Law, Informal Rules and Economic Performance

Law, Informal Rules and Economic Performance

The Case for Common Law

Svetozar Pejovich and Enrico Colombatto

Capitalism has outperformed all other systems and maintained a positive growth rate since it began. Svetozar Pejovich makes the case within this book that a major reason for the success of capitalism lies in the efficiency-friendly incentives of its basic institutions, which continuously adjust the rules of the game to the requirements of economic progress. The analysis throughout is consistent and is supported by evidence. Key components of the proposed theory are the rule of law, the market for institutions, the interaction thesis, the carriers of change, and the process of changing formal and informal institutions.

Chapter 9: The Rule of Law and Capitalism: An Overview

Svetozar Pejovich and Enrico Colombatto

Subjects: economics and finance, institutional economics, law and economics, public choice theory, law - academic, law and economics, politics and public policy, public choice


The economic efficiency of the use of resources is judged by the openness of the process through which voluntary interactions are carried out. Thus, a set of institutions that offers greater incentives for voluntary interactions is more efficient than another set of institutions that provides weaker incentives for free exchange. An Italian’s freedom to choose to spend 1000 euros on fast cars represents a more efficient use of resources than using the strong-hand-of-the-state to force him (via tax or some other ‘incentives’) to invest the same 1000 euros in a project that promises 10 percent growth. That is so because the latter interferes both with the Italian’s freedom to pursue his own ends and with scarcity prices that can only be established via voluntary interactions. The incentive effects of open market competition and the freedom of choice are efficiency-friendly. Competition reduces the transaction costs of exchange by conglomerating information about exchange opportunities and the terms of exchange for all the various goods. Freedom of choice allows individuals to exploit those exchange opportunities in accordance with their subjectively determined cost/benefit ratios. Observed (market) prices are the outcome of those voluntary human interactions.1 If individuals had complete information about all exchange opportunities and if information were equally available to all individuals, observed prices would be true scarcity prices. Individuals have limited abilities to predict the future, while their subjective perceptions of reality and evaluations of the same set of exchange opportunities differ from one person to another. Thus we have no way...

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