The rule of law and the economy: creating prosperity for all
Working with the Bingham Centre for the Rule of Law, we commissioned a review of evidence on the relationship between the rule of law and the economy.
This report, authored by economist Dr Laura Lopez-Gomez, demonstrates how the rule of law supports economic growth and prosperity.
Why the rule of law is important for businesses
Whenever we make a purchase or enter a contract, we do so on the basis of assurances.
For example, assurances that a hired electrician will complete work to a high standard, or that our home cannot be seized by the government.
If these expectations aren’t met, then we want to know there is someone who can handle our complaint and put things right.
It’s these assurances that make us more willing to part with our hard-earned cash.
The same is even more true when there are large sums of money at stake.
For businesses to make deals and investments, they want to know that:
- their property will be protected
- their contracts enforced, and
- any disputes will be decided fairly by an independent adjudicator
This is what the rule of law does.
It establishes the rules of the game which set expectations and make sure everyone is held to them.
When the rules are clear, predictable and reliable, there is less risk.
This enables businesses to spend their money more confidently and efficiently.
At a national level, this creates a stable economy. One in which government is required to play by the same rules as the rest of us.
This not only makes a country more attractive to investors but also enables government to make long-term plans using resources for the benefit of us all.
Key findings
Improvements to the rule of law leads to greater economic growth
Evidence from multiple case studies point to this.
When the economy is predictable, it reduces uncertainty in markets and allows nations to plan and allocate resources more efficiently.
Stability is essential for large-scale investments and progress – all of which drives economic growth.
On a microeconomic level, the rule of law plays a role in how people and businesses make decisions
It reduces risk and uncertainty, and the costs associated with mitigating these, by providing a predictable framework.
This framework defines:
- what actions are allowed
- what obligations exist
- how disputes are resolved
This increases trust, encourages investment and long-term contracts, and formalises markets.
On a macroeconomic level, the rule of law stabilises economic policy by constraining the arbitrary exercise of power
This enhances investor confidence.
It provides the predictability, stability and security needed by governments, businesses and citizens for long-term planning.
This also enables effective resource allocation, allowing these to be channeled into productive activities.
The relationship between the rule of law and economic development is mutually reinforcing
This means that, while the rule of law supports economic development, this tends to lead to further improvements in legal frameworks, institutions and rule of law norms.
This mixes cause-and-effect, making it more difficult to isolate and understand the impact of the rule of law.
The rule of law performs different functions depending on the level of economic development
This is seen particularly in:
- low- and middle-income countries: where institutions are weaker and markets less developed, it acts as a catalyst for growth
- high-income countries with developed economies: its role is more that of a stabiliser. It safeguards institutions, prevents backsliding and maintains the credibility of and confidence in national economies
Access to justice has consequences for productivity
Access to justice (an element of the rule of law) has consequences for productivity for both individuals and businesses.
Unresolved legal issues can lead to:
- physical and mental health problems
- workplace absence
- unemployment
- business disruption, and
- other social issues
Some economies achieved significant development despite weak rule of law standards and institutions
China is a prime example.
However, this is poorly explained by current frameworks and would benefit from further investigation.
The UK is a key example of how the rule of law has influenced economic growth
The rule of law played a central role in shaping and supporting economic growth across UK history.
From the middle ages to the industrial revolution and the consolidation of our modern, globally competitive service economy.