Earnings Inequality in Production Networks

Why do firms differ in the wages paid to otherwise identical workers and in the share of revenue that they allocate to labor? This paper explores the role of production networks. Using linked employer-employee and firm-to-firm trade transactions data from Chile, we show that firms with better access to both buyers and suppliers of intermediate inputs tend to have higher earnings premia and lower labor shares. Motivated by these facts, we develop and estimate a model with labor market power, worker and firm heterogeneity, and heterogeneity in firm-to-firm linkages in the production network. Greater access to larger buyers and more efficient suppliers raises the marginal revenue product of labor and lowers the relative cost of intermediates to labor. This leads to higher wages in the presence of labor market power and lower labor shares when labor and materials are substitutes. Through counterfactual simulations of the estimated model we find a substantial role for production networks in explaining the variances of earnings premia and labor shares across firms.