Contract Law and Development

We relate the design of contract law to the process of development. Contract law defines which private agreements are enforceable and which are not. Specifically, we consider an economy where agents face a hold-up problem. The resulting time-inconsistency problem leads to inefficiently low levels of effort and trading among agents. The solution to this problem requires a social contract which meets two conditions: (i) a judge responsible for the enforcement of the social contract and (ii) a set of non-enforceable private contracts. However, because this mechanism is costly, it is infeasible in the early stages of development. The appearance of enforcement institutions and regulation is delayed for the later stages. At this point of time, the hold-up problem is solved and this spurs economic growth further. Finally, the relationship between economic development and the evolution of contract law may be non-monotonic, which may explain why empirical studies fail to find a robust relationship between the two