chapter  7
19 Pages

Testing for credit restrictions in Chinese agriculture

ByXIAOLI LIU

The importance of credit has long been recognized as a vital element for coping with risk and enhancing investment efficiency in the literature (Besley, 1995). Specifically, one of the most important advantages may be that finance is able to benefit both individual households and rural development in an economy (Adams, 1984a). Induced by such a perspective, credit markets have been at the center of policy intervention in developing countries. Many governments have adopted a cheap credit policy to channel formal credit at subsidized interest rates to rural households in order to improve agricultural production and reduce poverty. However, this cheap credit policy does not work as well as it is supposed to. Combining with information asymmetry and adverse selection in the credit market, the cheap credit policy even deteriorates credit rationing in agricultural sectors. When credit is rationed, liquidity can become a binding constraint on many farmers’ operations, thus causing the amount and combinations of inputs used by a farmer to deviate from their optimal levels, resulting in a drop in output. Therefore, to empirically detect and measure the marginal effect of credit has been an active topic in both theoretical and empirical literature (Petrick, 2005).