Market Potential And Regional Wage Differentials: Evidence From China's Prefecture-level Panel Data Analysis

The problem of income inequality is always a theme of the economic growth theory and development economics. Meanwhile, it is also an important practical problem cared by policy makers of government. The increasing income inequality in China after its underwent economic reform and openness in the late 1970s has coincided with the international trend towards an increasing wage gap between regions. Since the 90's, the problem of income disparity becomes more and more seriously. Because of the assumption of neoclassical economic growth theory being completely competition and constant returns to scale, these studies didn't find out the real mechanism of income disparity. So, we tried to think of the causes of persistent enlarge in income disparity from a new framework.Starting with the seminal contribution by Krugman (1991) , the new economic geography has been prominent on the research agenda in economics in recent years. New economic geography (NEG) emphasizes the interplay of transport cost, imperfect competition and plant-level increasing returns. In these models, the spatial distribution of demand is a key determinant of economic outcomes. Models of economic geography predict that transportation costs directly affect demand for goods and the supply of intermediate inputs. NEG try to explain that why Economic activities are certainly not equally distributed in space. In one strand, it is argued that higher demand gives rise to a more than proportionate increase in production, a result known as the home market effect. Another strand emphasizes the effects of market sizes on factor prices. The paper uses recent literature on economic geography models for reference which use market potential as an important variable in determining income. Using panel data on 176 prefectural level cities in China, we examine the link between wages and market potential. The estimation results confirm that wages are positively correlated with market potential and predict that wages are higher in regions closer to large markets. We find that elasticity coefficient of wages with respect to market potential is about 75-77%. Based on above empirical research, we argue that regional difference of market potential results in wage inequality, and the former is closely related with insufficiency of labor mobility in our country. In addition, human capital, FDI and natural conditions are also correlation with regional wages. We also find how the predicted regional wage change varies as we increase the distance of the point at which the shock is presumed to occur. This suggests that importance of proximity to markets for wages has also increased over time, but the effect of such shock is geographically limited. We argue that it is important to achieve a balanced development between regions through building some economic growth cores in China.