In the most recent budget statement, the government has suggested that it is a “national economic imperative” to revitalise Bermuda’s hospitality sector. This can be seen in the $930 million list of projects in Table 1 of the budget statement which all, in some shape or form, touch on the tourism sector.

Bermuda is making a bet that these investments will reinvigorate our fading tourism product and offer a renewed growth engine for an economy that has dangerously come to rely more and more on international business, or more specifically reinsurance, to support the nation. The question, of course, is what actually drives tourism dollars and success. To get these answers we can get a little help from the International Monetary Fund (IMF).

The December 2014 IMF Working Paper “Revisiting Tourism Flows to the Caribbean: What is Driving Arrivals?” offers some clues as to what, economically speaking, drives tourism. (see: http://www.imf.org/external/pubs/ft/wp/2014/wp14229.pdf) What they discovered was, both price and income factors are found to have a significant impact on tourism arrivals and expenditure. More specifically:

“A 1.0 per cent appreciation of the tourism-weighted real exchange rate is associated with 0.16 per cent decrease in arrivals, and a 0.1 per cent decrease in tourism expenditure …. Interestingly, price elasticity is found to be statistically insignificant for high-end destinations. This suggests, not surprisingly, that these destinations attract tourists who are less sensitive to the price factor. Intuitively, travellers to higher-end destinations might be less sensitive to price (real effective exchange rate) changes since consumer preferences (typical of higher income tourists) suggest a greater willingness to pay a higher marginal cost to maximise utility, for a given tourism product.”

We would suggest that, if these findings adhere to the situation in Bermuda, that all low-cost tourism projects be abandoned and Bermuda exclusively focuses on a very high-end luxury product. It is unlikely, given our uncompetitive cost structure, that we will ever be able to compete with jurisdictions which offer base costs materially lower than our own. This finding also suggests that by pegging our Bermuda dollar to the US dollar which appreciated by more than 20% versus a basket of world currencies over the past year could negatively affect any demand from regions outside of the US since their costs in dollars has gone up.

The IMF also found:

“A 1.0 per cent increase in the tourism-weighted unemployment rate implies a 2.1 per cent decrease in arrivals, and a 3.7 per cent decrease in expenditure in the baseline specification during 2000-2013 … The finding shows that arrivals in the Caribbean are very sensitive to economic conditions in source countries.”

The implication here is rather positive for Bermuda as the countries within its tourism-weighted group have fared well over the past year. Based on recent air arrival statistics from the Bermuda Tourism Authority and the change in unemployment rates among Bermuda’s major tourist customers, Bermuda could see a 2.1% increase in air arrivals and a 3.7% increase in tourist expenditures.

The calculation of this weighted change in unemployment is seen in Table 1.

The problem with this analysis is it does not seem to have worked for Bermuda recently. While the unemployment rate has fallen nearly 3 per cent in the United States since 2011, for example, Bermuda air arrivals from the US have fallen 7.8 per cent and per person tourism spending has declined by 12 per cent. Clearly something is broken in Bermuda. Recent tourism woes in Bermuda have become very much a local product problem. This may partially be explained by the increase in business tourism which has replaced some of the traditional vacationers coming to the Island. Bermuda benefited as the IB sector grew but both the conference business and business visitor figures have declined in line with job losses on the island.

The IMF paper also considered supply factors. These results are telling:

“The number of airlines has a statistically positive impact on arrivals and expenditure. The number of hotel rooms is found to have no significant impact on tourism arrivals to, or expenditure in the Caribbean, either for the higher end or lower cost destinations. To address concerns of reverse causality, the number of hotel rooms and airlines lagged by one year are also tested; the results are similar.”

If this study holds for Bermuda’s situation it would likely be incorrect to assume that adding more hotel inventory will increase arrivals. The mantra of “if we build it they will come” may not be applicable to tourism investments. The success of arrivals may be tied much more to other factors of supply like the number of airlines that service the Island, creative marketing programmes, special events like the America’s Cup and new source markets. The quick fix, may in this case, be to focus on courting more airlines from different source markets rather than courting additional building, notwithstanding the ancillary benefits afforded by employment from construction on the Island.

The IMF report also concludes by suggesting that “the cost of an average one-week beach holiday in the Caribbean is higher than in other beach regions of the world”. Thus it may be safe to say that Bermuda could hold the dubious honour of being THE most expensive beach holiday.

The IMF also offers policy considerations for those who are developing macroeconomic and structural policies with the tourism sector in mind. I will summarise these four points below:

1. Price and cost factors. The IMF gives two sets of advice: one for high-end countries and the other for lower-cost destinations. Their policy suggestions highlight the importance for high-end jurisdictions like Bermuda to ensure that public services and security are provided that meets the taste of high-end consumers. They suggest that governments need to ensure infrastructure investments are made that deliver high-end tourism environment. Failure to deliver on expectations could result in countries experiencing “sharp declines in tourist arrivals if quality does not meet the ‘high-end’ calibre”.

2. Post-financial crisis. The IMF suggests the world has now changed. Tourism arrivals and expenditures are less sensitive to price and income indicators. As a result, they caution that the Caribbean region may not see sustained strong growth in the tourism sector again, or at least not until we see pre-crisis growth or full employment. As a result, they encourage governments to “pursue prudent fiscal policies to adjust domestic absorption to match with potential GDP”. They state a need to focus on structural reforms and increased productivity. Sound advice for Bermuda.

3. Price and tourism quality. In this case we’ll simply quote the IMF: “In designing a tourism sector strategy, the findings for ‘high-end’ destinations suggest that it would be important to review carefully whether product and service quality is consistent with the ‘high-end’ classification. For the Caribbean overall, the ‘Week at the Beach’ index suggests that non-price factors would, ceteris paribus, need to be superior to ensure that the marginal benefit is at least as high, or higher, than the marginal cost of a holiday in Caribbean.” In other words, if Bermuda is selling a high-end destination, it needs to make sure its product and service is indeed high-end. Pricing Bermuda tourism high but offering an average product or service is a recipe for disappointment.

4. Vulnerability. The IMF recommends governments or tourism boards’ focus on diversifying source countries to reduce sensitivity to any one market that could have economic issues. They suggest focusing on higher growth emerging markets such as Latin America. Bermuda’s renewed focus on driving tourism from the US, specifically the east coast, does not appear to be reducing our nation’s vulnerability to economic shocks within the US. Bermuda needs to get creative in courting new emerging source markets.

All the Caribbean islands and Bermuda mostly offer the same thing and they tend to compete internationally thus sharing a rather stagnant market size among themselves. Today the Cayman Islands is the hot destination, most likely siphoning off high-end tourists from Barbados, Bahamas and possibly Bermuda.

A few years from now, Cuba could be the sexy spot — especially if US developers pile in with large and creative investments. Ultimately, to succeed, a tourist nation must develop a unique strategy or something others simply can’t offer.

Health City Cayman Islands, for instance, opened in 2014, designed to lure North Americans looking to shorten surgery wait times, for a reasonable price. It’s based on Narayana Health chairman and India’s most renowned heart surgeon, Dr Devi Shetty.

According to the Forbes article by Dr Robert Pearl: “With a laser focus on efficiency and quality, the average Narayana cardiac hospital performs 40 heart surgeries a day for less than $1,600 a case. That’s about 2 per cent of the average heart surgery cost in the US with outcomes that rival the best American facilities.”

If Bermuda is to succeed, the IMF report suggests we should focus solely on high-end tourism and ensure it is done right. We also need to get creative and offer something unique to our island, in addition to diversifying our source markets internationally.

Nathan Kowalski is the chief financial officer of Anchor Investment Management.