Uncovering Acemoglu's Black Box: Why the Contribution of Formal Property Law to Economic Growth Cannot Be Linear But Must Depend on the Development Stage of a Country

Abstract

Much evidence has been presented that legal institutions, and particularly property rights, cause economic growth. Yet, precisely for those countries with the most urgent need for development, we know less about the direction of causation and the functional form of the association between the strength of legal property rights and per-capita incomes. A seminal work in this literature, by Acemoglu, Johnson and Robinson (2000), provides optimistic outlooks, whereby also the Least Developed Countries could grow out of poverty if they implemented strong legal property rights.This paper challenges two of Acemoglu et al’s findings. First, I derive a range of micro-mechanisms suggesting that the relationship between the strength of legal property rights and output may not be linear as asserted by Acemoglu et al and a number of other scholars and institutions. Instead, these mechanisms imply the existence of a weak relationship between property rights and output in the lowest stages of development and a structural break after early growth. Second, I suggest why the direction of causation may turn around after early development. I confirm the predictions from my analysis of those mechanisms with non-parametric, instrumented regressions. My results hold not only for Acemoglu’s dataset but are robust for alternative specifications of property rights. I use four different datasets that employ different methodologies for measuring formal property rights protection and with each of them my theoretical predictions are empirically confirmed. Both predictions also hold true when interacting quantifications of property law and contract law, and whether or not the data is instrumented.Institutional reforms, and particularly reforms to property rights, have been advocated as a panacea in development policy of recent years, for example by the World Bank. The Acemoglu et al (2000) study has continuously been cited as one of the main pieces of evidence supporting these policy suggestions. My study shows, however, that the strength of formal property law matters mostly at specific stages of development and not across all countries. One policy does not fit all cases. I show that property law matters greatly for Mid-Income Countries but that it is important not to overestimate its potential for the Least Developed Countries. We must not stop searching for the causes of growth in the earliest stages of development; reforming and enforcing property law alone does not resolve the poorest nations' poverty traps.