Economic Impact of Tourism and Globalisation in Indonesia

Guntur Sugiyarto, Adam Blake, M. Thea Sinclair 1

Abstract

The issue of whether globalisation is beneficial remains controversial.

Knowledge about its effects is only partial, as globalisation policies are often
examined without consideration of their interactions with key sectors of the
economy, notably tourism. This paper uses a computable general equilibrium
model of the Indonesian economy to examine the effects of globalisation via
tariff reductions, as a stand-alone policy and in conjunction with tourism
growth. The results show that tourism growth amplifies the positive effects of
globalisation and lessens its adverse effects. Production increases and welfare
improves, while adverse effects on government deficits and the trade balance
are reduced.

Keywords: Tourism, globalisation, taxation, economic impact, SAM, CGE,

welfare, distribution.
JEL classification: C68, D58, E62, L83, O53

1). The authors are respectively Research Associate, Research Fellow and Professor at the Christel DeHaan
Tourism and Travel Research Institute, Nottingham University Business School, Jubilee Campus, Nottingham
NG8 1BB, UK. http://www.nottingham.ac.uk/ttri

1
 Economic Impact of Tourism and Globalisation in Indonesia
Guntur Sugiyarto, Adam Blake and M. Thea Sinclair

INTRODUCTION

In recent years, tourism and its associated economic repercussions have taken place

within a wider context of globalisation of the world economy. Macroeconomic policy-

makers have been concerned to decrease barriers which impede international flows of

goods, services and financial capital and to ensure flexibility of exchange rates,

interest rates and wages, with the aim of inducing markets to operate more efficiently.

The introduction of such macroeconomic policies has been a source of some

controversy because of the implications for income and employment, as well as

income distribution and the welfare of local populations.

Policies to promote trade liberalisation are a case in point. Trade liberalisation is

occurring in conjunction with World Trade Organisation, IMF and World Bank

pressures for lower tariffs and the elimination of import quotas, and also as part of the

process of integration within regional trading blocs. Although trade liberalisation is

supposed to bring about long-term benefits by allowing countries to reap gains from

specialisation in production on the basis of their comparative advantage, a number of

problems may occur. The first can take the form of a balance of trade deficit, as

consumers purchase increasing quantities of the cheaper imports. The second involves

a government budget deficit, as the government receives less revenue from the lower

tariffs. The third concerns the effects of trade liberalisation on the distribution of

income and levels of welfare of the local population. The issue addressed here is,

therefore, whether the growth of tourism can help to resolve these problems.

2
 This issue has received little attention from macroeconomic policy-makers, who

have tended to formulate and implement policies without taking account of their

predicted effects in the context of tourism growth, even in countries whose economies

are highly dependent on tourism. Nor has the issue received much attention in the

tourism literature, which has tended to concentrate on the income and employment

impacts of tourism per se, rather than on its wider range of economic impacts,

including those on distribution and welfare, in alternative macroeconomic contexts.

Therefore the aim of this paper is to develop existing research in the area by

examining the economic impacts of tourism within the macroeconomic context of

globalisation in the form of increasing trade liberalisation, as well as in the context of

lower domestic taxation. The issue will be examined for the case of Indonesia, the

fourth largest country in the world in terms of its population of over 210 million

inhabitants. As one of the former ‘Asian tigers’, Indonesia is an important emerging

economy which has experienced both growth in tourism and a push towards

increasing trade liberalisation in recent years. It has a wide range of tourist attractions

and natural resources. The growing international demand for these assets, in the

context of decreasing levels of trade protection, has significant implications for

domestic income and employment generation, income distribution and welfare. This

paper will examine these effects in the cases of tourism, trade and tax policies in

Indonesia.

The paper will build on previous contributions to research in the area of tourism

impact analysis, which has been undertaken using direct and indirect income changes

(Gartner and Holecek 1983), input-output models (Archer 1995; Archer and Fletcher

1996; Fletcher 1989; Johnson and Moore 1993) and, subsequently, by using a social

accounting matrix (Wagner 1997) and computable general equilibrium (CGE) models

3
(Adams and Parmenter 1995 for the Australian economy; Zhou et al. 1997 for

Hawaii; Alavalapati and Adamowicz 2000 for the environmental impacts of tourism

in Canada; Blake 2000 for Spain; and Dwyer et al. 2000 for the Australian economy).

All of these approaches have the advantage of taking account of the interrelationships

between tourism and other sectors of the economy. This paper will use a CGE model,

which has the advantages of incorporating the full range of feedback between the

different sectors of the economy, along with flexibility of prices and factor

substitutability. It is well suited for examining the effects not only of tariff reductions

but also of domestic taxation, which is a topic of growing concern in the tourism

literature (Jensen and Wanhill, 2002).

The paper is organised as follows. The next section of the paper will be concerned

with explaining recent trends in tourism in Indonesia and outlining the types of trade

liberalisation that have been undertaken. The following section will set out the main

characteristics of the Indonesian Social Accounting Matrix (SAM), which is used to

characterise the flows between different sectors of the economy. The computable

general equilibrium (CGE) model which is used to undertake the analysis will then be

developed, enabling the full range of economic impacts to be quantified within a

multi-sectoral framework. The model is particularly useful for understanding the

characteristics of the economy and for quantifying the effects of alternative policies in

relation to tourism, trade liberalisation and taxation. The results from using the model

to measure the effects of trade liberalisation per se and of trade liberalisation

combined with decreases in domestic taxation will be compared with the results

obtained from implementing these policies in a context of tourism growth. The final

section of the paper will provide some policy implications and conclusions.

4
TOURISM AND TRADE LIBERALISATION IN THE INDONESIAN
ECONOMY

Indonesia is the largest archipelago in the world, stretching 5.110 km along the

equator from east to west and 1.888 km from north to south. It consists of five mayor

islands (Java and Bali, Sumatra, Kalimantan, Sulawesi and Irian Jaya) and about 30

smaller groups, with more than 17,000 islands in total. The chain of islands divides

the Indian and Pacific Oceans and is enriched with natural resources and diverse

cultures, offering a vast range of tourism activities. It has long been a popular tourist

destination.

Foreign tourism is an integral part of the Indonesian economy. For the decade prior

to the crisis of 1997 the tourism industry experienced strong growth, with large

increases in arrivals of foreign tourists, tourist spending and investment. The growth

of foreign visitors was more than 15% per year, contributing to an increase in foreign

currency receipts as both foreign tourists’ expenditure and their length of stay

increased. The number of foreign visitors in 1997 was 5.2 million, contributing

around 6.6 billion US$ to foreign income - about 3 % of GDP (World Bank, 2002). In

2005, the number of arrivals from abroad is expected to be around 11 million,

generating foreign currency receipts of over $15 billion. Tourism contributed 16% of

total job creation in 1995, and in 2007 it is estimated that 1 of every 11 new jobs will

originate from tourism (Kompas, 06/02/1999). Despite many criticisms of its adverse

effects (see, for instance, Copeland 1991; Pleumarom 1999a, 1999b), tourism in

Indonesia is expected to play a more important role in the future, especially in the face

of the declining role of oil and dependence on low wage, labour-intensive sectors. The

increasing reliance on the tourism sector is also demonstrated by the government’s

efforts to attract more foreign investment in the tourism industry, by allowing 100 %

5
foreign ownership, introducing a tax holiday and welcoming foreign professional

workers in the tourism sector (Kompas, 30/01/1999).

Other policies pursued by the Indonesian government have been concerned with

trade liberalisation. Decreases in the world prices of oil and other primary products,

along with the international debt crisis of 1982, resulted in deterioration of the current

account of the balance of payments and encouraged the Indonesian government to

introduce remedial measures. These included cuts in the number of tariffs from 25 to

11 and a reduction in the top tariff rate from 225% to 60%. Following the fall in the

price of oil in 1986, many import licenses were converted to tariffs and the licensing

procedures for hotels and other tourism facilities were simplified.

During the 1990s, there were further reductions in tariffs in line with Indonesia’s

membership of AFTA (the ASEAN Free Trade Agreement) and APEC (the Asia-

Pacific Economic Co-operation) Agreement. After the Asian crisis of 1997, import

tariffs on over 150 goods were decreased, import subsidies on some goods were

eliminated and import quotas were replaced by tariffs. Thus, the policy is one of

moving away from an import substitution strategy towards an outward-oriented

economy. However, various problems remain. The trade balance remains highly

vulnerable to changes in world prices of oil and other natural resources and the

government has also incurred budget deficits. Employment levels, poverty and

income distribution worsened considerably following the crisis. The question of

whether a policy of further trade liberalisation combined with tourism growth can

contribute to alleviating these difficulties will be examined in the following sections.

6
THE CGE MODEL FOR TOURISM IN INDONESIA

Despite the important role of foreign tourism in the Indonesian economy, there has

been a lack of comprehensive studies of its economic impacts, especially in the form

of economy-wide modelling using the CGE approach. Previous applications of CGE

modelling to the Indonesia economy were not concerned with tourism (Azis 1996;

Behrman et al. 1989; Devarajan et al. 1997; Roland-Holst 1992; Thorbecke et al.

1992; Robinson et al. 1997). Therefore, this is the first attempt at developing such a

model, in line with similar research on different economies (for instance Adams and

Parmenter 1995, Zhou et al. 1997 and Blake 2000). In addition to these ‘flexible

price’ CGE models, there have been some economic impact studies using ‘fixed-

price’ input-output or SAM-based multiplier models (for instance Bergstrom et al.

1990; Fletcher 1989; Heng and Low 1990; Khan et al. 1990; West 1993; Loomis

1995; Wagner 1997; Huse et al. 1998).

The tourism-CGE model that will be developed for Indonesia will permit a range

of analysis relating to ongoing economic issues related to tourism. The model’s

development and its use in policy analysis (comparing simulation results with

benchmark conditions) is directed towards, first, encapsulating the main

characteristics of the Indonesian economy, especially with regard to the current level

of foreign tourism and the globalisation process. Second the model will facilitate

analysis of the economy-wide effects and distributional implications of globalisation

and the growth in foreign tourism. The results that are obtained from the model should

provide useful implications for future economic policy-making, which is also

compatible with the growth of foreign tourism and the overall development of the

economy.

7
 In the model, foreign tourists consume a range of exported commodities,

particularly services. This assumption is in line with the World Tourism Organisation

recommendations on Tourism Satellite Accounts (TSA) that some parts of exports

should be attributed to foreign tourism. Given the way that foreign tourism is

modelled, it is important to note that this study does not aim to measure the ‘actual-

definitive’ magnitude of the tourism impacts (as commonly estimated in fixed-price

input-output and SAM-based models, for instance Archer 1995; Archer and Fletcher,

1996), but rather to measure the ‘overall-indicative’ directions of the effects,

especially on production activities, factor markets, foreign trade, the welfare of

domestic residents and income distribution, i.e. the general equilibrium economy-

wide effects (see Greenaway et al. 1993; Shoven and Whalley 1992; and Robinson

et al. 1999 for fuller discussions of CGE modelling).

The globalisation process is modelled by a combination of appropriate functional

specifications used in the modelling development and in the policy scenarios

introduced in the simulations. The modelling specifications capture various

transactions between the domestic economy and the rest of the world. These include

factor payments coming to and going from the domestic economy, capital injections

from the rest of the world to the domestic economy (i.e. for financing the savings-

investment gap) and transfers from the rest of the world to the government and

domestic firms (i.e. as part of the open capital account policy adopted by the

Indonesian government).

The policy scenarios are modelled by classifying the process into two stages:

partial and far-reaching globalisation. The former is represented by changes in

government policies towards more open international trade, while maintaining other

taxation and an open capital account to balance the domestic saving-investment gap

8
and the domestic current account deficit. The move towards greater trade

liberalisation seems inevitable, given the Indonesian government’s commitments to

the World Trade Organisation (WTO), Asia-Pacific Economic Co-operation (APEC)

and Association of South East Asian Nations (ASEAN) agreements to liberalise

international trade. The lowering of tariffs is then combined with reduction in the

indirect taxation levied on the domestic economy in the far-reaching stage. The tariff

reduction, in conjunction with other measures such as domestic tax reform and the

replacement of quantitative restrictions by tariffs, has been part of the policy package

of the IMF/World Bank conditional loans in which the Indonesian government is

currently involved.

The Social Accounting Matrix used in the Model

A Social Accounting Matrix (SAM) is a system of representing the economic and

social structure of a country (region) at particular time, by defining its economic

actors and recording their transactions. It is an accounting record for a whole

economy. The disaggregation level and choice of representative actors depend on the

motivation underlying its development and the availability of data, so that there is no

'standard SAM'. In a statistical system, a SAM provides complementary economic

indicators, which concern not only the macroeconomic aggregates of the System of

National Accounts (SNA) but also the socio-economic structure and distributional

aspects of the economy. Accordingly, it can be thought of as a further development of

input-output accounts, which concentrate only on the production side of the economy.

Entries in a SAM can be categorised into two groups, one that reflects flows across

markets (i.e. representing product and factor markets) and the other that reflects

nominal flows or transfer payments. The transactions are presented in a square matrix,

9
with rows representing receipts and columns recording expenditures. It then follows

that every income has its corresponding expenditure, and the inflows and outflows of

any account always balance.

It must be noted that every SAM provides a static image or 'snapshot' of an

economy. Nevertheless, it can provide the statistical basis for the development of

plausible models when more than a static image is required (see Pyatt and Round

1985; Drud et al. 1986; Pyatt 1988; de Melo 1988; Robinson and Roland-Holst 1988

for fuller discussions about a SAM and modelling based on a SAM)

A schematic representation of the SAM for Indonesia is shown in Table 1. The

SAM captures the circular flows of income from activities to factors and then to

institutions, which create demand for goods and services. The factor accounts receive

factor incomes from both domestic activities and the rest of the world (ROW), while

current transfers are recorded in the intersection of rows and columns of institutions

(households, firms, government and ROW). These transfers constitute the non-factor

incomes, which augment the factor incomes to yield the income of institutions. By

representing transactions in this way, factor classifications may be set independently

of institutions, enabling the underlying characteristics and policy concerns about

factor markets and domestic institutions to be accommodated simultaneously. This

provides useful information and increases the versatility of the models developed

subsequently. The separation of commodity accounts from production accounts is

especially useful for models that focus on international trade (Robinson, 1989). The

disaggregation of commodities into domestically produced and imported also provides

a good background for modelling imperfect substitutability characteristics between

the two goods (Armington, 1969).

10
 Production activities are classified into 18 categories and the commonly used

assumption that one sector produces one good is adopted, so that classifications for

sectors and commodities are the same. Each production activity employs different

kinds of labour and capital. Labour is categorised into eight groups based on a

combination of sector, type of workers and job status, namely wage and non-wage.

The former refers to employees while the non-wage category includes employers,

self-employed and family workers. In the Indonesian economy context, the former

tends to be associated with higher income groups as most of the latter consists of self-

employed and unpaid family workers. On the capital side, capital is disaggregated into

five categories based on ownership and the nature of the capital. Land and other

agricultural capital, for instance, are combined into one category, while private

domestic capital is an aggregation of corporate and non-corporate private capital. The

other two categories of capital are government and foreign capital.

Households are classified into 10 groups, based on a combination of income

sources, area of residence and job status of the head of household or the highest

income earner. First, households are divided into agricultural and non-agricultural

households. The former is then split into employee landless farmers, small farmers

(land size < 0.5 hectare), medium farmers (between 0.5-1.0 hectare) and large farmers

(>1.0 hectare). For the non-farmers, the disaggregation is based on area of residence

(urban and rural), level of income and a combination of occupation and job status.

Based on these variables, the non-farmers in each area are then classified into low,

dependent and high-income groups. The dependent term refers to the households

whose highest income earner (head of the households) is not in the labour force,

relying instead on transfer incomes from relatives, friends and the government. The

household classification has been developed based on ‘real’ variables, which can

11
easily be identified for policy targeting, as commonly suggested in the development of

a SAM.

Main Characteristics of the Model

Production/Supply Side

In the model, output was specified as an input-output function of intermediate

input and value added. The intermediate input consumption was set as a constant
elasticity of substitution (CES) aggregation of domestically produced and imported
commodities (allowing imperfect substitution between the two commodities, with a
different degree of substitution for each type of commodity, as reflected by the value
of elasticity used) in the form of:

[
INTi = A α d Di(σ i −1)/σ i + (1 − α d ) M i(σ i −1)/σ i ] σ i / ( σ i −1)

(S.1)
where A = scale parameter, αd = share parameter for domestically produced
commodities as a share of total commodities available in the domestic economy
(0<αd <1), and Di and Mi are domestically produced and imported commodities,
respectively. The elasticity of substitution between domestically produced and
imported commodities is represented by σi.
The value added was set as a Cobb Douglas function of eight different types of

labour (farmers wages and non wages, production wages and non-wages, clerical

wages and non-wages and professional wages and non-wages) and five different types

of capital (land and agricultural, non-corporate private domestic, corporate private

domestic, foreign, and government capital). Moreover, the wage rates of farmers and

production workers were fixed to reflect the excess supply and various government

interventions to control the wage rates of these types of workers. For other types of

labour and capital, wages and rents are flexible to clear the market. These market-

clearing levels reflect the marginal productivity of the factor.

Total production was allocated to domestic demand and exports, which were then

disaggregated into two product categories: services, and agriculture and

12
manufacturing. The former is assumed to be consumed by foreign tourists, while the

latter is other exports. This treatment of foreign tourism is reasonable as fluctuations

in foreign tourist consumption should be reflected in the fluctuations of service

exports, as most of the service exports are consumed by foreign tourists. With regard

to the CGE modelling, policy analysis should place more emphasis on the general

equilibrium effects or direction of the impacts rather than on the magnitude of the

change. For the latter, a more refined method for estimating foreign tourist

consumption should, ideally, be used prior the development of the CGE model. This

may be possible in the future if a TSA is calibrated for Indonesia.

Demand Side

Total final demand in the domestic market consists of demand for consumption and

for investment purposes. Consumption is the sum of household and government

consumption, while the demand for investment is generated by the aggregated saving-

investment (capital) account. A schematic representation of the demand system of the

model is shown in Figure 2.

The Cobb-Douglas utility function used in household consumption implies that

households have a fixed consumption pattern. On the other hand, the government is

assumed to have planned consumption, which is reflected in the input-output

specification. The government consumption is, therefore, not affected by commodity

prices or the government’s income. Government saving is, accordingly, residual. In

addition, the government has access to foreign borrowing for balancing its budget

deficit -since 1967, the Indonesian government has continuously adopted a budget

deficit, which is financed by foreign funds. The same applies to domestic firms, so

that the two deficits have been contributing to Indonesia’s total foreign commitments.

13
In addition, there are direct transactions among institutions (i.e. the Rest of the World,

government, firms and households) in the form of direct taxes and other transfers that

are taken into account in the models.

Consistent with the government consumption behaviour, aggregate investment is

fixed (in quantity), reflecting the 'investment-driven' nature of the economy. This

specification was chosen to reflect the fact that the Indonesian government (the main

economic agent) has always set its budget and other macroeconomic targets at the

beginning of the year which, in turn, affects the economic behaviour of both firms and

households. In addition to the main functional specifications for production and final

demand, there are other equations in the model to define prices (for activities,

commodities, and factors), incomes and expenditures (by institutions) and to balance

the model.

Price Equations

The domestic price of each composite commodity (Pi) can be written as a CES

function of the domestic prices of imported (PMi) and domestically produced goods

(PDi):

[
Pi = α d PDi(σ i −1) /σ i + (1 − α d ) PM i(σ i −1)/ σ i ]
σ i /( σ i −1)

(P.1)

On the import side, the adoption of the small country assumption implies that the

domestic economy is a price taker and there is unlimited supply from the ROW at the

given world price. The domestic price of imports is given by

PM i = PW i (1 + tmi ) ER (P.2)

where PWi is the world price, ER is the exchange rate and tm is the tariff rate on

imported commodities. The bar sign indicates that the variable is fixed. Assuming

14
that domestic products sold in the international market face a downward sloping

demand curve, the export price (PWE) can be represented as

PWEi = PDi / (1 + tei ) ER (P.3)

where te is the export subsidy rate.

Income and Expenditure Equations

Household incomes (Yh) consist of factor incomes (wages and rent payments for its

capital used domestically and abroad, expressed by the first two parts of equation I.1

on the right hand side) and transfer incomes from the government (TGH)gh, domestic

firms (TFH)fh, other households (THH)hh and the ROW (TWH)wh. These incomes can

be written as:

∑ ∑ Wk Lkih + ∑ ( PN i X i − ∑Wk Lki ) h 

Yh =  i k i k 
 
 + (TGH ) gh + (TFH ) fh + (THH ) hh + (TWH ) wh ER (I.1)

Firms’ incomes (Yf) include payments for capital used in production, transfers from

other firms (TFF)ff and transfers from the ROW (TWF)wf, which is set as a residual. It

is given by:

 
Yf = ∑ ( PN i X i − ∑ Wk Lki ) f + (TFF ) ff + (TWF ) wf ER 
 i k  (I.2)

Government income (Yg) can be categorised into payments for capital used in

production activities, income taxes from domestic institutions (households, domestic

firms and government-owned companies), income from indirect taxes levied on

commodities and transfers from ROW (TWG)wg, which is endogenously determined

by the model. It is given by:

∑ ( PNi X i − ∑ Wk Lki )g + ∑ thYh + ∑ t f Yf + 

i k h f 
Yg =  
+ ∑ tdi X i PDi + ( TWG )wg ER
S

 i  (I.3)

15
 Transfer payments from the Rest of the World to households are set exogenously

(as shown by a bar sign on the variables in the equations), while transfers to

government and firms are set endogenously (as residuals). This is consistent with the

behaviour of domestic firms as well as the fiscal policy of the government; both rely

on foreign sources for funding their deficits. These transfer payments consist of

foreign loans, grants and other transfers.

Household expenditure (Eh) consists of consumption of composite commodities,

direct tax payments to the government, transfers to other household groups and

savings:

E h = ( ∑ Cih ) + ( ∑ t h Yh ) g + (THH ) hh + S h
i h (E.1)

The expenditures of firms (Ef) consist of transfers to households, direct tax

payments to the government, transfers to other firms (retained profit), transfers to the

ROW (TFW)fw and saving:

E f = (TFH ) fh + ( ∑ t f Yf ) g + (TFF ) ff + (TFW ) fw + S f

f
(E.2)

Government expenditure (Eg) consists of consumption of composite commodities,

transfers to households (TGW)gh, transfers to the government (TGW)gg, transfers to

the ROW (TGW)gw and saving:

E g = (∑ C ig ) + (TGH ) g + (TGG ) gg + (TGW ) gw + S g

∑h
i (E.3)

Saving and Investment Equations

Total saving in domestic economy consists of household savings (Sh), firms saving

(Sf), government saving (Sg) and capital injections from the Rest of the World (Sw):

S = Sh + S f + S g + S w
(S-I.1)

16
 In equilibrium, total saving equals total investment, which is distributed to each

sector based on fixed shares.

S=I
Ii = ∑δ i I and ∑δ i =1
i i (S-I.2)

Aggregate final demand (total final consumption of composite commodities) is

accordingly given by

C i = ∑ C ih + ∑ C ig + I i
h g
(S-I.3)

where

Cij = δ ij (1 − MPS j )(1 − th )Y j , j = h, g

Employment and Wages

For non-agricultural and non-production workers in Indonesia, wages are set in

competitive markets and reflect the marginal product of labour:

n
PN i (∂ X i / ∂ Lki ) = Wk with LDk = ∑ Lki and LDk = LSk ¨
i =1 (L.1)

For labour in the agricultural sector and production workers, wages are fixed and the

last part of equation above becomes

LDk = LSk where LSk < L*kS and Wk = Wk (L.2)

Thus, allowing for unemployment in the agricultural sector and among production

workers. D and S in the equations above refer to demand and supply while Wk is the

wage at equilibrium level.

Foreign Trade

The export demand equation is

Ei = Ei (AVEi / PWE i )η i (F.1)

17
where Ei = exports when AVEi = PWEi, PWE = supply price of domestic exports in

foreign currency, AVE = average world price of the commodity, η= the export

demand elasticity.

The import demand equation is

M i = (δi / 1 − δi ) σ i ( PDi / PM i ) σi Di (F.2)

where: δ = share parameter and Di = total demand for domestic use

The balance of payments equilibrium equation is given by:

 
 ∑ PW i M i + (TGW ) gw + (TFW ) fw + ( RMTW )kw 
 i 
 
=  ∑ PWEi Ei + ( RMFW ) wk + (TWH ) wh + (TWF ) wf + (TWG ) wg 
 i  (F.3)

The left hand side of the equation above is the ROW revenue that consists of imports,

capital flight, transfers from government and firms, and capital payment from foreign

capital used in domestic production to the ROW (remittances). On the right hand side

is the ROW total expenditure, covering exports, capital payments and transfers to

domestic households, firms and government. Since the transfers from ROW to

domestic firms and government are set as residuals, the current account deficit

equation is given by

 
(TWF ) wf + (TWG ) wg =  ∑ PW i M i + (TGW ) gw + (TFW ) fw + ( RMTW ) kw 
 i 
 
−  ∑ PWEi Ei + ( RMFW ) wk + (TWH ) wh 
 i  (F.4)

The model provided by the equations above is used to quantify the effects of trade

liberalisation, changes in taxation and foreign tourism growth in the Indonesian

economy.

18
RESULTS

Two main macroeconomic policy scenarios were considered, first in isolation and

subsequently in conjunction with foreign tourism growth. The first is termed ‘partial

globalisation’ and is modelled by a reduction of 20% in the tariffs on imported

commodities. This reflects external pressure on the government to implement tariff

reductions in conjunction with Indonesia’s membership of AFTA and APEC. It

occurs in the context of the government’s reluctant attitude towards globalisation,

stemming from its increasing reliance on revenue from import tariffs. Despite the

government’s trade liberalisation efforts, especially after 1982, revenue from import

tariffs contributed 4% of total government income in 1985. This amount more than

doubled to 10% in 1993 (Sugiyarto et al. 2001). In this scenario, the government is

assumed to reduce tariffs on imports but not on exports, owing to its reliance on

revenue from the external sector, and to maintain all kinds of taxation in the domestic

economy.

In the second scenario, termed ‘far-reaching globalisation’, the government is more

pro-business and balances the ‘involuntary’ (externally determined) import tariff cuts

with a ‘voluntary’ removal of distortions in the domestic market. The latter is

represented by the same reduction (20%) in indirect taxation levied on domestic

commodities. Another reason for considering a combination of the two policies is that

reductions in the level of indirect taxation on domestic commodities are a common

feature of tax reform policies, especially in developing countries (see Ahmad and

Stern 1991; Bird 1992; Bird and Oldman 1990; Gillis 1989; Newbery and Stern

1988; and Rao 1993).

The two scenarios are analysed by using the CGE model to estimate the effects of

partial and far-reaching globalisation on key economic variables: GDP, employment,

19
a range of measures of inflation, external performance, welfare, household and

foreign tourist consumption. The results are given in Table 2 and are calculated as

percentage changes from the benchmark data, where the benchmark refers to the

equilibrium values of the variables prior to the simulations. In most cases, a positive

number reflects an improvement and vice versa. Percentage changes in balance of

payments (BOP) deficits and trade balances should be interpreted carefully since the

absolute numbers can switch from negative to positive.

Partial Globalisation

The effect of decreases in tariffs is to reduce government revenue and also to lower

the price of imported commodities in the domestic market. As the domestic economy

is a price taker, this will increase the demand for imported products, contributing to an

increase in the availability of products in the domestic economy. On the other hand,

the demand for domestically produced goods in the domestic market decreases as

their prices become relatively more expensive. This will induce producers to export

more and, in turn, to produce more, as some of the lower price imported commodities

are also used as intermediate inputs. The stronger price effects on imports result in a

worsening the trade balance as imports increase by more than exports. The increase in

demand for imported products is also higher than the reduction in domestic demand

for domestic products, so that the total supply of products in the domestic economy

still increases. The overall effects increase GDP.

Column 2 in Table 2 summarises the effects of introducing import tariff reductions

on the key variables concerned, measured by the percentage changes from the

benchmark. It can be seen that the tariff reductions increase imports and foreign trade,

thus increasing the availability of products in the domestic economy (by 0.1%). This,

20
in turn, creates additional demand and stimulates production activities so that GDP

increases by 0.1%. Adverse effects of the policy take the form of a worsening of the

trade balance (imports increase by more than exports) and the government current

account deficit. The deficit deteriorates significantly due to the government’s loss of

revenue from tariffs combined with adherence to its planned expenditure. Welfare

improves, as indicated by the increases in total domestic absorption (by 0.1%) and

household real consumption (by 0.2%).

Foreign tourists are also better off as they can consume more with their benchmark

level of spending. Their expenditure on hotels and restaurants (the main items of

expenditure for foreign tourists) increases by 1%. The modelling procedure assumed

that there is no change in the total income (equals total spending) of foreign tourists.

The increase in consumption by foreign tourists may be higher, as the lower prices of

domestic commodities may encourage them to consume more or even attract more of

them to visit Indonesia (see Sinclair and Stabler, 1997, for discussion of the

microeconomic foundations of tourism demand and Smith, 1994, and Watson and

Kopachevsky, 1994, for analyses of tourism as a commodity). Moreover, a wide range

of studies, reviewed by Crouch (Crouch 1994a, 1994b), indicate that price is a crucial

factor for most tourists when choosing a holiday destination. Note that while total

GDP increases, some (import competing) sectors experience a decline in output and

GDP contribution. These loses are concentrated in agriculture (-0.06%) and

manufacturing (-0.04%) sectors. There may therefore be additional adjustment costs

as the economy reacts to tariff liberalisation by reducing employment in these sectors.

21
Far-reaching Globalisation

The positive effects of partial globalisation discussed above are amplified in the

far-reaching globalisation scenario, when import tariff reductions are combined with

reductions in indirect taxation on domestic commodities. The reason for this can be

traced from the effects of introducing the indirect tax reductions. On the production

side, this policy will reduce the domestic prices of domestic products, making them

more competitive. This, in turn, stimulates domestic production, creates more

employment and increases GDP. The greatest expansions are in the trade, food

processing and hotel and restaurant sectors. The increases in domestic production and

employment raise household incomes, which creates more demand for goods in the

domestic market. Imports increase to meet the higher domestic demand but exports

decrease due to the fact that the domestic market becomes more profitable for

producers. Therefore the trade balance deteriorates. The policy will reduce the

government’s income from indirect taxation and worsen its deficit, as the loss of tax

revenue has made the government less able to finance its planned expenditure. The

policy has positive impacts on welfare, as domestic absorption (including household

and government consumption as well as investment), and household consumption

increase.

Column 3 in Table 2 summarises the effects of the far-reaching globalisation. The

direct effect of the combined cuts is a decrease in the domestic prices of imported and

domestic commodities. The demand coming from higher household incomes (as a

result of the cuts in indirect taxation) magnifies the increase in import demand due to

lower import prices (resulting from the first policy). Therefore, the trade balance

deteriorates further as imports increase, while the positive impact of import tariff

reductions on exports is offset by the negative effects of indirect tax reductions on

22
exports. The end results show that imports increase by 1.9% while exports decrease

by 0.2% and the trade balance deteriorates by 23.5%. The increasing availability of

products in the domestic economy creates additional demand and stimulates

production activities, which results in higher GDP (0.6% increase) and employment

(1.3% increase). The government continues to experience adverse effects on its

current account deficit. Welfare improves, as can be seen from the increases in total

domestic absorption (1.1%), and household real consumption (2.0% increase).

Foreign tourists are better off for paying lower prices for the products and services

they consume. Their real consumption on hotels and restaurants increases by 0.9%.

Increasing Demand by Foreign Tourists

The growth of revenue from international tourism in Indonesia was expected to be

more than 15% per year, as was explained in the second section of the paper.

However, in the face of economic and then political crisis, this forecast may be too

optimistic. The governments of some western countries, including the USA and UK,

have warned their citizens not to visit some parts of Indonesia and the number of

foreign visitors from Australia could also be affected by the East Timor independence

process. In this section, therefore, a more reasonable 10% increase in foreign tourism

demand is simulated and is then combined with the previous two globalisation

simulations. This increase in foreign tourist expenditure can be achieved by an

increase in foreign tourist arrivals of less than 10% as, over the years, their spending

level tends to increase. Columns 4 - 6 in Table 2 summarise the results.

The increase in foreign tourism demand will create more production (GDP

increases by 0.1%) and employment (increases by 0.2%) but, at the same time, puts

pressure on domestic prices. This is clearly shown in the foreign tourist consumption.

23
The foreign tourists’ real consumption increases by 9.4% -less than the 10% increase

introduced in the initial simulation. Welfare improves, as domestic absorption and

household real consumption increase. Domestic absorption increases by 0.1%, while

household real consumption increase by 0.2%. Exports increase by more than imports,

resulting in an improvement in the trade balance (increase by 0.7%). The same

improvement also applies to the balance of payments deficits (reduced by 2.2%).

Globalisation and Foreign Tourism

The next two simulations consider the globalisation scenarios in the context of

foreign tourism growth. The results are given in columns 5 and 6 of Table 2 and show

that growth of foreign tourism demand amplifies the positive effects of globalisation

and, at the same time, reduces its adverse effects. The levels of GDP and employment

are higher, particularly in the case of the combination of tourism growth, trade and tax

liberalisation (column 6). The trade balance is in deficit, but to a lesser extent than in

case of trade and tax liberalisation without tourism growth. The balance of payment

deficit is now in a better position, owing to the increased income from foreign

tourism.

An obvious policy that the government can undertake is, therefore, to embark on

globalisation by reducing its reliance on import tariffs and indirect taxation at a rate

that enables the revenue lost by tariff and tax reductions to equal the additional

income due to the growth of foreign tourist arrivals. The income from foreign tourism

will enable the government’s income to be maintained at the benchmark level, so that

involvement in globalisation will not disrupt the government’s expenditure program.

This is a means by which governments, such as the Indonesian government, can

maintain their credibility and avoid fiscal problems. The government’s ability to

24
maintain its expenditure level is also important within a context of overall deflation,

as expenditure by the government can help to offset reductions in other components of

aggregate demand, such as exports of primary products.

The results obtained from different policy scenarios were subjected to sensitivity

analysis, in order to examine their robustness to changes in the export demand

elasticity value. This parameter value quantifies the responsiveness of the demand for

Indonesia’s exports to changes in their price and is particularly important for an

economy which is increasingly open to international trade and a depreciating

exchange rate. Columns 7 - 11 in Table 2 summarise the results of the sensitivity

analysis, which is conducted by doubling the export demand elasticity values used in

the five simulations. The increase in the elasticity values will make the demand from

the ROW more elastic, so that domestic market prices will be determined, to a greater

extent, by the export market. The results confirm that the elasticity values are

important in determining the overall results, including the magnitude and, in some

cases, the direction of the changes. For any policy changes introduced in the model,

higher export demand elasticity values will produce bigger impacts on the

real/quantity variables, as clearly shown in the case of globalisation (columns 7 and

8). On the other hand, the increase in foreign tourism demand will result in lower

price effects for the domestic economy, as shown by the results of third simulation

(column 9). The outcomes of these offsetting effects are shown by the last two

simulations (columns 10 and 11). In general, the sensitivity analysis shows the

robustness of the results and functional specifications employed in the models, as the

results conform to the theoretical predictions.

25
CONCLUSIONS

This study has shown that globalisation combined with tourism does not

necessarily have adverse effects on the domestic economy, in contrast to the past

portrayal of the combination as ‘a deadly mix’ (for example Chavez 1999).

Globalisation and foreign tourism growth can, in fact, reduce the domestic price level

and increase the amount of foreign trade and availability of products in the domestic

economy, thereby stimulating further production. The end result in the Indonesian

case is improved macroeconomic performance and welfare, as domestic absorption,

and household consumption increase. Foreign tourists are also better off for they can

consume more, given their spending level, and also benefit from the greater

availability of products. The trade balance and current account deficits are of concern,

indicating the need for appropriate accompanying policies, such as the promotion of

investment in manufacturing, underpinned by the booming service sector. Moreover,

the positive findings from this study do not take account of effects that foreign

tourism may have on the environment and culture.

The combined effects of the growth of foreign tourism and globalisation are

beneficial, overall, as the foreign tourism growth amplifies the positive effects of

globalisation and at the same time reduces its adverse effects. The trade balance and

government accounts are in a better position, owing to the additional receipts from

tourism. The ongoing growth of foreign tourism also reduces the government’s

burdens as a result of embarking on globalisation, by enabling it to reduce its reliance

on import tariffs and indirect taxation while, at the same time, maintaining the level of

income necessary to finance its expenditure. Tourism growth would, therefore, enable

the government to follow a fiscal policy of revenue neutral globalisation, allowing it

26
to finance its expenditure without imposing higher taxes on the Indonesian

population.

27
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31
Figure 1. Schematic Representation of Production System

Figure 2. Schematic Representation of Demand System

32
 Table 1: Schematic Representation of the Indonesian SAM
EXPENDITURE
RECEIPTS 1.Factor 2.Institutions 3.Activity 4.TTM 5.Dom.Com 6.Imp.Com 7.Capital 8.Ind. Tax 9. ROW
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
1.Factors
a).Labour Wages
b).Capital Profits/Rents Remittances
2.Institutions Factor Transfers Transfers
a).Households Income
b).Firm Factor Transfers Transfers
Income
c).Government Factor Direct Tax Ind. Tax Transfers
Income Revenue
3.Activities Transfer Production
4.Trade and Mark-up Mark-up
Transport Margin
(TTM)
5.Domestic Consumption Intermediate Investment Exports
Commodity
6.Imported Consumption Investment
Commodity
7.Capital Savings
8.Net Indirect Tax Tax Tax
9.Rest Of Remittances Transfers Imports Capital
theWorld (ROW) Outflows

33
 Table 2: Effects of Globalisation and Foreign Tourism Growth in the Indonesian Economy
(Percentage Change from the Benchmark)
Scenarios of Globalisation and Foreign Tourism Growth Sensitivity Analysis of Doubling the Values Of Export
Variables Concerned Demand Elasticities
PG FG DI PG & DI FG & DI PG FG DI PG & DI FG & DI
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
A. Macroeconomic Aggregates
1. GDP 0.05 0.64 0.06 0.11 0.70 0.11 0.69 0.03 0.14 0.72
a. Agriculture -0.06 1.54 0.17 0.11 1.71 0.02 1.65 0.12 0.14 1.77
b. Mining 0.00 -0.74 -0.14 -0.14 -0.88 -0.06 -0.81 -0.11 -0.17 -0.91
c. Manufacturing -0.04 0.33 -0.05 -0.09 0.28 0.08 0.41 -0.09 0.00 0.33
d. Services 0.04 0.46 0.14 0.18 0.60 0.05 0.45 0.12 0.17 0.56
-Hotel 0.04 0.87 2.81 2.90 3.60 -0.02 1.21 2.73 2.70 3.74
-Restaurant 0.00 1.47 0.53 0.54 1.98 0.04 1.58 0.50 0.53 2.04
2. Employment -0.01 1.34 0.16 0.15 1.49 0.11 1.42 0.10 0.21 1.51
B. External Conditions
1. Foreign Trade
a. Real Export 0.64 -0.18 0.24 0.88 0.05 0.88 -0.10 0.14 1.02 0.03
b. Real Import 0.91 1.86 0.20 1.11 2.06 1.09 1.87 0.12 1.21 1.99
c. Trade Balance -2.43 -23.49 0.70 -1.75 -22.90 -1.56 -22.60 0.36 -1.23 -22.33
2. BOP Deficits
a. Government 349.15 1195.34 30.41 380.35 1227.58 357.45 1189.06 24.74 382.20 1213.55
b. Firm -14.65 -42.91 -3.58 -18.28 -46.47 -16.48 -43.32 -2.63 -19.10 -45.79
c. Total 0.53 8.76 -2.16 -1.64 6.70 -0.88 8.10 -1.49 -2.36 6.76
C. Welfare and Distribution
1.Domestic Absorption 0.09 1.06 0.05 0.14 1.11 0.14 1.09 0.03 0.17 1.12
2. Household Real Consumption 0.16 1.97 0.15 0.32 2.12 0.25 2.01 0.11 0.36 2.11
a. Farmers 0.15 2.15 0.13 0.28 2.28 0.22 2.24 0.09 0.31 2.32
b. Rural Households 0.14 1.92 0.14 0.28 2.05 0.23 1.97 0.09 0.32 2.06
c. Urban Households 0.19 1.83 0.18 0.38 2.01 0.29 1.83 0.13 0.43 1.95
3. Foreign Tourist Consumption
a. Hotel and Restaurant 0.10 0.92 9.37 9.65 10.08 -0.04 2.20 9.09 9.03 10.67
b. All other services 0.13 -0.28 9.37 9.67 8.80 0.00 -0.26 9.09 9.09 8.08
Note: PG and FG are Partial and Far-reaching Globalisation, while DI is Foreign Tourist Demand Increase.

34