Consumption Smoothing and the Structure of Labor and Credit Markets

When borrowing is limited by possible insolvency, a higher lower bound for future income affords earlier consumption and higher welfare. Limited opportunities for consumption smoothing also imply that prospects of upward income mobility have smaller beneficial effects for workers whose labor income is temporarily low. These simple theoretical insights are consistent with the empirically more pronounced tendency of poor would-borrowers to favor government redistribution in countries where consumer credit is relatively scarce. They also offer a rationale for observed patterns of institutional covariation. In countries where inefficient legal systems restrict borrowing opportunities, policies that reduce the dispersion and volatility of labor income alleviate credit constraints. Empirical support for this proposition offers more general insights as to ways in which historically determined features and politico-economic interactions may jointly shape institutional aspects of different markets, and as to appropriate design of reform processes