The Localization of Interfirm Transaction Relationships and Industry Agglomeration

Using a unique dataset of more than 140,000 manufacturing firms in Japan containing information on their suppliers and customers, this paper looks at the physical distances between transaction partners to examine the localization of transaction relationships. We find the following. First, based on a counterfactual that controls for the location of firms and their potential partners, transaction relationships in about 90 to 95% of the 150 three-digit manufacturing industries can be labelled as localized at distances of 40km or less. This indicates that physical distance is a key factor in firms' choice of transaction partners. Second, based on a counterfactual that controls for the average distance of transaction relationships in the manufacturing sector as a whole, we find that in about 40?% of industries transaction relationships are localized at short distances of up to 40km. Third, the extent of industrial localization and the extent of the localization of transaction relationships are positively correlated. However, there are a number of exceptions and we provide potential explanations for these.