The effect of formal credit on output and employment in rural India

This paper estimates the output, investment, employment and wage effect of institutional credit using district-level panel data from India. Using a two-stage model to distinguish demand for formal credit from supply, the authors conclude that increased formal credit has a positive effect on crop production, on the use of fertilizer, and on private investment in machines and livestock. However, the effect of expanded credit on crop output is small. Crop output improves more because of increased use of fertilizer than because of capital investments, which merely substitute for labor.Credit decreases farm employment, yet increases the real agricultural wage because of its overwhelmingly positive effect on rural nonfarm employment. In short, improved financial intermediation in rural India greatly improves rural nonfarm employment and output, has a modest effect on crop output, and tends to substitute capital investment for farm labor.