Using administrative data for West Germany, this paper investigates whether part of the urban wage premium stems from fierce competition in thick labour markets. We first establish that employers possess less wage-setting power in denser markets. Local differences in wage-setting power predict 1.8–2.1% higher wages from a 100 log points increase in population density. We further document that the observed urban wage premium from such an increase drops by 1.5–1.9pp once conditioning on local search frictions. Our results therefore suggest that a substantial part of the urban wage premium roots in differential imperfections across local labour markets.

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Boris Hirsch, Elke J. Jahn, Alan Manning and Michael Oberfichtner

20 March 2019     Paper Number CEPDP1608

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This CEP discussion paper is published under the centre's Labour markets programme.