RDP 2007-05: Labour Force Participation and Household Debt 7. Conclusions

This paper examines the extent to which rising household indebtedness has led to higher labour force participation among prime-age Australians. Data from the HILDA Survey are used as it contains recent and detailed data on household wealth along with extensive labour market and demographic data.

A cross-section probit model is estimated using detailed measures of household debt and assets. In addition, a panel model, using only measures of owner-occupied housing debt and assets, is estimated over 2001–2005. The panel results suggest that accounting for unobserved heterogeneity across individuals is important when examining the influence of debt on labour supply.

The potential two-way relationship between debt and labour supply is investigated using an instrumental variables approach as the identification strategy. The tests suggest that, statistically, debt is exogenous to current labour force participation. However, the results generally suggest that indebtedness increases the probability of participating in the labour force, particularly as households have a commitment to meet the ongoing servicing obligation of that debt. Despite the finding of statistical significance, the size of the estimated effect of debt on participation depends on the characteristics of the individuals being considered. The results suggest larger effects for women with young children than those without, and much smaller effects again for men. This ordering mirrors generally accepted conceptions of these groups' respective attachment to the labour force.

While the marginal effects appear modest, it is important to remember that large, discrete changes in debt holdings are not uncommon, for example, those associated with the purchase of a new home. This means that the predicted probabilities (as presented in Section 6) are likely to provide a more meaningful guide than marginal effect estimates. For example, these results suggest that a woman with young children who purchases a $200,000 home and takes on a commensurate amount of debt will have a propensity to participate that is, on average, 3.3–6.2 percentage points higher than the same woman without debt.