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Monday, 8 September 2014

Judicial system and growth

A recent IMF working paper has an interesting summary of the latest empirical evidence on the channels linking the judicial system and growth :
Development of credit markets and cost of credit. Weak contract enforcement raises the cost of borrowing, and shortens loan maturities (Bae and Goyal, 2009; Laeven and Majnoni, 2003), with a detrimental impact on investment, the depth of mortgage markets, and GDP (Bianco et al., 2002; Laeven et al., 2003; Djankov et al., 2008).

Firm size. The literature also finds a positive correlation between the quality of the judicial system and firm size (Kumar et al. 2001, Beck et al. 2006). Weak incentives to invest and hire workers under uncertain contract enforcement and costly dismissal procedures are two factors that could explain this correlation. Italy certainly fits the pattern: SMEs account for nearly 70 percent of value added and, as discussed above, the judicial system is inefficient along many dimensions. Giacomelli and Menon (2012) use differences in court efficiency across Italian municipalities to establish a causal link and estimate that halving the length of civil proceedings could increase average firm size by 8–12 percent. Beyond firm size, rates of firm creation and destruction also suffer from court inefficiencies (Garcia-Posada and Mora-Sanguinetti 2012).

Labor market. Inefficient labor courts can have detrimental effects on the composition of employment and labor market participation (Gianfreda and Vallanti 2013a). Labor courts also affect job reallocation, which in turn impacts productivity and capital intensity (Gianfreda and Vallanti 2013b).

Weak enforcement reinforces vulnerabilities. Weak enforcement leads to late payments, which triggers liquidity issues, bumps up insolvency, and increases unemployment. Pervasive late payments are closely linked to a weak enforcement system (Intrum Justitia, 2013).

Entrepreneurship and innovation. Ardagna and Lusardi (2008) establish a link between entrepreneurship rates and the efficiency of the judicial system using micro data for a sample of countries.... erkowitz et al. (2006) find that stronger contract-enforcement institutions are positively correlated with more complex exports and less sophisticated imports. 
The various channels does highlight that judicial reform is an economic issue, especially for developing countries. Sadly this point is poorly understood by non-economists. I have previously touched on this here and it goes beyond simply making court access fast.  It is about having a judicial system that inspires confidence and minimises the generalised cost of court access. This is a big issue in Zambia. Civil and commercial cases can take a millennia. We only need to look at the Development Bank of Zambia and Zambia Airways case. Not to mention the low confidence of the public in the justice system. 

For completeness, I should note that the IMF paper is generally weak in parts particularly in the way it tries to explain the reasons for the bottlenecks in the Italian system. It gets cause and effect wrong, and is very superficial in analysis. However, it is helpful on collating the evidence cited above.

Chola Mukanga
Economist | Consultant | Researcher
Copyright © Zambian Economist 2014

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