Recently, I posted about Adam Smith’s fiscal principle:
“What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.”
In light of this rule, it is important to consider whether or not the state should bail out the heavily indebted poor. Considering hard cases such as those living in abject poverty can and should inform easier cases of those whose alternatives are much better. A new paper by Martin Kanz examines this question in India. He finds:
Debt relief leads to only a moderate improvement in the overall level of household debt among beneciary households …consistent with evidence from the literature on personal bankruptcy, which shows that households typically accumulate new debt very quickly after a settlement.
Clearing beneficiaries’ collateral did not have the intended effect of increasing… access to new bank credit
Debt relief does not increase the investment or productivity of beneficiary households. …we show that beneficiary households, in fact reduce investment in irrigation and agricultural inputs by as much as 7%, potentially as a direct result of the shift towards more expensive sources of financing.
Debt relief has a strong effect on expectations about the reputational consequences of default and perceptions about the seniority of debt; a one standard deviation increase in the amount of debt relief increases the probability that beneficiaries would default on a formal sector loan before any other claim by 2.3%.
Similarly, beneficiary households are significantly less concerned about the reputational effects of non-repayment in the case of loans issued by commercial or cooperative banks.
Bailouts, even in very extreme cases, are not a good means for achieving the intended outcomes of helping those in need.
HT: Chris Blattman