The evidence of the impact on investment rates of changes in the enforcement of contracts
This is a systematic review
This systematic review focuses on the evidence about one specific causal mechanism: from better enforcement of contracts to higher rates of capital accumulation.
The rationale for the review does not rest exclusively on the (still debated) causal effect of investment on growth, but also on the fact that donors and governments do invest resources and political capital in improving the business environment, and in particular in seeking to improve the enforcement of contracts. While some of these efforts could be simply justified on grounds of promoting the rule of law, the underlying assumption for many of those reform efforts is that investments will be unleashed by them, so analysing systematically the evidence in favour of that assumption may eventually help in deciding what priority those reforms should have.
Following a search of the literature and application of the inclusion and exclusion criteria, 22 papers were included in the mapping and synthesis stages.
Overall, the evidence gathered through this systematic review provides some support for the claim that more effective contract enforcement promotes higher levels of investment, but it is weak. First, there is only one study that unambiguously links an intervention or reform to enhance contract enforcement to changes in investment patterns. Second, few of the studies go beyond a generic discussion of direct and indirect effects to actually test the plausible indirect causal channels. Third, a majority of studies do very little or nothing in terms of robustness checks, or the strenuous but necessary attempts to rule out alternative explanations for the empirical findings.
Almost all the studies implicitly or explicitly adhere to a basic story stating that effective third-party enforcement enables more complex contracting and that contract uncertainty will tend to depress investment by affecting expected returns, increasing investment costs, restricting access to key resources or making some complex transactions unfeasible.
The main non-trivial mechanisms found in the studies are: weak enforcement encourages hold-up strategies that affect investments through impact on cash flows and indirectly through greater downward uncertainty of returns; enhanced legal enforcement in transition economies with financial repression may limit capital available to the private sector, and thus depress private investment; weak thirdparty enforcement involves higher costs to firms related to the need to get settlement through alternative mechanisms, affecting investment; and better contract enforcement facilitates the processes through which efficient-investing industries receive capital, and favours, in particular, ‘contract-intensive’ industries.
There is a protocol for this systematic review
Aboal, D.; Noya, N.; Rius, A. The evidence of the impact on investment rates of changes in the enforcement of contracts. A systematic review. EPPI-Centre, Social Science Research Unit, Institute of Education, University of London, London, UK (2012) ii+100 pp. ISBN 978-1-907345-41-8