What is the Relationship of
Law to Economic
Development?
Erik Jensen
Summer Fellows Program
July 26, 2012
Remember - What “Goods” Does
Rule of Law Deliver?
•
•
•
•
•
Citizen security and stability
Dispute resolution
Economic growth and development
Human rights protection
Protection from governmental
caprice and corruption
Causality?
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Three Questions
1.
Is ROL Dependent on Regime Type?
2.
How Does Law Develop?
3.
Is Law/Legal Institutions a Leading or
Lagging Indicator in Economic
Development?
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Remember My Contention:
ROL =/= Pregnancy
Rule of law is not like pregnancy, you
don’t either have it or not
Matters of degree with pockets of
performance
 Pakistan
 Singapore
 Cambodia
 China
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1. Is Regime Change
Necessary to Achieve ROL?
Five States of Legality
a. Anarchy
Breakdown of indigenous social
structures
b. Despotic Rule
Argentina 1976-79 where internal
secret military police played a
prominent role in governancea
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Rule by law
c. “Rule by Law”
• The use of law as in instrument of
domination.
• Authoritarian and oppressive
• “To my friends everything, to my
enemies the law.”
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Rechtsstaat
d. Rechtsstaat emphasizes law and order
(a) all state authority governed by law
(b) reason-based codification
administered by civil service
(c) evenly applied and adjudicable
 Trying to fit the messy phenomena
of life into a Code. (Casper)
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Democratic rule of law
e. Democratic rule of law
(a)upholds political rights; limits state
actors
(e.g., freedom of the press, free
and fair elections)
(b) upholds civil rights, and
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(c) holds all officials, high and low,
accountable
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2. How Does Law Develop?
Jerry Rosenberg, Hollow Hope: Can
Courts Bring About Social Change (1991)
-> Michael Klarman -> Pam Karlan
Law changes [or is upheld] when patterns
of demands and expectations change
Demand for law and legal institutions
increases as economies grow ( Marx,
Smith)
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Law’s Connectedness Depends On
…
Law is potentially connected to and shaped
by every aspect of society, economy and
polity.
• History, tradition and culture
• Political and economic system
• Distribution of wealth and power
• Degree of industrialization
• Mediation of ethnic, language and
religious differences
• Power dynamics among elites in society
(particularly influential)
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3. Is Law a Leading or Lagging
Indicator in Economic Development?
Underlying Assumptions
That a well-functioning judiciary is
necessary for economic growth and
development
That “substitutes” for a well
functioning judiciary entail high
transaction costs (unpredictability,
enforcement costs)
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Legal Substitutes for Formal
Processes

Relationships (clans, tribes)

Good faith/repeat dealings

Abundant information

Guilds, associations, codes
of conduct

Private security
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The Assertion
Legal Institutions and Judicial Enforcement Are
Necessary to Move From a Traditional Economy
(Economy of the Bazaar) to a Developed Economy
“Missing in the suq (bazaar economies engaged in
regional trade) are the fundamental
underpinnings of legal institutions and judicial
enforcement that would make such voluntary
organizations viable and profitable. In their
absence, there is no incentive to alter the system.”
Doug North, Institutions, Institutional Change and
Economic Performance (1991), p. 124.
Primitive Accumulation
Smith: “Previous Accumulation”
“The accumulation of stock must, in the nature of
things, be previous to the division of labour"
(Smith 1776, II.3, p. 277).
Marx: “Primitive Accumulation” – the separation of
people from their means of production
(expropriation, enslavement, etc.)
"Primitive accumulation plays approximately the
same role in political economy as original sin does
in theology" (Marx 1977, p. 873)
Marx’s “primitive accumulation” is the rule, not the
exception
Legal Institutions and Economic
Growth
The vast weight of evidence in critical earlier
stages of economic development:
(a) That a well functioning judiciary is not
needed for dynamic economic growth
(b) That law is not necessarily “better” (costeffective) than “legal substitutes” as a
device to govern economic activity
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China and India Problem
India: 2007 WB ranked India 173 out of
175 countries in contract enforcement –
only Bangladesh and Timor Leste faired
worse (2008 WB India 177 out of 178)
China: 9% growth over 25 years with
highly underdeveloped legal system,
poor corporate governance, relatively
small capital market
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Weber Redux
“Nonlegal” factors are important
Custom and convention difficult to change
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Differing Views
THE OTHER PATH, Hernando De Soto claims that:
“The legal system may be the main
explanation in the difference in
development that exists between
industrialized countries and those that are
not industrialized.”
“Development is possible only if efficient
legal institutions are available to all
citizens.”
“The law is the most useful and deliberate
instrument of change available to people.”
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Differing Views
East Asia Miracle pays no attention to legal
system
Doug North’s Institutions, Institutional
Change and Economic Performance asserts
importance
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Differing Views
Causal Arrows
• Do property rights and enforcement of
contracts cause economic growth?
• Or, does economic growth lead to the need
for greater respect for property rights and
contracts and better performance of legal
institutions?
• Where is the tipping point when demand
for law and legal institutions becomes more
pervasive?
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Property Rights and
De Soto
“What the poor lack is easy access to the
property mechanisms that could legally fix
the economic potential of their assets so
that they could be used to produce, secure,
or guarantee greater value in the expanded
market.”
Hernando de Soto, The Mystery of Capital
(2001).
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But is it that simple? The “De Soto
Effect”
If there is extreme poverty and little
competition, increasing property rights
registration can lead to greater exploitation
in the credit market because lenders can
foreclose on defaulting borrowers more
easily, without any efficiency gains.
If the state is unwilling to act to constrain
lender’s market power, then property
registration is not a win-win for borrowers
and lenders.
Tim Besley and Matreesh Ghatak, “The de Soto
Effect” (April 2009)
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Is it that simple?
Jensen et al research on slums
Jakarta – relocation of slum-dwellers
Confusion about “justice” and property rights
– who’s justice, when and how? Naga City
example
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Property Rights and Many Paths
[W]hen investors believe their property
rights are protected, the economy ends up
richer. But nothing is implied about the
actual form that property rights should
take. We cannot even necessarily deduce
that enacting a private property rights
regime would produce superior results
compared to alternative forms of property
rights….
Rodrik, One Economics, Many Recipies:
Globalization, Institutions and Economic
Growth (2007)
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Positive Law and Economic Growth
LLSV study found through elaborate cross
country regressions in forty-nine developed
and developing countries that common law
countries grew faster than civil law
countries.
BUT
“Startling result” contrary to the key
finding/bias of their study that the origins
and content of positive law explain
economic performance:
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Positive Law and Economic Growth
The poorest one-third of countries have
better substantive law than the richest
one-third by the LLSV authors’ own
definition of the crucial substantive rules!
Also, see Germany and France vs. UK
And see Tunisia, Morocco and Algeria vs.
most of sub-Saharan African common law
countries
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Working Hypothesis
EVIDENCE
Available empirical evidence: best working
hypothesis is that there are on-again-offagain connections between law, legal
institutions and economic growth and
development.
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Reasons for on-again-off-again
connections
A) Larger issue: Growing evidence that
desirable institutional arrangements have
a large element of context specificity,
arising from:
•
•
•
•
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differences in historical trajectories
geography
political economy or
other initial conditions…
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Reasons for on-again-off-again
connections
B) Legal substitutes for formal legal
processes:
- relationships (clans, tribes)
- good faith dealings (repeat dealings)
- abundant information
- guilds, vol. assoc., codes of conduct
- private security
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Reasons for on-again-off-again
connections
C) Common Business Practice
Data provide inconsistent evidence on the
importance of formal laws and legal
institutions to economic development
because the measurements fail to account
for common business practice.
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Risk and Economic Growth
FDI, for example, at least six types of risk are
possible:
(1) commercial risk (e.g., fluctuating
markets)
(2) political risk (e.g., expropriation)
(3) legal risk (e.g., unpredictable courts)
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Risk and Economic Growth
(4) regulatory risk from administrative action
(capricious rule or decision-making)
(5) security risk (crime)
(6) social risk (civil society action against or
for certain types of investment)
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“Legal Risk” and Investors
on-the-Ground
Important data point:
Fewer than half of firms in almost all
transition countries surveyed in 2002
believed that courts were able to enforce
their decisions.
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Investors on the Ground
Alternative hypotheses - investing despite a
poorly functioning legal system:
(1) Investors are not aware of the potential
damage that an inefficient or
unpredictable legal system can cause to
their investment
(2) Legal systems that deviate from the
“ideal” may nonetheless offer efficiency
and/or predictability
(3) Investors are aware of potential damage,
but view legal system as modest factor in
risk assessment
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What Comes First?
Order, Stability and Economic Growth
How much security is needed?
Level of “legal security” needed is variable.
And how you achieve security varies (e.g.,
cell phone towers in Afghanistan)
Level of sunk cost: power generating plant
vs. stitching factory
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What Comes First?
ROL Institution-Building + (the Politics of
Scarcity or Economic Growth)
(1)Karl Marx, Adam Smith: demand for law
and legal institutions as economies grow
(2) Palestine – meeting in 2004
• GDP: $1423 in 1999, $925 in 2003
• Poverty increased 20% during this four
year period to 47% (64% in Gaza)
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Successful Programs
at a National Level
Internalized Agenda
Country
Singapore
Korea
Hungary
Poland
Chile
Costa Rica
Indonesia
*GDP/PC/PPP 2011
($61,103)
($30,206)
($21,738)
($21,281)
($17,125)
($12,236)
($4,668) ???
$8,000-28,000 GDP/PC/PPP at reform tipping points in roughly
early 1990s, except Costa Rica (approx. $6,000)
*World Bank 2012 at http://data.worldbank.org/indicator/
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Conclusion
Bumper Sticker: “It’s Complicated”
On-again-off-again connections
The relationship of law to economy is
part of the “messy phenomenon” of
life where
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