Varun CHANDRA 260463204 Econ 460 William Watson

Book Review - Defense of Usury

In 1787, the English philosopher Jeremy Bentham published a series of letters entitled Defense of Usury, which aimed to criticize legal restraints placed upon interest paid on loans. In economics, interest represents the cost paid to a lender for the use of borrowed money, and usury in this context refers to abusively high rates. Religious and historical practice had traditionally condemned usury on moral grounds, and the English government maintained a maximum legal interest rate at the time of Defense of Usurys publication. These usury laws became increasingly contentious in England as the intellectual climate shifted towards increased economic liberty. Spurred by the nascent liberal movement and the economic changes introduced by the industrial revolution, English philosophers began to re-examine the legitimacy of economic regulation. Benthams ideological views coalesced during this era, and he was closely aligned with the liberal movement. His economic views were inspired by the classically liberal ideal of freedom from government interference, which held free economic choice as paramount. Bentham penned Defense of Usury in response to conservative legislators in the United Kingdom, who had proposed to further reduce the maximum legal interest rate. In addition, the work sets out to criticize Adam Smith, who endorsed the regulation of interest rates to prevent the misallocation of capital. The central aim of Defense of Usury is to argue against any limitations on the interest rate whatsoever, in favour of contractual freedom and economic liberty.

The core of Benthams objection to interest maximums is that "no man of sound mind, acting freely, and with his eyes open, ought to be hindered in the way of obtaining

Varun CHANDRA 260463204 Econ 460 William Watson

money, as he thinks fit. (Bentham I). Usury is not a crime forced on the borrower it is agreed upon by mutual consent between both parties. Bentham further argues that the entire concept of usury law is riddled with inconsistencies. The actual rate of any interest rate cap is entirely arbitrary. There is no objective natural fixed price of interest to determine a rate of usury (Bentham II). Interest rates are always a function of the specific economics of a given region. The only real criteria for an interest rate limit is a regions blind custom, the particular rate of interest that prevails among lenders in an area, which is why legal interest rates vary enormously between different countries and times. Usury only describes rates of interest beyond what happens to be convenient for a given set of lenders in a specific time and place, and is weak justification for coercive intervention in markets (Betham II). Bentham further argues that regulating the exchange of money alone ignores the fact that money is essentially a commodity like any other. The logic that applies to interest rate limits ought to apply to exchanges in general. The same economic principles guide "a man who takes as much as he can get for the use of a sum of money" and the man who buys an house with it, and [makes] a proportionable profit by the house" (Bentham II). Exclusively limiting interest paid on the exchange of money ignores the potential occurrence of usury in virtually any other commodity transaction. If an individual is free to trade goods at any profit, then one should also be free to lend money on any terms.

Proponents of usury laws argue that interest rate caps benefit the poor and uneducated, since they are particularly vulnerable to exploitative rates of interest. In response, Bentham claims that setting a cap on interest rates precludes the mutually beneficial exchanges that are possible with high interest. A poor man with every means and motive for forming a right judgement is certainly capable of improving his economic

Varun CHANDRA 260463204 Econ 460 William Watson

standing by taking high interest loans (Bentham IV). His willingness to take the loan is indicative of its value to him. However, if lenders are only willing to lend to the poor at high rates of interest, they will prefer not to lend at all if faced with interest maximums (Bentham VI). Interest rate caps thus exclude the poorest from the credit market and constrict their economic choices. Instead of alleviating their poverty, interest caps exacerbate it. Bentham further criticizes the idea that distant, disinterested legislators are better qualified to make economic decisions for the uneducated or simple than the agents themselves. It would require absolute idiotism on behalf of the agent for lawmakers isolated from the everyday economic realities of the poor to be a better judge of the agents welfare than the actual individual (Bentham V). Any adult with perfect knowledge of his own circumstances, needs and desires should never have his economic choices coercively made for him by another. Usury laws, then, are economically counterproductive and often offensively paternalistic.

Benthams secondary aim in Defense of Usury is to refute Adam Smiths theory of regulated interest rates. In his Wealth of Nations, Adam Smith argues that unless interest rates are capped, lenders will provide capital to projectors (analogous to start up entrepreneurs) who accept high interest loans to undertake risky projects (Bentham XIII). This misallocates capital into potentially unproductive and untested ventures, instead of established and reliable industries. A maximum interest rate would eliminate the highinterest loan market for projectors. Bentham, however, defends projectors as crucial to economic progress. The innovation that fuels economic growth requires investment in new and untried projects (Bentham XIII). Projectors provide positive externalities: if a projector discovers a profitable trade or method of production, it can be reproduced in similar

Varun CHANDRA 260463204 Econ 460 William Watson

industries and will augment national productivity. By prohibiting investment in innovative businesses, interest maximums guarantee economic stagnation and redirect investment into increasingly obsolete industries (Betham XIII). Because projectors deal with risky enterprises with little security, lenders would only be willing to provide loans at high interest rates. Usury in this context is beneficial and should be encouraged.

Bentham concludes his analysis by stating that the most economically advantageous approach to interest rates is to leave them completely unregulated. Welfare and technological growth are only maximized in the absence of external controls. Any government intervention ultimately violates free economic exchange and necessarily sacrifices economic efficiency. This argument is plausible and attractive for several reasons. It maximizes the degree of control that individual agents hold over their own economic choices and protects them from the injurious effects of unwise government legislation. Bentham also provides a fairly complete and intuitive justification for the economic benefits of unregulated interest rates, which seem to exacerbate the problems they set out to fix. However, upon closer examination, several key defects in Defense of Usury undermine the persuasiveness of his argument.

In many cases, a usury law could likely increases economic efficiency. Bentham largely ignores the powerful effects that the interest rate can exercise on growth and stability when carefully managed by the government. If applied correctly, a usury law could lower the maximum rate of interest and actually increase overall investment by effectively lowering the minimum rate of return sought by investors. In addition, an intelligently placed usury law could drive technological growth more effectively than simply lifting the

Varun CHANDRA 260463204 Econ 460 William Watson

restrictions altogether. Smiths objection to a floating interest rate is that capital lent at high interest ....would be lent to projectors, who alone would be willing to give this high interest. Sober people ... would not venture into the competition. (Bentham XIII). The basic premise for his argument is that high interest loans carry an adverse selection effect, where an individuals demand for high interest loans is closely linked to his probability of loss. Bentham counters this by claiming that investment in new, risky ventures drives technological progress, and so no caps on the interest rate should be placed at all. The optimal solution to maximize technological growth is a compromise between these two views. Projectors may be unrealistically optimistic about the profitability of their enterprise, and so are willing to take high interest loans based on their biased expectation of success. Lenders, who have no personal attachment to the enterprise, can more objectively assess the likelihood of success when providing capital and setting interest rates. Consequently, the highest interest rates paid in the lending market would be given to irrationally optimistic entrepreneurs with inferior projects. A usury law targeting this far end of the interest rate market could squeeze the most unrealistically optimistic projectors out of the credit market and free up capital to be allocated to more realistic and more successful projectors, intensifying the rate of technical progress. Lastly, Bentham relies heavily on the assumption that the lending market resembles perfect competition, so that interest rates are moderated and determined by the competitive effect (Bentham VII). In the real world, where several firms often dominate the lending market, abnormally high interest rates contribute to supernormal profits and actually detract from economic efficiency. If the market is non-competitive, usury becomes highly inefficient and results in unusually large transfers of wealth from consumers to financial lenders. In this context, a usury law could

Varun CHANDRA 260463204 Econ 460 William Watson

restrict monopoly profits and provide a more effective redistribution of wealth to compensate for the dearth of competition.

A more general concern with Defense of Usury is found in the basic analytical framework that Bentham uses to build his argument. All of his arguments are couched in the language of liberal economics. He adopts the concepts of consumer self-interest and rationality to model human behaviour in an extremely technical sense. For the purposes of economic analysis, he divorces these concepts of any unrealistic or negative associations that they may hold if actually applied to everyday praxis. Consequently, the merit of usury law is measured exclusively by the degree to which it affects economic growth, consumption and technological progress. Bentham ignores the broader cultural concerns that underpinned usury laws, restricting his analysis to a simple calculus driven by market values. Real human action is not exclusively motivated by economic considerations. The moral argument the degree to which exploitatively high rates of interest are incongruous with societys collective conceptions of justice and fairness is noticeably absent in Benthams analysis. Relevant cultural concerns such as preventing greed, encouraging charity, and sheltering the economically marginalized from the economically powerful need to be taken into account to adjust the effects of free market economics to better fit societys collective goals and values.

As a consequence of this highly technical analytical framework, Bentham glosses over the very real problem of asymmetric information and consumer irrationality in the marketplace. The most economically marginalized in society the poor and uneducated often lack the experience and training necessary to adequately understand debt. They are

Varun CHANDRA 260463204 Econ 460 William Watson

simultaneously likely to be attracted by the prospect of immediate financial purchasing power offered by lending, and are the most likely to incur abusively high rates of interest to compensate for their lack of collateral and risk of default. The transfer of wealth from the poorest sections of society to wealthy financial lenders in this context, a form of economic exploitation could understandably be seen as a violation of basic social principles of justice and fairness, despite conforming with Benthams principles of freedom of contract and individual liberty. In a modern context, the unregulated interest rates endorsed by Bentham often promote aggressive lending policies that create debt, which lenders rely upon to accrue profits. The enormous rates of consumer debt that have resulted from the lending policies of student loan, credit card and mortgage institutions indicate a kind of market failure engendered by completely unregulated interest rates. Still, Benthams point that usury limits are effectively arbitrary remains. Any government determination that certain interest rates are usurious is inherently subjective. If we accept that cultural norms provide a valid justification for tempering the effects of unregulated interest rates, then we could look to cultural and historical information to give us a reasonable approximation of these terms. The actual socially optimal interest rate remains a trade-off between individual economic liberty and social welfare, and there is room for debate as to what the actual level ought to be.

Defense of Usury had a lasting impact in the political and economic discourse of the time, inspiring revisions of interest laws in England and abroad. It highlights the inconsistencies of usury law and its potentially damaging economic effects. However, in advocating the removal of interest laws altogether, Bentham ignores their vast real effects

Varun CHANDRA 260463204 Econ 460 William Watson

as a tool for fuelling economic growth and the exploitation and injustice that usury often entails. His analysis remains insightful but ultimately problematic.

Varun CHANDRA 260463204 Econ 460 William Watson

Works Cited

Bentham, Jeremy. Defence of usury; shewing the impolicy of the present legal restraints on the terms of pecuniary bargains. 3d. ed. London: T. Payne, 1816.
*The work is presented as a series of letters each citation corresponds to the letter in which the information as found. http://www.econlib.org/library/Bentham/bnthUs1.html#LETTER I. Introduction.