Frictional Sorting

In many countries around the world, migration costs and housing supply restrictions interact with each other and combine to restrict workers’ location decisions. Using an equilibrium sorting model and rich micro data from China, we evaluate the impacts of these dual constraints on workers’ sorting behavior and quantify the resulting changes in aggregate welfare and inequality. We find strong policy interactions between the two kinds of frictions in determining welfare losses and regional inequality. Counterfactual simulations show that lowering migration costs can increase welfare and reduce regional inequality by moving workers from unproductive inland regions to productive coastal regions in China; such welfare and regional distributional impacts depend on the elasticity of housing supply in coastal regions and vice-versa. Results highlight the policy complementarities between reducing the two kinds of frictions and have general implications for countries with different levels of constraints on mobility and housing supply.