Legal Quality, Inequality and Tolerance

Transcription

1 Legal Qualty, Inequalty and Tolerance Chrstan Bjørnskov * Aarhus School of Busness December 11, 2003 Abstract: Prevous fndngs suggest that ncome nequalty leads to lower legal qualty. Ths paper argues that voters tolerance of nequalty exerts an addtonal nfluence. Emprcal fndngs suggest that nequalty leads to lower legal qualty due to ts effect on socal captal whle the tolerance of nequalty exerts an ndependent nfluence. JEL Codes: D63, K40, Z13 Keywords: Legal Qualty, Inequalty, Tolerance, Socal Captal * Department of Economcs, Prsmet, Slkeborgvej 2, DK-8000 Aarhus C, Denmark; phone: ; fax: ; e-mal: ChBj@asb.dk. I am grateful for comments and suggestons from Peter Kurrld-Kltgaard, Peter Nannestad and Gert Tnggaard Svendsen. All remanng errors are mne.

2 Introducton The legal system s an mportant part of the foundaton of modern natons. Vrtually no matter whch poltcal deology people ascrbe to, a strong and far legal system s part of any vson of the deal state. All ctzens demand protecton of ther lves and property rghts (unless they are hardcore communsts) and legal systems also perform mportant economc tasks: they combat corrupton (Tresman, 2000; Al and Isse, 2003), enable countres to attract foregn nvestments (Lambsdorff, 2003) and encourage economc growth (Kormend and Megure, 1985; Clague et al., 1999; Feld and Vogt, 2003). Lkewse, many studes fnd that nequalty leads to lower growth (Persson and Tabelln, 1994; Alesna and Perott, 1996; Dennger and Squre, 1998). The standard explanatons for the negatve result typcally obtaned n cross-country regressons nclude varous channels. The medan voter theorem suggests that nequalty may lead to an ncreased demand for redstrbuton, whch s often found to lower growth. By dvertng government resources from other purposes, ths could lead to lower nvestments n legal qualty. Inequalty may also affect the accumulaton of human captal when there are mperfectons n the fnancal markets (Perott, 1993; Barro, 2000), whch could n the long run lead to lower legal qualty f well-educated ctzens demand more legal protecton. Keefer and Knack (2002) specfcally connect these two sets of results by suggestng that nequalty affects economc growth through nfluencng the qualty of the legal system, statng that socal polarzaton s one characterstc of socety that can reduce the legtmacy of property and contractual rghts. They go on to fnd robust emprcal evdence that ncome nequalty leads to lower protecton of property rghts. However, 2

3 the way nequalty s thought to nfluence legal qualty s not free of value judgments that could dffer between countres. Alesna and Angeletos (2002) for example show that Amercans are more tolerant of nequalty than Europeans, whch could n tself lead to hgher legal qualty n the US, gven the argument that nequalty manly leads more people to queston the legtmacy of decsons of the courts. There s thus no reason to beleve that ctzens of dfferent natons have the same tolerance of nequalty; plenty of anecdotal evdence suggests the opposte. Ths paper therefore reexamnes Keefer and Knack s (2002) results but devates n two mportant ways. Frstly, the paper employs an alternatve measure of legal qualty; and secondly, t takes nto account that the effect of nequalty on legal qualty may depend on ndvduals dfferng assumptons about socety and tolerance of nequalty. The paper s structured as follows. Secton 2 develops a smple model where nequalty and mert assumptons affect ndvduals demand for legal protecton. Secton 3 descrbes the data used n secton 4 to test for the broad predcton from the mode. Secton 5 dscusses the results and concludes. 2. Model To llustrate how nequalty and tolerance mght nfluence legal qualty, I here develop a smple model. The model assumes that the economy has two frms, a large number of workers/consumers/voters and a government that supples legal protecton and collects taxes. One of the frms s an nnovator frm that produces product x. The frm nvests n new technology at the begnnng of each perod, whch leads to more effcent producton technology. The other frm s an mtator,.e. a frm that does not nvest n 3

4 new technology but merely mtates the nnovator frm; t produces product y. As (nfntely-lved) consumers have preferences for better products, the mtator has an ncentve to steal the new technology snce consumers are wllng to pay a hgher prce for better products;.e. the prce of product x, p x, s hgher than that of product y, p y. If nnovators technology s stolen, products x and y are of equal value and prces are equalzed at p x > p > p y due to ncreased competton. Ths naturally mples that the nvestment s wasted and creates a demand for legal protecton of the ntellectual property rghts to nnovatons. I assume that any nventon can be protected, e.g. by a patent, n only one perod after whch t automatcally splls over nto the mtator frm. As workers are pad ther (expected) margnal productvty, workers n nnovator frms wll get a hgher wage, w hgh, than workers n mtator frms, who get w low. Both types maxmze utlty n (1), dependng on consumpton of the two goods, where x s preferred n accordance wth the preference parameter b>1, labor l and ncome nequalty w low / w hgh. Maxmzaton s naturally condtoned on the standard budget constrant (2). γ ( 1 low α α β w U = + δ ) bx 0 + y l + c = w hgh (1) x y ( 1+ r) wl ( 1 t) = ( 1+ r) px+ py (2) = 0 = 0 Although frms are drectly affected by legal qualty, they do not vote n ths economy, workers do. I hence do not specfy frm behavor other than the assumptons about prces and wages above. Workers utlty maxmzaton also mples an optmal demand for legal qualty, dependng only on what they perceve that they wll get out of better 4

5 legal qualty, weghed aganst the tax that pays for the legal system and ther tolerance of nequalty. Legal qualty s captured by a probablty λ that the ntellectual property rghts to nnovatons are protected by the legal system. Now assume that the expected preference s (3), where B s the preference for better products. b = Bλ + 1 λ (3) Equaton (3) thus captures the lkelhood that both products are equally preferred when nnovators new technology s stolen wth probablty 1- λ. Ths also mples that workers n mtator frms receve a technology-nduced rase a perod early, compared to the stuaton where technologcal nnovatons are protected and thus only lead to rases n the nnovator frms. In the latter stuaton, nvestments n technology wll lead to ncreasng wages n nnovator frms n the same perod as the nvestment but only after one perod n mtator frms when the technology automatcally splls over. Fnally, assume that the postve margnal mpact of legal qualty on wages, w λ, s lnear and the same for both frms. g t denotes the necessary tax ncrease to fnance better legal qualty; θ s defned as λ+(1+δ) -1 (1-λ). Solvng the maxmzaton problem wth these assumptons yelds workers demand for optmal legal qualty, Dλ n (4); see the appendx for detals. x y ( ) + ( ) p p x p p y gt γ + w θ β βl w low, wl( 1 t) 1 t λ Dλ = γ c w w hgh, hgh, 1 w ( 1+ δ ) low, (4) 5

6 The mplcatons become clear when takng the logarthm to the expresson n (4), resultng n equaton (5). It s obvous that demand for legal qualty decreases wth the dscrepancy between wages n the two sectors (the expresson n brackets),.e. wth the level of ncome nequalty. 1 Ths effect s further enhanced when tolerance of nequalty s low,.e. when γ s hgh. Note also that the demand for legal qualty s ncreasng wth the overall wage level. ( γ ) x y ( ) + ( ) p p x p p y g t log Dλ = C+ log + w θ wl λ ( 1 t) 1 t hgh low 1+ log w log w logγ (5) ( ) C = log β + βlog l log c log w λ + log 1+ δ (6) As ncome nequalty n the long run s determned exogenously by the sze of each of the two frms, ths leads to the mplcaton that ncome nequalty can affect legal qualty negatvely, as average and medan demand for legal qualty depends on the composton of frms n the economy. It should be noted that the model also mples that economc growth s thus mpared by nequalty. By equaton (5) t should also be noted that all voters (workers ) demand for legal qualty depends on the actual level of nequalty multpled by ther tolerance of such nequalty. Ths result may be 1 Another mnor pont to note s θ, whch s dfferent for workers n nnovator and mtator frms. For workers n the nnovator frm, θ=1 snce ther wages ncrease n the frst perod followng an nnovaton. Workers n the mtator frm, however, only receve an mmedate rase wth probablty 1-λ and must wat one perod wth probablty λ, mplyng that they dscount the reward. Ths effect s, however, very small. Note that expresson (5) s an approxmaton. 6

7 exacerbated f workers n the two frms dffer wth respect to ther tolerance. Hence, gven that poltcal partes act n accordance wth voters demands, the level of nequalty could come to depend on both actual ncome nequalty and voters tolerance of nequalty. Fnally, the logarthmc term n parenthess can be nterpreted as a wealth effect mplyng that rcher populatons demand hgher legal qualty. The model above thus llustrates one of many ways n whch nequalty could affect legal qualty. It should be noted that the model s only partal, as t does not specfy frms decsons. However, the general results hold as long as frms are able to pay dfferent wages. As such, the model generates results that can be nterpreted n a way smlar to Keefer and Knack (2002), as demand for legal qualty wll be lower than actual legal qualty,.e. legal qualty s excessve and therefore not legtmate, f t protects a level of ncome nequalty above that preferred by voters. In that case, the nherent equty-effcency trade-off comes to be out of balance wth voters preferences. 3. Data In order to test the broad qualtatve predctons of the model, I draw data from varous sources. Frstly, I employ data from the Canadan Fraser Insttute to measure legal qualty (Gwartney and Lawson, 2002). These data are formed as ndces dstrbuted from 0 (no qualty) to 10 (perfect qualty) by drawng on data from varous prmary sources. The ndces are publshed once every fve years for a large set of countres and are assessed to be good ndcators for nsttutonal development (de Haan and Sturm, 2000; Paldam, 2003). The ndex used here measures legal qualty and the protecton of property rghts. I use the observatons from 1980, 1990 and 2000 and thus dvde tme nto three ten-year perods begnnng n As s standard, nequalty s measured by 7

8 the Gn coeffcent, obtaned from Dennger and Squre (1996). As some of the data are based on ncome whle other are based on expendture, I follow Dennger and Squre s (1996) approach n addng 6.6 to expendture-based Gn coeffcents to make the two types comparable. I use the earlest acceptable observaton for each country n a gven decade. In order to measure norms and tolerance of nequalty, I use poltcal deology as a proxy. Ths choce s based on results from expermental economcs, whch show that ndvduals mert assumptons and equty-effcency trade-offs are sgnfcantly assocated wth poltcal deology and nfluence ther behavor n economc experments (Mtchell et al., 1993; Scott et al., 2001). The studes show that people on the poltcal rght wng tend to be more tolerant of nequalty and behave accordngly, as they ascrbe nequalty to mert and effcency to a larger degree than ther poltcal opponents. The expermental studes thus suggest that poltcal deology may be used as a proxy for tolerance of nequalty. I measure such deology by usng the categorzaton n Beck et al. (2001) who defne the largest government party at any tme between 1975 and 2000 accordng to whether they have a leftwng, centrst or rghtwng poltcal orentaton. By codng leftwng partes 1, centrst partes 0, and rghtwng partes 1, a crude measure of the deology of government n any year s obtaned. I thereafter average ths measure over each decade and standardze the resultng varable. The resultng ndex s normally dstrbuted around zero, where countres that have had a leftwng government n all 10- year perods are assumed to have a medan voter wth leftwng sympathes and deology and thus also wth a low tolerance of nequalty (a hgh γ n the model). 8

9 Ths measure has both advantages and shortcomngs, as have all proxes. Ideally, one would wsh a drect measure of norms and tolerance of nequalty whle poltcal deology s only related to such norms. As such, I run the rsk that the measure captures behavoral trats of poltcans unrelated to such norms. On the other hand, normatve atttudnal measures such as those revealed n socal surveys may be unrelated to actual behavor. 2 In ths respect, poltcal deology as a drect measure could thus be a better measure of actual tolerance and norms by beng revealed drectly through voters behavor. It follows that the measure does not make sense f electons are not free, snce voters thus cannot reveal ther true preferences. I therefore mpose the restrcton that countres must have been democratc n at least two of the three perods accordng to the Gastl ndex of poltcal rghts (Freedom House, 2003). The remanng data fall n two groups. As control varables n all analyses below, I enter GDP per capta and trade volume as percentage of GDP (denoted openness) along nequalty and nequalty nteracted wth poltcal deology. Both derve from the Penn World Tables, Mark 6 (PWT6) and are corrected for purchasng power party (see Summers and Heston, 1991). The second group of varables s chosen to capture potental transmsson channels from nequalty to legal qualty. They nclude ethnolngustc fractonalzaton (ELF), defned as the probablty that two random ctzens of a gven country do not belong to the same ethnc or lngustc group. The ELF orgnally derves from a Sovet anthropologcal atlas but has been updated by Roeder (2001). I nclude two varables to capture government nvolvement n the 2 Bjørnskov (2003) provdes an example by showng that the degree of acceptance of corrupton as well as a broader measure of socal norms s absolutely unrelated to actual levels of corrupton. 9

10 economy. The frst s an ndex on government sze, whch ncludes tax levels and structure, government s share of GDP and the extent of government controlled enterprses, taken from Gwartney and Lawson (2002). The second, taken from the PWT6, s government s share of GDP. I test for the nfluence of schoolng by drawng average schoolng n years from Barro and Lee (2001). Two dummes measurng f a gven country has ether a common law system or a Scandnavan-type mxed legal system are drawn from CIA (2003). As the last transmsson mechansms, I nclude socal captal measured as the natonal percentage of people answerng yes to the queston In general, do you thnk that most people can be trusted, or can t you be too careful? ; ths s normally referred to as generalzed trust. Most varables are measured at the begnnng of each perod or as close to as possble. 3 Fnally, I nclude perod dummes to account for macroeconomc condtons and potental alteratons n measurement methods that leave the country rankngs ntact. Table 1 reports descrptve statstcs on the data. INSERT TABLE 1 ABOUT HERE 4. Results To test the theoretcal predctons, I employ a smple baselne specfcaton consstng of ncome nequalty, nequalty nteracted wth poltcal deology, and ntal GDP per capta. I also nclude openness to trade, as Rodrk et al. (2002) n an nfluental crtque 3 The excepton s socal captal, whch s treated as a tme-nvarant feature. All avalable observatons from the WVS are therefore averaged for each country and used n all perods. For a background, see e.g. the dscusson n Bjørnskov (2003). 10

11 of the trade-growth assocaton forcefully argue that the effects of openness on growth manly work through promotng nsttutonal development. Fgure 1 plots the smple relaton between legal qualty and the Gn coeffcent where the smple correlaton coeffcent s To substantate ths assocaton, Table 2 reports the results of regressng legal qualty on the baselne specfcaton employng dfferent estmaton methods. INSERT FIGURE 1 ABOUT HERE INSERT TABLE 2 ABOUT HERE Column 1 shows the results of estmatng the standard model,.e. excludng the nteracton term, by ordnary least squares (OLS) and thereby replcates Keefer and Knack s (2002) result that nequalty leads to lower legal qualty. Column 2 reports the results of estmatng the baselne specfcaton, demonstratng that the nteracton term not only becomes sgnfcant but also ncreases the precson wth whch the pure effect of nequalty s measured. The predctons of the model thus receve substantal support from the data. 4 However, these results could n theory be drven by ether a small number of devant observatons or be a result of reverse causaton. In order to corroborate the result, the next columns therefore employ two departures from OLS. Frstly, column 3 corrects for potental endogenety by estmatng the effects usng a two-stage least squares (2SLS) method where nequalty and the nteracton term are 4 It should be noted that I do not report any regressons where poltcal deology enters on ts own, as t never attaned sgnfcance n any specfcaton. 11

12 nstrumented wth values lagged one decade. Ths has the effect of ncreasng the sze of the coeffcents whle mantanng the sgnfcance of the results. Secondly, columns 4 and 5 (denoted sample robustness ) test for the effects of nfluental observatons by excludng outlers based on two statstcs: column 4 defnes outlers as observatons wth a resdual above ±2 standard devatons; column 5 alternatvely defnes outlers as observatons wth a DFBETA assocated wth the nteracton term above ±2 standard devatons. 5 Column 4 hence tests for the effects of general outlers whle column 5 tests for the possblty that the effects of the nteracton term are drven by a small number of observatons. In both cases, the sample s reduced by about a thrd to only 64 observatons. The excluson of outlers has the effect of ncreasng the sgnfcance of the estmate on nequalty and slghtly decreasng the sgnfcance on the nteracton term whle the szes of both prove to be qute robust to sample alteratons. The results n Table 2 thus pont to a total effect of nequalty that s medated by the proxy for tolerance, poltcal deology, and provde substantal support for the man hypothess of ths paper. To llustrate the effect, take the example of an average country that receves a shock to ts level of nequalty at the begnnng of a decade, mplyng that the Gn coeffcent ncreases by one standard devaton. The results ndcate that ths shock would, all other thngs beng equal, by the end of the perod have resulted n a decrease of legal qualty of about 0.67 ponts, or 10% of the ntal level, whch corresponds to the dfference between current legal qualty n Estona (6.67) and 5 DFBETA s the change n a regresson coeffcent that results from the excluson of a partcular observaton. It thus more precsely measures the mportance of sngle observatons to sngle coeffcents than the resdual. 12

13 Maurtus (6.00). However, the results also ndcate that the shock would have a 10% smaller effect n countres wth an deology one standard devaton above the average. Although ths may at frst seem an nconsequental effect, t corresponds to the dfference between deteroratng to the level of Tawan nstead of Maurtus. In the longer run, the nteracton term could thus have substantal mportance. Followng the approach n Keefer and Knack (2002), I next nclude a set of varables chosen to capture potental transmsson mechansms. The dea of ths approach s that ncludng a varable that captures a transmsson mechansm wll be reflected n the estmates on nequalty and the nteracton term;.e. f nequalty negatvely affects varable z that n turn affects legal qualty, the ncluson of ths varable wll then lead to a lower estmate on nequalty. The results estmated by 2SLS are reported n Table 3. INSERT TABLE 3 ABOUT HERE Frstly, the two frst columns replcate the effect of ncludng the nteracton term, ths tme corrected for potental endogenety. The results also show that openness to trade, whch s ncluded n the baselne specfcaton, s always nsgnfcant, changes sgn and has no effect on the estmates on nequalty. I thus fnd no support for the vew of Rodrk et al. (2002) that openness leads to growth manly through strengthenng nsttutons such as the legal system. Secondly, I nclude ethnolngustc fractonalzaton as an alternatve measure of socal polarzaton. Easterly (1997) and Tornell and Lane (1999) suggest that ethncally polarzed countres may experence a larger demand for redstrbuton between ethnc groups, whch ceters parbus would 13

14 leave less resources avalable for the legal system; Keefer and Knack (2002) fnd evdence of a smlar effect. The same result s obtaned n the local publc fnance lterature, where polarzaton s found to lead to lower provson of publc goods such as legal qualty (e.g. Alesna et al., 1999). Yet, ncludng ELF proves to have no effect. I also test more drectly for the potental effects of redstrbuton that are commonly credted for leadng to lower growth n the nequalty lterature (e.g. Persson and Tabelln, 1994). Includng government sze has no effect whle governments share of GDP becomes sgnfcant at p<0.10 although ths has no effect on the estmates on nequalty. Thrdly, nequalty nfluences legal qualty by leadng to lower rates of schoolng f better-educated ctzens demand more legal protecton. Perott (1993) and Barro (2000) both fnd that nequalty may lead to lower schoolng rates and the results n Table 3 ndeed suggest that some of the effect of nequalty may be due to ts effects on schoolng. The estmate on nequalty becomes approxmately 20% smaller and s sgnfcant at only p<0.10 whle the ncluson of schoolng has no effect on the nteracton term. Fourthly, I nclude two nsttutonal measures. The specfcaton n column 8 ncludes two dummes that take the value one f a country has ether a common law system or a Scandnavan legal system. The ncluson of these varables s based n fndngs ndcatng that countres wth ether system experence lower corrupton and hgher legal qualty (Tresman, 2000; Glaeser and Shlefer, 2002). Includng these varables has the multple purposes of both testng for the nfluence of dfferent systems and any specfc Scandnavan nfluence. The coeffcent on common law s vrtually zero and 14

15 whle the coeffcent on havng a Scandnavan system s postve as expected, t s nsgnfcant. The only real effect the varables have s to strengthen the dentfcaton of the effect of the nteracton term. The second nsttutonal measure to be ncluded s socal captal captured by generalzed trust scores snce nequalty s known to be negatvely assocated wth levels of trust (Zak and Knack, 2001; Uslaner, 2002). It could therefore be the case that nequalty comes to proxy for socal captal, whch has been found to lead to better legal performance (Rce and Sumberg, 1997; Knack, 2002). Includng the level of generalzed trust ndeed has the effect of renderng nequalty nsgnfcant whle socal captal becomes sgnfcant at p< Yet, the effect on the nteracton term s only margnal and the lower level of sgnfcance s manly due to the slghtly reduced sample sze. As a fnal check, I also nstrument socal captal as some authors suggest that socal captal may be an effect of formal nsttutons (Stolle and Rothsten, 2002; Rothsten, 2003). 7 The results, reported n column 9, ndcate that there s no real need for nstrumentaton as found by Knack (2002). However, the procedure has the effect of renderng nequalty nsgnfcant whle the nteracton term stll remans sgnfcant. It also has the effect of producng a much larger coeffcent on socal captal than wthout nstrumentaton, whch may seem surprsng. 8 I leave ths queston to future research. 6 Excludng nequalty from the equaton mples that the estmate on socal captal becomes slghtly larger and sgnfcant at p<0.05 whle t has no effect on the nteracton term. 7 The nstruments are ELF and schoolng. Both are almost perfectly uncorrelated wth the error term from the regresson n Table 3, column 2. 8 There can be two explanatons for ths result. The frst s sample varaton,.e. that although the nstruments should be uncorrelated wth the resdual, they could by chance be correlated n the slghtly smaller sample used n columns 8 and 9. Ths does nonetheless not seem to be the case. The second 15

16 In summary, the results ndcate that nequalty exerts a negatve nfluence on legal qualty, but more so n countres wth a leftwng deology. The most lkely transmsson channel s socal captal, whch s known to be hgher n countres wth a more equal ncome dstrbuton. However, the nteracton term between nequalty and deology s unaffected by each of the potental transmsson mechansms n the above, whch may pont to an ndependent effect of the tolerance of nequalty as descrbed n the theoretcal secton. 5. Dscusson and concludng remarks Ths paper has examned the effects of ncome nequalty on legal qualty. A smple model exemplfed how the behavor of perfectly ratonal voters/workers wth a preference for equalty can mply that nequalty leads to lower legal qualty and more so n countres where voters are less tolerant of nequalty. The data seem to broadly support the mplcatons of ths hypothess. The emprcal fndngs ndeed show that nequalty leads to lower legal qualty as prevously found by Keefer and Knack (2002). By ncludng varables to capture a set of potental transmsson mechansms, the fndngs suggest that the effects of nequalty on legal qualty are manly due to nequalty beng assocated wth lower socal trust, a result found by prevous studes not dealng wth nequalty (La Porta et al., 1997; Rce and Sumberg, 1997; Knack, 2002). One contrbuton of ths paper s thus to connect the emprcal fndngs wth explanaton s that the non-nstrumented estmate s n fact based downwards, whch would be the case f generalzed trust were an mperfect measure of features such as socal trust and trustworthness. Gven tat people s answers to such questons are lkely to be nfluenced by random fluctuatons (adverse stores appearng n the meda etc.) ths seems the more lkely explanaton. 16

17 respect to ncome nequalty and socal captal. The second contrbuton derves from the fndng that nequalty nteracted wth poltcal deology exerts a sgnfcant postve nfluence on legal qualty. The effect s broadly unaffected by ncludng the set of varables ntended to capture transmsson mechansms and thus warrants further dscusson snce poltcal deology, whch s used to proxy for tolerance of nequalty and related norms, could also measure other features of socety. It should be expected that nequalty leads to redstrbuton when tolerance of nequalty s low. It could also be the case that leftwng governments react to hgh nequalty by ncreasng redstrbuton efforts of purely deologcal reasons, whch would make any effect stronger, but more dffcult to nterpret. Yet, ths s clearly not the case, as I fnd no evdence of any effect of nequalty pertanng to redstrbuton. Purely deologcal dfferences wll lkely only show n a lmted number of cases, as most governments (after all) are relatvely pragmatc. But the robustness exercses n Table 2 also show that the results are not drven by a small group of outler observatons, whch further strengthens the case for consderng poltcal deology an approprate measure of tolerance of nequalty and related norms. It thus appears that poltcal deology does not have the expected consequences f t were only measurng government deology. It may therefore seem reasonable to nterpret the postve nteracton term as evdence of a legtmacy effect smlar to the argument n Keefer and Knack (2002). More specfcally, nequalty s assocated wth socal trust, whch leads to hgher legal qualty. Hence, where nterpersonal trust s hgh, legal decsons wll also tend to be consdered legtmate snce the persons takng the decsons wll be perceved more 17

18 lkely to act farly. Yet ths effect should be supplemented wth the fndng that legal qualty s lower n countres where ncome nequalty s hgh and s not tolerated by the general publc. In ths stuaton, legal decsons wll often be consdered llegtmate by a substantal part of the populaton whle nequalty may not be detrmental to legal qualty when t s tolerated, as e.g. resources may be unted to nvest n real mprovements. In the terms of the theoretcal model, legal protecton n a stuaton wth hgh nequalty leads most voters to wegh equty hgher than effcency and hence fnd the legal protecton of nnovatons excessve. Whle the paper connects the results of nequalty and socal captal, the man result may thus be that the tolerance of nequalty, measured by medan poltcal deology, has a functonal nfluence on the qualty of legal systems. In other words, nequalty does not affect legal qualty to the same degree n all countres. Controllng for the effect of socal captal, nequalty may even be benefcal n some countres where the socal tolerance of nequalty s hgh. Although the fndngs presented n ths paper warrant further research, tentatve poltcal and economc mplcatons of the results are that nequalty may not be a substantal concern n real terms n countres where t s less of a concern n normatve terms. When desgnng future polces to brng about better legal systems n e.g. developng and transton countres, ths dstncton should probably be kept n mnd, as t mples that one sze does not ft all. Appendx Formng a Lagrange functon, L, solves the model n secton 2. Ths yelds a number of frst-order condtons outlned here. Note that µ s the Lagrange multpler. 18

19 dl dx dl dy x ( ( ) ) = = bx p + p (A1) α 1 0 α µ λ 1 λ y ( ( ) ) = = y p + p (A2) α 1 0 α µ λ 1 λ dl β 1 = 0= β l + µ w( 1 t) (A3) dl Demand for legal qualty s solved n the same manner through a frst-order condton as f voters/workers could choose the level of legal qualty. Note that I drop tme subscrpts to denote steady-state demand (where labor supply s constant). The functon h t denotes the margnal mpact on taxes of ncreasng legal qualty. dl w w λγ C wλ λγ C wλ low γ low γ 1 = 0 = + hgh γ+ 1 hgh γ dλ w w x y ( 1 ) λ ( ) ( ) + µ l t w wlh p p x p p y (A4) Solvng ths problem yelds the soluton n equaton (4) n the text. 19

20 References Alesna, Alberto, Reza Baqr and Wllam Easterly Publc Goods and Ethnc Dvsons. Quarterly Journal of Economcs, vol. 114 (4), Alesna, Alberto and Roberto Perott Income Dstrbuton, Poltcal Instablty, and Investment. European Economc Revew, vol. 40 (6), Al, Abdwel M. and Hodan Sad Isse Determnants of Economc Corrupton: A Cross-Country Comparson. Cato Journal, vol. 22 (3), Barro, Robert J Inequalty and Growth n a Panel of Countres. Journal of Economc Growth, vol. 5, Barro, Robert J. and Jong-Wha Lee Internatonal Data on Educatonal Attanment: Updates and Implcatons. Oxford Economc Papers, vol. 53, Beck, Thorsten, George Clarke, Alberto Groff, Phlp Keefer and Patrck Walsh New Tools n Comparatve Poltcal Economy: The Database of Poltcal Insttutons. World Bank Economc Revew, vol. 15 (1), Bjørnskov, Chrstan Corrupton and Socal Captal. Mmeo, Aarhus School of Busness. Clague, Chrstopher, Phlp Keefer, Stephen Knack and Mancur Olson Contract- Intensve Money: Contract Enforcement, Property Rghts, and Economc Performance. Journal of Economc Growth, vol. 4, De Haan, Jacob and Jan-Egbert Sturm On the Relatonshp Between Economc Freedom and Economc Growth. European Journal of Poltcal Economy, vol. 16 (2),

21 Dennger, Klaus and Lyn Squre A New Data Set Measurng Income Inequalty. World Bank Economc Revew, vol. 10, Dennger, Klaus and Lyn Squre New Ways of Lookng at Old Issues: Inequalty and Growth. Journal of Development Economcs, vol. 57, Feld, Lars P. and Stefan Vogt Economc Growth and Judcal Independence: Cross-Country Evdence Usng a New Set of Indcators. European Journal of Poltcal Economy, vol. 19 (3), Forbes, Krstn A Reassessment of the Relaton Between Inequalty and Growth. Amercan Economc Revew, vol. 90 (4), Glaeser, Edward L. and Andre Shlefer Legal Orgns. Quarterly Journal of Economcs, vol. 117 (4), Gwartney, James and Robert Lawson Economc Freedom of the World: 2002 Annual Report. Vancouver, BC: the Fraser Insttute. Keefer, Phlp and Stephen Knack Polarzaton, Poltcs and Property Rghts. Lnks Between Inequalty and Growth. Publc Choce, vol. 111 (1-2), Knack, Stephen Socal Captal and the Qualty of Government: Evdence from the U.S. States. Amercan Journal of Poltcal Scence, vol. 46 (4), Knack, Stephen and Phlp Keefer Insttutons and Economc Performance: Cross Country Tests Usng Alternatve Insttutonal Measures. Economcs and Poltcs, vol. 7, Kormend, Roger and Phlp Megure Macroeconomc Determnants of Growth. Journal of Monetary Economcs, vol. 16, Lambsdorff, Johann Graf How Corrupton Affects Persstent Captal Flows. Economcs of Governance, vol. 4 (3),

22 La Porta, Rafael, Florenco Lopez-de-Slanes, Andre Schlefer and Robert W. Vshny Trust n Large Organzatons. Amercan Economcs Revew, vol. 87 (2), Mtchell, Gregory, Phlp E. Tetlock, Barbara A. Mellers and Lsa D. Ordóñez Judgments of Socal Justce: Compromses Between Equalty and Effcency. Journal of Personalty and Socal Psychology, vol. 65 (4), North, Douglass C Insttutons. Journal of Economc Perspectves, vol. 5 (1), Paldam, Martn The Economc Freedom of Asan Tgers. An Essay on Controversy. European Journal of Poltcal Economy, vol. 19 (3), Perott, Roberto Poltcal Equlbrum, Income Dstrbuton, and Growth. Revew of Economc Studes, vol. 60, Persson, Torsten and Gudo Tabelln Is Inequalty Harmful for Growth? Amercan Economc Revew, vol. 84 (3), Rce, Tom W. and Alex Sumberg Cvc Culture and Democracy n the Amercan States. Publus, vol. 27, Rodrk, Dan, Arvnd Sumbramanan, and Francesco Trebb Insttutons Rule: The Prmacy of Insttutons over Geography and Integraton n Economc Development. NBER Workng Paper no Roeder, Phlp G Ethnolngustc Fractonalzaton (ELF) Indces, 1961 and Data set avalable at (consulted February 24, 2003). Rothsten, Bo Socal Captal, Economc Growth, and the Qualty of Government: The Causal Mechansm. New Poltcal Economy, vol. 8 (1),

23 Scott, John T., Rchard E. Matland, Phlp A. Mchelbach and Bran H. Bornsten Just Deserts: An Expermental Study of Dstrbutve Justce Norms. Amercan Journal of Poltcal Scence, vol. 45 (4), Stolle, Detlnd and Bo Rothsten How Poltcal Insttutons Crate and Destroy Socal Captal: An Insttutonal Theory of Generalzed Trust. Paper presented at the Annual Meetng of the Amercan Poltcal Scence Assocaton, Boston. Summers, Robert and Alan Heston A New Set of Internatonal Comparsons of Real Product and Prce Levels Estmates for 130 Countres, Revew of Income and Wealth, vol. 34 (1), Tresman, Danel The Causes of Corrupton: A Cross-Natonal Study. Journal of Publc Economcs, vol. 76, Uslaner, Erc M The Moral Foundatons of Trust. Cambrdge (UK): Cambrdge Unversty Press. Zak, Paul and Stephen Knack Trust and Growth. The Economc Journal, vol. 111,

24 Table 1. Descrptve statstcs Average Mnmum Maxmum Std. dev. Obs. Legal qualty Inequalty Poltcal deology Intal GDP Openness ELF Government sze Government share n GDP Schoolng Common law system Scandnavan legal system Socal captal (trust)

25 Table 2. Results Estmaton method OLS 2SLS Sample robustness Inequalty *** (-2.712) ** (-3.462) ** (-2.394) *** (-3.043) *** (-3.087) Inequalty*deology 0.149** (2.419) 0.179** (2.537) 0.131* (1.836) 0.146** (2.019) Intal GDP 0.817*** (8.319) 0.784*** (8.091) 0.711*** (4.971) 0.667*** (7.719) 0.652*** (7.491) Openness (-0.469) (-0.823) (-0.486) (0.268) (0.373) Observatons Adjusted R squared F statstc Standard error of estmate Note: all regressons nclude a constant term and perod dummes; *** denotes sgnfcance at p<0.01; ** at p<0.05; * at p<0.10. Instruments for nequalty and the nteracton term n column 3 are values lagged one perod; excluson of outlers s based on resduals n column 4 and on DFBETA assocated wth the nteracton term n column 5. 25

26 Table 3. Results potental transmsson mechansms Inequalty ** (-2.051) ** (-2.394) ** (-2.370) ** (-2.318) ** (-2.394) * (-1.707) ** (-2.428) (-1.354) (-0.174) Inequalty*deology 0.179** (2.537) 0.180** (2.513) 0.179** (2.519) 0.172** (2.448) 0.169** (2.358) 0.197*** (2.740) 0.144** (2.213) 0.155** (2.215) Intal GDP 0.763*** (5.637) 0.711*** (4.971) 0.713*** (4.982) 0.719*** (5.116) 0.623*** (4.385) 0.666*** (4.640) 0.675*** (4.667) 0.672*** (4.585) 0.605*** (3.673) Openness (-0.166) (-0.486) (-0.454) (-0.421) (-0.074) (-0.466) (-0.582) (0.934) (1.134) Ethnolngustc fractonalzaton (0.119) Government sze (0.440) Government share n GDP * (-1.874) Schoolng (0.961) Common law system (-0.083) Scandnavan legal system (0.093) Socal captal (trust) 0.191* (1.827) 0.497** (2.030) Observatons Adjusted R squared F statstc Standard error of estmate Note: all regressons nclude a constant term and perod dummes; *** denotes sgnfcance at p<0.01; ** at p<0.05; * at p<0.10. Instruments for nequalty and the nteracton term are values lagged one perod. 26

27 Fgure 1. Inequalty and legal qualty 10 8 Legal qualty Income nequalty 27