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Working Paper 20-WP 516, Centre for Agricultural and Rural Development, Iowa State University, Ames, IA. Dong, Fengxia, Jing Lu, and Allen M. Featherstone, 2010

A study of credit constraints in rural China finds agricultural productivity and household income to improve by 31.6% and 23.2%, respectively, when constraints are lifted, suggesting that factors of production are underutilized when constraints remain.

Rural economic development is a priority for policy makers in China due to widening income inequality between urban and rural populations. Given that rural households are predominantly agriculture-based, any improvement to agricultural productivity will have a positive effect on income and equality. Moreover, since “agricultural production is strongly conditioned by the fact that inputs are transformed into outputs with considerable time lags,” households need to carefully plan income and expenditures, thus making a case for access to credit. Although a dearth of formal lending has led to rapid growth in informal credit, these loans are rarely used for productive purposes. Thus there is reason to believe that rural households remain credit constrained. Recent policy changes have encouraged entry of new rural financial institutions, yet only 33% of households had access to bank loans at the time of this study.

Credit constraints, productivity, and household income are jointly estimated for a sample of rural households in northeast China. Unconstrained households are analysed in parallel, serving to isolate the impact of credit constraints on productivity. Data is obtained from a 2008 rural financial survey in which 17% of households are found to be credit constrained.

Findings highlight the particular case of access to finance in China. Farmers are unable to own land in China, hence “land cannot be used as collateral.” Assets such as real estate and machinery could serve as collateral, but since they require considerable capital investment themselves they are not found to reduce credit constraints.

Productivity is only found to improve when credit constrained households have savings, which emphasizes the importance of liquidity. In contrast, households without credit constraints will see productivity improve with labour, technology, savings and other inputs to production. Consistent with earlier studies, the implication is that inputs cannot fully be utilized until credit constraints are removed. The model predicts that this would lead to a 31.6% increase in agricultural productivity.

The impact on household income mirrors the findings for productivity. Under credit constraints, no variable other than savings is found to significantly affect income. Conversely, for unconstrained households, income will increase with a greater amount of household labour, education, and greater use of inputs to production. The impact of removing credit constraints is estimated to yield a 23.2% increase in rural household income.

Measuring agricultural productivity and household income in the presence and absence of constraints shows that gains in productivity and income are achievable. Using policy to target removal of credit constraints would have the effect of making inputs to production more efficient, thus raising productivity and household income. The findings suggest that improving the income gap between rural and urban households does not necessarily require improving returns to agriculture.