Academic journal article Journal of Economics and Economic Education Research

Legal Origins and State Economic Freedom

Academic journal article Journal of Economics and Economic Education Research

Legal Origins and State Economic Freedom

Article excerpt

INTRODUCTION

The subject of economic development has transformed significantly in the past century. Historically, economic development fixated upon factors of production like capital and labor and less on the role of institutional quality in determining economic outcomes (Hall et al. 2010). As a result of the work of Nobel Laureate Douglass North (1990) and others, institutions have increasingly been considered an important force characterizing economic progress. North's work in particular, both in his earlier work (North, 1994) and in his later work (North et al., 2009) has helped to reshaped the way economists analyze the issue of economic development and turned attention toward looking at the effect of institutions--"the humanly devised constraints that shape human interaction" (North, 1990, 3)--on economic performance. In recent years, a growing body of research has used the Economic Freedom of the World (EFW) index (Gwartney et al., 2010) to measure institutional quality and has found a strong, positive relationship between quality institutions and economic growth (see, for example, Dawson, 1998; Gwartney et al., 1999; Cole, 2003; Gwartney et al., 2004; Gwartney et al., 2006; Hall et al., 2010).

If institutions are important to economic growth, then it is necessary to understand what factors are associated with institutional quality. Recently, the empirical literature discussing the relationship between institutions and economic growth has grown substantially. However, little focus been given to examining the sources of institutional quality across countries, with a few notable exceptions such as such as Crampton (2002), De Haan and Sturm (2003), Boockmann and Dreher (2003), Heckelman and Knack (2008), and Lawson and Clark (2010). While these studies are valuable, they limit their focus to recent causes of institutional change. As a result, they potentially overlook historical determinants of institutional quality. Countries with poor institutions in the past tend to have poor institutions today. Thus, we need to look to history--at least in part--for a better understanding of the sources of institutional diversity. A series of influential studies begun by La Porta et al. (1997; 1998) examine the relationship between a country's current economic condition and the origin of their legal system. Essentially, contemporary market conditions are potentially explained by past and present legal conditions, with present legal conditions represented as a function of past legal conditions.

In this paper we build off these important studies by taking a first look at the impact of colonial origins of U.S. states on current state economic freedom, with a particular focus on the role that the legal system of the settling country has on current institutional quality. As is recent convention in the empirical institutional literature, we measure a state's current institutional quality using the Economic Freedom of North America (EFNA) index, published annually by the Fraser Institute. We begin our analysis with further discussion of how the legal origins of state settlers might influence current institutional quality. We then proceed to describe our data and empirical approach, present our results, and then summarize our findings with a few concluding remarks.

LEGAL ORIGINS: CIVIL VS. COMMON LAW

Discovering the relationship between institutional quality and economic growth has motivated a well-defined body of research focusing on how good institutions are formed. Arguably, high-quality institutions are formed when the rule of law is in place because the rule of law facilitates the formation of other good institutions by creating certainty and protection from expropriation (North et al., 2009). Recently, economists have produced empirical evidence that financial markets contribute to economic growth and strong legal institutions contribute to the growth of financial markets (Mahoney, 2001). …

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