Beyond the Home Market Effect: Market Size and Specialization in a Multi-Country World

Abstract

SummaryThe standard two-country model of international trade with monopolistic competition predicts a more-than-proportional relationship between a country's share of world production of a good and its share of world demand for that same good, a result known as the "home market effect". We first show that this prediction does not generally carry through to the multi-country case, as production patterns are crucially affected by third country effects. We then derive an alternative prediction that holds whatever the number of countries considered. This new prediction takes into account important features of the real world such as comparative advantage due to cross-country technological differences and lack of factor price equalization. This article is a shorter revised version of the paper previously circulated under the title "Testing the 'home market effect' in a multi-country world". We thank two anonymous referees, the editor D. Trefler, as well as A. Anas, M. Brülhart, M. Bugamelli, D. Davis, G. Duranton, C. Ertur, L. Goldberg, G. Grossman, K. Head, E. Helpman, W. Koch, T. Mayer, P. Monfort, C. Michelot, S. Redding, Y. Sato, F. Schivardi, J. Südekum, F. Trionfetti, D. Weinstein, Y. Zenou, seminar AbstractThe standard two-country model of international trade with monopolistic competition predicts a more-than-proportional relationship between a country's share of world production of a good and its share of world demand for that same good, a result known as the 'home market effect'. We first show that this prediction does not generally carry through to the multi-country case, as production patterns are crucially affected by third country effects. We then derive an alternative prediction that holds whatever the number of countries considered. This new prediction takes into account important features of the real world such as comparative advantage due to cross-country technological differences and lack of factor price equalization.

Spatial inequality and urban costs: Revisiting the home market effect

“…In international trade literature, national product differentiation models predict that trade liberalization enables the small country’s industry to increase its share of output (reverse HME) because small market firms gain improved access to the consumers in the larger foreign market. In other studies, the HME may also disappear if trade costs accrue in both the manufacturing and the homogenous good sector (Davis, ), or in a multiple country setting (Behrens et al, ).…”

“…Consistent with existing studies, Proposition 1 demonstrates that wages in the large region are higher. Furthermore, as noted by Behrens et al (, footnote 1), Redding (), and Takahashi et al (), two HME definitions, the HME in terms of wages and the HME in terms of firm share , are known in literature. However, the interrelation between them: for example, Which one is more pervasive?…”

“…Takatsuka and Zeng () introduce mobile capital into the analysis and show that it generates a channel to offset the trade imbalance, as a result, the HME always emerges for arbitrary transport costs in both sectors of differentiated and homogeneous goods. On the other hand, two HME definitions, the HME in terms of firm share and the HME in terms of wages , are known in literature (see Behrens, Lamorgese, Ottaviano, & Tabuchi, , footnote 1; Redding, ; Takahashi et al, ). However, the interrelation between these two definitions is not well explored…”

Firm heterogeneity and the localization of economic activities

“…The impact of international trade costs and transport costs on the location choice of firms has been the subject of considerable study (Behrens et al. , among others). Behrens et al.…”

“…Behrens et al. () use a framework à la Krugman () to study how the ‘home market effect’ works in the multi‐country case. Behrens et al.…”