Spatial Sorting of Workers and Firms
Abstract:
Why do productive workers and firms locate together in dense cities? I develop a new theory of two-sided sorting in which both heterogeneous workers and firms sort across space. Three forces are essential for generating spatial disparities: complementarity between worker and firm productivity, random matching within frictional local labor markets, and congestion costs. I demonstrate that the equilibrium exhibits excessive concentration of workers and firms, and dispersing them away from dense locations can mitigate congestion without reducing output. I then provide direct empirical evidence of two-sided sorting using German administrative microdata. An exogenous increase in the quality of the local workforce results in more productive firms choosing the same location. Finally, to quantify the implications of the model, I calibrate it to U.S. regional data and show that policies which relocate workers and firms toward less dense areas can increase welfare.