Back in 2020, I wrote a post about the consequences of banning payday loans on the pawnbroking industry. The takeaway message was that banning payday loans simply shifted borrowers into borrowing from pawnbrokers, small-loan lenders and second-mortgage licensees, none of which was necessary good for the borrowers. This new article by Hunt Allcott (Microsoft Research) and co-authors, forthcoming in the journal Review of Economic Studies (ungated earlier version here), looks at a related question: How would payday lending restrictions affect consumer welfare?
Allcott et al. start by undertaking a field experiment and related survey with clients of a large payday lending provider in Indiana. As Allcott et al. explain:
Our experiment ran from January to March 2019 in 41 of the Lender’s storefronts in Indiana, a state with fairly standard lending regulations. Customers taking out payday loans were asked to complete a survey on an iPad. The survey first elicited people’s predicted probability of getting another payday loan from any lender over the next eight weeks. We then introduced two different rewards: “$100 If You Are Debt-Free,” a no-borrowing incentive that they would receive in about 12 weeks only if they did not borrow from any payday lender over the next eight weeks, and “Money for Sure,” a certain cash payment that they would receive in about 12 weeks. We measured participants’ valuations of the no-borrowing incentive through an incentive-compatible adaptive multiple price list (MPL) in which they chose between the incentive and varying amounts of Money for Sure. We also used a second incentivized MPL between “Money for Sure” and a lottery to measure risk aversion. The 1,205 borrowers with valid survey responses were randomized to receive either the no-borrowing incentive, their choice on a randomly selected MPL question, or no reward (the Control group).
Allcott et al. use the field experiment to determine how well borrowers anticipate the extent of their repeat borrowing, and whether they perceive themselves to be time consistent. On those questions, they find that:
...on average, people almost fully anticipate their high likelihood of repeat borrowing. The average borrower perceives a 70% probability of borrowing in the next eight weeks without the incentive, only slightly lower than the Control group’s actual borrowing probability of 74 percent. Experience matters. People who had taken out three or fewer loans from the lender in the six months before the survey - approximately the bottom experience quartile in our sample - under-estimate their future borrowing probability by 20 percentage points. By contrast, more experienced borrowers predict correctly on average...
On average, borrowers value the no-borrowing incentive 30 percent more than they would if they were time consistent and risk neutral. And since their valuations of our survey lottery reveal that they are in fact risk averse, their valuation of the future borrowing reduction induced by the incentive is even larger than this 30 percent “premium” suggests.
So, borrowers on average anticipate their repeat borrowing, and they recognise that they are time inconsistent. Allcott et al. then use their experimental results, along with the results of the associated survey, to construct a theoretical model of payday loan borrowing. They then use their model to simulate the effect of various payday lending restrictions on borrower welfare, and find that:
Because borrowers are close to fully sophisticated about repayment costs, payday loan bans and tighter loan size caps reduce welfare in our model. Limits on repeat borrowing increase welfare in some (but not all) specifications, by inducing faster repayment that is more consistent with long-run preferences.
In other words, banning payday loans, or reducing the maximum size of payday loans, makes borrowers worse off. The flipside of that result is that the availability of payday loans actually makes borrowers better off. However, if policymakers are concerned about payday loans' potential negative effects, the most effective policy (in terms of borrower welfare) is to restrict the number of repeat loans that borrowers can take out. I suspect many policymakers would be surprised by that. However, an open question that is not addressed by this research is to what extent repeat lending restrictions simply force borrowers to alternative lenders like pawnbrokers (as the earlier research I discussed found).
Finally, Allcott et al. fire some shots at 'expert' economists:
Before we released the article, we surveyed academics and non-academics who are knowledgeable about payday lending to elicit their policy views and predictions of our empirical results. We use the 103 responses as a rough measure of “expert” opinion, with the caveat that other experts not in our survey might have different views. The average expert did not correctly predict our main results. For example, the average expert predicted that borrowers would underestimate future borrowing probability by 30 percentage points, which would imply much more naivete than our actual estimate of 4 percentage points.
Ouch! But it does illustrate the unanticipated nature of Allcott et al.'s results. If your model of payday loan borrowing starts from an assumption that borrowers don't anticipate their future borrowing behaviour, then you are more likely to support strong restrictions on payday lending. The poor performance of the experts in anticipating borrowers' naivete also suggests that Allcott et al. should be listened to over these other experts. It is unusual to include results like these in a paper (or even to do this sort of analysis). I wonder if Allcott et al. would have presented these results if the experts had agreed with them?
[HT: Marginal Revolution, last year]
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