Is there rent sharing in Italy? Evidence from employer-employee data.

• Author: Matano, Alessia
• Position: Report

1. Introduction (3)

   Competitive labour market models predict no relationship between profits and wages at firm level: firms are wage-takers and face a horizontal labour supply. Therefore, if a firm becomes more profitable there is no reason why it should pay higher wages. However, non-competitive theories, such as efficiency wages models and bargaining theories, predict that there might be a positive relationship between wages and profits. In particular, rent sharing models underline that wages result from a bargain between the employer and the employees which generates a long-run positive relationship between wages and profits. In this setting, wages are determined by workers' outside options, by quasi-rent (firm profits evaluated at the opportunity cost of labour) and by relative bargaining power of the parties involved (Hildreth and Oswald, 1997).

   The aim of this paper is to investigate the existence and the extent of rent sharing in Italy. We make use of a unique employer-employee database from 1996 to 2003, constructed by merging the INPS employer-employee database with the AIDA database, which contains information on the balance sheet of capital-owned firms. As a result of this merger, we are forced to restrict our analysis to this type of firm. We estimate a wage equation that includes the quasi-rent variable, which is the proxy for rent sharing. We also take into account several issues that have been proved to be relevant in order to get reliable estimates of rent sharing (Martins, 2009). More specifically, we control for the correlation between profits and workers' unobserved heterogeneity as well as for firm characteristics and for the endogeneity between profits and wages. Moreover, our data take into account the fact that wage setting in Italy is the outcome of bargaining at two different levels: a first centralized (national) level where minimum wages for all occupations are set in all industries (with even more than a national contract for the same industry); a second decentralized level where the employer and employees (or unions at firm level) bargain the wages over the constraints imposed by national contracts. Therefore, we introduce in our estimation dummies that controls for the type of national contract applied to each worker. This turns out to be a more reliable and accurate measure for the first level of bargaining with respect to using industry dummies, as usually done in the empirical literature, since the national bargaining occurs at the national contract level and not at the industry level.

   The starting point of our empirical strategy is to use ordinary least squares (OLS) estimates, deriving an elasticity of wages with respect to quasi-rents per employee of around 6.8%, with a Lester range of 27%. After controlling for the first level of bargaining there is still a substantial role for rent sharing at the firm level: coefficient estimates are in fact reduced to around 15%, a finding in line with Arai (2003) and Arai and Heyman (2001) who point out that most of rent sharing takes place at firm level.

   We then move to the fixed effect estimates to control for individual unobserved heterogeneity. We find out that the sorting of high-ability workers into high-profit firms plays a substantial role (see Card, Devicienti and Maida, 2010, Arai and Heyman, 2001, Margolis and Salvanes, 2001, Martins, 2009), since estimates are significantly reduced.

   Finally, we take into account endogeneity issues, by applying IV estimates: we derive an elasticity of wages with respect to profits of 6% with a "Lester" range of variation in wages between unprofitable and profitable firm of 24% (4). We also look at the impact of quasi-rents on wages across several dimensions (gender, occupation, macroarea and economic activity) pointing out that the degree of rent sharing is strongly heterogeneous. In particular, we show that rent sharing is higher for males than for females, for white collars than for blue collars, in the service sector compared to manufacturing, and in the Southern regions.

   The structure of the paper is as follows. In Section 2 we review the theoretical as well as the empirical literature concerning the relationship between profits and wages. In Section 3 we describe the data we use throughout the empirical analyses. Section 4 discusses the empirical specification and presents the main results. Section 5 concludes.

2. Related Literature

   Standard competitive theories predict that there is no relationship between wages and profits at firm level, since wages are determined by labour market conditions and firms have no incentives to pay wages over the level set in the labour market. However, non-competitive theories underline that such a relationship can actually exists, i.e. that firms may indeed pay a wage over the level set in the labour market. This can occur for different reasons. For instance, it is possible that firms pay higher wages than those set in the competitive labour market due to efficiency wage arguments (see Shapiro and Stiglitz, 1984, Krueger and Summers, 1988). Also, according to bargaining theories, profits and wages can move together since employer and employee bargain on wages. More specifically, in a bargaining framework, wages at firm level are determined by workers' outside options, by the quasi-rent (firm profits evaluated at the opportunity cost of labour) and by the relative bargaining power of the parties involved (Hildreth and Oswald, 1997). (5)

   As for the empirical evidence, many works studied the existence and the extent of rent sharing in different countries, using various methodologies and data at different levels. Hildreth and Oswald (1997) and Blanchflower, Oswald and Sanfey (1996) -by using respectively firm level (for UK) and industry level data matched with individual data (for US)-provide evidence in favour of an important positive relationships between profits and wages, controlling for observed work heterogeneity and firm characteristics and applying GMM techniques (or using lagged values of profits) to control for the endogeneity of profits.

   Other papers used instrumental variables techniques to control for the endogeneity of profits, while using firm level data to take into account firm heterogeneity. For instance Abowd and Lemieux (1993), in the case of Canada, use instruments related to the international performance, namely the industry import and export prices, finding a very large degree of underestimation in the extent of rent sharing when not controlling for the endogeneity between profits and wages. Van Reenen (1996) analyzes the case of the UK using different measures for profits (net profits per head, quasi-rents and Tobin Q), and past innovations as instruments. His findings suggest a substantial amount of rent sharing in UK, and a severe underestimation when not controlling for endogeneity.

   More recently, various papers have made use of matched employer-employee panel data in order to control for the unobserved worker heterogeneity. Margolis and Salvanes (2001) investigate the case of France and Norway. They apply IV techniques using as instruments sales and operating subsidies, finding relevant rent sharing only in the case of Norway. For the case of France they show that when taking into account the unobserved individual characteristics in the IV estimation, rent sharing estimates turn out to be not significant. Similarly, using employer-employee data Arai (2003) analyzes the case of Sweden. He uses time-average of lagged values of profits and controls for observable firm characteristics to check the relevance of both the rent sharing and of other theories (based on efficiency wages and short-run labour market frictions). He finds robust evidence of rent sharing in line with bargaining theories, which does not differ across different worker categories. (6) In another related paper Arai and Heyman (2001) make use of a larger employer-employee matched dataset and apply instrumental variable techniques. They use different instruments such as lagged values of profits, demand elasticity (based on predicted response in sales due to higher prices) and measures indicating the degree of competition in the product market. Their findings confirm that rent sharing is underestimated when not controlling for endogeneity and greater estimates are provided when demand elasticity is used as instrument. Furthermore, they point out that white collar workers extract higher rents than blue collar.

   Another interesting related paper is Guertzgen (2009), which focuses on how rent sharing is affected by the different levels of bargaining in Germany, using firm-worker level...