Distance still matters

VoxEU has an intriguing post by Keith Head, Thierry Mayer and and John Ries, about their work on distance effects in trade in services. Surprisingly, they find some.

Using theory and estimated distance effects, we are able to measure the
extent to which geographic separation insulates local workers from
foreign competition. The calculations reveal that, from the point of
view of a London service purchaser, workers in Oxford can be paid 99%
to 373% more than workers in Bangalore in productivity-adjusted wages
and yet still be more attractive, once service-delivery costs are taken
into account. This is because the Bangalore workers are 100 times more
distant from London than the Oxford workers.

Those results indicate that geographic barriers offer high-wage
workers substantial insulation from low-wage competitors based in
remote countries. Distance has long acted as a serious impediment to
international transactions. Unfortunately, most of what we know about
the effects of distance on international transactions is based on
studies of trade in goods. A consensus appears to be forming that
freight costs cannot explain the strength and functional form of the
distance effect for goods. Instead, physical distance seems to be picking up some combination of
the barriers imposed by cultural differences, the continued desire for
face-to-face communication, and the geographically-biased structure of
social and business networks. These factors apply to services as well
as goods. Thus, there are two senses in which Mankiw is right to say it
does not matter whether imports arrive by ship or by broadband. First,
there will be potential gains from trade in either case. Second, there
will be distance costs that limit the realisation of those gains.

How much should high-wage workers fear competition from much lower
paid workers in India and China? Our findings suggest that distance
still provides significant protection. Since these estimates reflect
averages across a range of services, there are surely services where
competition is especially acute. Moreover, service delivery costs
associated with distance appear to have fallen over the last decade to
a level that is slightly below the level estimated for goods.
Unfortunately, the data do not clearly indicate whether distance costs
for services will continue their downward trend or level off. We
suspect that persistent cultural differences, as well as locally-biased
social networks, will maintain distance costs at a high enough level to
forestall the small, flat world envisioned by some journalistic
accounts.

It makes sense of course that cultural differences and social networks should affect costs in delivering services. What I find a bit more puzzling is that those effects should be significantly correlated with distance. Isn't Britain closer in those dimensions to the United States or Australia, say, than it is to France? Well, maybe not.