Testing the 'home market effect' in a multi-country world: A theory-based approach

Kristian Behrens (), Andrea Roberto Lamorgese (), Gianmarco .P. Ottaviano () and Takatoshi Tabuchi ()

No 561, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We propose a theory-based approach to testing the presence of the 'home market effect' in a multi-country world. Our framework extends Krugman's (1980, Am. Econ. Rev. 70(5), 950-959) model, in which the appeal of a country as a production site depends on both the relative size of its domestic market ('attraction') and its relative proximity to foreign markets ('accessibility'). We show that the extended model predicts a home market effect only after the actual production and trade data have been corrected for the impact of countries' differential access to world markets. This can be achieved through a simple theory-based linear filter. We propose a series of non-parametric sign- and rank-tests that are closely related to those used in factor proportions theory. When applied to a cross-section of OECD and non-OECD countries, the filtered data performs better than the raw one and our results strongly support the presence of home market effects.

Keywords: home market effect; new trade theory; multi-country models; market potential; economic geography (search for similar items in EconPapers)
JEL-codes: D58 F12 F17 R12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-int
Date: 2005-09
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