Credit Access Cuts Child Labor in Developing Countries

Summary of working paper 9018
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In poor countries, a move from the 25th to the 75th percentile of access to credit is associated with a 4.2 percentage point decrease in child labor.

Child labor is a troubling phenomenon and the focus of an intense political and policy debate, with proposals ranging from legislative bans and schooling subsidies in poor countries to trade sanctions against countries where child labor exists. Now an NBER Working Paper by Rajeev Dehejia and Roberta Gatti draws attention to the relationship between child labor in poor countries and the availability of credit. In Child Labor: The Role of Income Variability and Access to Credit Across Countries (NBER Working Paper No. 9018), the researchers suggest that extending access to borrowing may be an effective way of reducing child labor in poor countries.

In 1995, according to data from the International Labor Organization (ILO), there were 120 million children engaged in full-time paid work. The incidence of child labor was 2.3 percent of the work force among countries in the upper quartile of GDP per capita and 34 percent among countries in the lowest quartile of GDP per capita. Clearly, there is an established link between child labor and poverty. However, Dehejia and Gatti ask whether specific policy proposals might help to combat child poverty, independent of the more complicated challenge of promoting higher economic growth rates.

They begin with the theoretical link between child labor and financial development. Putting children to work raises current family income, but by interfering with the development of human capital among children, it reduces families' future income. The child can make an immediate contribution to household income, but this comes with a long-term cost. In addition to schooling, the researchers note, time spent at play contributes to a child's cognitive development (and thus is an investment in the child's future.)

The key economic variable that allows households to make the optimal trade-off between current and future income is access to credit. If households can borrow against future income, they can smooth earnings shocks without sending their children to work. If they cannot borrow, parents may choose an inefficiently high level of labor for their children.

Dehejia and Gatti proceed to conduct a cross-country comparison, using the degree of development of financial markets in a country as a measure of the credit constraints that households face. (The proxy for credit constraints is the ratio of private credit issued by deposit banks to GDP. This isolates credit issued to the private sector, excluding the government and public.)

They measure the extent of child labor as the percentage of the population aged 10-14 that is working, using ILO data for 172 countries since 1962. "Working" includes work for a wage/salary in cash or in kind, as well as unpaid family work. The ILO data does not distinguish between light work and full-time work that would interfere with human capital accumulation. However, because it relies on internationally accepted definitions, it allows cross-country comparisons.

The results confirm that as the availability of credit increases the prevalence of child labor decreases. The magnitude of the estimated coefficient is small for the full sample, relative to income. However, the relationship is particularly large in the sample of poor countries that have both less developed financial markets and a higher proportion of child labor - and therefore are of the most policy interest. In poor countries, a move from the 25th to the 75th percentile of access to credit is associated with a 4.2 percentage point decrease in child labor.

Thus, access to credit plays a significant role in explaining child labor. Dehejia and Gatti also look at the question of income shocks: that is, whether families send their children to work to help them cope with negative income shocks. If credit were widely available and households could borrow to smooth income variability, then they might not disrupt their children's education or leisure time. Splitting the sample into those countries where credit is widely available and those countries where it is not, the authors find that income variability in the low credit group enters the specification significantly and the magnitude of the coefficient is substantial. In the high-credit group of countries, the effect of income volatility on child labor is very close to zero. This confirms that household access to credit dampens the impact of income variability on child labor.

-- Andrew Balls