Contract Law and Development ∗
Aristotelis Boukouras†
25 November 2009 (First draft: 05 October 2009)
Abstract
We relate the design of contract law to the process of development. In this paper,
contract law defines which types of private agreements are enforceable (i.e. are binding
and enforced by courts) and which are not. More specifically, we consider an economy
where agents face a hold-up problem (moral hazard in teams). 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)
an economy-wide delegate (judge) responsible for the enforcement of the social contract
and (ii) a set of non-enforceable private contracts (regulation). However, because this
mechanism is costly, its effectiveness depends on the aggregate production of the economy.
To capture the interaction between contract enforcement and development, we introduce
a multi-period economy and show that, in the early stages of development, the mechanism
is infeasible. 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.
Keywords: contract law, development, enforcement institutions, hold-up, institu-
tional agent, regulation, social contract
JEL Classification: D02, D82, D86, K12, O12, O31, O43
∗I would like to thank Kostas Koufopoulos, Herakles Polemarchakis, Claudio Mezzetti, Tomas
Sjöström, Thodoris Diasakos, Juuso Vaalimaki, Abhinay Muthoo, Motty Perry, Macchiavello Rocco,
Valentina Corradi and Asako Ohinata for their very useful comments and remarks, for which I feel
grateful. I would also like to thank participants in CRETE 2009 and in the internal workshops of the
Department of