The Ripple Effect of an Uneven Credit Market

And for the roughly 24 million Americans and 27 million Europeans who rely on temporary work, that reality is often more distant still. Temporary workers not only face more income uncertainty than people who have permanent jobs but also have a very different experience in trying to get credit, says David Matsa, a professor of finance at the Kellogg School.

Lenders in the U.S. frequently rely on workers’ employer-paid W-2 income to determine if they qualify for financing. Since temporary workers are independent contractors who don’t receive reliable, W-2 income, banks view them as riskier borrowers than permanent workers. As a result, access to credit is harder to come by.

“The big picture is that this dual labor market [of temporary and permanent workers] begets a dual credit market,” says Matsa, who collaborated with Brian Melzer of Dartmouth College and Michal Zator of the University of Notre Dame to study this phenomenon in the U.S. and Europe.

In comparing the household finances and spending of people who have temporary versus permanent jobs, the researchers find that temporary workers are more likely not to apply for a loan or credit due to fear of rejection, while those who do apply are more likely to be denied. Moreover, because of their reduced access to credit, temporary workers are significantly less likely to make purchases that are typically financed, like a home or car.

And the impact is even more pronounced on young temporary workers, who are also less likely to live in their own place, less likely to be married, and less likely to have children than permanent workers with a similar background.

“Temporary work tends to be concentrated among younger workers, and younger workers are the ones for whom credit access can be so valuable,” Matsa says. “So to an extent, we’re transferring that credit access from people who need it to people who don’t.”

Less creditworthy

Though the dual labor markets in Europe and the U.S. differ somewhat, permanent jobs in both provide more stability than temporary jobs.

In many European countries, there are strong labor protections that make it difficult for employers to fire permanent workers without cause. These protections are less common in the U.S., though permanent workers in the U.S. still tend to benefit from more income security than temporary workers.

Matsa, Melzer, and Zator turned to household survey data to better understand how these differences in job and income security might be affecting workers’ finances.

They examined workers’ employment, purchase, and credit history in more than 20 European countries between 2009 and 2018, along with information on employment and homeownership from the U.S. Bureau of Labor Statistics in selected years between 1995 and 2017. The large dataset allowed them to compare permanent and temporary workers who otherwise had similar backgrounds, including the same gender, immigrant status, age, occupation, education, and income percentile.

Across nearly all occupations, the researchers find that the risk of job loss is roughly twice as high for temporary workers as it is for permanent workers. This job insecurity, in turn, negatively affects temporary workers’ chances of securing credit.

“The biggest difference between temporary and permanent work is job security,” Matsa says. “And since temporary workers have much less stable incomes, that—from the lender’s perspective—makes them less creditworthy.”

Income uncertainty

Indeed, the research also shows that temporary workers are less likely than permanent workers to get credit (by 2.3 percentage points); more likely to withhold their credit application due to fear of rejection (by 3.0 percentage points); and more likely to have their application rejected (by 4.1 percentage points).

Temporary workers are also 30 percent less likely to purchase a home (a decrease of 1.3 percentage points compared with permanent workers), and on average, the vehicles they buy are about 16 percent cheaper and the cars they own are worth about 30 percent less.

These trends are especially marked in occupations where the chance that someone might lose their job varies widely, like agricultural labor or food preparation. Temporary workers in these fields have a greater chance of getting their mortgage applications rejected (by 2.4 percentage points) than temporary workers in occupations with a more-consistent job-loss risk like teaching.

“Rejection rates are particularly high in occupations where it’s harder for the lender to know who’s a good credit risk and who’s a bad credit risk,” Matsa says. Lenders feel more comfortable about giving credit “if you have an occupation where everyone has about the same amount of unemployment risk, because even if it’s risky, the lender at least knows how risky it is and can set the interest rate accordingly.”

From temp to permanent

The researchers also followed the experiences of thousands of workers in Italy, Spain, and the Netherlands who transitioned from a temporary to a permanent job, or vice versa. They sought to understand how the transition might affect these workers’ ability to borrow money and purchase a home over the course of several years.

They find that the same workers’ credit applications are rejected less often when their job is permanent than when it’s temporary. Within the first two years, the research shows, people who transition from a temporary to a permanent job are significantly more likely to become a homeowner than they were before.

“It seems that even when you’re looking at the same person, you see the effects of income uncertainty,” Matsa says.

An unintended cost

The findings point to the unintended consequences of a system designed to prop up one type of worker more than the rest.

The case of 25-to-35-year-olds in Europe paints a clear picture. The research shows that countries that have a higher proportion of these younger temporary workers (10 percentage points more than another country does) have a lower proportion of younger to older workers who live on their own (by 5.7 percentage points), who are married (by 3.7 percentage points), and who have children (by 4.9 percentage points).

That’s not to say that labor protections set up by the government, or the income security provided by employers, are necessarily bad. Nor is it necessarily the case “that the credit market is the villain,” Matsa says. These practices are designed to increase job security and income stability for at least some workers, as well as reduce the amount of risk taken up by lenders.

“And yet if there are strong labor-market protections for only some workers, then all the risk is going to be concentrated on the workers without those protections,” he says. “Employment protection goes a long way toward getting households access to the credit they need, making them less likely to get rejected for a loan, more likely to get a lower interest rate, and more likely to be a home buyer.”

“But without these protections,” he adds, “workers on temporary contracts—many of them young adults trying to launch their careers—bear all of the risk and struggle to obtain credit and establish their financial independence.”

Ultimately, he says, “the onus is on policymakers to understand what the impact on these households is going to be when they set up labor-market regulations.”