Translated material
Path to development
Economist James Gwartney addresses in this article the problem of the close relationship between economic development and ensuring an effective legal regime in the state. Without respect for property rights and contractual obligations, the researcher says, no state will be able to achieve sustainable levels of development, since its population will not be able to fully benefit from free trade.
In terms of its characteristics, a market economy is similar to telephone and Internet networks. In the case of the latter, the more people use the network, the more its usefulness increases for each individual user. So it is in a market economy: the more people participate in free market exchange, the more benefits the market brings to each participant. The market system creates almost incredible benefits as a result of gains from trade, division of labor, expansion of markets, and the application of mass production technologies.
Most goods used in North America, Western Europe and other parts of the developed world reach consumers through “impersonal exchange,” as defined by Nobel laureate economist Douglas North, that is, through trade between exchangers who do not know each other and will likely never meet.
The coordination of such impersonal exchange is carried out according to the principle that another Nobel laureate in economics, Friedrich Hayek, called “market expansion” beyond the boundaries of an individual village or small town, then a region, a state, and all the way to all remote corners of the world. Without the market system, it would be impossible to achieve high levels of per capita income or today's high living standards.
However, the extensive benefits of a market system are unattainable without a developed and sustainable legal regime. People living in countries where property rights are not adequately protected, contract terms are not respected, and legislative or legal verdicts favor the highest bidder cannot be included in the global market system. Without respect for the rule of law, the benefits of trade will be limited to trading relationships among family members, neighbors and other acquaintances who know each other, or at least know of each other's existence. In this case, trade will be based on personal acquaintance, and the fulfillment of contractual obligations is achieved through family ties and social pressure. However, the benefits resulting from personalized exchange will be small compared to those that can be achieved through impersonal exchange within a free market system based on legally enforceable contractual obligations and the rule of law.
This thesis can be proven empirically. In the World Economic Freedom Index, produced annually by Canada's Fraser Institute, the Cato Institute, and others, we measured the level of economic freedom in more than 120 countries using 38 different policy and institutional criteria in five main areas: the size of the government, the legal structure of the state and the mechanism for protecting property rights, the stability of the monetary system, the degree of participation in international exchange, and the level of government regulation. Countries with higher levels of economic freedom receive higher scores in the ranking on a scale of 1 to 10 (see note).
The data contained in the ranking confirms the close relationship between the state legal structure and the protection of property rights, objective enforcement of contract rights, an independent judiciary and the rule of law. Among about 100 states for which information was available for the period 1980-2000, 24 had an average legal system rating of 7 points or higher. Table 1 shows that these 24 countries had an average per capita GDP of $25,716 in 2000 and an average economic growth rate of 2.5% annually over the past two decades.
Table 1
Effective legal system, income levels and economic growth
| Countries with an average legal system rating of more than 7 points for the period 1980-2000 | Legal system rating | GDP per capita for 2000 | GDP per capita growth rate, 1980-2000, % |
| Switzerland USA Netherlands New Zealand Austria Luxembourg Denmark Finland Germany Canada Norway Australia Iceland Sweden Belgium United Kingdom Ireland Singapore Japan Portugal France Hungary Hong Kong Taiwan
| 8.65 8.61 8.58 8.51 8.49 8.45 8.41 8.36 8.36 8.32 8.31 8.29 8.08 8.05 7.97 7.91 7.91 7.89 7.84 7.50 7.48 7.16 7.16 7.03
| $27,780 $33,960 $26,910 $17,840 $26,420 $53,410 $28,680 $24,160 $25,100 $26,840 $29,200 $24,550 $28,910 $23,650 $25,220 $23,580 $30,380 $23,700 $25,280 $17,710 $23,490 $11,960 $25,180 $13,279
| 0.82 2.12 1.98 1.29 1.99 4.26 1.74 2.27 1.70 1.69 2.42 1.96 1.67 1.66 1.91 2.29 4.91 4.92 2.34 2.91 1.72 1.31 4.07 6.00
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The lowest per capita income among these 24 countries was about $12,000. Perhaps more importantly, all 24 countries that had strong legal systems experienced real positive growth in GDP per capita over the past two decades.
At the other end of the spectrum, there were 21 states with an average legal system rating of less than 4 points for the period 1980-2000. Table 2 shows the income levels and economic growth rates of these countries. Their average GDP per capita for 2000 was $3,094, and their growth rate did not exceed 0.33% over the last two decades. Both of these figures represent only 1/8 of those of states with an effective legal system. The highest GDP per capita among these countries with dysfunctional legal systems for 2000 was $7,010 in Colombia. In 2000, none of these 21 countries was able to achieve both a GDP per capita level exceeding $3,400 and economic growth rates for 1980-2000. more than 1.1%. Thus, none of the states with fragile legal systems was able to maintain sustainable economic growth after the level of population income exceeded the $3,400 mark.
Table 2
Weak legal system, income levels and economic growth
| Countries with an average legal system rating of less than 4 points for the period 1980-2000 | Legal system rating | GDP per capita for 2000 | GDP per capita growth rate, 1980-2000, % |
| Indonesia Senegal Sri Lanka Pakistan Honduras Syria Iran Nicaragua Peru Philippines Algeria Colombia Uganda Nigeria El Salvador Republic of the Congo Bolivia Bangladesh Guatemala Haiti Democratic Republic of the Congo On average: | 3.90 3.84 3.67 3.66 3.62 3.56 3.55 3.54 3.52 3.49 3.47 3.43 3.42 3.34 3.27 3.27 3.20 3.19 3.02 2.98 2.38
| $2,970 $1,450 $3,400 $1,870 $2,830 $3,280 $5,720 $2,450 $4,630 $3,790 $6,150 $7,010 $1,450 $860 $5,240 $950 $2,310 $1,540 $4,430 $1,920 $730
| 3.69 0.57 3.49 2.46 -0.13 0.64 1.09 -2.26 -0.24 -0.02 -0.20 1.04 2.23 -0.93 0.57 0.37 -0.28 2.57 -0.08 -2.39 -5.31
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The benefits of impersonal exchange and expanding markets are the basis of the modern standard of living, and an effective legal system is necessary to realize this goal. Without a strong legal system to enforce contractual obligations and protect property rights, trade will occur only between parties who know each other and will cover only small geographic areas and limited markets. Thus, the benefits of impersonal trade exchange and market development will remain unrealized. Without realizing these potential benefits, it will be virtually impossible for these countries to reach even the lower levels of average income. Unfortunately, they will only continue to stagnate, and household incomes will remain relatively low.
This article is based on Gwartney and Lawson's 2004 study, Economic Freedom of the World: 2004 Annual Report, Vancouver: Fraser Institute, 2005, pp. 35-37. For individual country rankings and detailed information on research methodology and sources, see Economic Freedom of the World: 2005 Annual Report, Vancouver: Fraser Institute, 2005, Gwartney, Lawson For more information on the role of institutions in economic development, see the IMF's World Economic Outlook, Washington: IMF, September 2005, pp. 125-160For the first time: The Path to Development: When Does the Legal Environment Become Critical? // Economic Development Bulletin #7, April 10, 2006.