Explaining the border effect: the role of exchange rate variability, shipping costs, and geography

• Published in: Journal of international economics Vol. 55; no. 1; pp. 87 - 105
• Main Authors: Parsley, David C., Wei, Shang-Jin
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-10-2001; Elsevier; Elsevier Sequoia S.A
• Series: Journal of International Economics
• Subjects: Border effect; Borders; Boundaries; Cities; Economics; Exchange rates; Foreign exchange rates; International market; International market segmentation; International trade; Market segmentation; Price dispersion; Prices; Sticky prices; Sticky wages; Studies; United States > US; Japan; Price dispersion; International market segmentation; F30; F40; F15; Border effect
• ISSN: 0022-1996; 1873-0353
• DOI: 10.1016/S0022-1996(01)00096-4

This paper exploits a three-dimensional panel data set of prices on 27 traded goods, over 88 quarters, across 96 cities in the US and Japan. We show that a simple average of good-level real exchange rates tracks the nominal exchange rate well, suggesting strong evidence of sticky prices. Focusing on dispersion in prices between city-pairs, we find that crossing the US–Japan ‘Border’ is equivalent to adding as much as 43 000 trillion miles to the cross-country volatility of relative prices. We turn next to economic explanations for this so-called border effect and to its dynamics. Distance, unit-shipping costs, and exchange rate variability, collectively explain a substantial portion of the observed international market segmentation. Relative wage variability, on the other hand, has little independent impact on segmentation.