More on Urban Development
© Allen C. Goodman 2006
Localization Economies
• Scale Economies in Intermediate Inputs
– Input demand of an individual firm is not large
enough to exploit scale economies, but a bunch
of firms will increase the scale e.g. dress
industry with buttons.
– Transportation costs are minimized if there are
a lot of firms close by.
© Allen C. Goodman 2006
Labor Market Economies
• Search costs for workers are lowered, in
changing jobs, if there are a lot of different
firms.
– Information is cheaper
– So are actual money costs
© Allen C. Goodman 2006
Externalities
• What are they?
A> Costs or benefits that don’t accrue to the
activity.
• Suppose we are talking about office-based
activities (law firms, accountants, etc.).
They need office space.
© Allen C. Goodman 2006
Externalities
• They’re business involves dealing with
people. The more people that are around,
the more business there is, and the higher
their output, and profits.
• Let’s look at a market for downtown office
space.
© Allen C. Goodman 2006
Externalities
Rent/sq. ft.
S
R1
D’ with externalities
R0
D = MRPspace
S0
Sq. Feet
S1
Externalities
• So the improved communications reduce
costs (improving profits), inducing more
firms to locate together.
• These raise the demand for space  higher
land rents.
• Ultimately, these may be subject to
decreasing returns.
© Allen C. Goodman 2006
Urbanization v. Localization
• In a sense localization can occur anywhere.
Saturn built their factory in Spring Hill, TN.
• Urbanization is urban.
© Allen C. Goodman 2006
Urbanization v. Localization
• Empirical estimates of agglomerative economies.
– Henderson found them to be small.
– Segal found them to be larger.
– Most are old.
• Mun and Hutchinson (1995) look at agglomerative
economies in the office sector of Toronto. Find that
a 10%  in number of office firms  a 2.7%  in
productivity per office.
• Elasticity? 0.27!
© Allen C. Goodman 2006
Urbanization v. Localization
• O’Sullivan guesses that Segal’s estimate of large
urban economies is actually the result of
localization econ-omies -- larger cities may have
large concentrations of industries subject to
localization economies.
• Still may be premature to conclude that localization
economies are more important than urbanization
economies.
• Carlino found urbanization economies in 13 of 19
industries; localization economies in 5 of 19
industries.
© Allen C. Goodman 2006
Shopping Externalities
Cluster S
Initial S
or
$19,000
$18,000
D3 – customers
Who patronize
Cluster to
Comparison shop
D1
50
D2
100 110
Cars/Wk
Klepper: Detroit and the Auto Industry
• In its first 15 years, U.S. auto industry had lots of entry
and number of firms > 200!
• Despite robust growth, industry had a shakeout in
number of producers  3 dominating firms.
• Industry also evolved to be heavily concentrated
around Detroit.
• All of this resulted from:
– Success of four early entrants around Detroit, which led in
turn to:
– Large number of successful firms in Detroit area that
dominated the industry.
© Allen C. Goodman 2006
Which four firms?
• Olds, Buick/General Motors, Cadillac, and
Ford (recognize them?).
• Four firms led to 22 spin-off firms which 
another 19 additional firms, or:
• 41 descendants in all !!!
© Allen C. Goodman 2006
Analysis
Analysis gets a little thick but comes out to this:
1. Early entrants had substantial competitive
advantages. A few later firms like Chrysler built on
efforts of earlier entrants, but later entrants that
started from scratch were rarely able to compete.
2. Advantage did not dissipate. You had major scale
economies, and you needed big firms to achieve these.
The firms that were there had the size to do this!
© Allen C. Goodman 2006
Extreme Agglomeration – 3 Conditions
• Need new firms founded by people with distinctive
experience to compete with others. This does not
always happen
• Advantage of EARLY entrants associated with
technological change  entry to dry up.
• Chance locations of a few successful firms in one
narrow region.
© Allen C. Goodman 2006
Extreme Agglomeration - Why Detroit?
• Chance !!!
• Indicates that connection between the performance of
spin-offs and their parents suggests that successful
incumbent firms can be powerful incubators of
significant later entrants.
• Feels that the agglomeration seen depends on the
chance location of a few successful firms in one narrow
region, which is rare. “If all three conditions of the
models are required to produce the kind of
agglomeration that characterized autos, it would
explain why such extreme agglomerations are rare.”
© Allen C. Goodman 2006
Porter: Competitive Advantage
of the Inner City
• True Advantages
– Strategic Location
– Local Market
Demand
– Integration with
Regional Clusters
– Human Resources
• Real Disadvantages
– Land
– Building Costs
– Other Input Costs
(including regulation)
– Security
– Infrastructure
– Employee and
Management Skills
– Access to Funding
– Attitudes
Porter: A New Model
• New Model
–
–
–
–
• Old Model
Economic:create wealth
Private sector
Profitable businesses
Integration with regional
economy
– Companies that are
export oriented
– Skilled and experienced
minorities engaged in
building businesses
–
–
–
–
Social: redistribute wealth
Gov’t and soc. serv. orgs.
Subsidized businesses
Isolation from the larger
economy
– Companies that serve the
local community
– Skilled and experienced
minorities engaged in
social service sector
© Allen C. Goodman 2006