HEC Research Papers Series,
HEC Paris

Abstract: Will small countries deindustrialize when opening up to trade with large countries? Davis(1998) shows that for the home market e¤ect to lead to deindustrialization of small countries, trade costs for homogenous goods must be su¢ ciently smaller than trade costs in di¤erentiated goods, a condition which is not supported by empirical evidence. We show that if di¤erentiated goods production uses tradeable inputs small countries can become deindustrialized when trading with a su¢ ciently large country and if trade costs are low.

Keywords: home market e¤ect; deindustrialization; trade costs; economic geography; intermediate goods

JEL-codes: F01; R12

24 pages, March 19, 2009

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