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

By Waheeduzzaman, A. N. M.; Rau, Pradeep A. | Journal of Competitiveness Studies, January 1, 2006 | Go to article overview

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


Waheeduzzaman, A. N. M., Rau, Pradeep A., Journal of Competitiveness Studies


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). They are: markets, resources, efficiency, knowledge, and political safety. These factors or a mix of them can explain the level of FDI in a country. Various theoretical advancements explaining the FDI pattern include product and factor market imperfections (Hymer, 1960), international product life cycle (Vemon, 1966), portfolio investments (Aliber, 1971), ownership advantage (Caves, 1971), follow the leader (Rnickerbrocker, 1973), internationalization (Buckley and Casson, 1976), risk diversification (Rugman, 1979), and organizational assets and knowledge transfer (Kogut, 1983). In 1993, Dunning summarized these explanations in his eclectic paradigm (Dunning, 1993). His OLI framework argues that multinationals invest abroad because of ownership, location, and internalization advantages. The importance of market is recognized under the "location advantage" in Dunning's work. By and large, the eclectic paradigm has been accepted as an all-inclusive theory in FDI.

The argument for "markets attracting FDI" is intuitively powerful. Markets offer a base where a firm can sustain and grow. The market or the "demand conditions" of a country is the primary determinant of competitiveness (Porter, 1990). Firms find it convenient to invest in a country where they have a market. The nature and characteristics of the market influence the pattern of investment. …

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