Home Market E¤ect and its Extensive and Intensive Margins: The Role of Factor Endowments

This paper develops a factor proportions driven monopolistic competition model of trade to examine how home-market e¤ects (HME) vary across countries and industries. I extend the multi-sector framework of Hanson and Xiang (AER 2004) to a two factor case where …xed cost of starting a business is more capital intensive than the marginal cost. Countries with di¤erent factor endowments have di¤erent extensive and intensive margins of output growth in every sector due to factor price di¤erences. Most importantly, rich and poor countries experience HME in di¤erent sectors. For large capital abundant countries, the HME increase in industries exhibiting high trade cost and more di¤erentiated products. This is driven by increasing proportions of extensive margins (new varieties) in these sectors. For large labor abundant countries, the HME rise in sectors with high trade costs and less di¤erentiated products. This is driven by increasing proportions of intensive margins (quantity per variety) in these sectors. I con…rm the predictions of the model from bilateral exports data using Hanson and Xiang’s di¤erence-in-di¤erence gravity speci…cation. I …nd strong evidence that rich and poor countries exhibit HME in mutually exclusive sectors and that these e¤ects are driven by di¤erent degrees of extensive and intensive margins.(JEL F1, R1)