Designing Debt Restructuring: The Adverse Effects on Labor Market Outcomes

This paper examines how the design of debt restructuring or personal insolvency programs shapes labor market outcomes using Sweden as a case study. In the Swedish debt restructuring program, debt is forgiven following a 5-year partial repayment period. I estimate the causal effects of the program using an examiner instrumental variable (IV) design and show that traditional examiner IV estimates can be biased if there is path dependency in examiner decision-making. This bias is avoided by estimating examiner leniency from past cases. On average, participation in the debt restructuring program has negative effects on labor income and employment, but these findings mask a large heterogeneity. Initially employed participants experience relative gains in income and employment, while initially unemployed participants face substantial negative effects. Both of these effects persist even after the program has ended. Combining observational data and results from a survey I conducted among debt restructuring participants, I show that the risk of substantial increases in repayment obligations disincentivizes unemployed participants from seeking employment. I then calibrate a labor supply model and show that modest changes in the repayment plan structure improve welfare for both debtors and creditors. These findings challenge the practice of substantially adjusting repayment plans in debt restructuring programs in response to income changes.