The Rule of Law in the Economic Life. Does It Matter?

The article is based on a study prepared by CASE — Center for Social and Economic Research and European Academy Berlin within the project entitled ‘Norma praworządności i jej oddziaływanie społeczne jako czynniki rozwoju gospodarczego Analiza porównawcza Niemiec i Polski’/‘Das Prinzip der Rechtsstaatlichkeit und ihre soziale Wirkung als Determinante des ökonomischen Wachstums Eine vergleichende Analyse Deutschlands und Polens’ (№2018–26).

The rule of law is, as a matter of course, a sine qua non for a modern democratic society. It is also a necessary condition for existence of a stable, effective, and sustainable market economy. The connection between the rule of law and the economy has increasingly been the focus of much scientific and analytical work. According to the new institutional economics stream of research, the rule of law — and particularly inclusiveness and the transaction reducing properties of well-functioning institutions — are among the main determinants of the economic growth. The applicability and effectiveness of the relevant norms depends, however, on their social reception and validation. In the long term, insufficient understanding of the rule of law in a society can prompt the government to abandon or undermine the rule of law, which in turn threatens socio-economic wellbeing of a given population.

Understanding the Rule of Law in Poland and Germany

The current state and perception of the rule of law and public institutions in Poland and Germany have been shaped by historical and economic factors. While both countries benefit from rich constitutional traditions, there are clear divergences in terms of the role and level of the rule of law across the old lines of division that used to cut both countries in two (Germany) and three (Poland).

Germany

Performance of Germany in terms of the available rule of law indicators has remained high and historically stable. In the latest World Justice Project Rule of Law Index, in particular, Germany ranked 6th globally (score of 0.84) with the government accountability, freedom from corruption, and accessibility and efficiency of the court system praised as particularly strong. Similarly, according to the World Bank Doing Business ranking, Germany remains among the 25 top global performers.

As suggested by the results of the national surveys, however, a certain degree of divergence in terms of trust in public institutions can be found across the country. Subject to the economic downturn, missing identification of the newly built institutions, and a legacy of the former authoritarian state, the distrust in media, government, police, and administration have been found to be more common in the East Germany than in the Western part of the country. Thus, even if the absolute trust in public institutions continues to rise, the intra-country gap persists and remains one of the major challenges of the Federal Republic of Germany.

Poland

Despite being a historical vanguard of constitutional development in Europe, Poland underperforms relative to Germany and other EU countries in terms of the rule of law.

More importantly, in the recent years, Poland experienced a significant downturn across all main rule of law indicators. Following a strong performance in the World Justice Project Rule of Law Index and recognition as a successful reformer in the 2010 and 2011 editions of the report, Poland recorded a 25% drop in the constraints on government power indicator between 2015 and 2019, the largest decrease among the 126 countries included in the study. According to the Heritage Foundation’s Index of Economic Freedom, a significant decline was also recorded in the judicial effectiveness components (by 24% since 2018).

That erosion of the rule of law in Poland has taken form of both detrimental changes in the legal rules and in the approach of the ruling class to law or legal culture. Indeed, in the recent years the situation has been raising numerous concerns across both European and international actors.

Social Reception of the Rule of Law in Poland and Germany

The findings of the surveys and in-depth interviews[1] with business representatives in both countries underline intrinsic divergences in terms of the understanding and reception of the rule of law in Poland and Germany.

Polish companies tend to share a higher level of insecurity and have a restrictive vision of the rule of law as simple rule-obedience. For instance, one of the Polish respondents described the situation with regard to the rule of law in the country as a ‘dishonest application of the law that may apply in all spheres of living, including economic life. This foments the great anxiety […] which may be more felt in some areas. […] in reality, there is a risk that at some moment one wakes up to the totally new order, where there is no room for an activity or the business is taken over or nationalised.

This, in turn, is contrasted by the perception of the state actions in Germany: ‘[…] the state should also […] try to bridge or compensate for structural or temporary deficits with support so that the economy in our country can keep pace with the economies of competing countries. The framework is important, the rules are important […].’ Thus, in Germany, firms view the rule of law more as an instrument at their disposal, to be used vis-à-vis business partners and the state. This perception is not devoid of critique, however, with about one-third of small and big business representatives in Germany stating that ‘none’ of the rule of law elements are being adequately fulfilled in the country.

The difference in the levels of trust is particularly evident from the responses to the questions related to the impartiality of justice. As Figure 1 shows, ‘quality of the lawyers’ — most frequently perceived as the main condition of success in the court in both countries — is followed in Poland by the social connections of the opposing party rather than merits of the case itself.

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Source: CASE & EAB (2020). Rule of Law and its Social Reception as Determinants of Economic Development. A Comparative Analysis of Poland and Germany. Note: ‘DE’ stands for Germany and ‘PL’ for Poland. ‘SB’ and ‘BB’ correspond to small and big business representatives, respectively.
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Source: CASE & EAB (2020). Rule of Law and its Social Reception as Determinants of Economic Development. A Comparative Analysis of Poland and Germany. Note 1: ‘DE’ stands for Germany and ‘PL’ for Poland. ‘SB’ and ‘BB’ correspond to small and big business representatives, respectively. Note 2: range from 1 (unlikely) to 5 (certain).
Image for post
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Source: CASE & EAB (2020). Rule of Law and its Social Reception as Determinants of Economic Development. A Comparative Analysis of Poland and Germany. Note 1: ‘DE’ stands for Germany and ‘PL’ for Poland. ‘SB’ and ‘BB’ correspond to small and big business representatives, respectively. Note 2: range from 1 (unlikely) to 5 (certain).

When the cases against the administration are concerned, Polish business representatives (regardless of their size) tend to be more inclined to expect that the court will favour public administration (Figure 2). Similarly, Polish business representatives have been found to be more sceptical of the chances of a favourable verdict being implemented in practice (Figure 3).

Rule of Law and Investment

The sociological findings of the study suggest that the rule of law is not perceived as the main determinant of the investment decisions by companies neither in Germany nor in Poland. It is rather seen as a mean for securing a stable economic and institutional environment for running a business.

Based on the empirical results[2] , however, the rule of law has been proven to have a positive and substantial impact on investment.

The shift from the current level of rule of law[3] in Poland to its historical maximum (i.e. 0.964 in 2009–2010) would thus result in an increase in its income-based capital per worker[4] of an additional USD 3,216 (in 1990 constant USD). Similarly, if rule of law in Germany was to increase from its current level (i.e. 0.989 in 2018) to its 2012 maximum, the country would see a gain in capital of about USD 1,190 per worker after some time. Conversely, if Poland and Germany were to suffer lower levels of rule of law (i.e. shift for Poland from its current level to those witnessed in1986, and for Germany — from its current level to the level in the present day Poland), their workers would lose USD 11,240 and USD 7,911 in capital, respectively.

Conclusions

The findings of the study showcased underlying divergences in terms of understanding and execution of the rule of law in both countries. The rule of law, by securing civil and economic rights, can contribute substantially to enhancing trust and reducing transaction costs in relations between companies and administration. On the other hand, if not properly adopted, the rule of law can contribute to insecurity in the economic life.

More importantly, we find substantial and immediate adverse domino effects of poor rule of law. Crucially, as lower levels of the rule of law translate into lower investment, in the long term they adversely affect the socio-economic well-being of workers and pace of development of a country as a whole.

[1] For a detailed discussion of methodology, survey results, and insights from the in-depth interviews see CASE & EAB (2020). Rule of Law and its Social Reception as Determinants of Economic Development. A Comparative Analysis of Poland and Germany.

[2] For a detailed discussion of methodology and econometric results see CASE & EAB (2020). Rule of Law and its Social Reception as Determinants of Economic Development. A Comparative Analysis of Poland and Germany.

[3] As measured by the Varieties of Democracy (V-Dem) dataset, available at: https://www.v-dem.net/en/.

[4] Understood as the capital accrued over the lifespan of a worker whose income increases over time. Income-based capital per worker is used as a measure of productive investment in the econometric model based on Van Leeuwen and Földvári (2013), where the base of the empirical data comes from.

CASE — Center for Social and Economic Research is an independent, non-profit economic and public policy research institution, established in 1991 in Warsaw.

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