Home Market Effect In Service Sector:Empirical Analysis

As a quite recent topic in New Trade Theory, Home Market Effect (known as HME) has been spotlighted by many scholars in international trade, which was first proposed by Krugman in 1980. He believed that as long as the increasing return to scale and trade costs exist, firms would tend to produce in countries with larger market demand, and with the help of economies of scale, these countries would be an immense producer of the product and thus become a net exporter. The original model of Krugman (1980) described a world of two countries, two sections and two input factors, which managed to explain the logic behind the HME; however, it was not self-evident that the model can be extended to a multi-country world. Not until Behrens et al. (2004) studied the HME under a multi-country framework, did the multi-country HME model become the interests of scholars.Based on the work of Behrens et al. (2009), this paper further extends the HME model in a multi-country setting, to strip comparative advantages and locational advan-tages off the HME and to get a deeper insight. With a new dataset of 27 EU member states’Balance of Payment (BoP) characterizing trade in service from 2004 to 2009 and value-added output data from national account, this paper tests the theoretical model with non-parametric methods which is convenient and consistent for statistical infer-ences with respect to an unknown population.The conclusion that service sector does have much HME is derived, along with an analysis on heterogeneity of different service sectors. The magnitude of HME largely depends on the charateristics the sectors have, e.g. the sector which is not sensitive to trade cost will exploit HME most when international trade and investment decision is made; the sector is sensitive to trade cost would value more on the trade openness rather than on the scale of economy; the last category of service sector would value both scale effect and comparative advantages.As a result, with a tighter connection between countries in the service sector, we have to put emphasis on domestic market as well as on coordination effect of HME while we keep the original comparative advantages and locational advantages, so as to contribute to prosperity within a country and all over the world.