Law, Property Rights and Growth

Abstract

This paper investigates how different legal frameworks not only affect the amount of external financing available, but also the allocation of resources among different type of assets. Using a simple model, we show that a firm will get less financing, and thus invest less, in a weak law and order environment. We also show that weaker property rights can lead to an asset substitution effect with firms investing less in intangible assets. Empirically, these two effects appear to be equally important drivers of growth in sectoral value added for a large number of countries. Using individual firm data, we also show that weaker legal frameworks are associated with relatively more fixed assets, but less long-term financing for a given amount of fixed assets.