Contracting Constraints, Credit Markets, and Economic Development

Abstract

INTRODUCTION Development economists are, perhaps by necessity, optimistic people. One does not become a development economist if one believes that the world's poorest are doing as well as they possibly could. Indeed, the premise of the entire field is that there is talent in every people, if not every person, and if there is one central question, it has to be: What prevents people from making the best use of their natural talents? There are at least five distinct answers to this question. The first, which is elaborated here, is the answer from contract theory: Talent is not an apple; one cannot simply go to the market, sell one's talent, and expect to be paid the appropriate price. The second is coordination failure: Talent is talent only if it gets to work with the appropriate other inputs. Even Lennon needed Paul and George – had they decided to go to the City instead, he too might have found himself a different profession. The third is political economy: Governments can and often do make it harder for people to do what they are best at doing. The fourth is learning: People may not know what they ought to be doing, and even when they do the rest of the world may not appreciate them. For example, a growing body of evidence shows that farmers are often ignorant or suspicious of more rewarding crops and better seeds. The final answer comes from what has come to be called behavioral economics: People may not always seek out the best options because they are held back by psychological constraints or social norms.

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