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What the Berlin Wall Means for the Urban Density

Berlin's division and reunification provides a natural experiment for modelling the organization of economic activity within cities.

Gabriel Ahlfeldt, Stephen Redding, Daniel Sturm and Nikolaus Wolf, The economics of density: evidence from the Berlin Wall, Econometrica 83(6), 2015: 2127-89.

Sources: https://www.econometricsociety.org/society/awards

http://microeconomicinsights.org/economics-density-evidence-berlin-wall/

https://onlinelibrary.wiley.com/doi/pdf/10.3982/ECTA10876

Picture source: “Berlin Wall” by Jeison Higuita,  https://unsplash.com/photos/KSNkTaUmHKk

The Econometric Society has awarded the 2018 Frisch Medal of the Econometric Society to Gabriel Ahlfeldt, Stephen Redding, Daniel Sturm, and Nikolaus Wolf for their paper, "The Economics of Density: Evidence from the Berlin Wall”. The committee wrote the following citation:

“…breaks genuinely new ground in the modeling of cities and the spatial organization of economic activity. From the stepping stone of a long tradition in urban economics, the authors develop a theoretical model of an asymmetric city with a large number of “blocks” in which land developers offer floor space for production or residences, firms choose where to produce and whom to hire, and workers choose where to work and where to live. These city blocks differ, exogenously, in their innate productivity and residential amenities. But they can also, endogenously, become more attractive places to produce and reside through local-density externalities from other nearby firms and residents. Such agglomeration forces are the fundamental reasons for cities to exist, but measuring their strength has been a major stumbling block due to the very nature of endogenous agglomeration. To carry out their estimation, the authors compile unique block-level data from Berlin, going all the way back to the 1930s. They then estimate the strength of agglomeration externalities through a creative strategy, which relies on Berlin’s partition in 1961 and reunification in 1989 as sources of variation in the proximity of each West Berlin block to the local density of other blocks. …”

The following is a brief summary of this article.

Economic activity is highly unevenly distributed across space. This is reflected in the existence of cities and the concentration of economic functions in specific locations within cities, such as Manhattan in New York and the Square Mile in London.

Understanding the strength of the forces of agglomeration and dispersion that underlie these concentrations of economic activity is central to a range of economic and policy questions. These forces shape the size and internal structure of cities, with implications for the incomes of immobile factors, congestion costs and urban productivity. They also determine the impact of public policy interventions, such as investments in transport infrastructure as well as urban development and taxation policies.

Agglomeration, dispersion and locational fundamentals

Although much has been written about economic geography and urban economics dating back at least as far as Alfred Marshall’s Principles of Economics, published in 1920, a central challenge remains: distinguishing the impact of the forces of agglomeration and dispersion from the impact of differences in the fundamental characteristics of locations.

High land prices and levels of economic activity in a group of neighboring locations are consistent with strong agglomeration forces. But they are also consistent with shared amenities that make these locations attractive places to live – such as leafy streets and scenic views – or common natural advantages that make these locations attractive for production – such as access to natural water.

This challenge has both theoretical and empirical dimensions. From a theoretical perspective, to develop tractable models of cities, the existing body of research typically makes simplifying assumptions, which abstract from variation in locational fundamentals and limits the usefulness of these models for empirical work.

From an empirical perspective, the challenge is to find exogenous sources of variation in the surrounding concentration of economic activity to help disentangle agglomeration and dispersion forces from variation in locational fundamentals.

Internal city structure

Our research develops a quantitative theoretical model of internal city structure. The model incorporates agglomeration and dispersion forces and an arbitrary number of heterogeneous locations within the city, while remaining amenable to empirical analysis:

Locations differ in terms of productivity, amenities, the density of development (which determines the ratio of floor space to ground area) and access to transport infrastructure.

Productivity depends on production externalities, which are determined by the surrounding density of workers, and production fundamentals, such as topography and proximity to natural supplies of water.

Amenities depend on residential externalities, which are determined by the surrounding density of residents, and residential fundamentals, such as access to forests and lakes.

Congestion forces take the form of an inelastic supply of land and commuting costs that rise with travel time, which in turn depends on the transport infrastructure.

The division and reunification of Berlin

We combine our quantitative theoretical model with the natural experiment of Berlin’s division in the aftermath of the Second World War and its reunification following the fall of the Iron Curtain. The division of the city severed all local economic interactions between East and West Berlin, which corresponds in the model to prohibitive trade and commuting costs and no production and residential externalities between these two parts of the city.

To provide evidence on the resulting impact on the organization of economic activity within the city, we make use of a remarkable and newly collected data set for Berlin, which includes data on land prices, employment by place of work (which we term ‘workplace employment’), and employment by place of residence (which we term ‘residence employment’) covering the pre-war, division and reunification periods.

We focus largely on West Berlin, since it remained a market economy in all three of these periods, and hence we would expect the market-based mechanisms in the model to be at work.

We first present evidence that division led to a reorientation of the gradient in land prices and employment in West Berlin away from the main pre-war concentration of economic activity in East Berlin, while reunification led to a re-emergence of this gradient. In contrast, there is little effect of division or reunification on land prices or employment along other more economically remote sections of the Berlin Wall.

As Panel A of Figure 1 shows, Berlin’s land price gradient was approximately ‘monocentric’ prior to the Second World War, with the central business district located in the district ‘Mitte’ – just east of the future line of the Berlin Wall.

Around this central point, there were concentric rings of progressively lower land prices, including two areas in the future West Berlin – one around the Kurfuerstendamm and the other just west of the future line of the Berlin Wall, close to the Anhalter Bahnhof (see Panel B).

Following the division of Berlin, the second of these land price peaks was eliminated, as this area around the former Anhalter Bahnhof ceased to be an important centre of commercial and retail activity (see Panel C).

Following the reunification of Berlin, there was a re-emergence of high land price values in the pre-war central business district in Mitte (see Panel D) and in areas of West Berlin close to the pre-war central business district (see Panel E). Those parts of the city suddenly had access to all the knowledge and public resources in the resurgent central business district that they had been denied, spurring development and boosting land prices.

Changes in the organization of economic activity

We next examine whether our model can account quantitatively for these observed changes in the organization of economic activity.

We use exogenous variation from Berlin’s division and reunification to estimate jointly the model’s agglomeration and commuting parameters. This allows us to decompose overall productivity and amenities for each block into production and residential externalities (which capture agglomeration forces) and production and residential fundamentals (which are structural residuals that ensure the model rationalizes the observed data).

We estimate that a 1 percent increase in the density of workplace employment raises productivity by 0.07 percent, which is towards the high end of the range of existing estimates using variation between cities. But we also find that production externalities are highly localized within the city, decaying to close to zero after around 10 minutes of travel time.

Therefore, as an increase in total city population is typically achieved by a combination of an increase in the density of economic activity and an expansion in geographical land area, the resulting increase in travel times from a larger geographical land area attenuates the magnitude of these production externalities.

We also estimate that a 1 percent increase in the density of residence employment raises amenities by 0.15 percent, which is consistent with the view that consumption externalities are an important agglomeration force in addition to production externalities. Again we find that these consumption externalities are highly localized, decaying to close to zero after around 10 minutes of travel time.

Conclusions

The Berlin Wall provides a unique natural experiment for identifying the key sources of urban development. This research shows how property prices and economic activity in the east side of West Berlin, close to the historic central business district in East Berlin, began to fall when the city was divided; then, during the 1990s, after reunification, the same area began to redevelop. Theory and empirical evidence confirm the positive relationship between urban density and productivity in a virtuous circle of ‘cumulative causation’. The analysis has practical applications for urban planners making decisions on housing and transport infrastructure.

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