The Gains from Reshaping Infrastructure: Evidence from the division of Germany

This paper quantifies the gains from infrastructure investments and shows that reshaping the highway network after a large economic shock, the division of Germany, had positive welfare and income effects. To address the endogeneity between infrastructure and economic outcomes, I develop a multi-region quantitative trade model where infrastructure is chosen by the government to maximise welfare. I calibrate the model to the prewar German economy and estimate the key structural parameter of the model using the prewar Highway Plan. I exploit the division of Germany, a large-scale exogenous shock to economic fundamentals, to show that the model can predict changes in highway construction after the division. Using newly collected data, I document that half of the new highway investments deviated from the prewar Highway Plan. I find that the reallocation of these investments (one-third of the network) increased real income by 0.6\% to 2\% each year, compared to the construction of the original prewar Plan. Finally, I find a large cost of path-dependence: the ability to reshape the full network in anticipation of the division could have increased real income by an additional 1.5\%.