0

Air policy and incoming tourism demand: the cases of the Caribbean
Community and the Middle-East

David Warnock-Smitha* and Frankie O’Connellb

a
Division of Transport and Logistics
Queensgate
Huddersfield
West Yorkshire, England, UK
HD1 3DH

b Department of Air Transport

Building 115
Cranfield University
Cranfield
Bedfordshire, England, UK
MK43 0AL

Corresponding author:
*
E-mail: d.warnock-smith@hud.ac.uk
Telephone: +44(0)1484 473102
Fax: +44(0)1484 473019
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Abstract
It is generally agreed that government ownership and participation in national carriers and
regulated air service agreements can lead to inefficiencies and abuses of market power. This
can result in poor carrier performance and service levels, impeding further growth in tourism
markets. This study aims to contrast this theory with recent case evidence in the Caribbean
and the Middle-East. The former represents the mature exotic type beach holiday while the
latter a fast developing religious, cultural and multi-product form of tourism. In both cases
multi-step relationships exist between the development of air transport policy and the number
of incoming visitors. The strength and significance of these interrelationships can be tested
using two separate best-fit Structural Equation Models (SEMs) based on a panel data set of a
selection of endogenous and exogenous variables for the period 2000-2007. It is found that,
despite both regions’ continued government participation in national carriers, only in the
Caribbean has this appeared to have resulted in the theoretical dampening effect on tourism
output, whereas a reverse effect was found for the sample of Middle-Eastern states. Focussing
on their formidable hub-and-spoke networks, state owned and vertically integrated Middle-
Eastern carriers are still encouraged to offer competitive fare and service levels to capture 6th
freedom traffic with the growing number of long-stay visitors being one of the primary
benefactors of this.

Keywords: National carriers; Government control; Incoming tourism traffic

1. Introduction

This work builds on the exploratory work of O’Connell (2009), Lohmann et al (2008)
and Zammit (2008) by building an appropriate modelling framework for testing the
theoretical effect of protected national carriers and restrictive air policies on tourism output.

Partly due to a significant decline in traditional sugar and exotic fruit industries, the
tourism sector has become one of the main sectors upon which stability in the West Indies can
be afforded (Duval 2007). As shown in Table 1, 14 of the 20 full and associate Caribbean
Community (Caricom) member states are among the 35 most dependent countries on tourism
in the world (World Travel and Tourism Council 2009), most of which taking advantage of
cultural links dating back to colonial times as well as proximity to large North American
population centres with significant amounts of disposal income. The remaining 6 member
states do not depend on tourism quite so much, however, with agricultural and manufacturing
industries still playing a significant role in the economies of Guyana and Trinidad & Tobago,
for example. Foreign carriers control the lion’s share of extra-regional markets and in turn
facilitate the vast majority of tourism receipts into the region. Government owned or
controlled regional carriers, on the other hand, mainly cater for intra-regional travel although
some carriers, namely Air Jamaica and Caribbean Airlines do operate internationally to North
America and up until 2007 to the United Kingdom.

Conversely, the Middle-East economy has traditionally been dependent on its vast
hydrocarbon reserves and petrochemical industries although peak-oil and sustainability fears
have led a number of governments in the region to develop sector diversification strategies
with the UAE leading the way among the GCC (Gulf Cooperation Council) countries (Booz
& Co. 2005). When compared to other regions such as the G7 states, a continued reliance on
the oil and gas sector means that the average GCC economy is 10% more concentrated than
the average G7 country. Qatar, Abu Dhabi and Kuwait were the most notable examples of
concentrated GCC economies in 2005 (Booz & Co. 2005). Recent large scale investments in
other sectors such as tourism and real estate demonstrate, however, that many Middle-East
states have the financial strength to embark on comparatively rapid diversification strategies.
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This has helped to bring about significant increases in tourism, particularly religious and
multi-product tourism in the case of Saudi Arabia and the UAE respectively. The World
Tourism Organisation (2008) estimated that total Middle-East arrivals have increased from
around 25 million arrivals in 2000 to 46 million arrivals in 2007. As revealed in Table 1,
however, both in the Caribbean and the Middle-East there is a large amount of variation
hidden behind the aggregate estimates in terms of the travel and tourism sector’s contribution
to GDP and the number of growth markets and mature markets for tourism. There is less
variation evident, however, in the regions’ dependence on the air transport sector for the
facilitation of incoming tourism expenditure due to the ease of access to wealthy source
markets that long to medium haul air travel brings.

Table 1
Some socio-economic indicators for the full and associate sample states
Travel & Tourism % of GDP
Country GDP (PPP) $USmn % Visit Expen. arrive by air
(world ranking)
Anguilla 65.8 (5) 109 84
Antigua & Barbuda 73.5 (1) 750 95
Bahamas 50.0 (7) 6,105 88
Barbados 39.0 (8) 4,815 92
Belize 29.7 (16) 1,778 85
Bermuda 12.0 (61) 4,500 86
British Virgin Islands 37.4 (12) 853 94
Cayman Islands 29.1 (17) 1,939 67
Dominica 24.5 (26) 384 88
Grenada 25.0 (25) 440 96
Guyana 10.9 (65) 4,439 99
Haiti 6.9 (126) 13,970 N/A
Jamaica 27.0 (22) 12,180 92
Montserrat N/A 29 99
St. Kitts & Nevis 31.7 (14) 339 91
St. Lucia 37.4 (11) 866 90
St. Vincent & Grenadines 29.1 (18) 342 98
Suriname 4.4 (165) 2,893 93
Trinidad & Tobago 12.8 (53) 16,845 95
Turks & Caicos Islands 30.5 (15) 216 92
Mean Average 30.4 (35.1) 3,690 91
Standard Deviation 18.3 4,991 7
Bahrain 12.1 (60) 24,100 91
Egypt 15.0 (43) 405,400 80
Iraq N/A 102,400 99
Jordan 18.3 (32) 28,450 58
Kuwait 3.7 (175) 140,000 71
Lebanon 28.1 (19) 40,440 95
Libya 8.6 (94) 74,720 42
Oman 6.7 (130) 60,890 65
Palestine N/A 5,034 N/A
Qatar 9.4 (81) 71,420 91
Saudi Arabia 7.2 (119) 546,000 43
Syria 11.2 (63) 90,370 45
UAE 20.2 (30) 164,400 89
Yemen 6.1 (142) 56,240 71
Mean Average 12.2 (82.3) 129,276 67
Standard Deviation 7.1 155,509 21
Sources: Index Mundi (2007), World Travel & Tourism Council (2009) and Caribbean Tourism Org. (2005), WTO (2006)

The Caricom and Middle-East region were selected as case-studies on the basis that a)
both regions support national carriers in quasi-protected regulatory environments, b) both
regions are supported by regional institutions charged with promoting further regional
integration and social cohesion and c) the two regions have dissimilar socio-demographic
profiles and are at varying degrees of air transport and tourism development. The differences
apparent in the final selection criteria were important in picking up any case-specific
heterogeneity that could assist in explaining any possible departures from the general
economic theory. A general comparative snapshot of the two regions is provided below in
Table 2:
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Table 2
Comparative snapshot of case-study regions
Case-study region Caribbean Community Middle-East
Type of network Limited hubbing activity Hubbing activity
Tourism market type Traditional Growth
Tourism market segment Exotic, sun-sea-sand Religious, Cultural, Multi-product
Local population 16 million 179 million
Economic base Tourism (with exceptions) Oil and gas (with exceptions
National carriers Financially weak and poorly funded Financially strong and well funded
Fleet types Mixed fleets Widebodies favoured
Air policy Mixed liberal/non-liberal Mixed liberal/non-liberal
Government owned national carriers Government owned national carriers
Early stage intra-regional multilateral Early stage intra-regional multilateral
(Caricom Multilateral Air Service (Arab Civil Aviation Commission -
Agreement - CMASA) ACAC)

The statistical populations of the respective case-study regions are defined by the World
Tourism Organisation in the case of the Middle East (pop = 14) and the Caricom Secretariat
in the case of the Caribbean Community (pop = 20). A sample of states could then be selected
on the basis of their representativeness in terms of population size and variability. This
process was undertaken using a cluster sampling method whereby the final selection of states
denote groups of states left out of the sample. The first step was to select an appropriate
sample size. The confidence level Z was set to the commonly used 95% while an adequate
confidence interval C was set at +/-30%. It is also standard procedure to set percentage p to
50% reflecting the worst case result scenario. Incorporating these criteria into the following
sample size formula yields:

Z ( p )(1 − p ) = 1.96 (0.5)(1 − 0.5) = 10.67

2 2

n=
(1)
2 2
C 0.30

n 10.67 (2)
NewnCaricom = = = 7.19(7)
n − 1 1.484
1+
pop

n 10.67 (3)
NewnMEast = = = 6.31(6)
n − 1 1.690
1+
pop

As the population was known (finite population), equations 2 and 3 represent a standard
sample size adjustment. With the number of states to be sampled in each region known the
next stage was to select the states earmarked for further analysis. This was performed by
formulating groups of countries according to economic size (GDP), levels of air traffic (total
air passengers) and geographical location (sub-region). The final groups were determined by
categorising the numerical criteria into high, medium and low classifications. This was
supplemented by the geographical location data. Countries did not appear in the same group if
they did not have identical classifications for the three criteria. This led to some stand alone
states like Jamaica that had to be left within the final sample due to the fact that they did not
have an identical profile to any other state in the Caricom region. This grouping exercise as
well as the final selection of states is summarised below in Table 3:
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Table 3
Sample selection criteria: Caricom and the Middle-East
County grouping (Caricom) GDP per capita Air arrivals Sub-region Selected
(2006) (2006) state
Jamaica Low High Northern Jamaica

Trinidad & Tobago Medium High Southern Trinidad &

Tobago
Dominica, Montserrat Low Low Eastern Dominica

Bahamas, Bermuda, Cayman Islands, High Medium Northern Bahamas

Turks & Caicos
Antigua & Barbuda, Barbados, BVI, St. Medium Medium Eastern Barbados
Kitts & Nevis
Anguilla, Grenada, St. Lucia, St. Vincent Medium Low Eastern St. Lucia
& Grenadines
Belize, Guyana, Haiti, Suriname Low Low Peripheral Guyana
(landborder)
Country grouping (Middle-East) GDP per capita Air arrivals Sub-region Selected
(2007) (2005) state
Egypt Low High West Egypt

Iraq, Palestine, Yemen Low Low Various Yemen

Jordan, Syria Low Medium Various Syria

Kuwait, Libya, Qatar, High Low Central Kuwait

Lebanon, Oman Medium Medium Various Oman

Bahrain, Saudi Arabia, UAE High High Central UAE

Sources: CIA Factbook (2009), WTO Tourism Barometer (2008)
Notes: Class boundaries: GDP per capita, Low (US$0-7,000), Medium (US$7,001-17,000), High (US$>17,001); Air passengers, Low (0-
1,000,000), Medium (1,000,001-3,000,000), High (>3,000,001)

In groups with more than one state, the final selection was performed using random
sampling except in cases where this led to unworkable travel expenses and inconveniences.

2. Tourism flows and aviation policy

Tourism host markets in developing countries generally benefit from increased visitor
expenditure especially in cases with slack labour markets, idle tourist carrying capacity and
fixed exchange rates (Forsyth 2008). There are, of course, exceptions to this rule like the
examples of the Seychelles or Mauritius, where policy makers concluded that they would
have more to gain from a smaller volume of higher spending visitors, in line with their limited
carrying capacity, than the relentless pursuit of the mass market (World Tourism Organisation
1994). Indeed, one of the major supply levers at the tourism industry’s disposal is that of their
international air policy whereby the degree of airlift to and from a country can be somewhat
controlled by the level of flexibility or rigidity associated with their air transport markets. It is
clearly not the only way to constrain incoming tourism and can of course be performed
internally through the intelligent marketing, distribution and supply of tourism products and
services. In fact, recent growth and investment in carrying capacity within some regions,
namely the Middle-East and South-East Asia may have overwhelmed the possible cross-
industry negative effects of restricting entry to lucrative international and domestic markets.
These effects are often referred to as agglomeration economy effects (Forsyth 2008).
 5

The Caribbean, on the other hand, has seen a more typical rate of development in recent
years where, in some cases especially among the smaller islands of the region, investment has
been limited to increasing the quality rather than the quantity of the tourism product. This
contests the often made assumption that the Caribbean represents a conventional mass market
for tourism (Duval 2007). The reality is somewhat more heterogeneous with a multi-product
mix of mature, growth, exclusive and non-tourism dependent island destinations. Driven by
the concern that foreign carriers tend to ‘cherry pick’ commercially viable routes, local
governments have considered it an absolute necessity to prop-up loss making regional carriers
with periodical blanket subsidies in order to ensure a continuity of air access on thin and/or
intra-regional routes. In the Middle-East, ownership and control of air carriers is also
commonplace, but this frequently does not extend to blanket subsidy in order to underwrite
losses and ensure survival. In fact, Middle-Eastern carriers, even in their infancy stages, are
typically well financed and well orientated commercial enterprises. While in the Middle-East
tourism providers and air carriers have focussed on cooperation and in some cases on deeper
forms of integration, the activities and services provided by local carriers in the Caricom
region are often seen to be at loggerheads with local tourism development goals not least
because these carriers never provided access to the majority of the region’s source markets in
the first place.

It would appear then, at least on a superficial level, that a given degree of air transport
regulation and government involvement can have disparate effects on incoming tourism
which can be assumed to be a function of inter alia the long-term financial stability of
national carriers, whether or not there can be synergy between the strategic goals of local
airlines and tourism bodies and finally the nature and impact of foreign carrier services in the
presence or absence of national carriers. We can control for these elements through a logical
selection of case-study regions. In the Caribbean, evidence suggests there is an absence of
financially stable national carriers, airline/tourism body integration and local carrier facilitated
incoming tourism where as the opposite is generally the case in the Middle-East region. This
then provides the comparative framework for an empirical assessment of the theoretical
effects of quasi-restricted air transport markets on incoming tourism. In this study both
regions receive a similar treatment (national carrier ownership, restricted markets etc.) with
the expectation that similar results will be obtained in the theoretical scenario. Where the
empirical results disalign themselves from the theory, the abovementioned unobserved
differences along with minor discrepancies in the endogenous variable values will be used to
explain any departures from the theory.

3. Research strategy and measurement

Commonly used concepts such as ‘deregulation’, ‘liberalisation’, ‘carrier performance’

and even ‘tourism traffic’ can be measured in a number of different ways. The choice of
measurement regarding these highly complex and multi-faceted concepts partly determines
the plausibility and rationality of the resulting casual relationships between concepts. In the
literature this is often referred to as construct validity (e.g. see Bryman and Bell 2007). Levels
of competition at the route level have frequently been used as a proxy measure for a country-
pair’s level of liberalness. Assuming a representative amount of routes are sampled on a given
country-pair, predatory behaviour by incumbents, an inability of scheduled carriers to react in
the short-term and the effect of alternative indirect routes via 3rd countries can all contribute to
a decoupling of competition (the measure) from the degree of liberalness (concept). The main
emphasis therefore is to clearly specify the most appropriate measure of liberalness in
fragmented, multi-tier and complex regulatory environments such as those that exist in the
case-study regions.
 6

To a certain extent, carrier performance is said to depend on its level of freedom to enter
and exit markets. Again, it is important to support measurement of carrier performance with a
solid theoretical rationale in order to exact the subsequent causal effect of air policy induced
carrier performance on levels of incoming tourism. The term incoming tourist also needs to be
properly defined and extracted from aggregate traffic statistics in both the Caribbean and
Middle-East regions. For example, is it correct to include all types of visitor and all durations
of stay? Also, what would be the most useful unit of measurement, number of visitors or
amount of expenditure (total or average per day) and is it appropriate to subtract outgoing
travellers from incoming visitors to arrive at a net trade balance taking into account both the
importation and exportation of tourism services? These scope and measurement decisions will
clearly have a marked effect on the ultimate strength, direction and significance of the indirect
causal relationships between the specified variables as well as the unobserved, out-of-sample
influences.

4. Analytical framework – Structural Equation Modelling (SEM)

Given there are many factors influencing, for instance, carrier performance, it was
important to select an analytical tool that could allow for multiple measures of a concept,
effectively ending up with an index or scale which could be weighted in order to reflect the
varying impact of different factors on the dependent variables. Moreover, explicitly including
a wider range of carrier performance factors would increase the chances of this concept being
related to the selected independent variables. Another distinguishing feature of SEM over
traditional regression methods is its ability to assess multiple dependence relationships at the
same time. To put it another way, traditional regression methods can estimate a single direct
relationship between a selection of predictor variables and one or more dependent variables
while SEM can allow for an evaluation of indirect effects where a dependent variable in one
relationship automatically becomes an independent variable in another relationship.

Air policy has often been included explicitly as a dummy variable in demand, price and
capacity functions together with socio-demographic variables such as income levels,
population levels and GDP. However these variables clearly operate at different levels as
shown by the liberalisation/competition example in the previous section. The effective level
of competition has a direct and tangible impact on frequency, capacity and airfare whereas the
impact of a change in air policy is far less tangible and consistent. Air policy liberalisation
represents a supply stimulus which may or may not have an effect on actual supply levels.
This is partly due to specific network characteristics and complex demand and supply
interactions (ICAO Manual 2006). There may be a change in demand independent of supply
stimuli or a change in supply itself. For example, if income levels drop, demand can decrease
even if fares are reduced and service levels increased. Further, the observed change in service
levels and fares may or may not have been driven by a change in air policy and hence one
often ends up with a complex and dynamic set of relationships which cannot be sufficiently
explained by single equation models. In the case-study regions reform has often been
introduced in a fragmented and inconsistent manner adding further support for the application
of SEMs.

Other assessments of the effects of deregulation have used counterfactual out-of-sample

demand functions, where the partial impact of liberalisation on traffic levels is assumed to be
equal to the difference between non-open-skies and open-skies traffic levels. That is, non-
open skies traffic levels were predicted counterfactually using the standard cost and demand
variable coefficients emanating from the pre-liberal period (Brattle Report 2002). This
method could lead to overestimations; however, as significant proportions of the noted traffic
differentials may be attributable to changes in other variables. Moreover, out-of-sample single
 7

equation models still do not allow for an examination of indirect interactions between supply
stimuli (air policy), actual supply (capacity, frequency, fare) and demand (traffic).

A more recent global treatment of air transport liberalisation by the World Trade
Organisation considered a factor analysis for assigning the importance weighting attached to
different air policy provisions and consequently an expert-based approach where the effects of
the removal of different restrictions are based on the judgement of experts in the sector. In
both cases an overall comparative index was yielded and was later explicitly incorporated into
a gravity model (Piermartini and Rousova 2008). While a rigorous approach towards the
formulation of a reliable measure of liberalisation represents a huge step forward, the
empirical estimation model faces a number of difficulties. Firstly, gravity models tend not to
include supply side variables and thus they often overlook the importance of actual air carrier
behaviour and responses to changes in demand. It is therefore simpler to trace causality
between actual supply variables and actual passenger volumes than it is to establish causality
between socio-demographic and geographic factors and air traffic volumes. This difficulty
even holds for gravity models with high predictive power as they do not control for actual
airline behaviour which can clearly disturb the impact of the theoretical drivers of air traffic at
any time. The second issue relates to the quality of data. The ICAO World Air Service
Agreement (WASA) database has been found to be inconsistent with the actual air policy
‘status quo’ in effect on different country-pair markets (Warnock-Smith and Morrell 2008).
The database is only as reliable as the information provided by the respective ICAO member
countries. Reporting quality is inconsistent, especially in developing and thin markets for air
transport and it does not take extra-bilateral negotiations into account. These negotiations
often change the rules of the game without the WASA database picking them up.

To circumvent these issues, this study combined official ASA data from ICAO with
extra-bilateral updates thereby yielding a more realistic and reliable air policy database for the
two case-study regions. This data was only available after establishing contact with key
regulators in member state Ministries of Transport and clearly would not have been feasible
for a larger global sample such as that used by Piermartini and Rousova study (2008). To
address complex demand and supply interactions in the air transport sector, a multi-step
estimation approach using SEM is considered the most appropriate for establishing indirect
causality between change in policy and change in incoming tourism traffic levels (ICAO
Manual 2006).

4.1 Construction of path diagram and measurement model

It is possible to specify a single explanatory model which can be supported by a wealth of

historical evidence on the subject of air policy reform and its effect on total traffic levels (e.g.
Morrison and Winston 1995, Forsyth 1998 and Clougherty and Oum 2001). As it often forms
a major part of total traffic, it can be assumed that previous evidence applies equally to
incoming traffic levels, the variable of interest for this study. Unlike an exploratory factor
analysis, prior evidence is formulated using a confirmatory approach, whereby the variables
defining each construct are pre-specified. Constructs can then be linked together in the form
of a path diagram, representing a set of expected interrelationships. The set of constructs
proposed in this study are not intended to be all-encompassing (see Figure 1). In other words,
the proposed constructs do not constitute an ideal demand function for incoming tourism but
instead can be considered to be one of a number of equally valid explanations of an important
section of it, which can be compared across regions. Any notable omissions in the model are
reflected in the model’s error terms and do not affect the accuracy of the regional
comparisons. This is because the selected constructs are applied constantly across both data
sub-samples.
 8

Degree of liberalisation (X1) National carrier subsidy (X2) State ownership (X3)

Carrier performance (Y1)

Personal income (X4) Exchange rate (X5)

Incoming passengers(Y2)

Fig. 1: Input path diagram

The above path diagram can be developed into a measurement model (Equation 4 and 5)
by specifying each endogenous construct as a set of dependent variables. These relationships
can be expressed mathematically by specifying the variables describing each construct as
separate loadings (Table 4). This is performed in order to extract the standardised regression
coefficients which can be interpreted as normalised correlations between the constructs.

Y1 = β1 Χ 1 + β 2 Χ 2 + β 3 Χ 3 + ε 1 (4)

Y2 = β 4 Χ 4 + β 5 Χ 5 + β 6Y1 + ε 2 (5)

Table 4
Construct variables: Pre-specification of loadings
Variable Construct A Construct B Construct C Construct D Construct E Construct F Construct
(X1) (X2) (X3) (Y1) (X4) (X5) G (Y2)
1. TarifPol L1
2. 5thFreePol L2
3. CapFrPol L3
4. AccessPol L4
5. DesigPol L5
6. SubType L6
7. SubAmo L7
8. PercEq L8
9. QSIndex L9
10. AvProd L10
11. UnitCost L11
12. AvYield L12
13. DisInc L13
14. GDPpc L14
15. RealExR L15
16. IncPax L16

Each variable making up the respective constructs were inserted into a historical data
matrix, encompassing the period 2000-2007 across 53 country-pairs. The 24 selected Caricom
country-pairs are estimated separately from the remaining 29 Middle-East country-pairs yet
both incorporate a representative range of short, medium, long haul sectors and small,
medium and large market densities. A sample of this data is provided in the below Table of
input data (Table 5).
 9

Table 5
Input matrix (sample Caricom data)
Country- Year Incoming Liberalisation Subsidy State Carrier Income Exchange rate
Pair traffic (000) index index ownership perform. average index
(%) index (US$ per
capita)
US-Bahamas 2000 2,287,319 4.0 5 100 100 27,406 100
US-Bahamas 2001 2,551,182 4.0 5 100 99 27,066 100
US-Bahamas 2002 2,661,157 4.5 5 100 107 28,239 100
US-Bahamas 2003 2,331,341 4.5 5 100 114 28,029 100
US-Bahamas 2004 2,478,514 4.5 5 100 117 29,651 100
US-Bahamas 2005 2,710,762 4.5 5 100 122 31,628 100
US-Bahamas 2006 2,843,239 4.5 5 100 122 33,866 100
US-Bahamas 2007 2,926,717 4.5 5 100 128 36,099 100
US-Dom Rep 2000 1,200,463 3 0 0 100 14,339 100
US-Dom Rep 2001 1,364,360 3.5 0 0 96 14,987 100
US-Dom Rep 2002 1,609,043 3.5 0 0 102 16,960 111
US-Dom Rep 2003 1,751,375 3.5 0 0 108 18,026 173
US-Dom Rep 2004 1,947,396 3.5 0 0 110 19,282 154
US-Dom Rep 2005 2,161,972 3.5 0 0 117 20,449 164
US-Dom Rep 2006 2,388,646 3.5 0 0 119 22,402 165
US-Dom Rep 2007 2,466,895 3.5 0 0 122 24,110 165
Note: The Bahamian dollar was pegged to the US dollar at a rate of 1 to 1 throughout the observed period resulting in a constant exchange
rate index value of 100

4.2 Variable formulation and data sources

Each construct was derived by pooling corresponding variable values into quantifiable
indices before being standardised in SPSS to ensure that the resulting beta values were
comparable (each column was subtracted from its mean and divided by its standard
deviation). The process of converting raw data into the specified variables in Table 4 is now
described.

The first construct (X1) represents a quantification of Gillen et al’s (1999) nominal
classification of five important economic terms typically found in bilateral or multilateral air
service agreements but also present in extra-bilateral Memorandums of Understanding
(MoUs) and unofficial policy documents. Policy loadings included terms relating to tariffs
(TarifPol), 5th freedom traffic rights (5thFreePol), permitted frequency and capacity
(CapFrPol), the number of permitted access points (AccessPol) and the number of carriers
permitted to operate (DesigPol). Gillen et al’s (1999) descriptive classification was converted
into an ordinal scale with a restrictive policy lever assuming a zero value, a moderate status
‘0.5’ and a facilitating status a value of ‘1’. For this study each lever was equally weighted
with the final construct index for any given year representing the sum of the ordinal loading
values. Clauses relating to ‘cabotage’ rights and foreign ownership were not included. The
main data sources comprise the ICAO World Air Service Agreement (WASA) database and
extra-bilateral data from related government bodies such as the US Department of
Transportation (Office of Aviation Affairs), the UK Civil Aviation Authority, the Caricom
Secretariat and the UAE Department of Transport.

The endogenous carrier performance index (Y1) is constructed using a number of

extensively used air transport supply variables (see use of airfare and partial productivity
measures in Barrett 2006 and Kahn 2004, for example). Although the way in which the
variables have been pooled and transformed into an overall performance index is less
established in the literature. Indexed to the year 2000, quality of service (QSIndex), average
partial productivity (AvProd), change in average unit costs (UnitCost) and in average yields
 10

(AvYield) represented 25% respectively of the overall effect on carrier performance during
the 2000-2007 period. In the absence of route level data, average yield per Revenue Passenger
Kilometre (RPK) was collected by incorporating the most relevant regional route group
statistics from IATA’s World Air Transport Statistics (WATS) yearbook. As an example, all
Middle East-Singapore country-pairs in the sample were assumed to fall into the WATS
Middle East-Asia route group statistics. Only average economy and premium fares were
provided in WATS and so had to be converted into yield per RPK using the accompanying
traffic data in WATS. Intra-route group differences were compromised using this method but
it was still possible to compare across time periods, route groups and of course, between the
case-study regions. ICAO airline productivity and unit cost data1 was only available on a
network wide basis. To make this more applicable for a country-pair analysis, this
information was moderated by OAG market data to yield an average representation of all the
carriers operating on each country-pair in any given year along with the respective market
shares. OAG back data also provided an automation of a US Civil Aeronautics Board
contrived quality of service index consisting of a weighted average of aircraft size, number of
stops and frequency of operation.

The second dependent variable (Y2) included all incoming visitor embarkations and
disembarkations by air into all the sampled Caricom and Middle-East member states. In other
words, although the effects of the exogenous constructs can be equally applicable to local
outgoing residents, the magnitude of impact is effectively controlled to account for the
potential for tourism imports in the two case-study regions. Further, while air policy is
typically negotiated bilaterally or multilaterally, the focus of this paper is to explore policy
implications that are relevant to the tourism and transport sectors of the case-study regions.
Total traffic data obtained from Caricom airports and Ministries of Transport and Middle-
Eastern Ministries of Transport were multiplied by directional flow ratios gathered from the
Caribbean Tourism Organisation annual statistical report (number of visitors by air) and the
World Tourism Organisation market trends publication for the Middle-East region (total ratio
of incoming to outgoing visitors broken down by country as a proxy for the ratio of incoming
to outgoing air passengers).

The remaining policy variables included type of subsidy (SubType), subsidy amount
(SubAmo) and the percentage of government equity in national carriers (PercEq). The first
two variables were combined to form a subsidy index (X2). The absolute amount of subsidy
provided in any given year was intuitively controlled to take into account the type of subsidy
offered. Blanket subsidy typically involves carriers requesting periodic injections of capital
either to underwrite losses or to support new capital investments. But the lack of
accountability and structure associated with this type of subsidy resulted in a multiplier value
of ‘1’. Other forms of subsidy including non-operational subsidies associated with start-up
costs or exceptional items as well as structured tendering were assigned a multiple of ‘0.5’. A
World Bank Document (2006) and a report from the Caribbean Regional Sustainable Tourism
Development Programme (2007) provided details of recent capital injections into Caricom’s
local carriers. Subsidy data for Arab airlines were not available, however. Thus, it is assumed
for the purposes of this study that only majority government owned carrier operational losses
were written off during the period with the exception of Etihad where an initial capital
offering of approximately US$135 million (AED 500 million) in 2003 was included. In cases
of periodic subsidies, local airlines operating on respective sample country-pairs were

1
In line with the findings of Windle and Dresner (1992), two labour related partial indicators
(Revenue/employee and RPK/employee were employed as proxies to record changes in airline productivity.
System wide unit costs were measured in available tonne kilometres (ATK) and, in the absence of actual data,
were calibrated using OAG market data to disaggregate the network results by country-pair.
 11

assumed to benefit from this capital in equal proportions during subsequent time periods of no
further subsidy. Air Transport Intelligence (2008) and the Economic and Social Commission
for Western Asia (2007) were consulted for Caricom and Middle-Eastern carrier equity
percentages. These percentages were directly inputted into the input matrix as the state
ownership construct.

State subsidy and airline ownership data only applies to the case-study countries as it is
assumed that the principle of reciprocity results in a more restrictive negotiating stance by
both country-pair states in the presence of any protectionist market distortions2.

The final two external constructs were selected within the sample in order to increase the
goodness-of-fit of the air passenger demand variates. It is almost unanimously agreed that the
inclusion of an income variable is indispensable to any air transport demand function
although there is clearly more debate about the remaining predictor variables to be included or
left out of the final model specifications. For instance, Hooper (1993) contends that factors
influencing business (travel convenience, firm output levels etc.) and leisure (total travel
costs, relative price of other goods, income etc.) demand are different and should be modelled
differently.

Exchange rates were selected for two main reasons. First, it is frequently selected in air
transport demand functions and often yields significant and reliable coefficients (see
Profillidis (2000) and Vasigh et al. (2008), for example). Second, fluctuations in exchange
rates are highly relevant to all air travel segments. In order to extract a meaningful index for a
country-pair analysis, exchange rate fluctuations were weighted by the directional traffic flow
data. If, for instance, Jamaican dollars became stronger against the US dollar during the
observed period, then given the majority of traffic on the country-pair consisted of US
passengers bound for Jamaica this would resulted in a weighted reduction in the exchange rate
index with the year 2000 indexed at 100. For pegged currencies against the US dollar, the
exchange rate variable became a constant value of 100. Historical exchange rate data was
obtained from the University of British Columbia database retrieval system. The income
construct consisted of real GDP per capita data (GDPpc) obtained from the International
Monetary Fund world economic outlook database and GNI per capita (DisInc) as a proxy for
household disposable income from the World Bank Key Development database. Real GDP
figures were invariably higher than GNI figures as the former does not include depreciation of
personal assets or degradation of resources. The weighted average of both represents an
adjustment that approximates underlying economic output and disposable income (less taxes).
It was further modified to take into account the directional traffic flow ratio of each country-
pair before being inserted into the input matrix (Table 5).

4.3 Output path diagrams

The causal relationships between the supply and demand side variables have a theoretical
sign and magnitude which can be represented by the input diagram in Figure 1. To convert
this into an empirical set of output estimates, separate regressions are run for each dependent
variable in Equations 4 and 5 yielding beta values, which are subsequently inserted into an
output path diagram as shown in Figures 2 and 3.

2
On intra-regional country-pairs the government ownership and subsidy value represents the average of the two
state carrier ownership values relating to the two negotiating states.
 12

‐0.10
‐0.10 ‐0.33

Degree of liberalisation (X1) National carrier subsidy (X2) State ownership (X3)

R2Y1=0.03
e1Y1=0.98 ‐0.06
0.14 ‐0.04
Carrier performance (Y1)

Personal income (X4) Exchange rate (X5)
0.13

R2Y2=0.20 Incoming passengers(Y2) 0.33

0.18
e1Y2=0.89

Fig. 2: Output path diagram- Caricom region

The indirect effect of air policy on the number of incoming tourists can be estimated by
simply multiplying the direct effect of each policy variable on carrier performance by the
direct effect of carrier performance on the number of incoming passengers as depicted
graphically in Figure 2. The degree of variation in levels of incoming tourists that is
ultimately attributable to changes in air policy is therefore:
Liberalisation Carrier performance Incoming passengers (6)
= 0.14 x 0.13 = 0.019

Carrier subsidy Carrier performance Incoming passengers (7)

= -0.06 x 0.13 = 0.008

State ownership Carrier performance Incoming passengers (8)

= -0.04 x 0.13 = 0.005
Total indirect effect = 0.032
The same process was then performed on the input data for the Middle-East sample, the
results of which are presented in Figure 3.

‐0.13
‐0.15 ‐0.39

Degree of liberalisation (X1) National carrier subsidy (X2) State ownership (X3)

R2Y1=0.17
e1Y1=0.91 0.06
0.39 0.14
Carrier performance (Y1)

Personal income (X4) Exchange rate (X5)
0.17

R2Y2=0.13 Incoming passengers(Y2) 0.32

0.08
e1Y2=0.93

Fig. 3: Output path diagram- Middle-East region

 13

Liberalisation Carrier performance Incoming passengers (9)

= 0.39 x 0.17 = 0.066

Carrier subsidy Carrier performance Incoming passengers (10)

= 0.06 x 0.17 = 0.010

State ownership Carrier performance Incoming passengers (11)

= 0.14 x 0.17 = 0.024
Total indirect effect = 0.100

5. Results – Model estimates and goodness of fit

While the overall goodness of fit of the two confirmatory output models was notably
weak, reflected by the high error terms in the two measurement specifications (see Figures 2
and 3 for e1 and e2 values), the partial effect of policy changes could still be picked up and
compared across the two regions due to the fact that the respective regional data matrices
were derived and tested in an identical way. The sign and magnitude of impacts were
generally plausible, although an unexpected negative cross-correlation was evident between
the level of carrier subsidy and the percentage of government equity in local carriers in both
sub-samples. One possible reason for this could stem from the continued effects of the
unsuccessful privatisation of local carriers BWIA and Air Jamaica during the observed time
period. The former fell back into public hands in 2005 after being forced to ask for successive
rounds of capital injections and the latter being repossessed in 2004 by the Jamaican
government after experiencing heavy financial losses. Much of the sample market and
country-pair data included subsidised Air Jamaica and BWIA operations which may have
been partly responsible for the more notable beta value in comparison with the other cross-
correlations in the model. A similar effect was found for the Middle-East sample. Although
fully or partly owned and controlled by local government, carriers such as Oman Air and
Emirates did not receive any extra capital during the observed time period. Conversely,
publicly owned Kuwait Airways, Egypt Air, Yemenia, Syrianair and Etihad all received
capital injections during the same period which did not appear to have much of an affect on
the overall beta value outcome. The lack of variation inherent in the level of state ownership
construct could have also caused a degree of instability in the cross-correlations.

All cross-correlations remained below the 0.40 value, however, giving overall support to
the original specification of policy constructs. The cross-correlation between the degree of
liberalisation of the remaining policy areas were more predictable, however, returning beta
values of -0.10 respectively, indicating perhaps that continued involvement in national
carriers either financially or operationally can hinder progress on the path towards further
bilateral or multilateral liberalisation.

Other important non-policy factors influencing carrier performance such as management

effectiveness, alliance participation and the extent to which cost escapabilities are present
would all have had a clear effect on the overall goodness of fit especially given the temporal
aspect of the empirical data, where even if carriers are willing to react positively to a change
in policy, may not be able to do so in the short to medium term (see Keeler 1972) due to fixed
costs, aircraft procurement lag times or long term strategic or operational commitments to
alliances and/or specific airports. Despite a low number of degrees of freedom and a wide
range of country-pair markets being pooled into the same data set, the overriding importance
of optimising the regulatory framework in order to stimulate competitive behaviour was found
to have a positive knock on effect on levels of incoming tourism. Approximately 3% of the
 14

variation in incoming demand could be traced back to changes in Caricom air policy where as
this figure was notably more significant for the Middle-East region (10%).

Of particular interest to this study was the significant positive sign noted between the
level of state ownership and carrier performance in the Middle-East sub-sample. Although
this effect was not unanimous across all the country-pairs in the sample, the invariably high
operational performance of Emirates, Etihad and more recently Yemenia have pushed the
aggregate value towards a higher magnitude. There were some important moves towards
liberalisation in the Middle-East as well, especially in states like UAE, Oman and Kuwait
with Egypt and Yemen lagging behind somewhat. The net effect on carrier performance was
positive, however, which when combined with the strong ownership value, led to a higher
indirect impact effect on levels of incoming tourism. Unlike the Caricom model, subsidy had
an insignificant yet positive effect on carrier performance. The cross-correlation effect
between state ownership and subsidy levels may have had a distorting effect on this beta
value, however.

A final proviso must be made about the nature of the empirical data. On a number of
occasions air policy ‘status quo’ remained the same throughout the test period. This is partly
due to the fact that data was collected over eight time periods but more importantly it was due
the difficulty experienced in assigning numerical values to discrete policy events which are
invariably implemented on a gradual step-by-step basis or all at once with no change
occurring in the remaining periods. The same can be said for airline ownership and levels of
subsidy which are subject to review on a periodic as opposed to a continual basis. Carrier
performance and incoming tourism traffic numbers on the other hand vary year-on-year and
only some of this variation will coincide with the discrete policy changes. While this had
negative implications for the linearity of construct relationships as required in structural
equation modelling, the multiple regressions were still able to pick up cross-sectional
differences in magnitude for any given time period and a significant proportion of the
temporal effects as a result applying at least an ordinal level of data to the liberalisation
ownership and subsidy constructs. In the Middle-East sample 19 of the 29 country-pairs
experienced a change in policy during the observed 8 year period while in the Caricom
sample a lower number of country-pairs revised their policy (12 of 24).

6. Policy and industry implications

Vertical integration has, in some cases, been taken to a whole new level in the Middle-
East with carriers such as Emirates, Etihad, Qatar Airways and Kuwait Airways all playing
fundamental roles in the development of a number of new commercial and tourist hubs in the
region (Debbage and Alkaabi in Graham et al 2008). This world view type of model is both in
its infancy stage and unique to only a few well integrated state capitalism based economies,
where a clear economic direction and strategy can be implemented equally across all sectors
of an economy. The results of this study suggest that state ownership and influence in national
carriers may in fact have a positive effect on levels of incoming tourism, especially if it is
accompanied by increasingly liberal air service agreements and a withdrawal of blanket type
state subsidies. It is still early days to conclude with certainty, however, that continued state
control and ownership in the Middle-East will in fact accrue long term benefits in terms of
incoming tourism expenditure and increased consumer welfare.

On the other hand, in the absence of such political and economic uniformity, state
involvement in the air transport sector was found to have more typical consequences on
carrier performance and in turn on passenger demand. The Caricom region is a prime example
of a fragmented, disjointed economy which is often hindered by political disharmony and
 15

conflicting interests. In this type of scenario it is suggested that continued protectionism only
leads to inefficiencies and generally low productivity in the industry stifling much needed
incoming tourism demand and putting downward pressure on service levels. If government
divestment in national carriers is accompanied by bilateral and/or multilateral liberalisation
and a removal of state financial commitments to the same carriers, then it may be possible for
the Caricom region to become more competitive, at least in terms of travel costs and service
levels, and also tap into latent demand on some of the denser local markets which have
hitherto been slow to develop.

7. Conclusions

The aim of this research was to test the hypothesis that important indirect relationships
exist between changes in air policy and levels of incoming tourism and that the direction and
strength of these relationships are neither consistent nor static in different world regions.

The study’s findings firstly demonstrate that incoming air traffic and consequently
incoming tourism expenditure can be at lest partially stimulated through changes in aviation
policy by way of its indirect and significant effect on supply side performance.

Although there was a significant amount of variation hidden beneath the aggregate results
for each case-study region, it was still possible to hypothesise, based on the empirical results,
that movements towards deregulation and liberalisation of the aviation sector does not always
represent the only or most appropriate strategy for facilitating further catalytic spending in
local economies. Contrary to this neo-liberal theory, empirical evidence suggests that a
different optimal regulatory framework may exist for every region. For the Middle-East
region record tourism growth figures were accompanied by recent moves towards more
liberal air service agreements while at the same time many governments were reluctant to
withdraw their involvement in the region’s national carriers whether it be in the form of
ownership, start-up capital or strategic/operational direction. This has created a unique
situation where local carriers are only protected vertically and not horizontally, allowing for a
number of innovative synergies and greater integration with related sectors of an economy
along with the traditional benefits of greater competition on some of the core intercontinental
air transport markets (e.g. Europe-Asia, Asia-Europe Asia-Africa).

In the Caricom region, it was more typical for government owned and subsidised carriers
to operate in restricted markets. A number of bilateral agreements were partially liberalised
during the observed period, with notable examples occurring in states with national carriers
interests (e.g. the Bahamas) and without (e.g. St. Lucia) such interests. However, the presence
of a number of mature and low growth potential markets along with the negative effect of
including currently restricted markets in the same sub-sample led to a more modest total
indirect effect on levels of incoming tourism. Given the poor financial record of the region’s
local carriers, the lack of vertical sector integration as well as the presence of a number of
internal (limited airport infrastructure, no actual or potential hubbing activity) and external
(dependence on limited number of source markets, limited trading activity) barriers,
liberalisation would need to be accompanied by an end to regional carrier blanket subsidies
and ownership/control to reap a partial stimulus for the tourism sector.

A number of limitations to this study provide an opportunity for further research. First, it
was assumed that local governments wish to stimulate further growth in tourism exports.
Some states within the sampled case-study regions may in fact have an alternative tourism
strategy, especially if there is limited carrying capacity or if a niche tourism product is being
developed such as eco or adventure tourism. The overall welfare implications of protectionist
 16

or non-protectionist policies would need to include an evaluation of the impact on non-

lucrative regional routes and equitable allocations of air transport resources (e.g. spatial
inequalities associated with hubs) within the respective regions. Moreover, it is clear from the
generally low predictive value of the confirmatory models that incoming demand and carrier
performance can also be influenced by a number of unobserved factors such as destination
hotel rates and other ground expenses in the case of the former and barriers to contestable
markets such as airport congestion and predation in the case of the latter.
 17

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