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%-95% of the 150 three-digit manufacturing industries can be labeled 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 about 40% of industries transaction relationships are localized at short distances not exceeding 40km. Third, the extents of industrial localization and localization of transaction relationships are positively correlated. However, there are a number of exceptions, for which we provide potential explanations.