JOE PERI, Ph.D., Full Professor MAJA 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 two decades, the service sector has expanded rapidly and has come to play an increasingly important role in national economies and in the international economy. The structure of foreign direct investment worldwide has also shifted towards services. In the context of this work it is necessary to emphasize that tourism is major service industry. Many developing countries are looking to tourism and tourism foreign direct investment as a promising avenue for economic and human sustainable development. But, it must be kept in mind that FDI 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 role in economic development because it is accepted as an important vehicle for the transfer of technology, especially for developing countries. It is possible to say that foreign direct investment is as an engine of economic growth and development. A large number of developing countries have placed the attraction of FDI as one of their top economic priorities. The structure of foreign direct investment worldwide has shifted towards services. In the context of this work it is necessary to emphasize that tourism is major service industry and it is a priority sector in an increasing number of developing countries 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. According to this, the main objective of this paper is to provide some conceptual issues about FDI in tourism and their impact on the developing counties.

1. SIGNIFICANCE OF FOREIGN DIRECT INVESTMENT Foreign direct investments have an important and essential role in the development of the world and individual national economies. The importance of FDI for development has dramatically increased in recent years. FDI is now considered to be an instrument through which economies are being integrated at the level of production into the globalizing world economy by bringing a package of assets, including capital, technology, managerial capacities and skills, and access to foreign markets.1 FDI is considered a vehicle through which new ideas, advanced techniques, technology and skills are transferred across borders hence provide substantial spillover effects. The idea to produce abroad goes back a long way. Several activities similar to nowadays 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 of dollars)

Source: World Investment Report 2009

1 2

A Partnership for Growth and Development, UNCTAD, 1996., p. 14 Peri, J., Europska unija i izravna strana ulaganja: trendovi, odnosi, uinci , Fintrade & Tours: "Adami", Rijeka, 1999, p. 65

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. After uninterrupted growth in FDI activity till 2000, global FDI inflows fell in the period 20012004. FDI inflows begins its growth again 2005th and since then recorded a constant growth. 1.1. Sectoral composition of FDI Just as there is a distinct geographical concentration of the countries supplying and receiving FDI, so is there a marked difference in the sectoral composition in which FDI 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 industrialising countries (Germany, Japan, South Korea, Singapore, China and Mexico) attract an above-average share of inward investment in secondary sector. The US, the UK, France, Switzerland, Hong Kong (China) and Fiji record the highest share of tertiary investments.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 services in all the countries. The global stock of both inward and outward FDI in the primary sector more than doubled between 1990 and 2002.4 The primary sectors share in world FDI stock decreased noticeably from 9% in 1990 to 6% in 2002.5 Stated result from slower FDI growth in primary sector than in manufacturing and services. The manufacturing share in world FDI stock rose nearly threefold during the period 1990 2002.6 Its 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 period 1990-2002.7 As 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, compared to less than 50% in 1990.

Dunning, J. H., Lundan, M., Multinational Enterprises and the Global Economy, Second Edition, Edward Elgar Publishing Limited, UK, 2008, p. 34 4 UNCTAD, World Investment Report 2004, p. 29 5 Ibidem 6 Ibidem 7 Ibidem, p. 31

Figure 2: Sectoral distribution of FDI stock in the world, developed and developing countries, 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 economic activity in developed countries. The growth of an economys service sector is an

important aspect of its development and is strongly associated with product specialisation, income growth and economic modernisation. The importance of services to an economy is even greater than that reflected in direct sectoral shares of GDP because services are inputs for all aspects of processing and production.8 As part of the Uruguay Round of global trade negotiations, contracting parties to the General Agreement on Trade and Tariffs (GATT) signed the General Agreement on Trade in Services (GATS). The GATS is the first binding multilateral agreement covering trade in services. The World Trade Organisation (WTO) administers the agreement. Trade in services rules are an important way in which WTO membership may enhance trade performance through their potential effects on inward FDI. The GATT/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). The range of services covered by the General Agreement on Trade in Services (GATS) is: 1. Business services 2. Communication services 3. Construction services 4. Distribution services 5. Educational services 6. Environmental services 7. Financial services 8. Health-related and social services 9. Tourism and travel-related services 10. Recreational, cultural, and sporting services 11. Transport services 12. Other services not elsewhere included GATS commitments in the tourism sector (sector 9) can be divided into four sub sectors: A. Hotels and Restaurants (including Catering) B. Travel Operators and Tour Operators C. Tourist Guide Services D. Other. Countries can commit any of around 160 sub-sectors and four modes. Four possible modes of service delivery are defined in the GATS. Crossborder supply is where the supplier and consumer are located in different countries, as with overseas telephone services. Consumption abroad involves the consumer moving to the foreign supplier, as in tourism or education . Temporary movement of people involves the supplier moving temporarily to the consumer, as in consulting services. Commercial presence is where the supplier establishes a commercial presence, often through FDI, to deliver the service in a foreign country. Commercial presence in particular relates to the conditions under which foreign firms have access to particular services sectors, and which conditions apply after their establishment.

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

FDI plays a key role in services trade. Restrictions on FDI can therefore potentially have significant implications for services trade. In theory, it is possible to identify 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 existing liberalisation. Hence, GATS is scarcely used as a liberalising tool. Second, the set of trade rules contained in GATS (especially mode 3 on investment) provides for a transparent framework conducive to private sector activities, reducing uncertainty and encouraging investment. Uncertainty can have significant negative effects on investment, when investment involves large sunk and irreversible costs and there is the option to delay the decision to make the investment until further information becomes available. Signalling is the third effect. Countries that make offers and requests to GATS are 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 with consumers is important or the nature of the services means that other modes of supply are not feasible or viable. FDI growth is expected to be led by services in computing and ICT, public utilities (such as the generation and distribution of electricity, water and gas), transportation, followed by tourism, hotels and restaurants, construction, banking and insurance, retail and wholesale and business services, all of which were noted by more than 40% of both IPAs and experts.

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

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

2. DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN SERVICES It is clear that nowadays services, and particular tourism, have become the major area of economic activity in developed countries. The growth of services reflects a 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 for some 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 less productive service activities; 4. The growing importance of marketing, distribution and aftersales maintenance and servicing activities to the value of a physical product; 5. The growth of finance, banking, legal, insurance, transport, and other support services; 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 is crucial in the process of internationalization, which is becoming increasingly important determinant of competitiveness. The determinants of FDI in services can be categorized as follows: 11 market size, 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 in goods. The impact of the host country market size on the inflow of FDI in services is found to be a significant determinant for transnational banks, international advertising agencies and transnational insurance firms. Although market size is an important determinant 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 in services as this increases the number of informed customers in the host country, who are aware of the services and therefore are more likely to create demand for these services. 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 a field study, Management International Review, April, 1995 11 Banga, R.: Foreign Direct Investment in Services: Implications for Developing Countries, Asia-Pacific Trade and Investment Review, Vol. 1, No. 2, November 2005, p. 61

They therefore follow FDI by downstream firms from the same home country and only later become more responsive to local demand since they find it initially difficult to attract local customers. (c) Host government policies/openness Similar to FDI in goods, the rule of law is the major barrier to FDI in services. Categorical refusal to permit FDI in selected services still exists in many countries. However, post GATS, many countries, mainly developing countries, are now changing their policies and allowing FDI into selected service sectors although restrictions on the extent of foreign ownership still exist. One of the most important determinants 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 FDI in services needs to be adapted to the tastes of local customers. In this respect, cultural distance 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 of ownership, location and internalization advantages by Dunning (1989). As international competition in services grow, competitive advantages become increasingly important determinant of FDI in services. However, competitive advantages in services are difficult to measure and also transfer, especially if they are culturally and institutionally embedded. A countrys competitive advantage in a particular sector is revealed by either higher exports from that sector or outbound FDI from that sector. It is found that FDI in services is positively affected by the international competitiveness of the home countrys service industry. However, when the impact of ICI is estimated for different services, it is found that it is not a significant determinant in the case of trade-related services 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 the international transaction in services can occur mainly by inward FDI or by an indigenous firm producing under a licensing arrangement with a foreign transnational corporation. However, the tradability of services has improved considerably with the advances made by information technologies. This has led to an emergence of networkbased trade. Thus, the location boundedness of FDI has reduced. The higher the tradability of services is, the lower will be the chances of providing services through the FDI route. (g) Global oligopolistic reaction Oligopolistic reactions occur when firms are mutually interdependent. FDI in manufacturing have been found to follow both their domestic and international competitors 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 States and find that such an oligopolist strategy does explain FDI in this service industry. This implies that FDI in services also needs to compete on the basis of a global strategy.

(h) Firm size International expansion is one of the major growth strategies of the firm. Larger firms are more likely to become transnational than smaller firms. As in the manufacturing of goods, firm size also has been found to be a significant factor in the international behaviour of several service industries such as banking and advertising. With respect to the determinants of FDI in services, we observe that the determinants that are found to be significant for FDI in goods are also found to be significant for FDI in services. However, the importance of the determinants differs. Some of the most important determinants for FDI in services are government regulations and policies, cultural distance and the tradability of services. For FDI in goods, the most important determinants 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 potentially promising avenue for economic and human development and FDI is one of the routes through which they can further developing tourism. FDI is often considered one of the most effective engines for harnessing capital, infrastructure, knowledge and access to global marketing and distribution chains. All of the above is a critical for the tourism. It is also important to note that foreign investment can give rise to more investment in tourism in total.12 3. TRENDS IN INVESTMENT TOURISM-RELATED FOREIGN DIRECT

Tourism is a priority sector in an increasing number of developing countries economic strategies. International tourism is an activity whose growing trade is linked closely to international investment. FDI plays a particularly important role in supply of tourism services. In particular, the degree of control and openness that a host country might adopt in relation to FDI is central. 13 If they want to realize the expected growth of 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 direct investment in developing countries and economies in transition.14 Firstly, even though tourism is the largest industry in many countries, it appears to be one of the least globalized. Contrary to perceptions, FDI in tourism is still rather low in developed as well as developing countries compared to the levels of FDI 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 activities covered 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, The Journal of Tourism Studies, Vol. 14, No. 1, May 2003., p. 72 13 Juda, N., Richardson, S., Preliminary Assessment of the Envuronmental & Social Effects of Liberalisation in Tourism Services,WWW International Discussion Paper, February 2001, p. 33 14 FDI in Tourism: The Development Dimension, UNCTAD, 2007, p. 13

Table 1: FDI is concentrated in a subset of tourism activities TSA component Hotels and similar Restaurants and similar Second homes Passenger transport rental equipment Railway 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 Frequency with which FDI appears to occur Most frequent Occasional Rare

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

Secondly, tourism FDI is concentrated primarily in developed countries. It appears that 85 90 per cent of TNC hotels are located in developed countries, with only a small proportion in developing countries. Tourism appears to be an economic activity in which domestic investors, including small and medium-sized enterprises (SMEs), dominate. The third trend is that tourism related FDI to developing countries is increasing. This growth can be expected to continue over the next five years, according to respondents to the UNCTAD survey of international hotel investors. Figure 4: TNC expansion plans for hotels during the period 2006-2011

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

All responded that they planned to increase, especially with respect to the areas 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 and Eastern Europe were almost 70 per cent. According to these three trends, it is expected that foreign direct investment in tourism should increase worldwide. 4. IMPACT OF TFDI ON ECONOMIC GROWTH IN DEVELOPING COUNTRIES Tourism is today world's largest industry. As stated earlier, many developing countries are looking to tourism and tourism foreign direct investment as a promising avenue for economic and human sustainable development. FDI in tourism are one of the key factors for increasing competitiveness of developing country on the domestic and international market.15 But, it must be kept in mind that FDI in tourism, as well as in every other sector, has two sides, positive and negative. The main impacts of tourism FDI in developing countries, according to UNCTAD, 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 brands further enhanced their image as tourist destinations. If an industry is potentially volatile, TNCs can be more robust and stable than local firms and thus help ensure the stability 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 hotelski menadment, Opatija, 2007., p. 254 16 FDI in Tourism: The Development Dimension, UNCTAD, 2007, p. 51

lowquality, mass-market destination. They are also occasionally unpredictable, they are moving out partly or entirely on the basis of changing international tourism trends and demand patterns. The financial contribution of tourism-related TNCs is relatively small in most developing economies, especially because much of their involvement takes non-equity forms. Although some host governments expected their help in the development of infrastructure it does not come though. They can introduce a diverse range of new technologies and skills into an economy, including advanced management, environmental and financial systems. These improve the productivity and sustainability of the sector and economy and, potentially, lead to beneficial spillovers to other firms and sectors. TNCs can help raise standards through advanced systems and quality control 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 and offer a better package to employees than local firms. In more mature destinations or those with a history of public investment in training, these distinctions between TNCs and local firms are less marked or absent. Tourism-related TNCs make an effort to establish linkages with local suppliers and distributors, sometimes to a greater degree than equivalent local firms, which generates economic activity and business opportunities. TNCs can sometimes also crowding out local firms. TNCs can potentially provide positive impacts through competitive and demonstration effects. There was little evidence that tourism-related TNCs are more likely to have a negative 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. TNCs do repatriate profits, but at the same time they boost tourist arrivals and hence foreign exchange earnings considerably. Expatriates repatriate some of their earnings, but are also 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 and development and a large number of developing countries have placed the attraction of FDI as one of their top economic priorities. FDI has grown over time in all three economic sectors, primary, manufacturing and services, but the sectoral composition has 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 other economic activities, including other services industries. This is partly because tourismrelated FDI is concentrated in just a few of the many related activities covered 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.

For a developing country, FDI could play a significant role in its economic development in general and to tourism sector in particular by improving countrys infrastructure such as airports, highways and hotels which are the keystones to tourism development. In recent years many developing countries have become more open to FDI in tourism. But if developing countries want to take full advantage of FDI in tourism, a coherent and integrated policy framework is need. Although in recent years many developing countries have become more open to FDI in tourism, there is a surprisingly little information about the use of necessary policy framework, and it is an area for further research. REFERENCE
Banga, R.: Foreign Direct Investment in Services: Implications for Developing Countries, Asia-Pacific Trade and Investment Review, Vol. 1, No. 2, November 2005 Blaevi, B.: Turizam u gospodarskom sustavu, Sveuilite u Rijeci, Fakultet za turistiki i hotelski menadment, Opatija, 2007. Dunning, J. H., Kundu, S. K., The Internationalization of the hotel industry some new findings from a field study, Management International Review, April, 1995 Forsyth, P., Dwyer, L., Foreign Investment in Australian Tourism: A Framework for Analysis , The Journal of Tourism Studies, Vol. 14, No. 1, May 2003 Hardin, A., Holmes, L., Service Trade and Foreign Direct Investment , Australian Government Productivity Commission, Industry Commission Staff Research Paper, November 1997 Juda, N., Richardson, S., Preliminary Assessment of the Envuronmental & Social Effects of Liberalisation in Tourism 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: The Case 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