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

3 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.

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

5 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

6 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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9 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

10 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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14 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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16 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

17 Thank You!

18 Non-parametric estimates

19 American and Russian Advance

20 Pre-WWI German and post-WWI Border Changes

21 Theoretical Model (Henderson 1974, Helpman 1998) Producer Behaviour Consumer Behaviour Trade costs

22 Equilibrium Nominal and Real Wages Factor Mobility Equilibrium Wages