Understanding the City Size Wage Gap

Abstract

In this paper, we decompose city size wage premia into various components. We base these decompositions on an estimated on-the-job search model that incorporates latent ability, search frictions, firm-worker match quality, human capital accumulation and endogenous migration between large, medium and small cities. Counterfactual simulations of the model indicate that variation in returns to experience and differences in wage intercepts across location type are the most important mechanisms contributing to observed city size wage premia. Variation in returns to experience is more important for generating wage premia between large and small locations while differences in wage intercepts are more important for generating wage premia betwen medium and small locations. Sorting on unobserved ability within education group and differences in labor market search frictions and distributions of firm-worker match quality contribute little to observed city size wage premia. These conclusions hold for separate samples of high school and college graduates.

Keywords: Agglomeration; Urban Wage Premium; Wage Growth.

Figure 1

Actual and Predicted Wages by Experience: College Sample Notes: Each plot shows mean actual and predicted log wages in cents by work experience. Means are calculated separately within each year of work experience. Dashed lines are actual mean wages and solid lines are mean wages based on model simulations. Table A1 lists the parameter values used for simulations.

Figure 2

Actual and Predicted Wages by Experience: High School Sample Notes: See the notes to Figure 1 for a description of the plots.

Figure 3

Experience Profiles Implied by Parameter Estimates Notes: Each panel graphs real wages excluding the firm-worker match and measurement error components as functions of years of experience by location type, education and ability. These are plots of Equation (7) in the text but restricting ε and u to 0 and assuming no mobility across locations. Thin lines are for small sized locations, dashed lines are for medium locations and thick solid lines are for large locations. The parameters used to graph these functions are found in Table A1.

Figure 4

Firm-Worker Match Component of the Wage Notes: Each panel graphs the mean of the match component ε of the real wage assuming no mobility across locations. Data for the plots are constructed by simulating the model using parameters in Table A1 except that the mobility costs are set to be infinite.