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Market Size and TFP in New New Trade Theory

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  • Gabriel Felbermayr
  • Benjamin Jung
  • Gabriel J. Felbermayr

Abstract

Recent trade theory in the Krugman (1980) tradition predicts that countries with larger market size enjoy higher levels of total factor productivity (TFP) – and equivalently of real per capita income or welfare – as a smaller fraction of spending on inputs is affected by trade costs. However, in cross-country data, there is no such positive correlation between market size and TFP. We argue that models with heterogeneous firms and selection help to reconcile theory and data. While they do feature a home market effect – larger countries have an over-proportionate share of firms – and, therefore, have more input varieties available, the average productivity of firms is lower as greater market size protects inefficient firms. To reconcile theory with data, we show that a lower degree of external economies of scale (EoS) is needed than what is implicitly assumed in the usual formulation of aggregate CES production functions. Whether trade liberalization triggers convergence or divergence of TFP also depends on the strength of EoS.

Suggested Citation

  • Gabriel Felbermayr & Benjamin Jung & Gabriel J. Felbermayr, 2015. "Market Size and TFP in New New Trade Theory," CESifo Working Paper Series 5583, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_5583
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    Cited by:

    1. Felbermayr, Gabriel & Jung, Benjamin & Larch, Mario, 2012. "Tariffs and welfare in new trade theory models," University of Tuebingen Working Papers in Economics and Finance 41, University of Tuebingen, Faculty of Economics and Social Sciences.
    2. Mario Larch & Wolfgang Lechthaler, 2013. "Whom to send to Doha? The Short-sighted Ones!," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 634-649, October.
    3. Iader Giraldo & Fernando Jaramillo, 2018. "Productivity, Demand, and the Home Market Effect," Open Economies Review, Springer, vol. 29(3), pages 517-545, July.
    4. repec:eee:eecrev:v:98:y:2017:i:c:p:316-340 is not listed on IDEAS

    More about this item

    Keywords

    trade; monopolistic competition; heterogeneous firms; total factor productivity; scale effects; home market effect;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • R12 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)

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