Incentives and the De Soto Effect∗

This paperexplores theconsequences of improvingpropertyrights tofacilitate the use of fixed assets as collateral, popularly attributed to the influential policy advocate Hernando de Soto. We use an equilibrium model of a credit market with moral hazardtocharacterizethetheoretical effects andalsodevelopa quantitative analysis using data from Sri Lanka. We show that the effects are likely to be nonlinear and heterogeneous by wealth group. They also depend on the extent of competition between lenders. There can be significant increases in profits and reductions in interest rates when credit markets are competitive. However, since these are due to reductions in moral hazard, that is, increased effort, the welfare gains tend to be modest when cost of effort is taken into account. Allowing for an extensivemarginwhereborrowers gainaccess tothecredit market canmakethese effects larger depending on the underlying wealth distribution. JEL Codes: D23, O12, O16, Q15.