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 11: The Interaction Thesis

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


Institutional change generally refers to the enactment of formal rules. A new formal rule can be out of tune with other formal rules. However, formal rules are a policy variable and the government can take care of old rules that conflict with the new one. The government can also change the new formal rule to accommodate the old ones. On the other hand, the government can do little and perhaps nothing about conflict arising between formal and informal rules because the latter are not a policy variable. Hence the focus of analysis is on the relationship between new formal and prevailing informal rules. The process and implications of changes in informal institutions or culture are discussed in Chapter 14. A new formal rule creates new choices for human interactions or modifies the old ones. In either case, it changes the opportunity set within which the game is played. The effect of this new rule on economic performance must then depend on how individuals perceive and subjectively evaluate new tradeoffs. It follows that the interaction of a new rule with other rules is critical because some new rules enhance coordination and cooperation with informal institutions, while some do not. The prevailing culture thus plays a major role in determining the transaction costs of integrating the new rule into the prevailing institutional structure. Transaction costs specific to the reaction of the prevailing culture to the enactment of a new formal rule include the effect of the new rule on the predictability of...

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