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Home Market Effects on Innovation

Author

Listed:
  • Thibault Fally

    (University of California Berkeley)

  • Ana Cecilia Fieler

    (University of Pennsylvania)

  • Justin Caron

    (HEC Montreal)

Abstract
We model and estimate the home-market effect and study its implications for inequality within and across countries. The home-market effect occurs when exogenous differences in demand across countries generate endogenous differences in comparative advantages through technical change that is specific to a country and sector. Estimating it has proved difficult because econometricians do not directly observe exogenous differences in demand but only observe equilibrium expenditures, which also depend on supply-side characteristics. Our solution is to exploit non-homotheticity in preferences to construct instruments for the location of production, which determines comparative advantage through a home-market effect on innovation. Motivated by data, the model features factor-biased technologies and imperfect technology diffusion, which generate both Ricardian (endogenous relative productivity) and Heckscher-Ohlin-type comparative advantage (endogenous factor intensity). Because the production of income-elastic goods concentrates in rich, skill-endowed countries, technology diffusion implies that income-elastic goods in the model are endogenously more skill intensive in all countries. Home-market effects thus generate within-country inequalities through skill-biased technical change while they generate across-country inequalities because countries differ in their access to larger, richer markets. We explore counterfactual simulations using the estimated model to evaluate the effects of trade and technology diffusion on inequalities.

Suggested Citation

  • Thibault Fally & Ana Cecilia Fieler & Justin Caron, 2017. "Home Market Effects on Innovation," 2017 Meeting Papers 609, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:609
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    Cited by:

    1. Arnaud Costinot & Dave Donaldson & Margaret Kyle & Heidi Williams, 2019. "The More We Die, The More We Sell? A Simple Test of the Home-Market Effect," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(2), pages 843-894.
    2. Eddy Bekkers & Michael Landesmann & Indre Macskasi, 2017. "Trade in Services versus Trade in Manufactures: The Relation between the Role of Tacit Knowledge, the Scope for Catch up, and Income Elasticity," wiiw Working Papers 139, The Vienna Institute for International Economic Studies, wiiw.

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