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 15: Efficiency-Friendly Institutional Change within the Structure of Tradition

Svetozar Pejovich and Enrico Colombatto


This book is intended to examine how the process of institutional change has a bearing on differences observed in economic progress. The term efficiencyfriendly recognizes that, in a world of uncertainty and incomplete information, we can never be sure whether an outcome of human interactions is efficient. The best we can do is to determine whether the prevailing system of incentives and constraints encourages human interactions that are consistent with economic efficiency. The term ‘tradition’ means a set of rules that have been at the heart of the institutional landscape in the West since the birth of capitalism and that are respectful of the wisdom of the past. Analysis throughout the book is consistent and is supported by evidence: institutions, formal and informal, create their own behavioral incentives. Different incentives have different effects on the transaction costs. Different transaction costs have different effects on the extent of exchange, the supply of entrepreneurship, and the integration of new rules into the prevailing system. And the extent of exchange, the supply of entrepreneurship and the integration of new rules into the system are major determinants of economic performance. The Theory This theory of efficiency-friendly institutional change posits that the four basic institutions of capitalism – (the law of contract, private property rights, a constitution and an independent judiciary, together constituting the rule of law) – promote economic progress because of their incentive effects (reducing the transaction costs of exchange opportunities; encouraging acceptance of risk; eliminating bias against long-lived consequences; and enhancing adoptive behavior) and...

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