DP5097 A Test of Trade Theories when Expenditure is Home Biased

Author(s): Marius Brülhart, Federico Trionfetti
Publication Date: June 2005
Keyword(s): border effects, home-market effects, international specialization, new trade theory
JEL(s): F10, R30
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5097

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.