Human capital externalities in Western Germany

The paper sheds light on the impact of spatial agglomeration of human capital on individual wages in Western Germany. Using panel data it shows that regional wage differentials are to a large extent attributable to localized human capital externalities arising from the regional share of highly qualified workers. Employing the regional number of public schools and of students as instrumental variables the paper shows that human capital externalities are underestimated in ordinary panel regressions for wages of highly qualified and non-highly qualified workers alike due to supply shifts of highly qualified workers. An analysis by sector reveals that human capital externalities are more pronounced in manufacturing than in the service sector. We find indication that highly qualified workers benefit from intra-industry knowledge spillovers, while non-highly qualified workers profit from pecuniary externalities between industries. Our findings are stable among a variety of indicators of regional human capital and robust to the inclusion of other sources of increasing returns, as well as wage curve, price level, and amenity effects.