Governments can help solve the collateral problem by improving the codification of property rights. In many countries, particularly in Africa, governments have taken steps to improve land registration. Whether these actions
have the desired effect is debatable, especially in the short run, where attempts
to codify rights may lead to disputes and increased land insecurity (Attwood). Such programs also raise tricky ethical questions about the extent to
which countries should be encouraged to adopt Western legal notions of
property. In addition, the link between improved property rights and improvements in the workings of credit markets, while intuitively clear, is not yet firmly
established from empirical work. Interesting studies in this direction on Thailand (Feder, Onchan, and Raparla 1988) and on Ghana, Kenya, and Rwanda
(Migot-Adholla and others 1991) explore the connections among property
rights, investment, and credit.
In some important respects the government is itself part of the enforcement
problem; indeed, government-backed credit programs have often experienced
the worst default rates. In their pursuit of other (particularly distributional) objectives, governments have often failed to enforce loan repayment. Governments are often reluctant to foreclose on loans in the agricultural sector, in
part because the loans are concentrated among larger, politically influential
farmers (see, for example, Neri and Llanto 1985, on the Philippines). As a result, borrowers take out loans in the well-founded expectation that they will
not be obliged to repay them and consequently come to regard credit programs
solely as a pot of funds to be distributed among those lucky enough to get
"loans." This lack of sanctions weakens incentives for borrowers to invest in
good projects and strengthens those for rent seeking.
Appropriation of benefits by the richer, more powerful farmers has been a
particular problem of selective credit schemes. The greater the credit subsidy,
the higher the chances that the small farmer will be rationed out of the scheme
(Gonzalez-Vega [1984] describes this as the "iron law of interest rate restrictions"). The evidence on this exclusion of small farmers is quite strong (see,
for example, Adams and Vogel 1986). Given the political constituencies that
governments have to serve, they are unlikely to be able to enforce repayments
under certain conditions in programs that they back. Witness the reaction of
the U.S. government, which, in the face of crises in the U.S. farm credit program, tends to protect the influential farming constituency by not foreclosing
on delinquent borrowers or by helping them refinance their loans. A strong case
may be made for privatizing credit programs to separate them from the government budget constraint. As noted above, state-owned banks are a common
institution in developing countries.
The problem of weak government resolve is not confined to cases where the
government actually sets up and runs the programs. Governments in various Indian states have made debt-forgiveness declarations binding on private creditors.
Such practices, along with bailouts of bankrupt credit programs, give the wrong
signals to borrowers if they engender expectations that bad behavior will ultimately be rewarded by debt being forgiven. Ultimately, the government's ability
to commit itself credibly to a policy of imposing sanctions on delinquent borrowers is a significant aspect of the political economy of credit programs.