John M. Olin Law & Economics Working Paper No. 271

Institutions, History, and Economic Development

If one wants insight into how the developing world can attain the Rule of Law, one good place to start would be to ask how countries in today's developed world did it. Though the developed world now stretches well beyond the countries of Western Europe where the Rule of Law first arose, developed countries such as the United States, Canada and Australia—and in a less direct fashion, Japan—were blessed with a successful transplant of Western European legal institutions. Perhaps the Western European experience can provide insights into how this process of legal institutional development can succeed in developing countries where the transplant remedy is obstructed by historical, societal, or other differences from Western European nations. Western Europe, after all, was not blessed with a Rule of Law in the Middle Ages but successfully achieved it over a number of centuries.

The first step in this analysis is to recognize that Rule of Law institutions are not essential for economic activity (though they are relevant to economic growth). In every country goods and services are exchanged, usually against money. In fact, in some of the poorest countries, the level of economic activity in local marketplaces is intense, truly something to be marveled at. And yet this exchange takes place without law playing a significant role.

Let us consider the public market, or bazaar, the primary economic institution of the medieval world and even today a common sight in the developing world. After verbal agreement between seller and buyer is reached, the seller hands over the goods and the buyer hands over the money. The quid and the quo are exchanged simultaneously. But, as Greif put it, suppose the quid and the quo are separated.1 They can be separated in time, as when the buyer promises to pay later but wants to take the goods with him. What will then give the seller confidence that he will be paid as promised? In the absence of law (or, as we shall see, some ongoing relationship between seller and buyer), the seller is likely to simply refuse to sell except against money pressed into his hand. The same problem arises where goods are to be made to order with the seller requiring advance payment