Rule of Law, Economic Structure and Development

If rule of law discourages relationship-specific investments, then industries that use intermediates which require relationship-specific investments should have a disproportionately low share of output in countries where rule of law is weak. We find robust support for this prediction using data on industry composition for 189 countries. Using a standard preference framework, we then show that the estimated coefficients imply that variation around the world in rule of law accounts for between a quarter and a half of variation in GDP per capita, depending on the specification and on the elasticity of substitution. We conclude that that the interaction between relationship specificity and rule of law is economically significant