How much does legal uncertainty cost?

With the Paraguayan justice system currently in the eye of the storm, it is important to reflect on the economic value of legal certainty and, above all, on what we as a country may be losing by projecting an image of institutional weakness—particularly on the part of the state’s judicial bodies.

Our country has adopted the social state governed by the rule of law as its form of political organization, one of whose main characteristics is the submission of both citizens and the State to the authority of the existing legal system. Thus, political, economic, and other powers must be subject to the national legal system.

For the “Social Rule of Law” to have practical effect, the positive legal system to which the State and private individuals are subject must be clear regarding its scope and the enforceability of its consequences. This certainty regarding what is permitted, what is prohibited, the intended consequences, and the effective enforcement of those consequences constitutes what we call legal certainty.

From an economic standpoint, when conducting transactions or economic activities in general, a specific market is used that is subject to a jurisdiction with a certain level or quality of legal certainty; This factor determines the degree of predictability of the rules of the game, the costs of accessing the justice system, the time it takes to obtain results, and the consistency of the final outcomes with the applicable laws.

The factors mentioned above will directly affect what are known as “transaction costs”—that is, the costs associated with the transfer of goods and services within a market. Consequently, a low level of legal certainty leads to unpredictability, which the parties will seek to mitigate—to the extent that it is cost-effective—through the use of mechanisms that provide certain levels of protection in transactions (security interests, surety bonds, etc.), which will generate higher costs that, strictly speaking, are not inherent to the business itself.

The danger facing countries with a low level of legal certainty is that parties involved in commercial transactions may decide that using that particular market entails such high transaction costs and unforeseeable risks that they will need to seek out other, “safer” markets in which to make their investments.

In this regard, as early as 2005, Roberto Dañino, then Senior Vice President and General Counsel of the World Bank, had noted in a presentation at the First Ibero-American Business Forum: “The decision to invest in a country is typically based on multiple factors, the most important of which are the existence of a profitable business opportunity and the general perception of a country’s risk. Generally, investors manage the inherent risk of any economic activity, but they typically shy away from legal risk and pull back when they observe instability in the rules of the game or arbitrariness in their application. Investors who accept this instability do so at the expense of their business efficiency, as they must incorporate an additional risk factor into their models and projections—a factor that typically results in higher capital costs.

Another important point is that Fitch Ratings, in its December 2017 report, maintained the country’s credit rating at “BB” and upgraded the outlook from stable to positive; however, it clearly states that structural factors remain the main obstacles to a higher rating for the country. The agency maintains that these structural factors are reflected in the governance and per capita GDP indicators, which, in Paraguay’s case, are well below the average for countries with a “BB” rating.” (As of 2017, Paraguay has a per capita GDP of USD 4,134, while the regional average is USD 12,000).

Among the factors measured when determining a country’s level of governance is the strength of the rule of law, which involves assessing the existing level of legal certainty. Thus, we might assume that, along with other factors, the lack of or low quality of legal certainty is what prevents Paraguay from being classified by rating agencies as “investment grade.”.

On the other hand, in recent years, the government has been focused on the laudable task of promoting Paraguay in order to attract private investment, with one of its selling points being that it is a “low-cost country” in terms of tax and social security burdens, etc., and boasting a demographic dividend and an efficient workforce. However, I believe that this quality alone is insufficient to achieve sustained growth in attracting private capital, and that the current political landscape may present an opportunity to finally make a qualitative leap forward from an institutional standpoint and move toward becoming a safer and more predictable country from a legal perspective; otherwise, being merely a “cheap” country could end up costing us more in the long run.

With regard to estimating the cost of legal uncertainty, we could say that it varies depending on the perception of the parties involved in each economic act or transaction; however, it is now abundantly clear that this lack of institutional strength prevents Paraguayans from having the country they deserve—or, at the very least, the one they aspire to.

With this in mind, I hope that both voters and elected officials in the upcoming elections will demonstrate the maturity necessary to make it a civic priority to restore the strength, independence, and credibility that our institutions—particularly the judiciary—have lost, thereby laying the groundwork for serious and sustainable growth.