Abstract

Using administrative data for West Germany, this paper investigates whether part of the urban wage premium stems from fierce competition in thick labour markets. We first establish that employers possess less wage-setting power in denser markets. Local differences in wage-setting power predict 1.4–1.9% higher wages from a one standard deviation increase in log population density. We further document that the estimated urban wage premium from such an increase drops by 1.3–1.4pp when controlling for local search frictions. Consequently, our results suggest that a substantial part of the urban wage premium roots in differential imperfections across local labour markets.