Published on Tuesday, May 15, 2012
[From the Daily Bulletin]
by Jay Prag
HOME mortgages, student loans, California, Greece, Spain - by all accounts the world is over-run with debt. Some people say the only way out is to wipe it off the books and start over.
But that would mask and likely exacerbate the underlying problem. It's not the debt.
Debt means someone borrowed money from someone else and agreed to repay that loan in the future.
The borrowed money was supposed to be used to do something productive that would allow both the borrower and the lender to be better off in the long run.
When a business borrows to build a factory, the profits from the factory allows the business to repay the loan with interest. The business is, in a sense, sharing the returns from the new factory with a lender. If it works out according to the plan, the business and the investor are better off.
Similarly, if a student borrows to go to college, they will share their increased lifetime income with the lender.
A home mortgage borrower shares the increased home value. And a government shares the increased national output associated with the productive government expenditures.
Borrowing and lending is a fairly simple game of connect the dots between the present and the future where the connector is a productive asset or project.
But it all goes wrong when the borrowed money is not put to productive use. If the borrowing government wastes the money on useless, unproductive expenditures, the borrowing country does not have increased future income with which to pay the debt.
If the student borrows $50,000 to study something that does not increase their lifetime income, they cannot pay their debt. And if a home buyer overpays for a house, they cannot repay the mortgage because the asset that they bought loses value.
In all the discussion about forgiving debt or using bankruptcy as a solution to the economic problems of the world, we cannot lose sight of the fact that behind every bad loan was a bad expenditure.
The problem is not that we borrowed too much money; the problem is, we wasted too much borrowed money.
Jay Prag is a professor at the Peter F. Drucker and Masatoshi Ito School of Management at Claremont Graduate University. Prag also serves as academic director for the school's Executive Management Program, and can be heard weekly on "Inland Empire News Hour" on KTIE-AM 590.