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explain such clustering, is an old one. I don't know who first pointed it out, but the economist who made
the most of it was none other than Alfred Marshall. Indeed, to those who imagine that increasing returns
are something only recently discovered, it is startling to see how much attention is given in Marshall's
Principles to local externalities. They are emphasized both for their intrinsic importance and for the
way they exemplify his concept of external economies in general.
What Marshall meant by an external economy was not exactly what later authors meant. In the 1940s
and 1950s economists came to make a clear distinction between technological external economies pure
spillovers and pecuniary externalities mediated through the market. In a world of constant returns at the
level of the firm and perfect competition, pecuniary externalities don't have any particular importance,
so only technological spillovers matter. Marshall, however, did not make this distinction. He lumped
together the ability of a large local market to support efficient-scale suppliers of intermediate inputs, the
advantages of a thick labor market, and the information exchange that takes place when firms in the
same industry cluster together two pecuniary externalities, one technological. In the light of current
theory, of course, he was right to do so. We now understand that the sharp distinction between
technological and pecuniary external economies holds only in a constant-returns world; in general
market-size external economies are just as real as technical spillovers.
Even if Marshall did not restrict his discussion to "pure" external economies, however, it was certainly
possible to do Marshallian analysis with such pure external economies and in so doing, to make use of
the apparatus
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