On the geography of inequality: labour sorting in general equilibrium

Abstract

ABSTRACT We study how cities’ amenities and limited housing supply contribute to aggregate wage inequality and affect housing prices through the sorting of heterogeneous skilled workers. We develop a general equilibrium model where workers differ along a continuum of skills and compete for limited housing. Our analysis suggests that spatial sorting accounts for 7.5% of the aggregate wage dispersion, increases average housing prices by 20–40% in constrained cities, and makes the economy 1.9% more productive. In addition, we evaluate a place-based policy that aims to expand the supply of houses in 1% of constrained cities and find that it improves aggregate productivity between 0.2% and 0.4%. However, the place-based policy has the unintended consequence of aggravating aggregate wage inequality by the same magnitude.