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In standard economic theory wages are simply prices on the labor market determined in equilibrium by the supply and demand of labor. Looking across space within countries it is however standard to find a relative large variation in local wage levels. At the same time labor is often very mobile again within countries.

For the United States of America the U.S. Census reveals that in 1990 four percent of white males age 25 to 34 moved across state lines, with the cumulative effect that almost a third of this group no longer resided in the state in which they were born.

When individuals move the supply of labor changes and one could expect wages to equalize based on the assumption that the migration itself was motivated by the one state offering higher wages than another. Seen in the light of this it can seem a little puzzling that spatial wage differentials nonetheless continue to exist. What are the main explanations offered by economic theory?

Jesper Hybel
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  • Many people do not want to move due to family connections, etc. And for people in the lower economic categories moving can be too expensive, especially when you consider the cost of accommodations in the destination. – Hot Licks Dec 10 '20 at 16:26
  • @Jesper Hybel Could you be confusing different things?

    Wages are simply prices on the labor market. How is that comparable to your "space within countries"?

    If you think it's standard to find a variation in local wage levels, can you Post three or four examples?

    Why care if the US Census said that in 1990, 4% of 25to-34 white males crossed state lines, cumulating in a third no longer residing anywhere?

    If you expect wages to equalize due to one state offering higher wages, what other factors do you dismiss?

    In reality, how could "spatial" wage differentials seem puzzling?

     – Robbie Goodwin Dec 10 '20 at 22:06

3 Answers3

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There are several explanations for this in the literature (the order does not necessarily reflect importance of each explanation).

  1. Different Price Levels: Non-trivial portion of the wage differential is due to different price levels/cost of living. Once you adjust for different price levels and compare real wages gap narrows. This is obvious but since you do not mention in your question whether you are talking about real or nominal wages I thought it is useful to mention that.
  2. Regional Institutional Differences: For example Blackaby and Murphy (1991) argue that inter regional real wage differentials are at least partially due to labour market institution heterogeneity (unionisation and the bargaining system). This applies especially to unions/federations like US where there can be large heterogeneity in regional laws & regulations.
  3. Regional Heterogeneity/compensating differentials: Even within one country the geography is usually heterogenous which creates opportunity for compensating differentials (Farber and Newman, 1989). If you are offered two jobs that are same in all aspects but one job requires you to relocate somewhere to Alaskan wilderness and the other job requires you to relocate to some pleasant state with nice beaches you will likely be willing to accept lower salary from the job in nicer place because you are compensated by the fact that you are living in a nice place. Some regional differences could be also explained by agglomeration economics (e.g. urban vs rural areas have different economic implications), see for example Combes & Gobillon (2015).
  4. Worker Heterogeneity: The wages would only equalize among workers that are homogenous across all work relevant characteristics. However, people are different from each other and often people who are similar tend to cluster together. For example, would it be surprising to find that average wage in silicon valley is higher than average wage in some farming community? This would be just comparison of apples to oranges. Hence looking at average wages can be deceptive and research that takes into account worker heterogeneity find that the wage differentials shrink substantially (see Gerking and Weirick, 1983; Dickie and Gerking, 1987; Farber and Newman, 1989 and Combes, Duranton and Gobillon, 2008).
  5. Regional Differences in Human Capital: Workers are not just compensated for their labor but also get return for their human capital. Human capital endowments might differ across regions (perhaps due to regional differences in quality of education) leading to wage differentials (see Duranton and Monastiriotis, 2002; Motellón, López‐Bazo & El‐Attar, 2011).

I think the above summarizes all the major factors but there might be some further ones as well for that you can see the sources above and ones cited therein.

1muflon1
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  • '+1' nice answer. Does economies of agglomeration matter? – Jesper Hybel Dec 07 '20 at 15:20
  • @JesperHybel yes I think these would fall under the regional heterogeneity (some areas can be considered urban others rural). Also network effects relate to labor heterogeneity. Similar people can locate close together due to network effects - and this intra-regional homogeneity would result in inter-regional heterogeneity. I am sure that other concepts from agglomeration economics might play role as well. – 1muflon1 Dec 07 '20 at 15:24
  • I would happily accept your answer if you could add a note about agglomeration economies either under regional heterogeneity or as an independent point. Some standard references would be "MICRO-FOUNDATIONS OF URBAN AGGLOMERATION ECONOMIES (2004) GILLES DURANTON and Diego Puga (theoretical) and "The Empirics of Agglomeration Economies" (2015) Combes and Gobillon. Again thank you for a nice answer. – Jesper Hybel Dec 07 '20 at 15:35
  • @JesperHybel ok added reference to them under regional heterogeneity – 1muflon1 Dec 07 '20 at 16:55
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    The cost of living argument seems very circular. Why is San Francisco so expensive? Because a lot of the people who want to live there can afford to pay a lot. Why do they have so much money? Because they get paid a lot. Why do they get paid a lot? Because it's so expensive to live in San Francisco. Why don't tech companies just move to San Jose? – user3067860 Dec 08 '20 at 17:48
  • @user3067860 not it is not circular argument. In economics there are two types of variables: a) nominal variables. b) real variables. Real variables tell you about economic reality. For example, which person is better off a person with 5 thousand US dollars or 1 million of Zimbabwe dollars? Well that clearly depends on difference in price level between the countries (based on which real exchange rate is based). This example might be more clear for non-economists as you deal with different currencies when you travel but in the same way US dollar does not have the same buying power – 1muflon1 Dec 08 '20 at 17:53
  • @user3067860 everywhere (this is similar to the fact that 1US dollar wont have the same value also over time). But these nominal differences do not mean that in terms of economic reality something is necessarily actually more expensive in some areas and less in other areas. If someone has to work 1 hour to earn enough money for dinner in two different cities then it economically does not matter if in one city wage is 10USD but dinner cost 10USD and in another city wage is 20 USD and meal costs 20USD they are equally expensive. That's why you always need to correct for this in econ analysis – 1muflon1 Dec 08 '20 at 17:57
  • @user3067860 but this is no more a circular argument then a physicists saying that if two cities use different ways of measuring temperature you have to first recalculate the temperatures to some common scale before making comparison so you actually compare apples to apples instead of apples to oranges. – 1muflon1 Dec 08 '20 at 17:59
  • @1muflon1 I understand that the buying power of money is not the same everywhere. The question is why. If the answer to that is "because people in some areas make more so the cost of goods and services increases" then this is circular. – user3067860 Dec 08 '20 at 18:10
  • @user3067860 but those are nominal costs. The argument here is simply that nominal costs are different so nominal wages have to be different. That is no more circular than saying that Fahrenheit is a scale that starts at higher level than scale Celsius and has higher dispersion between degrees, so the same temperature will report higher value when you use Fahrenheit than when you use Celsius. – 1muflon1 Dec 08 '20 at 18:14
  • Why are nominal costs different? Why does something cost more in Hong Kong than it does in Mumbai? – user3067860 Dec 08 '20 at 18:27
  • @user3067860 because of different price levels/different regional inflation rates. These in turns can be caused by various different factors. For example, these differences can exist to prevent arbitrage as they create implicit real exchange rate. They can also be results of money supply spreading unevenly throughout economy. Institutional factors such as some policies that impose some nominal restrictions like minimum wage can have effect on different price levels. Because velocity of money can be different between regions and because regions might face asymmetric macro shocks. – 1muflon1 Dec 08 '20 at 18:37
  • Let us continue this discussion in chat. – user3067860 Dec 08 '20 at 18:38
  • It is true there is a circularity. This circularity is taken to its limit when you imagine one area - such as San Francisco - as being economically isolated, no factors of production moving in or out. To break the circle it is assumed that some companies produce tradable goods. Because they do not produce local goods - depending on being consumed locally like housing - they may just as well produce these goods elsewhere. So these companies will only pay the higher wages if production in San Francisco is to some extent more efficient. – Jesper Hybel Dec 09 '20 at 15:00
  • For a reference on this argument in general equilibrium setting see MORETTI, E. (2011), “Local Labor Markets”, in Ashenfelter, O. and Card, D. (eds), Handbook of Labor Economics, Vol. 4. (Amsterdam: Elsevier), 1237–1313. – Jesper Hybel Dec 09 '20 at 15:01
  • @JesperHybel but this argument does not apply to nominal wages - the person before was saying that point 1 about nominal wages is circular. Also if there is a difference between efficiency between two places I would not call that circularity - then its not that wages are high because wages are high but wages are high because efficiency is higher – 1muflon1 Dec 09 '20 at 15:02
  • I can only say that I think he has a valid point and that the same point is made in the reference I gave. The way I understand it is that workers are modelled as living and working in the same area. To have the same "quality of life" or "real wage" their wage is compared to local costs out of which housing is a considerable part. So if housing is twice as expensive so must wages be for the residents to as well off as the residents of the neighbouring state where housing is half the nominal cost and wages likewise. – Jesper Hybel Dec 09 '20 at 15:40
  • @JesperHybel right but I think issue is here not understand the definition of circular argument. For an argument to be circular it needs to always get back to itself - that is where it gets its name- if housing costs there are more expensive because it is difficult to build there, or if wages are higher because more efficiency that is not circular argument even if there are some general equilibrium effect. For argument to be circular the nominal wages there must be higher because cost of living is higher which is higher because nominal wages are higher - this would be a circular argument. – 1muflon1 Dec 09 '20 at 15:43
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    @JesperHybel I can’t believe that published literature would suggest that there is really a circular argument there (since that is logical fallacy why would that even be then used as an argument in research). Again circular argument is not the same as saying there is reverse causality or endogeneity, or general equilibrium effects multipliers and what not – 1muflon1 Dec 09 '20 at 15:44
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    Those are, I agree, also a valid points. – Jesper Hybel Dec 09 '20 at 15:45
  • Let us continue this discussion in chat. – Jesper Hybel Dec 09 '20 at 15:46
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I would add two more, and rather primitive, factors in @1muflon1 long list:

  1. Labor input is not perfectly mobile with respect to the wage. We should never forget that the concept of a utility function allows for arbitrary "goods" to be "utility enhancing". It follows that migrating in chase of a better wage does not always prevails when this may mean that the worker will leave behind some intangible utility-enhancing goods, like for example a sense of belonging in a specific place, or a network of friends, kin and extended family.

  2. Information is not complete nor perfect. Even in today's era of information overdose, "demand for labor" is not what the employers demand, but what the workers know that the employers demand. And not all job opportunities are posted on-line.

Alecos Papadopoulos
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  • '+1' Good points. Point 1 could perhaps also include more tangible but localized goods such as amenities in a classic Roback (1982) Wages, Rents, and the Quality of Life, kind of thinking? – Jesper Hybel Dec 07 '20 at 17:26
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    @JesperHybel I would include these in the "Regional Heterogeneity / Institutional differences" category. – Alecos Papadopoulos Dec 07 '20 at 17:30
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    Point 1. People who have benefitted from higher education tend to be mobile when job-seeking. People with little academic ambition or attainment tend to stay near family and friends - provided their situation is bearable. If extreme poverty reigns then working-class people will move, given the opportunity. This is most likely to happen where there is no government-provided social security. The phenomenon of complacency due to govt payouts in Britain gave rise to the much discussed "Get on your bike" slogan https://www.express.co.uk/news/uk/230675/Get-on-your-bike-Norman-Tebbit-says-again – chasly - supports Monica Dec 07 '20 at 23:13
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    If that network provides free childcare, cheap accommodation, etc. the benefits may be financially measurable, unlike a sense of belonging - though separating the financial from the other benefits of having family around would be tricky. Information, and the ability to act on it, isn't timely either - notice periods, the need to find a house/school/job for a partner all impose delays. In specialised fields trying to relocate despite the 2-body problem can mean years of double job-hunting. – Chris H Dec 08 '20 at 09:24
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tl;dr– Even simple homogenous systems don't necessarily equalize across space.

Unbiased systems aren't necessarily homogenous.

Naively, one might assume that if we have a large unbiased system, its members will tend to form one homogenous community. But that's not the case.

For example, consider a pure substance in a glass jar at its triple point. Then there can be three stable phases: one gas, one liquid, and one solid. There doesn't need to be an external bias or forced separation to maintain this; it's often just favored over a single homogenous phase.

Likewise, have you seen oil and water separate after being mixed? Actually, both phases tend to have both water and oil, just in different ratios. Just one phase tends to have a high ratio of water-to-oil while the other has a high ratio of oil-to-water. So it's not a full separation nor single ratio, but rather two different ratios coexisting.

Other answers have made good points about how biases can prevent everything from equalizing out across space. The point here is just that we wouldn't tend to expect everything to equalize out across space even if there weren't biases.

Nat
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