City Size and Skill Intensity: Is it All Housing Cost?

Abstract

Substantial attention has been given to the stylized fact that workforce education level tends to increase with city size. This paper demonstrates that the positive relation between city size and skill intensity is a spurious result due to the omission of housing cost, which increases with city size. The theory is straightforward. If the income elasticity of demand for a primary residence is less than unity, the ratio of skilled to unskilled worker wages falls as housing cost rises. This changing wage ratio induces a substitution effect in production across all industries causing the skill intensity of the labor force to rise.

Empirical tests show that the apparent relation between skill intensity and city size disappears when housing cost is added to models. Furthermore, the estimated elasticity of skill intensity with respect to housing cost agrees remarkably well with the value calculated from calibration of a theoretical model. These results call into question models of urban population determination and development that assume either homogeneous population or homothetic preferences.

Keywords: human capital externality, returns to education, skill intensity ratio, skilled wage ratio

JEL Classification: J24, R12, R13