Market Size

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Market size has been the single most widely accepted as a significant determinant of
FDI flows (Chakrabarti, 2001). The larger the host area’s (country, region, and sub region) total
income and its potential for development, the greater the amount of the FDI investment
(Billington, 1999). A large market is necessary for efficient utilization of resources and
exploitation of economies of scale (Chakrabarti, 2001). On the other hand, Asiedu (2002)
argues that market size is not a determinant for a developing country due to low income. In the
FDI literature, not much research on the impact of the market size has been conducted yet for
developing countries

Billington, N. (1999). The Location of Foreign Direct Investment: An Empirical Analysis. Applied
Economics, 31(1), 65-76.
Asiedu, E. (2002). On the Determinants of Foreign Direct Investment to Developing Countries:
Is Africa Different? World Development, vol. 30 (1), 107-119.
Chakrabarti, A. (2001). The Determinant of Foreign Direct Investment: Sensivity Analysses of
Cross-Country Regression. Kyklos, 54 (1), 89-114
Jordaan (2004) mentions that FDI will move to countries with larger and expanding markets and
greater purchasing power, where firms can potentially receive a higher return on their capital
and by implication receive higher profit from their investments. Charkrabarti (2001) states that
the market-size hypothesis supports an idea that a large market is required for efficient
utilization of resources and exploitation of economies of scale: as the market-size grows to
some critical value, FDI will start to increase thereafter with its further expansion. This
hypothesis has been quite popular and a variable representing the size of the host country
market has come out as an explanatory variable in nearly all empirical studies on the
determinants of FDI. In ODI (1997), it is stated that econometric studies comparing a cross
section of countries point to a well-established correlation between FDI and the size of the
market, which is a proxy for the size of GDP, as well as some of its characteristics, such as
average income levels and growth rates. Some studies found GDP growth rate to be a
significant explanatory variable, whereas GDP was not, probably indicating that where the
current size of national income is very small, increases may have less relevance to FDI
decisions

than

growth

performance,

as

an

indicator

of

market

potential.

DOI:

10.18267/j.pep.337 Econometric results on market size are far from being unanimous. Edwards
(1990) and Jaspersen et al. (2000) use the inverse of income per capita as a proxy for the
return on capital and conclude that real GDP per capita is inversely related to FDI/GDP, but
Schneider and Frey (1985), Tsai (1994) and Asiedu (2002) find a positive relationship between
the two variables. They argue that a higher GDP per capita implies better prospects for FDI in
the host country. Pärletun (2008) finds that the variable GDP is positive and statistically
significant at less than 1% level. She argues that the enlargement of market size tends to
stimulate the attraction of FDI to the economy. Ang (2008) finds that real GDP has a significant
positive impact on FDI inflows. He also finds that growth rate of GDP exerts a small positive
impact on inward FDI
.
Ang, J. B. (2008), "Determinants of Foreign Direct Investment in Malaysia." Journal of Policy
Modeling, 30 (1), pp. 185-189.
Jaspersen, F. Z., Aylward, A. H., Knox, A. D. (2000), "The Effects of Risk on Private Investment:
Africa Compared with Other Developing Areas," in P. P. Collier, C. (Ed.), Investment and Risk in
Africa. New York: St Martin’s Press.
Edwards, S. (1990), "Capital Flows, Foreign Direct Investment, and Dept - Equity Swaps in
Developing Countries" (Working Paper No. 3497 ed.): NBER
Tsai, P. (1994), "Determinants of Foreign Direct Investment and its Impact on Economic
Growth." Journal of Economic Development, 19(1), pp. 137-163
Jordaan, J. C. (2004), "Foreign Direct Investment and Neighbouring Influences." Unpublished
doctoral thesis, University of Pretoria.
Schneider, F., Frey, B. (1985), "Economic and Political Determinants of Foreign Direct
Investment." World Development, 13(2), pp. 161-175.
Pärletun, J. (2008), "The Determinants of Foreign Direct Investment: A Regional Analysis with
Focus on Belarus." http://biblioteket.ehl.lu.se/olle/papers/0002948.pdf

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