[Desk Column] Paradoxes Create Monsters

Discussion on Lowering the Legal Maximum Interest Rate Resurfaces After 2 Years
Political and Economic Leaders United on Reducing from 24% to 20%
Government Price Controls Raise Concerns of Greater Side Effects Like Undersupply
Low-Credit Borrowers Concentrated in Lower-Income Groups May Be Driven to Illegal Private Loans

Lee Chohee, Head of Finance Department

[Asia Economy, Lee Cho-hee, Head of Finance Department] It has been two years. The discussion about lowering the statutory maximum interest rate for low-credit borrowers is heating up again. The maximum interest rate, which was 27.9% in 2018, is currently 24%. There is a back-and-forth debate over lowering it to 20%. This is because government economic department heads have responded positively to the necessity following successive bill proposals from the political sphere. With the ruling and opposition parties moving in unison for the first time in a while, the likelihood of the amendment passing through the National Assembly has increased. The government is also expected to release the results of its review on the amendment.

Originally, lowering the maximum interest rate was a campaign pledge of President Moon Jae-in. The rationale is clear: to reduce the interest burden on ordinary people and help their rehabilitation. The core idea is to control interest rates to benefit financially vulnerable people who cannot borrow money due to high interest rates. This idea stems from the frame of "high interest rates = evil."

In 1917, U.S. Congressman Andrew J. Volstead introduced a law (Prohibition Act) banning the brewing, sale, and distribution of alcohol. The intention was to reduce crimes caused by drinking by eliminating alcohol distribution. Ironically, this policy turned the U.S. into a mafia haven in the 1920s. When legal alcohol production and distribution were blocked by Prohibition, mafias jumped into the U.S. "bootlegging" business and began amassing enormous wealth. Al Capone, the legendary American gangster, was the worst mafia born from Prohibition. He was untouchable, openly roaming the streets despite killing hundreds. A well-intentioned Prohibition law thus resulted in a historic tragedy.

Although the government and political circles agreed on lowering the maximum interest rate to 20%, past cases show that the interest burden on ordinary people did not decrease but rather increased. According to data received by Rep. Yoon Chang-hyun of the People Power Party from the Financial Supervisory Service, the number of users of the top 20 registered lending companies dropped from 1,045,000 in 2017 to 530,000 last year, halving in two years. While the maximum interest rate was lowered from 27.9% to 20%, the number of users was cut in half. This raises concerns that low-credit borrowers, who could not borrow even from the regulated last-resort lending market, will inevitably turn to illegal private loans. According to the Korea Inclusive Finance Agency, the approval rate for lending companies last year was 11.8%, down to half compared to 21.2% in 2015. This means only one out of ten applicants for emergency loans from lending companies actually received a loan.

Illegal business card-type flyers from loan companies found in a traditional market in Seoul. (Photo by Jeong Jun-young)

Many Precedents Where Good Intentions Led to Bad Outcomes
Price Controls in Competitive Markets Cause Under-Supply Side Effects

In Johann Wolfgang von Goethe’s masterpiece Faust, a demon named Mephistopheles appears. He introduces himself as someone who "starts things with evil intentions but always produces better results." This is called the 'Mephisto’s Law.' There is also a proverb passed down since Roman times: "The road to hell is paved with good intentions." Contrary to Mephisto’s Law, this means that things started with good intentions can sometimes lead to the worst outcomes.

Maximilien Robespierre, who led the French Revolution to success in the 18th century, forcibly lowered milk prices when the living conditions of ordinary people worsened right after the revolution. The intention was to allow everyone to drink milk cheaply. However, price controls in a competitive market caused under-supply. As milk prices fell, dairy farmers, who could no longer make a profit, began selling their cows. With demand for milk unchanged but supply reduced, the 'invisible hand' pushed milk prices back up. Ultimately, ordinary people found it harder to drink milk, and milk traded at high prices in the black market became the exclusive privilege of the wealthy.

Government-imposed price controls inevitably distort market functions. Suppressing prices causes under-supply, which is basic economic knowledge. This manifests as a side effect in the form of black markets. Prices must be determined by market autonomy. Policies must always start with an understanding of market principles. There are countless examples showing how premature regulations that ignore fundamental principles can collapse futilely. The world is more complex and full of contradictions than expected. Policies made by looking only at the 'trees' without seeing the 'forest' can create monsters like Al Capone at any time. This is why policymakers must never ignore the voice of the market.