Daniel Indiviglio at the Atlantic has another piece on how credit is bad for poor people. Like Daniel’s previous writing on credit and the poor, his reasoning amounts to partial partial equilibrium analysis that misses the big picture and really doesn’t capture the effects of credit on the poor.

One way to clarify the various effects he introduces is to think of them in terms of labor supply curves. First, he argues that credit makes people feel richer, and so decreases wages:

Credit pacifies those with lower incomes to make them feel like they’re better off than they actually are. If you can use a credit card to buy an iPad or new shoes, then you are more satisfied than you would be based on your income alone… The more content you are, the less need you’ll feel to try to increase your income.

So credit makes people feel wealthier, and because leisure is normal good that you consume more of when you’re wealthier, people want to consume more leisure. Therefore the labor supply curve shifts left as people choose leisure over work, and thus wages go up. That part is missing from Daniel’s story. Importantly, it’s not obvious that income goes down in this scenario; it depends on the slope of the labor demand curve.

Ok, so maybe that’s the wrong way to frame it, and credit simply works as an income multiplier instead as a wealth effect. This means individuals get $1.2 worth of consumption from every $1 of income, which increases the returns to income. But this would increase the value of work relative to leisure, which would shift labor supply right, which would decrease wages but increase hours worked. Again, the effect on income depends on the labor demand curve.

So from the start, the effect on income are unclear and depends on the slope of the labor demand curve and the relative sizes of the wealth and income effects. But then Daniel makes the analysis even less clear by undoing the effects he just established:

The poorer you are, the more expensive your credit, but the more credit you’ll feel like you need…And they’re paying relatively high interest rates, which further eats into their relatively lower income, reducing their wealth potential.

So he just told us that credit was increasing peoples perceived wealth and income, but now he’s saying it’s lowering their actual wealth and income. Are people completely unaware of this? Over their entire life that is a highly unreasonable assumption. In fact, most people surely understand from the get-go that borrowing money is not magically making them richer, and that it must be paid for in the long-run. I sincerely hope Daniel isn’t going to argue that most borrowers think they won’t have to pay it back.

So people are choosing to consume more now rather than later, and while ability to smooth consumption should increase their utility, it is far from clear using just the effects that Daniel has laid out whether it increases or decreases their lifetime income and wealth. But when you include other effects, like the increased ability to borrow and invest in positive NPV investments like, say, a college education, it becomes obvious how credit could increase lifetime wealth and income of poor people. Wealthy people don’t need to borrow to make positive NPV investments like that, but poor people do. So the benefits disproportionally benefit poor people.

As I’ve previously written, more credit not only increases investment in college, but also high school and grade school. Given the importance of credit in allowing poor people to make important human capital investments that increase lifetime wealth, income, and well-being, Daniel is going to have to work a lot harder to make a convincing case that credit is bad for poor people. His partial partial equilibrium analysis is not even close.

[Update: broken link fixed]

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