Contract Enforcement: A Political Economy Model of Legal Development

Abstract

In an effort to understand why the relative usage of relational and legal contracts differs across societies, this article builds a political economy model of legal development where legal quality of contract enforcement is a costly public good. It finds that legal investment tends to be too small under elite rule but too large under majority rule in comparison with the socially optimal level. Furthermore, elite rule, low legal quality, and high-income inequality may form a self-perpetuating circle that hinders economic development. In contrast to the conventional view, this article suggests that the often-observed association between heavy reliance on relational contracts and under development is most likely caused by the presence of elite rule rather than by a more collective-oriented culture per se because it is optimal for societies better at using relational contracts to start legal investment relatively late and to have lower quality of legal enforcement. (JEL O1, K49, H40, C72)