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 13: Formal Institutions

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


Both formal and informal institutions affect individual behavior. However, unlike informal institutions, formal rules are a policy variable. Formal rules are constitutions, statutes, common laws and other governmental regulations. They usually take a written form and are externally enforced. They define the political system (the hierarchical structure, decision-making powers, the individual’s rights); the economic system (property rights, freedom of contract, open entry into all markets); and the protection system (judiciary, police, military). Formal rules could be institutionalized customs and traditions, whereby they serve the function of making informal rules more uniform, predictable, enforceable and transparent. Formal rules are also enacted in order to accommodate changes in the economic conditions of life, in which case they reduce the transaction costs of playing the game. Finally, formal institutions can also be the outcome of a top-down decision-making process in response to the majority rule, lobbying and the pressure from rent-seeking groups. I conjecture that the first two reasons for making formal rules are consistent with the interaction thesis; that is, they have low transaction costs of integration with the prevailing informal institutions. By implication, those two reasons for enacting formal rules are consistent with institutional change within the structure of tradition. The issue to discuss is the incentives and constraints under which the carriers of change (i.e. makers of law and regulations) work in common law and civil law countries. The point of departure for analysis is the Public Choice School assumption that the carriers of change pursue self-interest. This means that...

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