Berkeley Program in Law and Economics

Sustained growth occurs in developing nations through improvements in markets and organizations. Entrepreneurial innovation resembles biological mutation that is unpredictable before it occurs and understandable afterwards. It is unpredictable because it begins with an innovator who acquires private information and earns extraordinary profits. It is understandable because its ends with the public figuring out the innovation and all investors earning ordinary profits. These characteristics of innovation have important consequences for law and policy to foster economic growth. Government officials who rely on public information cannot predict which firms or industries will experience rapid growth. Consequently, industrial policies that promote growth are unlikely to succeed. Proponents of industrial policy today make the same mistake as the mercantilists whose interventions Adam Smith attacked as a cause of national poverty. In contrast, secure property and contract rights, and effective business law (especially the laws regulating financial markets), create conditions under which competition naturally produces entrepreneurial innovation and nations become rich. The main obstacle to sustained economic growth in poor countries today is ineffective civil and business law.