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November 06, 2007



I don't see how to distinguish usury laws from any other nanny-statism, and on principle I can't support them. That said, perhaps other initiatives might achieve the same thing without imposing a semi-arbitrary interest-rate limit on everyone regardless of circumstances.

As Nathan points out, present and past selves do take steps to "tie the hands" of future selves, girding against temptation. This is just one end of a spectrum of self-construction* that also includes inculcating in ourselves an aversion to what formerly tempted. Is there some program the government (or better, some private entity) could offer individuals that would allow a person to bind their finances in a way that allows them to respond to emergencies and opportunities but makes profligacy difficult? Probably, though I haven't anything more comprehensive than things that already exist like IRAs, mutual funds and so on. Perhaps the best thing to do would to just lower the barriers to entering into the existing methods. This might cause something of an investment bubble, though I doubt it because the US can afford to increase its savings rates more than most of the developed world.

As an aside, discounting the future makes a good bit of sense, because the future is so uncertain. I would be willing to bet that the less secure a person feels in their prospects, the greater the discount will be. Even in the best of times, one has more information regarding one's current goals than the goals of one's future self. It's a little like the basic argument against a command economy even in a nation of angels: no one knows one's needs as well as that individual, and attempts to allocate goods from the outside are almost always doomed to be less efficient.

Also, some people know their time is almost up. If they have a low bequeathment value**, their discount on the future must be quite high. Really, for economic systems to be stably efficient over the long run, either lifespans must be indefinite, or society must intrude*** on the freedoms of the elderly. I prefer the former solution, of course.

*That is, our ongoing project of making ourselves into what we wish to be - a project that is never finished and on which we sometimes make negative progress. I take this way of thinking from Dennett's "Elbow Room" - specifically the chapter "Could Have Done Otherwise" - my favorite chapter of anything of all time.

**High bequeathment values are just altruism, and a system that relies on altruism to maintain efficiency is already broken.

***Is there a way for an intrusive society (I'm including government under the "society" rubric) to be stable over the long run? I find that dubious.

Nathan Smith

Usury laws would seem to be a form of nanny-statism, and if people do have time-inconsistent discounting and limited self-control, so that well-designed usury laws can improve welfare, they become a test case of the rationale for the libertarian model of the state. If you support libertarian principles on *utilitarian* grounds, you either have to prove that usury laws are not welfare-improving, or else make this an exception to libertarian principles. If you support libertarian principles on deontological grounds, you might say that no one has a right to prevent consenting parties to enter into usurious contracts, even if it is welfare-improving; in this case, allowing the naive to be exploited by unscrupulous loan sharks is part of the price you pay for doing the right thing.

You might also make a sort of mixed deontological/utilitarian argument, as follows. Suppose that a usury laws set some maximum interest rate, r-max, and prohibit private agents from lending or borrowing at higher rates. Further suppose that if r-max is chosen in a certain range, say over 20%, the usury law will be welfare-enhancing, with any negative effect on entrepreneurship more than offset by the positive effect on the personal finances of the naive. If, however, r-max is less than 20%, the harms to entrepreneurship and commerce will be greater than the beneficial effect on personal financial discipline, and the the usury law will be, on balance, welfare-reducing. Some optimum, r-max*, would probably exist, somewhere above 20%, where the excess of benefits from discipline over harms from suppressed commerce would be greatest.

Now, further suppose that the society can choose to recognize freedom of lending contracts as a fundamental right or not. If it recognizes the right, then any usury law is reckoned inadmissible. If it does not recognize the right, usury laws will be passed, and r-max will be chosen in the political arena and ultimately determined by the median voter. Possibly the median voter will desire an r-max lower than 20%, either because the median voter just doesn't understand economics, or because he somehow benefits from the redistributive effects of financial repression. For example, a middle-class median voter might be a borrower with reputational capital; if borrowers can't compete by bidding up the interest rate, lenders will prefer middle-class borrowers to lower-class borrowers with poorer reputations, and the median voter will pay lower interest rates than he would.

In this case, one might support the right to lend and borrow freely, because even though a good usury law would benefit society, the political machinery will set rates in a harmful way. Rights are a way of taking power out of the hands of agents who will abuse it. There is perhaps some historical support for this: medieval usury laws, or contemporary Islamic fatwas on finance, certainly seem to do more harm than good. It's less obvious that US usury laws do net harm.

In any case, the moral issue changes if we're talking about a *religious* usury law, in a society where religion lacks coercive powers-- an interesting question for contemporary Islam or perhaps Catholicism. Churches have means of altering behavior that do not violate libertarian scruples about coercion. A Christian citizen might hold, for example, that one who lends at 20% should face no legal penalty, but should be excommunicated from the church. A church might want to set guidelines for its members' economic life, in the interests of deterring them from sin. If an entire society is dominated by a single faith, or if the various faiths that a citizenry adheres to are in agreement, religious usury laws, though not binding from the point of view of the civil power, might shape credit markets. Why borrow from an atheist moneylender at 20% if you can borrow from a Methodist moneylender at 10% because his religion forbids him to ask more? Does all this speculation actually describe the historical situations in which usury laws were relevant? I'm not sure, but it would be interesting to investigate further.


"One might support the right to lend and borrow freely, because even though a good usury law would benefit society, the political machinery will set rates in a harmful way. Rights are a way of taking power out of the hands of agents who will abuse it."

Just so. I do not think that in all cases people will do better for themselves than some panel of experts (or whomever) would do for them. Rather, I think that circumstances in which outside agents control the action of the individual in a non-dynamic manner are always unstable, inefficient, or both. There's too much incentive for the experts to make recommendations benefiting themselves or their political backers, and methods to "control" those experts frequently end up producing lame rules.

As a practical matter, however, I have equivocated. I certainly support violations of libertarian principles* in the world-as-it-is, but always with the recognition that violations create precedents and invite more of the same (which might not be so beneficial in any calculus). We should estimate the return on their violation should be, in my opinion, quite high before we support said violation.

*It may be relevant to point out that sophisticated utilitarianism can look very deontological.

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