History and Coordination Failure

An extensive literature discusses the existence of a virtuous circle of expectations that might lead communities to Pareto-superior states among multiple potential equilibria. It is generally accepted that such multiplicity stems fundamentally from the presence of positive agglomeration externalities. We examine a two-sector model in this class, and look for intertemporal perfect foresight equilibria. It turns out that under some plausible conditions, positive externalities must coexist with external diseconomies elsewhere in the model, for there to exist equilibria that break free of historical initial conditions. Our main distinguishing assumption is that the positive agglomeration externalities appear with a time lag (that can be made vanishingly small). Then, in the absence of external diseconomies elsewhere, the long-run behaviour of the economy resembles that predicted by myopic adjustment. This finding is independent of the degree of forward-looking behavior exhibited by the agents. ∗We are grateful to Rahul Roy and an anonymous referee for comments that improved the final draft. Ray gratefully acknowledges support under Grant SBR-9709254 from the National Science Foundation. Address correspondence to: Debraj Ray, Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215. Email: [email protected] and [email protected]