AUSTIN, Texas — Countries in which courts more easily enforce contracts see less economic volatility overall than nations that don’t adhere as well to the rule of law. That’s the finding from a study by a finance researcher at The University of Texas at Austin.
The research suggests that when contract enforcement is poor, employee morale suffers, ultimately sparking churn, which leads to more economic volatility and greater differences in productivity across companies. Countries that adhere less to the rule of law as measured by the World Bank have greater volatility in their growth rates and in the economy overall.
“In countries where the rule of law is worse, if I’m an employer, I have more incentive to default on my promises to you when a bad shock hits,” said study co-author William Fuchs, a professor of finance in the McCombs School of Business. “Without an avenue for concerned employees to seek help, you work less, become less productive, and that amplifies the shock to the economy.”
The findings appear in the Journal of Monetary Economics.
Fuchs, with Martin Dumav of the Universidad Carlos III de Madrid and Jangwoo Lee of Chinese University of Hong Kong, used game theory—the study of how people make strategic decisions—to create a model in which two entities, such as a boss and an employee, interact over time.
The model includes two building blocks. The first is the concept that businesses are hit by shocks that make them more or less profitable. The second is that...
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