The Ripple Effects of the Great Credit Expansion

Gordon Phillips and colleagues uncover how consumer credit impacts individuals and families.

Getting a credit card these days is, for most people, no big deal. But it wasn’t always so easy or so common. In the 1950s and ’60s, credit cards were mainly used by wealthy people who wanted to pay for goods and services at department stores and restaurants without carrying cash. At the time, women could not get a credit card without a male cosigner. That began to change in the 1970s.

Professor of Finance Gordon Phillips, the Laurence F. Whittemore Professor of Business Administration, teaches the MBA elective Venture Capital and Private Equity.

The Equal Credit Opportunity Act of 1974 prohibited discrimination against credit applicants based on gender. A cascade of improvements to credit access followed: lending markets were deregulated, interstate competition was promoted, bankruptcy laws were softened, and credit scoring was invented. All that led to the democratization of credit. In 1970, only 16 percent of U.S. households had at least one general-purpose credit card; today, it’s 77 percent.

Has the expansion of consumer credit been good for society? It depends on your perspective. “People view consumer debt as always being a negative, that it always causes problems for consumers,” says Gordon Phillips, the Laurence F. Whittemore Professor of Business Administration at Tuck. “We wanted to look at whether there are positive aspects of consumer credit. Our evidence shows that if it’s used wisely, there are a lot of benefits.”

Phillips and his longtime research colleague Kyle Herkenhoff of the University of Minnesota received a $300,000 grant from the National Science Foundation to study those benefits. Tuck also supported the research project. In a series of four research papers, Phillips and Herkenhoff use microdata from the U.S. Census along with credit data from TransUnion to uncover how consumer credit impacts families through employment, new business formation, student debt, and intergenerational mobility.

Consumer Credit Leads to More Self-Employment and Entrepreneurship
In the first paper in this series, published in The Journal of Financial Economics in 2021, Phillips and Herkenhoff examine how consumer credit affects entrepreneurship by linking three million earnings and pass-through tax records to credit reports. They find that self-employment and employer firm ownership increase along with credit limits and credit scores. And they find that, following the removal of a bankruptcy flag (which improves credit access), people are more likely to start a business and borrow extensively. Those who start new businesses with employees borrow $40,000 more after bankruptcy flag removal, compared to start-ups with a founder still in bankruptcy.  This represents a 33 percent gain relative to the sample average. 

We wanted to look at whether there are positive aspects of consumer credit. Our evidence shows that if it’s used wisely, there are a lot of benefits.
— Gordon Phillips, Professor of Finance

Consumer Credit Is a Boon to the Unemployed—And the Public Insurance System
One beneficial aspect of consumer credit is that it doesn’t really change when a consumer loses their job. Phillips and Herkenhoff used this as a starting point for their paper “Can the Unemployed Borrow? Implications for Public Insurance,” which is forthcoming in The Journal of Political Economy. In it, they find that workers do, in fact, maintain their access to credit after a layoff, and those who can borrow take advantage of their credit, using it to fill some of the gap left by their lost income. On the other hand, workers who lacked good credit access before they were unemployed take a different route when they lose their job: they default on their debt and generally deleverage themselves. Given those findings, the authors build a model of how credit access can supplement unemployment insurance. Their model shows that the level of credit lines in the U.S. is such that the government can optimally reduce unemployment transfers to the unemployed—in effect, lean on the private credit market to insure out-of-work consumers.

Consumer Credit Is Good for Job Seekers
Building on their findings about the benefits of credit for the unemployed, Phillips and Herkenhoff focused on credit’s effects on job seekers. In “How Credit Constraints Impact Job Finding Rates, Sorting & Aggregate Output,” forthcoming in The Review of Economic Studies, the authors find that people with greater access to credit markets take longer to find a better job and eventually earn more and work at more productive firms versus taking a less attractive job more quickly. They find this effect to be the strongest for the lower quartile of the wage-per-worker distribution—i.e., lower-income job seekers. Relatedly, they find that people younger than 40 are better at using credit to buy time to find higher-paying jobs. “As credit expands,” they write, “high-quality workers with credit increases find high-quality jobs.”

Credit Access Has Mixed Effects on Intergenerational Mobility and Inequality
The great credit expansion of the 1970s opened the door to the largest natural experiment on credit access in history. In their most recent working paper, “Intergenerational Mobility and Credit,” which they presented this summer at the National Bureau of Economic Research, Phillips and coauthors study two novel questions about that expansion. First, to what extent—and through what channels—does parental credit access affect the future earnings of children? And second, how has credit expansion impacted earnings inequality and mobility? To answer those questions, the authors combined the Decennial Census, credit reports, and administrative earnings records to create the first panel dataset linking parental credit access to the labor-market outcomes of children in the U.S. 

As credit expands, high-quality workers with credit increases find high-quality jobs.

In general, they find that children have better job and wage outcomes when their parents have more credit. For example, a 10 percent increase in parental unused revolving credit during their children’s adolescence is associated with 0.28 percent to 0.37 percent greater labor earnings of their children during early adulthood, regardless of the educational attainment of the child or parent. Moreover, they find that increased parental credit access is associated with their children having higher rates of college graduation, fewer nonemployment spells, and a greater likelihood of working at higher-paying firms. 

Surprisingly, credit expansion has not been good for intergenerational mobility and inequality. As the authors find, this is because the decreased bankruptcy costs of the credit expansion basically incentivized consumers to reduce their savings (who needs savings when you can use credit to fund emergencies and big-ticket items?). Bankruptcy, in turn, results in reduced investment in children’s human capital among low-income households and a broadening of income inequality and consumption inequality across a wide spectrum of consumers. 

One implication of their results is that it may benefit society to shorten the time in consumer bankruptcy from the current seven to 10 years to something shorter.  While bankruptcy may deter aggressive borrowing, it is not clear the time in consumer bankruptcy should be this long.  It would be worthwhile, Phillips says, to conduct an experiment to understand the impact of shortening the time in consumer bankruptcy after default to four to five years.

This story originally appeared in print in the winter 2024 issue of Tuck Today magazine.