Spatial sorting with heterogeneous firms and heterogeneous sectors

•The paper introduces different capital intensities among firms and sectors.•Our model can produce sorting to the large regions from both ends of the productivity distribution.•Firms with very high and very low capital intensity tend to relocate to the core.•Several sectors show patterns consistent with two-sided sorting using Japanese micro data.

The present paper focuses on spatial sorting as a mechanism behind the well-established fact that there is a central region productivity premium. Using a model of heterogeneous firms that can move between regions, Baldwin and Okubo (2006) show how more productive firms sort themselves to the large core region. We extend this model by introducing different fixed costs in terms of capital among firms and sectors. In accordance with empirical evidence, more productive firms are assumed to be associated with a higher fixed cost in terms of capital. As a result, our model can produce sorting to the large regions from both ends of the productivity distribution. Firms with high capital intensity and high productivity as well as firms with very low productivity and low capital intensity tend to relocate to the core. We use Japanese micro data to explore the predictions of the model. Many sectors show patterns that are consistent with two-sided sorting. We also find supportive evidence for our model prediction that two-sided sorting occurs in sectors with a high capital intensity.