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.

Externalities Sq. Feet Rent/sq. ft. S D = MRP space R0R0 S0S0 D ’ with externalities S1S1 R1R1

© Allen C. Goodman 2006 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.

Shopping Externalities Cars/Wk Price/car Initial S Cluster S D1D1 D2D2 $18, D 3 – customers Who patronize Cluster to Comparison shop $19,000 or 110

© Allen C. Goodman 2006 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.”

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

© Allen C. Goodman 2006 Porter: A New Model New 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 Old Model –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