Unemployment Dynamics in a Short-Run Two-Sector Model of a Tourism Exporting Small Open Economy

Abstract

This paper investigates the effects of an increase in inbound tourism demand on unemployment in a small open economy, comprising an industrial sector and a tourism sector. The demand of foreign tourists may either rise exogenously (for example, owing to an increase in foreigners' income) or because of advertising efforts of the domestic country. The author develops a short-run, two-sector model with separated non-Walrasian labour markets, characterized by search of the Pissarides type. Unemployment results from time consuming and costly matching of vacancies with searching agents. A 25% long-run increase in foreigners' tourism demand causes unemployment dynamics in both sectors. The economy-wide unemployment rate shows a nonmonotone adjustment and is reduced by roughly 0.3 percentage points. Similar results are obtained if the demand increase is due to successful advertising. The model therefore supports the popular view that tourism can reduce unemployment.

Keywords

two-sector open economy model sectoral search unemployment tourism demand

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