Global Competitiveness Report 2015 Home

Market size

Historically, the size of an economy has coincided with its domestic market. However, in a globalized world, a country’s market may or may not coincide with its political borders. Market size is therefore defined as a combination of country size and foreign markets.

Economic research, in line with the current GCI, suggests two ways through which market size affects productivity: economies of scale in production and incentives for innovation.

In general, market size produces efficiency gains by allowing for specialization—an idea that remains as true today as when Adam Smith proposed it in 1776. Furthermore, large markets can take advantage of economies of scale in the production of goods and services. Public goods tend to have high fixed costs and low marginal costs, and consequently the per capita cost of services such as justice, defense, and infrastructure decreases in places where a greater number of taxpayers pay for them.93 Similarly, firms may also attain increasing returns to scale that enable them to produce more output with proportionally less input by using larger and more efficient capital equipment.94 As argued by Balassa (1967) and Kravis (1971) and modeled by Krugman (1979), economies of scale play a crucial role in explaining the postwar growth in trade, since extending the market through trade allows exploitation of economies of scale in production.95

The second driver of productivity is perhaps even more important: larger markets create substantially bigger incentives for generating new ideas. Larger stocks of resources increase the likelihood of finding new ways to use those resources, and a single idea can make more profit when it is sold in larger markets.96 On the same note, larger markets create positive externalities in the accumulation of human capital and transmission of knowledge because of increasing returns to scale embedded in technology or knowledge creation.97

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93 See Alesina et al. 2005b.
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94 In other words, the cost of a producing one additional unit of output diminishes when the total amount of production increases. Economies of scale are often productivity enhancing; however, for sake of completeness, it is sometimes possible to attain diseconomies of scale. This happens when the marginal cost of production is higher than the average cost, in which case there is a trade-off between the size of the economy and its efficiency.
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95 Similarly, Matsuyama 1991 models industrialization by considering a manufacturing sector subject to increasing returns.
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96 Romer 1996 uses US time series to show that techniques of mass production emerged in the United States in the first half of the 19th century. He chose the United States because the larger market and larger stocks of resources create substantially bigger incentives for discovering new ways to use the resources.
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97 Jones 1999 shows that, because ideas are non-rivalrous and can be used for each unit simultaneously, the total production of new products (i.e., novels, computer games, and automobiles) is characterized by increasing returns once the fixed cost of creating the idea is taken into account. A similar concept is also presented by Lucas 1988 and Grossman and Helpman 1991.
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