Wealth creator

The FINANCIAL — What makes cities thrive? Is it proximity to natural resources like rivers, oceans or energy reserves? Or does the cumulative effect of population increases stimulate waves of economic activity such as restaurants, bars and shops?

Because of the complex history of many cities, identifying the source of their development is notoriously difficult. But a group of urban economists have developed a model that shows the positive relationship between economic activity and urban density, and predicts how further development will change a city and its surrounding areas, according to LSE.

Such is the scale of their achievement, Gabriel Ahlfeldt, Stephen Redding, Daniel Sturm, and Nikolaus Wolf, who began the project almost a decade ago at LSE, have received the Frisch Medal, one of the most prestigious prizes in economics.

Dr Ahlfeldt, of LSE’s Department of Geography and Environment, says the challenge was finding the right experiment to identify the driver of urban development. He says: “The idea that density and productivity in cities is linked has been circulating for a long time. But the hard part is to establish where a city’s growth is coming from.”

The researchers sought a case study where a part of a city is reconnected to the economic and social resources of another part to see how it changed the city. They settled on a unique event from history; when East and West Germany reunified in 1991 after 41 years apart. Berlin, Germany’s capital, was at the crux of the divide, hosting two opposing political and economic systems; capitalism in the West and socialism in the East.

Dr Ahlfeldt, a Berlin native, says: “When the city was split, both sides suffered. But West Berlin lost almost half of its labour pool and access to the main economic and scientific resources of the city.”

The researchers tracked the fortunes of West Berlin, which remained a market economy during the division period, collecting data on employment, population and rents between the 1930s to the 2000s. They found that 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, the same area began to grow and develop again, according to LSE.

Dr Ahlfeldt says: “After reunification, West Berlin suddenly had access to all the knowledge and public resources in the resurging central business district it had been denied. That spurred development in these areas, and land prices close to the central business district increased. This showed that exposure to density has a positive effect on the areas around it.”

Using the evidence from their Berlin study, the researchers established that cities benefit from ‘cumulative causation’. According to the theory, density makes cities more productive, which attracts companies and employees, increasing productivity further. Urban density also increases demand for services, which increases consumption, with services such as theatres, restaurants, cafés and shops all emerging as their consumer base grows.

Professor Redding, internal research associate of LSE’s Centre for Economic Performance, explains: “We show that our model is successful in explaining the observed reorganisation of economic activity within West Berlin, not only qualitatively, but also quantitatively.”

The research team believe the model will have practical applications for urban planners making decisions on infrastructure and housing. Professor Sturm of the Economics department says: “If a city is considering a subway, our model will show how property prices are likely to increase. We will also be able to simulate what happens to the places close to the new infrastructure, and the economic spill over into other locations.”