How Credit Markets Substitute for Welfare States and Influence Social Policy Preferences: Evidence from US States

Abstract

AbstractWhat is the relationship between debt and the welfare state? Recent arguments suggest that credit markets fill gaps left by limited social benefits but often rest on thin empirical grounds. This article makes two contributions to this debate by using micro-level panel data and leveraging variation in welfare state generosity across US states and over time. First, it shows that households that experience unemployment borrow significantly more in states where unemployment benefits are low compared to states where benefits are high. A 10-percentage-point decrease in unemployment replacement rates increases debt levels by about 30 per cent, or $5,300. Secondly, the article documents that rising indebtedness in the context of weak social policies has political consequences and increases support for a stronger safety net. One explanation is that voters seek social protection against downstream debt-induced economic risks. These findings suggest that welfare states can play a critical role in mitigating growing indebtedness.