The economics of domestic market integration

This paper reviews the literature that evidences the extent of the integration and fragmentation of domestic markets from measuring internal border effects. The empirical evidence from three main approaches—trade flows‐related, capital flows‐related, and price‐related—are reviewed. They are evaluated with emphasis on the role of recent methodological developments that adequately deals with the spatial and data aggregation problems and use disaggregated (micro) data, refined distance measures, and fine‐grained geographical areas. In particular, it enables distinguishing trade costs due to informal administrative impediments (border effects) and geographical barriers (distance effect). These allow for better inferences about internal border effects and domestic market integration to be drawn. They reveal that traditional approaches, which fail to tackle these inadequacies, have over‐estimated the size of the internal border effects and in effect domestic markets are more integrated than earlier documented. This addresses the reported mixed evidence found in earlier studies.