Understanding the City Size Wage Gap

In 2000, wages of full time full year workers were more than 30 percent higher in metropolitan areas of over 1.5 million people than rural areas. The monotonic rela-tionship between wages and city size is robust to controls for age, schooling and labor market experience. In this paper, we decompose the city size wage gap into various components. We propose a labor market search model that incorporates endogenous migration between large, medium and small cities. This model is su ¢ ciently rich to allow for recovery of the underlying ability distributions of workers by city size, arrival rates of job o¤ers by ability and location, and returns to experience by ability and location, when structurally estimated using longitudinal data. Estimates from the structural model facilitate a more complete empirical decomposition of the city size wage gap than is possible using results in existing research. Counterfactual simula-tions of the model indicate that variation in returns to experience and di¤erences in wage intercepts across location type are the most important mechanisms contributing to the overall city size wage premium. Di¤erences in wage intercepts generate the largest part of the city size wage premium for high school graduates while di¤erences in returns to experience are more important for college graduates. Sorting on unob-served ability within education group and di¤erences in labor market search frictions contribute slightly negatively if at all to observed city size wage premia. The authors gratefully acknowledge \u85nancial support for this research from National Science Foundation Award SES- 0720763. Mike Kuklik and Cemal Arbatli provided excellent research assistance. We hav