The Costs of Remoteness: Evidence from German Division and Reunification Stephen Redding London School of Economics Daniel Sturm University of Munich.

The Costs of Remoteness: Evidence from German Division and

Reunification

Stephen ReddingLondon School of Economics

Daniel SturmUniversity of Munich

2

Motivation

• What determines the spatial distribution of economic activity?

• Main competing explanations:– Institutions– Natural Advantage– Market Access

• Very difficult to empirically disentangle the effects of these factors

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This Paper

• Exploit German division and reunification as a natural experiment

• Division of Germany exogenously reduced the market access of West German cities close to the new East-West border relative to other West German cities

• Reunification reverses this loss to some extent

• Basic empirical strategy is diff-in-diffs. Compare:

a) Population growth in W German cities close to the new E-W German border to other W German cities

b) Both before and after division.

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Map 1 – Germany in its pre - World War II borders

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An Economic Geography Model

• There are N locations which are endowed with an exogenous stock of housing (immobile resource in fixed supply)

• Firms produce Dixit-Stiglitz varieties of a manufacturing good with IRS and use labor as the only input

• Manufacturing varieties are subject to (iceberg) transport costs between locations

• Consumers demand both housing and the manufacturing varieties

• Population is perfectly mobile across locations and migration equalizes real wages

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Empirical Implication

• Suppose the N locations are divided by a closed border

• Cities near to the new border experience a reduction in market and supplier access relative to other cities

• This reduction in market and supplier access will reduce their equilibrium size relative to cities further from the border

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Sim

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- A

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9 P

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atio

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<25 25-50 50-75 75-100 100-150 150-200 >200

By distance in km from the East-West BorderFigure 1: Simulated Change in West German City Population

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Pop < 1939 median Pop >= 1939 median

within 75km of E-W border, city population above and below 1939 medianFigure 2: Simulated Change in West German City Population

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Empirical Strategy

• Difference in Differences Estimation:– Compare population growth in West German cities

close to the E-W border with West German cities distant from the E-W border both before and after division

• Examine the treatment effect of re-unification separately

• Baseline Specification:

• Basic specification considers a 75km border zone

Popgrowct Borderc Borderc Division t d t ct

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• We focus on a sample of West German Cities– We consider all West German cities which had a

population larger than 20,000 in 1919– We aggregate cities that merge during the sample

period

• This results in a sample of 119 West German cities of which 20 are within 75 km of the East-West German border.

• Time Periods– Pre – WW II Germany : 1919, 1925, 1933, 1939– Cold-War : 1950, 1960, 1970, 1980, 1988– Reunification : 1992, 2002

Description of the Data

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11

.21

.41

.61

.8

1920 1930 1940 1950 1960 1970 1980 1990 2000year

Non-border index Border Index

Inde

x (1

919

=1)

Figure 3: Indices of Border & Non-Border City Population

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-0.3

-0.2

-0.1

0.0

1920 1930 1940 1950 1960 1970 1980 1990 2000year

Bor

der

Inde

x -

Non

-bor

der

Ind

exFigure 4: Difference in Population Indices, Border - Non-border

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(1) (2) (3) (4) (5)

Population Growth

Population Growth

Population Growth

Population Growth

Population Growth

Border × Division -0.746*** -0.746*** -0.746***(0.182) (0.183) (0.196)

Border × Year 1950-60 -1.249***(0.348)

Border × Year 1960-70 -0.699**(0.283)

Border × Year 1970-80 -0.640*(0.355)

Border × Year 1980-88 -0.397***(0.147)

Border 0-25km × Division -0.702***(0.257)

Border 25-50km × Division -0.783***(0.189)

Border 50-75km × Division -0.620*(0.374)

Border 75-100km × Division 0.399(0.341)

Border 0.129 0.129 0.325*(0.139) (0.139) (0.187)

Year Effects Yes Yes Yes Yes YesState ("Länder") Effects YesCity Effects Yes

Observations 833 833 833 833 833R-squared 0.21 0.21 0.21 0.22 0.32

Table 2 - Baseline Empirical Results

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The Role of Market Access

• The decline of the border cities is consistent with our model

• Institutions or natural endowments can not explain the decline

• However, there are at least three other possible explanations for the decline:– Fear of further armed conflict– Differences in industrial structure– Differences in war related destruction

• There are several pieces of evidence that the decline is driven by a reduction in market access

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(1) (2) (3) (4) (5) (6) (7)Population

GrowthPopulation

GrowthPopulation

GrowthPopulation

GrowthPopulation

GrowthPopulation

GrowthPopulation

Growth

Border × Division -0.746*** -0.052 -0.434 0.095 0.079 -1.097*** -0.384(0.182) (0.208) (0.307) (0.366) (0.399) (0.260) (0.252)

Market Potential Index 4.790***(0.490)

Eastern Market Potential Loss -0.344 -1.176*** -1.205***(0.227) (0.277) (0.367)

Border 0.129 0.230* 0.129 0.129 0.043 0.233 -0.009(0.139) (0.121) (0.139) (0.139) (0.184) (0.215) (0.148)

Year Effects Yes Yes Yes Yes Yes Yes Yes

Year Sample

1919-1939 & 1950-1988

1919-1939 & 1950-1988

1919-1939 & 1950-1988

1919-1939 & 1950-1970

1919-1939 & 1950-1970

1919-1939 & 1950-1988

1919-1939 & 1950-1988

City Sample All Cities All Cities All Cities All CitiesCities within 150km of the E-W border

Small Cities Large Cities

Observations 833 833 833 595 230 420 413R-squared 0.21 0.30 0.21 0.11 0.24 0.23 0.30

Table 4 - Market Potential and Size Effects

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Conclusions

• Negative treatment effect of proximity to the East – West border on city development in market-based West Germany

• The evidence suggests that this treatment effect can be largely explained by the change in market access

• While institutions and natural advantage are certainly also important, market access plays a substantial role in determining economic prosperity

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Thank You!

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Non-parametric estimates-1

01

2

0 100 200 300Distance to the East-West German border (km)

Est

ima

ted

Div

isio

n T

rea

tmen

tFigure 5: Non-parametric Division Treatment Estimates

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American and Russian Advance

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Pre-WWI German and post-WWI Border Changes

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Theoretical Model(Henderson 1974, Helpman 1998)

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Equilibrium Nominal and Real Wages

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