Looking only at new spending and income are not sufficient to determine public sector investment in hotel and tourism projects, and a broader definition and measurement of the economic impact of these projects is necessary.

Generating economic impact is the primary rationale for public investment in arenas, convention centers, conference facilities, convention center headquarters hotels and other tourism infrastructure projects. Annual new spending associated with the project is the typical measure used to quantify that impact, with direct spending multiplied by the indirect and induced spending. However, new spending is not the full measure of economic impact. The purpose of this paper is to define economic impact in micro-economic terms and using this definition, provide a theoretical framework for analyzing the economic consequences of public facility development.

Economic impact can be broadly defined as a change in wealth or utility of producers and consumers that results from investment in a project. In the language of micro-economics, this is called a change in consumer and producer surplus. Producer and consumer surplus occurs in efficient markets as illustrated in Figure 1 below.

Figure 1

The intersection of an upward sloping supply curve and a downward sloping demand curve jointly determine the market equilibrium (a) where a specific quantity (Q) is produced with a market price of (P). The amounts by which price exceeds the cost of production is the producer surplus (the area aPb). The amount of which the willingness of consumers to pay for the product exceeds the equilibrium price is called consumer surplus (the area aPc). The sum of producer and consumer surpluses is the amount of wealth created in the economy as a result of investment in a project.

Since properly functioning private markets generate economic impact, creating economic impact is hardly the purview of governments. In the context of the hospitality and tourism industries, the demand curve may represent the desirability of a destination and the willingness of consumers to pay to visit that destination. The supply curve may represent the cost of production of the goods and services that serve visitors to the destination.

If the private sector can produce economic impact, then what rationale does the public sector have for investment in hospitality and tourism infrastructure? The primary reason is market failure – economic circumstances in which there exists an opportunity to create economic impact but no incentive for the private sector to produce the goods and services that would create a more efficient market equilibriumⁱ.

Public goods are one such cause of market failure that is particularly relevant to investment in tourism infrastructure. Public goods are those in which the marginal cost of production is near zero. Transportation infrastructure, public parks, and street improvements, are examples. As illustrated in Figure 2, public goods may require some level of initial investment and periodic reinvestment, but the consumption of that good by any one individual does not have a measurable cost.

Figure 2
Since the supply curve is not upward sloping, the producer surplus is near zero and private investors have no incentive to produce these goods. Public art, streetscapes, waterfront development, and destination marketing are typical publicly-financed tourism products that contribute to destination appeal and create economic impact by creating consumer surplus.

A second type of market failure that is particularly relevant to public facilities development is externality. That is, the producer of the good cannot internalize or capture the benefits of investment. Air pollution is the classic example of a negative externality. Polluters invest in industrial equipment or automobiles, but do not bear the cost of the pollution they produce. Convention centers and other tourism amenities have potential to create positive externalities, where only a small portion of the benefits of investment is captured by the owner.

A comparison of private and public development of conference and convention space illustrates this form of market failure. The development of convention and conference space in hotels is generally thought of as a loss leader. The capital investment and operating expense associated with conference and convention space does not in itself provide an adequate return on investment. Hoteliers develop the space because they realize an increase in room revenue, thereby increasing the overall return on hotel investment. Consequently, hotel conference and convention space is usually sized to match the room count. In this way most of the benefits of the investment is internalized or captured by the investor.

In contrast, convention centers are designed to attract groups that use multiple hotel properties, and provide external benefits to area producers of tourism goods and services. This may include lodging, transportations services, restaurants, retail and other attractions. Figure 3 below illustrates the increase in economic impact that may result from convention center development if it causes an increase in demand for the destination.

Figure 3

Suppose a local area market does not have a convention center. The equilibrium in the market without the convention center is shown in Figure 3 as the intersection (a) of the supply curve and the demand curve (D1) producing certain producer and consumer surpluses (area abc).

The addition of a convention center may increase the demand for hotel room nights and other tourism products (D2). A new equilibrium is established (d) with the production of more tourism products (Q2) at increased prices (P2). As a result of the investment in the convention center, the market may generate a greater overall economic impact (area bde) with a net increase in economic impact (area adce).

Where private investment in convention centers occurs, an attempt is made to capture the external benefits. The Opryland Hotel and Convention Center in Nashville, Tennessee is one such example. This convention center is surrounded by several hotels, retail and entertainment amenities, all with a single ownership entity, so as to create a self-contained destination and thereby capture the majority of convention delegate spending.

Public investment is also likely to increase the supply of tourism amenities in the market. Public financing of hotels, for example, increases the supply of hotel rooms and meeting space. It is commonly thought that such projects only increase economic impact if they result in an increase in number of hotel room nights generated. Figure 4 illustrates the counterintuitive notion that an increase in the supply alone may generate greater economic impact.

Figure 4
Assume the equilibrium in the hotel market without a headquarters hotel is represented by the intersection (a) of demand and supply (S1). The addition of the headquarters hotel causes an increase in supply at every price level (S2) producing a new equilibrium (d). Although price has declined (P2) as may be observed in the market by decreases in average daily room rates, the number of room nights sold increases (Q2). The combination of changes in price and quantity results in a net increase in economic impact (area acbd).

Investment in public facilities is most likely to produce a combination of changes in supply and demand as is illustrated in Figure 5.

Figure 5
In this example, both the supply of and the demand for hotel rooms increases and equilibrium quantity of occupied room night shifts from Q1 to Q2. Despite no increase in the price level (Pn), the consumer and producer surplus increase.

Opposition to public subsidies for hotel development frequently arises from competing hotel interests because new hotel development may depress rate and occupancy in the market.

Declines or lack of change in rate and occupancy levels are used as evidence that convention center hotels do not generate their purported economic impactⁱⁱ. But a micro economic framework shows that hotel owner income as measured by rate and occupancy levels does not measure economic impact.

Rather, the concerns of competing hotel interests are better characterized as concerns over potentially damaging changes in the distribution of income within the local area hotel market.

New economic impact may be generated in situations in which investment does not necessarily increase the overall levels of supply and demand. Investment in public facilities may change the slope of the supply or demand curve thereby increasing consumer surplus. In this way, the substitution of one tourism product for another may generate an increase in economic impact. Public investment in stadiums and arenas may cause this substitution effect as illustrated in Figure 6.

Figure 6


Assume that the supply curve in Project A represents an existing array of entertainment facilities in a given market. The supply curve in Project B represents a displacement of some of that infrastructure with a new arena, stadium facility or other public facility. The demand for the new amenity may be such that it increases consumer surplus. As an example, the benefit of attending professional sporting events rather than other entertainment options may be greater to consumers even though the price and quantity of these amenities remains the same. This phenomenon is sometimes discussed in public policy circles as a "quality of life" issue. This concept runs counter to the common assumption in economic impact studies that either price or quantity of consumption must change in order to generate economic impact.

The economic models and hypothetical situations discussed in this paper are not meant to support the argument that all public investment in tourism amenities generates economic impact. Nor does this author take the position that public investments that would increase consumer or producer surpluses should all be undertaken.

Public investment requires taxation, which displaces other private investment. Hotel taxes, which are commonly used to support public facility projects, are no exception to this rule. To the extent that the economic incidence of a hotel tax falls on owners, it reduces the availability of income for private reinvestment. Consequently, the decision to make a public investment should be done with the realistic expectation of improving market efficiencies and thereby increasing the overall level of investment in tourism infrastructure.

Furthermore, public entities face a nearly infinite set of possible investment alternatives some of which will generate more economic impact than others. Consideration should always be given to alternative forms of public investment and, to the extent possible; projects should be compared based on their overall level of impact on the local economy. These types of issues are usually sorted in the public processes that establish public investment policies.

ⁱSee Stiglitz, Joseph, Carl E. Walsh, Principles of Microeconomics, Third Edition, W.W. Norton & Company, March 2002 for a general discussion of the economic causes of market failure.

ⁱⁱSee Walker. Bruce, Convention Center ‘Headquarters' Hotels: Do they Generate Additional Market Demand?, Citizens for a Sound Economy, www.cse.org/reports/texas_hotel_study.pdf , March, 2003 as an example of research that only relies on rate and occupancy data to measure economic impact.

Thomas Hazinski has an advanced degree in Public Policy from the University of Chicago and 18 years of practical experience in the public sector and the consulting business. Tom is nationally recognized by rating agencies, bond insurers, and investors on Wall Street, as well as by clients throughout the world, for his expertise in entertainment and hospitality projects. thazinski@hvsinternational.com