RDP 2007-05: Labour Force Participation and Household Debt 1. Introduction

In the past decade or so there has been a substantial rise in the indebtedness and debt-servicing obligations of Australian households. This has occurred at the same time as a trend increase in labour force participation (LFP) for women and more recently for men. Microeconomic data show a clear positive correlation between indebtedness and LFP. This paper explores the role of household debt in the LFP decisions of prime-age Australian women and men. It accounts for the role of assets in offsetting the impact of higher debt burdens on labour supply. The estimation methodology also allows for the potential two-way causation between debt and labour supply.

Data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey, a panel of Australian households and individuals from 2001 to 2005, show that those with owner-occupied mortgage debt have a higher participation rate than those without (Table 1). For example, over 2001–2005, 79 per cent of women aged 36–50 years with debt participated in the labour force compared to 69 per cent of those without debt. A similar difference was apparent for men of that age group.

This paper seeks to extend our understanding of labour market decisions by considering the effect of debt and its servicing obligations on participation. Existing studies are generally framed in terms of a life-cycle model, where the statistical significance of debt in a labour supply regression can be interpreted as evidence that credit constraints bind. If credit constraints are binding, debt is expected to induce an increase in labour supply as additional labour generates additional income which can be used to relax the credit constraints. Most studies concentrate on partnered women, with a significant effect of debt on participation generally found. While this paper closely follows Fortin (1995) and Bottazzi (2004), our analysis includes tenants as well as home owners and single, as well as partnered, women. In addition, we analyse male participation. Like Bottazzi and Fortin, this paper is one of the few that assess the potential endogeneity of debt in the LFP decision.

The HILDA Survey is used to estimate separate probit models of LFP for men and women. Wave 2 of the survey – corresponding to 2002 – contains full balance sheet information on household debts and assets including owner-occupied housing, investment property and financial assets. Using these data, a cross-section is first analysed. The endogeneity of debt is considered using an instrumental variables approach exploiting available data on house prices, year of house purchase and ownership status. In contrast to earlier Australian studies, we exploit the panel data in the HILDA Survey to control for unobserved heterogeneity. In the panel, the effects of owner-occupied housing debt and assets are considered; data on non-owner occupied housing assets and debt are only available for 2002.

In line with existing studies, we find that family structure, education and health status are important determinants of LFP. Indebtedness is also found to have a significant effect on current LFP. We typically find that the debt-servicing ratio has a positive and significant effect on the probability of LFP. The effect is generally larger for women than for men. While it seems plausible that debt and LFP are jointly determined (particularly over the longer term), there is no statistical evidence that debt depends on current LFP. This may reflect the fact that borrowing decisions associated with large purchases are often re-examined only infrequently and, therefore, that they can be treated as pre-determined when making current LFP decisions.