Spatial Sorting and the Rise of Geographic Inequality

Abstract

I show that unobserved sorting patterns of firms and workers across space can account for the tight link between rising aggregate wage inequality and rising spatial inequality in West Germany. Two-sided sorting patterns of workers and firms interact with a change in technology to produce a spatially concentrated increase in inequality, driving up regional disparities. These sorting patterns are determined jointly in equilibrium and depend on theoretical objects that are difficult to measure in the data. This paper develops a novel bi-clustering method to recover these objects empirically and uses these results to structurally estimate a dynamic spatial search model with two-sided sorting. I find that regional sorting of firms is more pronounced than regional sorting of workers and the former is an important determinant of workers’ job ladders and lifetime values. Compensating differentials between regions are large, driven in part by better labor market outcomes in rich places. The model allows me to consider the redistributive effects of spatial policy, which I find to be strong.