The Role of Informal Legal Institutions in Economic Development

Abstract:     
The purveyance of the rule of law in developing countries has frequently been associated with positive economic development. Better clarity, scope, transparency and enforcement of the laws will promote confidence and trust in the formal legal system, the argument suggests. At its core, this argument misses a fundamental yet widely recognized tangent to the rule of law - the role of informal legal institutions. The perception of legal systems perpetrated by the state - formal legal systems - is negative in many developing countries. Corruption, high costs and lengthy time periods for issue resolution limit the ability and willingness of many citizens, especially the poor, to access justice via the state. Accordingly, informal mechanisms are frequently relied upon to litigate property disputes, enforce contracts, regulate labor relationships, and address a variety of other legal issues. While some of these informal legal decisions are recognized and given effect by formal legal systems, the overall environment of two legal systems - formal and informal - begs the question, is the potential economic development effect of rule of law programs muted by the existence of a two-track legal system that leads many citizens to seek remedies outside of formal law‘ This briefing paper lays the groundwork for this discussion by presenting background on the existence of informal legal systems, an explanation of their benefits and discussion of their significant limitations, and an outline of the nature of the informal economy that is largely affected by informal legal mechanisms. The paper concludes by explaining the contribution that informal legal systems can make to economic development when they are linked to formal legal enforcement.

Number of Pages in PDF File: 31

Keywords: informal economy, law, legal institutions, economic development

JEL Classification: O17, K31, K42, K11, K12, K41, D63, E11, F02, J21, J49

working papers series