A sound system of commercial law is central to encouraging private sector development. Commercial law governs all aspects of business activity. It determines how businesses are created, the ways in which contractual arrangements are structured, the enforcement of contracts and how firms close down either voluntarily or through bankruptcy proceedings. It governs debt enforcement and how property rights are established and protected. In other words, the legal system encompasses virtually every area relating to the private sector and its activities. Experience in many countries has shown that inadequate commercial laws place private sector development under severe constraints.
Some policymakers and economists err in thinking that informal commercial systems are not important in promoting sustainable economic growth and competitiveness. However, as a practical matter, such informal systems can never grow much outside of existing business partners and clients because no system of contract enforcement exists. When businesses try to expand beyond such known boundaries, business dealings cannot be formally enforced and informal enforcement breaks down. Economic growth in these countries, especially small and isolated economies, therefore, requires establishing a sound legal and regulatory framework for business, which is based on a sound economic analysis of the laws and regulations. It is increasingly recognized that aligning the commercial law with the economic needs of these countries is a top priority for growth and poverty alleviation. Frequently, however, analysis of the laws relating to private sector development is limited to legal review. This misses many of the important factors that determine commercial behavior. The core of the approach described in the following section is that legal and economic analysis are inextricably related when it comes to determining the effects of laws on private sector activity.