The Sequencing of Land and Credit Market Reforms in Developing Countries: A Theoretical Perspective

1:T1iis paper proves two theoretical results that serve to qualify the orthodox view that privatizing land rights should, or must, precede the extension on a wide scale of the formal credit market in the rural sectors of developing countries. First, we show that prior to the establishment of an integrated national credit market, the ability of the social group to exercise some control over land transfers can be efficiency-enhancing through its effect on the performance of segmented, informal finance markets. Second, we show that financial or physical collateral in credit markets is not limited to land or other pre-existing endowments. We analyze a novel mechanism, that creates a bootstrap form of collateral that can substitute for mortgageable land as collaterg. iThe mechanism entails a tax on labor output that finances a transfer to each individual equal to the average tax payment made. Individuals can pledge the transfer payments as collateral in the formal credit market. We show that this bootstrap collateral has the potential to make every individual better off.