How much is urban productivity worth – and who pays for it? A new study shows that part of the economic advantage of large cities is reflected not only in higher wages, but also in higher commercial rents. This means that the true benefits of city size may be larger than previously measured.
In their paper The Price of Productivity, Gabriel M. Ahlfeldt, Stephan Heblich, Tobias Seidel, and Fan Yin examine how productivity gains from agglomeration are capitalized into commercial rents. Agglomeration refers to the productivity advantages that arise when firms and workers cluster together in dense urban areas. The central question of the study: if large cities are more productive, does this show up only in wages – or also in the price firms pay for office and commercial space?
Most previous research has focused on wages to measure the benefits of city size. Wages are easier to observe and compare across regions. However, firms also compete for scarce floor space in central locations. If productivity is higher in these locations, firms may be willing to pay more in rent. Ignoring this channel may therefore underestimate the full economic impact of agglomeration.
To answer this question, the authors construct a new commercial rent index for Germany. They use five million commercial real estate listings from the online platform Immobilienscout24, covering the years 2007 to 2024. The data allow them to measure rents at a very fine geographic level – down to individual postcode areas.
The researchers also identify central business districts (CBDs), defined as the most economically dense “prime locations” within each local labor market. A local labor market is a region where most people both live and work. By combining rent data with information on city population and geography, the authors can compare cities of different sizes in a consistent way.
The first result concerns spatial patterns within cities. In large German cities, commercial rents decline by about 17 percent per kilometer as one moves away from the CBD. This decline is steeper than for residential rents. The pattern suggests that firms value central locations highly, consistent with higher productivity in these areas.
The second result concerns differences between cities. Commercial rents in CBDs rise strongly with city size. The estimated elasticity – an elasticity measures the percentage change in one variable in response to a one percent change in another – is about 15 percent. In other words, if city population increases by 10 percent, commercial CBD rents increase by roughly 1.5 percent.
Using a standard spatial equilibrium framework, the authors interpret these rent patterns as evidence of productivity differences. Total factor productivity (TFP) – a measure of overall efficiency in using inputs such as labor and space – appears to increase with city size by around 4 to 6 percent. Importantly, this estimate combines both wage effects and rent effects.
The study shows that wage-based estimates alone capture only part of the story. Because some productivity advantages are capitalized into commercial rents, focusing only on wages leads to an understatement of agglomeration benefits. The gap is especially pronounced in large cities, where competition for central floor space is strongest.
The findings also shed light on how German cities have evolved over time. Despite discussions about remote work and the weakening of city centers, the study finds that CBDs in large German cities remain strong. Commercial rent gradients have remained steep, and in some cases have become even steeper.
Policy implications
If productivity advantages are reflected in both wages and rents, then restrictions on commercial development in central areas may have larger economic costs than previously thought. Land-use regulation that limits the supply of commercial floor space can raise rents and reduce access to high-productivity locations.
At the same time, investments in transport infrastructure that improve access to central business districts may generate higher economic returns than conventional estimates suggest. By expanding the effective supply of central space, such policies can support productivity growth.
Overall, the study offers a more complete picture of the “price of productivity” in economies. It shows that the benefits of city size are real – but they are not free. Firms pay for access to dense, productive environments not only through higher wages, but also through higher rents. Understanding both channels is essential for measuring the true economic value of cities.
About the Authors
Gabriel M. Ahlfeldt is Professor of Economics at Humboldt University Berlin, faculty of the Berlin School of Economics, visiting professor at the London School of Economics, and a research affiliate at LSE-CEP and CESifo and a fellow of CEPR and IAB.
Stephan Heblich is Professor of Economics at the University of Toronto and a research affiliate of Munk School of Global Affairs and Public Policy, CESifo, CEP and the NBER.
Tobias Seidel is Professor of Economics at the University of Duisburg-Essen and a research affiliate of CESifo.
Fan Yin is a doctoral researcher at Humboldt University Berlin and the Berlin School of Economics.
