Firms and Inequality in Latin America

• Examines the connection between firms and inequality in Latin America
• Focuses on core facts of this relationship

Key Points

• There's an extreme prevalence of small businesses with owners and workers in the bottom income brackets
• These businesses aren't likely to improve productivity or hire more workers for better pay
• The region is short on employment from small and medium-sized enterprises (SMEs) when compared to larger corporations and microbusinesses
• Microbusinesses tend to pay low incomes to owners and workers while larger corporations tend to pay high wages but show low labor shares

Global Context

• Superstar firms are growing rapidly and taking large market share, increasing income for shareholders
• Since 1990, the richest have increased their share of income/wealth while the labor share of national income has decreased and average market power has increased

Skewed Business Distribution in Latin America

• Latin America stands out due to its skewed market structures by number of workers
• Employment creation is concentrated in businesses with under 10 employees
• Around half of workers in this segment are self-employed, working alone
• Around 70% of the regions workforce stands in these business sizes
• High income economies have less than 30% employed in the same business sizes, where employment occurs at firms with 10 or more employees

Business Size and Inequality

• Earning strongly correlates to the size of the business
• Only 3% of the bottom decile work in businesses with 10+ employees
• 55% of the top earners work at firms with more than 10 employees

Employment Distribution

• Latin American economies have fewer workers in businesses with 10-50 employees than expected by their level of development
• There's more self-employment than economies with similar GDP per capita
• The employment distribution is U-shaped of businesses below 10, and above 50-100 employees, with less in the intermediate sizes
• The largest firms are thinner than in advanced economies
• Firms employing over 50 people account for 20% in Latin America compared to 60% in the U.S and over 40% in the EU

Firm-Level Data

• Show smaller businesses are prevalent but miss a large proportion of economic activity
• Data coverage varies across countries
• The Mexican Economic Census covers all productive units, however the census only shows 50% of total workers in the economy

Prevalence of Small Businesses

• Worker related evidence confirms small businesses prevalence across regions
• Over 85% of formal firms in Brazil have up to 10 employees
• 76.2% of all formal firms stand in Mexico

Informal Firms

• Most informal firms concentrate in small sizes, 93% employ less than 10 people
• There is still a mass of informal firms, over 6 thousand of them, declaring more than 101 employees

Firm Dynamics

• Concentrated firms in small sizes suggest slow growth
• Firms in Brazil and Mexico experience growth over their life cycle with a flat growth after 4 years
• Firms in the Latin American countries grow significantly less than those in the US with Colombian firms showing the flattest growth
• Colombian plants aged 5-9 years are 8% larger than those between 0-4 years old, where the US equivalency is around 100%
• Indian firms have more drastic growth, with growth on average near zero

Entry and Exit Rates

• Entry and exit rates and transition rates to over ten employees from less than 10 for plants in Colombia vs the US vary greatly
• All these rates tend to be substantially larger in the US compared to Colombia.
• Exit rate of plants under 10 employees is almost 13x larger in the US than in Colombia
• Decreasing from over 10 to less than 10 employees is similar between the two countries
• Less plants enter business in Colombia, and the plants don't grow as much
• It's also less likely they grow to be larger than a micro category and unlikely they exit business once established

Earnings vs. Business Size

• Alvarez et al (2018) shows that most of the wage inequality reduction in Brazil is related to between-firm inequality
• The link between firm size and inequality in Latin America is largely tied to working own-account or in microbusinesses with low earnings

Quintiles of Earnings

• Calculations showing Brazil, Chile, Colombia, Costa Rica, Mexico, Peru and Uruguay percentages of self-employed workers
• Workers in businesses under five employees decrease between the lowest and highest earning percentiles, quintiles
• The percentage of workers at +5 employee businesses is higher among high wage earners
• The bottom two quintiles have people in the 30%-40% range, where they likely belong to households below the poverty line

Influence of Business Size

• The WID is used to correct the weight of individuals who tend to underestimate
• Likelihood of being an owner or worker at firms with 10+ employees is higher for those at the top of the earnings distribution in all regions
• Self-employment absorbs more workers than microenterprises
• Likelihood of working at +10 employees increases more slowly along the income distribution
• The likelihood of being a business owner of an employee is higher among those with high earnings in Latin America

Earnings and Firm Size

• Average earnings (PPP dollars of 2019) for people working at businesses with differently sizes
• People whose income generates from a 50+ employee firm earn an average of 691 USD more than self-employed

Factors explaining Gaps

• Gaps don't change when comparing factors of age group, gender, years of education, and sector of employment
• The largest change happens when controlling for education
• This also reduces estimated earnings gap between those at 50+ employees firms and smaller businesses
• The income distribution trends mimic the business size distribution with the heavy bottom tail

Wages of Salaried Workers

• Shows the patterns change using data on salary employees
• The differentials in average worker earnings across business sizes are persistent
• Employees who generate their income at firms with 50+ employees earn $708 (PPP) more than those working at firms with 1-4 employees
• Schooling is a personal characteristic that weighs into these gaps
• The size of the business remains a key explanatory factor

Impact of Inequality

• Documented inequality in firm size has first-order effects on wage inequality, even with conditioning on formal firms and workers
• The results reinforce importance of firm size distribution and firm growth (or lack of) when trying to understand wage inequality in developing countries
• Lower labor shares are exhibited despite LATAM firms paying higher wages
• Labor shares tend to be higher in less concentrated markets

Market Concentration

• Market concentration can make exercising market power easily linked to social and political power
• Market concentration increase is linked to increases of actual productivity by the dominate firm

Latin American Market Structure

• Market structure matters for high inequality, low productivity and poor economic growth
• The top of business size distribution market concentration is as big of a concern as in the developing world
• High market power and significant family ownership concentrates rents into a few hands
• The region has large share of workforce employed in firms with less than 5 workers or are self-employed
• Data shows earnings are explained more by business where people earn a salary, versus workers personal characteristics
• Latin Americans work in low-productivity working arrangements, causing the developed administration records to characterize inequality and business performance to return with incomplete results, ignoring the massive left tail distributions