Heterogeneous firms, mark-ups and income inequality

Abstract

Firm heterogeneity affects not only the implications of trade policies for countries, but also income distributions within-countries since firms generate most of wage and capital income payments. Recently, both within-country wage- and capital income inequality have been rising in various countries. In this dissertation we study empirically whether mark-ups and profit margins differ between exporting and domestic firms within the same, narrowly defined sectors. Firm heterogeneity in these indicators has been hardly analysed. In addition, we contribute to the literature by extending the analyses to cover service sector exporters and micro-sized and small firms in contrast to previous studies concentrating on larger firms in manufacturing sectors. Moreover, we analyse theoretically how a decrease in mark-ups affects within-country income inequality when firm heterogeneity is taken into consideration. First, we analyse the distributions of mark-ups in 70 Finnish manufacturing and service sectors with non-parametric methods and a panel of firm level micro data. In contrast to the common constant mark-up hypothesis, we find (i) large differences in mark-ups within sectors, (ii) higher mark-ups for small firms and domestic firms, (iii) greater mark-up heterogeneity in sectors with low capital-labour ratios and a large number of firms and (iv) higher mark-up variation in service sectors in comparison to manufacturing sectors. The results indicate that different types of firms within the same sector cater to specific market or consumer segments with unequal demand elasticities. Second, we study the relationship between profitability (ratio of profits over sales or assets) and internationalization both theoretically and empirically. Predictions derived from existing theoretical models suggest that profit rates for exporters are lower than or equal to those for non-exporters in the same sector. We test the hypothesis empirically with two parallel micro databases from Finland and the Netherlands, and by analysing four different profitability indicators. We employ fixed effects panel regressions and propensity score matching. The results support the theoretical hypothesis. Exporting firms are found to have mostly equal or significantly lower profitability levels as compared to domestic firms within the same sector and size class. Exporters seem therefore willing to endure (temporarily) a lower profit rate in order to obtain a higher absolute profit level, since exporters have significantly higher revenue levels than domestic firms thanks to the larger market potential. Third, we analyse theoretically how a competition increase, leading to an increase in the demand elasticity and a decrease in firms' mark-ups, affects different income inequality indicators and the unemployment rate in an open economy. We use the general equilibrium framework of Egger & Kreickemeier (2012), which includes firm heterogeneity in productivity and a fair wage setting. Contrary to earlier studies, our results indicate that tougher competition increases the unemployment rate, the income inequality between profit and wage income and the Gini indexes of both wage and profit income. With relatively common parameter values, the effect of a competition increase on the mentioned indicators is found to be often bigger than the effect of an equal decrease in trade costs in percentage terms.