Does Everybody Need Good neighbors? Labor Mobility Costs, Cities and Matching

This paper analyzes the role of costly spatial interaction between regional labor markets in the matching process. We adapt Shimer and Smith's (2000) assignment model with search frictions to an economy with two connected regions. We then show that the existence of labor mobility costs will induce only the high-skilled workers in the small town to commute (migrate) to the large city, while low-skilled workers continue to search jobs locally. Since there are fewer workers searching for jobs in the small town, fewer firms enter the region resulting in a decrease in the local contact efficiency for workers. This implies that only high-skilled workers benefit from the proximity to large cities, whereas low-skilled workers in the small town suffer from a deteriorated local contact efficiency. Empirical evidence using Belgian linked employer-employee data is consistent with the implications of the model.