To What Extent are Credit Constraints Responsible for the Non-Separable Behavior at Household Level? Evidence from Tobacco Growing Households in Rural Malawi

Abstract

Microfinance Institutions world-wide are continuously developing strategies for addressing credit market failure among liquidity constrained households. While an enormous amount of research has provided evidence for the positive welfare impact of access to credit at household level, very little is known regarding the extent to which credit can be used as a tool for enhancing separation in the making of consumption and production decisions at household level, which is an important precondition for specialization. The objective of this paper is to examine the extent to which credit constraints can be used to explain non-seperability among households from Malawi. The data used was collected by the International Food Policy Research Institute (IFPRI). The test for separation of consumption and production decisions is done using the on-farm labor demand model. Consistent with theory, results indicate that household demographic factors affect demand for labor among credit constrained households while they have no effect among unconstrained households. The implication from the study is that increased access to credit can be an important tool for arresting current market failures faced by poor rural households to the extent that once liquidity constraints are relaxed households can hire extra labor to enhance their productivity.

Keywords: credit constraints, separability, labor demand, Malawi