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Learning Advantages of Working in Big Cities

The combination of static gains and learning advantages together with the fact that higher-ability workers benefit more from bigger cities explain why the distribution of earnings in bigger cities has higher mean and higher variance.

Jorge De La Roca and Diego Puga,Learning by Working in Big Cities,Review of Economic Studies (2017) 84 (1): 106-142. doi:10.1093/restud/rdw031

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Picture source: Whirlwind by Marina Ahun, http://marinaahun.com/

The productive advantages of bigger cities manifest in the higher productivity of establishments located in them. They also show up in workers’ earnings. Workers in bigger cities earn more than workers in smaller cities and rural areas. The positive relationship between earnings and city size is strong in developed countries. In the U.S., workers in metropolitan areas with population above 1 million earn on average 30% more than workers in rural areas. In France, workers in Paris earn on average 15% more than workers in other large cities, such as Lyon or Marseille, 35% more than in medium-sized cities, and 60% more than in rural areas.

The following Figure plots mean annual earnings for male employees against city size for Spanish urban areas. Workers in Madrid earn 31,000 euros annually on average, which is 46% more than workers in Santiago de Compostela (the median-sized city), and 55% more than workers in rural areas.  Moreover, differences remain large even when we compare workers with the same education and years of experience and in the same industry.

How do we understand worker’s earning premium in big cities?

There are three potential sources of the city size earnings premium: static advantages, sorting based on initial ability, and dynamic advantages. First, there may be some static advantages associated with bigger cities that are enjoyed while working there and lost upon moving away. Secondly, workers who are inherently more productive may choose to locate in bigger cities. Thirdly, a key advantage of cities is that they facilitate experimentation and learning. In particular, bigger cities may provide workers with opportunities to accumulate more valuable experience. Since these dynamic advantages are transformed in higher human capital, they may remain beneficial even when a worker relocates. 

This leads to a further question: how can we quantify the exact contributions of the three factors on the earning premium?

In a recent paper published in Review of Economic Studies, Learning by Working in Big Cities, Jorge De La Roca and Diego Puga use a large and rich panel data set for workers in Spain and provide a quantitative assessment of the importance of each of these three mechanisms in generating earnings differentials across cities of different sizes.

The overall findings suggest that workers in big and small cities are not particularly different to start with; it is largely working in cities of different sizes that makes their earnings diverge. Workers attain a static earnings premium upon arrival in a bigger city and accumulate more valuable experience as they spend more time working there. Returns to experience and wage level effects are the most important mechanisms contributing to the overall city size earnings premium. The additional value of experience in bigger cities persists after leaving and is stronger for those with higher initial ability. The combination of static gains and learning advantages together with the fact that higher-ability workers benefit more from bigger cities explain why the distribution of earnings in bigger cities has higher mean and higher variance.

This study also calculates the elasticity of earnings with respect to city size. The authors distinguish between a short-term elasticity that captures the static advantages of bigger cities—i.e. the boost in earnings workers obtain upon moving into a big city—and a medium-term elasticity that further encompasses the learning benefits that workers get after working in a big city for several years. The estimated medium-term elasticity of 0.0510 is more than twice as large as the short-term elasticity of 0.0223 implying that, in the medium term, about half of the gains from working in bigger cities are static and about half are dynamic.

The authors present results in an illustrative way, that is, to plot the evolution of earnings for workers in cities of different sizes. In panel (a) of the following figure, the higher solid line depicts the earnings profile over 10 years of an individual with no prior experience working in Madrid (the largest city) relative to the earnings of a worker with identical characteristics (both observable and time-invariant unobservable) who instead works in Santiago de Compostela (the median-sized city).

The figure shows that a worker in Madrid initially earns 9% more than a worker in Santiago, and this gap then widens considerably, so that after 10 years the difference in earnings reaches 36%. The lower solid line depicts the earnings profile over 10 years of an individual working in Sevilla (the fourth largest city) relative to the earnings of a worker in Santiago. There is also a substantial gap in the profile of relative earnings, although smaller in magnitude than in the case of Madrid: an initial earnings differential of 3% and of 14% after 10 years.

The dashed lines in the figure illustrate the portability of the learning advantages of bigger cities. The top dashed line plots the difference in earnings between two individuals with no prior work experience and identical characteristics, one who works in Madrid for 5 years and then moves to Santiago and another one who works in Santiago during the entire 10-year period. Up until year 5, the relative earnings profile of the worker who begins in Madrid and then relocates is the same as that of a worker who always works in Madrid as captured by the top solid line discussed above. At that point, he relocates to Santiago, and his relative earnings drop as a result of the Santiago fixed effect replacing the Madrid fixed effect. The worker is able to retain the 14.5% higher earnings resulting from the more valuable experience accumulated over 5 years in Madrid after relocating to Santiago. From that point onwards, the additional value of the experience acquired in Madrid depreciates slightly but a substantial gap remains relative to the benchmark of having always worked in Santiago.

The evolution of earnings shows that much of the earnings premium that bigger cities offer is not instantaneous, but instead accumulates over time and is highly portable. Furthermore, workers are able to take these dynamic gains with them when they relocate, which can be interpreted as evidence that learning in bigger cities is important, which get embedded in workers’ human capital. Where workers acquire experience matters more than where they use it.

In summary, the authors find that workers in bigger cities do not have higher initial unobserved ability as reflected in fixed effects. Instead, they obtain an immediate static premium and accumulate more valuable experience. It is worth mentioning that there are several restrictions in the sample which the authors use to run the models and draw the conclusions. The sample is a monthly data set for men aged 18 and over with Spanish citizenship born in Spain since 1962 and employed at any point between January 2004 and December 2009. Female labor is not included. Job spells in agriculture, fishing, mining, and other extractive industries are excluded and Job spells in the public sector, international organizations, and in education and health services are also left out.

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