An Urban Accounting for Geographic Concentration of Skills and Welfare Inequality

Using Jones (2014) generalized human capital accounting, we extend the urban accounting model of Desmet and Rossi-Hansberg (2013) to account for the geographic distribution of skills across US metropolitan areas. The methodology allows the productivity of high-skill workers to depend on location advantage and local skill mix; the latter also determines the productivity of low-skill workers. Urban friction, rising with population size, reduces worker consumption relative to their wage income. Amenities for high-skill and low-skill workers in each city are calibrated so that the utility for each skill type is equalized across cities. We examine counterfactual skill-mix distribution across cities and welfare gap between the skill groups by shutting down spatial heterogeneity in location advantage, amenity and excess friction respectively. We show that skill mix becomes more even across cities absent heterogeneity in location advantages or in excess friction but it becomes more dispersed absent amenity heterogeneity. The welfare gap widens when heterogeneity in any of the three factors is eliminated. The generalized urban accounting model can shed light on the causes of increased concentration of skilled workers in large cities in US highlighted by E. Moretti (2008) and Diamond (2012) and the implications for welfare gap between the skill groups.