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Dynamic Model for International Tourism Demand for Malaysia: Panel Data
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Article  in  International Research Journal of Finance and Economics · November 2009

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International Research Journal of Finance and Economics
ISSN 1450-2887 Issue 33 (2009)
© EuroJournals Publishing, Inc. 2009
http://www.eurojournals.com/finance.htm

Dynamic Model for International Tourism Demand for

Malaysia: Panel Data Evidence

Fateh Habibi
PhD Student in the Department of Hospitality and Recreation
Faculty of Economics and Management, University Putra Malaysia
43400, Serdang, Selangor, Malaysia
E-mail: habibif2004@yahoo.com

Khalid Abdul Rahim

Professor in the Department of Hospitality and Recreation
Faculty of Economics and Management, University Putra Malaysia
43400, Serdang, Selangor, Malaysia
E-mail: khalid@econ.upm.edu.my

Sridar Ramchandran
Lecturer in the Department of Hospitality and Recreation
Faculty of Economics and Management, University Putra Malaysia
43400, Serdang, Selangor, Malaysia
E-mail: sridar@econ.upm.edu.my

Lee Chin
Lecturer in the Department of Economics, Faculty of Economics and Management
University Putra Malaysia, 43400, Serdang, Selangor, Malaysia
E-mail: leechin@econ.upm.edu.my

Abstract
Tourism industry has been an important contributor to the Malaysian economy. The
Malaysia is one of the most important tourist destinations in the Asia and the Pacific
region. The purpose of this study is to recognize and measure the impact of the main
determinants of the international tourism flows to Malaysia. The estimated coefficient for
the lagged dependent variable could be the importance of consumer constancy to the
destination. The annual panel data set includes the number of arrivals from the 15 most
important generating countries during the period 1995–2005, and a number of possible
explanatory variables.

Keywords: International tourism demand, Panel data, GMM estimators.

JELClassification Codes: C33, C51, L83

1. Introduction
Before its dependence in 1957, the Malaysian economy was heavily dependent on primary
commodities mainly tin, rubber, palm oil and petroleum products. Tourism industry effects positively
on the economy besides an increase in foreign exchange earning, and employment opportunities. The
Malaysian government has serious attention to develop tourism industry after decrease in oil and the
International Research Journal of Finance and Economics - Issue 33 (2009) 208

world economic recession in the middle of the 1980s. The Ministry of Culture, Arts and Tourism had
established in 1987 and later upgraded it to the Ministry of Tourism in 2004. The government was also
allocated amount of fund to tourism industry besides providing sufficient basic infrastructure. In 2006,
tourism Malaysia received 30% more funding for advertising and other promotions in preparation for
Visit Malaysia Year in 2007. The Malaysian government will spend RM1.8 billion under the Ninth
Malaysian Plan (2006–2010), on upgrading tourist destinations and infrastructure, as well as on
marketing promotions in major source markets(Government Malaysia, 2006).
According to 2005 data from World Tourism Organization (WTO), Malaysia places 14th in the
ranking of counties either by international tourism arrivals. International tourism arrivals in Malaysia
increased from 7.93 million in 1999 to 17.55 million in 2006, representing an average annual growth
rate of about 13.9% and the growth of tourist receipts has been even more spectacular, rising from RM
12321.3 million in 1999 to RM 36271.7 million in 2006 with an annual growth rate of about 19.9%
(Malaysia Tourism Statistics, 2007). The direct and indirect effect of travel and tourism in Malaysia in
2006 was expected to account for 14.6% of GDP and 1,345,000 jobs (12.6% of total employment). The
travel and tourism sector generated US$18.1 billion in export revenue, representing 10.1% of exports
in 2006, making tourism Malaysia’s the second largest contributor of foreign exchange earnings to the
country after the manufacturing sector (WTTC, 2006).
Tourism industry is very important to the economy and is identified as one of the major sources
of economic growth. Therefore serious attention should be given in studying the factors that affect
international tourist arrivals to this country. In this paper, a dynamic demand model for tourism in
Malaysia is used to identify and estimate the income, tourism price, and trade value elasticities of the
tourism demand to Malaysia from origin countries. Using a dynamic specification, we inspect the
extent to which current tastes are influenced by past consumption behavior. The results obtained may
be valuable for helping professionals and policy-makers in the decision making process.
The rest of the paper is organized as follows: In Section 2, the tourism data sources are
presented and, the main characteristics of demand from the different generating countries are
explained. Section 3 focuses on methodology and econometric methods used for estimation while
section 4 presents the empirical results and their economic interpretation. Conclusion and policy
implication are presented in section 5.

2. Tourism demand
This section explains the most relevant characteristics of tourism demand in the Malaysia. The volume,
composition and recent evolution of tourist flows are investigated by using the number of arrivals of
tourists for the period 1995–2005. The aim of this work is to investigate the international tourism
demand, which represents 92% of all tourism arrivals with a total of almost 16.5 million international
tourists in 2005.
The total number of international tourists rose by an accumulative yearly average of 11.5%
between 1995 and 2005. Figure1 shows the international tourist arrivals to the Malaysia during 1995-
2005. In fact, tourism increased between 1995 and 2005 but also a 2-year decline is observed in 1998
and 2003. The most important decline took place in 2003 with a 19.8% drop in the numbers. The
worldwide evolution of tourism as a consequence of the SARS crisis in 2003 events may explain this
decrease.
209 International Research Journal of Finance and Economics - Issue 33 (2009)
Figure1: International tourist arrivals to the Malaysia (1995-2005).

Table 1: Tourist arrivals by country of origin (2005)

Country No. of international arrivals (in thousand) Percentage share of the total

Singapore 9634.51 58.64

Thailand 1900.80 11.57
Indonesia 962.96 5.86
Brunei 486.34 2.96
China 352.09 2.14
Japan 340.03 2.07
Australia 265.35 1.61
United Kingdom 240.03 1.46
India 225.79 1.37
Philippine 178.96 1.09
United States 151.35 0.92
Hong Kong 77.53 0.47
Germany 59.34 0.36
France 40.47 0.25
South Korea 13.21 0.08
Total 16431.06 100.00

Table 1 shows the relative importance of each of the origin markets according to 2005 data on
numbers of arrivals. The traditional tourism market for the Malaysia has been Asia Pacific region, and,
in particular, Singapore. In terms of composition, it can be observed that international tourism is highly
concentrated in a few countries of origin. Singapore and Thailand represent more than 70% of
international arrivals. When the next three markets are added (Indonesia, Brunei, China), they represent
up to 81% of the tourism arrivals.
International Research Journal of Finance and Economics - Issue 33 (2009) 210
Figure 2: Yearly average rates of growth of arrivals by country of origin (1995-2005).

Figure2 shows the rates of growth for the 15 most important origin markets during the period
1995–2005. The most positive evolution of tourism arrivals point out India with an accumulative
yearly average of 31.08%, and at the opposite end is Hong Kong with a decrease in 2.8%. Differences
in the rates of growth have also been observed between the two main generating markets (Thailand and
Singapore). Tourist arrivals from both countries show a positive evolution, but the rates of growth for
tourists arriving from the Thailand (16.79%) were larger than from Singapore (11.24%).
According to data of profile of tourists by select markets 2006, the average length of stay of
international tourists was 6.1 nights in year 2005. Differences in the duration of stay between origins
are observed. Figure2 shows that the highest and shortest values are registered by UK (9.8 nights) and
Singapore (4.4) tourists respectively.

Figure 2: Average length of stay of international tourists by country of residence (2005).

2.1. Selection of the variables

2.1.1. Dependent variable
The international tourism demand is often measured either in terms of the number of tourist arrivals,
tourist expenditure, and number of tourist nights in the destination country (Ouerfelli, 2008). Data
limitations constrain the representation of the dependent variable. In the case of this study, the
available data have not permitted the construction of a tourism receipts or number of tourist night’s
211 International Research Journal of Finance and Economics - Issue 33 (2009)

variables for each of the origin countries. An alternative way of measuring the volume of tourism is to
use the number of tourists arriving at a destination (Malaysia) from the fifteen origin country.
Published articles in the tourism literature have denoted that number of tourist arrivals can be
an appropriate indicator of demand for tourism (Ouerfell, 2008; Teresa, 2007; Naude and Saayman,
2005; Dritsakis, 2004; Song et al., 2003; Song and Witt, 2003; Ten et al. 2002; Kulendran and Witt,
2001; Lim and McAleer, 2001, 1999; Morley, 1998; Gonzalez and Moral, 1995). Data on international
arrivals from the fifteen origin country were obtained from the Tourism Statistics Update published by
Ministry of Tourism Malaysia (1995-2006).

2.1.2. Independent variables

The most generally tested independent variables are income, population, relative prices, exchange
rates, and transportation costs. In this study, we are going to consider a dynamic specification of
international tourism and thus the selected independent variables will be the following:

2.1.2.1. Lagged dependent variable

Once people have been on holiday to a special destination and liked it, they tend to come back to that
destination. Moreover, information about the destination extends as people share their holiday
experiences with friends and family, thus reducing the amount of uncertainty for potential visitors to
that country. In fact this ‘word of mouth’ recommendation may well participate a more important role
in destination selection rather than commercial advertising. Therefore, the number of people choosing a
given destination in any year depends on the numbers who chose it in the previous years (Song et al.,
2003).
Garin-Munoz (2007) discussed the justifications of including a lagged dependent variable in
tourism demand models. Two possible justifications are provided. Firstly, there is less uncertainty
associated with holidaying in a country that you are already familiar with, compared with travelling to
a previously unvisited foreign country, also tourism is generally risk averse and may feel more
comfortable in choosing the same previous destination country. Secondly, knowledge about the
destination extends as people talk about their holiday, thus reducing the uncertainty for potential
visitors to that destination. Studies where the model includes the lagged dependent variable for
explaining tourism demand are: Fujii and Mak (1981), Garin-Munoz (2005, 2007), Garin-Munoz and
Martin Montero (2007) and Witt and Martin (1987).

2.1.2.2. Income
The income measure selected in this study is the Gross Domestic Product of origin country in per
capita terms and was collected from the IMF International Financial Statistics Yearbook published by
International Monetary Found (IFS, 2007). We expect that as origin’s income increases, the number of
tourist arrivals in Malaysia by its residents will increase. Therefore, we expect a positive sign for the
estimated coefficient of this variable.

2.1.2.3. Price
The selection of a price variable to be included in the study is particularly difficult. For a product
similar international tourism, price is combined of several components. The price of goods and services
bought in the destination would usually account for a significant part of the total price. The price
variable specified in this way combines the effects of prices and exchange rate between destination and
origin countries. However, other costs such as transportation to the destination, travel insurance,
opportunity cost of travel time may also be significant and can affect totals.
In this study tourism prices were described as costs of living in Malaysia by the tourists from
the origin countries. In explaining this price variable, consumer price indices were used as a proxy for
the cost of tourism in destination (Malaysia) relative to the cost of living in the origin country adjusted
by the exchange rate (Morley, 1993; Carey, 1991; Martin and Witt, 1987). Demand theory
hypothesizes that the demand for international tourism is an inverse function of relative prices, i.e., the
International Research Journal of Finance and Economics - Issue 33 (2009) 212

lower the cost of living in the destination relative to the origin country, the greater the tourism demand
and vice versa. We therefore expect a negative sign for this variable.
The definition of the tourism price variable in this study is
TPit = (CPIMalaysia / CPIOrigin) (1/ ERMalaysia/Origin) (1)
where, ERMalaysia/Origin is the number of monetary units of the Malaysia by each monetary unit of origin
countries, and CPIOrigin is the consumer price index of each of the fifteen considered origin country.
Data on exchange rates (ER) and consumer price indexes (CPI) for the Malaysia and origin countries
were collected from the International Financial Statistics Yearbook published by the International
Monetary Fund (IFS, 2007).

2.1.2.4. Trade Openness

International tourism is quite often the generator of international trade flows. Certain the increasing
quantity of business travel, particularly in a destination where the economy is greatly driven by
international business such as in Malaysia, international arrivals could be determined by the level of
business activities among the destination and its economic partners.
In this study, trade opennes is included in this analysis because arrivals on business purposes
consistently made up about 11 percent on average of total arrivals to Malaysia in year 2006 (Tourism
Statistics Update, 2007). For this reason, volume of trade is hypothesized to affect the demand for
travel to Malaysia and it was therefore contained in the model to help explain demand. The initiative of
including this variable in tourism demand analysis in inline with that of Turner et al. (1998), Turner
and Witt (2001), Song and Witt (2003) where tourist flows are disaggregated into different purposes of
visit, including business visit. Trade openness was measured as the total value of import and export of
goods and services between Malaysia and the origin country divided by GDP Malaysia.
TOmi,t = (EXmi,t + IMmi,t ) / GDPt,m (2)
where EXmi,t is the export volume between Malaysia and origin country i at time t, IMmi,t is the import
volume between Malaysia and origin country i at time t, and GDPt,m is the Groos Domestic Produacts
in Malaysia at time t. Export and import values between Malaysia and fifteen origin country were
collected from the Direction of Trade Statistics Yearbook published by the International Monetary
Found (DTS, 2007).

2.1.2.5. Special factors

A many number of special factors or events may influence the demand for international tourism. This
study contained the following dummy variables:
D97 is the dummy variable with a value 1 for the Asian financial crisis in 1997 and is 0
otherwise.
D03 is the dummy variable with a value of 1 for the SARS crisis in 2003, and is 0 otherwise.
There are a few variables in Malaysia that may affect tourism demand such as the advertising
and marketing expenditure in the origin country/origin, tourist education, security at the destination,
and other variables that depend on knowledge of consumer types and motivation. The data on these
variables are either unavailable or difficult to measure. Finally, it is important to note that there are two
more variables implicitly incorporated in the model. One of them is population, which is incorporated
by using it in the denominator of the variables used for measuring income and volume of tourism. The
other variable is the exchange rate that has been used for producing the cost of living of origin
countries in Malaysia.

3. Model specification and econometric method

Studies published between the 1960s and the 1990s mainly followed the traditional regression
approach in that the models were specified in static regression models can experience from a number
of problems, including structural instability, forecasting failures and spurious regression (Witt and
Song, 2000). So that avoid these potential problems, one way of treatment the dynamic structure of
213 International Research Journal of Finance and Economics - Issue 33 (2009)

preferences is to regard as taste changes as endogenous by including previous consumption in the

model (Fujii and Mak, 1981; Garin-Munoz, 2005, 2007; Garin-Munoz and Martin Montero, 2007; Witt
and Martin, 1987).
The model constructed in this study is based on the classical economic theory which assumes
that income and price factors are probably to play a important role in determining the demand for
international tourism. Several empirical studies have found that the conduct of tourists may also be
affected by non-economic factors, such as political instability, terrorism and natural disasters (Hisao et
al. 2008; Page et al, 2006; Richter, 2003; Wang, 2008).
We estimate a model to explain the demand for Malaysia international tourism by using data on
number of tourists arriving from the 15 major origin countries (i =1,…, 15). These fifteen origins are:
Australia, Brunei Darussalam, China, France, Germany, Hong Kong, India, Indonesia, Japan,
Philippine, Singapore, South Korea, Thailand, United Kingdom and United States. The data set pointed
out the annual arrivals during the 11-year period between 1995 and 2005 (t=1995, …, 2005).
Therefore, we have a complete panel data set with 165 observations.
There are several advantages in using this type of data. First, the use of annual data avoids the
problems due to seasonality. Second, by using the different origin countries as observational units, an
increase in the range of variation of the variables is considered. Finally, the utilization of a pooled
time-series/cross-sectional data set enables us to have more degrees of freedom than, and reduce the
problem of multicollinearity, hence improving the accuracy of parameter estimates (Garin-Munoz and
Martin Montero, 2007).
Therefore, the tourism demand function takes the following form:
TAi,t = ƒ(TAi, t-1, GDPi,t, TPi,t, TOi,t, Dum), (3)
where TAi,t is the number of tourists arriving to the Malaysia from country i during year t; TAi,t-1 is the
number of tourist arriving to the Malaysia from country I during the last period; GDPi,t is the gross
domestic product in each of the origin country; TPi,t is the relative cost of living of tourists in Malaysia;
and TVi,t is the trade volume between Malaysia and each of the origin country. The dependent variable,
as well as the lagged dependent and the GDP variables, are expressed in per capita terms.
There are several functional forms that can be used to determine the demand for international
tourism. In this study, as in most of previous empirical literature, the tourism demand model has
adopted the double-logarithmic form. The model to be estimated would be
ln TAi,t = β0 +β1 ln TAi,t-1 + β2 lnGDPi,t + β3 ln TPi,t + β4 ln TOi,t + β5 D1997 + β6 D2003 + t + i
+ it. (4)
In Eq. (4), vit = t + i + it is the fixed effects decomposition of the error term in which t and
i are the time and destination-specific effects, respectively. The error component it is assumed to be
serially uncorrelated with zero mean and independently distributed across destinations, but
heteroskedasticity across time and destinations is allowed for. Moreover, it is assumed to be
uncorrelated with the initial condition LnTAit, for t = 2,…,T, and with the individual effects i for any
t. The two dummy variables (D1997 and D2003) were included to capture the affect on tourism of the
Asian financial crisis in the year 1997 and the SARS crisis in the year 2003, respectively. D1997 takes
the value of 1 in Malaysia for the year 1997 and 0 otherwise. D2003 takes the value of 1 in Malaysia
for the year 2003 and 0 otherwise. A positive sign is expected for the coefficients β1, β2, β4 and a
negative sign for the coefficients β3, β5, and β6.
When lagged dependent variables are included as regressors, the simple estimation procedures
are asymptotically valid only when there are a large number of observations in the time dimension (T).
The current available response to this problem (Arellano and Bond, 1991; Holtz-Eakin, 1988; Hsiao,
2003) is to first difference the equation to remove the individual effects and then estimate by
instrumental variables (IV), using as instruments the values of the dependent variable lagged two or
more periods. This treatment leads to consistent but not efficient estimates, because it does not make
use of all the available moment conditions (Garin-Munoz, 2007). The solution provided in this study is
International Research Journal of Finance and Economics - Issue 33 (2009) 214

to use the generalized method of moments (GMM) procedure of Arellano and Bond (1991). They
dynamic model to be estimated will therefore be
∆ ln TAi,t = β1 ∆ ln TAi,t-1 + β2 ∆ lnGDPi,t + β3 ∆ ln TPi,t + β4 ∆ ln TOi,t + β5 ∆ D1997 + β6 ∆
D2003 + i,t, (5)
Where i = 1, …, 15; t = 1995, …, 2005; and all the variables are in first differences. That means
∆ln TAi,t = ln TAi,t – ln TAi,t-1 and, analogously, for the other variables.
Because of the double-logarithmic form of the model, the parameters may be explained as
elasticities. An advantage of using a dynamic model is that both short and long-run elasticities are
obtained. Long-run elasticities can be obtained by dividing each of the coefficients by (1- β1). A further
advantage relates to the fact that, by differencing data, we avoid the problem of non-stationarity and
this method will give us confidence in the reported coefficients and standard errors.

4. Empirical results and policy implications

For the estimation of equation (5) we have used STATA v.10.0 econometric software to obtain the
Arellano-Bond dynamic panel estimates of the model. The consistency of the estimation depends on
whether the lagged values of the endogenous and exogenous variables are valid instruments in our
regression. We have also conducted a test for autocorrelation and the Sargan test of over-identifying
restrictions as derived by Arellano and Bond (1991). Failure to reject the null hypothesis in both tests
gives support to our model.
Table 2 shows the results from the estimation. The results of Table 2 show that the model
performs satisfactorily. No signs of serial correlation are found and the Wald test denotes the joint
significance of the explanatory variables. Since a double-logarithmical model is used, the estimated
coefficients are direct elasticities.

Table 2: Estimation results for the dynamic model (1995-2005)

Variable GMM-DIFF estimator of Arellano and Bond

ln TAi, t-1 0.91 (31.02)

ln GDP 0.03 (0.75)
ln TP -0.6 (-3.27)
ln TO 0.02 (0.20)
D1997 -0.25 (-2.41)
D2003 -0.42 (-8.10)
Autocorrelation2 0.17 (0.86)
Sargan 140.41 (0.21)
Wald test 3615 (0000)
No. observation 150
Long-run parameters
ln GDP 0.33
ln TP -6.67
ln TV 0.22
Note: Dependent variable (lnTAi,t): log of tourist arrivals per capita. t-ratios in Parentheses.

So that explain the results of Table 2, it should be noted that the estimated coefficients are
short-run demand elasticities. Long-run elasticities can be obtained by dividing each of the coefficients
by (1- β1). The long-run elasticity values are income elasticity = 0.33; cost of living elasticity = -6.67
and trade volume elasticity = 0.22.
215 International Research Journal of Finance and Economics - Issue 33 (2009)

The results show that tendency persistence is important for explaining foreign tourism demand
in the Malaysia. In fact, 91% of total international arrivals are attributable to tendency persistence
and/or word-of-mouth effect on the consumer decision of the destination. The policy implication of
this result is that, in order to attract more tourists to the destination, the suppliers of tourism
products/services should improve their service quality and upgrade their brand image.The estimated
coefficient for the income variable has the expected sign and insignificant. According to the estimated
short-run elasticity value (0.03), tourism to the Malaysia is considered by foreigners as a non-luxury
service.
Tourism in the Malaysia is very sensitive to prices. The estimated short-run price-elasticity (-
0.6) could lead to the conclusion that revenues could be increased by increasing prices. However, the
long-run effects of prices on tourism demand (-6.67) may be a reflection of the numerous alternative
destinations. Thus, suppliers must be careful with prices in order to maintain the competitiveness of
their products. The important thing, at this point, is to control the quality/price relationship and, given
that prices in Malaysia are no longer low, the strategy should be to increase the quality of the services.
In this consideration, there are several competitor destinations that are making major efforts to improve
the quality/price relationship of their products. This is the case of countries like Indonesia, Thailand,
Singapore and China.
The trade openness has an insignificant and positive impact on the tourism demand in
Malaysia. We have found that external shocks may have an impact on tourism demand. The dummy
variable D1997 and D2003 has been included to reflect the impact of the Asian financial crisis in 1997
and the SARS crisis in 2003. The results confirm the expected negative sign and show that it is
significant for explaining the decrease number of arrivals.

5. Conclusion and Policy Implication

On the basis of an international tourism demand model, we have estimated a dynamic panel data model
for Malaysia and are affected by several factors. The purpose of this study is to measure the impact of
the main determinants of international tourism flows to the Malaysia. We use a dynamic model
estimated with a panel data set using up-to-date estimation techniques and provides short and long-run
elasticities for the variables of interest. Our panel has many degrees of freedom, high variability in all
the variables and little multicollinearity.
The model was used to assess the performance of tourist arrivals from fifteen generating
countries to the Malaysia between 1995 and 2005, and it was estimated by using the GMM-DIFF
estimator proposed by Arellano and Bond (1991) for the case of dynamic panel data models.
Therefore, we have a complete panel data set with 165 observations. One of the main conclusions of
the study is the significant value of the lagged dependent variable (0.91), which may be interpreted as
high consumer constancy to the destination and/or as an important word-of-mouth effect on the
consumer decision of the destination. The policy implication of this result is that, in order to attract
more tourists to the destination, the suppliers of tourism products/services should improve their service
quality and upgrade their brand image. The estimated values of the income elasticity suggest that
tourism to the Malaysia is considered by foreigners as a non-luxury service.
Tourism in the Malaysia is very sensitive to prices. According to the selected model, the
estimated values for the own-price short- and long-run elasticities are -0.6 and -6.67, respectively.
Thus, suppliers must be careful with prices in order to maintain the competitiveness of their products.
Hence, policy makers and suppliers must closely monitor all tourism service providers such as hotels,
restaurants, tourist operators, and transportation companies such as airport taxis and tourist buses to
ensure that they do not charge ‘unreasonable’ prices for their services. We have found that external
shocks may have an impact on tourism demand. The results confirm the expected negative sign and
show that it is significant for explaining the decrease number of arrivals.
International Research Journal of Finance and Economics - Issue 33 (2009) 216

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