The Choice of Regulatory Regimes: a Unified Framework Peihong Yang1 Abstract: This paper tries to understand the choice rule of different regulatory regimes which include norms, legal systems and regulations. We adopted an approach different from legal origin theory and discarded the belief that one legal system was better than others or vise versa. The costs associated with different regulatory regimes are disintegrated into variable and fixed parts which are generated from the properties of these regulatory regimes. By varying these costs, the choice rule is given and the convergence of these regulatory regimes are also illustrated. 1 Unirule Institute of Economics. I am extremely grateful to Alberto Alesina, William Alford, Zhiwu Chen, Edward Glaeser, Nica Liu, Peterpan Wang, Yushi Mao, Sam Peltzman, Kangyu Ren, Jeffery Williamson especially Andrei Shleifer for their comments and help. 1 1. Introduction Why some countries adopt civil law system while others common law system? At first sight, it deserves no discussion because one may say that these regulatory regimes are determined by historical factors or by some exogenous shocks. Thus it is beyond reasoning. Exogenous shocks can of course affect the choice of legal systems. But in the long-term, this explanation is not solid because under any one specific legal system, there are enough opportunities for a country to switch into other legal systems after the impact of those exogenous shocks fade. It is reasonable that the function of law is to regulate human behaviors. But why there are some other regulatory regimes, such as norms, customs and regulations. Obviously, all of these regulatory regimes are instruments making human behavior more socially desirable. Are they substitutes or complements? In this paper, these regulatory regimes will be put into one unified framework for us to understand its selection. Regulation has been a focus for economists over many decades. The traditional view on justifying regulation was based on public interest approach [Pigou, 1938; Meade, 1948]. According to this theory, government regulations are good for curing some bad results of market mechanism. We can find that these scholars treat regulators as fair, selfless and primarily competent agents. It cannot be denied that some regulators behave like agents with morality and wisdom. In most cases, however, the regulators would like to abuse their authorities if there are no other institutional arrangements of checking and supervising its power. This approach obviously overlooked the agency problem. Regulators will also try to maximize their interests just like other rational agents. In many cases, these interests maximization behavior will make regulation activities socially undesirable. Different from this approach, economic theory of regulation, mainly advocated by some Chicago school economists, like Stigler [1971] and Peltzman [1989]. This approach highlights the rational character of regulators. It contends that regulators will be captured by some first movers. Regulators in this case will not only regulate for the public interests but also deter competition. First movers will buy the authority of regulators to deter the entrance of followers. If we consider the effect of group behavior [Olson, 1971], the economic theory of regulation will be more realistic. Apart from these two approaches, some economists [Glaeser and Shleifer, 2003; Djankov et al, 2003] think that regulation works as a precautionary measure to reduce possible damages. They contend that the incentive of defendant to bribe judges or to affect judicial process through campaigns will grow with the increase of damages. In this sense, regulation is socially desirable. But we may raise following critiques. First of all, it is not appropriate to distinguish regulation from law by ax ant and ex post classification. Regulations may appear as precautions. But we may ask why not integrate these regulations into legal system and let courts serve as regulators. Law from any point of view can also be viewed as precautions. Particularly in common law countries where one agent can do whatever law doesn’t prohibit. Secondly, in comparison to law, regulations are less authoritative. Regulations are, at best equivalent to law but are not law. When there is a dispute, law is the final reference. Thus it is hard to view regulations as a 2 substitute of law. Last but not least, regulators are more vulnerable to bribes than judges. All of these three doubts will indicate otherwise about the adoption of regulation. The contribution of this paper is trying to embed regulations in legal systems. Regulation is not a substitute or complement to law. We contend it is not right to disintegrate this spectrum of regulatory regimes. It will be organized like this. In part one, we briefly review the properties of regulatory regimes, and the characteristics of regulation and major legal systems will be discussed. We contend that written law is concise and case law is precise. In part two, a simple model will be given to illustrate this evolution. The third part will analyze the convergence of these regulatory regimes. And the fourth part is the concluding remarks. 2. Properties of Regulatory Regimes At the beginning, we will point out that there is no special advantage or superiority of one legal system over another. Common law is not necessarily better than Romano-Germanic family of law or vise versa. The approach [Glaeser and Shleifer, 2002] from the economic performance to justify the advantage of legal system is not valid. Different legal system may have different impact on some specific elements of economy, such as human rights, property rights etc. But we cannot draw the conclusion that common law is superior in economic performance. There are many crucial factors behind economic development. Legal system is never the most determinant one. Actually, it is political institutions that one country choose before choose legal systems. There are indeed some common law countries that are wealthier than civil law countries. But there are also some common law countries that are less developed than civil law countries. In the long run, it will be clearer. It is absurd to use the history of 19th century Germany and 13th century Great Britain to conclude that civil law system is better or compare with 20th century America to say common law system is better. In this regard, from a socially efficient perspective, the costs associated with any given legal system resulted from its own properties. There is no loss that if one country selects common law systems instead of civil law systems or vise versa without considering its needs. In other words, selecting different legal system only matters when it mismatches its needs. The first regulatory regime is custom. The striking characteristic of custom is selfenforcing. Customs are developed within some specific community as common knowledge to all. In a traditional society which migration is absent, the residents of this society have no incentive to violate these customs because they may face severe punishments such as being discriminated, untrusted etc. This enforcement mechanism is strong enough to keep this community moral and stable in this context. However, with the development of community, customs will lose its significance. In this situation, the interactions among residents are not strong enough to make this enforcement mechanism self-enforceable. This is also the reason that Greek philosophers emphasized the benefits of small and homogeneous communities. Plato even calculated the optimal size of a polity down to the precise number of households, namely 5,040 heads of families. 3 Aristotle argued that a polity should be no larger than a size in which everybody knows personally everybody else. In fact, he argued in The Politics “experience has shown that it is difficult, if not impossible, for a populous state to be run by good laws.” In that period of course laws were usually local customs. In a modern society, the role of customs as a justiciable regulatory regime is decreasing except that we can find some traces in some Muslin law countries. Of course, we by no means say that these customs are not important. However, in this paper, we will only treat justiciable regulatory regimes and will skip customs. We will focus on two major legal systems, civil law system and common law system. It is widely held that civil law system is the written law system and common law system is the unwritten law system. Or even one may attribute the difference between common law and civil law system to codification or not. But in America, England and other common law countries, there are many statutes, codes or even written constitutions. It is obvious that this classification is not appropriate. But it is true that in common law countries, decided cases are generally more important than statutes. It is appropriate to treat common law as case law. In civil law countries, the first reference of judges is enacted law. So in this paper, the core of common law will be defined as case law system, civil law as enacted law system. Like we stated in the above, there is no special superiority of one legal system over the other. Thus, the costs of one given legal system are equal to its social costs. For any kind of regulatory regime, it will face two costs. One is fixed costs that resulted from start-up process. To establish a regulatory regime, some institutional infrastructure would incur some costs, such as prison, police, court and the establishment of rules for adjudicating. For simplicity, in this paper, we will restrict fixed costs of one legal system to the costs of rule-establishment because both civil law and common law systems will have prisons, police and other devices. This cost is not closely connected with legal systems but correlated to the crime rate of one society2. The other cost is variable costs, which are associated with adjudication process. This cost is a monotone increasing function of the number of cases. In this paper, we will assume a linear cost function. Thus, for one society, it will try to minimize the sum of these two costs. In common law countries, if we look back at theirs history, we will find that it has some start-up costs. Before 1066 of Norman Conquest, England was governed by County or Hundred Courts which were the assemblies of free man. The rule for these courts to adjudicate cases was local customs. But between Norman Conquest and the accessions of Tudors (1485), County Courts were gradually replaced by royal courts. Royal courts of justice revised and invented “comune ley”, an English law truly common to the whole of England. We must bear in mind that these precedents are not necessarily the real cases, but are fictions and inventions. They may be in some aspects similar to decided cases under the rule of local customs. But more likely it is different from these local customs. We know that after the collapse of Roman Empire, Saxons, Jutes, Danes and Angles 2 It is possible that some countries have more prisons and police etc given the same crime rate because of different political institutions. But in this paper, this variance will be neglected. 4 divided up England. These tribes have their own customs and rules in adjudicating disputes. How can we expect a rule common to these different tribes without invention and reconstruction? These inventions will of course induce some costs; at least it will try to make it enforceable in different tribes. Fixed cost is also associated with another character of common law. In common law system, not all cases are binding. For instance in England “Only selected cases are published [as precedent]: 75 percent of the decisions of the House of Lords, 25 percent of those of the Court of Appeal and 10 percent of the High Court of Justice will be selected as precedents” [David and Brierley, 1985]. This shows that precedent is not arbitrarily established but carefully selected. In civil law countries, laws are enacted by legislative organs and laws are in written forms. We will anticipate that there are enacting costs of these written laws. This cost varies according to the difference of political structure. In a totally dictatorial country, the words of dictators are laws. It will be of very low costs to enact one law. But in a democratic country, there are many different political groups. These groups may negotiate and bargain on one specific provision or article of law. This bargaining process in some cases can prohibit the enactment of one law. We can conclude that the start up costs of law in a democratic civil law country will increase with the growing number of political groups. More political groups will make the start-up costs higher. There is another kind of country called authoritarian country that is the mixture of dictatorial country and a democratic country. It has the elements of both a democratic regime and dictatorship, such as some partial elections, controlled market economy etc. In authoritarian countries, the start-up costs of written law will be greater than those in dictatorial countries but it will be less than that in democratic countries. For regulations, its start-up costs will be smaller than written law because regulatory bodies are authorized to pass specific regulatory rules as long as they are not contradictory to laws and constitutions. In common law countries, regulations are generally conducted by commissions that are controlled by legislative branch. It is called administrative power, the fourth power distinct from the three traditional powers. In civil law countries, regulations will generally go through executive branch. But in both legal systems, regulatory bodies have jurisdictions to enact rules by themselves. In comparison to law enacted by legislative branch, regulations have smaller start-up costs because there is no need to go through formal political process. After one legal rule is established, we will face its enforcement costs. How to apply established rule to different cases? Application costs have huge difference under different regulatory regimes. For simplicity, we assume a linear form of this variable cost function that is the product of number of cases and unit cost. Of course, the unit cost will vary in different legal systems. In common law countries, although decided cases are binding, judges will also try to search suitable cases. It can be expected that no case will be completely the same to the decided cases. Judges will choose distinguishing cases and make a new rule or following different precedents that are similar to the current case from different aspects. With the growth of precedents, both judges and lawyers will have to look into more cases to find 5 the most suitable precedent. Considering the adversary system in common law countries, it will be more difficult to find a suitable precedent that are persuasive to both defendant and plaintiff. We must bear in mind that in common law countries procedure is given the primary attention. It is “not a law of universities, or a law of principles; it is a law shaped by proceduralists and practitioners”. In this context, if two cases are similar, the results should be also similar, but there may be obvious deviations if one party finds a more favorable precedent and changes this expectation through procedures. From it, we can draw the conclusion that in common law countries, the adjudication costs of cases will be higher. This adjudication costs may take the form of higher lawyer charges, longer court time, and the piecemeal like of adjudication etc. However, civil law countries adopt inquisitorial system. Judges focus on substantive aspect of justice. As a matter of fact, judges have bigger discretion in comparison to its counterparts in common law countries because the results of one case will more depend on the interpretation on law by judges, not through court adversaries. It is widely believed that common law is law made by judges. But this is not to say common law judges have more discretion in adjudicating cases. In fact, common law system endogenously has one reputation mechanism to guarantee its judges will not abuse this power. The philosophy difference in these two legal systems is also reflected in the structure of law. Because of the procedural consideration, statutes in common law countries are longer and described in more detail. But in civil law countries, because of the substantive justice consideration, the enacted law is shorter and concise. The advantage of these concise laws is its wider and easier applications. We take contract law as an example. Common law countries highlight procedures. A contract will be valid once the acceptance party signs it and gives it to the postal office. In civil law countries, three elements: offer, adequate consideration and acceptance must be satisfied. It can be duplicated to different territories by just focusing on these three elements. But for common law, if the offer party wants to cancel and the contract happens to lose during delivery, it will take lots of time to adjudicate this dispute. There are also other possibilities. Each possibility may be different and it has to be adjudicated from a proceduralist perspective. It will cost more in comparison to civil law system when facing the same category of cases. But for regulations, the duplication cost will be lower than that of case law because it is concise. In comparison to written law, regulations have higher application cost because the final resort is still law. A regulation will be invalid if it contradicts law. 3. The Choice of Regulatory Regimes Based on above analysis, we conclude that there is no special superiority of common law over civil law or vice versa. The cost of one legal system comes from start-up costs and application costs. Thus from social efficiency perspective, it will try to adopt a legal system that minimizes the sum of these two costs. We assume the start-up costs for common law, civil law and regulation are a p , al and ar respectively. a p ar al , a , a , a R p r l . The unit costs of application are c p , cl and cr . With 6 cp cr cl , c p , cr , cl R . Thus the cost function of common law will be p a p c p n , n is the number of cases. The cost function of civil law is l al cl n and r ar cr n for regulation. At the beginning, we consider a static situation that one given country is open to al a p selections of legal system. In order to minimize social costs, when n , where c p cl according to the above assumptions we know n 0 , this country will select common law system because in this situation p l . But with the growth of cases needing adjudicating, al a p the comparative advantage of common law is losing. When n , it is no longer c p cl efficient for this country to adopt common law system. On the contrary, civil law will be al a p more efficient. We take N n as the critical number of cases that determines c p cl the selection of legal systems if there is a new country having no legal system beforehand and free to select legal system. This means that common law generally has a smaller jurisdiction in comparison to civil law system. It is not difficult to understand that even in modern world, common law countries are smaller than civil law countries. In common law family, America is a big country. But we should bear in mind that America is a federal state. The amendment X to the American constitution enacted in 1791 states “ the powers not delegated to the United States by the constitution, nor prohibited by it to the States, are reserved to the States respectively or to the people”. We can find from this statement that States have the residual authority. In the case of Erie Railroad Company V. Tompkins, Justice Brandeis stated: “ [e]xcept in matters governed by the Federal Constitution or by Acts of Congress, the law to be applied to any case is the law of the state. And whether the law of the State shall be declared by its Legislature in a statute or by its highest court is not a matter of federal concern. There is no federal common law” Since then, the United States Supreme Court has frequently had occasion to re-affirm and to apply the principles formulated in Erie R.R. Co. V. Tompkins and it is now a well established principle of American law [David and Brierley, 1985]. Besides America, other big countries in common law family, such as Canada, Australia and India, are federal countries. Under the federal system, states or provinces have great jurisdiction in determining their own affairs except for sovereignty and other very limited fields. Now, we consider a dynamic situation when the number of cases exceeds the critical number N . One point should be noticed is that once one legal system is selected; it will 7 be more difficult to switch into another one because of the rigidity of legal system. For those countries of legal transplantation, we can generally find that there are many confrontations between the old and new legal system. Sometimes, this confrontation is very harsh, such as the military confrontation in colonization process. Historically, there are very few legal system changes except for revolution, colonization. It is rare for one country to switch into other legal systems in peaceful times. So in this section, we will assume that one specific legal system is given and to see what will happen if the number of cases exceeds this critical point. Firstly, we will look at one common law country. In the above, we know that if n N , the optimal choice is to adopt common law system. But in this country when n N , it will not change into civil law system when c p (n N ) al . This means that if the start-up cost of civil law system is greater than the inefficiency when the number of cases exceeds critical number, the optimal choice for this country is to maintain its legal systems because pn a p c p N c p (n N ) pN al pn al . This condition can be stated as: if n al N , a common law country should not change its legal system. ap al N N which means the number of cases ap adjudicated by common law system is greater than its optimal number. There will be some inefficiency, such as the overload of judges, the shortening of court time, and higher probability of injustice etc. But if c p (n N ) ar cr (n N ) , that means if But the distortion happens because ar N , there will be some efficiency improvement if this country adopts some c p cr regulation. In order to make this condition reasonable, we should assume that c ar al (1 r ) . Thus in one common law country, if the number of cases is smaller than cp ar N , it will be better to adopt the pure common law. If the number of cases is c p cr a ar greater than N but smaller than l N , this country should adopt common law c p cr cp a and regulation together. But when the number of cases exceeds l N , there by no cp means that this country should maintain its legal system. It should adopt civil law system.(See Figure One) n 8 Figure One: Case Law (Common Law) / / 0 N Regulation / ar N c p cr Written Law (Civil Law) / al N ap It may be dismal that from the above analysis that finally all common law countries will be replaced by civil law system. It is true that if there are no reforms, common law system will be more and more inefficient with the growth of number of cases. There are some possible ways to get out of this situation. Primarily, it should reduce the number of cases to be adjudicated by common law system. The other one is to reduce the application cost of common law. With the expansion of economic activities and human interactions, one country will be more and more heterogeneous; the number of cases will surely grow. But if there are some cases which are resolved by regulatory bodies or its people behaves better, it is still possible that the number of cases will not grow so fast even the last resort is still law. For regulations, we already know that its application costs are smaller than that of case law systems. The underlying reason behind it is that regulation will not focus too much on procedural justice. The officers will mainly look at substantive justice. And if both disputed parties don’t want to shoulder the cost when this case moves to court and the result by regulatory bodies doesn’t deviate from their expectations too much, both parties have incentive to resolve their disputes through regulations, not courts. However, the bad thing for regulation is also its deviation from procedural justice. Sometimes, substantive justice is so elusive and depends on interpretation, just like in civil law countries; regulators may seek their own interests rather than a fair and just resolution. Actually, opportunistic behavior of regulators in many countries is pervasive, particularly in civil law countries because regulations in civil law countries are generally in the form of directives and they very concise. In comparison to regulations in common law countries, regulations in civil law countries are shorter and more abstract. It leaves too much discretion to regulators. But even in common law countries, regulatory bodies are more likely to be bureaucratic and inefficient. It is also more likely that regulators are captured than judges. The good thing is that non-governmental regulations can play a bigger role. In terms of the function of regulation, it can be divided into two categories: standard-related regulation and liability-related regulation. For standard-related regulation, government should not be the only source. As a matter of fact, some associations, society and clubs can play this role. We can expect that this kind of regulation will increase. From the competition perspective, more and more firms want to set some standards because it may give them some monopoly power to deter the low-cost duplication of their products. If there are clear and enough standards, as a matter of fact, the workload of regulatory 9 bodies will reduce. For example, if there is a clear requirement that a firm on the security market should disclose its information, have a given amount of independent member in the board etc, then it will be easier for regulators to adjudicate related disputes. In terms of liability-related regulations, with the development of financial market, there will be more financial derivatives to distribute these risks. The other means is to reduce the application costs of common law. Historically, some jurists like Coke recognized the shortcomings of putting too much attention to procedural justice. It may also hurt substantive justice. So in England, it developed out equity law system to correct the defects of common law. In some cases, some minor deviation away from procedural justice will make common law more applicable. But of course, there will be some dangers of dictatorship. Now, we turn to civil law countries. From the analysis on the nature of civil law, it has comparative advantage when the number of cases is greater than N . So, in civil law system, it is not efficient to change into common law system when facing a growing number of cases. But we can find some interesting phenomena from a political perspective. We already know that if one country selects civil law system because of its large number of cases, then in this county for n N cases, it is still adjudicated by civil law system. We will now consider that if this country is a democratic country, there are many opposition parties, political groups, interests groups etc. And these political groups are very difficult to compromise. The direct implication is that the start-up costs of one enactment will be very high. Taking a ' which is the start-up of enactment in a l democratic country, which means that al' cases will be N ' al . In this situation, the critical number of al ' a p al a p which is greater than N . Comparing these two c p cl c p cl terms, we can find if one enactment will go through a bargaining political process, the critical number of cases will go from N to N ' . This means a distortion because at least N ' N cases will have to be adjudicated not by new laws but by old laws. If this country is dictatorial, it will have low start-up costs because the words of dictators are law but it will face higher application costs because this law is totally not selfenforceable. It is against the will of its people and few will respect it. This will lead to higher application costs in dictatorial regimes and will also increase the critical number a ap of cases because N '' l is greater N . Thus for dictatorial county, there will be c p cl ' N '' N cases be adjudicated partially by law because of the chaos associated with the disrespect of law which is also a distortion. It is appropriate to assume that both in democratic countries and dictatorial countries, enough and suitable regulations are desirable. It will be easy to understand this for a 10 democratic country but may be doubtful for a dictatorial country. For dictators, they also want society well regulated, not by law of public will but by the will of dictators. However, when considering political process, there will be N '' N and N ' N cases cannot be efficiently adjudicated by law in dictatorial and democratic regimes respectively. In this situation, the optimal response is to adopt some regulations to fill these gaps. Because regulation has a lower start-up costs in comparison to law, it will have comparative advantage when the compromise is very difficult to reach. But the application costs of regulation will be smaller than the application costs of law in a dictatorial regime though it is greater than that in a normal country. Thus, in civil law countries, N '' N and N ' N cases should be governed by regulations. (See Figure Two) Figure Two: A: Democratic Country Regulation / N / al ' a p c p cl B: Dictatorial Country Regulation / N / al a p c p cl ' 3. Convergence In recent years, the trend of convergence between different legal systems is speeding up. It is difficult, if not impossible, to find the pure common law or civil law system in the world today. Legal systems are presenting a mixture. One hundred years ago, Walton [1907] gave one classic definition of a mixed jurisdiction: "Mixed jurisdictions are legal systems in which the Romano-Germanic tradition has become suffused to some degree by Anglo-American law." From this definition, we will find that the direction of suffusion is the reception of common law elements in former Romano-Germanic tradition, not the opposite direction. In this section, we will briefly state the mechanism of this convergence. 11 From section two, we find that if n N , the optimal choice for one country is to adopt common law system. In a civil law country, generally the total number of cases will exceed this critical number because of large population, big territories and heterogeneity. However, we must bear in mind in a pure civil law system, there are no common law elements. That means that for cases fall in (0, N ] , it is still adjudicated by civil law system, although from the efficiency perspective, it should be adjudicated by common law. It is appropriate to assume that in a civil law country, if there are more cases to be adjudicated, the start-up costs of law will be higher because it will need more laws to satisfy the social needs. We assume al al (1 )al , 0 1 , when the number of cases n exceeds the critical number N , ln al cl n al cl N ' (1 )al cl (n N ' ) . We know in this case N ' al a p c p cl N . It means that 0, N ' should be adjudicated by precedent rule. And ln pN ' L' (n N ' ) , this condition says that it is more efficient for a civil law country to adopt a mixed legal system. At the same time, we will find that N ' N , this means that in a civil law country, the function of precedent is limited. Furthermore, it is negatively correlated to the start-up costs of civil law system. With the decrease of al , the comparative advantage of precedent will also decrease. How about common law countries? If common law countries receive civil law system, then the efficiency improvement must exceed the start-up costs. For a common law country, this start-up cost is very high because of the difference in the understanding of law, the shortage of professional judges to interpret substantive justice, the difference of legal structure etc. Thus it is inefficient for one common law country to receive civil law system. The possible solution to maintain common law tradition but cope with increasing number of cases is to enact some statutes, the elements of civil law tradition. It should be pointed out that legislature or statutes are not the fundamental difference between civil law and common law system. In common law system procedure is especially important, so statutes are detailed, precise and specific. However, in civil law countries, substantive justice relies on the interpretation of judges, so statutes are generally shorter, concise and abstract. Thus in common law countries, it is more efficient to keep its legal system but enact more statutes a because pn pN pn N pN ln N , if n l N . ap Now we will show that there will be efficiency improvement if both legal systems adopt some regulation. In a civil law country: ln lN 0 lN 1 N 0 ln N 1 pN 0 rN 1 N 0 ln N 1 Given N 0 al a p c p cl , N1 al a p c p cl , 1, 0, 0, and al ar a p That means the combination of (0, N 0 ] cases adjudicated by precedent, ( N 0 , N 1 ] cases adjudicated by regulation and the remaining cases adjudicated by its original civil law system will be 12 more efficient than any single legal system. This condition and conclusion from section two also show that if the start-up costs of civil law system are not large enough to cover the start-up costs of case law and regulation, then it will be more efficient to have only regulation and civil law, and not to introduce case law. al N this legal system should ap be replaced by civil law system. Otherwise, this legal system cannot function well. But a N ' l N is greater than N . This means that although common law system should be ap maintained in the perspective of legal system rigidity, but there are some distortions because it exceeds the optimal number of cases it can efficiently and fairly adjudicate. In a common law country, we already know that if n al . This means ap that if the regulation cost exceeds the welfare lose from keeping case law unchanged, it is better not to introduce regulation. Otherwise, some regulation will improve efficiency. We will see from this condition that if the start-up cost of civil law system is very high, and there are increasing number of cases to be adjudicated, the comparative advantage for regulation will be higher. If regulation is introduced, it must satisfy the condition that rN ' N c p The convergence of regulatory regimes can be showed by following graph: 13 Common Law IPF’ IPF A IPF1 G E Regulation Premium E’ K Case Law F O B Written Law Regulation (IPF: Institutional Performance Frontier) B’ Civil Law The old constraint without regulation is curve AB. Under this constraint, at equilibrium E, there is OF cases be adjudicated by civil law and OK cases by common law. After regulation is introduced, the new constraint is AB’, equilibrium becomes E’. KG is regulation premium that reflects the impact of regulation on common law system. From this graph, we can find that the institutional performance curve of any pure legal system is lower than a mixed one. In graph, IPF1 is always lower than IPF. And there will be some efficiency improvement if regulation is adopted, because IPF’ is higher than IPF. 4. Concluding Remarks The logic in this paper is purely theoretical. From some given period of history, the mechanism revealed in this paper may be contradicted. But from the long-term perspective, this logic captures the evolution of legal system. This explains why large countries generally adopt civil law systems, smaller countries adopt common law systems, 14 and norms and customs will govern the daily behaviors in a community. For big common law countries, they generally adopt federal system to diversify the jurisdiction and delegate authorities to local political units. We can also expect that the number of cases will grow when economic activities expand. It really proposes a challenge to common law system. But there are also some possible solutions, such as federalization, delegate more authority to local political units, adopting regulations, enacting statutes and others. For civil law countries, the challenge is to balance the possibility of dictatorship and chaos [Shleifer, 2005]. But for these two legal systems, referring more cases to non-state regulators will be always desirable because the final resort is still court thus it will not hurt justice of one society but can reduce the load of judicial sectors. Reference: Djankov, S., Glaeser, E., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A., ‘The new comparative economics’, Journal of Comparative Economics, Vol. 31, 2003b, 595–619. Glaeser, E. and Shleifer, A., ‘Legal Origins’, Quarterly Journal of Economics, V117, no.4, 1193-1230 Glaeser, E. and Shleifer, A., ‘The rise of the regulatory state’, Journal of Economic Literature, Vol. 41, no. 2, 2003, 401–25. Meade, J., Planning and the Price Mechanism: the Liberal Socialist Solution (London: George Allen and Unwin, 1948). Peltzman, S., ‘The economic theory of regulation after a decade of deregulation’ Brookings Papers on Economic Activity, Special Issue, 1989, 1–41. Olson, M. Logic of Collective Action: Public Goods and the Theory of Groups, (Cambridge, Harvard University Press, 1971) Pigou, A., The Economics of Welfare, 4th ed. (London: Macmillan, 1938). David, R. and Brierley, J. Major Legal Systems in the World Today: An Introduction to the Comparative Study of Law, (London: Stevens, 1985). Shleifer, A, Understanding Regulation, European Financial Management, Vol. 11, No. 4, 2005, 439–451 Stigler, G. J., ‘The theory of economic regulation’, Bell Journal of Economics, Vol. 2, 1971, 3–21. Walton, F., The Scope and Interpretation of the Civil Code (Montreal: Wilson & Lafleur Ltée, 1907), Reprinted by Butterworths, Toronto (1980), with an introduction by Tancelin, M. 15