Producers' Service Improvements and Manufacturing Agglomeration When Taking Trade Costs as a Mediator Variable: Mechanism and evidence from China

Most studies about the effects of producers' services on manufacturing agglomeration focus on the effects themselves while neglecting the mechanism that such effects spread. By stressing the key role of trade costs in the process of manufacturing agglomeration, this paper identifies a chain of effects from producers' service improvements to manufacturing agglomeration via changing trade costs and builds a simple model to enable empirical analysis. Both in the mechanism used to assess this chain of effects and in the empirical model, trade costs are dealt with as a mediator variable. Empirical tests using firm-level data from China support the hypothesis that producers' services affect manufacturing agglomeration via changing trade costs. Further tests at the two-digit sector level show that these types of mediator effects vary in accordance with differences in sector factor intensiveness. Specifically, the mediator effects are more significant in the technology-intensive manufacturing industries than they are in the labor- or capital-intensive manufacturing industries. The policy implication of this finding is that encouraging the development and regional concentration of producers' services would not only promote manufacturing agglomeration but also stimulate technology progress in related sectors.