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Endogenous Growth in the Presence of Informal Credit Markets: A Comparative Analysis Between Credit Rationing and Self-Revelation Regimes

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Basab Dasupta (University of Connecticut)

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Abstract

This paper examines whether the presence of informal credit markets reduces the cost of credit rationing in terms of growth. In a dynamic general equilibrium framework, we assume that firms are heterogenous with different degrees of risk and households invest in human capital development. With the help of Indian household level data we show that the informal market reduces the cost of rationing by increasing the growth rate by 0.7 percent. This higher growth rate, in the presence of an informal sector, is due to the ability of the informal market to separate the high risk from the low risk firms thanks to better information. But even after such improvement we do not get the optimum outcome. The findings, based on our second question, suggest that the revelation of firms' type, based on incentive compatible pricing, can lead to almost 2 percent higher growth rate as compared to the credit rationing regime with informal sector.

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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2005-18.

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Length: 41 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:uct:uconnp:2005-18

Note: I am really grateful to my advisor, Christian Zimmermann for his guidance and valuable comments. I am also indebted to Prof. Samar K. Datta, IIMA, India. Usual disclaimer applies.
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Related research
Keywords: credit rationing informal credit markets self revelation mechanism

Find related papers by JEL classification:
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment
O17 - Economic Development, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
E26 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy

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  10. Demirguc-Kunt, Asli & Maksimovic, Vojislav, 1996. "Financial constraints, uses of funds, and firm growth : an international comparison," Policy Research Working Paper Series 1671, The World Bank. [Downloadable!]
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  12. Basab Dasgupta, 2004. "Capital Accumulation in the Presence of Informal Credit Contracts: Does the Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information?," Working papers 2004-32, University of Connecticut, Department of Economics. [Downloadable!]
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  14. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September. [Downloadable!] (restricted)
  15. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November. [Downloadable!] (restricted)
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  17. Jayaratne, Jith & Strahan, Philip E, 1996. "The Finance-Growth Nexus: Evidence from Bank Branch Deregulation," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 639-70, August. [Downloadable!] (restricted)
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  19. Datta Samar K, 2003. "An Institutional Economics Approach to the Problems of Small Farmer Credit in India," IIMA Working Papers 2003-07-01, Indian Institute of Management Ahmedabad, Research and Publication Department. [Downloadable!]
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