The Effect of Redistribution
The discussion so far has justified why allocation of credit can be suboptimal. This section develops the idea that the distribution of capital in the economy becomes tied together with efficiency in such situations. Suppose that
there are two individuals, one with a worthwhile project to invest in and the
other with some capital. If the one with the capital is uncertain about the quality of the other's project, he may be unwilling to lend enough for the project
to reach its full potential. But if capital is redistributed-that is, if the person
with the project now has the capital as well-the project is more likely to be
undertaken because the investor does not have to allow for the risk posed by
inadequate information. (For a formal analysis of such redistribution, see Bernanke and Gertler 1990.) Clearly, there is no Pareto improvement, because one
individual now has less capital; however, the information problems in the
economy are now reduced. The outcome would be quite different in the absence of information problems, when it should not much matter which of the
individuals owns the capital because each has full information about the quality of the investment project.2
When lenders face information problems, therefore, the distribution of assets matters for other than purely distributional reasons, which may help explain why such things as land redistribution can enhance growth. If severe
information problems beset credit markets, land redistribution is tantamount
to a redistribution of assets that can enhance investment by reducing the costs
of information imperfections-assuming, of course, that the individuals to
whom assets are redistributed really have access to superior investment technologies. Binswanger and Rosenzweig (1990) argue for that assumption on the
basis of evidence that small farmers have good investment opportunities that
go unexploited because of high risk and limited access to credit. Their argument is not, however, based on efficiency. It is either a straightforward redistribution argument, or it might be justified by adopting a social welfare
function that attached special importance to investment.
In practice, there is little doubt that many arguments in favor of intervention
in credit markets are motivated by a belief that those who have few assets
nonetheless have good investment opportunities. Unwillingness of lenders with little information about the poor to lend is thought to be costly in terms of
investment efficiency. Sometimes intervention in credit markets emerges as an
alternative to redistributing assets. Intervention may make sense for both political and incentive reasons, but it may have little to do with market failure
as defined here