| A modern theory of regional economics is applied to the theory of inter-area differences in wages. The theory links inter-area differences in wages to inter-area differences in prices and amenities. Examination of this theory leads to several empirical implications which have been largely ignored by previous researchers. First, many wage specifications can be supported by the theory, but the interpretation of coefficients on variables depends on the entire set of variables included. Second, errors in price variables should be an intrinsic part of the model, rather than an afterthought in empirical implementation. Third, amenities are goods which are either measured with error or can not be measured using standard statistics, so that alternative modeling techniques should be used.;The empirical results support most of the implications of the theory. First, the coefficients on crucial price and amenity variables vary across specifications, thus implying that there are strong inter-correlations of dependent variables. Second, a commonly used price index is shown to perform poorly compared to a more modern index. Third, the results support the presence of unobserved amenities; furthermore, these unobserved amenities appear to play an important role in wage-setting, suggesting that future research on inter-area wage differences should focus on unobserved amenities, rather than measures of observed amenities. |
