Natalie Solent

Politics, news, libertarianism, Science Fiction, religion, sewing. You got a problem, bud? I like sewing.

E-mail: nataliesolent-at-aol-dot-com (I assume it's OK to quote senders by name.)

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Wednesday, April 13, 2005
Interest rates and the Third World. A reader writes, regarding my statement in the previous post that I did not know enough to comment on high rates of interest on loans as a reason for world inequality:

Oh, you do. If you allow me, interest is charged, out in the real world, based on percieved risk.

Hence, large stable countries with a history of reliably paying off their debt get a good rate, dead-beats who default, who have poor cash flow, and reliably have revolutions get poor rates.

Similarly, if you borrow to build a productive asset, like say a power dam, or tools based on a decent "business plan" you tend to get a better rate than if you borrow to buy Mercedes Limo's for the boss men, and jet-fighters and fuel to go bomb the revolutionaries.

I'm mixing stuff up here a little bit, but it's clear, I hope.

The 3rd world gets shitty rates because they are terrible credit risks and because they invest in stupid shit with poor, or no, returns.

This is the same reasoning that 60 years old lawyer who has been married 30 years buying a $1,000,000 dollar loan on 3rd house to serve as a rental (with a stable tenant already there) gets a far better rate than a 20 year old highschool drop out with credit problems buying an over powered motorcycle. (In reality, Mr. 20years old gets told to pound sand.)
As this reader implies, I did know something about this, although I could not have explained it so clearly. The question that I really don't know the answer to is whether high interest rates actually hinder development. Maybe, by discouraging foolish prestige projects, they help it. On the other hand sensible people who want loans for sensible projects pay the price for the folly of their compatriots.

What is brought out well in this reader's explanation is that if you want to put a one-line explanation of the effects of interest rates on third world poverty in your textbook, the phrase "third world countries are bad credit risks" would be far more informative than "high rates of interest on loans." Most sixteen year olds, the target audience for a GCSE revision guide, will regard interest rates either as an inexplicable natural phenomenon or as an act of malice directed against defenceless Third Worlders by wicked usurers. In the end my position is that interest rates should be as disaggregated as possible, and, of course, should not be manipulated by politicians, so they fulfil their function of transmitting useful information about risk.

UPDATE: The EU Serf writes:

I have a little experience of a high interest rate economy. What basically happens is:

1) Rich people make money really easily, creating a permanent, useless rich class.
2) Anyone with any money lends it to the state rather than invests in anything else.
3) Business models are all designed to create cash flow for lending to the state, not to maximise long term profit.

The upshot is very little productive investment is made as all the money goes ultimately to fund state borrowing. Established companies face little threat from newcomers, so they treat customers badly. They make only those investments that give a very fast return. Unemployed people are screwed. The investment needed to creat jobs never comes.

Oh and it is always the fault of poor government that interest rates are high.

An aside on the large numbers of small children. As birth rates drop swiftly, this leads to a huge labour force as a ratio of the population. This is one of the big driving forces of all successful developing economies. Its also a one of opportunity that can be lost if other things are not done correctly.