Modern pillories: Overdue debts of the poor

Abstract

We model the consequences of the soft budget constraint in the context of retail borrowers. While János Kornai formulated the term of “soft budget constraint” mainly for organizations (firms, banks, municipalities, NGOs, etc.), we show that it can be applied to individual borrowers as well. We derive the feasibility conditions for private and public debt relief programs in a utilitarian framework and find that lenders have no interest in offering payment reductions if non-performing borrowers are few, have small debts, and are difficult to reach – precisely the characteristics of the poor. In this situation, poor debtors serve better as deterrents, similarly if we put them into a pillory. We calibrate the model parameters to survey data on poor households struggling with overdue debts in small villages in a disadvantaged rural region in Hungary. We find that in normal economic circumstances, private debt relief programs are not feasible. State intervention can be justified by positive externalities and moral considerations.