The real question, however, is not whether the policy is fair. This is the kind of choice such a sweeping loan forgiveness will encourage among borrowers and political leaders.
The answer: bad ones. There are enough examples around the world to make it clear that politically motivated loan cancellations are almost always costly and counterproductive.
India, for example, has repeatedly waived loan repayments for many of its small, marginal farmers. While college graduates in the United States might be among the richest 1% in the world, marginal Indian farmers are certainly not; they are among the poorest people in the world. On the basis of fairness and justice alone, it is difficult to argue against bailing out those of them burdened with heavy debts.
But the consequences of loan waivers, as they are called in India, have not been positive for farmers at all. Economists have noted that the waivers have encouraged farmers to take out more credit than their productivity warrants, putting them further into debt. This cycle of forgiveness and indebtedness reduces the overall flow of agricultural credit, while privileging the minority of borrowers willing and able to game the system. Over the years, multiple rounds of debt cancellation have not improved household savings, investment, or credit flow.
Loan waivers have also not necessarily reached the poorest farmers. Those who need help the most are those who are least likely to be able to navigate the red tape required to prove their bona fides. In India, the programs ended up helping wealthier landowners and institutions. That should give the Biden administration, which has touted that its own agenda will be means-tested, pause.
The debt relief policy is also deeply damaging. Indian state governments in the run-up to elections often announce loan cancellations and World Bank economist Martin Kanz has found, unsurprisingly, that voters “heavily reward” candidates affiliated with any party or coalition that decreed the bailout.
In other words, once you announce a loan forgiveness program, the incentives of borrowers and politicians change to make future defaults and future forgiveness more likely. In the United States, it is quite likely that future administrations will succumb to demands to extend bailouts to those with private loans, for example, or to raise the cap to something like $50,000 per person.
The long-term implications of such generosity could be disastrous. Even if Larry Summers is wrong and this particular cycle of debt cancellation in the United States is not overly inflationary, a structural shift to debt cancellation by the federal government would have major negative implications for the deficit. and debt. This has certainly been the case in most places where loan waivers have been attempted.
The American debate over higher education funding is eerily disconnected from the evidence emerging from elsewhere in the world. If American voters decide that college should not be a luxury or seen as a rational investment in a particular career, then the government should simply make college free rather than having periodic student loan bailouts. Several European countries have free college, after all.
However, even that might not lead to fairer outcomes. In fact, a 2017 report from the Brookings Institution found that after free college ended in England a decade ago, “after many years of growing inequality, socio-economic gaps in academic achievement seem to have stabilized or slightly decreased”.
Most Americans probably still think of college as an investment in the future. If so, as with any investment, the incentives for both borrowers and lenders must be properly structured. Loan cancellation is bad policy and terrible precedent – and one that is not informed by both theory and global practice.
More other writers at Bloomberg Opinion:
• Forgiving student loans will be a costly mistake: Editorial
• Student loan program fails older borrowers: Alexis Leondis
• Most students don’t need debt forgiveness: Matthew Yglesias
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Mihir Sharma is a Bloomberg Opinion columnist. A senior researcher at the Observer Research Foundation in New Delhi, he is the author of “Restart: The Last Chance for the Indian Economy”.
More stories like this are available at bloomberg.com/opinion