Why Has Urban Inequality Increased?

The increase in wage inequality since 1980 in the United States has been more pronounced in larger cities, even after accounting for differences in the composition of the workforce across locations. Using Census of Population and Census of Manufacturers data aggregated to the local labor market level, this paper examines the importance of changes in the factor bias of agglomeration economies, capital-skill complementarity, changes in the relative supply of skilled labor, and mutual interactions for understanding the more rapid increases in wage inequality in larger cities between 1980 and 2007. Parameter estimates of a production function that incorporates each of these mechanisms indicate strong evidence of capital-skill complementarity, increasing skill bias of agglomeration economies and declining capital bias of agglomeration economies. Immigration shocks serve as a source of exogenous variation across metropolitan areas in changes to the relative supply of skilled labor versus unskilled labor. The direct relative demand effects of the changing factor biases of agglomeration economies rationalize 77-82 percent of the more rapid increases in wage inequality in more populous local labor markets. Interactions between capital-skill complementarity and changes in the factor bias of agglomeration economies have generated outward and inward shifts in the relative demand for skilled labor in larger cities that approximately offset.

Source: Brown University (and others)

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