Growth potential is an organization's future ability to generate larger profits, develop its workforce and increase production. In the business, an organization's growth potential relies heavily upon its leadership's expectations for success, and the quantitative and qualitative measures, that are being used to determine expansion readiness.
Use of potential growth
Growth potential can be measured from an organization's planned movement into new markets, the employment of more effective marketing techniques, the development of new product lines, or other methods that grow a business from a small market to a more volume operation. Growth potential is often a barometer for investment interest from private and public investors, venture capitalists and other stakeholders (Anand R. i in., 2014).
Measuring growth potential
Potential growth can be broadly defined in a number of ways.
- First, it can refer to a statistical estimation of the tendencies. Typically, estimation is fulfilled by filtering or decomposing raw data into a cyclical or trend component, by using statistical specifications.
- Second, potential growth can also be defined, in a macroeconomic sense, as a rate of growth compatible with the natural rate of unemployment and stable inflation. In this connection, trend growth is usually estimated by exploiting the connection between inflation and output gaps.
- Finally, potential growth can be defined as the long-term potential growth rate given the technology, productive capacity, as well as factor inputs of the economy (Faal, 2005)
Statistically based filtering method
This approach is consistent with the definition of trend growth above, but partly relies on the link between output gaps and inflation. An important pros of this class of approaches is that it is simple and clear. The main drawback is that, as purely statistical techniques, these filters estimate trend growth without a firm mapping to economic theory and in particular disregard economic relationships (Anand, 2014).
Macroeconomic model-based multi-filter method
This approach brings consistency between the estimation of trend growth and the observed values of other key macroeconomic variables, such as inflation and non-accelerating inflation rate of unemployment (NAIRU). A drawback is lack of transparency, it is not straightforward to immediately dissect the relation between different factors and trend growth (Anand, 2014).
Production function approach
It takes into consideration both physical and human capital. This approach is transparent but it does not explicitly link the estimation of trend growth of the relationship between the output gap and inflation. Its main advantage is to estimate trend growth and provide a framework for thinking about future shifts, for example, through analysis (Anand, 2014).
- Anand R. (2014), Potential Growth in Emerging Asia, Wiley,
- Cubeddu L. (2014), Emerging Markets in Transition: Growth Prospects and Challenges, International Monetary Fund,
- Faal E. (2005), GDP Growth, Potential Output, and Output Gaps in Mexico, International Monetary Fund,
- Mehta U. (2001), A two-stage-to-orbit spaceplane concept with growth potential, DIANE Publishing,
- Nin-Pratti A. (2011), Yield Gaps and Potential Agricultural Growth in West and Central Africa , International Food Policy Research Institute.
Author: Katarzyna Adamczyk