Specialization in Luxury Goods, Productivity Gaps and the Rapid Growth of Small Tourism Countries

Abstract

This paper shows that specialization in luxury goods accounts for the remarkable growth performance of small tourism countries during recent decades. Two two-country models are constructed for this purpose. One country is large and rich and produces traded capital goods; the other is a small poor economy that produces traded tourism services. The models differ only in the luxury good nature of tourism. In both models, the tourism economy grows sustainably because its terms of trade improve continuously. This result is related to sectoral productivity gaps. Throughout the transition, the growth differential between the countries is significantly higher when tourism is a luxury good. In this case, there is a faster increase in the tourism imports of the rich economy. As a result, the terms of trade of the poor economy improve greatly and its investment is boosted.