The Quality of Distance: Quality sorting, Alchian-Allen effect, and geography

Either quality sorting or the presence of a specific cost (the so-called Alchian-Allen effect) is considered to be the main mechanism for the positive relationship between product quality and the distance to market. However, the reduced-form regressions found in the literature generally fail to reveal which of these two mechanisms (or even whether both are) is the main driving force. In this study, we employ unique Japanese individual goods price data to identify separately the effects of quality sorting and specific costs. Our empirical analysis shows that while high-cost producers produce high-quality goods, as suggested in Baldwin and Harrigan (2011), the quality-sorting mechanism solely is not sufficiently strong to account for the purported positive link between quality and distance. Moreover, we do find that the technology parameter that relates costs to quality is overestimated in the absence of specific costs. On this basis, we confirm that the presence of specific costs is significant, which may generate the positive relationship between quality and distance. We also find that the specific-cost components in transport costs are more distance elastic than any ad valorem components, a finding qualitatively consistent with the trade cost specification in Hummels and Skiba (2004). Finally, our results are robust with respect to various measures of distance and specification.