The impact of welfare on household debt

Abstract

Abstract This article aims to advance the theoretical understanding of how welfare affects household needs and willingness to take on debt across OECD countries. Previous sociological literature has attempted to explain indebtedness through the quantity of welfare spending, by searching for a tradeoff between the lack of welfare and the increase of household debt. Based on the “life cycle” hypothesis, according to which people take on debt when they are younger and pay it off as they age, this paper argues that divergence in household debt across countries is a function of the welfare state’s orientation toward old-age provisions and the insider/outsider cleavage in the labor market. A welfare state that is generous toward the youth, facilitates the possibility for people to plan ahead in life and, by stabilizing financial expectations, makes people less risk averse. Higher debt ratios are more common in Northern countries as social protection is more extensive; while in continental countries, where welfare benefits are narrower and tend to target the already employed and the elderly, people are more risk-averse toward debt. The proposed theory is supported by an illustrative empirical analysis using data from the OECD SOCX, the Comparative Welfare Entitlements Dataset (CWED2) and the ECRI statistical package.