On the Origins of Border Effects: Insights from the Habsburg Empire

What are the origins of border effects on trade and why do borders continue to matter in periods of increasing economic integration? We explore the hypothesis that border effects emerged as a result of asymmetric economic integration in the unique historical setting of the multi-national Habsburg Empire prior to the First World War. While markets tended to integrate mainly due to improved infrastructure, ethno-linguistic networks had persistent trade diverting effects. We find that the political borders which separated the empire’s successor states after the First World War became visible in the economy from the mid-1880s onwards, already 25-30 years before the First World War. This effect of a ‘border before a border’ cannot be explained by factors such as administrative barriers, physical geography, changes in infrastructure or patterns of integration with neighbouring regions outside of the Habsburg customs and monetary union. However, controlling for the changing ethno-linguistic composition of the population across the regional capital cities of the empire does explain most of the estimated border effects.