Have We Lost the Moral Values That Undergird a Commercial Society?

David Brooks is one of the most thoughtful newspaper columnists. In a recent op-ed ("The Great Seduction," New York Times, June 10, 2008, p. A 23), he argues that the founders of the nation "built a moral structure around money. The Puritan legacy inhibited luxury and self-indulgence. Benjamin Franklin spread a practical gospel that emphasized hard work, temperance and frugality…For centuries, [the nation] remained industrious, ambitious and frugal." But, Brooks continues, over the past 30 years much of that legacy "has been shredded," while "the institutions that encourage debt and living for the moment have been strengthened.""And here he mentions "an explosion of debt that inhibits social mobility and ruins lives," because of "people with little access to 401(k)'s or financial planning but plenty of access to payday lenders, credit cards and lottery agents." Among other "agents of destruction" are state lotteries--"a tax on stupidity," which tells people "they don't have to work to build for the future. They can strike it rich for nothing." Other culprits are the astronomical interest rates charged by payday lenders; and the aggressive marketing of credit cards by banks and other financial institutions, as a result of which by the time college students are in their senior year more than half of them have at least four different credit cards. The cures that Brooks offers include "rais[ing] consciousness about debt," encouraging foundations and churches to offer short-term loans in competition with payday lenders, strengthening usury laws, and taxing consumption rather than income, thus encouraging saving.

All this is very interesting, but is it correct? I have my doubts, except about the desirability of eliminating double taxation of savings, a problem with our income tax.

Max Weber argued convincingly in his famous book The Protestant Ethic and the Spirit of Capitalism that the frugality and industriousness promoted by the early Protestants in opposition to the opulence of the Roman Catholic Church were values conducive to and perhaps critical in the rise of commercial society. Protestants who believed in predestination wanted to show by their modesty, austerity, and avoidance of lavish display that they were predestined for salvation.

But saving plays a less important role in economic progress today than it did in the sixteenth century. Its role in powering economic growth has been taken over, to a large extent, by technology. The great rise in standards of living worldwide is due far more to technological progress than to high rates of savings, that is, to deferring consumption.

At the same time, now that we have efficient debt instruments that in former times did not exist or were extremely costly, the role of personal debt (Brooks does not criticize corporate or government debt) in human welfare is more apparent than it was. Apart from its role in solving short-term liquidity problems resulting from delay in the receipt of income, debt enables consumption to be smoothed over the life cycle. Without debt, a family might have to wait 20 years before it could afford to buy a house. Of course, debt creates risk for both lender and borrower, as the subprime mortgage crisis has dramatically illustrated. But if the risks are understood, it is unclear why the assumption of them should be thought harmful to personal or social welfare. At worst, debt leads to bankruptcy, but bankruptcy is not the end of the world either for the borrower or for the lender.

In situations of desperate poverty, one can expect a heavy debt load; but such a load can also be positively correlated with prosperity, which cushions the risks that debt creates. It is especially odd to suggest as Brooks does that taking on debt is antithetical to hard work; on the contrary, it increases the incentive to work hard by making it at easier for people to obtain the goods and services they want by borrowing the money they need to pay for them, yet at the same time increasing the risk of bankruptcy should they slack off on their work and so let their income fall.

The very high interest rates for payday loans tell us that many people will pay a very high premium to shift consumption from future to present. As long as they understand what interest rates are and what interest rates they are paying, it is hard to see why their preference for present over future consumption, and hence for spending and borrowing rather than saving, should have social implications. People who take out payday loans are unlikely to be potential savers (i.e., lenders); and by taking on heavy debt they force themselves to work very hard; and I have suggested that saving is not as important as it once was.

I particularly do not understand how, if high interest rates for payday loans are a problem, loans by foundations and churches are a solution. If, as I assume Brooks must mean, these loans are to made be at lower interest rates than payday loans, the former payday borrowers will borrow more. If to try to prevent this the charitable lenders ration their credit tightly, the payday borrowers will borrow what they can from those lenders and top off with a payday loan; their total debt burden is unlikely to fall.

As for the "tax on stupidity," it is of course irresistible to finance as much as government as possible by a system of voluntary taxation, which is what a state lottery is. And I don't think "stupid" is the right word to describe all or even most of the people who buy lottery tickets. I do think that some of them consider themselves "lucky" and so in effect recalculate the odds in their favor. That is stupid; in a game of chance, "luck" is randomly distributed. Some people, though, simply enjoy risk. Others like to daydream, and a daydream is more realistic if there is some chance it may come true, even if a very small chance. And finally and most interestingly, there are people whose marginal utility of income is U-shaped rather than everywhere declining. Usually we think of it as declining: my second million dollars confers less utility on me than my first million, and that is why I would not pay a million dollars for a lottery ticket that gave me a 50.1 percent or probably even an 80 percent probability of winning $2 million. But maybe I lead a rather drab life, and this might make such a gamble rational even if it were not actuarially fair. Suppose that for a $2 lottery ticket I obtain a one in a million chance of winning $1 million. It is not a fair gamble because the expected value of $1 million discounted by.000001 is $1, not $2. But if having $1 million would transform my life, the expected utility of the gamble may exceed $2, and then it is rationally attractive.

Brooks complains that government sponsorship of lotteries sends an official and therefore authoritative message that a person can strike it rich for nothing. But of course that is true, even when there are no lotteries. (And he gives no indication of wanting to forbid private lotteries.) You can inherit great wealth. More commonly, you may be able to leverage modest talents into great wealth by the luck of being in the right job at the right time. Brooks himself complains in his op-ed about the message sent by the fact that hedge fund managers often make more money than people who "build a socially useful product." Only the latter, he believes, should earn fortunes. But he doesn't propose an excess-profits tax on hedge fund managers; he accepts the legitimacy of their fortunes at the same time that he attributes those fortunes to luck. There is also an echo of the traditional but erroneous suspicion of speculation as an activity that does not create social wealth but merely shifts it around. That is incorrect. Speculation aligns prices (whether commodity prices or the prices of companies) with values and so creates more accurate signals for production and investment. It is a vital economic service. That is not to say that speculators "deserve" higher incomes than ditch diggers. Desert doesn't enter. Incomes are determined by supply and demand.

What is true is that easy credit facilitates bubbles, such as the housing bubble and the related mortgage-financing bubble, and the bursting of a bubble can, as we have been relearning recently, cause economic dislocations. This may require some regulatory adjustments; it does not require a return to Calvinism.