Today's Article of the Week is Creative Destruction: Barriers to Urban Growth and the Great Boston Fire of 1872 by Richard Hornbeck and Daniel Keniston in the American Economic Review.

/u/Upsidevii wrote a summary to introduce the paper:

Hornbeck and Keniston exploit the Great Boston Fire of 1872 as a natural experiment to take an empirical look at externalities of building investment. At risk of over simplifying, the authors’ theory (made mathematically formal in the paper itself) is that a high quality building increases the value of other nearby buildings. Because the number of buildings effected may be extremely large, it is much too costly to solve this externality through private bargaining. The result is that too many low quality buildings (from a social optimum perspective) exist since landowners do not wish to pay the cost of reconstruction. A fire forces all landowners to rebuild and greatly reduces the number of low quality buildings.

The authors test their theory against data using a difference in difference framework. By looking at the differences in burned and unburned plots before the fire and comparing to the differences in burned and unburned plots after the fire, they are able to isolate the causal effect that can be contributed to the fire. They find that both land and building values increase substantially in plots effected by the Great Fire. For comparison, they look at other fires in Boston that only destroyed a single building and find that, in these cases, building values increase but land values do not. This is consistent with their model; the increase in land value following the Great Fire is due to the large increase in the number of high quality buildings surrounding the land. Additionally, the model predicts that the majority of the increase in average building quality comes from the improvement of the lowest quality buildings. Looking at the data, the authors are able to verify this result.

Understanding how building values interact is extremely important in understanding urban development and, by extension, housing prices. Some have speculated that, in certain areas, housing demand curves slope upwards, and large externalities from buildings could play a role if this is indeed the case. The authors are also quick to caution that, like any other reduced-form study, external validity is important to consider. Modern zoning regulations are much more complex than those in 1872 Boston and could mean that these results are not generalizable. Additionally, 1872 Boston was growing extremely quickly compared to most cities today which could mean that present-day externalities are much smaller. It's worth noting that similar results were found by a paper investigating the 1906 fire of San Francisco, so these results appear to be fairly robust.