Economic Development Before the Law

One of the most pervasive and apparently self-evident assumptions of development economics is that sustainable investment and growth requires the rule of law. Without impersonal, general norms and their enforcement by independent judicial authorities, according to this view, little development, if any, is possible, because the risks facing both labor and capital – including corruption, arbitrariness, and rigid traditions – will be too high. But is this conventional wisdom always right?

Consider an admittedly limited but nonetheless revealing counter-example: South Africa’s booming mini-bus taxi industry. The mini-bus taxis developed in response to severe shortcomings in the country’s public transport system, one characterized by high prices, low-quality service, and a chaotic operating network, but they operate entirely outside of formal laws and regulations. What makes the industry work is a commonly agreed informal business “culture” that is flexible, innovative, and keeps operating costs down.

The results are undeniable: at peak times, mini-bus taxis hold 65% of the entire commuter market. The mini-bus taxi industry thus illustrates the importance of informal conventions. Local culture and traditions not only matter, but they are decisive in shaping the behavior of people – all the more so in developing countries, particularly those that are labeled failed or fragile states, where the courts don’t work and regulations, assuming they exist, thus are inadequately enforced. But malfunctioning formal institutions do not mean that there are no functioning structures at all.

In these societies, the social order is predominantly shaped by informal agreements rather than formal laws and regulations. As the South African example shows, such agreements can even promote a country’s development. In many developing countries, village associations that are solely based on trust and peer pressure provide access to credit and insurance, guarantee help in times of distress, and facilitate the construction of public roads and sewage systems. The community-based health insurance schemes that are prospering all over Africa are a good example of this.