Economic aspects of Enforcing the Rule of Law International Conference Perspective of sustainable growth in the countries of SEE Budapest 6th November DG Enlargement Ollivier Bodin European Commission DG Enlargement

The Rule of Law A top priority on the EU accession agenda To protect human and civil rights, to guarantee implementation of the EU and EU related legislation, and as cornerstone of a functioning market economy . Substantial gap between the country reality and the high standard required from a Member State DG Enlargement

To protect human and civil rights, to guarantee implementation of the EU and EU related legislation, and as cornerstone of a functioning market economy .

Substantial gap between the country reality and the high standard required from a Member State

Conditions for a functioning market economy Secured property rights Contracts effectively enforced Fair competition and free market entry and exit; Fair, predictable and accountable public administration, equal treatment/access in relation to public services and taxation . DG Enlargement

Secured property rights

Contracts effectively enforced

Fair competition and free market entry and exit;

Fair, predictable and accountable public administration, equal treatment/access in relation to public services and taxation .

Where do the candidate countries stand ? DG Enlargement

EBRD TRANSITION INDICATORS SEE6 (Western Balkans only)

Obstacles to do business Obstacles related to RoL among top ten

Three questions How is the economy regulated, if not by the Law? And how does this impact on economic activities, trade, investment? Does the alternative regulation affect the way we can formulate economic policy recommendations and how? Reciprocally, how can economic policy and reforms contribute to establish the rule of law?

How is the economy regulated, if not by the Law? And how does this impact on economic activities, trade, investment?

Does the alternative regulation affect the way we can formulate economic policy recommendations and how?

Reciprocally, how can economic policy and reforms contribute to establish the rule of law?

Weak justice leads to informal network regulation People do not cease activities in case of weak justice, but restrict transactions to people they know. Repetition of transactions among limited number of same persons augments trust inside the network DG Enlargement

People do not cease activities in case of weak justice, but restrict transactions to people they know.

Repetition of transactions among limited number of same persons augments trust inside the network

Robust network,… ..but inward oriented DG Enlargement

..but inward oriented

Stable, but inefficient Fragmentation of business activities in networks disconnected one from each other result in poor division of labour CONCLUSION: As a result of weak Rule of Law, a twin market failure Less than optimal level of transaction (« trade crunch »), and underinvestment DG Enlargement

Fragmentation of business activities in networks disconnected one from each other result in poor division of labour

CONCLUSION: As a result of weak Rule of Law, a twin market failure

Less than optimal level of transaction (« trade crunch »),

and underinvestment

A regulatory trap? DG Enlargement Low productivity and weak international integration Greater reliance on informal network regulation Low credibility of the judicial system and weak public sector

Variante to reputational networks Religious or ethnic demarcation criteria can in some cases help to expand, but is far to be so efficient as impartial judicial and can be easily abused. Open « functional » networks, either informal, or business associations, cooperatives, increase overall efficiency, but need, exactly as market transactions, the umbrella of the Law to avoid that openness be abused DG Enlargement

Religious or ethnic demarcation criteria can in some cases help to expand, but is far to be so efficient as impartial judicial and can be easily abused.

Open « functional » networks, either informal, or business associations, cooperatives, increase overall efficiency, but need, exactly as market transactions, the umbrella of the Law to avoid that openness be abused

Evidence is being accumulated “ (Inter-enterprise) trust is higher where courts are perceived by business to be fair and honest, but the relation does not extend to other dimensions of the judicial system, such as speed or affordability” (Raiser, Rousso, Steves, 2004) The belief in strength and impartiality is important,.. .,not the affordability of dispute DG Enlargement

“ (Inter-enterprise) trust is higher where courts are perceived by business to be fair and honest, but the relation does not extend to other dimensions of the judicial system, such as speed or affordability” (Raiser, Rousso, Steves, 2004)

Rule of Law and Integration into the World Economy DG Enlargement

Rule of Law and Integration into the World Economy DG Enlargement

The need for sequencing reforms Reform capacity is limited at a given time by political, financial and administrative constraints; To be popular and sustainable, policies and reforms need to bring results; Need to sequence and prioritize according to effectiveness, and under constraint.

Reform capacity is limited at a given time by political, financial and administrative constraints;

To be popular and sustainable, policies and reforms need to bring results;

Need to sequence and prioritize according to effectiveness, and under constraint.

Which bottleneck(s) should be widened as a priority? «Overall» investment return depends upon: Infrastructures and other public goods; Input prices (energy, material, aso.) Direct and indirect unit labour costs Effective owner’s return depends upon Financing cost (for a good part, RoL) Direct taxes Fairness of competition (RoL) Predation by private (weak contract enforcement, weak debt collection, mafia) (RoL) Predation by public officials (corruption) (RoL) DG Enlargement

«Overall» investment return depends upon:

Infrastructures and other public goods; Input prices (energy, material, aso.)

Direct and indirect unit labour costs

Effective owner’s return depends upon

Financing cost (for a good part, RoL)

Direct taxes

Fairness of competition (RoL)

Predation by private (weak contract enforcement, weak debt collection, mafia) (RoL)

Predation by public officials (corruption) (RoL)

Are internal forces sufficient to escape the regulatory trap? DG Enlargement Low productivity and weak international integration Greater reliance on informal network regulation Low credibility of the judicial system and weak public sector

Reinforcing the Rule of Law Three main obstacles Two first relate to the willingness and ability of the political system to « supply » the Rule of Law Political and administrative elite want to preserve rents and opposition to redistribution exists Complexity due to an output, being unspecific and difficult to monitor, and to intensity of input (several actors, rules and transactions) The third relates to the « demand » for the Rule of Law, the r obustness of networks and lack of trust DG Enlargement

Two first relate to the willingness and ability of the political system to « supply » the Rule of Law

Political and administrative elite want to preserve rents and opposition to redistribution exists

Complexity due to an output, being unspecific and difficult to monitor, and to intensity of input (several actors, rules and transactions)

The third relates to the « demand » for the Rule of Law, the r obustness of networks and lack of trust

Supply of the Rule of Law Condition accession EU accession conditional upon significant progress Provides a long term vision Legitimacy of elite depends upon progress made towards accession Strong conditionality required DG Enlargement

EU accession conditional upon significant progress

Provides a long term vision

Legitimacy of elite depends upon progress made towards accession

Strong conditionality required

Supply of the Rule of Law Promote reforms Insist on reforms reducing the opportunities to extract rents at all levels of administration Improve public expenditure management, obviously Conceive policies which are rule based at the implementation level to reduce discretionary power of the administration DG Enlargement

Insist on reforms reducing the opportunities to extract rents at all levels of administration

Improve public expenditure management, obviously

Conceive policies which are rule based at the implementation level to reduce discretionary power of the administration

Supply of the Rule of Law Technical assistance Provide broad based technical assistance in coordination with other donors Address gradually all key aspects in a strategic frame Assess regularly progress (trial and error) DG Enlargement

Provide broad based technical assistance in coordination with other donors

Address gradually all key aspects in a strategic frame

Assess regularly progress (trial and error)

The demand for the Rule of Law Support SME Increase benefits for enterprises to work « legally » Organise the provision of public goods, such as vocational training, access to information, seller/buyer network Support functional organisations, business associations, cooperatives to provide those goods DG Enlargement

Increase benefits for enterprises to work « legally »

Organise the provision of public goods, such as vocational training, access to information, seller/buyer network

Support functional organisations, business associations, cooperatives to provide those goods

The demand for the Rule of Law Loosening the socio-economic network dependency Invest in education If you need to trust somebody for a regime change, it goes even better with a safety net DG Enlargement

Invest in education

If you need to trust somebody for a regime change, it goes even better with a safety net

END PS… DG Enlargement

END

PS…

PS: What economists, being policy makers or theorists, do not know “ But mature markets rely on deep institutional underpinnings, institutions ….However, we do not know in detail how these institutions can be engineered, and policy makers cannot always know how a market will function without them.” The Growth Commission, 2007 “… neither empirical nor theoretical research has yet advanced to the point of offering clear or confident policy recommendations for the process of institution-building or reform.” Avinash K. Dixit, on p. 150 of his 153 pages book on this topic, 2004 DG Enlargement

“ But mature markets rely on deep institutional underpinnings, institutions ….However, we do not know in detail how these institutions can be engineered, and policy makers cannot always know how a market will function without them.”

The Growth Commission, 2007

“… neither empirical nor theoretical research has yet advanced to the point of offering clear or confident policy recommendations for the process of institution-building or reform.”

Avinash K. Dixit, on p. 150 of his 153 pages book on this topic, 2004

In other words, the stone of wisdom is not yet found Economist know where countries have to go, but they do not know how exactly countries can go there ; how exactly to assess the consequences of the countries not being there .

Economist know

where countries have to go, but

they do not know

how exactly countries can go there ;

how exactly to assess the consequences of the countries not being there .