Why Bother? Understanding the Impact of Financial Obligations on Wage Selectivity

Approximately 80 percent of Americans have a significant financial obligation. A substantial fraction of these individuals rely almost solely on labor income to meet these needs. Using a two-period model we demonstrate that when agents are risk averse, increasing the level of financial obligation will have a differential effect on the likelihood a wage offer is accepted depending on the initial size of the obligation. Increasing financial obligations from low levels is found to reduce wage selectivity, while increasing it beyond a certain threshold reverses this effect. We test our theory using online experiments. We confirm our theoretical results in the form of a statistically significant "dip" in wage selectivity for risk averse subjects assigned moderate financial obligations. This non-monotonic effect suggests that heterogeneity in financial obligations may exacerbate income and wealth inequality through individuals' labor market decisions. Policy makers interested in distributional effects should consider this feedback mechanism when designing policies related to loan forgiveness or debt discharge.