Credit Markets Help to Reduce Child Labor

Those readers involved in consumer and mortgage credit have probably not realized (until now) that you are contributing to a reduction in child labor. The National Bureau of Economic Research has just published a study by Rajeev Dehejia and Roberta Gatti, titled Child Labor: The Role of Income Variability and Access to Credit Across Countries (NBER Working Paper No. 9018). As might be expected, the incidence of child labor varies greatly by the income of families. A worldwide study by the International Labor Organization found that in 1995 there were 120 million children engaged in full-time employment for wages. The frequency of such employment varied from 2.3 percent of the work force in the upper quartile of income to 34 percent among countries in the lowest quartile.

The authors' basic point is that, if children are forced to work to help support the family, they do not have a chance to build their own human capital. As a result, they and their children are doomed to repeat the cycle of work without increasing their human capital. However, if credit were available, it could allow children to attend school and build their human capital. In this way, the cycle of poverty leading to child labor leading to no increase in human capital perpetuating poverty would be broken.

But, there is a way to break this cycle. "The key economic variable that allows households to make the optimal trade-off between current and future income is access to credit. If households can borrow against future income, they can smooth earnings shocks without sending their children to work."

This important reason to encourage greater efficiency in credit markets (and the resulting wider access to credit) is supported by evidence closer to home. Research on U.S. income inequality has found a stubborn pass-through of low economic status from generation to generation. Studies underway at the Federal Reserve Bank of Chicago are finding that "Although the underlying factors that cause substantial (income) immobility in the U.S. remain poorly understood, some preliminary work suggests that borrowing constraints among families with low net worth may play a role in perpetuating income inequality." For example, the author suggests that families facing credit constraints may have neither the assets nor the ability to borrow against future income to invest properly in their children's education. These results are tentative, but if correct they reinforce the importance of efforts to broaden access to credit down the income spectrum. For more details see See Bhash Mazumder, "Analyzing Income Mobility Over Generations," Chicago Fed Letter, Number 181, September 2002.