Zeng Yan: Live with no Excuses and Travel with No Regrets - A Cross-country Study on the Effectiveness of the Legal System and Inbound Tourism


Tourism industry

Tourism has become one of the most remarkable socio-economic phenomena since World War II. It is now considered a vital dimension of global integration and trade activities and has therefore become the world’s largest source of foreign exchange receipts. Especially in developing countries, international tourism as a superior good  may well become an important factor for economic development.

As tourism may be a relevant factor for development, an important question to answer is which determinants can push the demand for tourism in the countries of origin. We analyse determinants which explain the huge differences in tourism flows between countries. 

Tourism literature

There is abundant literature investigating the determinants of inbound tourism from a variety of perspectives. Various cultural variables, macroeconomic indicators, and travel health risks are used as possible drivers of the inbound tourism indicators (see e.g., Kubickova, 2019; Lorde & Jackman, 2013; Peng, Song, & Crouch, 2014; Saha & Yap, 2014 & 2015; Song, Witt, & Li, 2009 & 2012; Wang, 2009). However, these factors do not adequately explain international tourism inflows in destination countries. 

The literature also embraces another dimension which focuses on the quality of institutions. The institutions are of critical economic significance to the operations of all economic sectors (Davis & Trebilcock, 2001). In the tourism sector, for instance, low quality of institutions increases uncertainty and transaction costs and influences the reputation of tourism destinations. The existing literature is mostly comprised of case studies examining the institutional mechanism in the tourism industry. Only a few studies have conducted cross-country research investigating the economy-wide institutional factors in affecting tourist inflows and revenues derived from international tourism (Das & Dirienzo, 2009; Nunkoo, Ramkissoon, & Gursoy, 2012; Saha, Su, & Campbell, 2017; Su & Lin, 2014). In line with this literature, we aim to examine the impact of formal institutions on tourism development. The main hypothesis of this paper is that the effectiveness of the legal system promotes the development of the tourism sector.

Informal and formal institutions 

Formal institutions include constitutions, contracts, and form of government, while informal institutions include ‘traditions, customs, moral values, religious beliefs, and all other norms of behavior that have passed the test of time’. 

From an institutional lens, the impact of institutional quality on tourism development has been investigated to some extent. To the best of our knowledge, the prior literature focuses on the indicators of informal institutional quality such as democracy, economic freedom, civil liberty and trust and power (Das & Dirienzo, 2009; Balli, Balli, and Louis, 2016; Demir & Gozgor, 2019; Saha et al., 2017), rather than indicators of formal institutional quality. The informal institutions may serve as substitutes for the formal institutions as legal enforcement and protection of property and contract rights but with hidden cumulative costs (Posner, 1998). As a result, the legal system itself, other than the informal substitutes, should be explored as well. The existing literature lacks a comprehensive capture of the various aspects of the legal system.

A comprehensive measurement of the legal system 

In order to fill in this gap, we follow the literature (Alesina & Giuliano, 2015) to measure (indices of the legal system and the protection of property rights) and to consider a wider range of legal institutional qualities and their effect on inbound tourism. Specifically, we consider the measures of nine indicators of the efficiency of the legal system: “i) judicial independence, ii) impartial courts, iii) protection of property rights, iv) military interference in rule of law and politics, v) integrity of the legal system, vi) legal enforcement of contracts, vii) regulatory costs of the sale of real property, viii) reliability of police, ix) business costs of crime.” 

Data and model estimations

The index values of those nine indicators aforementioned are obtained from the Economic Freedom in the World (EFW) dataset. The dependent variable of the empirical model is the number of tourist arrivals (in millions) (i.e. inbound tourism), and the related data are obtained from the World Development Indicators (WDI) database of the World Bank (2019). 

Following the previous literature, various controls are also considered. Specifically, we consider macroeconomic indicators, such as the GDP per capita (current U.S. Dollars), nominal exchange rate (official exchange rate domestic currency per U.S. Dollars), and (nominal) trade openness. These data are collected from the WDI database. We also consider geographical control variables, such as the coastline (km), the coastline per total land area, landlocked countries (dummy variable if a country is landlocked, it is equal to one, otherwise it is zero), total land area (km2), and total surface area (km2). These data are obtained from the World Fact Book database of the Central Intelligence Agency (CIA). All of these variables are considered in the natural logarithm form in the estimations. Finally, we consider the number of heritage since inclusion in the World Heritage List can attract more tourists. The related data for the World Heritage List are collected from the United Nations Educational, Scientific and Cultural Organization. 

Mainly, we estimate the equations above by implementing the fixed-effects estimators and their consistency have been checked by Hausman test. Given that the robust standard-errors (clustered at country level) are used, implementing a traditional Hausman test can create the size distortions. Therefore, we run the “robust Hausman test” in order to avoid potential size distortions.

In some cases, fixed-effects estimators can be weak since they ignore time-invariant tourism variables. At this point, the paper implements the estimator of Hausman and Taylor (1981), aka the HT estimations, which also captures the time-invariant variables. In short, we implement both the fixed-effects and the HT econometric methods to handle potential “omitted variable bias” in estimations.

Furthermore, the fixed-effects estimations assume a “strict exogeneity” that is valid when we do not have any lagged dependent variables in the fixed-effect estimations. Specifically, there could be endogeneity issues, which terminate the strict exogeneity assumption. Using the system GMM estimations proposed by Arellano and Bover (1995) and Blundell and Bond (1998), we address potential endogeneity issues. Specifically, there could be an endogeneity bias (also known as the omitted variable bias) which is caused by the exclusion of lagged tourist arrivals as the right-side variable. We also run the two-stage estimation procedure with the consistent estimators to avoid potential multicollinearity between controls.

Discussion and policy implications

The findings imply that for the purpose of developing the tourism industry, countries need to enhance the legal system quality and provide better protection of property rights. It is more beneficial for the lower-income countries than their OECD counterparts to carry out legal reforms since the potential gains are greater for the poorer countries. 

In details, a growth in the tourism industry is accompanied with a higher judicial independence and a better enforcement of contracts, a lower level of regulation on the restrictions on the sale of real property and a lower cost of crime and military interference in the rule of law and politics.

Higher judicial independence helps to more effectively solve conflicts and disputes when tourists and tourism companies face legal problems. Policymakers may need to increase judicial salaries to attract well-educated and honest lawyers. But it would be costly for the poorer countries with scarce resources. Alternatively, countries may alter the structure of judicial compensation by adjusting up the generous pension that is no longer available if the judge is removed from office for incompetence. Another change worth considering is to have judges sit in panels rather than by themselves. But it would increase costs, too.

In countries where the enforcement of contracts is higher, damages are more likely to be compensated when tourists and tourism companies want to make claims of infringement of legal rights. Policymakers may enact rules that certain disputes during tourism seasons can be referred to binding arbitration to avoid lengthy judicial procedures, or entitling the winner of a judgment for damages to receive interest from the date the suit was filed to bypass the cumbersome judicial discussions.

Posner (1998) suggest adopting a system of efficient rules for the existing inefficient institutions to administer, which saves money and time in comparison to heavily investing in upgrading the existing legal institutions. The poorer countries may adopt foreign laws from well-structured economies and adjust them to fit into local customs since there is no need to start from scratch.

Briefly speaking, there is a range of approaches for policymakers of various countries to consider if they want to achieve a higher level of legal system quality and better protection of property rights to enhance the tourism industry. They need to understand there is a trade-off between benefits and costs and make decisions based on the specific conditions in a specific country.


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