More Apples vs. Better Apples: Distribution and Innovation-Driven Growth

We model distribution, the delivery of goods to customers, as an activity governed by its own technology and undertaken by firms subsequently to production operations. We then use the model to investigate how distribution shapes innovation-driven economic growth. We contrast two canonical specifications of distribution costs, iceberg vs. per-unit, and characterize their implications for innovation. The per-unit cost implies that factoryspecific productivity improvements cannot sustain steady-state growth. The reason is the classic Alchian-Allen insight: as the unit cost of production falls relative to the cost of distribution, it becomes harder to increase sales through cost reduction. Quality improvement, on the other hand, raises the services that customers obtain from each physical unit of the good so that firms can increase the volume of services delivered without increasing the volume of shipments. This mechanism explains why as the economy develops it gradually engages in more quality improvement relative to cost reduction. Unless technological advancements allow the distribution cost to fall to zero, quantity growth must cease and long-run growth must be driven by quality improvement. More generally, the ratio of distribution to manufacturing unit costs must be constant in the steady state. The iceberg cost delivers this property by assumption. The per-unit distribution cost, instead, yields an endogenous structure of the costs of serving the market.