By Shahid Mehmood
Originally published in The News, December 26th, 2016
One of my friends runs a small-scale business. His business is located in the older part of Rawalpindi – in a place popularly known as purana shehr. While the outlines and landscapes of cities outside these old places have changed dramatically over time, these spaces have retained many of their old charm. It’s as if time moves slowly or stands still in purana shehr.
Another important aspect of these particular areas that distinguishes them from more developed parts of cities is the way economic transactions take place there. A substantial part of economic activity is informal, with even large-scale businessmen operating without bank accounts or modern financial services. One of the most prominent drivers of life and business in these areas is credit.
Since 2008, business in these areas has generally been on the decline. My friend owns a small ‘frames and stationery’ shop. Once filled with customers, it now usually gives a deserted look whenever I get the opportunity to take my weekly sojourn. Customers don’t come in droves anymore and there are often days when my friend hardly records a sale of Rs200-300. He is not alone in this predicament. The majority of small and medium-scale shops are struggling to stay in business while some are either gradually winding up or have already closed down.
What has kept my friend, and many like him, afloat in the last eight or so very trying years is recourse to credit. But this is not the credit that we are accustomed to – from banks or loan sharks that charge exorbitant interest rates. It is a system of non-interest borrowing, prevalent in these parts of the cities. This credit helps businessmen keep their shops functional, allows them to accumulate savings and makes their survival a little easier in today’s tough conditions.
This form of credit also offers certain advantages over traditional borrowings from the financial sector. Unlike the system at banks, the borrower in these areas does not need to have assets to obtain debts. The basis of this credit economy is social connections and reciprocity. A person credits a friend or an acquaintance who may need money for business inventory, a ‘committee’ (a form of communal savings), or to meet some social or family obligation. It’s not necessary for the creditor to know the borrower directly. The transaction can take place due to a third person or a mutual acquaintance. The borrower at some stage, once his financial means improve, becomes a creditor to help another credit seeker. This way, the process keeps repeating itself.
It would be unwise to assume that the creditor gets nothing in return. He does not get an interest on his credit but that is usually compensated by social recognition and added prestige he accumulates; word about a person’s generosity spreads quickly. People tend to undermine the role of social standing – but in reality it confers advantages that money cannot. For example, in times of need, creditor with a social standing would find more than enough people to help him.
Without credit, economic activity would cease. And just like a body withers away when blood circulation gets restricted, economic activity stagnates if circulation of money becomes limited. Therefore, one of the best things a government can do is to ensure the continuous flow of money in order to propel economic activity and to discourage concentration of money in fewer hands. This phenomenon forms the basis for loan sharks and payday loans that charge exorbitant interest rates upon credit.
The story has an important lesson for us. My friend, whatever credit he has accumulated or wherever he has accumulated it from, managed to get money without any requirement for paying interest on the sum he borrowed. This happened solely because he has social relations and connections going back at least two to three decades. This is true for almost all the people in older parts of cities. They run on trust and social connections.
This has an important implication – if society and the government really want to discourage interest charged on loans, then one of the best strategies is to build social capital and trust between citizens. In the older parts of the city where interactions between people are regular, social capital tends to be comparatively high. Not surprisingly, money mostly circulates without any interest charged on it. People trust each other and have limited qualms about facilitating credit without recourse to charging interest. In the newer parts of cities and posh areas, where interaction between individuals is reserved and infrequent, recourse to credit implies payment of interest on loans. In these areas, social capital tends to be weak and limited.
Of course, within this credit system there are always people – loan sharks, payday lenders and habitual borrowers – who get the chance to exploit weaknesses. Payday lenders and loan sharks play mostly on peoples’ difficulties and their dire need to meet an obligation that they cannot set aside. This enables them to extract an interest for using their money. It’s unethical from a philosophical point of view but acceptable from the viewpoint of law because the exchange happens without any compulsion and with the consent of the borrower. Habitual borrowers squander money instead of utilising it in something productive. But they ultimately get signalled out.
From the point of view of economic management and establishment of an interest-free economy, no amount of government or court decrees can limit interest rates on borrowed money. History suggests that people always tend to find ways around them. The latest evidence of this comes from India, where people found ingenious ways to legalise their black money within hours of the issuance of a government decree regarding monetisation.
Credit has always been an important part of the economic history of nations. It has facilitated trade and propelled economic activity and this process will continue in the future. But if the aim is to keep the economy in continuous motion and prevent interest charge on credit from becoming a detriment, formation of social capital and building of trust between citizens is important.