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(I have super limited knowledge with economics/finance/etc so please forgive me for any misunderstandings or misrepresentations.)

Why do we need debt? People who make profit by lending to others don't seem to be contributing much actual value to a society/country/civilization. They seem to make money just by having money.

To illustrate this with a toy scenario, consider the sudden founding of a country that successfully banned debt, as in all transactions must be immediately settled somehow. And let's just say that everybody start off with some similar amount of wealth so that there isn't anyone super poor or super rich.

In this scenario country, other than slowed growth, wouldn't everybody be better off in general in the long term?

  • It would make the price of stuff like housing more stable and closer to real value, as they would only really be as expensive as what someone is willing to pay for them. (Seems to address some current issues with overpriced housing markets that are driving people away)
  • Fix the lives of a lot of middle and lower class people who are stuck constantly paying off their debt and so don't have enough money to get any richer. This allows everybody to have their own savings and stuff.
  • I guess the stock market wouldn't be a thing? Companies might have to get starting money by collecting from to-be employees? (I do see how this is a little iffy but I don't think it would take that much to bootstrap a small operation)
  • Allow the government to have more direct control over value of money in a sense, as value can't just pop in and out overnight, perhaps.
  • I vaguely understand that "growth" would be slower without debt but I don't know enough to compare it to the other points.
  • As an example, corn farmers currently can sell you "future corn" that they promise to give you in the future, when the harvest time comes. Without debt, the corn farmer just needs to keep their own savings so that if their corn field burned up one year, they have enough saved up to back them up.
  • People who own a lot of houses still pretty much get money by having assets, but they need to price it where someone could afford it to make money

What are other considerations when it comes to this? What are ways that my bullet points are wrong? Is there some glaring problem that the lack of debt creates?

To a complete outsider like me, it seems like debt really only makes the rich more rich and the poor stay poor?

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Why do we need debt? People who make profit by lending to others don't seem to be contributing much actual value to a society/country/civilization.

Having debts actually contributes to the society great deal.

First, it allows people to smooth consumption over time thus preventing shocks to the consumption patterns which create disutility (see discussion in Romer (2014) advanced macroeconomics ch 8). This has first order impact on people's welfare so it is quite an important reason in its own right.

Second, and far more important reason, it helps the economy to function more efficiently and supports economic growth. This is because it allows people to pursue business ideas/projects they could not otherwise be able to with equity financing. In fact evidence shows that developing countries with higher levels of private debt generally grow faster (Schclarek 2004). In turn, economic growth has such profound and transformative benefits to society that it is fair to say that in long run there is nothing that would even hold a candle to economic growth. Even most redistributive Rawlsian maximin welfare system effect on wellbeing of the poor would pale in comparison with an effect of 20y worth of 3% economic growth on the wellbeing of poor, and due to compounding nature of growth the more years you add the better growth looks.

Third, it is generally accepted in developmental economics that many developing nations are poor because banks in many developing countries are not willing to issue debt (since many people lack collateral and countries have bad contract enforcement). Consequently, one of the most important areas of developmental research is actually to bring debt financing to poor countries (see Banerjee & Duflo: Poor Economics). Generally speaking countries and people are poor when they lack access to debt not when they have it. Of course, one can always find some exceptions where person accumulates some bad debt by financing some nonsense frivolous spending, but empirically the benefits of debt still outweigh the costs as discussed in the B&D source above, and in addition one can make good arguments for regulating or limiting ways in which people can get into debt but that is not the same as eliminating debt altogether.

There is virtually complete consensus that having access to debt is beneficial for society. This does not mean that debt should not be regulated, and that there might be some forms of debt that are less desirable than others, but if we talk about debt vs no debt only then I don't think there exists a university educated economist who would say we should have absolutely no debt. Even if there is some it would be exception to the rule.

It would make the price of stuff like housing more stable and closer to real value, as they would only really be as expensive as what someone is willing to pay for them. (Seems to address some current issues with overpriced housing markets that are driving people away)

There is no evidence that debt is not making price of housing stable. In fact if anything there is evidence to the opposite that increases in housing prices make people to go more in debt (Disney & Gathergood 2009). The main reason for price increase of housing in virtually all places are inflation which depends on monetary policy (e.g. see discussion in Ahearne et al 2005), and although modern monetary policy utilizes debt in principle any level of money supply imaginable can be achieve with or without debt, and supply constraints on building new housing (e.g. see Paciorek 2013, Hilber et al 2016 or Glaeser et al 2002). In fact this is also one of the major reason for house price volatility, since Paciorek finds that there is

strong relationship between the volatility of house prices and the regulation of new housing supply.

Moreover, price of housing would likely not change in absence of debt or perhaps even increase. Demand for housing would be likely exactly the same just people who cannot afford house with their salary would rent instead of buy. Price of housing depends also on its rental price since buying and renting decisions directly compete against each other. If anything one could argue that if you take away choice of debt financing some landlords will get captive audience allowing them to raise prices. In some unrealistic scenario where anyone has enough money to directly buy house this would not matter, but that is not the world we live in and even if that scenario would become reality mortgage markets would disappear in reality as well (perhaps only in countries where debt can be used as tax shield there would be still some). Furthermore, no matter how everyone would start of wealth would eventually be redistributed through markets based on people's productivity and savings decisions.

Fix the lives of a lot of middle and lower class people who are stuck constantly paying off their debt and so don't have enough money to get any richer. This allows everybody to have their own savings and stuff.

This does not make any economic sense. As already discussed above, people are kept poor by lack of access to debt (again see Banerjee & Duflo: Poor Economics).

Also, the statement that it will somehow support saving is nonsense. Saving is by definition difference between income and consumption $Y-C$, if you are repaying some old debt, literally the only way you can do that is by saving. Moreover, any debt can only come from savings of other people. Increase in demand for debt is tantamount to increase in demand for saving. This will ceteris paribus lead to higher interest rate (price of savings), which will encourage more people to save.

In a long-run borrowing \$1000 results in the same level of saving as saving \$1000. Actually, \$1000 borrowing would even lead to more saving given that most debt carries interest and people will have to save to repay debt.

Furthermore, taking on debt does not mean you are getting poorer per se. If you take on \$100000 debt to buy \$100000 house, you wealth, which is commonly defined as value of net assets, does not change since now you have \$100000 - \$100000 = \$0 net wealth. So getting debt does not make you poorer per se (of course, if you get debt and then set that money on fire or flush them down the toilet it does, but as long as you purchase assets with them your wealth will net zero if the value of asset is same as the debt). If the return on buying that house per year is larger than interest payment it actually makes you richer over time not poorer.

I guess the stock market wouldn't be a thing? Companies might have to get starting money by collecting from to-be employees? (I do see how this is a little iffy but I don't think it would take that much to bootstrap a small operation)

This is absurd prima facie. Exactly the opposite, stock markets would be even more important than ever. Stock market is literally the alternative to issuing debt for company. If you eliminate debt from economy even firms that would never go to stock market otherwise will be forced to.

Allow the government to have more direct control over value of money in a sense, as value can't just pop in and out overnight, perhaps.

Governments via central banks actually use debt to control money supply. Moreover, creating portion of money via debt makes money supply more elastic and responsive to the economy.

Governments can create more money in three main general ways; by physically printing notes or minting coins, by issuing government debt in exchange for newly created money from central bank, or by central bank lowering interest rate which increases borrowing, or by instituting or changing reserve/capital requirements (see Blanchard et al Macroeconomics ch 4).

Eliminating debt would just take away instruments from the government, and taking away instruments from central bank decreases its ability to control, not enhances it. Also, in principle central bank could always decide to switch to 100% reserves or capital requirements severing private banks ability to create new money with debt, without elimination of debt itself. But there is very little evidence that something like this would be welfare enhancing (e.g. see Fiebiger 2014).

I vaguely understand that "growth" would be slower without debt but I don't know enough to compare it to the other points.

This was already covered by the introduction, absence of debt would make it harder for some people to start business or otherwise participate in the economy. Absence of debt would also make it harder to smooth consumption over time leading to inefficient consumption decisions, relative to the situation households have access to debt (see again the sources in introduction).

As an example, corn farmers currently can sell you "future corn" that they promise to give you in the future, when the harvest time comes. Without debt, the corn farmer just needs to keep their own savings so that if their corn field burned up one year, they have enough saved up to back them up.

And this would lead to inefficient allocation of risk (to the farmer instead of financial market) and thus to lower agricultural productivity (assuming farmers are risk averse). Futures markets are good for the economy and help it run smoother and more efficient, eliminating them would just make everyone worse off. While futures markets also have some costs, it is accepted that benefits of organized futures markets well outweigh any costs (e.g. see Telser & Higinbotham 1977). We can talk about proper regulation or restriction on some parts of such activity but again I do not think there is any serious economist who would endorse banning it.

People who own a lot of houses still pretty much get money by having assets, but they need to price it where someone could afford it to make money

House price as any price is determined by supply and demand. As explained previously having/not having access to debt does not significantly change demand for housing, people still have to live somewhere, if people cannot afford to buy house they will rent it. Rental price of house and price of bought house are linked together. In fact, in long run equilibrium renting should have exactly the same cost as buying the house (of course there might be some discrepancies due to market imperfections etc, but point is those prices are closely linked).

To a complete outsider like me, it seems like debt really only makes the rich more rich and the poor stay poor?

No, this is fallacious as it sort of assumes that borrowing is some sort of zero sum game. While, it is undeniably true that there can be some cases where debtors (but the same holds about creditors in some cases as well) can be left worse off taking debt (e.g. borrowing to play slot machines at a casino), generally speaking debt benefits both parties. Creditor gets return on his/hers savings that would otherwise might just be used less productively, while debtor gets to transport some of his/her future income to the present to be able to take advantage of some business opportunity, or opportunity to study etc, that will in the end enhance future income of said person.

As mentioned in the introduction, a large number of developmental literature works on getting access to debt to poor households (e.g. microfinance and so on). People are typically poor because they do not have access to financial markets the same way as richer people in developed countries have (again see Banerjee & Duflo: Poor Economics). Thus it is actually other way around, poor people are often poor because in poor countries or poorer regions private banks are generally less interested to provide loans, either because they worry about default risk of individuals in such places, or people lack collaterals, or because such places have worse institutions and financial infrastructure and so on.

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  • $\begingroup$ Thank you for the excellent and thorough answer. It's very enlightening to me as a total beginner to all this. I really appreciate the sources you include as well! $\endgroup$
    – crossroad
    Aug 30 at 19:15
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I am also new to Economics, but this is my understanding

We need debt, For suppose if I need to start a business I need capital as I have no enough capital I need to take debt, if my business is successful, I can give more employment, I can pay more tax, I can contribute more. it means DEVELOPMENT.

People who make profit by lending are actually contributing to the economy, the profit they earned will be used to make investment and it will give employment to others, tax to the government and ultimately development.

This example(1) is used to explain your points, as all have same amount, some people will buy houses, some will buy farms, some will just buy livestock, some just buy alcohol and drugs. if for suppose there is a famine or cyclone the people who bought farms will get loss, the people who bought houses and livestock are safe, when there is some disease like bird flu people with livestock will get loss, then others are safe. In either way the inequality increases and ultimately at some point of time history repeats, how the people with farms and livestock will live now without taking debt, yes government will help them but it is not enough to live equally with the people having houses.

Another scenario, If there is some disaster like tsunami, this country is worst hit, and government lost so much assets, majority people lost farms and livestock and even houses. economy became worst, and there is need of money and help. Then there is no option other than taking debt. here not only development but also LIVES of people are at risk. so what I am telling here is it is practically impossible to not take debt.

Another scenario, All the people of that country will have same amount, for suppose let it be X, I need to start a business (low cost medicine business for welfare of people) for which I need capital 2X, as debt is banned, where should I get that money? (other people are not interested in investing my company), Ok for suppose government is handling all businesses, then there will be no foreign direct investments (FDI), very less forex reserves, if there is no FDI, no employment in our country, less taxes for government, less development. Here in this case we are not only lacking development but also EMPLOYMENT.

Now your points

  1. from example (1) inequality rises at some point, house prices will not be stable any more.

  2. from example (1) the people who lost assets because of famine should take debt in order to revive their life. so someone should should take debt compulsarily.

  3. stock market, all people will not be interested in investing in business, some will just buy farms, if business is successful the people who invested in it will become rich. now again inequality arise as people in business is earning more than people with farms.

  4. if you give money control to the government, then it will be closed economy then there will be very less export and import, no country will have all resources. so it is better to leave money control to market forces.

At last debt will not make rich richer and poor poorer, the point how you use that debt, if you use that debt for good investment, it will yield profits and you will become rich, if you use for bad investment then vice versa

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    $\begingroup$ Hi, welcome to Economics:Stack Exchange. Please consider improving the answer by adding references from reputable and scholarly sources. As many other science stacks do, we require formal proofs, statistical evidence or links to external sources for answers making claims which are not common knowledge. Unsourced material can be edited or deleted. For more details see our help center and FAQ on community standards for answers $\endgroup$
    – 1muflon1
    Aug 30 at 17:34
  • $\begingroup$ Thank you for guiding, as i am new to economics can you please tell me whether my answer right or wrong, if i am wrong please tell me so that i can improve. I understood that i should add references. $\endgroup$ Aug 31 at 2:09
  • $\begingroup$ "the profit they earned will be used to make investment " - this doesn't seem correct. The lent money will be used to invest. The profit is what the lender takes back as a reward for lending the money. $\endgroup$
    – user253751
    Sep 1 at 9:15
  • $\begingroup$ Please add further details to expand on your answer, such as working code or documentation citations. $\endgroup$
    – Community Bot
    Sep 3 at 12:09

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