Abstract: The conventional view of pandemics, rooted in the Malthusian framework, predicts that mortality shocks leave the spatial distribution of economic activity intact: fixed locational advantages anchor production, and population returns once the shock subsides. We argue that this prediction fails in modern economies, where capital is mobile and urban production exhibits increasing returns to scale. In such settings, a pandemic that reduces the labor force relatively more in some regions triggers a reallocation of capital toward lower-mortality locations, shifting the spatial equilibrium permanently rather thantemporarily. We formalize this argument using a core-periphery model with capital mobility and test its predictions using the 1918–1920 influenza pandemic in Spain. Exploiting quasi-random variation in flu-driven provincial mortality, we find that a one-standard-deviation increase in flu-driven mortality reduces urban mortgage credit per capita by 13.6 percent over 1915–1929. This credit reallocation, channeled through Spain’s provincial mortgage market with a lag reflecting the institutional speed of credit intermediation, raised relative urban GDP by 9.5 percent in receiving provinces. The primary mechanism is the expansion of housing supply rather than asset price inflation. Our findings identify economic structure, not shock magnitude, as the key determinant of whether a pandemic produces spatial recovery or spatial divergence