Cities, Matching and the Productivity Gains of Agglomeration

The striking geographical concentration of economic activities suggests that there are substantial benefits toagglomeration. However, the nature of those benefits remains unclear. In this paper we take advantage of a newdataset to quantify the role of one of the main contenders - the matching of workers and jobs. Using individuallevel data for two large US states we show that thicker urban labour markets are associated with moreassortative matching between workers and firms. Another critical condition is required for this to generatehigher productivity: complementarity of worker and firm quality in the production function. Usingestablishment level productivity regressions, we show that such complementarity is found in our data. Puttingtogether the production and matching relationships, we show that production complementarity and assortativematching is an important source of the urban productivity premium.