Inputs and Credit Dr. George Norton Agricultural and Applied Economics Virginia Tech Copyright 2009

Objectives Discuss issues associated with new or improved inputs for farmers Consider why agricultural credit is important and how formal and informal money markets differ Bangladesh credit officer giving advice

Manufactured inputs increase in significance as agriculture intensifies New seeds Chemical fertilizers and pesticides Irrigation systems and mechanical power

Why are these inputs necessary? Why are they complementary to each other?

Input issues Public versus private role in producing and distributing seeds and other inputs Regulation of inputs Chemicals Seeds Input price policies Types of mechanical inputs needed Farm financing of input purchases

Why is mechanization a controversial issue in developing countries? Why do governments subsidize the purchase of inputs? Is it a good idea?

Agricultural credit Why is it important? How do formal and informal money markets differ? Do informal money markets exploit borrowers Why does the government get involved and what are the effects?

Two types of money markets Organized money markets Examples Commercial bank Government credit Cooperative banks Credit societies Store credit (some) Informal money markets Examples Moneylender Friends Family Pawnbrokers Landlords Stores (some)

Why are small farmers in LDC’s not served more by organized money markets? High transactions costs Small loans so time spent evaluating borrowers, collecting payments, supervising loans is high Fraud within the system Government controlled interest rates and subsidized credit programs

Does informal money market exploit the borrower? r = a + b + c + d Where: r = rural interest rate a = administrative cost b = risk premium c = opportunity cost of capital d = monopoly profit a & c are small so answer to the question depends on b & d

Effects of subsidized credit Creates excess demand for credit Erodes available capital Undermines rural financial institutions Credit goes to a few Politicizes credit system

Why so much subsidized credit? Easy way to transfer money to agricultural sector Political advantage

Why do governments often support credit programs? To facilitate technology adoption Reduce moneylender profits Combine education and supervision with credit Political reasons Offset negative effects of other policies Stimulate the economy

Micro-credit programs Poverty lending Group lending Peer pressure Small subsidized loans to poor Financial systems lending Savings as well as lending Non-subsidized

Lessons for credit policies Availability of credit is critical for technology adoption Tradeoff between credit availability and subsidized interest rates Credit is fungible Need to reduce risk and transactions costs to get interest rates down