Title

Contractual Restrictions and Debt Traps

Author(s)

Ernest Liu Ernest Liu (Princeton University)

Benjamin N. Roth Benjamin Roth (Harvard University)

Abstract

Microcredit and other forms of small-scale finance have failed to catalyze entrepreneurship in developing countries. In these credit markets, borrowers and lenders often bargain over not only the interest rate but also implicit restrictions on types of investment. We build a dynamic model of informal lending and show this may lead to endogenous debt traps. Lenders constrain business growth for poor borrowers yet richer borrowers may grow their businesses faster than they could have without credit. The theory offers nuanced comparative statics and rationalizes the low average impact and low demand of microfinance despite its high impact on larger businesses.

Creation Date

2020-07

Section URL ID

Paper Number

2020-30

URL

https://scholar.princeton.edu/sites/default/files/ernestliu/files/lr2020_rfs2r.pdf

File Function

Jel

E51, O12

Keyword(s)

credit markets, developing countries

Suppress

false

Series

13