Michigan) having 36 percent. The analysis also included cities engaged in textiles, apparel, aircraft, communication, pulp and paper, shipbuilding, steel, petrochemicals, industrial machinery, and leather products. There were some specialized service cities, though in 1970 they were mostly state-college and state-capital cities (for example, Champaign-Urbana or Austin). Larger cities, such as Chicago and Dallas, were still classified as “diverse manufacturing.” These studies demonstrate that automobile and textile manufacturing have few colocation benefits: they do not learn from each other or trade in intermediate inputs. So, to exploit within industry-scale externalities and limit city sizes to reduce urban congestion and other size disamenities, workers and firms partition into different types of cities specializing in production, with city sizes tailored to the degree of agglomeration benefits in their respective production types.

Why then do we have big, diverse manufacturing cities? These could be centers of experimentation in an urban product-cycle model. According to Duranton and Puga (2001), while there are specialized cities, there are also diversified cities where potential manufacturers experiment with different technologies and products until they find what they are best suited to produce. Then, they decentralize to a specialized city. More generally, bigger cities are centers of research and development and higher technology development, where diversity and cross-sector fertilization in a Jacobs (1969) framework aids innovation and new product development. Fujita and others (2004), on Japanese electronics firms, show an innovation and production hierarchy. Branches of electronics firms doing research and development and trial production are found in larger metropolitan areas, while mass production of standard items is found in nonmetropolitan areas or offshore in developing countries. This pattern coincides with the higher return to learning in larger cities observed in the United States, even after accounting for the sorting of high-skill and high-ability workers into larger cities.<sup>9</sup> There are many complications to this paradigm. First are changes in developed countries, such as the United States since 1970. In a study based on 2000 data rather than 1970 data, Black and Henderson (2003) show that U.S. deindustrialization has reduced the share of manufacturing cities and resulted in the development of many more service cities. These include health, entertainment, transport services, insurance, and finance cities, in addition to the traditional statecollege and state-capital cities. A number of cities are transitioning out of manufacturing, and former large, diverse manufacturing cities are now more market and service oriented. Duranton and Puga (2005) show that, as cities have deindustrialized in recent years, sector specialization has declined. And as Kolko (1999) shows, the most industrialized parts of the United States are now rural (really nonurbanized) areas and smaller cities.

To some extent, larger cities now display what Duranton and Puga (2005) call “functional specialization.” Larger firms now separate production from administrative and service functions, including the widespread development of sales office networks.<sup>10</sup> Firms now have multiple “headquarters,” mostly administrative offices working in law, advertising, marketing, or finance.

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