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of individual maximization and competitive equilibrium that economists were coming to understand
ever better. Thus local external economies never disappeared as a concept from economics. Indeed, if
you were to ask a mainstream economist at any time between, say, 1930 and the last few years why
cities exist, or why some industries are so concentrated in space, he or she would surely answer in terms
of just such local externalities.
One can go further, and mainstream economists did. Suppose that we think of positive local external
economies, which tend to promote concentration of production, as being opposed by other
effects congestion or land costs that tend to promote dispersal. Then we are on our way toward a story
about both the optimal size of cities and, if we are prepared to make some assumptions about the
process of city formation, a theory of the actual size and number of cities. An elegant model along these
lines was laid out by Vernon Henderson in 1974, and Henderson's urban system model has become the
basis for a large literature, including a considerable amount of useful empirical work.
And yet while the idea of external economies has always been respectable indeed recognized as essential
by any sensible economist who thought about it it has been surprisingly neglected in our economic
tradition. If you consider the intrinsic importance of urban external economies as a real-world issue, and
then look at the actual attention they get from economists, it is obvious that there is a major mismatch.
Why?
My own guess is that while it has been possible to make the sources of agglomeration safe for
neoclassical economics by assuming that they are pure technological externalities, this strategic evasion
has been costly in terms of both
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