I propose a dynamic spatial equilibrium model that accounts for the hetero geneous labor market experience of workers across US cities. Productivity differentials between large and small cities emerge as an equilibrium outcome due to spatial sorting, increasing returns to scale in job search, and knowledge diffusion through local peer effects. The model delivers testable predictions with respect to selection into and returns to migration, which are supported by the data. I use this framework to quantify the aggregate implications of relaxing zoning regulation in large cities. I show how the resulting relocation of workers affects the size and composition of cities, the return from local interactions, and the spatiam distribution of productivity. Failing to account for the impact of housing policy on local productivity would lead to overstating the magnitude of equilibrium income gains by a factor of 3.
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Macroeconomics Workshop Series