Market Potential and Foreign Direct Investment: Exploring the Relationship in Emerging Markets

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ABSTRACT

Market potential is one of the critical variables in determining the competitiveness of a country. The study investigates the classic relationship between market potential and foreign direct investment in twenty-six emerging markets using the Market Potential Indicator (MPI) of Michigan State University (MSU). MPI is a composite of market size, market growth rate, market intensity, market consumption capacity, commercial infrastructure, economic freedom, market receptivity, and country risk. Findings indicate that MPI moderately explains the FDI inflow in the emerging economies. A factor analysis reveals that the true dimensions of MPI are power of the market, openness and growth, and capacity and infrastructure. When regressed on FDI, the factors show better explanatory power than MPI as a composite. Additionally, the common indicators of market potential like GDP, Per Capita Income, and Population are also regressed on FDI using longitudinal data for a period (1960-2000) when the emerging markets experienced one of the fastest growths in their history. Some of these variables significantly explain the FDI pattern. Findings of the study are preliminary and should be taken with caution. More data would be needed to determine the true nature of influence.

INTRODUCTION

Today, emerging markets are drawing the attention of the world because of their market power and growing competitiveness. They are growing faster than the developed world by about two percentage points on average (The Economist, February 5,2005). Their size and future potential is very attractive to international marketers. The combined market of India, China and Indonesia constitutes about two-fifth of the world population. Brazil, Mexico, Argentina and Chile provide three-fourth of Latin America's GDP. Half of America's export in the 1990s went to ten big emerging markets (Garten, 1996).

The importance of the emerging markets has been well recognized by business, governments, and academia. The Economist publishes the emerging market indicators every week. Most stock markets around the world follow their growth regularly. The U.S. and European governments proactively seek business relationship with these countries. Academic researchers have also addressed the market potential, growth, and strategy of the emerging markets in various studies, indexes, country reports, and similar works.

This study investigates the relationship between market potential and foreign direct investment in emerging markets using two different approaches. The first approach uses the Market Potential Indicator (MPI) of the emerging markets maintained by the Center for International Business Research (CIBER), Michigan State University to determine the relationship. The approach, in a way, also tests the efficacy or the usefulness of MPI as an indicator of market potential. The second approach regresses the common indicators of market potential like GDP, Per Capita Income and Population on FDI using longitudinal data (1960-2000). By and large, the classic relationship between market potential and foreign direct investment holds true in emerging markets.

The paper is divided into five sections. Section I introduces the paper. Section II provides a background. Section III presents the research questions and the methodology. Findings of the study are presented in Section IV. Section V describes the limitations of the paper and provides direction for future research.

BACKGROUND

During the last forty years an immense body of literature has emerged explaining the growth of foreign direct investment. A number of theories have been proposed and tested. As a phenomenon, FDI has been investigated from the perspective of the firm, industries, and countries. The literature is diverse and crosses disciplinary boundaries. In broad terms, the strategic motives of foreign investment can be classified into five categories (Nehrt and Hogue, 1968). …