A Test of Trade Theories When Expenditure is Home Biased
41 Pages Posted: 8 Aug 2005
Date Written: June 2005
Abstract
We develop a criterion to distinguish two dominant paradigms of international trade theory: constant-returns perfectly competitive models, and increasing-returns monopolistically competitive models. Our analysis makes use of the pervasive presence of home-biased expenditure. It predicts that countries' relative output and their relative home biases are positively correlated in increasing-returns sectors (the 'home-bias effect'), while no such relationship exists in constant-returns sectors. This discriminating criterion turns out to be robust to a number of generalizations of the baseline model. Our empirical results suggest that the increasing-returns model fits particularly well for the mechanical and electrical engineering industries, which account for close to half of manufacturing output.
Keywords: International specialization, new trade theory, home-market effects, border effects
JEL Classification: F10, R30
Suggested Citation: Suggested Citation
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