural, informal and tourism service sectors. Land and labour are two primary inputs in the agricultural sector. The informal sector uses intermediate goods produced in the agricultural sector as an input. The tourism sector requires labour and specific ‘touristic’ capital as factors of production. Tourism services pollute the environment. The government introduces a pollution tax to control this pollution. We get the following interesting results. Tourism development, through an increase in foreign tourist arrivals, raises the price of the tourism service sector, tourism production and environmental pollution in the economy. Tourism development raises national income but raises welfare if the pollution tax rate exceeds the Pigouvian level tax rate. Touristic capital’s inflow (outflow) raises (lowers) both tourism services and environmental degradation under some conditions. Finally, if the direct effect of an increase (decrease) in pollution tax outweighs the indirect effect through a change in the price of tourism services, then an increase (decrease) in the pollution tax lowers (raises) both emissions and the production of tourism services.