The rural credit system in traditional agrarian societies has long been associated with “usury,” and therefore often considered a hindrance to rural development. Three aspects of the traditional rural credit system are used to substantiate this assertion. First, traditional rural credit often entailed interest rates above the ceiling set by law. As early as 1790 b.c., the Laws of Hammurabi established annual interest ceilings of 33.3 percent for grain loans and 20 percent for cash loans. Any loan charging interest beyond the ceiling was illegal (Sowards 1983, 5). To many contemporary scholars, even a ceiling of 20 to 30 percent seems exorbitant: given the low return of traditional farming, peasants could hardly afford to borrow at such high interest rates. Second, from a socioeconomic perspective, high interest rates suggest unequal relations between debtors and creditors. According to Rao, the origin of this unequal relationship lies in market imperfection, or so-called “connectedness”—the link between wealth inequality and the failure-of-markets mechanism (1986). A fragmented and noncompetitive market, this view maintains, facilitates personalized credit transactions which not only extract surplus but also perpetuate peasants' credit dependency on the landlord. This credit dependency, in turn, creates a situation in which compulsive indebtedness gradually deprives the peasantry of the means of production (Bhaduri 1983, chaps. 4, 5). Finally, it is asserted, traditional rural credit had little to do with production. Most peasants used rural credit for consumption purposes, which had destructive effects on agricultural production. Rural credit, in these views, is a siphon that draws resources out of the rural sector, locks peasants into a vicious cycle of debt, creates rural inequality, and hinders production. Scholars who have studied the Chinese peasant economy agree, by and large, that that was the nature of Chinese rural credit system.
Financial and Total Wealth Inequality with Declining Interest Rates
