It doesn't always work out that way.
Even a well-intentioned usury law has the unintended consequence that poorer, smaller, less well connected people find it harder to get credit. And it benefits richer, well-connected incumbents, by keeping down the rates they pay, and by stifling upstarts' competition for their businesses. Toby and Effi present a powerful case that this is what happened in 19th century America.
I like this paper also for a deeper methodological reason. Cause and effect are devilishly hard to distinguish in economics. We have many fewer good instruments or "natural experiments" than we would like. Toby and Effi build a strong case for cause and effect with patient and exhaustive circumstantial evidence. I can't cover all that in a blog post, but it's good to look for it in the paper.
Here are just a few of the fun facts.
- Tighter usury laws led to less credit. People didn't easily get around them.
- Tighter usury laws led to slower growth. A one percentage point lower rate ceiling translates in to 4-6% less economic growth over the next decade.
- Usury laws only affect the growth of small firms. Big firms do fine.
- Usury laws relax in financial crises, when all interest rates spke and even well-connected borrowers are starting to be affected.
- Usury laws are stronger in states where voting is restricted to wealthy people. It's also stronger in states with other restrictions on competition such as restricted incorporation laws
- Usury laws are relaxed when there are more newspapers, and when those newspapers are more active an challenging politics and corruption.
Now let's think about our massive financial regulation and consumer financial "protection." Let's guess who will end up benefiting...
While i'm sure you're sick of stimulus related things, there's an interesting new paper by Valerie Ramey:
ReplyDeletehttp://weber.ucsd.edu/~vramey/research/NBER_Fiscal.pdf
Too Long Didn't Care to Scan: Government spending shocks tend to depress private spending, of course implying fiscal multipliers towards the left side of her previous reasonable range of .8-1.5 multipliers.
Okay, I stole the link from MR.
I agree that there is definitely some financial regulation that has unintended consequences by driving up interest rates.
ReplyDeleteTo be fair though, not all financial regulation might have this effect. For instance, regulation that tries to ensure that consumers are sold the financial products that are fitting for them, and tries to minimize the incentives of financial advisors to advize the wrong products. For instance by limiting payments from the producers of financial products to financial advisors. Marco Ottaviani has an interesting paper on this:
http://www.kellogg.northwestern.edu/Faculty/ottaviani/homepage/Papers/pay%20for%20advice.pdf
I don't immediately see the adverse effects that such a policy would have on credit rationing of new entrants.
Friendly regards,
Mark Dijkstra (University of Amsterdam)
Sounds interesting, will read the paper. Another example of the Law of Unintended Consequences, even when the law has excellent intentions. Rent control comes to mind.
ReplyDeleteCoincidentally, the Wall Street Journal has an editorial today (Jan 31) about President Obama bashing pay-day lenders. The President wants stricter controls on them. Following the paper's reasoning, guess who will benefit and who will not.
If usury laws relax in times of financial crisis then you would expect to see faster growth where there are relaxed usury laws just because the economy will be recovering from the crisis.
ReplyDeleteA really interesting paper covering a lot of the factors involved in differential U.S. states' growth, but hardly determinative. A little more attention to comparative levels of income would have been useful; and perhaps also some kind of price-level relationship. And, Heaven forbid whether there was any relationship between income inequality and "free" lending. In any case, in today's economy, we have to wonder whether lenders are on "strike" - not lending as a deliberate strategy to force consumer protection pull-backs.
ReplyDeleteinteresting, but may I suggest a different hypothesis from the work: The rich and powerful prefer all kinds of limits on finance, including lending, because such preserves their power and position in society.
ReplyDeleteProhibiting lending or limiting interest does not limit entrepreneurial drive or ambition, it only forces the entrepreneur to give up some part or all of ownership to wealthy partners, either silent or over or both. Look at how business is done in Muslim countries with no "lending." It is often what we would call "partnerhips."
We have the same forces at work today. Look, for example, at venture capital. There would be little or no room for venture capital if our financial markets were deregulated enough to where entrepreneurs could go directly to large number numbers of investors for direct placement of stock with limited risk and information. Why a $100,000 bank loan when Groupon could raise $100,000 for a new restaurant by selling 1000 S/H a share at 1,000 each with a 20% discount on weekday meals?
Thanks, useful info.
ReplyDeleteCoach Signature Large Ashley Sabrina Business Satchel Duffle 15440 Khaki Mahogany
Usury laws are so hard to understand, thanks for breaking them down for me. In the timeshare industry there are lot of prohibited lending and limited interests.
ReplyDelete