Wishful Economics 101

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Modern economic practice involves a lot of wishful thinking. Many politicians believe that you can spend billions bailing out car companies and auto unions, and magically consumers will buy from these companies again. People aren’t much better. We think we should be able to buy whatever we want, whatever our income.

Recently two young, married friends of mine arrived back from four years of university ready to launch into their adult life. She’s got a job, he’s about to land one, and they’re living with her mother.

That may not sound like much of a success story, but they have a plan. By the end of the summer they’ll have paid off their student loans. By next spring they’ll have the downpayment for a house. They’ve scrimped and saved, paid for their used car in cash, and collected hand me down furniture. They may not have much now, but they’ll succeed, because they know how to exercise self-restraint.

Many people don’t believe in saving money for a purchase. They plop down their credit cards for everything, and then can’t make the payments. The credit card companies jack up the interest rates, and these financial dunces either take years to pay it off, or they default.

Last week, Obama decided that those with bad credit histories shouldn’t have to pay such exorbitant rates. He demanded that banks stop hiking rates without warning, and put some measures in place to protect the young. Our Finance Minister followed suit. Flaherty forced credit card companies to inform customers clearly before the rates get hiked, and he gave customers a reasonable chance to pay their bills before interest is charged. It was a good compromise.

But some opposition parties didn’t think this went far enough. One NDP proposal floating around was that credit card interest rates should be capped at 5% above prime.

Yet the banks only charge these high rates because some people are high risk. If you pay your credit card bill on time, in full, you don’t have a problem. Those high interest rates only kick in when you don’t.

Maybe you think that’s not fair. But if you limit what banks can do with their high risk clients, you run into two problems. First, banks will just charge their good customers more, in the form of higher annual fees or fewer rewards programs. Those good customers, who are only in it for the air miles, will turn to debit cards instead, reducing the profitability of credit card companies. But more importantly, banks will stop lending to those with bad credit. Only the wealthy and those with good payment histories will be eligible for credit.

It’s a similar dynamic to the recent American proposal to force employers to give their employees one week of paid vacation—rather than just give them the time off. What lawmakers seem to forget is that if a company employs 100 workers, and you suddenly tell them you have to pay each of those workers for one week of vacation time, two of those workers will likely get fired, especially during a recession where money is tight.

Too many legislators think that their policies exist in a vacuum. They mandate something, and everybody will do it, without changing anything else. Legislators want to force people to be generous, but the world doesn’t work that way. They can’t force companies to take on higher costs without repercussions, any more than they can force people to buy Chryslers again.

We are in this mess because government, banks, people and unions got too greedy. We’re not going to get out of it until everyone tightens their belts, acts responsibly, and learns basic economics. I wonder how long that will take?

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