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Earnings of employed workers are on average higher in urban areas than in rural parts of Canada. Similarly, earnings in larger urban areas are higher than in smaller urban areas. And the magnitude of these differences is quite large: the earnings gap between urban and rural areas within provinces is often greater than the earnings gap across provinces (Beckstead and Brown 2005).

The objective of this paper is to develop a better understanding of the factors that underlie these differences in earnings across the urban–rural spectrum. In the broadest terms, earnings are likely to increase with the size of metropolitan area because firms in larger urban areas are more productive, allowing them to pay higher wages, and/or because the average skill level of workers—their human capital—is higher.

It has long been argued that larger cities provide firms with a productive advantage that is not available to the same degree in smaller cities and rural areas. These agglomeration economies stem from numerous sources, including the better matching of worker skills with firm needs, access to shared infrastructure (e.g., airports) and knowledge that percolates more effectively among firms in close proximity to each other.

In contrast to agglomeration economies, relatively little attention has been paid to the role of human capital as a driver of urban–rural earnings differences. However, one of the distinguishing characteristics of larger cities is populations with relatively high levels of education—one of the main sources of human capital accumulation. Hence, there is a need to take human capital into account.

The overarching purpose of this paper is to begin to disentangle the effects of agglomeration economies and human capital composition on urban–rural earnings differences. If agglomeration economies are the primary force underlying earnings differences, then the urban–rural earnings gap may be driven by the productive advantages that firms derive from the geographic concentration of economic activity. It is the very nature of urban economies themselves—the dense intertwining of firms and workers—that leads to their advantage. And yet, if it is the skill composition of cities that matters, then the advantage of cities turns on their capacity to educate, as well as attract and retain, highly skilled workers.

1. How much does employment earnings per week vary across urban and rural areas?
   Weekly employment earnings decline consistently as city size declines, and between cities and rural areas. In 2000, metropolitan areas with a population of 500,000 or more had average earnings that were 8% above the national average, while medium-sized metropolitan areas with populations of 100,000 to 499,999 and small cities with populations of 10,000 to 99,999 had weekly employment earnings that were 4% and 8% below the national level, respectively. Rural areas, on average, had earnings that were 14% below national levels.
2. Is human capital associated with urban–rural earnings differences?
   The average number of years of education of individuals increases with city size and also between rural and urban areas. This pattern accounts for between one-third and one-half of urban–rural earnings gap. Hence, human capital—as measured by years of education—plays a significant role in our understanding of urban–rural earnings differences.
3. How important are agglomeration economies as a possible source of urban–rural earnings differences?
   After taking into account human capital, and a number of other controls, the size of a region still has a significant effect on earnings levels. Therefore, it is both the concentration of human capital in cities and the nature of urban economies themselves—the geographic concentration of workers and firms—that are associated with urban–rural earnings differences.

The advantage of cities lies as much in their capacity to educate, attract and retain highly educated workers, as in their innate ability to facilitate the interaction of workers and firms, although these are likely tied together.