The transmission of violence to microeconomic decisions of credit

Abstract

This document analyzes the hypothesis that high levels of criminal violence strengthens the obstacles that prevent the development of formal credit markets. It develops and solves a dynamic and stochastic theoretical model that internalizes the levels of violence in the credit choices of a representative agent. The theoretical results state that the size of the demand for formal credit shrinks in a state of relatively high violence. Additionally, it shows that the costs of violence are not uniform but U-shaped. The empirical analysis employs data from Mexico, where both credit markets have been historically underdeveloped and violence have reached unprecedented levels. The econometric results are consistent with the theoretical findings. When the level of violence increases, the probability of participating in formal credit markets drops. The effect is larger for low and high-income sectors than for those in the middle-income class. The success of financial development policies critically depends on the extent to which their design effectively internalizes the prevailing levels of violence.