Employer Credit Checks: Poverty Traps versus Matching Efficiency

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.