still fall back into debt Given an out, people...2019/01/14 · themselves to perpetual debt by...
Transcript of still fall back into debt Given an out, people...2019/01/14 · themselves to perpetual debt by...
Understanding how people get sucked into these debt traps is an important public-policy
issue, according to Northwestern’s Dean Karlan, Chicago Booth’s Sendhil Mullainathan,
Given an out, peoplestill fall back into debtResearch finds that keeping people out of debt traps isn’t as simple aspaying off their loans
Credit: Associated Press
DEE GILL | JAN 14, 2019
SECTIONS FINANCE PUBLIC POLICY
T o the frustration of financial counselors everywhere, millions of people doom
themselves to perpetual debt by repeatedly taking out small but expensive
short-term loans they can barely afford. In the United States, these typically
come from payday or car title lenders and go to financially strapped
individuals. In developing countries, small-scale entrepreneurs rely on daily or weekly loans
for working capital. In both cases, borrowers pay exorbitant interest rates and, often,
additional fees to extend a loan over and over. Interest payments can quickly add up to
more than the loan amount.
and Harvard’s Benjamin N. Roth. They conducted a series of experiments with indebted
entrepreneurs in India and the Philippines and find that having their short-term loans paid
off took the participants out of debt only temporarily. The entrepreneurs in question quickly
took out new, profit-sapping loans.
In these experiments, completed in 2007 and 2010, the researchers provided brief financial
training to market vendors who had high-interest debt. The Indian entrepreneurs were
paying average monthly rates of 432 percent, while the Philippine borrowers averaged 13
percent in monthly interest costs, according to the study. By comparison, annual rates on
payday loans in the US range from about 390 to 780 percent (according to the nonprofit
Consumer Federation of America). The training delivered the message that borrowing from
moneylenders was far more expensive than alternatives such as reducing consumption.
The researchers then paid off the moneylender debts of some of the participants—in India,
the reduced interest was equivalent to doubling their income. The remaining participants
served as a control group. Participants completed four follow-up surveys between a month
and two years after the repayments.
Within two years, debt levels for the vendors whose debts had been paid off rose back to the
level of the control group, the researchers find. Most vendors fell back into debt within six
weeks, even though some of them generated considerably higher profits after the
repayment because their profits weren’t being eaten up by interest payments.
Financial training may have only delayed the entrepreneurs from returning to lenders,
according to the researchers. Across the board, debt relief did not affect spending habits.
The entrepreneurs with paid-off loans were no more likely to have savings after two years
than the others, Karlan, Mullainathan, and Roth report.
Poverty and scarcity affect decision making, other research finds. (See “How poverty
changes your mind-set,” Spring 2018.) Understanding the reasons behind such continued
borrowing is important for policy makers in addressing predatory lending, including high-
interest loans offered to small-scale entrepreneurs. Restrictions on such lending would not
make sense, for example, if the loans helped vendors to significantly increase their
earnings, the researchers write. In addition, if these loans save borrowers from destitution
because of unexpected bills or wage losses, improving social services might be more
helpful than outlawing lending.
Karlan et al., 2018
Some high-interest debt appeared to be
justified, such as when vendors were able to
increase profits by investing the borrowed
money in their businesses, the study finds.
However, if vendors were going to be wise
about the debt, they would have used the
new profits to get debt-free again, which
they didn’t do.
Some appeared to stay maxed out on
expensive loans because they were
repeatedly hit with financial shocks. In that
case, the research indicates, making a one-
time payoff simply enabled more borrowing.
Karlan, Mullainathan, and Roth suggest that
a better understanding of how vendors
spend borrowed funds is needed to craft
policies that might prevent these debt
cycles.
© 2019 CHICAGO BOOTH REVIEW. ALL RIGHTS RESERVED
WORKS CITED
Dean Karlan, Sendhil Mullainathan, and Benjamin N. Roth, “Debt Traps? Market Vendors andMoneylender Debt in India and the Philippines,” Working paper, April 2018.
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