Working Paper: NBER ID: w25005
Authors: Dean Corbae; Andrew Glover
Abstract: We develop a framework to understand pre-employment credit screening through adverse selection in labor and credit markets. Workers differ in an unobservable characteristic that induces a positive correlation between labor productivity and repayment rates in credit markets. Firms therefore prefer to hire workers with good credit because it correlates with high productivity. A poverty trap may arise, in which an unemployed worker with poor credit has a low job finding rate, but cannot improve her credit without a job. In our calibrated economy, this manifests as a large and persistent wage loss from default, equivalent to 2.3% per month over ten years. Banning employer credit checks eliminates the poverty trap, but pools job seekers and reduces matching efficiency: average unemployment duration rises by 13% for the most productive workers after employers are banned from using credit histories to screen potential hires.
Keywords: pre-employment credit screening; labor market; poverty traps; adverse selection; matching efficiency
JEL Codes: E24; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Employer credit checks (G51) | Positive correlation between labor productivity and credit repayment rates (J24) |
| Unobservable worker characteristics (J29) | Productivity and creditworthiness (E23) |
| Poverty trap (I32) | Low job finding rates (J68) |
| Low job finding rates (J68) | Poor credit status (G51) |
| Banning employer credit checks (G28) | Elimination of poverty trap (I32) |
| Banning employer credit checks (G28) | Reduced matching efficiency in labor market (J68) |
| Poverty trap (I32) | Wage loss equivalent to 23% per month over ten years (J17) |