Home market effect and intra industry trade relationship: Sectoral panel data analysis for OECD countries

Intra-Industry Trade (IIT) is defined as the simultaneous import and export of products produced in the same sector. Home Market Effect (HME) is defined as the proportional relationship between the share of a country in world production in any good and the demand of that country for the same good. When we consider the increasing returns to scale, the existence of imperfect competition markets and transportation costs, HME has a result that a country whose domestic demand is above the world average for any commodity has an above average production share in the same production in the world. Since the Krugman (1980), it has been seen that the HME thesis, which was put forward to determine the components of international trade, has been tested in many empirical studies. However, no study examining the effect of IIT and HME was found. What motivates us for this study is the idea that it may be one of the determinants of IIT, which is associated with market size, increasing returns to scale and transport costs. The aim of the study is to determine whether the effect of market size is one of the determinants of IIT. In this context, dynamic panel data analysis was performed by using the data of foreign trade data and country data of manufacturing industry of 34 OECD countries between 2000-2016. According to the results obtained, the coefficients of the variables (export, transportation costs) that we included in the model representing the HME were significant and it was concluded that the HME was a variable contributing to IIT in accordance with our expectations. The most important contribution of this study is to provide a new perspective to the IIT in terms of market size effect. In addition to the theoretical contribution of the results obtained, it is thought that countries can shed light on the political practices related to foreign trade components.