Earnings Inequality in Production Networks∗

Abstract

Recent research on firm-to-firm trade has documented a robust fact: there is substantial heterogeneity in buyer-seller matching between firms. To what extent does this matter for earnings inequality between workers? We study this question by using a novel combination of two administrative datasets from Chile: (i) employer-employee data from income tax records, merged with (ii) firm-to-firm transactions data based on value-added tax records. We develop a new theoretical framework to study the pass-through of heterogeneity in the production network to earnings inequality: (i) imperfect competition in labor markets for workers of heterogeneous ability, and (ii) monopolistically competitive firms that produce output by combining labor with inputs sourced from other firms in a heterogeneous production network. We show that several key parameters mediate the impact of the network structure on earnings: the labor supply elasticity, the elasticity of substitution between labor and intermediates, and the price elasticity of demand. We structurally estimate these parameters and use the model to quantify the importance of production network heterogeneity for earnings inequality by simulating counterfactual equilibria in which firms match with customers and suppliers at random. We find that firm heterogeneity of connectivity in the production network accounts for 41% percent of log earnings variance in Chile and around half of the between-firm component of earnings variance. Heterogeneity in matching with suppliers is quantitatively more important in explaining earnings inequality than matching with buyers

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