Raising markups to survive: small Spanish firms during the Great Recession

A recent literature documents a secular increase in the sales-weighted markups in the United States, a phenomenon that was driven by large and productive firms at the top of the profit distribution. Using rich balance-sheet data, this paper documents the behavior of markups in Spain before, during, and in the aftermath of the Great Recession. We document that markups rose during the financial crisis. Unlike in the U.S., these dynamics were led by small firms: in response to a drop in sales, these firms were unable to increase their productive efficiency when average costs increased. As a consequence, and in order to escape a sharp decline in profit rates, they increased their markups. Simultaneously, large firms were able to increase efficiency, and their markups remained relatively constant. We argue that the increase of relative markups by small firms came at the expense of losing market share, which in the very short run proved to be preferred than exiting the market.