The Effect of Legal Institutions on the Wealth of Mexico: Evidences from a Sub-National Empirical Investigation

Abstract

This paper seeks to quantify the functioning costs of Mexican property and contract law system for the sub-national panel of Mexican States and Mexico City and examine the respective effects of such increasing costs on sub-national paths of economic growth. Paper identifies a persistent negative effect of increased property and contract enforcement costs on the speed of economic growth. Mexican states with high enforcement costs generated by legal institutions are significantly more likely to experience slower economic growth whereas the states with decreasing extent of such costs tend to experience consistently higher economic growth. Obtained results suggest that effectively enforced law and its institutions are one of the most significant sources of human wealth. The negative effect on the contrasting sub-national paths of economic growth is robust to the alternative model specifications, and to a variety of control variables such as unemployment, investment rate, government spending, human capital investment, demographic structure, and geographic differences that might confound the effects of enforcement costs on economic performance. The evidence also reveals that economic performance of Mexican states is not directly affected by the drug-related organized crime whereas states with higher incidence of organized crime induced by drug cartels tend to experience systematically rising transaction costs. The validity of exogeneity instruments is confirmed and tested against multiple exclusion restrictions which confirms the relevance of organized crime in accounting for the differential patterns of transaction costs across Mexican states where the effect of rising costs appears to be causal.