Law, Informal Rules and Economic Performance
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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.
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Chapter 2: Transaction Costs

Svetozar Pejovich and Enrico Colombatto


In a world of bounded rationality, the rules are costly to produce, monitor and enforce, and the game is costly to play. Thus transaction costs, as those costs are called, are the costs of all resources required for playing the game (e.g., discovering exchange opportunities, negotiating exchange, monitoring the fulfillment of contracts and enforcing the terms of exchange) and for developing, maintaining and protecting the rules of the game (e.g., judiciary, police, armed forces). The transaction costs have an effect on the extent of exchange in the community, the flow of innovation, and the maintenance of prevailing institutions. Ronald Coase, a Nobel laureate, was perhaps the first economist to pay serious attention to the importance of transaction costs. He wrote (1988, p. 175): ‘The reason why economists went wrong was that their theoretical system did not take into account a factor which is essential if one wishes to analyze the effect of a change in the law on the allocation of resources. This missing factor is the existence of transaction costs.’ Academic research by scholars such as Armen Alchian, Harold Demsetz, Henry Manne, Doug North and Oliver Williamson supports Coase’s analysis of the importance of transaction costs, as does empirical evidence. As shown in Chapters 11 and 12, the transition process in post-socialist Central and Eastern Europe provides the most compelling and recent evidence about the importance of transaction costs. Transaction Costs and the Coase Theorem Professor Richard Adelstein of Wesleyan University has provided perhaps the simplest classroom explanation of...

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