Distance and political boundaries: Estimating border effects under inequality constraints

Abstract

The 'border effects' literature finds that political boundaries have a large impact on relative prices across locations. In this paper, we show that the standard empirical specification suffers from selection bias and propose a new methodology based on binned-quantile regressions. We use a novel micro-price dataset from Uruguay and focus on city borders. We find that, when the standard methodology is used, two supermarkets separated by 10km across two different cities have the same price dispersion as two supermarkets separated by 30km within the same city, implying that crossing a city border is equivalent to tripling the distance. By contrast, when upper quantiles are used the city border effect disappears. These findings imply that transport cost have been systematically underestimated by the previous literature. Our methodology can be applied to measure any kind of border effect. We illustrate this in the context of online-offline price dispersion to measure an 'online-border' effect in the city of Montevideo.