New Horizons in International Business series
Edited by Jean-Louis Mucchielli and Thierry Mayer
Chapter 8: Footloose capital, market access and the geography of regional state aid
Gianmarco I.P. Ottaviano INTRODUCTION 8.1 Market access plays a key role in many recent models of international trade. Such models study the impact of frictions in goods and factors mobility on the location of imperfectly competitive industries in the presence of increasing returns to scale (Helpman and Krugman, 1985). Their central result is the so-called home market or market size eﬀect (henceforth, HME), according to which, in the case of a two-country economy, the location with larger local demand succeeds in attracting a more than proportionate share of ﬁrms in the aforementioned industries. In the case of more than two countries, rather than local demand, what matters is overall market access (Krugman, 1993). For example, a small central country may have better overall market access than a large peripheral one and, thus, despite its local demand disadvantage, may end up attracting a larger share of imperfectly competitive ﬁrms.1 This pattern of demand-driven specialization maps into trade ﬂows and generates the theoretical prediction that large central countries should be net exporters of goods produced under increasing returns and imperfect competition.2 From an empirical viewpoint, those predictions seem to ﬁnd some support in the data. For example, Feenstra, Markusen and Rose (1998; 2001) argue that the HME is crucial to understand the empirical success of gravity equations, which explain bilateral trade ﬂows in terms of incomes and distance between trade partners. Using disaggregated trade data from Statistics Canada World Database, they show that the HME appears to be relevant in both...
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