ESNIE European School on New Institutional Economics

Institut d’Etudes Scientifiques de Cargèse

21 May 2008Hans-Bernd Schäfer

Rule of Law and Economic Growth

GDP Growth in Relation to the Rule of Law World Bank, World Development Indicators (2006)

R2 = 0,0095

-4

-2

0

2

4

6

8

10

12

-2 -1 0 1 2

Rule of Law Index 1996

Ave

rag

e p

er c

apit

a G

DP

g

row

th 1

995-

2004

Law and the Poverty of Nations

Capital accumulation explains 30-35% of per capita growth Barro (1997), Hall/Jones 1999), Easterly (2001), Acemoglu/Johnson et. al (2003)

Factor mobilisation explains growth in few countries Investment in human capital explains little of growthGood institutions which protect property rights and

contracts are crucial for growth (Rodrick/Subramanian/Trebbi 2004) Glaeser/Laporta/Silanes 2004)

“Countries with corrupt government officials, severe impediments to trade, poor contract enforcement, and government interference in production will be unable to achieve levels of output per worker anywhere near the norms of western Europe, Northern America, and Eastern Asia”.

Hall/Jones 1999 „QJE

0

5

10

15

20

25

30

Middle income Low income High income OECD

Fig. Gross national savings (% of GNI) 1970-2003 World Development Indicators 2005

Capital Stock per Capita vs.Capital Output Ratio 1980ies (Data from King/Levine 1994)

129 Countries

0

1

1

2

2

3

3

4

4

5

0 10000 20000 30000 40000 50000 60000

Capital Stock per Capita

Cap

ital

Ou

tpu

t R

atio

Capital Output Ratio, Algeria, Tunesia, UK (1960-1988) Data from King/Levine (1994)

0

0,5

1

1,5

2

2,5

3

3,5

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Year (1960=1)

Cap

ital

Ou

tpu

t R

atio Algeria

UK

Tunesia

Growth in Rich and in Poor Countries 1993-2003

-1

0

1

2

3

4

5

6

High income Low & middle income

GDP per capita growth (annual %)

State Led Growth

Nationalization of key industries including banks and insurance companies

Price distortions

Import Substitution

Planning, Industrial Policy

“The most important change in state policies in underdeveloped countries is the common

understanding that they should each and all have a national economic development policy…Indeed it is also universally urged that each of them should

have an overall, integrated national plan. All underdeveloped countries are now attempting to

provide themselves with such a plan, except a few that have not yet been reached by the Great

Awakening.

Gunnar Myrdal 1957

Washington Consensus (around 1980)

• Liberalization

• Privatization

• Free international trade, free international capital movements

• Macroeconomic stabilization (low inflation)

• (J. Williamson 1993)

Low Growth High Growth

Argentina -3,5 Albania 122,3

Brazil 6,5 Botswana 38,1

Congo, Rep.of -32,5 Chile 38,9

Cote DÕIvoir -3,2 China 133,2

Ecuador -2,6 Cyprus 45,2

Gabon 3,6 Finland 41,6

Honduras -1,3 Hungary 36,4

Nicaragua 4,6 India 55,4

Niger -4,2 Ireland 97,8

Papua New Guinea 0,5 Korea, Rep. of 54,4

Paraguay -9,9 Malaysia 46,6

Sierra Leone -21,6 Poland 50,3

Uganda -11,8 Slovenia 45,1

Ukraine -11,8 Taiwan 46,9

Zimbabwe -20,7

Source: Calculated from Penn World Ta bles 6.2 , 2000

Accumulated Growth of Per Capita GDP in Per Cent in Selected Countries from 1993 to 2003

GDP per Capita in Eastern Europe (population

weighted averages)

0

1000

2000

3000

4000

5000

6000

1990

1992

1994

1996

1998

2000

2002

2004

GD

P p

er c

apit

a (U

S$)

8 new EU

members in 2004

12 non-EU post-

Soviet countries

Source: Word Development Indicators 2006

1.000

1.500

2.000

2.500

3.000

1989

1991

1993

1995

1997

1999

2001

2003

Year

GD

P p

er c

apita

(con

stan

t 20

00 U

S$) Russian

Federation

Shock Therapy in Russia

GDP in Central European Countries 1990-2004 (World Development Indicators 2006)

2.000

3.000

4.000

5.000

6.000

7.000

1990

1992

1994

1996

1998

2000

2002

2004

US

Do

lla

rs (

20

00

)

Czech Republic

Hungary

Poland

Source: Word Development Indicators 2006

2.000

2.500

3.000

3.500

4.000

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

Year

GD

P p

er c

apit

a (c

on

stan

t 20

00 U

S$)

Latin America& Caribbean

Stagnation in Latin America

A shift from import substitution policy to free international trade implies a decline of import

substituting industries and intends rapid growth of export-oriented industries. If however capital

markets are imperfect and intellectual property rights are not protected, expanding becomes

difficult. In many Latin American countries “numerous small and middle enterprises have

been forced to close down, in many cases not as a result of their long-term inefficiency, but as a

consequence of imperfect factor markets which precluded their access to long-term finance, engineering and managerial know-how[1]”.

[1] J. Katz (2000),

0

2.000

4.000

6.000

8.000

10.000

12.000

14.000

Year

Rea

l GD

P p

er c

apit

a

Argentina

Brazil

Chile

Mexico

GNP in Arab Countries (from World Development Indicators 2007)

60

80

100

120

140

160

180

GN

P pe

r cap

ita (1

986=

100) Arab countries (oil)

Arab countries (Non-oil)

Low income countries

Source: Word Development Indicators 2006

0

100

200

300

400

500

600

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Year

GDP

per

cap

ita (c

onst

ant

2000

US$

)

India

Source: Word Development Indicators 2006

0

200

400

600

800

1000

1200

1400

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Year

GDP

per

cap

ita (c

onst

ant

2000

US$

)

China

Source: Word Development Indicators 2006

400

450

500

550

600

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

Year

GD

P p

er c

apita

(con

stan

t 20

00 U

S$)

Sub-SaharanAfrica

“The cross-national literature has been unable to establish a strong causal link between any particular design feature of institutions and

economic growth. We know that growth happens when investors feel secure, but we have no idea

what specific institutional blueprints will make them feel more secure in a given context. The literature

gives us no hint as to what the right levers are. Institutional function does not uniquely determine

institutional form.”[1]

[1] D. Rodrick (2006)

The Barcelona Consensus (2004)

• … both basic economic reasoning and international experience suggest that institutional quality -such as respect for the rule of law and property rights- plus a market orientation with an appropriate balance between market and state, and attention to the distribution of income, are at the root of successful development strategies.

• Moreover, the institutions that put these abstract principles into reality matter, and developing countries should work hard to improve their institutional environments. But effective institutional innovations are highly dependent on a country´ s history, culture and other specific circumstances.

What Makes Law Reform so difficult?

• Why do people with power accept limits to their power? An even more pointed formulation is: why do people with guns obey people without guns? An economic twist is: why would the rich even voluntarily part with a portion of their wealth? In legal theory, the parallel question runs: why do politicians sometimes hand over power to judges? Why do politicians allow judges, who control neither purse nor sword, to overturn and obstruct their decisions and sometimes even send office holders to jail?...Societies may approximate the rule of law if they consist of a large number of power wielding groups, compromising a majority of the population, and if none of them becomes so strong as to be able thoroughly to dominate the others. We may be able to loosen the grip of a few organized interests on power by forcing them to share political leverage with a variety of other groups. This is polyarchie; it is also rough justice, the only kind human beings will ever experience. Formulated differently, the balancing of many partialities is the closest we can come to impartiality. This may not sound particularly ideal, but it is nevertheless historically quite rare and very difficult to achieve.[1]

•[1] S. Holmes, Lineages of the Rule of Law” (2003)

Neglect of finance and corporate governance in development economics

What matters most

1. Property

2. Finance and corporate governance

3. Contract

4. Torts

0

20

40

60

80

100

120

140

160

180

Middle income Low income High income OECD

Fig. Domestic credit to private sector (% of GDP) 1970-2003From World Development Indicators 2005

Distribution of Assets and Collaterals in 60 Developing countries, 200-2003 (Data

from Safavian/Fleisig/Steinbuks,2006)

01020304050607080

Percentage ofTotal Assets

Percentage ofCollaterals

Land and Building Accounts Received Machinery

0

5000

10000

15000

20000

25000

30000

35000

High income Low & middle income

Market capitalization of listed companies (current US$) (bill) Data from World Dev. Indicators, 2005

0

100

200

300

400

500

600

700

China India Russian Federation

Market capitalization of listed companies (current US$) (bill)Data from World Dev. Indicators 2005

Enforcement of Shareholders Rights and Market Capitalization

(from Claeessens/Klingebiel/Schmuckler, 2002)

Value of control-block votes in relation to rule of law

ItalyKorea (Rep.)

Czech Republic

South Africa

Mexico

Brazil Australia

France

Chile

Hong Kong

UK

0

10

20

30

40

50

60

70

-1 -0,5 0 0,5 1 1,5 2 2,5

Rule of Law Index, 1998

Val

ue

of c

on

tro

l-blo

ck v

ote

s/F

irm

V

alu

e in

%

Widely held Family State

Argentina 0 65 15

Hong Kong 10 70 5

Mexico 0 100 0

Singapore 15 30 45

South Korea 55 20 15

France 60 20 15

Germany 50 10 25

Italy 20 15 40

UK 100 0 0

USA 80 20 0

The ex-post and ex-ante approach to corporate governance

Regulation vs. Civil liability

Rules versus Standards

Qualification and loyalty of judges

(Black, R. Kraakman, and J. Hay, 1996)

Crosslisting

The institutional element of cross listing „rent a regulator“

The increasing number of cross listed companies in developing countries

Cross listing and share prices (Karyoli 1998

Reese/Weisbach, Didenko 2005)

Large barriers to entry and to exit in developing countries

-Licensing laws-overregulation -labor relations -dismissal,-bancruptcy procedure, -establishing a firm-tax law

Consequence: development of a large informal sector which evades law altogether

Source: Schneider 2004