The Costs of Remoteness: Evidence from German Division and - PDF document

The Costs of Remoteness: Evidence from German Division and Reunification Stephen Redding London School of Economics and CEPR Daniel Sturm London School of Economics and CEPR 1 The Costs of Remoteness - 2 - Stephen Redding, Daniel Sturm Motivation • What determines the spatial distribution of economic activity? • There are several competing explanations: – Institutions – Natural Advantage – Culture – Market Access • Very di ffi cult to empirically disentangle the e ff ects of these factors.

The Costs of Remoteness - 3 - Stephen Redding, Daniel Sturm This Paper • We exploit German division and reunification as a natural experiment to provide evidence for the importance of market access. • Key Idea: Division and Reunification exogenously changed the relative market access of West German cities. The Costs of Remoteness - 4 - Stephen Redding, Daniel Sturm

The Costs of Remoteness - 5 - Stephen Redding, Daniel Sturm Plan of the Presentation 1. Sketch of the theoretical model 2. Empirical strategy 3. Basic results 4. Further evidence 5. Conclusion The Costs of Remoteness - 6 - Stephen Redding, Daniel Sturm Theoretical Model I • We consider a standard new economic geography model based on Helpman (1998). • There are N locations (here cities) which are endowed with an immobile resource (housing). • Consumers: – Spend a share µ of their income on manufacturing varieties and the remaining income on the immobile resource. – Have CES preferences with an elasticity of substitution σ over manufacturing varieties. – Inelastically supply one unit of labor.

The Costs of Remoteness - 7 - Stephen Redding, Daniel Sturm Theoretical Model II • Manufacturing firms have IRS, use labor as the only input and are monopolistically competitive. • Manufacturing varieties are subject to iceberg transport costs T , which are in turn a function of distance ( T ij = dist φ ij ). • In the long-run population is perfectly mobile across locations and migration equalizes real wages. The Costs of Remoteness - 8 - Stephen Redding, Daniel Sturm Calibration • We use central values from the existing literature for the three key parameters of the model ( σ = 4 , µ = 2 / 3 and φ = 1 / 3 ) • We calibrate the stock of the immobile resource in each city so that the 1939 distribution of population across cities in pre-war Germany is the (unique) equilibrium of the model. • We simulate the division of Germany and allow the population of the West German cities to adjust to this exogenous shock.

The Costs of Remoteness - 9 - Stephen Redding, Daniel Sturm Figure 1: Simulated Change in West German City Population By distance in km from the East − West Border 5 Mean Simulated Change (%) 0 − 5 − 10 − 15 − 20 <25 25 − 50 50 − 75 75 − 100 100 − 150 150 − 200 >200 The Costs of Remoteness - 10 - Stephen Redding, Daniel Sturm Figure 2: Differences in Simulated Population Changes within and beyond 75km of E − W border for small and large West German cities 0 Mean Simulated Difference (%) − 5 − 10 − 15 Pop < 1919 median Pop >= 1919 median

The Costs of Remoteness - 11 - Stephen Redding, Daniel Sturm Data • We focus on a sample of West German cities which had at least 20000 inhabitants in 1919. • We aggregate cities that merge during the sample period. • Observations: – Pre-war: 1919, 1925, 1933, 1939 – Division: 1950, 1960, 1970, 1980, 1988 – Reunification: 1992, 2002 The Costs of Remoteness - 12 - Stephen Redding, Daniel Sturm Basic Empirical Strategy • Di ff erence-in-Di ff erences Estimation: – Compare population growth in West German cities close to the East-West border with other West German cities both before and after division. • Baseline Specification Popgrowth ct = β Border c + γ ( Border c × Division t )+ d t + ε ct

1.8 Treatment group Control group 1.6 Index (1919 5 1) 1.4 1.2 1.0 1920 1930 1940 1950 1960 1970 1980 1990 2000 Year F igure 3. I ndices of T reatment and C ontrol C ity P opulation The Costs of Remoteness - 14 - Stephen Redding, Daniel Sturm Figure 4: Difference in Population Indices, Treatment − Control 0.0 Treatment Group − Control Group − 0.1 − 0.2 − 0.3 1920 1930 1940 1950 1960 1970 1980 1990 2000 year

Table 2 - Basic Results on the Impact of Division Stephen Redding, Daniel Sturm Population Population Population Population Population Growth Growth Growth Growth Growth (1) (2) (3) (4) (5) Figure 5: Non − parametric Division Treatment Estimates Border × Division -0.746*** -1.097*** -0.384 300 (0.182) (0.260) (0.252) Border × Year 1950-60 -1.249*** (0.348) Border × Year 1960-70 -0.699** Distance to the East − West German border (km) (0.283) Border × Year 1970-80 -0.640* (0.355) 200 Border × Year 1980-88 -0.397*** (0.147) Border 0-25km × Division -0.702*** - 16 - (0.257) Border 25-50km × Division -0.783*** (0.189) Border 50-75km × Division -0.620* (0.374) 100 Border 75-100km × Division 0.399 (0.341) Border 0.129 0.129 0.233 -0.009 Yes (0.139) (0.139) (0.215) (0.148) Year Effects Yes Yes Yes Yes Yes City Sample All Cities All Cities All Cities Small Cities Large Cities The Costs of Remoteness Observations 833 833 833 420 413 0 R-squared 0.21 0.21 0.21 0.23 0.30 4 2 0 − 2 − 4 Notes : Standard errors are heteroscedasticity robust and adjusted for clustering on city. * denotes significance Estimated Division Treatment at the 10% level; ** denotes significance at the 5% level; *** denotes significance at the 1% level.

The Costs of Remoteness - 17 - Stephen Redding, Daniel Sturm Is it Really Loss of Market Access? • The decline of the cities along the East-West border is consistent with our model. • There is no simple explanation for the decline in terms of institutions, endowments or culture. The Costs of Remoteness - 17 - Stephen Redding, Daniel Sturm Is it Really Loss of Market Access? • The decline of the cities along the East-West border is consistent with our model. • There is no simple explanation for the decline in terms of institutions, endowments or culture. • However, there are other possible explanations for the decline: – Di ff erences in industrial structure – Di ff erences in war-related disruption – Western Economic Integration – Fear of further armed conflict

The Costs of Remoteness - 18 - Stephen Redding, Daniel Sturm Quantitative Analysis of the Model • Can the model not only qualitatively, but also quantitatively account for the decline of the cites along the East-West border? The Costs of Remoteness - 18 - Stephen Redding, Daniel Sturm Quantitative Analysis of the Model • Can the model not only qualitatively, but also quantitatively account for the decline of the cites along the East-West border? • To compare moments in the simulation and the data, we undertake a grid search over 21 values of each parameter: – Elasticity of substitution ( σ ) from 2.5 to 6.5 – Share of tradeables in expenditure ( µ ) from 0.65 to 0.85 – Distance elasticity of transport costs ( φ ) from 0.10 to 1.10

The Costs of Remoteness - 19 - Stephen Redding, Daniel Sturm Identification • We first show that the relative decline of the East-West border cities is a well-behaved function of two relationships: – The strength of agglomeration and dispersion forces: σ (1 − µ ) – The coe ffi cient on distance: (1 − σ ) φ The Costs of Remoteness - 19 - Stephen Redding, Daniel Sturm Identification • We first show that the relative decline of the East-West border cities is a well-behaved function of two relationships: – The strength of agglomeration and dispersion forces: σ (1 − µ ) – The coe ffi cient on distance: (1 − σ ) φ • We pin down values for σ (1 − µ ) and (1 − σ ) φ by comparing the predictions of the model with our two key empirical findings: – The relative decline of the East-West border cities. – The more pronounced relative decline of smaller cities.

The Costs of Remoteness - 20 - Stephen Redding, Daniel Sturm The Costs of Remoteness - 21 - Stephen Redding, Daniel Sturm

The Costs of Remoteness - 22 - Stephen Redding, Daniel Sturm Figure 6: Contours of the Simulated Division Treatment 1.3 1.25 Strength of Agglomeration -0.384 1.2 1.15 1.1 1.05 - 1 . 0 9 7 -1.8 -1.6 -1.4 -1.2 -1 -0.8 -0.6 Distance Coefficient Small Cities Large Cities The Costs of Remoteness - 23 - Stephen Redding, Daniel Sturm Figure 7: Simulated and Estimated Division Treatments 4 2 Division Treatment 0 − 2 − 4 0 100 200 300 Distance to East − West German Border (km) Simulated Treatment Estimated Treatment