The Need for State Intervention in Scottish Tourism

Introduction

1. This chapter considers the general need for the functions undertaken by STB. It therefore covers the options of complete or partial abolition outlined in the previous chapter.

Background

2. The Scottish Tourist Board exists as an arm of regional economic development and the reason why it exists has to be rooted in a view of how government intervenes in the workings of the economy. At the macro-economic level, there is a general presumption against the intervention of government in private markets. HM Treasury sums up this argument as follows:

"Public expenditure cannot generally create a sustainable increase in employment or output at the national level, because of the combined effects of displacement and crowding out. If it is financed by taxation, extra public consumption or investment directly displaces private sector consumption or investment. If it is financed by borrowing, and inflation targets are to be met, then prices in the economy must adjust (in particular interest rates and the exchange rate), and these changes crowd out activity elsewhere in the economy. Generally, this means that only policies which produce supply-side improvements will have employment benefits at the national level. . . . It follows that the assumption for displacement and crowding-out combined at the UK level would be 100 per cent, or more, unless there are supply-side improvements."¹

Thus, government intervention will only have a net positive effect if there are resulting supply-side improvements. A necessary condition for this to be the case is the existence of market failure. Also, government should not intervene in private markets unless the resulting costs and benefits represent efficient use of national resources.

3. The existence of market failure is therefore crucial to the need for the Scottish Tourist Board. Market failure can be defined as a situation in which the best (economically efficient) outcome has not been achieved because of imperfections in the market mechanism. Markets will fail to deliver the optimum level of activity in the following sorts of circumstances:

­ where goods are non-rival in consumption (ie where more consumption by one person does not mean less for another). This is the case for public goods such as defence;

­ where important costs or benefits are not reflected in prices. These are known as externalities and occur where a firm's economic activity produces benefits for other firms or individuals, or costs to others which it does not have to meet itself;

­ where there is imperfect information and uncertainty. Information can be thought of as a commodity that is tradable on the open market. The fact that information may be costly to produce does not necessarily imply market failure. However, if information is not available at a price closely related to the cost of providing it, then there may be a market failure justifying public intervention. Imperfect information can lead to uncertainty which in turn may produce an inefficiently low level of transactions;

­ where there are barriers to entry and exit which lead to insufficient actual or potential competition meaning that the market in question produces an inefficient level of output.

The Steering Group accepted this broad analysis and sought a rationale for the Scottish Tourist Board in terms of an economic case for intervening in the tourism market. However, the distinction between collective action through private sector collaboration and public intervention was noted. The Steering Group agreed that it was necessary both to find evidence for market failure in the tourism sector and to make the case for public intervention. This chapter therefore deals with both aspects of this question.

4. The existence of market failure does not, though, provide the only reason for intervention or the need for the Scottish Tourist Board. There is also a 'social' argument: for example, to help slow down and arrest the long-term trend of depopulation in rural areas.

5. Accordingly, the Steering Group took the view that the possible rationale for government intervention in the tourism sector could be split into two distinct parts:

­ An economic rationale which would have to be firmly based on the existence of market failures. In terms of the tourism sector, the main market failure is likely to relate to imperfect information brought about by externalities associated with the supply of this information. It is costly for the supplier of a particular good or service to provide consumers with the necessary product information to allow the consumer to make an informed choice. In addition, the individual supplier cannot be sure that all of the benefits of providing information will accrue directly to him. For example, if a hotel owner in Aviemore advertises his business, he will also be promoting Aviemore in general and other tourism operators located there. These other operators will therefore have an incentive to 'free-ride' on the hotel owner's expenditure. If all tourism providers act rationally, the logical outcome is that none will undertake advertising activity, as each will hope to free ride on others' expenditure.

­ A social rationale, which recognises that it is not desirable for all economic activity to be located in one area of the country. This objective is inevitably coloured by the political thinking of the day, although it is unlikely that any administration would wish to see large spatially ­ concentrated pockets of unemployed resources. Thus, steps may be taken to promote economic development in one particular region compared to other regions. In economic terms, the net effects of such intervention could be zero as activity is simply displaced from one area of the country to another. However, in social terms, there may be important benefits. In acknowledging the possible validity of this rationale, the Group was also clear that social objectives could not simply be assumed: they had to be adequately specified and their pursuit should not result in a decrease in overall economic efficiency.

6. Each of the Scottish Tourist Board's broad areas of activity ­ ie marketing activities overseas, marketing activities in the UK, efforts to minimise seasonality, efforts to increase the spread of tourism expenditure, efforts to improve quality, and efforts to disseminate research and co-ordinate strategic guidance ­ have been examined against one or both of these rationales. The remainder of this chapter will first describe some important characteristics of the Scottish tourism industry before reviewing each of the areas of STB activity in more depth and reaching conclusions.

Characteristics of the Scottish Tourism Industry

Diffuse Nature

7. As was explained in Chapter 3, it is not easy to define tourism or to measure its extent. Tourism is not classified as an industry in terms of the Standard Industrial Classification system and tourists spend money in a wide variety of industrial sectors. Traditionally, the accommodation sector is seen as the core of the industry (and this has sometimes resulted in the accommodation sector being overly influential in the formation of tourism policy). In practice, the tourism industry consists of all the sectors in which tourists spend money either directly or indirectly. It is really a component of final demand rather than a sector of industrial activity. Thus, the careers of a banker in Oban, or a greenkeeper in St Andrews, or a laundry worker in Aberfeldy, or a piper on the streets of Inverness are tied to the fortunes of tourism just as much as those of a hotelier in Edinburgh.

Dominated by Small Businesses

8. Most businesses are small, typically family-owned and run. For example, the average Scottish hotel/guesthouse has 16 bedrooms and 31 bedspaces. Table 5.1 shows the average number of bedspaces per hotel/guesthouse by ATB area. The predominance of large (ie 100+ bedroom) hotels in Glasgow and relatively few guesthouses means that Glasgow and Clyde Valley have by far the largest size of establishment at 65.9 bedspaces, followed by Edinburgh and Lothians, Aberdeen and Grampian, and Perthshire. This pattern reflects areas of high or relatively high population density which benefit from business as well as holiday tourism. Fife has the smallest average size, representing less than 20 bedspaces and 10 bedrooms, with Scottish Borders and the Scottish islands around 20 to 22 bedspaces. It is also worth noting at this point that Scottish hotels tend to be small by international standards and international hotel companies considering investment in Scotland (Sheraton and Marriott are recent examples) will build their smallest hotels here ­ about 250 rooms ­ and yet produce hotels which are among the largest in the country.

Table 5.1: Average Size of Hotel/Guesthouse by ATB Area, 1996

9. In terms of employment, most businesses have fewer than 10 staff. At the last Employment Census in 1995, there were 160,300 people employed in tourism-related activities. With a further 16,600 individuals estimated to be self-employed, this makes a total of around 177,000. The Census also indicates that tourism is characterised by a high level of female and part-time workers: 66% of workers in the hotels and restaurants sector were, for instance, women while 55% were part-time against only 26% for all industrial sectors.

10. Table 5.2 shows employment in tourism-related activities as a proportion of all employment in ATB areas. About 8% of Scottish employees are associated with tourism and the figure is over 14% in the Highlands and Perthshire.

Table 5.2: Tourism-Related Employment in ATB Areas, 1995

11. Table 5.3 shows tourism expenditure by ATB area. These figures also underline the relatively greater economic significance of tourism in rural areas of Scotland. Indeed, in the more rural and remote parts of the Highlands and Islands, the impact of tourism is significantly higher than the average figure suggests. At the height of the tourist season, well over 30% of economic activity is directly related to tourism and, in areas such as Skye and Oban, this is estimated to rise to 40%. The majority of tourism businesses in the Highlands and Islands are very small with well over 75% employing less than 5 people. When coupled with seasonality, a significant proportion of businesses must be considered as either subsistence or lifestyle occupations only. Low profitability means that long-term investment is difficult with high staff turnover, low skill levels and low wages also hindering effective development.

Table 5.3: All Tourism Receipts in Mainland ATB Areas, 1996

12. One benefit of the proliferation of small tourism businesses throughout Scotland is that leakage of expenditure is relatively low but a significant disadvantage is that it is difficult to ensure that standards of service are uniformly high.

Little vertical integration in the industry

13. The Scottish tourist industry is made up of a wide-ranging and large number of autonomous service providers who are, nevertheless, mutually interdependent. For instance, people do not come to Scotland just to sample its visitor accommodation. Clearly, they require good accommodation at reasonable prices but Scotland's appeal as a visitor destination rests largely on attractions which are either preserved or developed for non-tourism reasons. Thus, Historic Scotland and the National Trust for Scotland welcome tourists and need income from tourists but both organisations do not simply maximise profit and can undertake activities that the private sector would not be able to justify on straightforward commercial grounds. Market research undertaken by STB consistently shows that Scotland's greatest asset is its natural environment. But, by and large, the owners of that natural environment, both in the public and private sectors, are unable to generate significant financial return from the Scottish landscape and therefore have little incentive to advertise it.

14. Tourism in Scotland (and in the UK as a whole) has not participated to any significant extent in the huge expansion of the British package travel industry. The reasons for this expansion are not completely clear but are presumably related to a latent demand among the British for Mediterranean-type holidays which was not fully exploited until, among other things, the development of cheap air travel and reliable computer reservation systems. The recent strength of sterling may also have had a small effect, but even a future depreciation of the pound is unlikely to offset this long-term trend. Thus, the expansion of the package travel industry has been associated with a relative increase in the number of Scottish residents taking holidays abroad compared to overseas residents taking their holidays in Scotland. It is noted in this context that there has not been the integration of the transport, accommodation, and visitor attraction sectors in Scotland that has occurred in, for example, ski and coastal resorts in continental Europe.

STB Intervention to Alleviate Market Failure

15. This section relates STB activity in five areas to the concept of market failure. The activities are:

1. General marketing efforts
2. Efforts to minimise seasonality
3. Efforts to increase the spread of tourism expenditure
4. Efforts to improve quality
5. Efforts to disseminate research and provide guidance.

Marketing Activities (Overseas and UK)

16. The argument that the public sector should undertake tourism marketing activities relies on two tenets. Firstly, that the private sector will not undertake this activity itself (or will undertake an inefficiently low level) and, secondly, that potential visitors are sufficiently ill-informed about the destination country.

17. The explanation for an under-provision of marketing activities by the private sector rests on a market failure argument. It is expensive to tell potential tourists about the attractions of Scottish holidays. This is particularly the case given that the market is dominated by visitors who arrange their own holidays rather than purchase them through intermediaries eg package travel operators. Table 5.4 shows the position in 1996 with almost 90% of holiday visits being arranged independently. The private sector (either at the level of the individual firm) will not spend at the necessary level on advertising because of the fear (probably justified to at least some extent) that the majority of the benefits from advertising would accrue to rivals.

Table 5.4: Type of Holidays, 1996

18. This is a clear example of an externality: those firms paying for the costs of advertising cannot capture all the benefits and rival firms will be tempted to 'free-ride' on other firms' expenditure. Therefore, firms will invest in marketing activities only up to the point where they can capture the benefits for themselves. However, this is an under-estimate of the benefits to the industry as a whole and thus represents an inefficient allocation of resources.

19. The situation is aggravated by the structure of the industry with a large number of marginal businesses who cannot achieve the economies of scale that would result in resources being made available for major marketing efforts. In other words, it is probably rational for tourism operators to go along with a situation where less information is provided to consumers than would maximise income.

20. The existence of externalities is not an argument in itself for public intervention. A private sector-led solution identified by the Steering Group would be the formation of trade associations. However, the formation of such groups may also be subject to market failure. Imperfect information (on the costs of establishing such groups and the likely future benefits that will accrue) mean that an insufficient number of groups will be formed.

21. Some organisations do exist, (eg the Association of Scotland's Self-Caterers, the Association of Scottish Bed and Breakfast Operators, and the Association of Scottish Visitor Attractions) but these are usually poorly funded and do not engage in substantial marketing activities: for instance, in 1996-97 the Association of Scotland's Self-Caterers had a total income of £13,000 with limited spending on marketing. Conceivably, private agents would be more active if STB did not exist but the more fundamental reason seems to be that the associations themselves are troubled by the free-riding phenomenon. Thus, for example, the visitor attraction sector will not advertise at a sufficient level because much of the benefits might accrue largely to the accommodation sector: the bed and breakfast sector will not advertise sufficiently because benefits might accrue to hotels and so on.

22. Having established that there are likely to be significant market failures in marketing activities, it then becomes necessary to demonstrate that the provision of information to potential visitors could lead to an increase in the number coming to Scotland. STB has ample evidence that potential and actual tourists to Scotland are remarkably ignorant about the attractions of Scottish holidays. The "Close to Home" surveys undertaken by STB and other more recent surveys often reveal remarkably poor detailed knowledge about potential Scottish holidays. Frequently held and misleading perceptions revealed by such surveys include:

­ little/nothing to do in the evening;

­ expensive accommodation;

­ little to do in wet weather;

­ very poor weather;

­ lengthy travel time to Scotland (a view particularly held by the English market);

­ not a destination for children; and

­ everything closes in off-peak months.

23. In 1995 STB and Highlands and Islands Enterprise conducted a series of Local Research studies on tourists who had just completed their holidays. These surveys identified strengths and weaknesses (and often confirmed that quality of accommodation and quality of service are no longer seen as weaknesses by those who have actually visited Scotland). What was particularly revealing, however, was that visitors often knew relatively little in advance about the area they were to visit and were often more pleased than they expected to be.

24. Most other countries where tourism is a major activity also undertake national tourism marketing efforts: Annex F gives some examples. Such evidence is not considered as justification for Scotland following suit, but it does show that Scotland would be unusual if it left tourism marketing simply to the private sector. The relative lack of activity by the US government in tourism marketing has been quoted as an example the UK should follow. However many, if not most, of the individual states in the USA are heavily involved in tourism marketing and the more apt analogy may be Scotland within the UK.

Efforts to minimise seasonality

25. A good example of the difficulties posed by a short and intensive main tourist season is the ferry company Caledonian MacBrayne which on some routes has to deal with about half its customers over a period of about 12 weeks. Efforts to alleviate seasonality are needed so that the use of capital by tourist businesses is more evenly spread. Moreover, additional income in the off-season will be very largely profit as fixed costs have already been incurred. The Steering Group considered the justification for state intervention in terms of an extension of the free-rider argument about marketing in general. Operators are reluctant to get involved in advertising for the shoulder seasons not just for the reasons they are reluctant to get involved in all advertising, but also because it is even more difficult to attract tourists in the off-season. It is to the clear advantage of the industry to advertise off-season but the risks of such advertising benefiting competitors seem greater. So again it is rational for an operator not to advertise and hope others will do so. Indeed, there is an argument that state sponsored advertising should only refer to off-season holidays if the industry is at an equilibrium with the existing level of seasonality.

Efforts to increase the spread of tourism expenditure

26. One of STB's corporate objectives is to increase the spread of tourism expenditure. This can be justified on both economic and social grounds. The economic case is founded on the relative under-utilisation of capital in the remoter areas, ie it may be cheaper to persuade tourists to go to under-utilised hotels in Deeside than to build expensive new hotels in Edinburgh with the associated congestion costs. There is also a powerful social argument inasmuch as further depopulation of rural Scotland is undesirable and tourism is probably the most likely source of commercially viable jobs in such areas.

Efforts to improve quality

27. Since its establishment as a statutory body in 1969, STB has pursued policies designed to improve the quality of accommodation and service in Scotland. The need for government intervention to secure such improvements is based on the argument that it may be in the interest of individual operators to set their own standards lower than those of the industry as a whole. This is again because of externalities. A visitor's single bad experience can seriously detract from the quality of that person's overall holiday experience. This may not have any particular effect at the level of the operator whose behaviour caused the adverse reaction, as the poor quality supplier will continue to "free-ride" on the reputation of others and will see no need to invest in a better standard of service or facility. Cumulatively, however, this bad experience may be to the serious detriment of the industry as a whole. The Steering Group accepted this general proposition and recognised that the effect would be for the total supply of tourists to be slightly diminished but the poor quality establishment to stay in business.

28. The Steering Group also concluded that there is a likelihood that visitors will be more impressed by a quality control scheme operated by a national agency which is perceived to be unbiased compared to a trade association. This, however, is an argument for state operation (or at least supervision) of quality control rather than state subsidy of the programme. In STB's case, the relatively small level of expenditure that does exist ­ currently £270,000 ­ can be justified as a legitimate cross-subsidy to bring up the level of quality in those firms which are prepared to commit themselves voluntarily to the achievement and maintenance of an improved product, and thereby enhance the general reputation of the industry.

Efforts to disseminate research finding and provide strategic guidance

29. STB efforts in these fields can also be justified by variations of the externality/free-rider arguments. Market research on the industry is beneficial to all, but companies will not undertake the necessary expenditure as no firm on its own could justify the total expenditure. Firms will not combine to conduct the necessary research for fear that the resulting information would benefit their numerous competitors. The Steering Group accepted, therefore, that STB is justified in spending money to provide market research information to benefit the whole industry.

30. It is similarly accepted that there is a need for STB to provide guidance to the industry on a range of relevant issues which the latter might not necessarily be aware of and, for that reason, could not respond to. Such issues include matters of best practice, research findings, their interpretation and practical value, and advice on marketing opportunities likely to arise in both the short and, particularly, long term.

Conclusion

31. Leaving aside arguments of equity and seasonality, the case for state intervention in the Scottish tourist sector depends on the existence of market failure (or weak price signals) which left alone would result in levels of activity below the optimum. The Steering Group concluded that the tourism sector in Scotland is characterised by mismatches between the information sought by tourists and the incentives to business to provide that information. There is a disincentive for suppliers to provide information as they cannot adequately recover the associated costs (as externalities mean they cannot capture all the benefits). Similarly, although it may be beneficial to consumers to purchase product information, the long term and diffuse nature of these benefits is likely to act as a disincentive against its purchase. Information flows are therefore reduced, and this may have a negative effect on the overall level of transactions within the industry.

32. The Steering Group recognised that making a case for intervention based on market failure is to make a necessary, but not sufficient, case for the continued existence of STB. The critical question then is why suppliers fail to co-operate jointly by forming trade associations which would serve as a means of providing the necessary information to eliminate any market failure. This is a "prisoner's dilemma" problem where no single firm will provide information to the market for fear of free-riding by remaining competitors. The trade associations are weak, and are likely to remain so, as the benefits of collective action are unlikely to accrue solely to those who have paid for that action.

33. On the whole, the Steering Group felt it reasonable to conclude that collaboration between the many small firms of the Scottish tourist industry is difficult to achieve. The Steering Group was also clear that collective action is necessary to remedy market failure. Even if conditions within the industry approximated to perfect competition, there would continue to be a requirement for such action. With little possibility of fully effective trade associations, the Group concluded that optimal industry activity appears achievable only through public intervention and some form of tourism support appears essential if the economic potential of Scottish tourism is to be fully achieved.

34. Consequently, the Steering Group concluded that there remains a requirement for all the main activities currently undertaken by STB to continue at the broad functional level discussed in this chapter. The prior options of privatisation or complete abolition have therefore been rejected as viable alternatives. As there was no single category of activity among those discussed here which in the Steering Group's view appeared unnecessary, the option of partial abolition was also rejected by the Group.