Can search frictions be the source of increasing returns to scale (IRS) that brings people
together in big cities? The empirical studies on this issue are not encouraging, since they favor
constant returns in search. However, this research is troubled by all sorts of selection bias. We
develop a model of an economy with several regions, which differ in scale. Within each region,
workers have to search for a job-type that matches their specific skills well. They face a tradeoff between match quality and the cost of extended search. This tradeoff differs between
regions, because search in larger regions is more efficient. Then, interregional mobility and
trade lead to a pattern of specialization where large regions undertake more search intensive
activities. Empirical evidence for the United States corroborates the implications of the
model. Search can explain about 75% of the wage differentials between large metropoles and
small cities. |
