Encyclopedia of Law & Economics - 0580 LAW AND ECOMOMICS OFDEVELOPMENT

0580

LAW AND ECOMOMICS OFDEVELOPMENT

Edgardo Buscaglia

Hoover Institute, Stanford University

© Copyright 1998 EdgardoBuscaglia



Contents

Abstract

1. Introduction

A. Substantive Aspects of the Law and Economics ofDevelopment

2. Efficiency and the Sourceof Legal Norms

3. Legal Transplants andEconomic Efficiency

4.Case Study: Intellectual Property Laws in Developing Countries

5. Trade-Related IntellectualProperty Rights

6. Legal Transplants andEconomic Integration

7. Legal Integration andEconomic Development

8. InferentialJurimetric Analysis of Legal Integration

9. The Impact ofLaws on Organizational Structures

B.Procedural Aspects of the Law and Economic Development

10. The Judiciary andEconomic Development

11. Judicial Systems inDeveloping Countries

12. Economic andInferential Analysis of the Courts

13.Corruption and Institutional Inertia: Causes and Consequences

14. The Social Impact ofCorruption

C. Conclusion

15. Scope of the Field

16. Future Research Path

Acknowledgments

Bibliography on Law and Economics of Development (0580)



Abstract

This chapter provides a review of the main channels through which legal systems affecteconomic development. High costs for determining property rights are still common in mostdeveloping countries. Confiscations; multiple, high, and unanticipated taxation applied to thesame bundle of property rights again and again; unclear definition of contractual obligations;inconsistent application of the laws coupled with corruption, and ad hoc regulations makeproperty rights more insecure and have also caused increased transaction costs within themarketplace. This institutional instability increases the discount rate applied to socialinteractions in future periods, thereby, hampering investments, savings, and the consumptionof durable goods.

This chapter approaches the main substantive and procedural legal factors that nationsneed toaddress in order to promote economic growth and development. The substantive legalrequirements for economic development are analyzed here by identifying the efficiencyenhancing sources of legal norms (i.e , bottom-up formalization of legal norms; legaltransplants, and legal integration). Economic growth and social development are also affectedby legal procedures and the mechanisms through which norms are enforced and interpretedby the court system and alternative dispute resolution mechanisms. This chapter alsoidentifies how corruption and the lack of efficiency and effectiveness found in dysfunctionalcourt systems affect investment and economic development.

JEL classification: K00, O54

Keywords: Law and Economics, Development, Judiciary, Research



1. Introduction

To what degree does law promote economic development? To what extent does creatingwealth through the accumulation of human and nonhuman capital require a set of rulessecuring property rights, governing civil and commercial relationships, and making theexercise of the state's power more predictable? To what extent might economic growth beaffected if rules are clearly defined, made public, and applied in a consistent manner? Towhat extent are investment projects affected by mechanisms to resolve conflicts based on thebinding decisions of an independent judiciary and procedures to change the rules when changeis needed? Measuring the extent of the impact of the law is an empirical inquiry. Theanswers to these questions represent the new frontier in law and economics. In most lessdeveloped countries, uncertainty related to the application of the law due to discretionarypower and an inefficient administration of justice are affecting trade and investment byincreasing transactions costs and fostering corruption. Observations and logical truths areabundant, yet the empirical verification of these logical truths seems to be scarce.

The first part of this chapter approaches the main substantive legal factors that nationsneed toaddress in order to promote economic growth and development. This first part will addressthe substantive legal requirements for economic development by identifying the mainefficiency-enhancing sources of legal norms (i.e., bottom-up formalization of legal norms;legal transplants, and legal integration). I examine the impact of legal transplants oneconomic efficiency and demonstrate this by reviewing the transplantation of trade-relatedintellectual property laws in Latin America. Also examined is the incorporation ofefficiency-enhancing legal doctrines through economic integration and a jurimetric case studyof tradeagreements in South America. Finally, this part of the chapter analyzes the impact of laws onorganizational structures.

The second part of this chapter addresses the procedural aspects of the law and economicsofdevelopment. I first address the role of the judiciary and its impact on economicdevelopment. Also presented is a case study providing an economic and inferential analysisof the court systems in Latin America. Finally, the chapter provides an account of thesymptoms of a dysfunctional court system (i.e., inefficiency, ineffectiveness, and corruption)and examines the impact of these institutional symptoms on economic development.

The conclusion to this chapter defines the scope of the field and possible future areas ofresearch.

The process of economic transformation through deregulation and the privatization of themeans of production in many developing countries coupled with intensified international tradeof complex goods and services requires a legal framework with clear rules for economicinteraction. The magnitude of the economic transformation experienced by many developingcountries in recent years involves increasingly complicated contractual relationships amongsavers, producers, investors, and customers. This process of growth needs a system of rulesable to enhance risk management in a increasingly complex economy. Legal, judicial, andalternative dispute resolution systems are potential institutional improvements in how societydeals with higher social complexity and increasing risks generated by human interactions. The clear identification and specification of these improved mechanisms is the first problemwaiting to be solved by the economic analysis of law in developing countries.

A modern market economy requires laws that are able constantly to redefine rights andmarketrelationships when new forms of corporate structure emerge; to provide ever changingdeterminations of contractual obligations, and extend them to new forms of financialinstruments, tangible, and intangible property; to redefine and enforce the rights of victims ofnew technologies and activities while protecting the environment from newly emerging risks. These are only some examples of the tremendous flexibility that the legal and judicial systemsrequire in order to adapt the laws to a dynamic economic system. As Cooter (1996, pp. 2-3)states in his pioneering piece, "if economic law is poorly adapted to the economy,expectations conflict, cooperating is difficult, and disputes consume resources. Conversely, ifeconomic law is adapted to the economy, people cooperate with each other, harmonize theirexpectations, and use resources efficiently and creatively." If public institutions are defectiveand political conditions too unstable, private contractual arrangements will also becomeriskier and negatively affect private investment. In short, the formation of larger markets andthe possibility of longer-term contracts, both necessary conditions for economic growth, arehampered by an unclear or undefined system of legal rules and inconsistent application andinterpretation of those rules. The application of the economic analysis of law to developmentissues sponsors a clear and consistent definition and enforcement of the conditions ofownership in developing countries undergoing transformations. As Orr and Ulen (1993, p.3)argue, "a government that credibly commits itself to upholding rights of property and contractenforcement not only provides a basis whereby partners in economic transactions can trusteach other; it also reinforces the hope that the government itself can be trusted to transacthonorably and to meet its contractual obligations."

Yet high costs for determining property rights are still common in most developingcountries. Confiscations and multiple, high, and unanticipated taxation applied to the same bundle ofproperty rights again and again, unclear definition of contractual obligations, inconsistentapplication of the laws coupled with corruption, and ad hoc regulations have all madeproperty rights more insecure and have also caused increased transaction costs within themarketplace. This institutional instability increases the discount rate applied to socialinteractions in future periods, thereby, hampering investments, savings, and the consumptionof durable goods. The most interesting question then remains: What are the structures of themost effective legal and judicial mechanisms that would be able to interpret and translatethose social norms into laws in less developed countries?

The economic analysis of the law in developing countries represents an attempt to identifychanges in laws, regulations, and enforcement mechanisms that, within the legal tradition ofeach country, would be able to enhance economic efficiency and improve equity. EdmundKitch (1983) argues that law and economics focuses on the study of the impact of a system ofrewards and penalties that affect individual behavior. These rewards and penalties are definedby laws, regulations, doctrines, court cases, social norms, etc. The central goal of law andeconomics is then to analyze the individuals' and firms' maximizing behavior within a systemof rules in order to identify the effects of laws. In this sense, law and economics follows amethodology compatible with a legal realism and within an elaborate framework of analysisprovided by microeconomic theory. In this context, I will analyze how legal doctrines are nothermetically sealed, self contained, or even self sustaining. I will follow a legal realism foundin law and economics where the law cannot be understood apart form its social context. Thus,an understanding of how to enhance a more efficient social order through legal reform will beattained through an empirical study of human behavior.



A. Substantive Aspects of the Law and Economics ofDevelopment

2. Efficiencyand the Source of Legal Norms

One recently emergent line of research in the law and economics of developmentliteratureconcentrates on the microeconomic foundations of the sources of those rules that will allowthe law and its enforcement mechanisms to adapt to a modern economy and, by adapting,foster economic growth. This topic is explored by Cooter (1996) who argues that efficiencyis enhanced by a "bottom up" process of capturing social norms that are already in place as"informally" relevant in human interaction. Norms are understood here as coordinatingmechanisms for social interaction. This decentralized approach to lawmaking stands in sharpcontrast to the centralization proposed by the first law and development movement that duringthe 1960s and 1970s proposed a clear centralization and "modernization" of the laws throughtransplants. The most important works in this first movement can be ascribed to Seidman(1978), Galanter (1974), and Trubek (1972) , who sponsored a comprehensive,centralized,and top-down legislative reform aimed at modernizing the public and private dimensions ofthe law.

There are four legal traditions relevant in this century: civil law, common law,administrativelaw, and socialist law. Eastern Europe and China have slowly shifted from a socialist legalsystem characterized by the production of centralized public rules to prerevolutionary privatecivil law. The common or judge-made law sustained by stare decisis hassuffered from thesignificant expansion of administrative law. In this scenario, administrative law, as theframework establishing the rules to be followed in the relationship between the state andprivate individuals, has been the byproduct of the expansion of the government role in westernsocieties. Therefore, these legal traditions are in a constant state of flux.

The civil law systems are currently facing a choice between either legalizing andenforcingsocial norms in a bottom-up approach by following the policy prescriptions of Hayek (1973)or creating regulations in a centralized top-down manner. For example, the civil code caneither capture the norms of local and international business communities or simply imposerules on a top-down approach. One of the most important dilemmas facing developingcountries in their current legal evolution is the choice between centralized law versusdecentralized law-making capabilities. Following Hayek (1973), one could argue that thehigher information constraints that are the product of added social complexity require publicpolicy to decentralize law-making by capturing norms and thus reducing market transactioncosts. As Cooter (1996), p.148 states,"efficiency requires the enforcement of customs inbusiness communities to become more important relative to the regulation of business." AsCooter (1996, p 154) also argues, "customsarise when external effects align with incentivesfor signaling." From this perspective, the irrelevance of the laws enacted by parliaments inmany countries must be understood as a reflection of the lack of links between the essence ofwhat the law stipulates and the social norms followed by people and businesses in their dailylife. When regulations or laws show this lack of compatibility, the costs of complying andenforcing the law become higher. These are the so-called "bad laws" mentioned by de Soto(1989) in his path-breaking work in which he identifies a deficient rule by comparing theapproximate transaction cost of complying with the law against the transaction cost offollowing the social norm within an informal market. In de Soto's work one can observe thatthese higher transaction costs are rooted in the drive of governments to centralize lawmakingwithout regard to the true social practices followed by people. Only when the laws andregulations reflect these practices will the transaction costs of the social interactions affecteddecline and a movement towards efficiency occur. From de Soto's (1996) perspective, the sizeof many informal sectors around the globe is intimately related to the way laws andregulations fail to capture the social practices followed by society.

By following the pioneering studies by Cooter(1996, 1994) and Mattei (1993) we could arguethat the laws generating obedience are the ones truly compatible with the ethical codeprevailing in society. Individuals in social frameworks seek the kind of predictability thatwill tend to increase their capacity to generate wealth through their interactions. The state ofnature or "grab what you can" is not a priori desirable or compatible with long term survivalunder a "veil of ignorance." Different levels of concentration of political and economic powermay be compatible with predictable rules of the game. Yet for all levels of concentration ofpolitical and economic power, the social norms and values supporting the prevailing andpredictable rules of political and economic interaction would tend to enhance allocative andproductive efficiency by reducing transaction costs of interacting. In this scenario, civilsociety's norms will be found by public institutions and transformed into formalized legalrights and obligations.

One could here extend Cooter's analysis and state that, in order to enhance efficiency,politicsmust follow not just the market but also the non-market social norms. In a morecomprehensive fashion, civil society's market and non-market rules for social interactionprovide a law-making guide for the legislature and the judiciary. By making laws familiar tothe individual, the transaction costs of human interactions decrease and allow society toachieve efficiency in its market and non-market activities. The evolution of intellectualproperty laws in developing countries, described in the next section, provides a good exampleof how legal transplants provided a channel through which national laws started to capturebusiness practices and social norms.



3. LegalTransplants and Economic Efficiency

Let us now address the economic analysis of efficiency-enhancing substantive legalreform indeveloping countries. There are two main choices for a developing country when selectingthe source of its laws. A country can adopt a law from within its own institutionalmechanisms, or it can transplant rules from outside its political-legal zone of dominance. Akey need in the economic analysis of the law is to determine a framework for predicting whichof the two options is the most efficiency-enhancing alternative. Watson (1978) has shownthat most legal reforms are due to transplants. Therefore, we should also explain why, froman international pool of laws available for transplant, certain rules and institutions arecommonly used while others are rejected. For example, why is it that some countries adoptthe same rules to protect intellectual property? In more general terms, we should also explainwhy some countries adopt civil law as opposed to common law systems, or separation ofpowers as opposed to parliamentary systems. As Mattei(1994) and Ulen (1996) pointed out,one reason could be simply "prestige." Yet, they point out that prestige is not a measurablevariable and, thus, it is difficult to verify the hypothesis in a scientific manner. Microeconomic theory, on the other hand, can provide a justification for the transplant bytesting if the legal rules transplanted are also the most efficient ones. In other words, anintertemporal cost-benefit analysis may provide an explanation of why some legal rules andsystems are adopted and others rejected. Within this scenario, Eggertson (1990) and Ulen(1997) point out that the economic efficiency hypothesis proposes that different legalsystemsmay compute the costs and benefits of legal rules for the same situation differently becausereal economic factors (such as resource endowments and tastes) are different across regionsand nations. At the same time, it is also true that legal reforms are subject to the politicalsupply and demand given by vested interests. That is, professional interests which may bethreatened by any profound alteration in the legal system as it exists and from which they havebenefited. To a large extent, the successful implementation of any reform depends on theseagents, ultimately responsible for effective law-enforcement.



4. Case Study: Intellectual Property Laws in DevelopingCountries

Buscaglia and Ulen(1994) apply the above cost-benefit approach to transplants to the recentadoption of intellectual property laws under the GATT umbrella. Recent empirical studiesconducted by Foray andFreeman (1993) show that in order to ensure a "catching-up" growthprocess, developing countries need to expand the size of their domestic savings and humancapital pools through the application of clear laws and consistent enforcement. The observeddifferences in wealth among countries has always captured the attention of scholars in manyfields. Lucas (1988) describes the powerfuleffects of technological change and the need toenhance technological learning in the process of economic development. Yet "catching-up" isa process that depends on much more than just technological change, understood as increasingthe incorporation of new technologies into the production capacity of firms. Bell, Martin, andPavitt (1993) bring to our attention the importance of technological learning, defined asanincrease in the resources needed for generating and managing technical change. In thiscontext, what needs to be addressed is not just the lack of industrial capacity or technicalchange but also consider the dearth of technological capability as the most basic and acutedeficiency in most less developed countries (LDCs). Technological learning, however,requires a deeper transformation in a society than technological change does. Technologicallearning implies the building of institutions and skills capable of generating technical changein the future. It is at this deeper level that, for example, the intellectual property frameworkwill affect future technical change.

The increasing permeability of national frontiers subject to international trade and ideas isofsuch magnitude that it has forced national authorities to reconsider the legal foundation ofintellectual property rights. The Paris and Berne Conventions provided a legal framework formore than a century containing two main doctrines. The doctrine known as"territoriality"sustaining that property rights are to be honored according to each state's rules; and thedoctrine of "independence" establishing that granting property rights within one state did notforce other states to grant the same rights. These two doctrines have become irrelevant underthe new order emerging after the Uruguay Round. Under the supervision of the newly createdWorld Trade Organization, the harmony or uniformity of laws has been sought as the idealway to encourage the international flow of goods and services. This new framework hassolidified the view that the justification for granting intellectual property rights, such as apatent, is based on social norms required by the need to exchange benefits between societyand the innovator. The innovator receives a monopolistic return from an investment in orderfor society to be able to benefit from an incremental diffusion in knowledge that otherwisewould have been kept as a secret.

The international enforcement of intellectual property rights experienced a drasticevolutionduring the past three decades. For more than a century, the international intellectual propertyregime was governed by the Paris and Berne Conventions which provided ample scope forcooperation but at the same time left to national legislation to define the main aspects ofintellectual property rights. After World War II, a concern with the balance between the rightsof the author and the benefits of diffusing knowledge to less developed countries (LDCs) asfast as possible challenged the norm based on the aforementioned exchange of benefitsbetween society and the innovator. The need for rapid industrialization and vastimprovements in technologies were justifications for LDC governments to imposerequirements limiting the rights and benefits of innovators. Two typical examples oflimitations to the rights of innovators occurred in most LDCs when: (a) a patent can only begranted if the intellectual property is worked and exploited within the national frontiers of acountry (a working requirement); and (b) the terms and royalties for licenses of intellectualproperty can be determined by the government in the absence of agreement by the innovator(compulsory licensing). Under these two types of restrictions, LDC governments abandonedthe formula of exchange based on monopoly for diffusion and replaced it with an approachbased on granting intellectual property rights in exchange for foreign direct investment. Difficult problems remained, however. Common features of many legal systems in LDCsshow intellectual property rights subject to inconsistent coverage, uncertain terms ofprotection, arbitrary transferability, compulsory licensing regimes, and inadequateenforcement. The national character of this type of legislation, however, has beenincreasingly called into question by industrialized countries. The advanced economies'challenge to the old legal order can be explained by drastic changes in business practices andnorms of behavior. More specifically, the need for legal reforms were caused by thetechnological breakthroughs of the 1970s and the subsequent revolutionary impact ofmicroelectronics, biological inventions, computer software, and other high technology sectors. These sectors required increasing investments in research and development paid bybusinesses from those industrialized countries mainly responsible for the production of theseknowledge-intensive products. Under this scenario, international trade ofknowledge-intensiveproducts gained relevance as a proportion of each developed countries' exports and nationalproduction.



5.Trade-Related Intellectual Property Rights

The new reality shows that the United States (US), the European Union (EU), and Japanareincreasingly dependent for their competitiveness on their ability to protect the value inherentin intellectual property. At the same time, most of the LDC are extremely dependent onexports to advanced economies. Many of these LDC exports benefit from theGeneralizedSystem of Preferences (GSP) granted by the European Union and the United States, wherebyspecial lower tariffs or preferences are applied to designated LDC exports. This mutualdependence made it possible for advanced and developing economies to start bilateralnegotiations with a potential for mutually beneficial agreements in order to find a solution tothe lack of protection of intellectual property rights. The "stick" in these negotiations wasprovided by the threat of loss of access to the United States and European markets through thecancellation of GSP benefits. But foreign pressure is not the only force that is able to explainlegal reforms in LDCs.

Since 1995, and under the World Trade Organization (WTO) supervision, many lessdeveloped countries have adopted trade-related intellectual property rights (TRIPs) that aremore compatible with the American and European minimum standards of protection. Somemay even classify these legal reforms as "transplants." As part of the GATT framework, theWTO will (a) finally enforce a set of internationally recognized standards for the protection ofintellectual property rights for incorporation into national laws; and (b) develop a consultationand dispute settlement mechanism for overseeing the implementation of the internationalnorms and resolve any government to government disputes regarding the interpretation ofsuch norms.

Primo-Braga (1990) observes thatmodern intellectual property rules have not been applied orenforced by governments in developing countries even when the benefits of such rules arewidely recognized by local business interests and by the countries generating the essentialtechnologies needed for development. However, the forces explaining this pre-GATT inertiaor the causes behind the current emergence of a region-wide intellectual property reformthroughout Latin America have been overlooked. This oversight is explained by the failure torecognize how the costs and benefits of legal reform operate on a different time frame. Morespecifically, the costs of legal reform are seen by politicians in less developed countries as ashort term liability hampering their chances for reelection. On the other hand, the benefits ofdefining and enforcing intellectual property rights are perceived as more distant and lesstangible.

As stated in Buscagliaand Ulen (1994, p. 159), legal reforms in developing countries must beseen as the joint effect of local political conditions and foreign economic pressures. Thesetwo forces explain the international legal convergence observed in the intellectual propertyarena. As stated above, the foreign economic pressures to reform intellectual property lawsarise particularly because an increasing proportion of imports to Latin America consist ofinformation-intensive goods and services. From a domestic policy perspective, the movementtoward intellectual property reform corresponds with the complete failure of the importsubstitution approach to development. From the early 1930s until the late 1980s, mostdeveloping countries encouraged domestic (import substitution) manufacturing investment,suppressed agricultural prices, and expanded the size of their public sector enterprises whileattempting to stimulate savings and investment through taxation and credit allocated by thepublic sector. The prevailing view, represented in Prebisch (1950), was that a shortage ofdomestic physical capital was the key impediment to development. Import substitutionindustries grew behind protective walls based on subsidies and tariffs in a milieuwhere manyother determinants of the rate of economic growth, such as investment in human capital andthe role of microeconomic incentives, were completely ignored by policy makers. Protectionof import substitution industries allowed domestic prices and costs to far exceed internationalprices and created little incentive for efficiency. These protected industries producedsubstitutes for imports but usually depended on the import of raw materials and technology. Import demand grew rapidly as these firms imported capital goods to accelerate investment. The anti-export bias, combined with the import-substitution program, caused a scarcity offoreign exchange, and this, in turn, created a structural barrier to the investment in expensivefirst-rate technologies. Within this environment protected from international trade, however,firms could still survive investing in second-rate technologies. As described in Buscaglia(1993) this approach to development came to an end during the international debt crisisof the1980s when developing countries' policy makers realized that internal markets and importsubstitution were not enough to assure sustainable growth. The demise of theimport-substitution model left most developing countries with no other option for economicgrowththan to eliminate trade barriers and promote competitive exports through the incorporation ofworld-class technologies. As a result of these foreign and domestic pressures, LDCs wereforced to reconsider many of their legal institutions, including their national intellectualproperty laws. In this context, the international economic and political environment describedhere has produced a convergence of LDC laws towards the intellectual property legalframeworks prevailing in nations generating standard technologies.



6. LegalTransplants and Economic Integration

Legal transplants are a key main source of trade-related legal changes in developingcountries. Most less developed countries (LDC) have chosen an export-led approach to economic growthand they are also eager to attract much needed foreign direct investment (FDI). In order toenhance trade openness abroad and at the same time attract foreign investment to theirdomestic markets, they must provide a more stable environment in which to do business. Therefore, competitive pressures arise on LDCs to harmonize their legal systems with those incountries exporting capital by incorporating foreign legal frameworks that developed-countryfirms perceive to enhance their productive efficiency.

A central topic to be addressed in law and economics of development must focus on thestudyof what are the main economic factors explaining the formation of legal transplants and legalintegrations that tend to enhance productive efficiency. As stated in Ulen (1996, p. 9), "Lawand Economics has been one of the most important and productive innovations in legalscholarship of the twentieth century. Yet its contributions to the issues of constitutional law,including federalism, are relatively modest." From this perspective, we could add that theattention paid to the analysis of legal and economic integration have also beeninsufficient.

The mechanisms through which parliaments and the judiciary in civil law countries wouldcapture and translate these norms into law would require an identification of those practicesthat have become standard in business communities and a required justification of how thosepractices create efficiency-compatible incentives. The efficiency aspects of these practicesmust be analyzed with the aid of the theoretical and empirical tools used by economists. Forexample, this approach to law-making could use empirical techniques within the so-calledjurimetric framework of analysis. In this way, the economic impact of legal reforms could becaptured through the use of parametric and non-parametric techniques. Relatively fewempirical studies have been advanced in law and economics and even fewer within theeconomic analysis of development. Yet studies by Long and Buscaglia (1997), Cooter andGinsburg (1996), and Buscaglia and Guerrero (1995) have clearly shown the great advantagesof applying statistical techniques to the economic analysis of the law. Without any doubt,jurimetrics represents a real frontier in the law and economics of development. The potentialto rationalize public policy-making with the help of jurimetric techniques represents a clearimprovement in the analysis of the economic impact of legal reforms proposed in alldeveloping countries.

Many may argue that civil law systems would tend to reject the economic analysis of theirlaws. Yet, quoting Cooter (1996, p.145),"Judges allegedly make law in civil law systems byinterpreting codes, not finding social norms. Compared to common law countries, thecodifiers in civil law countries apparently have more influence and the judges allegedly haveless influence. Interpreting some codes, however, looks a lot like finding social norms. Comparative lawyers, consequently, debate whether the apparent differences in the twosystems are real or illusory." From this perspective, one could argue that civil law systemshave the capacity to react to efficiency forces as much as common law systems do. Moreover,it may come as a surprise to many sponsoring a centralized legal system that the civil laworiginally evolved as a common law system. In Watson(1978) we can find an excellentaccount of this evolution. Let us not forget that, before the 19th century, the Europeaniuscommune was based on the judge's interpretation of Roman law within the local normsandpractices. The centralization of law making through legislatures aimed at replacing lawsbased on social norms, practiced by people and found by judges, with what Cooter (1996)calls "rational" rules that were "designed" to engineer a better way of life for society. Thejudge was supposed to only interpret laws generated by legislatures and not find norms. Theinterpretation of norms, however, was also subject to an implicit and subtle application ofsocial norms as inputs in the opinions of judges. Yet, this post Napoleonic framework tookaway power from the judicial branch and made it more dependent.

The formation of trading blocks can be analyzed with the same tools that law andeconomicshas applied to the analysis of federalism. This approach focuses on identifying and measuringthe benefits versus the costs of generating added political and economicintegration. Longand Buscaglia (1997) recently advanced empirical research in this area. It is useful topresenta summary of this empirical study on economic integration below. The methodology used inthis piece provides an alternative research path where the links between the existence of legaltransplants and economic structures can be explored and discussed in future studies.

Developing nations are currently facing a unique opportunity created by global free trade,thecontinuous decline in transportation and communication costs coupled with the unprecedentedavailability of generic applied knowledge, and the expanding flows of international financialinvestments. However, many of these countries lack the institutional capability to create orabsorb the applied knowledge aforementioned. Legal and economic reforms that are currentlyoccurring in LDCs are, in some cases, strengthening the foundations for economic growth. Inall cases, these legal and economic reforms are based on strategies aimed at giving domesticproducers a more important role in the development of their economies.

During the 1980s, increasing competition and volatility in world markets have inducedindustrialized and developing countries alike to cluster together in regional economic blocs. This trend was spurred by three additional main factors: (i) technological innovations intransportation and communications have expanded the relevant size of the markets for anincreasing number of goods and services; (ii) the overall economic slowdown in world tradeduring the period 1988-92, accelerated by the collapse of the Communist regimes and; (iii) thenear failure of the multilateral trade negotiations sponsored by GATT at the Uruguay Round. In turn, the near-breakdown in multilateral trade negotiations served to create an environmentcompatible with bilateral and regional accords.



7. LegalIntegration and Economic Development

Legal integration is another main external source of legal changes that have an impact onefficiency in many developing countries. Of central interest, in our analysis, is whygovernments choose some strategies over others in pursuing legal/economic integration. Longand Buscaglia (1997) propose that a successful legal/economic integration is a functionof theconvergence of three broad conditions: (1) the compatibility of political systems; (2) thepublic sector's expectation of gains from liberalizing international trade; and (3) the privatesector's expectation of gains from regionalizing production, transferring capital andtechnology, and harmonizing trade-related rules. Some or all of these factors are key drivingforces behind the main trade agreements within the western hemisphere, Europe and Asia: theNorth American Free Trade Agreement (NAFTA) of the United States, Canada, and Mexico;the Andean Pact involving Bolivia, Colombia, Ecuador, Peru, and Venezuela; and theCommon Market of the South (MERCOSUR) covering Argentina, Brazil, Chile, Paraguay,and Uruguay, the European Union, and the Asian Economic bloc. As a case study, theempirical study summarized below concentrates on providing an empirical verification of theabove third condition in Latin America.

The ongoing Latin American economic transformation has created a need for new andmajorlegal developments. Yet, what are the main economic forces explaining the drive to integratethroughout Latin America's economic history? A jurimetric analysis in Long and Buscaglia(1997) shows that growth in international intra-sectoral trade comes hand-in-hand withtheprivate sector's growing demand for the harmonization of trade-related laws. In addition tothe legal issues mentioned above, harmonization does occur in many other areas. A survey ofthe legal history of economic integration reveals that harmonization occurs in specific areassuch as banking, insurance, securities, liberal professions, international securities exchangeregulations, and transport. We see that the future of hemispheric integration and tradeprocesses necessarily entails the deepening and development of these legal areas. However,Latin American economic history has been littered with the hulls of shipwrecked tradeagreements seeking legal integration. Yet, the compatibility in the evolutionary natures of twoor more legal systems has to be introduced as a factor that will affect the need and feasibilityof legal integrations. Moreover, the empirical review of patterns of trade in Long andBuscaglia (1997, pp. 10-12) shows that this legal compatibility is driven by internationalsimilarities in economic structures.

Table 1 aims at associating legal agreements seekingharmonization in trade-related rules withother economic factors such as the number of high growth non-agricultural trade-relatedsectors of the economy of selected LDCs. A review of Table 1below shows that there existsa strong association between the emergence of high growth (above 5 percent annual growth insales) non-agricultural sectors (i.e., changes in economic structure) and the number of legalamendments in the commercial codes on the one hand, and the drive of a country toharmonize its legal system through international trade-related agreements on the other. Forexample, we observe that Argentina and Brazil who possess the most dynamic economiesduring the period 1850-1990 (with 16 and 14 new non-agricultural trade-related sectorsrespectively) are also the countries with the largest number of amendments to theircommercial codes and with the largest number of trade-related legal treaties signed (i.e., 31for Argentina and 35 for Brazil). As expected, more complex economic systems (i.e., a largernumber of high growth new trade-related sectors) experience more complexity in their legalsystems by undertaking more amendments in their commercial codes. At the same time,Table 1 shows that dynamic economies are also more likely toharmonize their legal systemsthrough international legal agreements.

Table 1
Legal Changes vs. Economic Structure During 1850-1990

Country# of Amendments InCommercial Codes# of Trade Related Non-AgriculturalSectors# of InternationalLegal Agreements
Argentina5151631
Bolivia1913
Brazil5211435
Chile4671125
Colombia907
Ecuador1416
Peru56012
Uruguay1215
Venezuela521


Table 2
Matrix Of Inter-Country Legal Agreements Covering CommercialAreas

ArgentinaBrazilBoliviaChileColombiaEcuadorPeruUruguayVenezuela
Argentina01411021210
Brazil1402732421
Bolivia120000000
Chile1070021311
Colombia230200000
Ecuador120100200
Peru240302001
Uruguay120100001
Venezuela010100110


Table 2 shows a clear pattern where the region's mostdynamic economies are also the onesthat are more likely to enter into international legal agreements with each other involvingharmonization of private law. One can argue that as an increasing number of businessexchanges occur in countries with overlapping growing trade-related sectors, their need forlegal harmonization will tend to increase. This explains why in Table2 we observe that mostattempts to harmonize legal frameworks have mainly involved countries such as Argentina,Brazil, and Chile. These countries all experienced growth in the most dynamic trade-relatedsectors (e.g., agro-manufacturing, minerals, steel, financial services, transportation, andenergy).



8.Inferential Jurimetric Analysis of Legal Integration

Based on the evidence found in Tables 1 and 2 taken from Longand Buscaglia (1997), we canassert that many Latin American experiments aimed at legal harmonization may have failed toproduce substantive results due to a lack of private sector lobbying pushing for compatiblelegal solutions addressing trade issues. More specifically, countries with overlapping dynamictrade-related sectors (i.e., experiencing a higher proportion of intra-sectoral internationalexchanges as a proportion of total trade) will at the same time possess private sectorsdemanding compatible legal frameworks within the areas affecting their products. This alsoexplains the push for intellectual property and competition reforms and harmonization of rulesamong Argentina, Brazil, and Chile. In this context, imagine two types of countries hoping toharmonize their commercial laws: Countries where private commercial laws are not far fromtheir evolutionary base and where no dynamic trade-related non-agricultural sectors producinginformation-intensive products exist (e.g., Bolivia, Colombia, Uruguay), and, in contrast,countries with relatively evolved commercial legal systems and with a high proportion of theirtrade concentrated on dynamic sectors (such as Argentina, Brazil , Chile). The quantitativeevidence (Table 1 and 2) and theanalysis advanced above would predict that legalharmonization between these two types of countries will have less chances of success. Inthese cases, the private sectors within each of these types of countries will demand differentkinds of commercial legal frameworks. As a result, integration will be more difficult. Forexample, one can observe that private sector firms in Bolivia importing Brazilian computersoftware and hardware, compact disks, or movies, do not have an incentive to lobby for theenactment of intellectual property, government procurement, or competition laws compatiblewith the needs and interests of the Brazilian firms exporting these products to Bolivia. Graph1 below shows that the main drive to harmonize trade-related laws was concentrated amongthose countries experiencing high levels of international intra-sectoral trade. For example, wesee that Brazil and Argentina with 35 and 31 trade-related legal agreements, respectively, arealso the countries with the highest level of intra-sectoral trade.

Clearly, Argentina, Brazil, and Chile are the countries with the highest levels ofintra-sectoraltrade as a proportion of their total trade that, according to our argument, also possess the mostdynamic private sectors lobbying for legal integration. The number of legal agreementsattached to each of these three countries during the period 1890-1990 clearly support ourclaim. In fact, those industries involved in intra-sectoral trade within MERCOSUR were themain forces lobbying for legal harmonization of standards and regulations. Let us note thatintra-sectoral trade within MERCOSUR grew at an unprecedented rate after tariffs were firstreduced in 1988 as part of the ABIP Treaty. The relative importance of intra-sectoral tradebetween Argentina and Brazil increased from 19.2 to 39 percent of total exports in Argentina,and from 5.3 to 23.8 percent in Brazil. These industries included the automobile, energy,steel. pharmaceutical, mineral, and textile sectors.

One could also claim that the relatively larger countries (Argentina and Brazil), due to thelarger stakes in trade and their larger GDP, will seek to determine a specific type of legalharmony with their main trade partners through legal agreements. On the other hand, smallercountries in Latin America (e.g., Uruguay and Ecuador) will just "free ride" by transplanting legal frameworks to their own environment. A regression analysis covering the variablesaforementioned will test this and the above claims. We can see in Table 3 below that thenumber of legal agreements during the period 1890-1990 in the twenty countries surveyed isour dependent variable. The number of amendments to the commercial codes (AMEND), thenumber of non-agricultural trade-related sectors (NO_TRNA), and the average intra-sectoraltrade as a proportion of total trade (AV_INTRA) are all predictors. These are all variablesthat help to predict the drive to harmonize legal frameworks within Latin America during theperiod 1850-1990. As we can see, all these explanatory variables are significant at the 5percent level. On the other hand, the relative size of the GDP (%GDP/T.GDP) is not asignificant variable. In other words, relative size does not explain the drive to harmonize legalframeworks. Finally, we see that 62.7 percent of the variability in our dependent variable isexplained by the independent variables included.

Table 3
Multiple Regression Analysis

DEP VAR:NO_LEGAG
SQUARED MULTIPLE R: 0.627
N: 20MULTIPLE R: 0.792
STANDARD ERROR OF ESTIMATE: 2.04
VariableCoefficientStdError TolleranceTP
(2-tail)
CONSTANT14612012160
AMEND101957492
NO TRNA435958610
AV INTRA7223993160
%GDP/T.GDP515863334




9. TheImpact of Laws on Organizational Structures

The impact of substantive norms on productive efficiency needs to be assessed byidentifyingthe type or organizational structures that would emerge under different sets of legal rules. Thefull identification of the implicit price transmitted by institutions to firms and individuals, onthe one hand; and the specification of the institutional structure needed to attain allocative andproductive efficiency on the other, are two areas where law and economics possesses acomparative advantage with respect to other social sciences. Thus, the works presented in thisfield cover a positive and a normative approach to the economic analysis of the law. DouglassNorth (1990) has already pointed at the relationship between the property rightsframework,transaction costs, and economic growth. Moreover, the study of market and non-marketbehavior reacting to implicit prices established through laws falls within the best tradition ofthe University of Chicago approach to law and economics. Yet other approaches need to beincorporated into the legal and economic study of development, such as the study of thebehavior of organizations and their economic environment proposed by Oliver Williamson(1991) and the analysis of the factors related to intermediate organizations with thepotentialto hamper economic growth described by MancurOlson (1982 and 1993). In short, theunderstanding of how laws have an impact on market and organizational structures also needto be the focus of attention of development economists in search of answers explaining thelack of international convergence in economic growth rates.

Coase (1960) has shown that transactioncosts determine the nature and organization ofeconomic activity and the distribution of income. One interesting aspect to be addressed indevelopment studies are the changes in legal rules and their enforcement mechanisms that areneeded to promote the existence of public and private organizations in which their members'increase in wealth position is compatible with attaining the goals of the organization andimproving the overall wealth of society. In this scenario, behavioral patterns such as lowfactor productivity incentives and corruption (i.e., a transfer of wealth caused by the use ofpublic office for private benefit) can be understood as symptoms of organizational defectsexplained by systems where individuals perceive that their well being does not go hand inhand with the well being of the organization in particular and society in general. In thisscenario, a pattern of defective organizational structures hampers the creation of wealth andeconomic growth.

There are specific key variables whose dynamic interplay determine the performance ofallorganizations. These key variables correspond to the following two main areas: (a) theinternal organization of an economic or political unit that includes the internal structures andarrangements between the principal and the agents by which the owner causes the managers toact for the goals set by the owner; and (b) external incentives that are composed of all thosevariables relating primarily to market factors that, although not under the control of theprincipals, discipline the agents and principals in performance. The past eight years ofeconomic and political reforms across eastern Europe, Latin America, and Africa have made itclear to those working on public policy reforms that the social and economic development ofnations require newly designed organizations that are able to harmonize the incentive to createprivate wealth with the progress of society in general. This amounts to an invisible handwithin the organization that can be explained by its own structure.

The links between the impact of private and public law on organizational structures indeveloping countries has not been explored until recently. The work advanced by MichaelTrebilcock (1997) goes into the main links between the quality of public sectorgovernance ,organizational structures, and the economic progress of nations. This work covers therelationship between the nature of a political system and its economic performance. Subsequently, it answers two main questions: (i) what type of institutions are most conduciveto economic development and (ii) what factors or conditions encourage or alternativelyimpede the adoption of efficient institutions.

The research conducted by de Soto (1996and 1989) follows an original examination oftheproperty rights framework in developing countries, in this case Peru, and describes the way inwhich the lack of predictable property rights rules have affected the structure of private firms,investment, and economic growth. de Soto's historical analysis provides a decisive linkbetween ownership rules and the complexity in the pattern of market transactions. Clearly, hisanalysis provides answers to key questions through the use of the economic theory ofproperty. First, de Soto asks what should be privately owned in an environment where stateownership has been the norm until recently; and second, how should property rights beenforced in order to assure a compatibility between social norms and written law. In thisscenario, de Soto requires this compatibility in order to assure that the law will be followed bythe average citizen. In this context, he stresses the fact that in the absence of clear andenforced legal rules, people will substitute clear and enforceable customs and norms for thecollectively enforced set of legal rules. As stated in Buscaglia and Ratliff (1997), from aneconomic standpoint, regionally-determined bubbles of customary systems may not be asefficient as a bottom-up collectively enforced set of legal rules.



B. Procedural Aspects of the Law and EconomicDevelopment

10. TheJudiciary and Economic Development

As developing countries continue their process of economic reforms, the need for a wellfunctioning judiciary becomes increasingly evident. Yet, the empirical dimension of theeconomic analysis of legal procedures is in its infancy. As stated in Buscaglia and Domingo(1995), democratization, growing urbanization, and the adoption of market reforms haveallcreated additional demands for court services throughout the region. These three factors haveincreased the complexity of social interactions, thereby making the enhancement of thejudiciary's conflict-resolution capabilities even more necessary. In addition, the shift of mosteconomic transactions toward the market domain and away from the public administrativesphere of the state has created an unprecedented increase in private sector demand for animproved definition of rights and obligations.

The judiciary is a key element of economic development. The judicial system includes allthemechanisms needed to interpret and apply the laws and regulations. More importantly, thejudiciary is the main link through which the economic impact of the legal system can beidentified. The productive role of the judicial sector within the economic system consists ofresolving conflicts by providing the substantive and procedural structure to facilitate theexchange of rights to physical and intangible assets. Judiciaries in most developing countries,however, suffer from increasing backlogs, delay, and corruption. As shown in many Galluppolls, this has generated complete distrust of the system by the private sector and the public ingeneral. Moreover, the judiciary can also affect the behavior of private investment. Lack ofaccess to an equitable and efficient judicial system creates added uncertainty and hampers therealization of beneficial transactions. In the absence of an impartial and efficient judiciary,the performance of mutually beneficial transactions depends upon the presence of pre-existingreputation and repeated transactions among parties. This requirement excludes manypotentially beneficial transactions involving previously unfamiliar parties or startupbusinesses from occurring.

Legal principles supporting the prevailing economic systems in many developingcountries arenominally based on the freedom to exercise individual property rights. But legislation ismeaningless without an effective judicial system to interpret it. Consistent interpretation andapplication of the laws by courts provides a stable institutional environment in which the longterm consequences of economic decisions can be assessed by businesses and the public. Inthis context, an ideal judicial system is composed of institutions capable of applying andinterpreting laws equitably and efficiently. Under most of the judicial systems in LatinAmerica, however, laws are not subject to predictable interpretation. This uncertainty,coupled with delays in resolving cases, further increases the costs of access to justice anddoing business.



11. JudicialSystems in Developing Countries

The belief that the judicial sector in Latin America is ill-prepared to foster private sectordevelopment within a market system is growing. Business surveys conducted by the WorldBank (1993) indicate that the judicial system is considered to be among the top tensignificantconstraints to private sector development. Basic elements that constitute an efficient judicialsystem are missing: relatively predictable outcomes within the courts; accessibility of thecourts by the population, regardless of income level; reasonable time to disposition; andadequate court-provided remedies. Increasing delays, backlogs, and the uncertainty associatedwith expected court outcomes have diminished the quality of justice throughout the region. The judiciary is faced with several obstacles, including a dysfunctional administration ofjustice, lack of transparency, and a perception of corruption.

As an example found in Buscaglia(1995), Table 4 below presents country comparisons in themonthly percentage changes in delays and backlogs in federal jurisdictions of selected LatinAmerican countries that have reliable data. Average changes, in monthly terms, for the period1983-93 show a pronounced deterioration compared to the period 1973-82, which helpsexplain the public's dissatisfaction with judicial systems throughout the region.

Table 4
Change in Delay and Backlogs in Latin American Courts,1973-93

% Change in Median Delay

% Change in Backlogs

Country1973-821983-931973-821983-93
Argentina16747892479
Brazil2339122197
Chile84111121294
Colombia3427891281
MexicoN/AN/A72341
Venezuela31483118513
Sources: Supreme Court Bureau of Statisticsfor respective countries.

This data may also explain the results from a recent survey of the region's judicial systemsconducted by The World Economic Forum(1993 and 1994) that shows the majority of courtusers are "not inclined" to bring disputes to court because they perceive the system as slow,uncertain, and costly, or of "poor quality." Lack of confidence in theadministration of justiceis more pronounced among small economic units and low-incomefamilies.

One of the main premises within the economic analysis of the law is that institutionstransmitimplicit prices. An empirical analysis of legal procedures must identify the extent to whichthe prices imposed by legal procedures change the court users' behavior. The followingexample given in Buscaglia (1996) providesan option for future research. In this example,the court system can increase the cost of resolving disputes when times to dispositionincrease. Figures 2 and 3 belowapply to the Civil Courts in Ecuador and Argentina. Thesegraphs clearly show that the yearly percentage growth in the times to dispositions faced by thegeneral public (measured on the horizontal axis) have been increasing in both countries since1984. The median percentage increase in the times to disposition have been pronouncedduring the period 1984-94. This clearly represents an increase in the average costs oflitigation. We observe that the public reacts to this increase in costs by decreasing their filingsper capita. This "price effect" explains the decrease in the average filings per court afterdiscounting for changes in the number of courts, forms of case termination, and for economicand population growths within the Federal District in Argentina and Quito in Ecuador. Wecan then interpret this graph as an expression of the effects of the increase in the implicit priceimposed by the growing times to disposition faced by the general public. People react to thisadded cost by reducing their filings and not redressing their grievances within the courtsystem. Our results also confirm the account of the informal courts of justice given by deSoto (1989) in Peru where people quit the formal court system and resolve their disputeswithin neighborhood councils.

A judicial crisis is also identified with precision for the first time in the literature in Buscaglia(1996) and Buscaglia,Ratliff, and Dakolias (1995) by using the quantitative measures basedon growth rates in times to disposition and growth rates in filings per court. Specifically, ajudicial crisis begins at the point where backlogs, delays, and payoffs increase the cost(implicit or explicit) of accessing the system. When costs become too high, people startrestricting their use of the judiciary, as we also see in Figures 2and 3 below. By examiningthese graphs, we see that the points of inflexion show when a judicial crisis -- morespecifically, the judicial crises occurring in Ecuador in 1986 and in Argentina in 1985 -- starts. Let's note that the collapse of the Latin American judiciaries takes place under the completeabsence of legally enforced alternative dispute resolution mechanisms (e.g. arbitration ormediation).



12.Economic and Inferential Analysis of the Courts

The enhancement of the capability of the courts to satisfy the demand for dispositions isoneof the most challenging and important aspects of judicial reform. Almost everywhere in LatinAmerica, courts are unable to supply enough services to satisfy the current demand. The lackof ability to satisfy this demand manifests itself through the increasing backlogs and timedelays observed in Table 1 above. These delays are usuallyascribed to lack of resources orprocedural defects. For example, it is often argued that many countries in Latin Americaprovide inadequate budgets to the courts, which impedes the judiciary from sustaining eventhe minimal needs to ensure the public's access to justice. It is also believed that inadequatebudgets perpetuate the dependence of the judiciary, generate corruption among courtpersonnel, and prevent the judiciary from attracting well-qualified judges and support staff. Inthis context, many judges and legal scholars argue that the judiciary must have a separatebudget subject to its control and management. The jurimetric analysis in Buscaglia and Ulen(1997) provides a statistical framework within which those key variables affecting thetimes todisposition are identified through non-parametric techniques.

If the judiciary is to provide the impartiality and efficiency necessary for public trust, awelldefined program for judicial reform needs to address the major causes of deterioration in thequality of court services. This reform effort must address the root political, economic, andlegal causes of an inefficient and inequitable judiciary, and not simply deal with its symptoms. Basic elements of judicial reform must include improvements in the administration of thecourts and case management practices; the redefinition and/or expansion of legal educationprograms and training for students, lawyers, and judges; the enhancement of public access tojustice through legal aid programs and legal education aimed at fomenting public awarenessof its rights and obligations in the courts; the availability of ADR mechanisms, such asarbitration, mediation, and conciliation; the existence of judicial independence (i.e., budgetautonomy, transparency of the appointment process, and job security) coupled with atransparent disciplinary system for court officers; and the adoption of procedural reforms,where necessary. Each component is an integral part of judicial reform as a whole. It isunrealistic, however, to think that all the components can be dealt with at once. Stages ofaction must be planned with consideration given to the costs and benefits of reform asperceived by the judiciary.

Some countries in Latin America have proposed allotting a pre-specified proportion of thegovernment's budget to the judiciary as a way to address the low-salary problem but also as amechanism to reduce times to disposition and backlogs. However, a country-by-countryapproach is always required. International differences in procedural requirements, substantivelaw, and cultural legal history mean that the resources needed by courts in commercialjurisdictions to produce a certain type and quantity of services (e.g., 1000 bankruptcy rulings)will greatly vary among countries. This means that 3 percent of the government budgetdevoted to the judiciary in one country may have a very different impact on times todisposition than the same amount devoted to the courts in another country. Therefore, it isdoubtful that a higher fixed proportion of the government's budget would necessarily improvethe functioning of the judicial system.

Based on these figures and the times to disposition in Chart 1, there is no provensignificantinternational correlation between judicial efficiency (measured in terms of backlogs and timesto disposition) and size of the government budget allocated to the courts. Figure 4 belowclearly demonstrates this lack of correlation within Latin America. The country-specificaverage percentage changes in the median times to disposition are measured on the verticalaxis with a two year lag after the average percentage changes in real spending devoted to thejudiciary (measured on the horizontal axis) are introduced. The changes in real spending areadjusted for population and economic growth in each of the countries considered. Thesemeasurements are applied to the civil jurisdictions in each country. As we can see, countrieswith the largest changes in spending are not usually those experiencing the lowest times todisposition. For example, Brazil and Chile are clear examples of this lack of correlation.

The reason for this lack of correlation lies on the fact that, on the one hand, additionalresources (personnel and capital) initially reduce backlogs and delay due to improvements incourt productivity. But after our two-year lag, a better endowed judiciary starts attractingadditional demand (filings per court) from citizens and businesses that otherwise would bereluctant to use the courts due to the previously high litigation costs. The joint effects of bothforces make it difficult to determine the consequences of adding or subtracting resourcesdevoted to the judiciary. It is therefore much more sensible to implement a budgetarymechanism where courts can request funds based on projected increases in filings within eachsubject matter and geographical jurisdiction.

The enhancement of the courts' capacity to satisfy the demand for dispositions is one ofthemost challenging and important aspects of judicial reform. Everywhere in Latin America,courts are unable to perform their basic function as mechanisms for the interpretation andapplication of the law. The inability to satisfy this demand manifests itself in increasingbacklogs and time delays observed throughout the region. These delays are due, in part, to thelack of resources or, in many cases, to procedural defects. Other reasons are the lack of legaltraining, the absence of an active case management style, or an excessive administrativeburden falling on judges. For example, Buscaglia, Dakolias, and Ratliff (1995) found thatapproximately 70 percent of Argentine judges' time is spent on nonadjudicative tasks. Thesame administrative duties occupy 65 and 69 percent of available judicial time in Brazil andPeru, respectively.



13. Corruption and Institutional Inertia: Causes andConsequences

The development of an economic theory of judicial and procedural reform is in itsinfancy. Only by defining the factors enhancing or hampering judicial reform can we propose policyprescriptions for the modernization of the judiciary. In this context, we must take into accountnot only the present and future costs and benefits of reforms to society, but also the changes inpresent and future individual benefits (rents) as perceived by court officers, in particular, andgovernment officials, in general. We need to examine two elements of judicial reformimplementation. First, the causes of institutional inertia that impede much needed courtreforms need to be identified. Second, we also need to ask why reforms occur in some placesbut not in others by identifying the costs and benefits of implementing judicial reforms, asperceived by members of the court. Nevertheless, one key question remains: Why are thevery judicial reforms that would eventually benefit most segments of society often resistedand delayed by the judiciary? The answer stems from the institutional inertia observed duringthe implementation of judicial reforms.

There is a widespread perception in Latin America that government officials use thecourts asrent-seeking mechanisms. We can here identify substantive, procedural, and organizationalfactors explaining the increasing presence of corrupt activities within the courts. Let us firstpoint at the lack of consistency found in the jurisprudence that gives judges discretionarypower to decide cases within a wide range of possibilities. The lack of a computer system thatwould permit judges and lawyers to monitor the latest decisions and to detect doctrinalinconsistencies adds to the persistence of irregularities and corrupt practices. Moreover,poorly trained judges in an overburdened legal system are also susceptible to corruptinfluences and create an environment where the rule of law cannot be guaranteed. From aprocedural standpoint, ex parte communication is permitted and common practice in mostLatin American countries where judges can spend a good part of the day meeting lawyers andparties separately. Such communication creates incentives for corrupt behavior and lack ofaccountability within the courts. A second procedural element contributing to the existence ofcorruption has to do with the lack of standards applied to the times to disposition experiencedby each type of case. Lack of time standards coupled with court delay allow court personnelto "charge a price" for speeding the procedure. From an organizational perspective, theconcentration of power given by the multiple roles assumed by a typical judge (i.e., in mostcourts the judge is responsible for strategic planning, managing personnel, administeringresources, budgetary control and planning, and adjudicating cases) create incentives forcorrupt behavior due to the lack of external and internal organizational control mechanisms. Addressing these substantive, procedural, and organizational factors is a necessary conditionto eradicate corruption within the court systems.

If the judicial sector and other members of the government use the courts for rent-seekingpurposes, then it should not be surprising to find members of the bench and their clerksblocking efficiency-enhancing judicial reforms. In this context, court reforms promotinguniformity, transparency, and accountability in the process of enforcing laws, wouldnecessarily diminish the courts' capacity to extract rents, in the form of illicit payments fromthe private sector.

Previous studies argue that judicial inertia in enacting reform stems from the long termnatureof the benefits of reform, such as added economic growth or investment. These benefitscannot be directly captured in the short term by potential reformers within the government. Contrast the long term nature of these benefits with the short term nature of the main costs ofreform, notably a perceived decrease in rents to the courts (e.g., explicit payoffs and otherinformal inducements provided to court officers). This asymmetry between short term costsand long term benefits tends to block judicial reforms and explains why court reforms, whicheventually benefit most segments of society, are often resisted and delayed. Reformsequencing, then, must ensure that short term benefits compensate for loss of rents by courtofficers responsible for implementing the changes. That is, initial reforms should allow forshort term benefits for court officers. In turn, court reform proposals generating longer termbenefits to the judiciary need to be implemented in later stages of the reform process.

Additional forces also enhance the judicial reform process. We usually observe thatperiodsof judicial crisis come hand-in-hand with a general consensus to reform the court system. Asstated above, a judicial crisis begins at the point where backlogs, delays, and payoffs increasethe cost (implicit or explicit) of accessing the system. When costs become too high, peoplerestrict their use of the judiciary, as shown in Figures 2 and 3 above, to the point where thecapacity of the courts to extract rents will diminish. At that point members of the court andgovernments embrace judicial reforms in order to recover their prestige and rent seekingcapacity. The judiciary would more likely be willing to conduct deeper court reforms during acrisis as long as reform proposals contain sources of short term benefits, such as greateradministrative power of lower courts, judicial independence, and increased courtresources.

It comes as no surprise, then, that those Latin American countries undertaking judicialreformshave all experienced a deep crisis as characterized above -- that is, sharp decreases in averagefilings per civil court. Important judicial reforms are being implemented in Ecuador, Mexico,and Venezuela. In each of these three cases, additional short term benefits guaranteed thepolitical support of key magistrates who were willing to discuss judicial reform proposals onlyafter a deep crisis diminished their capacity to serve the public. These benefits includedgenerous early retirement packages, promotions for judges and support staff, new buildings,and expanded budgets. Nevertheless, to ensure lasting judicial reform, short term benefitsmust be channeled through institutional mechanisms capable of sustaining reform. The bestinstitutional scenario is one in which judicial reforms are the by-product of a consensusinvolving the judiciary and at least one of the other two branches of power, the legislative andexecutive branches. Additionally, the political leverage of expected winners from reformshould counteract the activities of potential rent-losers.



14. The Social Impact ofCorruption

In short, according to Buscaglia, Ratliff, and Dakolias (1995, pp. 34-36), two counteractingforces explain why many developing-country-governments have failed to provide an efficientjudicial sector compatible with a market economy. On the one hand, efficiency-enhancinginstitutional change accounts for the actual reform and institutional transformation of LatinAmerican judiciaries. While on the other hand, issues related to corruption within the courtsaccount for institutional inertia in enacting judicial reform. Then, the nature of therelationship between a society, its legal rules, and its judicial sector can be explained in termsof political rent-seeking activities and economic efficiency arguments. These two influencescan also contribute to the understanding of the legal and judicial development of a nation.

Before a judicial crisis strikes, however, corruption runs rampant within the judiciary. Inallcases one can observe that corruption generates immediate positive results for the individualcourt-user who is willing and able to pay the bribe. Nevertheless, thewidespread effects ofcorruption on the overall social system are extremely pernicious. Those court-users who arenot able or willing to supply illicit incentives will be excluded from the provision of asupposedly "public good" (i.e., court services) that in reality corruption transforms into aprivate good subject to an uncertain price. Even though corruption may remove red tape forthose who are able to pay the bribe, the judicial system becomes inequitable in the perceptionof all of those who are excluded from the system. This sense of inequity has a long termeffect on social interaction. A corrupt judiciary promotes an inequitable social system wherethe allocation of resources subject to adjudication is less correlated to rights and obligationsand more directly determined by the initial endowment of resources held by thecourt-user.

Buscaglia (1996) shows that a"perceived" inequitable allocation of resources hampers theproductive incentives of those who are excluded from the provision of basic public goods,such as court services. One may initially think that, by eliminating bureaucratic red-tape, thepayment of a bribe can also enhance economic efficiency. However, this is a fallacy. As in atypical prisoner-dilemma, corruption may benefit the individual who is able andwilling tosupply the bribe. However, the macro-social environment is negatively affected by adiminishing economic productivity over time caused by the general perception that theallocation of resources is determined by corrupt practices, and therefore is inherentlyinequitable. In this respect, present corruption decreases future productivity, thereby reducingdynamic efficiency (i.e., the present value of future national income). From this perspective, amore efficient public court system coupled with available ADR mechanisms provided by theprivate sector can foster the necessary balance between equity and efficiency in the provisionof justice -- a balance that is notably lacking throughout Latin America. Even more so,judicial reform programs must also address the lack of court access afforded to low-incomesegments of the population. Court reform increases efficiency and reduces these barriers tolow-income segments, thereby contributing to the stabilization of democracy in LatinAmerica.



C.Conclusion

15. Scope of theField

As a body of knowledge within the social sciences, the economic analysis of the lawcertainlyneeds to reinforce its power to verify claims based on observations. Here, of course, wewould depart from the Austrian School's tradition of limiting itself to the identification oflogical truths in the study of human action and interaction and side with a legal realism whichallows to develop a more structured public policy in the legal realm. In no other area is thedevelopment of a "tool kit" of empirical capabilities more necessary than in the legal andeconomic study of development.

We have approached law and economics of development in this chapter by covering themaintheoretical and empirical scholarly work identifying the substantive sources ofefficiency-enhancing legal doctrines (i.e., bottom-up approach to law making, legaltransplants, and legalintegration) in less developed countries. We have also discussed the main proceduralrequirements needed to sustain an economic system based on impersonal exchange (a judicialsector with alternative dispute resolution mechanisms) while also exploring some of the mainsymptoms of a dysfunctional judiciary (corruption and lack of efficiency in the courts).



16. Future ResearchPath

The measurability of the price matrix set by institutional frameworks relates, of course, toachieving efficiency in consumption and production through much needed reforms in privateand public law. Yet, these legal reforms and their impact on efficiency must also connect tothe issue of fostering political stability through a widespread perception of equity within themembers of society. This brings us to one of the most important areas of law and economicsto be developed in future studies: the links between legal reform, efficiency, and equity. Economists tend to shy away from the microeconomic study of "ethics." Yet, as Cooter's(1996) study has shown, the rigorous microeconomic analysis of the compatibilitybetweenequity and efficiency is real and useful. As demonstrated in Alesina, Sule, Nouriel, andSweagel (1992), developing countries face a social environment in which a vastproportion oftheir population lives under material conditions incompatible with social and politicalstability. Paying close attention to the links between legal reforms and efficiency is only onestep in the right direction.. From all those possible "efficiency" scenarios one could arguethat the economic analysis of the law needs to provide a framework within which one canselect among the many efficiency-enhancing legal institutions and rules that would foster aperception of equity among the population. From this perspective, as stated in Buscaglia(1996) a perception of a level playing field can be traced to the individual's incentives toenhance its own productivity within the economic system. At this point in time, there is muchmore scholarship to be offered in this area.



Acknowledgments

Comments of three anonymous referees are gratefully acknowledged. The author is alsograteful for the outstanding research assistance of Brian Johnson, Shawn McMahon, andPaulina Sierra Samano. The usual disclaimers apply.



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