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Analysis

FDI drivers and domestic markets: Does size matter?

The size of a country’s domestic market is normally one of the key considerations for multinational companies when selecting their next FDI destination. However, bigger doesn’t always mean better.

hong kong-domestic-fdi
Markets with a relatively small size and population, such as Hong Kong, can still attract high levels of FDI, showing that the size alone of a domestic market doesn’t necessarily matter. (Photo by Dale De La Rey/AFP via Getty Images)

Multinational companies (MNCs) select a foreign direct investment (FDI) destination for myriad reasons, a key one being to gain access to its domestic market to whom to sell its products.

How attractive a country’s domestic market is to an MNC depends upon a number of factors, from the size of its population, its GDP per capita and, often most importantly, the scope for economic growth. Countries with large populations and a growing middle class are frequently seen as ideal targets. Examples of such locations include Poland in eastern Europe, and China, India and Indonesia in South East Asia.

Bigger doesn’t always mean better for FDI

The correlation between FDI inflows and the size of a country by area is not always a direct and unequivocal one.

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Data collected from CIA World Factbook and the UN Conference on Trade and Development’s World Investment Report 2020 shows some correlation between larger countries by area and FDI attraction in examples such as China and the US.

However, smaller countries by size such as the UK, the UAE, Singapore and Hong Kong attracted a significant level of FDI in 2019, while larger countries such as Chad and the Democratic Republic of Congo have attracted few FDI projects over the same period despite their size (see chart below).

This is because size in and of itself does not make for a large domestic market that an MNC can sell to. The size of the population, the location of the country and, most importantly, the size of its GDP are crucial factors.

“Size, or space, does not buy products – people buy products,” says Investment Monitor chief economist Glenn Barklie. “These people need to have the income in order to buy products. This is why we see a stronger correlation between GDP – the value of goods and services produced within a country – and FDI, rather than population or country size.”

The chart below, for instance, shows that a large population in a developed country is more attractive to investors compared with one in a developing country. This could be because there is a larger, more developed domestic market with the means to buy what an investor is selling.

Investment Monitor’s analysts noticed a weaker link when comparing the population of all countries – both developed and developing – and their FDI projects.

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Less-developed countries with high populations do not necessarily offer a stronger consumer base, as their residents are unlikely to have the means to buy what an investor is looking to sell.

Size, or space, does not buy products – people buy products. These people need to have the income in order to buy products. Glenn Barklie, Investment Monitor

The link with higher volumes of FDI projects over a year is more evident when compared against larger economies by GDP. This is likely to be because countries with higher levels of GDP normally have a larger middle and upper class that are able to spend their money on new products entering a more productive market.

The chart below shows the US and China as top of the league, but they are joined by countries with a much smaller population but a strong middle class, such as the UK and Germany.

Sector dependency and an evolving driver

A healthy economy, a strong middle class and a large population are not the only factors that make the size of a country’s domestic market attractive to investors.

Gregg Wassmansdorf, senior managing director, global corporate consulting, at commercial real estate advisory firm Newmark, explains: “Access to market is always one of the first considerations for MNCs when selecting their next FDI destination.

China is less compelling for labour arbitrage opportunities, but becomes more so as its middle-class consumer population continues to grow. Gregg Wassmansdorf, Newmark 

“However, globalisation looks different for companies in different industries and those that are active along different parts of the value chain. Some firms will focus on the domestic market of consumers, whereas others will focus on the market to access cheap labour or highly skilled talent.

“This is a relationship that continues to evolve. China, for instance, is less compelling for labour arbitrage opportunities, but becomes more compelling as its middle-class consumer population continues to grow.”

Like most of the other drivers, the size of the domestic market is a multidimensional driver. While gaining access to a local market might be the main consideration for an MNC, a country’s regulatory environment, research and innovation capabilities, education and talent also contribute to making a local market more attractive.

With this in mind, Barklie looks at the UK’s domestic market from a broader angle: “Although the impact of Brexit is deemed to be negative, with companies moving operations to other EU countries, there will still be the need for companies to have a presence in the UK as there will still be demand for their goods and services.”

This article is part of a series on FDI drivers. The full list comprises:

Viola Caon

Viola Caon

Senior editor

Viola Caon is a senior editor at Investment Monitor, focusing on infrastructure, logistics and the Americas market.