Distance, production, and trade

Abstract

This paper investigates the relationship between geographical distance and both the extent of trade and foreign production. Industries engaged in exporting and co-production activities across national boundaries are identified through their use of the Offshore Assembly Provisions in the US tariff code. Findings counter conventional wisdom. Trade and foreign production activities are found to drop off rapidly over the first third of the distance scale, rise over the middle portion, reach a peak in the final third, and decline thereafter. This pattern suggests frictions associated with distance can be offset by government policies and other country attributes. Management control, information and communications costs, and the ability to implement just-in-time delivery strategies may not be as distance sensitive as previously thought. Theorists should re-evaluate the role of distance in trade models and refrain from using distance as a proxy for transport costs.

Key words:

• Geographical distance
• co-production activity
• global sourcing

Acknowledgements

I am grateful to Donald Bruce, Kevin Cullinane, and an anonymous referee for providing many helpful comments.

Notes

¹ The simple correlation between geographic distance and ad valorem international transport charges in the present study is only −0.07.

² Cost component averages, expressed as a percentage of total transport costs, are as follows: cargo handling (45 per cent), port charges (7 per cent), and other charges such as container and administration costs (23 per cent). See Stopford (1997, pp. 351 – 355).

³ Carr et al. (2001) investigate the relationship between production by foreign affiliates of multinationals and distance between the host and source countries.

⁴ Imports under item 9802.00.80 account for 99 per cent of all OAP imports. The remaining 1 per cent involves articles of metal that were exported for processing and subsequently returned to the US for additional processing. Included here are primary metal industries that produce steel, iron, copper, aluminum, and nonferrous metals. More than half of the 4-digit Standard Industrial Classification (SIC) industries use the OAPs.

⁵ Four types of manufacturing operations use OAPs. Included here are foreign-based manufacturers that use US components, US producers that move assembly to low-wage countries, US-based firms that produce abroad to expand markets, but send some goods back to the US, and multinationals that process metals. See US International Trade Commission (1988).

⁶ Variable definitions and measurement units are discussed in the Appendix.

⁷ It is common practice to interpret differences in per capital income across countries as differences in capital – labor endowment ratios. Unskilled labor abundant countries will have relatively low levels of per capita income. See, for example, Helpman and Krugman (1985) and Helpman (1987). A preferred approach would be to use actual capital – labor endowment ratios. These figures are unavailable for most countries covered in the present study.

⁸ Rodrik (1999) argues the links between openness and growth are weak, and are contingent on the presence of complementary policies and institutions.

⁹ A likelihood ratio test is used to compare random effects models with a model that does not include random effects. We reject the null hypothesis that industry random effects do not contribute to the models at all standard levels of significance.

¹⁰ When quadratic terms are dropped from each model, the following elasticities of OAP activity with respect to distance are obtained: OAP imports (−0.59), dutiable OAP imports (−0.58), and non-dutiable OAP imports (−0.76). Grossman (1998) argues a plausible value for distance elasticities in gravity models is −0.60.