Abstract
In the presence of scale economies, industries are incentivized to localize production. Geography plays a key role in determining where that location is. The Home Market Effect (HME) predicts that locations with a large consumer base tend to be the host. Yet, since its inception in the 1980s by Paul Krugman, the theory has only been shown to be generally valid in two location models, therefore questioning its empirical relevance. I prove that the HME is maintained in an arbitrary geography provided trade is home biased. Intuitively, without home bias, consumers don’t buy locally; production is therefore not incentivized to localize near them. I use inter-country input-output data on OECD countries to quantify the role of geography in the HME.
Invited by: Bruno Conte