Location and the effect of demographic traits on earnings

With mobile workers and competitive markets, equilibrium nominal wage rates rise with the local cost of living but fall with the value of local amenities. Earnings and wage regressions that ignore such effects may suffer from omitted variable bias because observed education and demographic attributes affect both worker skill levels and locations choice. Geographic fixed effects can be used to control for unobserved locational attributes provided that their scope is at least as narrow as the underlying labor markets, but not so narrow as to introduce simultaneity problems arising from the endogenous choice of location on the basis of income. Estimates from the 1985-1989 American Housing Survey suggest that SMSA-level fixed effects control for unobserved locational attributes without introducing simultaneity problems. In addition, failure to control for location leads to biased estimates of the effect of important demographic characteristics.