Reconsidering the home market effect in a model with costly foreign investment

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The aim of this paper is reconsidering the home market effect (HME) in a model with costly foreign investment. We extend the two-sector, two-factor model by Takatsuka and Zeng (2012) to allow for the Samuelson's iceberg transport costs in international capital movement. Using a model with perfectly integrated capital market. Takatsuka and Zeng (2012) shows the appearance of the HME. By introducing an assumption of costly foreign investment, our model shows that an existence of large transport cost in capital movement hinders the appearance of the HME. The effect of a reduction in the transport cost in capital movement is generally unclear, because it affects (i) the relative price advantage, and (ii) the relative market size between two countries in opposite directions. However, as long as the market for industrial (differentiated) goods is already integrated sufficiently, a reduction of the transport cost in capital movement clearly contributes to increases the share of firms in the small-pupulation (and less-wealthier) country and promotes industrialization in that country.

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