State formation and market integration: Germany, 1780–1830.

• The Napoleonic Wars removed borders and increased the legal capacity of states. • Higher legal capacity allowed trade reforms in Germany between 1780 and 1830. • In pre-industrial Germany, removal of internal tariffs increased market integration. • Territorial consolidation does not guarantee market integration. • During the unification, border removals reduced price gaps in German reformer states. The rise of modern states is an important factor for economic development. We test the effects of territorial consolidation and the increase in legal capacity on market integration. The political transformation of Germany in the wake of the Napoleonic Wars, which reduced territorial fragmentation and transformed former semi-autonomous estates to sovereign polities, serves as a natural experiment. We apply a difference-in-differences framework to a new dataset of grain prices and show that territorial consolidation reduced trade costs conditional on trade reforms that replaced heterogenous internal duties by a unified system of external tariffs. The effect was equivalent to a reduction of price gaps by 31 percent. Cities that were part of Prussia both before and after the Wars and experienced trade reform saw a reduction in price gaps of similar magnitude. By contrast, there was no market integration in late-reformer states such as Hanover and Saxony. Trade reforms were the main channel through which territorial consolidation fostered market integration. [ABSTRACT FROM AUTHOR]