Inefficient Growth

The notion that legal institutions matter for growth and development can hardly be disputed in a world of non-zero transaction costs. This research advances the hypothesis that transaction costs explain large and wide-standing cross-country productivity differences. We examine the contribution of transaction costs to total factor productivity for a large panel of countries. We show that transaction costs reflect the policy constraints, country-specific policies, distortions and barriers to entry that discourage the adoption of the efficient use of technology by protecting the vested interests in the existing production process. Our findings suggest that lower costs of contract enforcement, low-cost and efficient insolvency framework and accessible property rights contribute substantially to TFP growth over time while weaker effects are found for lighter business registration and licensing requirements. Our results are stable across a variety of estimation techniques. By exploiting the variation in pre-industrial urbanization rate, disease environment, and latent cultural traits, we show that the negative effect of rising transaction costs on TFP appears to be causal.