The Growth Effects of Property Rights: The Role of Finance

This paper examines the relationship between property rights and growth using data for 91 countries from 1980 to 2005. The relationship is complex. In countries with mature financial strictures strong property rights are generally beneficial for growth. However, in countries where the financial architecture is weak, the relationship can be nonlinear; stronger enforcement may raise growth, but only up to a point. We provide a simple theoretical rationale for these findings using a model of financial intermediation and growth, where borrowers fall into two types and informational asymmetries dilute the quality of financial contracts offered to good borrowers. Within this context stronger property rights have two opposing effects. On the one hand it increases capital formation and growth. On the other hand it reduces outside opportunities to bad borrowers by mitigating predation. This latter effect encourages more bad borrowing practices and dilutes financial contracts in general. Thus there exists an optimal level of property rights which maximizes growth. However, as financial markets mature, the ability of lenders to discern borrower types improves, and the negative effects associated with stronger property rights become weaker