Labor Market Power Across Cities

Workers in larger cities are paid higher wages. The city-size wage premium may reflect the productivity gains from agglomeration or sorting of more productive workers in densely populated areas. However, local labor markets in large cities have more firms and are expected to be more competitive, which could also generate part of the urban earnings premium. I quantify the importance of this channel with rich administrative data for Spain using a spatial equilibrium model to guide the empirical strategy. To address the identification challenge posed by labor market power and wages moving endogenously with unobserved local productivity shocks, I first control for firms’ revenues per worker and for time trends that are heterogeneous across local labor markets. I then develop a new instrumental variable that leverages quasi-experimental variation in monopsony power stemming from changes over time in the size of local public firms. I conclude that 20–30% of the city-size wage premium and 6–15% of the employment gap between small and large cities can be attributed to differences in labor market power across locations.