Essays on credit constraints

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This dissertation includes three essays on credit constraints. The first paper, “Risk, Credit Constraints and Self Employment: Evidence from the United States”, analyzes the impact of credit constraints on self-employment. In this paper, I argue that credit constraints restrict the ability of households to borrow from the credit market for investment purposes, which establishes a barrier to the development of small-scale businesses and limits employment creation at the firm level. This study empirically examines the impact of credit constraints on households’ choice to become self-employed using data from the 2019 wave of the Survey of Consumer Finance (SCF) for the United States.

This paper contributes further by exploring the various measures of credit constraints, including the combinations of (i) applied but turned down credit applications, or not given as much credit as applied for, and (ii) did not apply because the interest rate was too high, or did not think to be approved. The results are based on the Instrumental Variable (IV) Probit model and suggest that credit constraints reduce self-employment opportunities as well as startup business activities in the United States. The findings are robust to alternate specifications of the model and proxies of key variables, i.e, rejected borrowers and discouraged borrowers. The regression results also conclude that the effect of rejected and discouraged borrowers in reducing self-employment is more than the impact of other measures of credit constraints. Further, the analysis shows that high-risk attitude households significantly prefer to be self-employed. Lastly, the industrial level impacts are evaluated to analyze household occupational choice, and the evidence shows that industrial sectors related to transportation, information service, finance, insurance, and real estate contribute significantly more to self-employment.

The second paper, “Retirement Planning under Credit Constraint: Financial Literacy in the United States”, analyzes the impact of credit constraints on retirement planning in the presence of financial literacy. This paper highlights that credit constraints restrict households from financing their investments with future labor income. In the household finance literature, this problem adversely impacts the amount saved during working life, which further limits saving for retirement. To maintain a decent standard of living during retirement, households invest in Defined Contributions (DCs) plans and Individual Retirement Accounts (IRAs). But all of these investment plans require financial knowledge and complex economic decision-making in the presence of credit constraints.

This paper uses the data of 11,000 US households from the 2020 wave of the Survey of Household Economics and Decision-making (SHED). The findings based on the Instrumental Variable (IV)-Probit approach suggest that credit constraints significantly reduce retirement planning contributions across the various specifications of the regression model. In addition, less financial literacy and more credit constraints significantly contribute to insufficient retirement planning. The results also indicate that individuals who are under 35 years old, female, and married observe more credit constraints, while it is lower among individuals with less than high school education, Asians, high-income groups, and self-employed households. The results are robust across the various specifications of the model at both national and regional levels.

The third paper, “Labor Supply as a Buffer: The Implication of Credit Constraints in the United States”, analyzes the implication of financial constraints on labor supply decisions in the United States. In contrast to the “first generation” model, modern literature recognizes the importance of labor supply decisions as a “buffer” and margin of adjustment in response to a borrowing constraint. Credit constraint-an example of an incomplete credit market has an impact not only on consumption but also on labor supply decisions and work hours. Hence, labor supply, in general, and unemployment in particular, is worsened by the friction in the credit market.

On the employee side, increasing labor supply, through participation and providing extra work hours are used as a tool to overcome the impact of credit constraints. On the employer side, the high fixed cost of training, labor mobility, and employing new workers force the employers to offer more work hours. From this perspective, this study uses the various waves of cross section data from the Survey of Consumer Finance (SCF) and analyze the impact of credit constraints on labor supply decision and work hours in the United States. This study further extends the analysis by considering the socioeconomic factors, including worker’s age and gender, marital status, and income level. The findings based on the instrumental variable least square and Probit Instrumental variable model suggests that credit constraint and its various measures encourage the households to join the labor force and increase the work hours to offset the financial constraint.

Embargo status: Restricted until 09/2027. To request the author grant access, click on the PDF link to the left.

Credit Constraint, Household Finance, Self-Employment, Retirement Planning, Labor Supply, Instrumental Variable Regression Analysis