Dynamic effects of tourism shocks on innovation in an open-economy Schumpeterian growth model

International travel restrictions during the COVID-19 pandemic drastically reduced the number of tourists. This study explores the dynamic effects of tourism shocks in an open-economy Schumpeterian model with endogenous market structure. A tourism shock affects the economy via a reallocation effect and an employment effect. A positive tourism shock increases employment, which raises production and innovation in the short run. However, a positive tourism shock also reallocates labor from production to service for tourists, which reduces production and innovation. If leisure preference is weak, the reallocation effect dominates, and the short-run effect of positive tourism shocks on innovation is monotonically negative. If leisure preference is strong, the employment effect dominates initially, and the short-run effect of tourism shocks on innovation becomes inverted-U, which is consistent with the stylized facts that we document using cross-country data. Finally, permanent tourism shocks do not affect the steady-state innovation rate in our scale-invariant model.