Development economics: theory and applications

Developmental Econ

The expansion of formal sector lending at low interest rates is likely to result in a more equitable distribution of credit in developing countries.

Not necessarily. Availability of credit will not automatically lead to enhanced access to credit. Individuals in the developing world must be made aware of these new opportunities, as well as have expanded access to the credit market itself. Even in America, many government loans and grants are under-utilized because people do not know how to apply for these sources of funding, or even that the money exists. The needy of the developing world must be made aware of the existence of these new sources of financing and they must also have transportation and access to lenders. Transportation, legal information and representation, a full understanding of banking all may be lacking in the developing world, even with an expansion of the formal sector for lending opportunities in the short-term. Long-term development is also required to help individuals avail themselves of these new opportunities.

Finally, although the new interest rates may be low, that does not necessarily mean that the lenders wish to target the developing world, at least not all aspects of the developing world, because of borrower's inadequate collateral, national infrastructure problems, and other issues that plague nations and deter investment in the developing world.

A2. Suppose we observe borrowers in the rural sector of developing countries borrowing from moneylenders charging a high interest rate, even though lower interest lenders exist (e.g. development banks). We can infer that the borrowers are acting irrationally.

Once again, the answer is -- not necessarily. Simply because other lenders exist does not necessarily mean that the development banks will lend money to the borrowers, if the borrowers lack what these lenders consider appropriate collateral. Even if the borrowers can obtain a loan at a better rate from a legitimate source, as opposed to a local moneylender, the legitimate bank may offer them less quick and ready cash, while the moneylender may offer them more money upfront. For an individual who is accustomed to living in debt, or who is desperate, taking the quick payoff of a larger amount in the short-term may seem like a more attractive option. Because of borrower ignorance, the moneylender may offer a false incentive that rural individuals with little economic background cannot understand, like 'no interest' on the loan for the first few months. the, the interest rate will 'kick in' at a much higher rate.

There are other sociological and cultural factors at play as well, in terms of encouraging borrowers to make what seem like irrational decisions, as seen through the cold calculating view of an outside observer. The usurious moneylenders might have an important place in the community, and can help the borrower in other ways, either by influencing corrupt government bureaucrats or providing other forms of assistance and protection. The usurers might be members of a local, organized crime ring and the borrowers may be afraid to borrow from anyone else, because of fear for their survival. And the borrower, because he or she knows the moneylender personally, may trust the moneylender more than a faceless banker. This is not irrational, but reflective of a cultural ideal that favors personal and community relationships and ties over impersonal agreements, however advantageous those agreements might seem to an objective observer. In fact, the local moneylender might be a relative.