The Home Market Effect in International Arms Trade

Abstract

I show that military spending contributes to international arms proliferation through a push effect: large demand encourages production growth in the domestic market if transport costs are non-negligible. Under increasing returns to scale, the country can then supply weapons on the global market at low prices. This is a manifestation of the home market effect, which states that countries with higher demand for a differentiated good will be net exporters of that good. I construct a monopolistic competition model of international trade which accounts for differences in demand across countries, and test its predictions using post-Cold War data.

Keywords: home market effect, arms trade, military expenditure, economic geography, government procurement

JEL Classification: F1, H5, R1