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Does Unemployment Steer Personal and Corporate Bankruptcies?

H. Platt, M. Platt and S. Demirkan

Review of Business and Economic Literature, 2011, vol. 56, issue 1, 52-73

Abstract: When companies fail, workers lose their jobs which raises the unemployment rate and some displaced workers with less financial wealth, larger financial obligations, and who are the sole bread winners in a family become likely candidates for a personal bankruptcy filing. The central role played by the unemployment rate in this nexus of decline – unemployment, corporate bankruptcy, and personal bankruptcy – is not well understood. This knowledge is critically important to policy makers seeking to predict when a weakened economy will emerge from the throes of an infectious cycle of economic despair. This paper documents a strong positive relationship between unemployment, personal bankruptcy and corporate bankruptcy. The relationship between unemployment and bankruptcy is contemporaneous with respect to consumer bankruptcies but is both contemporaneous and lagged with respect to business bankruptcies. That is, business bankruptcies are related to lagged unemployment while personal bankruptcies are related to the current unemployment rate. Unemployment’s lagged impact on business bankruptcies may result from consumer spending being slow to respond to changes in family circumstances similar to Duesenberry’s (1949) relative income hypothesis. In contrast, a rise in the current unemployment rate caused by people losing their jobs and income leads directly to personal bankruptcies. The three way relationship is tested with state level data in a 19 year panel study with coefficient estimates derived from OLS, 2SLS and 3SLS regressions. After controlling for other factors such as GDP, employment levels, and aggregate financial state variables, a 10% increase in current unemployment is found to increase corporate bankruptcies by 23.2%, while a 10% increase in lagged unemployment leads to a 4.6% increase in corporate bankruptcies. Similarly, a 10% increase in the current unemployment rate increases personal bankruptcies by 14.4%. These high elasticity values result from the extraordinary volatility in the two bankruptcy rates. Further, a 10% increase in the corporate bankruptcy rate increases personal bankruptcies by 2.2%, while a 10% increase in personal bankruptcies increases corporate bankruptcies by 7.8% and the unemployment rate by 0.4%. These results clearly demonstrate that the three rates are positively related and should be considered together when designing economic or social policy.

Date: 2011
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