Inputs and Credit

Dr. George NortonAgricultural and Applied

EconomicsVirginia 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