JUDICIAL REFORM AND ITS EFFECT ON THE ECONOMY. THE CASE OF BULGARIA Neli Borisova Ivanova* Student ID: 141400 Supervisor: Prof. Stefan Voigt Date: 16th August 2014 Well-functioning institutions have long been discussed as crucial for economic development. This paper focuses on judicial systems as an important factor for economic growth. It contributes to the related literature with an empirical study of the judicial reform in Bulgaria. Unlike, the majority of the existing studies it not only estimates the efficiency of the judicial system in Bulgaria but also explores its effect on economic growth. The analysis uses data for 112 District Courts in Bulgaria for the period 2005-2012. The selected time-frame covers both periods before and after Bulgaria has become a Member State of the European Union. The approach adopted to obtain efficiency scores for the Bulgarian judiciary is Data Envelopment Analysis. In addition, the linear and non-linear effects of the efficiency of the judicial system on economic growth are estimated. In order to address the endogeneity problem, a Two-Stage Least Squares methodology is used. The main findings of this paper are: (1) the judicial reform in Bulgaria after entering the EU has been beneficial to the efficiency of the judicial system and (2) there is a positive correlation between the efficiency of the judicial system and GDP after Bulgaria’s accession to the EU. These conclusions have both implications for the policy of the on-going judicial reform in Bulgaria as well as macroeconomic implications. *Acknowledgement: I would like to express my heartfelt gratitude to my supervisor, Prof. Stefan Voigt for his valuable guidance and support. Special thanks to Mrs Sonia Naydenova, Representative of the Supreme Judicial Council. - 1 - Authorship Declaration I hereby declare and confirm that this thesis is entirely the result of my own work except where otherwise indicated. I acknowledge the supervision and guidance I have received from Prof. Stefan Voigt. This thesis is not used as part of any other examination and has not yet been published. Neli Ivanova 16.08.2014 - 2 - CONTENTS 1. INTRODUCTION………………………………………………………………4 2. THE BULGARIAN JUDICIAL SYSTEM AND THE REFORM………..........…6 2.1 Structure of the Judicial System……………………………………………….6 2.2 Judicial Reform before Entering the EU…………………………...………….8 2.3 The Reform after 1st January 2007……………………………….…………. 11 2.4 Pending Issues……………………………………………….……………... 14 3. RELATED LITERATURE……………………………………………………. 16 3.1 Why Judicial Reform……………………………………………………….. 16 3.2 Judicial Efficiency…………………………………………………….…….. 17 3.3 Measuring Judicial Efficiency………………………………………….……. 20 4. EMPIRICAL ANALYSIS PART I ………………………………………........... 21 4.1 Methodology: Data Envelopment Analysis………………….……………… 21 4.1.1 Specifications of The Model: CRS vs VRS……………….…………. 26 4.1.2 Specifications of The Model: Output- vs Input-Oriented…….……... 26 4.2 Data……………………………………………………………………...… 26 4.3 Application and Results…………………………………………………….. 28 5. EMPIRICAL ANALYSIS PART II…………………………………...………... 33 5.1 Methodology…………………………………………………………...…... 33 5.2 Data……………………………………………..…………………………. 34 5.3 Model Specification and Results……………………...…………………….. 35 6. FURTHER DISCUSSION………………………………….…………………. 39 7. CONCLUSION……………………………………………….……………….. 41 8. APPENDICIES………………………………………………….…………….. 43 9. BIBLIOGRAPHY………………………………………………………………78 - 3 - 1. INTRODUCTION Literature on judicial reforms is of extreme importance due to the key impact it has on economic growth (Schumpeter, 1934). This paper presents an empirical study of the efficiency of the judicial system in Bulgaria and its correlation with economic activity. It provides new evidence of this relationship using data concerning the reforms in the judiciary in Bulgaria both before and after its accession to the EU. Since the beginning of the 1990’s the link between judicial reform and economic growth has been explored in the literature (El Bialy and Garcia-Rubio, 2011). According to Posner (1998), for a country to enjoy economic prosperity it has to have a legal system that protects property and contract rights. Furthermore, a reform towards such a legal infrastructure can increase economic growth and generate resources for other reforms with bigger impact (Posner, 1998). Messick (1999) holds that a well-functioning judicial system supports economic development by checking government abuse, by protecting the rule of law and by facilitating the exchange of goods and services between private individuals. Other studies explore the correlation between the rule of law and economic growth, democratic governance and investment. Weder(1995) claims that economic development can only be achieved with a strong legal system. This paper focuses on the case of Bulgaria. This is an interesting case as Bulgaria is a post- socialist country and one of the newest members of the EU. Having gone through many changes in its economic and political development has made judicial performance crucial for the reputation of the country. Bulgaria is still in a position where a sound judicial system can help it attract investment and improve many economic indicators. And reform is a proof of work in that direction. However, questions such as how successful the reform has been and whether it has an actual impact on the economy, remain. - 4 - Even though work towards a more efficient judicial system has been done for years in Bulgaria, upon its accession to the EU on 1 January 2007, it still had various weaknesses in its judicial system that needed attention. Accordingly, the European Commission undertook a Cooperation and Verification Mechanism in order to be able to verify the progress made against six benchmarks set for this purpose. However, the results of the reform in the Bulgarian Judicial system are neither fully obvious nor easily quantified. It is considered that the judicial reform in Bulgaria has had the greatest impact on District Courts. This is due to the fact that District Courts (First Instance Courts) in Bulgaria are considered to be the most active and dynamic part of the judicial system. Apart from descriptive statistics and progress reports, to the best of our knowledge, there are no empirical works on the actual impact of the reform on the efficiency of the District courts in Bulgaria. This study focuses on court efficiency as one of many aspects of court performance. Efficiency refers to when maximum output is produced with a certain given combination of inputs or when a given output is produced with minimum input. The paper represents a within-country study of Bulgaria. This has the benefit that all features unique to a particular country do not need to be controlled for, leaving less scope for problems due to “omitted variables” bias (Voigt, 2014). It not only gives evidence of the efficiency of the Bulgarian District Courts but also reflects on the extent to which entering the EU has been a key factor for the improvement of efficiency and through that for the Bulgarian economy as a whole. Furthermore, it adds to the scarce literature in the field on post-socialist EU-member states (Murrell, 2001, Buscaglia and Dakolias, 2000, Dimitrova-Grajzl et. al., 2010). - 5 - This study answers two questions: (1) whether the efficiency of the judicial system in Bulgaria has improved after entering the EU; and (2) whether the efficiency of the judicial system has had an effect on the economic growth. As a first attempt to assess the efficiency of District Courts in Bulgaria, a significant part of the empirics rely on self-collected data not published earlier in this format. The study covers 112 District courts for a period of 8 years, covering a period before and after Bulgaria’s accession to the EU. It uses a Data Envelopment Analysis to measure court efficiency. It then compares the technical efficiency before and after Bulgaria became a member of the European Union. In the second part of the empirical analysis a TSLS is performed to establish the effect of efficiency of the judicial system in Bulgaria on GDP. The structure of this paper is as follows: Section 2 describes the Bulgarian judicial system, the judicial reform in Bulgaria and some pending issues of concern. Section 3 presents a literature review. Sections 4 and 5 focus on the empirical analysis. Section 6 provides a further discussion and Section 7 concludes the paper. 2. THE BULGARIAN JUDICIAL SYSTEM AND THE REFORM 2.1 Structure of the Judicial System The structure of the Bulgarian Judiciary includes the Supreme Court of Cassation (SCC), the Supreme Administrative Court (SAC), Courts of Appeal, Provincial Courts and District Courts (World Bank Report, 2008). (See figure 1) Independent from the judiciary body is the Constitutional Court in Bulgaria, which derives its powers directly from the constitution (Judicial Systems in Member States, 2014). The Supreme Court of Cassation is the supreme instance for criminal and civil cases and its jurisdiction covers the entire country. The Supreme Administrative Court has the supreme - 6 - jurisdiction to overview the precise and equal application of laws by administrative courts (The Constitution of Bulgaria Atr. 125(1)). The District Courts deal with all first instance cases, apart from cases with a specific category that is considered as relevant to and assigned to Provincial Courts. The Bulgarian judiciary is governed by the Supreme Judicial Council (SJC) which is chaired by the Ministry of Justice. It represents the judiciary and ensures its independence. Its main