Credit-constraint — the Inability to Borrow

For anyone concerned about the poor and poverty, the first task is to clearly define the words “poor” and “poverty.” Wealth and income are reasonable measures that usually serve in defining a poor person: one who has less than some defined minimum of wealth and/or income.

But that definition is not comprehensive. What if a person could borrow the money needed for an investment with a sufficiently high return such that it would be possible to return the money with interest, and still have some left over? Then the person is not poor. Meaning, anyone able to borrow is not poor. Conversely, anyone who is unable to borrow is “credit-constrained” and is comprehensively poor.

For a person to be considered poor, it is not necessary that the person have zero net worth or wealth. The sufficient condition for being poor is that one is credit constrained. Even if a person has negative net wealth, as long as the person is able to borrow, the person is not poor.

For example, consider a person who does not have money for acquiring a particular skill that would enable him to earn a very good living. Suppose further the person could borrow the money needed and be able to pay back the loan from the higher income from the acquired skill. When he borrows, his net wealth (his assets minus the loan liability) will actually be less than zero. Yet he will not really be poor because it will only be a temporary situation. In this case, he creates assets (acquires the skill) using the loan that later enables him to repay the loan.

We are familiar with many cases of “wealthy” people who at some point in their lives had negative or zero wealth but were able to borrow (sometimes to the tune of hundreds of millions) that allowed them to build up their fortunes and repay the loans. Even with a negative net wealth, they were not poor because they were not credit constrained.

So what is the main implication of this definition of being poor? It is this. An efficient way to help those who are poor is to somehow release the credit-constraint they face. Economic efficiency considerations recommend that.

But what if the poor are being denied access to wealth that they have a legitimate claim to, and which they need? Then it would be a moral imperative to return that wealth to them.

The poor of India have a share of the public wealth of India. It is economically efficient and morally right to give them that wealth. It has to be done now, and not in some indeterminate future. [Previous post in this series: Public Wealth Return.]

Author: Atanu Dey


4 thoughts on “Credit-constraint — the Inability to Borrow”

  1. The main problem is by what mechanism should the credit be disbursed.
    For instance, Austrian Economists hold that fractional reserve banking as a means of creating credit is what leads to business cycles of boom and bust and also misdirection of resources in the economy-termed as ‘malinvestment.’
    But doing away with fractional reserve banking will lead to contraction of credit which, you argue, is needed for the purposes of economic efficiency.


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