Discussion paper

DP5097 A Test of Trade Theories when Expenditure is Home Biased

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.

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Citation

Trionfetti, F and M Brülhart (2005), ‘DP5097 A Test of Trade Theories when Expenditure is Home Biased‘, CEPR Discussion Paper No. 5097. CEPR Press, Paris & London. https://cepr.org/publications/dp5097