Law and Finance Matter: Lessons from Externally Imposed Courts
James Brown; Iowa State University
J. Anthony Cookson; University of Colorado
Rawley Heimer; Federal Reserve Bank of Cleveland
March 15, 2015
Abstract
This paper provides novel evidence on the real and financial market effects of legal institutions. Our analysis exploits persistent and externally imposed differences in court enforcement that arose when the U.S. Congress assigned state courts to adjudicate contracts on a quasi-random subset of Native American reservations. According to area-specific data on small business and household credit, reservations
assigned to state courts, which enforce contracts more predictably than tribal courts, have stronger credit markets. Moreover, the law-driven component of credit market development is associated with significantly higher levels of per capita income, with stronger effects in sectors that depend more on external financing. By using exogenous variation in legal institutions across relatively similar sovereign entities,
our study offers compelling evidence that stronger contract enforcement and better-developed credit markets lead to significant improvements in broad economic outcomes.
