CEP Discussion Paper No 648 September 2004 Cities , Matching and the Productivity Gains of Agglomeration

The striking geographical concentration of economic activities suggests that there are substantial benefits to agglomeration. However, the nature of those benefits remains unclear. In this paper we take advantage of a new dataset to quantify the role of one of the main contenders the matching of workers and jobs. Using individual level data for two large US states we show that thicker urban labour markets are associated with more assortative matching between workers and firms. Another critical condition is required for this to generate higher productivity: complementarity of worker and firm quality in the production function. Using establishment level productivity regressions, we show that such complementarity is found in our data. Putting together the production and matching relationships, we show that production complementarity and assortative matching is an important source of the urban productivity premium.