So what do working poor people do with 200% APR payday loans? Can they possibly make them better off? A paper* by Dean Karlan and Jonathan Zinman employs a clever randomization technique to estimate the effects on borrowers of receiving high APR cash loans in South Africa.

They find that expanded access to credit significantly improves overall outcomes. Borrowers have higher employment, income, food consumption, and an index value of several measures of subjective well-being for the six-to-twelve months after the loan decision. Receiving a loan increased the likelihood of being employed by 20% for marginal borrowers. This is a stunning number. The authors argue that this may be because many of the loan applicants were borrowing to avoid losing their jobs. As seen in the table below, which I created using numbers from the paper, 19.4% used the loans for transportation costs. One can also imagine the 5.4% that went to healthcare may have helped people keep jobs as well; if they cannot get rid of an illness fast enough they may be fired for absence.

The study did interestingly find a negative effect on a second measure of subjective well-being that captured stress and depression. Looking at the impacts over longer horizon, the study finds that in the 15-27 month period following the decision there is a positive impact upon whether or not the borrower has a credit score, and no effect on the actual credit score. They also report confidance intervals that rule out substantial negative effects, so that, at worst, the impact of the policy is zero. Finally, they find that the loans were profitable for the lender, although less profitable than normal.

Consumer borrowing and credit access is an area of conflict between behavioralist and revealed preference approaches to economics. The revealed preference approach argues that it is good for consumers to be able to borrow at any rate of interest, because they will only borrow if it makes them better off, thus the option of even very high interest rate loans can only make people better off. The behavioralist response is that consumers may be worse off. They may have present biased preferences, be overly-optomistic, or underestimate the interest rate on short-term loans. Behavioralists have argued that all three of these may cause excess borrowing.

This study presents evidence for revealed preferences; the borrowers are by almost all measures better off.

(You can find a working paper version here. Gated final version at the Review of Financial studies here, not sure if there’s much difference.)

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