Disdain is no guide to regulating a socially useful sector, writes Tim Harford

I believe it was December 1980 when my father sat down with me and warned me gravely that the central heating had broken down. It would cost money to repair, money that simply could not be summoned out of thin air. I should not count on getting the toy I wanted (a Lego Space Cruiser, in case you were wondering). I considered myself duly warned.

Such a conversation is hard to imagine today. Why empty such a big bag of sadness over the head of a seven-year-old Lego fanatic? Why not, instead, log on to Wonga.com and borrow a cheeky £150, just until payday at the end of December? Wonga would charge £27.99 interest, plus a £5.50 fee – is £33.49 really too big a price to pay for the happiness of a young boy?

But the story will not end there, will it? The total repayment of £183.49 after 18 days might not sound such a lot, but it is an effective annual interest rate of almost 6,000 per cent. At 6,000 per cent a year, the money to buy a pricey toy one Christmas will balloon into a debt that could have paid for a small car by the year after – and a large house the year after that.

That would seem usury enough. But there are more serious dangers lurking for an unwitting borrower. Wonga charges £30 for late payment, substantially increasing the cost of the loan for the most vulnerable. At that point, the hapless borrower’s credit rating will start to slide, and he will find himself unable to tap into more conventional sources of credit.

It is a minor tragedy: the journey that begins by buying the toy for the much-loved child ends not long afterwards with a treacherous plunge into financial ruination.

Wonga has found itself surrounded by critics, naturally enough. Justin Welby, the Archbishop of Canterbury, announced this year that he would compete them out of existence. (That’s a tough proposition: you don’t compete with Wonga on price but by offering faster access to more convenient, less-scrutinised loans.)

A parliamentary select committee toasted representatives of the payday loan industry this week. When Ed Miliband, the Labour leader, sought a phrase to summarise all that is wrong with life in Britain under his political opponents, he settled on “the Wonga economy”. But there was worse: financial guru Martin Lewis, a man with a knack for attracting the spotlight, condemned payday loan companies for “grooming” young people with catchy advertisements on children’s television channels. When your critics borrow language that is normally reserved for sexual abusers of children, you have an image problem.

This conversation has turned into the country’s favourite pastime: a witch hunt. Little good will come of it.

Start with Wonga in particular. It is suffering the fate of many industry leaders: precisely because it is a familiar brand, critics attack it for what it symbolises more than for what it does.

In the 1990s, Nike found itself shouldering the blame for sweatshops everywhere; in the 2000s, Starbucks came to represent the oppression of coffee growers; more recently, when activists wanted to raise concerns about Chinese labour conditions, they went for Apple. This is understandable as a campaigning strategy but makes for poor policy.

Some of the specific allegations against Wonga look hysterical. Wonga is not trying to sell loans to five-year-olds. The company advertises on children’s TV, one surmises, because parents of young children are prime candidates for emergency loans. That is not pretty, but let’s call a spade a spade rather than calling it a cluster bomb.

Nor could Wonga be accused of lacking transparency. The fees, the four-figure interest rates, the late payment charges, the impact on credit ratings: everything is laid out on the website in the simplest and clearest terms imaginable.

No high-street bank comes close to this clarity, and an unauthorised overdraft may cost far more than the loan that prevents that overdraft. Outcompeted on convenience, on comprehensibility and perhaps even on price by the likes of Wonga, Britain’s banks should hang their heads in shame.

But while critics of payday lending may content themselves with attacking Wonga, its defenders cannot merely protest that it is the best of a bad lot. The real question is what to do about payday lending in general. The focus on “grooming” or deceptive terms and conditions allows us to look away from the real problem – which is that an adult can be presented with unambiguous facts about a payday loan but still do something she comes to regret.

The twist is that a payday loan can do real good, as a cash injection that helps avoid far more serious financial consequences, such as the loss of a job because the car broke down or penalty charges for failing to pay a bill on time. A randomised trial conducted in South Africa showed that this was not just a theoretical possibility. The experiment randomly approved or rejected applications for loans at an annual percentage rate of 200 per cent. Those who received one ended up better off than those rejected.

This is the problem. One person uses a payday loan to buy the suit he needs for the job interview, and gets the job; another person uses a payday loan to buy lottery tickets. I know of no law that can allow one case and forbid the other. Transparency and fair dealing is no guarantee of happy outcomes. A cap on interest rates will do no good, because for small short-term loans the interest rate is not a meaningful measure of what the loan costs.

I view the payday loan industry with disdain. I cannot imagine using it myself and would be horrified if I knew that a close friend felt the need to turn to Wonga for help. But my personal contempt for the industry, from my position of privilege, is not much of a guide to how we should regulate it.

The world is full of products that people demand yet seem harmful, from cigarettes to lottery tickets. That is not capitalism gone mad: it is simple evidence of human frailty. I sympathise with Mr Miliband’s discomfort at living in the “Wonga economy”.

But Wonga did not create modern Britain; modern Britain created Wonga.

Also published at ft.com.