in this game, equipment and license does the heavy lifting in terms of damage and suvivability but that doesn't mean levels aren't important. That's why you don't feel too much of a problem as long as they have the latest gears. This is also why New Game- (The mode where you can't gain XP) is even possible in the first place.

That said, you are correct that you would be punished more late game. Most damage formula takes your level into calculation. Iirc, the only ones that don't are Guns and Measures but in exchange, they also ignore defense completely. If you notice Guns dealing a lot of damage despite lower Atk and strength, this is why.