Moneylenders and Bankers: Price-increasing Subsidies in a Monopolistically Competitive Market
In many areas of the world, governmental institutions for enforcing contracts are not well developed, and a significant part of the cost of obtaining a good or service is the direct cost of enforcing the contract.
Presents models that illustrate with endogenous enforcement costs in a money lending market, a subsidy may have perverse effects by:
- Creating monopolistic competition;
- Increasing equilibrium interest rates of loans by a loss in scale economies or from negative externalities among suppliers;
- Inducing exit in lending market.
Finds that increasing subsidized institutional credit to large landowners does not necessarily increase their on-lending to small landowners. Part of the increase will be dissipated through excessive entry into the money lending activity and the remainder "bottled up" because the induced new entry has driven up marginal costs of lending.
Concludes that in order to increase poor households' access to capital, the formal sector must lend to them directly.
