Trade Flows in a Spatial Oligopoly: Gravity Fits Well, But What Does it Explain?

This paper argues that large distance and border effects on trade flows in some industries might be a result of the (explicitly or tacitly) collusive division of geographic markets. A simple spatial oligopoly setting demonstrates how goods can travel shorter distances, or trade between regions can be more limited, in the joint profit maximizing outcome relative to the less collusive Cournot outcome. The Brazilian cement industry provides a clear-cut example. Traditional gravity equations fit the data well, yet the limited regional flows that I observe are due to firms' strategic behavior. Thanks to a unique institutional setting and an unusually rich dataset, I am able to directly control for trade costs which---in spite of their importance---cannot account for the observed segmentation of local markets at current prices. The paper highlights how collusive behavior can magnify the effects of distance, as firms can use geography to coordinate on more profitable outcomes, sustaining higher prices and avoiding trade costs.