Institutions are the secret to development, if only we knew what they were

Here’s an example of a simple rule. But is it as simple as it seems? A literal reading of the rule would ban a woman wearing a dress and sandals from entering the store, while it would allow either gender to wear a shirt, shoes, and nothing else. In a Northern beach town in the winter, this rule would be irrelevant. In the same beach town during the summer, if it were particularly carefree, the rule might be ignored.

This example gives a private rule, but it’s a good metaphor for official legal rules. All rules (such as those that make up a legal system) interact with non-rule factors, in this case the population’s clothing habits, the climate, an understanding of the intent of the rule-makers, and the degree of compliance by the population. So when we measure an “institutional” variable such as “rule of law,” we are really measuring some complicated mix of the legal and non-legal. An econometric finding that “rule of law” causes higher per capita income (a) gives little confidence that we have identified a clear relationship between the legal system and development, and (b) gives no guidance on how to modify the legal system to make development more likely.

If I want to understand law and development, maybe I should get a good lawyer. Fortunately, I have one at NYU’s law school, Kevin Davis. He inspired all the thoughts above in a paper that mocks the “rule of law” concept used by economists (available in a preliminary ungated version here). You can also hear Kevin give a fantastic lecture on law and development on the occasion of his getting the high honor of being named the Beller Family Professor of Business Law.

Kevin points out that two current measures of “rule of law” used by economists in “institutions cause development” econometric research are by their own description a mixture of some characteristics of the legal system with a long list of non-legalistic factors such as “popular observance of the law,” “a very high crime rate or if the law is routinely ignored without effective sanction (for example, widespread illegal strikes),” “losses and costs of crime,” “corruption in banking,” “crime,” “theft and crime,” “crime and theft as obstacles to business,” “extent of tax evasion,” “costs of organized crime for business” and “kidnapping of foreigners.” Showing that this mishmash is correlated with achieving development tells you what exactly? Hire bodyguards for foreigners?

What if “institutions” are yet another item in the long list of panaceas offered by development economists that don’t actually help anyone develop?

Back to constructive thoughts on the next blog post!