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 between medium and small locations. Sorting on unobserved ability within education group and differences in labour 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.