In the last few years there has been an intense debate on the relationship between nutrition and income. More specifically on the response of nutrition intake to rising incomes. This paper is about this relationship which has some far reaching policy implications for the developing countries on how best to reduce malnutrition. If the income elasticity is close to zero (Behrman and Deolalikar (1987)), the implication is that improvement in the income of the poor will have little impact on the extent of malnutrition. Then the developmental policies intended to improve nutrition will have to use policy instruments which attack malnutrition directly rather than relying simply on rising income. This debate was apparently triggered by the pioneering study of Behrman and Deolalikar (1987), who showed that, in the (six) ICRISAT villages of South India, the Income elasticity of calorie intake was quite low, and not significantly different from zero in statistical terms. Even among the very poor, as incomes rise households mostly purchase additional taste.
Critics on the other hand have concentrated their firepower on the finding that the income elasticity of calorie intake is low (Strauss and Thomas (1989), Ravallion (1990). Bouis and Haddad (1992), Deaton and Subramanian (1996)). Subramanian and Deaton (1996), for instance, questions the validity of the Behrman and Deolalikar (1987) initial findings, and based on the National Sample Survey data estimate the expenditure elasticity of calorie intake in rural Maharashtra. They find this to be in the range of 0.3-0.5 and in any case statistically different from zero. The debate appears to focus on the size of the calorie-income elasticity, especially at low incomes. See table 1 for a summary of various estimates from the literature.
This paper studies dynamic financial contracting when cash flows are not contractible. In such contracts, the prevention of default relies on the threat that the borrower be denied access to credit in the future. We identify the ability of parties to renegotiate the initial contract as an important constraint on the form and profitability of optimal contracts.
In credit transactions, the terms of the exchange are not simultaneous. For instance, the repayment of a loan falls due some time after the loan is granted. Because of their dynamic nature, credit arrangements have to take into account the possibility that one party, the borrower, does not deliver his term of the exchange in the future. At the time the borrower should repay the loan, he may be unable to do so, typically because the project financed by the loan failed, was delayed or did not generate enough returns. This is a case of liquidity default. However, the debtor may be able to repay the loan but choose not to do so. This is a case of strategic default.
Reputation concerns deter opportunistic behavior by creating a link between past actions and expectations about future actions. Consider, for example, an environment in which lenders provide funds to firms whose risk-taking decisions and profits are unobservable. Firms could take excessive risk, appropriating most of the benefits from large successes and imposing most of the losses from big failures on lenders. This inefficient risk-taking reduces lending and increases its cost. However, if firms generate signals correlated to decisions, lenders could use those signals to construct reputation and offer better lending conditions to firms with better reputation. Firms are then afraid of losing their reputation and are deterred from taking excessive risk. This role for reputation has been extensively discussed in the literature.
