A trade hierarchy of cities based on transport cost thresholds

Abstract

Empirical evidence has been lacking to explain trade agglomerations within countries. Starting with a novel micro-database of road freight shipments between Spanish municipalities for the period 2003–07, we break down city (municipal) trade flows into the extensive and intensive margins and assess trade frictions and trade concentration relying on a unique generalized transport cost measure and three internal borders: NUTS-5 (municipal), NUTS-3 (provincial) and NUTS-2 (regional). We find a stark accumulation of trade flows up to a transport cost value of €189 (approximately 170 km) and conclude that this high density is not due to administrative borders effects but to significant changes in the trade-to-transport costs relationship. To support this hypothesis, we propose and conduct an endogenous Chow test to identify significant thresholds at which trade flows change structurally with transport costs. These breakpoints allow us to split the sample when controlling for internal borders, and to define trade market areas corresponding to specific transport costs that consistently reveal an urban hierarchy of cities. The results provide clear evidence with which to corroborate the predictions of Central Place Theory.