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Does Market Potential Matter? (Part 1)

Does Market Potential Matter? (Part 1)

Does Market Potential Matter? Evidence on the Impact of Market Potential on Economic Growth in Iranian Provinces


The market potential is an indicator showing the level of market access and national demand for products of a region. The aim of this study is to study the effect of market potential on regional economic growth in 28 Iranian provinces over the years 2001–2011. In order to do that, a model of regional growth was estimated by using Spatial Dynamic Panel Data technique. This technique allows us to control for endogeneity biases. Based on the findings, the market potential has a significant positive impact on economic growth of Iranian provinces. This means that as the regional market of products gets bigger, it will experience a higher economic growth.


The market potential is an indicator that shows the level of market access. In fact, the term is taken from physics. It has emerged into economic studies from Harris (1954). Harris defines the market potential for a specific area as Gross Domestic Product (GDP) of other regions divided by the distance between regions. Market potential affects regional growth from several channels. As an area has a larger market potential, it has a larger market to sell its goods. The larger market, effects on the manufactures’ profitability; because larger markets increase the demand for various regional products, and manufacturing firms will benefit from increasing returns to scale. So, the manufacturers located in areas with larger market potential has higher profitability than firms settled in areas with smaller market potential. So, an area with larger market potential will be an attractive site for industrial firms’ concentration. According to the new economic geography model, concentration of industrial activities in a region leads to regional growth by Localization Economics. Furthermore, agglomeration of activities can also lead to higher productivity, real wages and higher living standards, and regional economic growth. Several studies on the impacts of market potential on the economic variables have been done. The first group of studies examined the impact of market potential on GDP and growth (Clemente, Pueyo and Sanz, 2009; Enbai, Hong and Wenqing, 2012; Martinez-Galarraga, Tirado, and González-Val, 2015). The second group of studies investigated the impacts of market potential on wages (Niebuhr, 2003; Redding and Venables, 2004; Amiti and Cameron, 2004; Hanson, 2005; Head and Mayer, 2006; Paillacar, 2007; Lopez and Faina, 2007; Kosfeld and Eckey, 2010; Fally, Paillacar, and Terra, 2010; Hering and Poncet, 2010; Pareds, 2012; Kamal, Lovely, and Ouyang, 2012; Cieślik and Rokicki, 2013; Turgut, 2014). The third group of studies are those which investigated the the impact of market potential on industrial activities’ concentration (Hanson, 2004; Harris, 2008; Tokunaga and Jin, 2011; Bagoulla and Peridy, 2011), and the fourth group focused on the impacts of market potential on productivity (Ottaviano and pinelli, 2006; Nicoloni and Artige, 2010; Liu and Meissner, 2015).
This paper studies the impact of market potential on regional economic growth within the framework of the new economic geography model. In the new economic geography models, the focus is on industrial concentration as one of the most important variables affecting regional growth. Therefore, growth and concentration of industrial activity are interdepended. On the other hand, according to Cambridge Econometrics (2008), Tokunaga and Jin (2011), and Bagoulla and Peridy (2011), the market potential affects industrial activities and there is a relationship between them. Therefore, in estimating growth model, the endogeneity between variables should be considered. Also, two problems arise when estimating growth and agglomeration economies: unobserved heterogeneity and simultaneity. If we cannot control this problem, we will have biased estimation. So, in order to control this problem, we used generalized method of moments in spatial panel data. This method has not been used in any other research studies.

The contribution of this study is considering the effect of market potential on regional economic growth in Iran for the first time, and using spatial dynamic panel data to consider this effect.
The remainder of the paper proceeds as follows. Section 2 investigates the theoretical framework of market potential impact on economic growth. Section 3 presents model specification and description of the data used. Section 4 proceeds spatial autocorrelation of provincial real product in Iran, and section 5 shows basic results. Conclusions and recommendations are presented in Section 6.

Theoretical Framework

The market potential was presented by Colin Clark. It was similar to the concept of the population potential (the potential population) stated by Jon Stewart (1947). The market potential is an indicator of the severity of the market connections or access to the market. This concept is taken from physics, in similarity to the strength of an electric, magnetic and gravitational field formula (Harris, 1954). Market potential is designed to assess the spatial relationships between producers and market which shows the flow of goods from one point to another. Market potential or the market capability of each province is actually a measure of the national market demand for a province product. As the market demand for a region's products increases, the production in the region increases. Market size is an important factor in locating and establishing a manufacturer in one region. Two theories are proposed in relation to locating activities. In the first, locating is conducted based on the cost, and the models include Weber’s model, the Von Thunen’s model, the sum of the minimum distance method model, and the Léonard model. In this category, transportation costs and adjacency to the market are important elements in locating firms. In the second category, locating is conducted based on market structure. In these models, firms producing market monopoly locate closer to the consumer’s market.
Therefore, access to markets and intermediate inputs is important in locating, and manufacturers try to be located near the market. Being near the market makes manufacturers' access to consumers and suppliers easier, and thus reduces the cost of transportation. In new economic geography model, one of the main growth factors of a region is its market size. In this model, the interaction of increasing returns to scale, market size, distance and industry structure are addressed.
The turning point of these models is recognition of the increasing returns and transportation costs that makes the market size important (Cambridge Econometrics, 2008; Fujita and Mori, 2005). In the new economic geography model, economic activities are concentrated to obtain economies of scale, and are located where there is a large consumer market with better access to production markets (Cambridge Econometrics, 2008); because adjacency to the markets makes access to consumers and manufacturers easier, and as a result reduces the cost of transportation. Reduction of transportation costs lead to increase in profit, and thus, in turn, increase wages. The appeal of high wages, in addition to increasing intra-regional labor income causes migration flows towards areas placed close to the market. Migration increases the population in these regions which will lead to larger domestic markets for the exchange of goods and services, information and production. Increase in the amount of demand for the products of a region attracts industrial firms to the area, as with higher local demand, domestic economies to scale increases and attracts more manufacturers. Increase in the number of manufacturers may result in an integration in the region and through economies of agglomeration (a kind of positive externality in production), production of manufacturing firms in the region increases, and in the end, growth in the region economy will occur. So, it could be stated that according to the new economic geography model, if there is a high demand for products of an area, manufacturers will benefit more of locating in this area. They can also pay higher nominal wages and increase labor income. This leads to higher local demand (because of increased local workers’ income and labor migration to the region), and external demand (national level) for products. It increases manufacturers’ production and economic growth in the region.

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Ref: Iran. Econ. Rev. Vol. 21, No. 4, 2017. pp. 847-863 - Zahra Dehghan Shabani, Ali Hussein Samadi, Amene Zare