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THE ROLE OF LAW IN ECONOMICGROWTH: A LITERATURE REVIEW

Guangdon

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1 Introduction.

2 Fundamental Causes of Economic Growth: From Geography to Institutions

3. Law Matters: Contributions of LLSV

4. Is Common Law Better? Supporting Evidence and Dissenting Opinions

5. Concluding Remarks/ 26

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I ABSTRACT

Compared with other explanatory variables, such as capital accumu-lation, technological innovations, geographical endowments, economic openness,and cultural factors, institutions, especially legal institutions have been regardedas a crucial condition for economic growth in recent years.

• The importance of legal rules is systematically revealed by a series of cross-country econometric studies conducted by La Porta et al,who claim that legal origins are central to understanding the divergence in living standards across the regions and countries of the world ,compared with civil law countries ,especially those countries with French civil law tradition ,common law countries have enjoyed superior economic outcomes .

• INTRODUCTION• This paper reviews the theory of economi

c growth, with special attention to the role of legal institutions.

• Among these factors, institutions which shape incentives and determine the allocation of resources, have been increasingly accepted as being the fundamental determinant of economic growth.

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legal institutions enforced by the state are recognized to exert a more important influence on economic performance in modern economy (Cross, 2002).

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Morality and Cooperation in Business

• a series of cross-country econometric researches conducted by four economists, La Porta, Lopez-de-Silanes, Shleifer and Vishny (hereafter LLSV).

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Morality and Cooperation in Business

The interaction between law and economic outcomes has been extensively studied.Since the 1960s, within the discipline of law and economics originating from coase’s seminal article on social cost. Coase’s contribution became the seed for flood of articles which have extended the approach of law and economics to most every area of the legal system. However, before the1990s, scholars of law

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2. Fundamental Causes of Economic Growth: From Geography to Institutions

In exploring what accounts for the rise of theWestern World, North and Thomas (1973, p. 2) challenge the traditional wisdom byasking the question: “if all that is required for economic growth is investment and innovation, why have some societies missed this desirable outcome?” North andThomas go further and say that “The factors we have listed (innovation, economiesof scale, capital accumulation, etc.) are not causes; they are growth ”(Northand Thomas, 1973, p. 2, italics in original).geography, trade, culture and institutions

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3. Law Matters: Contributions of LLSV

3.1 Common Law versus Civil Law

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The methodology of LLSV can be summarized in the following simple regressionmodel:E i = β0 + β1 LR+ β2 LO+ β3 CV+ εi

whereEi is a measure of economic performance for country i (stock or bond market capitalization to GDP, private credit to GDP, etc.), LRmeasures the attributes of specific legal rules (the strength of legal protection of outside investors’ interestsin commercial laws, for example), LOis the legal origin dummy variables, CVisa set of control variables (GDP per capita, inflation, etc.) and ε i is the errorterm. The coefficient β 1 is of most interest for LLSV, who interpret a positive and performance.

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3.2 Works of LLSV

3. an explanation

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Royal Judges versus Independent Juries

The first and most notable finding of LLSV is that common law countries protect investors (shareholders and creditors) better than civil law countries (especially the French one) do; free of expropriation by corporate insiders, investors are more willing to finance firms and hence financial markets flourish in the former countries

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Morality and Cooperation in Business

4.2 Dissenting Opinions

4.2.1 Methodological Weaknesses

4.2.2 Problems of Coding and Classifying

4.2.3 Contrary Historical Evidence

4.1 Surporting evidenceLLSV’s propositions are supported by a number of financial economists who carry on the studies on the relationship between the legal system and corporate

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Commentators such as James Harrington ,Henry Neville ,and John Locke described the foremost function of government as the protection of property .They also championed the concept of the rule of the law as a superior orgnizational priciple to royal absolutism.

In the dispute between property owners and the crown ,the common-law courts and Parliament took the side of cconomic freedom and opposed the Crown.(For example Cantberry Biship)

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Morality and Cooperation in Business

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5. Concluding Remarks

Dissenting opinions • LLSV’s conclusions have drawn criticisms on vario

us grounds, especially in view ofthe existence of abundant anomaly countries, some of which have developed rapidlyfrom civil law origin and others have stagnated notwithstanding their common law origin. For an obvious example, although French civil law is assumed to be inefficient, France in fact experienced greater economic growth than the United Kingdom over most of the period from 1820 to 1998. French civil law seems to vhave worked adequately, at least for France (Dam, 2006, pp. 38–39)

4.2.1 Methodological Weaknesses

• LLSV’s studies are criticized for their methodology of relying on ordinary least squares (OLS) regression to estimate the relationship between law and economic performance, whereas OLS can fail to yield reliable estimates of causal effects for many reasons, two of which are particularly salient.

• Another doubt cast on LLSV’s works is about omitted variable bias, which can arise if explanatory variables that should be included in regression equations are not included and correlated with included explanatory variables.

4.2.2 Problems of Coding and classifying

• From the beginning, legal commentators question whether LLSV’s indices capture the most important aspects of corporate law.

• LLSV relate their classification to the mainstream comparative law literature,such as Zweigert and K ¨otz (1998), whereas modern comparative law scholarship barely recognizes such global classifications and generalizations as that proposedby LLSV.

4.2.3 Contrary Historical Evidence

• As La Porta et al . (2008) admit, perhaps the most difficult challenge to the hypothesis that legal origins cause outcomes has been posed by historical

• arguments.

• For example, Rajan and Zingales (2003) examine the financial development in developed countries over the twentieth century, and find that the state of development of the financial sector does not change monotonicallyover time.

• Based on the finding of the ‘great reversal’, Rajan and Zingales (2003) present an interest group theory to explain the rise and fall of financial markets in developed countries. They argue that incumbents, both in the financial sector and in industry,have a vested interest in preventing financial development because a more efficientfinancial system facilitates entry and encourages competition, and thus leads tolower profits for incumbent firms and financial institutions.

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Some historical evidence about legal and financial development in their early stages is presented to challenge LLSV’s conclusions.

The key point is, common law countries such as the United Kingdom and the United States, were more hospitable than civil law countries to private self-regulatory institutions, which were enforced by private bodies (most notably, private stock exchanges) to convince minority shareholders that they would not be exploited.

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5. Concluding Remarks The proposition that institutions matter seems to receive most support from the evidence across both time and space, and thereby has become a consensus among scholars, advisors and even international agencies.Compared with other institutions, legal institutions exert a more important influence on economic performance in modern economy.

• LLSV’s theory, or the legal origins hypothesis, is regarded as ‘one of the most important and influential idea to emerge in the social sciences in the past decade’(Armour et al ., 2009).LLSV did contribute substantially to the understanding of the economic consequences of legal origins.

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The common law and civil law continue to reflect their intellectual heritage and as a consequence ,legal origin is relevant both to the ideological background and the structual design of government .

At an ideological or cultural level ,the civil-law tradition assumes a larger role for the state ,defers more to bureaucratic decisions and elevates collective over individual right .

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IV.Stuctural Consequence

• It cast the judiciary into an explicitly subordinate role .In the common law tradition ,by contrast ,judicial independence is viewed as essential to the protection of individual liberty.

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A central feature of the civil law is a sharp distinction between “private law ”(which governs relations between citizens) and the public law (the law that governs relations between the citizen and the government .)

Procedurally ,the ordinary courts in a civil-law jurisdiction typically have no authority to review government action .

Under the common law ,by contrast ,there is no sharp distinction between private and public law .The same judges who enforce private rights ,moreover ,review administrative action.

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This paper examine difference in average annual growth in real per capita GDP.

The coefficient on the common-law dummy variable is both economically and stastically significant.Controlling for the other vairiables ,the common-countries grew,on average ,0.71percente per faster than the civil-law counties .

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Morality and Cooperation in Business

IV:Law and Growth :cross-country evidence

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One might wonder whether common-law versus civil-law origin ,for part of the world ,is merely a proxy for protestant versus Catholic religions heritgage .

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Conclusion

• The common law and civil law, in this view,proceed from different views about the relative role of collective and indi-vidual action.

• Judges are invested with greater prestige and insulated more from political influence in common-lawsystems. Administrative bodies are insulated more from judicial influence in civil-law systems. These differences result in stricter protection for property and contract rights against government action in the common-law tradition

Problem :

• what can explain the ideological difference between the common law and civil law?

• How to explain the efficiency of the common law?