Earnings Inequality in Production Networks

Abstract

This paper investigates the importance of firm-to-firm production network linkages for earnings inequality. We develop a quantitative model in which heterogeneous firms hire workers of different abilities in an imperfectly competitive labor market and source intermediates from heterogeneous suppliers in a production network. The model delivers an earnings equation with a firm-specific wage premium that depends endogenously on both firm productivities and firm-to-firm linkages in the production network. We establish identification of the model parameters and estimate them using linked employer-employee and firm-to-firm transactions data from Chile. Counterfactual simulations using our estimated model show that heterogeneity in network linkages explains 21% of log earnings variance, while passthrough of productivity shocks via network linkages explains between 20-25% of earnings volatility. We also examine the effects of a minimum wage policy and find strong spillover effects to worker earnings above the wage floor, with substitution of materials for labor explaining around 40% of these effects.

Being up Front about Income Inequality

“…In terms of the research on firm-level inequality, and the extent to which income inequality is driven by inequality within firms or firms (e.g Mueller et al, 2017;Song et al, 2019),. the proposal is thus closest to recent work on production networks (e.g Huneeus et al, 2021). which suggest their importance as a determinant of income inequality.…”

Minimum Wages and Optimal Redistribution in the Presence of Taxes and Transfers

“…Third, this paper adds to a literature that studies the interaction of different policies in second-best contexts (e.g., Diamond and Mirrlees, 1971;Atkinson and Stiglitz, 1976;Gaubert et al, 2020;Ferey, 2020). Fourth, the model presented adds to the literature that studies the theoretical foundations of monopsony power and firm wage premiums (e.g., Card et al, 2018;Haanwinckel, 2020;Berger et al, 2021Berger et al, , 2022Engbom and Moser, 2021;Huneeus et al, 2021;Jarosch et al, 2021;Kroft et al, 2021;Lamadon et al, 2022). Finally, the empirical results add to a large empirical literature, referenced throughout the paper, that studies the effects of minimum wages on labor market and firms outcomes.…”

Foreign Demand Shocks to Production Networks: Firm Responses and Worker Impacts

“…More recent evidence includes Lamadon et al (2022), who estimate an average labor supply elasticity in the U.S. economy of 4.6, and Kroft et al (2020), who estimate a labor supply elasticity in the U.S. construction sector of 4.2. By comparison, Huneeus et al (2021) find labor supply elasticities that range from around 3 to 6 in Chile, and Chan et al (2021) estimate the elasticity to be 5.7 in Denmark.…”

“…Note that the CES substitutability parameters in firms' production technology are restricted to be the same as the substitutability parameter in final demand. This assumption, which is common in the literature (see Huneeus et al, 2021 andDemir et al, 2021 for example), implies that firms face the same demand elasticity regardless of who they sell their output to, and, thus, charge common markups under monopolistic competition.…”

“…Adao et al (2020) study the impact of trade on inequality in a framework with perfect competition, and Alfaro-Urena et al ( 2019) estimate the effects of foreign multinationals on workers. Huneeus et al (2021) estimate that supply shocks transmitted through the production network can account for around 20 percent of the earnings volatility of Chilean workers. 3 All these studies analyze data on firm-to-firm transactions in developing countries.…”