Friday, August 12, 2011

Does usury exist?

Dan Lemire writes:
What is usury? Lending money knowing that it will make people poorer... 
Economists who expect people to be rational won’t believe in usury. Surely, people borrow money to be better off. Yet the average credit card debt per household is over $15,000 in the USA (and it grows all the time, of course). Does anyone believe that these $15,000 are invested in highly profitable ventures? (They would need to be highly profitable since credit cards often charge over 15% for loans.) 
...can anyone convince me that credit card companies produce wealth by charging exorbitant interests to people who use the money to buy beer and chips? 
First, as a pure matter of tone, I'm going to interpret "economists who expect people to be rational" not as "economists, who expect people to be rational," but rather as "the subset of economists who expect real people to actually be rational."  And by way of preterition, I'm not going to make any comment about the difference between a useful model and actually believing something literally about the real world, or about the variously constraining definitions of rationality and whether the aforementioned subset is even nonempty under the definition that noneconomists typically have in mind when they talk about economic rationality.  Instead, we will charge ahead and leave the question of whether economists are delusional fools to another day.

Now, accepting this definition of usury, the first step is to be careful about what it means to make someone "poorer."  Dan is taking "poorer" to mean something like "lower present value of wealth with respect to whatever interest rate," so that borrowing at 15% makes you poorer unless you're taking that borrowed money and investing it in another project with an even higher return.  But if that's poorer, then forget borrowing at 15% --- consuming makes you poorer!  It's fine to use "poorer" in this way, but then you don't get to equate "poorer" with "worse off."  A rational person's allegiance is to making himself better off, not maximizing his bank account!  (Rational people consume, of course).

By contrast, economists might take "poorer" to directly mean "worse off," i.e. having access to less desirable consumption bundles.  But then borrowing at 15% doesn't necessarily make you poorer.  It gives you access to fewer bundles tomorrow, but more today.  If you want the extra consumption today more than the foregone consumption tomorrow, you are not poorer for borrowing to enable that consumption pattern.

Upcoming, a few ways to complete the story. Perhaps -- for a special reason I will soon make clear -- the same consumption bundles are not offered over time, in which case people could simply prefer the consumption bundles offered today to the ones offered tomorrow.  Or perhaps the bundles are constant over time but there is something going on with their time preferences that makes them prefer to consume a lot up front.


  1. Or, possibly, the people in question prefer more consumption today, today, but will tomorrow regret the lower consumption that they experience, and wish they had chosen differently. I think I'm essentially saying that rationality isn't such a good assumption.

  2. Robert, I believe that will fall under the header of "something going on with time preferences." I'm particularly sympathetic to your claim, as you will see when we get to the topic of time preferences. (The post is already written, and will come out in a couple days.)