Agglomeration Economies and Industrial Policies
Paul Krugman:
Motor City Stories: Brian Palmer has a nice summary of the reasons behind the concentration of car companies in Michigan… historical accident perpetuated by agglomeration economies. What he doesn’t say is that there is a close relationship between such stories and the case for the auto bailout. Agglomeration economies exist because… the network of suppliers, the skills, the interchange of knowledge supported by a geographical industry concentration in turn gives firms in that industry concentration an advantage…. Now, the existence of important agglomeration economies immediately implies that there are social consequences to the success or failure of an individual firm that aren’t captured by the profit and loss statement of that firm alone. Let General Motors fail, and the resulting collapse of its suppliers will hurt other firms too, possibly driving them out of business too. You don’t want to overuse this sort of argument…. But it was surely a major consideration for the auto bailout — and a reason why hard-line opposition to any such action was bad economics.
Brian Palmer:
Why are all the big American car companies based in Michigan?: Detroit and its environs had a lot to offer the nascent auto industry around the turn of the 20th century. Iron ore… timber… [r]ail and water routes…. And Detroit already hosted heavy industry like machine shops and stove works…. Detroit’s eventual dominance probably had more to do with a couple of historical accidents than any geographic advantage. First, innovators like Henry Ford and Ransom Olds happened to live in Michigan. Second, automotive executives in early-20th-century Detroit behaved a lot like Silicon Valley executives today: They regularly switched companies and launched spinoffs and startups. This culture of cross-pollination spread innovative manufacturing and design ideas among the Detroit manufacturers. Distant competitors couldn’t keep up with Motown’s research and development….
[N]one of the 69 companies that entered the auto industry (PDF) between 1895 and 1900 was located in Detroit. Olds Motor Works became the city’s first major carmaker when it relocated from Lansing in 1900. Ransom Olds then made a decision that would shape the course of the industry—rather than creating hundreds of small components in-house for his Curved Dash Runabout, he subcontracted much of the work…. The people who built the car’s parts eventually learned so much about automotive manufacturing that they went on to launch their own brands….
The number of U.S. carmakers peaked at 272 in 1909, including major manufacturers in New England and Ohio. During the 1910s, however, the Detroit brands pulled away. In 1915, 13 out of the country’s 15 most popular car brands were in Detroit. Motor City executives, particularly Ford, invested heavily in research and development, distancing their products from the out-of-towners…
