Contracts
One of the strengths of free market based systems are the mechanisms for voluntary contracts between citizens - property rights, contract enforcement, and credit markets. These institutions enable cooperation on a larger scale than would otherwise occur spontaneously by informal association networks. Specific measures of these institutions is detailed in Table B.8 from the Legatum Prosperity Index. The Elements were shortlisted because they scored a high value (0 no relationship, 1 very related) in their relationship to the “general success measure” (living conditions) used in the statistical analysis in Appendix B.
Table B.8 : Legatum Prosperity Index - Elements shortlisted as statistically correlated with general success measure and the score of correlation.
Contract enforcement | Financing ecosystems | Property rights |
0.47 | 1.0 | 0.88 |
Alternative dispute resolution mechanisms Legal costs Quality of judicial administration Time to resolve commercial cases | Access to finance Commercial bank branches Depth of credit information Financing of SMEs Quality of banking system and capital markets Soundness of banks Venture capital availability | Intellectual property protection Lawful process for expropriation Procedures to register property Protection of property rights Regulation of property possession and exchange Reliability of land infrastructure administration |
Property rights, contract enforcement
The World Bank economists cited property rights at several points in the report as essential for development. They mentioned that these rights should extend to the informal sector and remarked that in the actual reforms in Latin America these were more of an “afterthought” (Birdsall, 2010). Contract enforcement and property rights were identified in Ostrom’s analysis as essential for sustainable common pool resource governance (Ostrom, 1990).
As Ostrom describes, the failure of the commons is a situation where no participant has the incentive to cooperate with collective rules. She cites binding agreements, arbitrators of conflict resolution and clear boundaries of who has the rights of access for appropriate rents as essential for participants to gain the threshold level of trust that they would be rewarded for the risk of restraint and commitment (Ostrom, 1990).
Financial credit markets
Credit markets together with property rights enable investment and the accumulation of capital. In situations where investments and accumulation of capital are supportive of development goals, financial credit markets are likely to be instrumental to those improvements. While Ostrom did not emphasize the institutions of credit markets, she did mention the importance of continued supply and maintenance of investment capital. Her game theory analysis concluded that participants must be incentivised to make the investments - to have a stake in the long term outcomes by applying low discount rates to the expected future stream of rents (Ostrom, 1990).
Credit markets also like property rights facilitate cooperation on a large scale. They further lower barriers to investment institutions by enabling those with opportunities to deploy capital and make investments to be financed by pooling resources from those who have surplus savings.
Credit markets apply leverage to the economy and this institutional factor was identified as one of the strongest correlated factors to social success measures tested in the analysis in Appendix B. The World Bank review of Latin America reforms provided more qualified critique for financial market reforms. The report cautioned that imperfect credit markets could impede growth and entrench existing inequalities by reinforcing existing corrupt institutions (Birdsall, 2010). The report cautions that rapid deregulation of the financial markets without the corresponding regulatory institutions to monitor, regulate risks and set disclosure standards risked build-up of credit bubbles and instability (Birsdall, 2010).
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