Interest Rates and Factor-Use Proportions in Agriculture

Interest rates on formal agncultural loans m most low income countries are less than rates of inflation and below rates charged on commercial loans. Many development economists have criticized cheap credit because they felt it induced farmers to use too much capital (such as tractors) at the expense of labour. This argument is an extension of neoclassical economics where mterest rates strongly influence investment dec1s10ns. Four arguments are evaluated that might be used to support this hne of thinkmg under conditions where rural fmanc1al markets are fragmented: low interest rates reduce the cost of capital inputs relative to other inputs, low interest rates result m borrowers using discount rates on future benefits from capital inputs that are also too low, cheap loans are often tied to the use of capital mputs, and low mterest rates cause lenders to concentrate loans m the hands of producers who use relatively large amounts of capital mputs. These supportmg arguments are weak and that low interest rates probably have relatively httle impact on farmers' decisions about factor-use proportions Low mterest rates have more in1portant impacts on income distribution, the costs of financial mtermediation, fmancial savings, and the vitality of financial systems.