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 5: The Law of Contract and the Judiciary

Svetozar Pejovich and Enrico Colombatto


Chapter 1 addressed the costs and benefits of free exchange, which are the same as the costs and benefits of contracts and need not be repeated here. Individuals seek exchange because they expect that trade will make them better off. An unintended consequence of exchange is then to move goods from lower to higher valued uses. Chapter 2 explained that different institutions have different effects on transaction costs, and that changes in transaction costs, in turn, have different effects on the extent of exchange and on economic performance. Avner Greif provided an excellent comparison of the efficiency of exchange under two different institutional arrangements in the eleventh to thirteenth centuries: the collectivist culture of the Maghribi community and the individualistic culture in Genoa. He found that the rules of the game in the Maghribi community created behavioral incentives characteristic of those that are common in the communities based on the extended family. Those are still observed in many underdeveloped countries. Genoa, in the pursuit of more trade, reduced the transaction costs of exchange by substituting formal (legal) contracts for informal sanctions. The enforcement of those contracts reduced the transaction costs of exchange across family lines and ethnic groups. Greif (1994, p. 942) summarized the implications of those differences as follows: ‘Collectivist cultural beliefs led to a societal organization based on the group’s ability to use economic, social, and, most likely, moral sanctions against deviants. In contrast, individualist cultural beliefs weakened the dependence of each individual on any specific group [and...

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