Rule of Law Presence and Firms' Growth: The Persistent Effects of the Colonial Period

Literature on economic development showed that historical events have long term persistence over current social welfare. Specifically, places with historical state capacity are more developed than places without it. In this... [ view full abstract ]

Literature on economic development showed that historical events have long term persistence over current social welfare. Specifically, places with historical state capacity are more developed than places without it. In this paper, we focus on how rule of law presence, one crucial dimension of state capacity, affects the dynamics and structure of firms. Therefore, we focus on one mechanism through which state capacity affects development. This relationship is analyzed for the Peruvian case. First, we obtain a persistent and significant effect of colonial over current rule of law presence. Second, municipalities with rule of law presence have a larger number of formal firms per person, firm's size - measured by sales and workers -, and labor productivity. Furthermore, using the national economic census, we also find that firms in places with higher rule of law presence are less vertically structured. This is, firms prefer to perform more in the market than in a vertical structure. Our results are robust to several specification tests, a network approach considering own and spillover effects, and subsample estimations. Finally, we present preliminary evidence on mechanisms. Municipalities with rule of law enforcement have loosened financial frictions and better conditions to obtain a functioning license.