Market size and industry location: Traded vs non-traded goods

We investigate the importance of market size as a determinant for industrial location patterns. In order to focus on a broad range of sectors, including services, both traded and non-traded goods are taken into consideration. In our model, traded goods industries always exhibit a 'home market effect' (HME), whereas the existence of such an effect for non-traded goods crucially hinges on the degree of product differentiation. High degrees of product differentiation generally support a HME, whereas a reverse HME may arise when products are sufficiently close substitutes. Our results are in accord with the observed existence of a market size dependent 'functional hierarchy', both within and between countries.