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Market integration and institutional change

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Abstract

This paper examines the impact of institutional change on market integration. We show that the French Revolution’s ideals of freedom and equality that swept through Germany following French rule around the year 1800 significantly reduced city-to-city price gaps in nineteenth century Germany because the ideas led to institutional upgrading in the German states. The economic impact of institutions reduced price gaps by about 25%. Examining a range of indicators of institutional quality, we find that relatively broad indicators affecting multiple elements of commercial activity are most powerful in explaining institutions’ effect on the integration between economies. The paper shows that institutional change does not only change a given, individual economy but its impact is multiplied because institutional change affects the relationship between multiple economies.

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Notes

  1. North (1991) defines institutions as “humanly devised constraints that structure political, economic and social interaction”. Greif (2000) defines institutions as “a system of social factors—such as rules, beliefs, norms, and organizations-that guide, enable, and constrain the actions of individuals, thereby generating regularities of behaviour” (p. 257). See also North and Thomas (1973), North (1981). Acemoglu et al. (2005) and Nunn (2009) provide surveys.

  2. Buggle (2016) shows evidence consistent with persistent effects on social capital of the introduction of the Code Civil.

  3. See the work discussed in Nunn (2009), Nunn and Trefler (2014).

  4. We exclude the first years of the 19th century because economic activity was strongly affected by wars. The years between 1880 and 1900 are dropped because the foundation of the German Reich (1871) led to new dynamics.

  5. See Ganser (1922), Kisch (1962), and Lindberg (2009).

  6. The rules in the Northern German cities of Luebeck and Danzig stated: "No Nurembergers, Lombardians, English, Dutch, Flemish, Jews or any other foreigner had the right to live or trade in the city" (Lindberg 2009, 622). Religious barriers were common; in Aachen, for example, all non-Catholics faced severe restrictions (Ganser 1922, Ch. I.4)

  7. Urban guilds also supported the emergence of guilds outside the city walls in an attempt to strengthen their grip on market regulation (Ehmer 2008).

  8. Ganser (1922, Ch. I.4) cites bankruptcy and product liability laws as examples.

  9. According to the Aachen guild, it has to be prevented that “the big fish would swallow the small”, Ganser (1922), Ch. I.4 (in German).

  10. Some authors see guilds in a more positive light. For example, entry restrictions enforced by guilds might raise the rate of innovation because they generate rents, or the master-apprenticeship system organized by guilds might have led to higher human capital accumulation than would have been otherwise possible; see Epstein (2008).

  11. One may be concerned that high price gaps could be a sign of strongly different institutions in the two cities: good institutions in one, and bad institutions in the other. Empirically, we do not find evidence that price gaps are increasing in the difference of institutional quality between cities.

  12. See the seminal contribution of Fogel (1964) and more recently Donaldson and Hornbeck (2016) on the impact of railroads in the United States. Donaldson (2016) is an influential analysis of the railways in colonial India. Nineteenth century railways in Germany are examined in Fremdling (1975), and Hornung (2015).

  13. While comprehensive freight statistics on wheat for our sample do not exist we know, for example, that virtually all wheat from Bavaria in the early 1850s was exported by railways (Seuffert 1857, Chapters 5, 6).

  14. The sample restriction in Bairoch et al. (1988) is five thousand inhabitants at some point during their sample period; the density for Bairoch et al. in Figure 2 is based on all German cities covered in the years 1800 and 1850.

  15. While rye was at least as important as wheat in some regions of the sample, the difference in the pattern of rye and wheat market integration during the 19th century was relatively small (Keller and Shiue 2006).

  16. Absent information on wheat trade between all cities, we address the question whether transactions costs are equal to or smaller than the price gap by controlling for waterway access of cities, see below. Due to the relatively low cost of ship transport, we expect that trade took place in virtually every period between cities connected by waterway.

  17. The general conditions of 19th century wheat markets in Germany, as well as wheat trade, are discussed in Seuffert (1857).

  18. An analysis of the late 19th century corn trade between Chicago and New York shows that when inventory levels are low, the spot price difference typically exceeds transport cost by more than 5%; however, such low inventory levels are rare (less than 6% of all cases, Coleman 2009, Table 5).

  19. The institutional quality of a city is taken to be that of the jurisdiction (typically state or Free City) in which the city is located.

  20. One reason may be that Gewerbefreiheit often coincided with equivalent concessions permitting the setting up of manufacturing activities.

  21. A Gymnasium is a type of secondary school which had to be completed to be able to attend university.

  22. We allow for separate coefficients on institutional quality in cities i and j because this imposes fewer constraints on the impact of institutional quality and to address the unbalanced nature of our sample due to missing grain price observations. In Table 6 below we show results for a number of alternative definitions of institutional quality, including the average in cities i and j.

  23. Instead of the cross-sectional approach one may think about a panel set-up, especially given that we have data on grain prices and institutional quality that is varying over time. We do not pursue the panel approach because our instrumental variable, years of French rule, is inherently cross-sectional in nature.

  24. A specific hypothesis on the influence of religion, the relationship between religion and human capital formation, is discussed below.

  25. Below we will examine results for a number of alternative measures of institutional quality.

  26. See also Cantoni (2015).

  27. Employing the robust Cragg−Donald F-statistic leads to similar conclusions.

  28. We report the inter-quartile range because by construction the mean of the principal-components based measures is zero.

  29. We use the average of abolishment of guilds and equality before the law as benchmark because employing these two indicators has the advantage that it appears to combine orthogonal variation in institutional quality that is driven by French rule, as the relatively high first-stage F-statistic shows.

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Acknowledgements

We thank Daron Acemoglu, Sascha Becker, Holger Breinlich, Davide Cantoni, Anca Cristea, Erik Hornung, and Nathan Nunn, as well as many seminar participants for helpful comments on an earlier draft. We are grateful to Michael Kopsidis and Erik Hornung for help with data. Excellent research assistance was provided by David Silver and Austin Smith. Support from the National Science Foundation has been provided under Grants SES 0453040 and SES 1124426.

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    Wolfgang Keller & Carol H. Shiue

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Appendix: Data sources and construction

Appendix: Data sources and construction

1.1 Main variables

1.1.1 Price gaps

The annual price of wheat in each city is computed from government records of the market price of wheat. They were typically recorded every month, and in some cases every week. The information on cities in Mecklenburg are taken from Shiue and Keller (2007), while Seuffert (1857) covers cities in Baden, Bavaria, Brunswick, Hesse-Darmstadt, Hesse-Cassel, Hesse-Nassau, Saxony, and Wurttemberg. Our main wheat prices for Prussian cities were provided by Michael Kopsidis, see Kopsidis (2002). We have further expanded the coverage of the wheat price data using Fremdling and Hohorst (1979), Gerhard and Kaufhold (1990), and Vierteljahrshefte (1935), Köttgen (1890). General characteristics of the German wheat prices during this period, including spatial and temporal aggregation, are discussed in Shiue and Keller (2007). The number of wheat prices available varies by city. Wheat price gaps are calculated for all city pairs for which there is wheat price information for both cities. Since neither quantity nor monetary units were standardized in nineteenth century Germany conversion rates are required for our analysis of absolute price differences, and all prices are converted into Bavarian Gulden per Bavarian Schaeffel. The conversion factors are taken from the original sources reported in Shiue and Keller (2007) and from Seuffert (1857, p. 351).

The market prices for butter and pork in the cities of Aachen, Berlin, Cologne, and Muenster that we have employed to compare changes in market integration based on wheat versus based on other tradable goods-prices come from Jahrbuch (1867).

1.1.2 Railway costs

Given the role of steam railways in reducing transport costs we hypothesize that railway costs affect market integration. Railway costs were a key determinant of the likelihood that a particular line of track would be built and thus whether the arbitrage-enhancing effect of railways would materialize. Railway building in Germany was a decentralized decision where local governments and business groups mattered. Our measure of railway costs is derived from Nicolls (1878) who describes railways in the United States of America, which we take as a proxy for railway costs in Germany. Nicoll presents information on how much freight capacity had to be given up when operating a nineteenth century steam locomotive on steeper versus flatter terrain. In particular, for a locomotive with 1200 tons pulling capacity on flat land the towing capacity goes down to 1150 tons when the gradient is 5 feet to the mile, down to 939 tons if the gradient is 10 feet to the mile, and so on.

Specifically, Nicolls provides the following information (p. 82):

figure a

Gradient is measured in feet to the mile. Hauling is the hauling capacity of the locomotive in tons. Five feet to the mile is a gradient of about 0.095%, while 180 feet to the mile is a gradient of about 3.4%. The data is for a locomotive weighing 27 tons, going at a speed of 8–12 miles per hour uphill. We do not know of comparable data for going downhill, and it is assumed that the freight capacity of a locomotive varied for downhill trips (due to strains on the brakes, etc.) in the same way as it did for uphill trips. To convert this information into a cost measure, we assume that on flat terrain the locomotive can haul 1200 tons. Then, the cost in terms of foregone freight hauling capacity of a gradient of five feet to the mile is 50 tons (1200–1150), the cost of a gradient of ten feet to the mile is 261 tons, and so on. We fit a logarithmic function through this data to be able to work with any terrain gradient; this yields an R2 of 0.98.

With this cost function in hand we use a 90 m × 90 m GIS map of the relevant area in central Europe and the ArcGIS least-cost distance solver to compute the least-cost routes, as well as the associated costs of those routes, from each city to all other cities in the sample. Lakes are blocked out in this calculation, but not rivers. Because these railway costs are necessarily increasing in the distance between cities, we divide by distance to arrive at the gradient cost of terrain between i and j in terms of foregone railway freight capacity per unit of direct distance. Geographic distance is computed using the Haversine formula. Summary statistics for this railway cost measure is given in Table 2.

1.1.3 Institutional change and French rule

The data on institutional change is related to Acemoglu, Cantoni, Johnson, and Robinson (ACJR 2011), and to the extent that our analysis covers areas that are not included in ACJR’a sample we use their sources, in particular Dipper (1980). Departing from ACJR we define city-level institutions as the institutions that prevailed in the geographic area of the city. We employ three indicators of institutions: (1) abolition of guilds, (2) equality before the law, and (3) the redeemability of feudal lands. The institutional quality variables change over time to the extent that abolition of guilds, equality before the law, and redeemability of feudal lands changes over time. In the final step of constructing the institutions variables we take the average over the years 1820–1880, yielding, for example, the fraction of years during which guilds were abolished in a given city.

Our data on the length of French rule follows ACJR. The criterion is effective French rule, excluding purely military occupation. A special case are the former Hanse cities: Hamburg, Bremen, and Luebeck. We code these cities as not French-ruled, even though they actually were French départements from 1811 to 1814. We do so because French rule in the Hanse cities was different from French rule elsewhere. In the Hanse cities French rule was primarily designed to enforce the continental blockade versus England, which we expect had negative consequences on market integration. French rule in the Hanse cities was also more tenuous than in other areas; during part of the year 1812, for example, Hamburg was ruled by the Russians. The main results do not depend on this treatment of the Hanse cities.

1.2 Other variables

  • City population in year 1800 Measured in thousands, defined in logs. Source: Bairoch et al. (1988), de Vries (1984), and Mitchell (2008) for the larger cities; local population histories, wikipedia, and Keyser (1939) for smaller cities. Varies at the city level.

  • Latitude and longitude Source of this data is the entry on the city on www.wikipedia.com. Measured in decimals. Varies at the city level.

  • Distance to Paris Source Authors’ calculations from latitude and longitude of cities together with latitude and longitude of Paris: 48.85, and 2.35, respectively. Varies at the city level.

  • Distance to Wittenberg City of Wittenberg, in Saxony. Latitude: 51.8744, longitude: 12.606. Varies at the city level.

  • Protestantism Defined as the average share of Protestants in the city’s population between years 1820 and 1880. Source: Keyser (1939) for time-varying information on the share of Protestants in a city; we employ the mean for 1820 to 1880 given that time variation is limited. Varies at the city level.

  • Early Gymnasium Variable is equal to one if city established its first Gymnasium before the median city in the sample, which was the year 1581, and zero otherwise. Source: Keyser (1939), city histories and school histories on the internet. Varies at the city level.

  • Waterway Variable is defined to equal to one if the city is on a navigable river, canal, or on the coast in 1850, and zero otherwise. We have employed different thresholds for navigability (ship size in terms of tons), without changing the main results. Source: Kunz (2014a, b), http://www.ieg-maps.uni-mainz.de/mapsp/mapw850d.htm. Varies at the city level.

  • Coal production Variable is equal to one if there is coal production in the region the city is located in the year 1850, and zero otherwise. Source: Gutberlet (2014), Figure 2. Varies at the city level.

  • Zollverein determinants Variable based on the distance of a city-pair to its nearest coast, relative to other cities that are not yet members of the Zollverein customs union. Source: von Viebahn (1858) and Keller and Shiue (2014).

  • Price of butter and pork in Aachen, Berlin, Cologne, and Muenster: Available for the years 1820–1865; source: Jahrbuch (1867). Varies by city and year.

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Keller, W., Shiue, C.H. Market integration and institutional change. Rev World Econ 156, 251–285 (2020). https://doi.org/10.1007/s10290-019-00362-1

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