30 Hernando de Soto, THE MYSTERY OF CAPITAL (2000).
31 Id. at 35.
32 Id. at 46 (observing that it is “formal property that provides the process, the forms, and the rules
that fix assets in a condition that allows us to realize them as active capital”).
33 Id. at 51.
34 Id. at 158.
35 Id. at 21 (observing that the time required to gain recognition of legal land rights in Haiti was
nineteen years).
7
Moreover, many other legal rules and structures appear to have a material effect on economic welfare.
B. The Incompleteness of Substitutes for Law
While the potential value of legal institutions and property rights has been broadly recognized by institutional economists, the actual need for such institutions may be exaggerated. Individuals may voluntarily organize their transactions, without legal institutions, in a manner that generally enables their capture of the returns of investment. They may mutually agree upon informal property rights and contract, when they have informal assurances of performance by other parties. Perhaps law is not truly a necessary condition for development. North himself emphasized the importance of extralegal norms in protecting property rights, though only as a complement to legal enforcement of those rights.36 Some go much further and claim that private substitutes can take the place of legal arrangements and create the climate that enables economic growth.37 They argue that “the informal mechanisms which businesses use can be just as effective in supporting economic development as some formal systems.”38 In this view, the “case for state enforcement of contracts may be overplayed.”39
While private arbitration may be a valuable alternative for state enforcement of private deals in some cases, it has not proved to be a full substitute. Russia created private arbitration commissions to take the place of judicial enforcement, but “traders were reluctant to use these [commissions] despite the very high rate of contract violations.”40 Perhaps this is because even a victory in arbitration may not be collectible. Private enforcement seems inferior to state enforcement of contracts, because private enforcement is typically more costly, creates a competition of violence, is more difficult to monitor, and often inhibits changes in economic institutions that may increase efficiency.41
36 See STRUCTURE AND CHANGE IN ECONOMIC HISTORY, supra note 000, at 18 (noting the
importance of the “articulation of a set of moral and ethical behavioral norms to reduce enforcement
costs”). He notes that “[t]o the extent that the participants believe the system fair, the costs of enforcing the
rules and property rights are enormously reduced by the simple fact that the individuals will not disobey the
rules or violate property rights even when a private cost/benefit calculus would make such action
worthwhile.” Id. at 53.
37 See, e.g, Ginsburg, supra note 000, at 830 (observing that “some have claimed that the rule of law
is dispensable in the pursuit of economic growth”); Richard A. Posner, Creating a Legal Framework for
Economic Development, 13, WORLD BANK RESEARCH OBSERVER 1, 2 (1998) (reporting that there
“are many informal substitutes for the legal enforcement and protection of property rights” including
arbitration and reputation).
38 Amanda J. Perry, International Economic Organizations and the Modern Law and Development
Movement, in MAKING DEVELOPMENT WORK 19, 28 (Ann Seidman, Robert B. Seidman & Thomas
W. Wade eds. (1999).
39 Timothy Frye, Contracting in the Shadow of the State: Private Arbitration Commissions in
Russia, in THE RULE OF LAW AND ECONOMIC REFORM IN RUSSIA 123, 123 (J.D. Sachs & K
Pistor eds. 1997).
40 Contracting in the Shadow of the State, supra note 000, at 128.
41 See Contracting in the Shadow of the State, supra note 000, at 133.
8
The classic study of extralegal private governance is Robert Ellickson’s study of the Shasta County, California cattle industry.42 He found that ranchers in the area effectively created their own informal rules for common disputes, such as cattle trespass, boundary fences, etc.43 He therefore critiqued the theory of “legal centralism,” which maintains that governments must be “the chief sources of rules and enforcement efforts.”44 Ellickson therefore suggested that formal law was not necessarily required for economic arrangements to be effective. There are other examples of functioning private contract enforcement today, such as that found in the diamond industry45 or cotton industry.46 These informal approaches may even be more efficient than formal legal structures of property and contract.47
One may even argue that extralegal governance is an economically superior approach that has been undermined by the creation of law. The introduction of legal constraints may be counterproductive, by “undermining incentives to develop private cooperative arrangements and by creating incentives for entrepreneurs to engage in rent-seeking.”48 Larry Ribstein contends that trust is essential to efficient transactions and that the introduction of laws may be counterproductive.49 By providing for the enforcement of detailed contracts, the law, he maintains, may “crowd out” the trust that enhances efficient transactions50 or even breed distrust.51
42 Robert C. Ellickson, ORDER WITHOUT LAW (1991).
43 The ranchers resolution of these matters was not conducted in the “shadow of the law” and driven
by legal rules. Ellickson found that the parties were essentially oblivious to what the formal legal standards
were. See id. at 141 (noting that ranchers were ignorant of substantive legal rights on boundary fences and
badly misperceived legal requirements on highway collisions with livestock).
44 Id. at 138.
45 See generally Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations
in the Diamond Industry, 21 J. LEGAL STUD. 115 (1992).
46 See Lisa Bernstein, Private Commercial Law in the Cotton Industry: Value Creation Through
Rules, Norms, and Institutions, 99 MICH. L. REV. (forthcoming June 2001).
47 See, e.g., Robert Cooter, Structural Adjudication and the New Law Merchant: A Model of
Decentralized Law, 14 INT’L REV. L. & ECON. 215 (1994) (discussing land tenure in Papua New Guinea
and finding that shift from relationship-based economy to formal property ownership would be disruptive
and counterproductive); Jonathan R. Macey, Public and Private Ordering and the Production of Legitimate
and Illegitimate Legal Rules, 82 CORNELL L. REV. 1123 (1997) (arguing that “private ordering generates
substantive legal principles that are superior to those that the state produces”).
48 Bruce L. Benson, Economic Freedom and the Evolution of Law, 18 CATO J. 209, 229 (1998).
See also Satu Kahkonen & Patrick Meagher, Opportunism Knocks? Legal Institutions, Contracting, and
Economic Performance in Africa, IRIS Working Paper No. 204 (June 1997), at 24 (discussing “the extent
to which non-state contract enforcement is preferable to a more rigid and predictable state system in
countries at a low level of economic development and prone to economic shocks”); Jean Jacques Dethier,
Governance and Economic Performance, ZEF Discussion Paper No. 5 (April 1999), at 31-32 (describing
view that formal legal systems may not be preferred options for enforcing contracts and rights).
49 See generally Larry E. Ribstein, Law v. Trust, 81 B.U. L. REV. 553 (2001).
50 Id. at 570.
51 See id. at 576-584 (presenting “trust-based arguments against law”).
9
Matt Ridley, an evolutionary psychologist, maintained that trade predated law and thrived under the privately created and enforced rules that voluntarily arose.52 He observes that “[m]arkets, exchanges and rules can develop before government or any other monopolist has defined their rules,” because they “define their own rules.”53 Historically, merchant guilds created rules for transactions, with multilateral enforcement.54 For Ridley, modern commercial law was “invented and enforced” by merchants and “[o]nly later did governments try to take it over, and with mostly disastrous results.”55 In this story, law is the enemy of growth. The story is echoed today in the increasing calls to privatize the commercial law.56 It is too quickly assumed, though, that the extralegal private contract governance is necessarily efficient and effective.57 More significantly, the creation of formal legal rules may only enhance the private rules and not displace their benefits.
Under our relatively advanced legal system, contracts in any society may be considered formal (public legal) or informal (private extralegal). Parties clearly are able to transact, even absent formal legal institutions, through informal contracts, sometimes called relational contracts that depend upon mutual trust and fair dealing.58 Parties might even prefer relational contracts, which can employ a more subjective standard for judging performance.59 Creation of a legal institutional structure for formal contracting does not, however, necessarily preclude conducting relational transactions.60 It simply adds an additional level of contracting choice. There are “informal sectors within the geographic jurisdiction of a legal authority [that] often establish and enforce rules and resolve disputes.”61 Indeed, Ellickson’s classic discussion of private ordering
52 See Matt Ridley, THE ORIGINS OF VIRTUE 202-203 (1996).
53 Id. at 204.
54 See generally A. Greif, P. Milgrom & B. Weingast, Coordination, Commitment and Enforcement:
The Case of the Merchant Guild, 102 J. POL. ECON. 745 (1994).
55 Id. at 202.
56 See, e.g., Gillian K. Hadfield, Privatizing Commercial Law, REGULATION, Spring 2001, at 40.
57 See Avner Greif, Informal Contract Enforcement: Lessons from Medieval Trade, 2 THE NEW
PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 294 (reporting that the private
customary law that arose was not especially efficient).
58 Relational deals are sometimes captured in formal contracts but depend not on the parties’
enforcement of all legal entitlements but on flexible adjustments to maintain the ongoing business
relationship. For discussion of relational contracts, see Richard E. Speidel, The Characteristics and
Challenges of Relational Contracts, 94 NW. U. L. REV. 823 (2000); Charles J. Goetz & Robert E. Scott,
Principles of Relational Contracts, 67 VA. L. REV. 1089 (1981).
59 See A Legal Theory of Emerging Economies, supra note 000, at 248-249 (discussing differences
between formal and relational contracts).
60 There is, for example, the “right to contract around the rule” established by courts, enabling the
parties to establish their own governance rules. See Bruce L. Benson, Evolution of Commercial Law, in 2
THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 90-91 (1998).
61 Benson, supra note 000, at 91. Indeed private contractual governance has even overridden
government regulatory schemes. See Thomas Palay, Informal Contracts and Regulatory Constraints, in 2
THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 295-299 (reporting how
private arrangements in the railroad industry altered the regulatory scheme of the Interstate Commerce
Act).
10
among ranchers occurred in a state subject to formal legal rules. The government need not and generally has not prohibited private arrangements, such as arbitration agreements, and so formal law need not directly interfere with extralegal contracting. It may, however, considerably expand the scope of contracting. Parties may use clauses such as choice of law, choice of forum and arbitration provisions “to allocate certain aspects of their relationship to governance by associational norms or business custom, and others by state law.”62 Creation of formal law does not necessarily undermine norms but simply expands the horizon of contracting choices.63 Legal structures permit a party to structure a transactional relationship that was flexible and did not rely on strict legal requirements but maintain a structural legal “backstop” should the relationship fall apart and behavior become too opportunistic.64 To the extent that perfectly informal, extralegal deals are economically optimal, they should supplant formal contracts.65
The creation of law can supplement and enhance the ability of parties to order their private investments. This can be illustrated by the Delaware law of business organizations. Delaware provides an elaborate set of legal rules for corporations, including fiduciary duties imposed on officers, directors and controlling shareholders. These rules do not necessarily apply to partnerships, however, because the partnership agreement may override the default rules. Yet many entities choose to organize as corporations, subject to the legal rules, and many partnerships do not fully opt out of the default rules. This is a market test of the value of binding legal rules.
The model of extralegal contracting is surely a bit utopian – one study in Russia testing the degree of success in commercial transactions found that the law-related variables were more important than those reflecting the parties’ possibilities for forming long-term relationships.66 At best, voluntary, extralegal cooperation may substitute for law “when individuals repeatedly interact, when they have a great deal of information about each other, and when small numbers
62 Misgovernance or Misperception?, supra note 000, at 19.
63 Formal mechanisms may even strengthen the informal basis of contracting. See Christopher
Clague, et al., Institutions and Economic Performance: Property Rights and Contract Enforcement, in
INSTITUTIONS AND ECONOMIC DEVELOPMENT, supra note 000, at 69 (contending that the private
arrangements for contract compliance may be dependent on “the political and judicial institutions of the
society”) See also Misgovernance or Misperception?, supra note 000, at 161 (reporting survey findings
that “formal and informal mechanisms are complements rather than substitutes”).
64 See Robert Scott, A Relational Theory of Default Rules for Commercial Contracts, 19 J. LEGAL
STUD. 597, 615 (1990) (noting that parties may learn “to behave under two sets of rules: a strict set of
rules for legal enforcement and a more flexible set of rules for social enforcement”); Stewart Macaulay,
Relational Contracts Floating on a Sea of Custom? Thoughts About the Ideas of Ian Macneil and Lisa
Bernstein, 94 NW. U. L. REV. 775, 792 (2000) (discussing Bernstein’s suggestion that parties might want
to structure a relational deal but still “be able to turn to the written contract and enforce its formal
provisions” when the “relationship was no longer valuable or had been damaged beyond repair”).
65 See Steven R. Salbu, The Decline of Contract as a Relationship Management Form, 47
RUTGERS L. REV. 1271, 1359 (1995) (reporting that if formal contracts are inappropriate to transactions
“some variety or varieties of nonobligational relationship management form may be expected to evolve”).
66 See Kathryn Hendley, Peter Murrell & Randi Ryterman, Law Works in Russia: The Role of Law
in Interenterprise Transactions, in ASSESSING THE VALUE OF LAW IN TRANSITION ECONOMIES,
supra note 000, at 82-85. Similarly, a study in the Kyrgyz Republic and Kazhkstan found that “[a]ll
legalistic enforcement methods were found to be more effective than the options of stopping trade and
reporting problems to other enterprises.” Young Lee & Patrick Meagher, Misgovernance or
Misperception? Law and Finance in Central Asia, in id. at 158.
11
characterize the group.”67 These circumstances are obviously limiting. Reliance on extralegal norms for contract performance requires business to forego “potentially mutually beneficial exchanges among a much larger network of trading partiers for which these conditions do not hold.”68 Efforts to expand the range of business partners involve considerable transaction costs associated with ensuring the reliability of those more distant entities and it is these “costs of transacting that are the key obstacles that prevent economies and societies from realizing well-being.”69 The informal frameworks may limit transacting to members of one’s family or ethnicity.70 The consequent “shortage of new firms and new people can mean a dearth of new ideas and entrepreneurship, and an inability to enter into long-term contracts can inhibit the adoption and development of complex technologies.”71 Limiting one’s business partners to a small number of individuals with whom one is familiar and has long transacted is not exactly a prescription for widespread competition or even specialization of functions and division of labor. Long-term contracts, where performance is not simultaneous for the parties, require an external enforcement mechanism.72 Some of the contracts most critical for economic growth depend on
67 INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC PERFORMANCE, supra
note 000, at 12.
68 See Kevin Davis, Michael J. Trebilcock & Bradley Heys, Ethnically Homogenous Commercial
Elites in Developing Countries, 32 LAW & POL’L INT’L BUS. 331, 333 (2001). See also POWER AND
PROSPERITY, supra note 000, at 180 (noting how informal markets are constrained by factors such as the
need to make “both parts of the transaction simultaneous, by making trades only within families or other
close social groups where the aggrieved individual can bring social sanctions to bear, by restricting trades
to those who have invested too much to obtain a reputation for honoring deals to profit from failing to do
so, and so on”); A Legal Theory of Emerging Economies, supra note 000, at 273 (suggesting that “the
number of contracts that can be created under traditional law is limited”); Ginsburg, supra note 000, at 834
(reporting that “[u]nder conditions of weak formal protections, business is conducted within extended
family groups, and firms are typically family owned”).
69 Douglass C. North, Institutions, Transaction Costs and Economic Growth, 25 ECON. INQUIRY
419, 420 (1987).
70 See, e.g., BUILDING INSTITUTIONS FOR MARKETS, supra note 000, at 174-175 (describing
how informal institutions may exclude parties because of linguistic or cultural barriers and how the results
of such exclusion may be a growth of inequality, social unrest, and crime).
71 Cheryl W. Gray, Reforming Legal Systems in Developing and Transitional Countries, in
MAKING DEVELOPMENT WORK, supra note 000, at 62. See also Why Don’t Poor Countries Catch
Up?, supra note 000, at 591 (reporting that “[m]ore secure property rights and credible policy regimes
increase the incentives of entrepreneurs to adopt those techniques that maximize long-run profits”). See
also See Christopher Clague, et al., Contract-Intensive Money: Contract Enforcement, Property Rights,
and Economic Performance, 4 J. ECON. GROWTH 185, 185-186 (1999) (reporting that “markets in which
economic actors making exchanges requiring significant and irreversible commitments in the present” are
“less likely to exist when institutions for the protection of property rights and contract enforcement are
absent”); Edgardo Buscaglia, Obstacles to Judicial Reform in Latin America, in JUSTICE DELAYED:
JUDICIAL REFORM IN LATIN AMERICA 15, 16 (E. Jarquin & F. Carrillo eds. 1998) (reporting that the
need to rely on extralegal reputational cues in contracting “excludes many potential transactions, such as
those involving new partners or start-up businesses”).
72 Ethnically Homogenous Commercial Elites, supra note 000, at 332-333. See also Ginsburg, supra
note 000, at 835 (noting that reliance on informal mechanisms limits transactions to close-knit groups and
“can prevent many potentially beneficial transactions with new businesses or persons with whom the firm
is unfamiliar”); Thomas W. Walde & James L. Gunderson, Legislative Reform in Transition Economies:
Western Transplants: A Short-Cut to Social Market Economy Status, in MAKING DEVELOPMENT
12
secure enforcement. For example, investing in a company is for the long run and requires assurance that the managers will not steal the investment,73 and even putting money into a bank to obtain interest requires similar assurances.74 A survey in the Kyrgyz Republic and Kazakhstan found that businesses relied heavily in informal arrangements, but that “growth-oriented financial transactions, such as borrowing for company expansions or investments in new product lines, are consistently linked with the use of formal legal arrangements.”75 Without law, business must forego profitable alternatives.76 Law is not essential for the mere existence of free markets but may be crucial for large scale national economic growth.
Complex societies thus appear to require government enforcement of economic transactions.77 The need for government enforcement is apparent from arbitration provisions in contracts. It is relatively common for contracting parties to choose not to use a legal forum for dispute resolution but agree to arbitrate their disputes privately. Superficially, this might seem to demonstrate that a governmental legal structure is unnecessary. However, it is also relatively common for a party to reject the results in arbitration, requiring a court to step in and interpret and enforce the arbitration provision. In this circumstance, the law is essential to preserve the parties’ right to choose an informal private forum for their disputes. The law also provides a benefit by providing default rules and monitoring for opportunism,78 which efficiently reduces the
WORK, supra note 000, at 71-72 (reporting that “real economic development requires long-term, complex, multiparty investment transactions, and these are not feasible, or are very ineffective and generate high transaction cost, if the complex and long-term contractual arrangements constructed are not secured by a strong legal foundation”); Asli Demirguc-Kunt & Vojislav Maksimovic, Law, Finance, and Firm Growth, 53 J. FIN. 2107, 2108 (1998) (suggesting that legal restraints are necessary for a firm that wishes to obtain long-term financing to commit credibly to controlling opportunistic behavior by corporate insiders).
73 See, e.g., Alsi Demirguk-Kunt & Vojislav Maksimovic, Law, Finance and Growth 53 J. FIN.
2107, 2134 (1998) (reporting that an “effective legal system is important because a firm that wishes to
obtain long-term financing must be able to commit credibly to controlling opportunistic behavior by
corporate insiders”).
74 See POWER AND PROSPERITY, supra note 000, at 184-186 (noting transactions that require
legal enforcement, including capital contributions to corporations and depositing money in banks).
75 Young Lee & Patrick Meagher, Misgovernance or Misperception? Law and Finance in Central
Asia (April 2, 2000), at 1. The authors also found that legal weakness explained the “extremely low level
of commercial bank borrowing” in the republics, which “broadly suggests the linkage between weak legal
institutions and slow growth, and hence the need for stronger institutions to promote growth”).
76 See Christopher Clague, et al., Institutions and Economic Performance: Property Rights and
Contract Enforcement, in INSTITUTIONS AND ECONOMIC DEVELOPMENT, supra note 000, at 69
(reporting that in “societies without well-functioning contract enforcement institutions,” individuals and
companies may have to produce their own food rather than relying on market exchange, manufacture their
own products and maintain large stocks of inventories of replacement parts).
77 INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC PERFORMANCE, supra
note 000, at 35 (noting that we “cannot have the productivity of a modern high income society with
political anarchy”).
78
See also Paul H. Rubin, Legal Reform in Eastern Europe, in 2 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 554 (1998) (reporting that “[e]fficient contract law would limit the possibility for private opportunism”).
13
ex ante precautions that have to be taken by contracting parties.79 Moreover, extralegal arrangements may ironically lack the sort of adaptability and flexibility required by markets, that law may offer.80
Historically, the “removal of restrictions widening the gap between private and social returns frequently required positive action by government.”81 Government action can also provide other benefits for private transactions. By establishing the “basic rules of exchange,” the law may substantially reduce “negotiation and enforcement costs.”82 The law, rather than being antagonistic to informal norms and controls, may “invigorate” them.83 The experience of East Asia did not in fact demonstrate the private ordering could substitute for law.84 Moreover, the presence of informal networks of transacting parties may well have a “negative external effect on nonmembers” of the network.85 Contract law is still “an essential institution for an efficient market.”86
While Ribstein, Ridley and others have presented arguments for how private arrangements may substitute for and be preferable to legal enforcement, they are just arguments and not proved. Weighing these arguments against the counter-arguments requires empirical evaluation. In addition to the evidence in Russia and Asia and North’s broader historical evidence, there is rigorous cross-country evidence demonstrating that strong legal institutions to enforce property and contract rights are correlated with economic growth.87 This evidence should be sufficient to demonstrate that private arrangements cannot successfully substitute for legal institutions. Moreover, such arrangements may impose external costs on society.
79 See Alan Schwartz, Incomplete Contracts, in 2 THE NEW PALGRAVE DICTIONARY OF
ECONOMICS AND THE LAW, 279 (1998) (discussing the theoretical transaction cost efficiency benefits
of the creation of such default rules); Ugo Mattei, Efficiency and Equal Protection in the New European
Contract Law: Mandatory, Default and Enforcement Rules, 39 VA. J. INT’L L. 537, 538 (1999) (reporting
that default rules can “enhance efficiency by reducing transaction costs produced by time and energy-
consuming negotiations”).
80 See Richard A. Epstein, PRINCIPLES FOR A FREE SOCIETY 35 (1998) (reporting that custom
finds it “difficult to adapt sensibly to rapid discontinuities in traditional business or legal environments”).
81 STRUCTURE AND CHANGE IN ECONOMIC HISTORY, supra note 000, at 167.
82 STRUCTURE AND CHANGE IN ECONOMIC HISTORY, supra note 000, at 37.
83 ORDER WITHOUT LAW, supra note 000, at 284.
84 See Ginsburg, supra note 000, at 841 (reporting that the “ADB study effectively undercuts that
thesis by noting that the substitutes are themselves dependent on legal norms”).
85 Raja Kali, Business Networks in Transition Economies: Norms, Contracts, and Legal Institutions,
in ASSESSING THE VALUE OF LAW IN TRANSITION ECONOMIES, supra note 000, at 212. See
also id. at 218 (reporting a number of theoretical papers that suggest that “the partial equilibrium result – of
informal contract enforcement institutions enhancing economic efficiency – is not robust to a general
equilibrium extension, one that takes into account the effect of network structures on the economy as a
whole”).
86 Mattei, supra note 000, at 538. See also Chang Ju Choi et al., A Note on Countertrade,
Contractual Uncertainty and Transaction Governance in Emerging Economies, 30 J. INT’L. BUS. STUD.
189 (1999) (reporting that the “gains from trade require legal and governmental institutions that guarantee
individual rights to impartial enforcement of contract and property”).
87 See infra at ___.
14
Ellickson emphasized the importance of extralegal agreement and dispute resolution for “close-knit” groups,88 but a modern economy requires transactions that go beyond such groups. Reliance on family alliances alone may be “dysfunctional” and will create a “bias against new firms”89 established by other families. There is also a risk that the extralegal norms created by the close-knit groups may not be in the more general interest. As Ellickson observed, a “norm of ‘honor among thieves’ may well be welfare maximizing for thieves, but welfare diminishing for society at large.”90 He likewise cautioned that the “communitarian’s dream of numerous small autonomous communities might end up as a nightmare of constant strife between neighboring groups.”91 Even within groups, reliance on extralegal controls is more likely to result in violent self-help measures.92
In addition to the incompleteness of substitutes for the law, there is also a darker side to the absence of law and property rights. Trust alone has proved inadequate to support private markets. Free markets will arise, to some degree, under any set of conditions. Transactions will occur between friends and when simultaneous performance ensures compliance. Members of such communities will inevitably seek the greater efficiency and profit of expanding the range of available transactions, however. Those circumstances do not ensure perfect contract compliance, however. In the absence of government enforcement, these parties will seek out private enforcement mechanisms for breached contracts. These private enforcement mechanisms are likely to take the form of organized crime syndicates.
When law is unavailable for the enforcement of private transactions, parties will seek out “alternative enforcers of property rights.”93 These alternatives frequently employ “the threat and sometimes the actuality of violence.”94 When state action is unavailable, “the enforcers might be thugs, mafia, or even the police.”95 In Russia, the underground economy “ultimately led to the creation of the mafia as an alternative to government.96 As a result, the “contract killing of private businessmen has sadly become commonplace.”97 The use of criminals to enforce economic arrangements is not only violent, it is an unproductive and inefficient approach to
88 The “more close-knit a group, the more successful it will be at generating and enforcing utilitarian
norms to govern internal disputes.” ORDER WITHOUT LAW, supra note 000, at 250.
89 Creating a Legal Framework for Economic Development, supra note 000, at 3.
90 ORDER WITHOUT LAW, supra note 000, at 249.
91 Id. at 250.
92 Id. at 253.
93 Curtis J. Milhaupt & Mark D. West, The Dark Side of Private Ordering: An Institutional and
Empirical Analysis of Organized Crime, 67 U. CHI. L. REV. 41, 44 (2000).
94 Creating a Legal Framework for Economic Development, supra note 000, at 3. See also Ellen D.
Katz, Private Order and Public Institutions, 98 MICH. L. REV. 2481, 2481 (2000) (discussion the
“reliance of some private-order institutions on practices of exclusion, collusion, and physical violence”).
95 Opportunism Knocks?, supra note 000, at 11.
96 Civilizing the Russian Underground Economy, supra note 000, at 74.
97 Contracting in the Shadow of the State, supra note 000, at 133.
15
economy.98 Competition is stifled, and a “market economy dominated by illegal market activity is inefficient at best, and likely to foster inequality and exploitation.”99 In Bulgaria a study found that informal enforcement deployed “informal ‘mutual hostage’ situations and mafia-influenced enforcement.”100 In Latin America, shortcomings in the judicial system have led to “private justice” enforced by “justicieros or gunmen.”101
Even in a more economically developed nation like Japan, these “alternative enforcers” of “private ordering: also include mobsters known as yakuza.102 History demonstrates that “when the law has no way of enforcing contract, the underworld provides it.”103 Reliance on organized crime “closely track[s] inefficiencies in formal legal structures, including both inefficient substantive laws and a state-induced shortage of legal professionals and other rights-enforcement agents.”104 A careful empirical analysis found that the presence of organized crime could be attributed to the weakness of legal institutions.105 Japanese victims of traffic accidents have retained organized crime syndicates in order to recover “damages” from other parties.106 Japanese companies make extortion payments to sokaiya, to ensure that shareholder meetings go smoothly, because of weaknesses in the nation’s law of corporate governance.107 There is a “clear statistical correlation between yakuza activity and gaps in the legal infrastructure.”108 As noted above, this
98 See, e.g., Legal Reform in Eastern Europe, supra note 000, at 556-557. Rubin notes that
organized crime may also be invoked to intimidate creditors and prevent the enforcement of agreements.
The need to resist organized crime has forced Russian banks to protect themselves, so that “one-third of
bank employees are security guards.” Id. at 556. Moreover, the short time horizon of Mafiosi makes them
unreliable agents – they may simply recover due payments on a contract and just keep the money for
themselves. Such criminalization may be “destroying the Russian economy.” Id. at 557.
99 Civilizing the Russian Underground Economy, supra note 000, at 77. Mafia-like enforcers may
intimidate competitors from entering markets, create the functional equivalent of fixed prices, and
discourage outside investors. Id. at 76.
100 See Opportunism Knocks?, supra note 000, at 19.
101 Luis Pasara, Judicial Reform and Civil Society, in JUSTICE DELAYED, supra note 000, at 83,
85.
102 See Gilliam Tett, Gangsters who hold Japan’s future to ransom, FIN. TIMES, Oct 15, 2001, at 21
(reporting that because the “Japanese state has not been very effective at creating clear-cut rules for
business,” the country has relied on the yakuza to fill the vacuum). She observed that Japan has four times
as many yakuza as licensed attorneys. Id.
103 Thomas Schelllng, CHOICE AND CONSEQUENCE 168 (1984).
104 The Dark Side of Private Ordering, supra note 000, at 41.
105 Id. at 84.
106 See Frank B. Cross, The First Thing We Do, Let’s Kill All the Economists: An Empirical
Evaluation of the Effect of Lawyers on the United States Economy and Political System, 70 TEX. L. REV.
645, 680 (1992).
107 See Mark D. West, Information, Institutions, and Extortion in Japan and the United States:
Making Sense of Sokaiya Racketeers, 93 NW. U. L. REV. 767 (1999). Blackmail payments to the sokaiya
play some of the economic role of shareholder civil actions in the United States. See id. at 791-792.
108
Tett, supra note ___.
16
reliance on organized crime is not unique to Japan but has occurred in many other nations when legal institutions have broken down.109 Other countries have their own version of corporate sokaiya, when institutions protecting minority shareholder rights are absent.110 In addition to the economic limitations of purely private transactional arrangements, they may produce private enforcement arrangements that are unnecessarily violent.
C. The Exaggeration of Culture’s Importance
A second challenge to the importance of legal institutions emphasizes the role of local cultures. Some have questioned the value of attempting to export so-called “Western” notions of law and property rights to the nations of other parts of the world. They emphasize the cultural differences between nations and argue that a national’s fundamental cultural attributes, rather than its laws, is the key determinant of its society and economy. Much of the legal research on development has focused on this cultural aspect to growth. Some argued that the legal institutions that enabled the development of the West could not be transferred effectively to emerging nations in other parts of the world.111 The recent success of East Asian nations has been ascribed, not to legal institutions, but to features associated with a Confucian culture.112 Thus, the universalist vision of wise legal institutions could be criticized as either ineffectual or hegemonic.
Law and development research first thrived in the 1960s and 1970s with the work of authors such as David Trubek and Marc Galanter.113 At this time, scholars discussed the “legal liberalism” associated with the new institutional economics but questioned its application to developing nations. Although at first the researchers seemed to embrace the growth of liberal legalism, they increasing questioned whether law was anything more than a beard for authoritarian interests and whether the legal liberalism model could be effectively extended to other cultures.114 The general view of this strain of research was that the “law is not of primary importance” and that the fate of each particular country “rests upon its unique historical, cultural, economic, political and material (population, natural resources, technology base, and so forth) mix.”115 Attempting to extend Western institutions to developing nations was at best futile and at worst imperialist.116 These sociologists, sometimes called “legal peripheralists” dismissed “the
109 See The Dark Side of Private Ordering, supra note 000, at 45.
110 See Information, Institutions and Extortion in Japan and the United States, supra note 000, at 796-
797 (describing practice in Italy and South Korea).
111 See, e.g., Ginsburg, supra note 000, at 834 (reporting that “some have asserted that theories based
on the experience of Western countries may be inapplicable to societies with very different cultural
traditions”).
112 See, e.g., G.L. Hicks & S.G. Redding, The Story of the East Asian “Economic Miracle,” 2 EURO-
ASIA BUS. REV. 18.
113 See Richard Bilder & Brian Z. Tamanaha, Book Review and Note, AM. J. INT’L L. 470, 472-473
(1995); Amy L. Chua, Markets, Democracy, and Ethnicity, 108 YALE L.J. 1, 12-13 (1998) (reviewing this
history).
114 See David Trubek & Marc Galanter, Scholars in Self-Estrangement: Some Reflections on the
Crisis in Law and Development Studies in the United States, 1975 WIS. L. REV. 1062.
115 Bilder & Tramanaha, supra note 000, at 484.
116 See, e.g., James A. Gardner, LEGAL IMPERIALISM: AMERICAN LAWYERS AND
FOREIGN AID IN LATIN AMERICA 6 (1980) (associating “American legal models” with “authoritarian
17
legal system as ineffectual.”117 The research didn’t proceed to offer much of a positive vision, though, and the field soon died.118
More recently, legal academics such as Amy Chua have tried to explore the intersection of culture and development with somewhat more nuance. While not declaring hopeless the use of legal institutions to prod economic development, Professor Chua argued that “free market democracy” succeeded in the West because of particular societal features that are “largely absent from the developing world, and there is no reason to assume that they will be spontaneously generated by market and democratic reforms.”119 She suggests that attempts to deploy markets and democracies in underdeveloped countries will produce an anti-market backlash, a retreat from democracy, or even genocidal attacks on ethnic minorities.120 The success of democratic capitalism in the West, thus, could not be replicated in foreign cultures. Others criticize “shock therapy” privatization and in the process suggests that legal reform efforts that impress Western legal concepts on other countries will fail.121
Evaluating the cultural argument also requires factual investigation. Capitalist marketplace transactions are ubiquitous and irrepressible and spontaneously arise, even in what might be called noncapitalist countries.122 Absent the appropriate legal institutions, such transactions may be referred to as part of an “informal economy.” These informal markets do not depend upon the existence of a particular culture or even upon market participants sharing a culture.123 Such markets are “commonplace even in the poorest countries,” though “long-term,
abuse”); Lan Cao, Law and Economic Development: A New Beginning?, 32 TEX. INT’L L.J. 545, 550 (1997) (noting that the movement was criticized for “ethnocentrism, myopia and naivete”); Jane Kaufman Winn, How to Make Poor Countries Rich and How to Enrich Our Poor, 77 IOWA L. REV. 899, 922 (1992) (suggesting that past law and development efforts failed because the U.S. institutions were resisted by local cultures).
117 ORDER WITHOUT LAW, supra note 000, at 147.
118 See Markets, Democracy, and Ethnocentricity, supra note 000 at 13 (describing the death of the
movement); Law and Economic Development: A New Beginning?, supra note 000, at 545 (noting that law
and development was “declared dead by its proponents in the late 1970s”); Tom Ginsburg, Does Law
Matter for Economic Development? Evidence from East Asia, 34 LAW & SOC’Y REV. 829, 829 (2000)
(observing that the “Law and Development Movement ultimately fizzled”).
119 Amy L. Chua, The Paradox of Free Market Democracy: Rethinking Development Policy, 41
HARV. INTL. L.J. 287, 290 (2000).
120 Id. at 345-347.
121 See, e.g., Spencer Weber Waller & Lan Cao, Law Reform in Vietnam: The Uneven Legacy of Doi
Moi, 29 N.Y.U. J. INT’L L. & POL. 555, 558-559 (1997) (reporting that an “additional riska ssociated with
the law reform business is that Western-style business law may be inappropriate for the receiving
country”).
122 See, e.g, POWER AND PROSPERITY, supra note 000, at 173 (noting the ubiquity of markets in
poor nations); 174 (noting how such markets spontaneously arise); and 180 (noting that markets arise even
when “trade is illegal”); Contract-Intensive Money, supra note 000, at 185 (observing that markets are
“commonplace in all types of societies, including the poorest, and they exist even in remarkably
unfavorable conditions”).
123 See POWER AND PROSPERITY, supra note 000, at 174 (observing that “some types of markets
regularly emerge whether or not the participants have anything in common, and sometimes even when
participants have antipathy toward one another”).
18
simultaneous contacting is much less common.”124 It is difficult to say that capitalist transactions intrinsically contradict particular cultural fundamentals.
These informal transactions that arise outside the law are sometimes referred to as the “underground economy” or the “informal economy.”125 In some nations, this economy is huge. It “accounts for 50 percent of the GDP in Russia and Ukraine and a whopping 62 percent in Georgia.”126 According to the International Labor Organization, “85 percent of all new jobs in Latin America and the Caribbean have been created in the extralegal sector.”127 It is difficult to claim that there are many world cultures that reject marketplace transactions. Indeed, the notions of property rights underlying Western culture may not be local but reflect a concept that is “deeply ingrained in the human evolutionary past.”128 At least rudimentary concepts of property rights, contract enforcement, and capitalism are found even in the absence of the associated legal structures.
The presence of an enormous underground economy in a country does not demonstrate that legal structures are unnecessary, however. There is considerable waste associated with operating a business extralegally, as Hernando de Soto observed:
We found that operating outside the world of legal work and business was surprisingly expensive. In Peru, for example, the cost of operating a business extralegally includes paying 10 to 15 percent of its annual income in bribes and commissions to authorities. Add to such payoffs the costs of avoiding penalties, making transfers outside legal channels, and operating from dispersed locations and without credit, and the life of the extralegal entrepreneur turns out to be far more costly and full of daily hassles than that of the legal businessman.
Perhaps the most significant cost was caused by the absence of institutions that create incentives for people to seize economic and social opportunities to specialize within the marketplace. . . . Being unable to raise money for investment, they could not achieve economies of scale or protect their innovations through royalties and patents.129
It may be “bad law” that “discourages the entry of the informal economy into the official economy.”130 It would seem difficult to suggest that a nation’s culture somehow dictates that transactions must be conducted illegally and underground.131
124 What Makes Poor Countries Poor?, supra note 000, at 42.
125 See, e.g., Daniel McGrory, Civilizing the Russian Underground Economy: Requirements and
Prospects for Establishing a Civil Economy in Russia, 5 TRANSNAT. LAW & CONTEMP. PROBS. 65,
66-70 (discussing concepts of underground and informal economies in context of Russia).
126 THE MYSTERY OF CAPITAL, supra note 000, at 69.
127 Id.
128 O. Lee Reed, Law, the Rule of Law, and Property: A Foundation for the Private Market and
Business Study, 38 AM. BUS. L. J. 441, 454 (2001).
129 THE MYSTERY OF CAPITAL, supra note 000, at 83.
130 Civilizing the Russian Underground Economy, supra note 000, at 69.
131 Actually, some have sought to argue that what we call corruption is a cultural artifact, explained
by gift-giving cultural conventions. See Nii Lante Wallace-Bruce, Corruption and Competitiveness in
Global Business – The Dawn of a New Era, 24 MELB. U. L. REV. 349, 351 (2000) (reporting the “view in
19
It remains common to attribute great importance to culture as a determinant of economic growth and a barrier to the development and operation of legal institutions to facilitate development. Studies of immigrants by Thomas Sowell and others have urged that the relative success of ethnic groups can be deterministically explained by “culture.”132 Some ascribe the economic failings of various population groups to a lack of competitiveness, lack of trust, or taste for conspicuous consumption.133 Assessing the validity of these claims, though, is frustrated by the fact that their notion of “culture” is “suspiciously flexible, maddeningly ambiguous, and ultimately elusive.”134
More seriously, the deterministic view treats culture as if it were an immutable and exogenous genetic fact of certain populations.135 In reality, “culture” is a more complicated phenomenon and what passes for culture is seldom truly innate to a region’s people.136 Culture may instead represent a response to external conditions and change as those conditions change.137 The very nature and institutions of the law may themselves influence or even redirect culture.138
certain quarters that corruption has its roots deeply embedded in cultures”). However, this view has been “dismissed as a myth,” as every major religion or school of thought condemns the practice. Id. at 352. See also Padideh Ala’I, The Legacy of Geographical Morality and Colohialism: A Historical Assessment of the Current Crusade Against Corruption, 33 VAND J. TRANSNAT’L L. 877, 904-905 (2000) (discrediting claims that gift-giving or other cultural attributes validate corruption). In addition, it appears that corruption is explained by traditional economic factors See J.S. Nye, Corruption and Political Development: A Cost-Benefit Analysis, 61 AM. POL. SCI. REV. 417 (1967) (explaining how corruption was a response to economic circumstances and could be beneficial); Steven R. Salbu, Information Technology in the War Against International Bribery and Corruption: The Next Frontier of Institutional Reform, 38 HARV. J. LEGIS. 67, 86 (2001) (reporting that in “many places and in many instances, corruption represents a successful adaptation to the world in which people find themselves”).
132 See, e.g., Thomas Sowell, MIGRATIONS AND CULTURES: A WORLD VIEW (1996);
Lawrence E. Harrison, WHO PROSPERS? HOW CULTURAL VALUES SHAPE ECONOMIC AND
POLITICAL SUCCESS (1992).
133 See Kevin Davis, et al., Ethnically Homogenous Commercial Elites in Developing Countries, 32
LAW & POL’Y INT’L BUS. 331, 340 (2001) noting reports that native Fijians “are accustomed to a
subsistence lifestyle” and that Sub-Saharan Africans suffer from an absence of trust and “predilection for
engaging in conspicuous consumption rather than reinvesting profits in their businesses”).
134 Peter H. Schuck, Perpetual Motion, 95 MICH. L. REV. 1738, 1744 (1997).
135 See ORDER WITHOUT LAW, supra note 000, at 154 (reporting tendency among sociologists to
treat social norms as if they were “exogenous givens”).
136 See, e.g., Amartya Sen, DEVELOPMENT AS FREEDOM 243 (1999) (addressing how the
“image of regional self-sufficiency in cultural matters is deeply misleading” and how many “national
traditions” in fact bear the imprint of past outside influences).
137 Sowell, for example, suggests that a group’s culture may be a rational response to their geographic
circumstances. See Schuck, supra note 000, at 1747.
138 Certain ethnic immigrant minorities may succeed in countries with poor legal institutions, because
of their ethnically-based trading networks, that require little legal enforcement and thus causes them to
“incur lower contracting costs” than do other groups. Ethnically Homogenous Commercial Elites, supra
note 000, at 347. If this is the case, improving legal institutions would simply extend those benefits to
other groups and have a positive economic effect.
20
Many cultural features suggest the presence of underlying self-interest, and a historic review of cultural features suggests that they are “quite often shaped by politics.”139 The law “influences conventional understandings of value.”140 Fuller suggests that it was the law that made murder culturally taboo, rather than vice versa.141 The same is true of other behaviors, such as tax compliance.142 The American South clearly had a cultural norm of racism and segregation that for a time was reinforced by the law but later largely overcome due in significant part to legal change.143
A society’s culture may be an endogenous product of societal institutions, or even a state of poverty itself, rather than an exogenous constraint that controls the effect of institutions.144 Fareed Zakaria observed:
Cultural explanations persist because intellectuals like them. They make
valuable the detailed knowledge of countries’ histories, which intellectuals have
in great supply. They add an air of mystery and complexity to the study of
societies. . . . But culture itself can be shaped and changed. Behind so many
cultural attitudes, tastes, and preferences lie the political and economic forces
that shaped them.145
Much of what passes for culture “is not the inevitable result of people’s ethnic or idiosyncratic
traits but of their rational evaluation of the relative costs and benefits of entering the legal
property system.”146 As the rules of that system change, so will rational behavior. An
anthropological investigation of sixty pre-industrial societies found that their cultures of
production and distribution could largely be explained by standard economic variables.147
Another study of marriage and family systems found that “the economic determinants of these
social customs are statistically significant.”148
Economists may regard culture as a factor that determines an individual’s “tastes” or “preferences.” While such tastes are often treated as exogenous to a system, they may in fact be altered by different legal regimes. Robert Cooter has explained several ways in which this may
139 The Quality of Government, supra note 000, at 230.
140 Margaret J. Radin, Compensation and Commensurability, 43 DUKE L.J. 56, 83 (1993).
141 See Lon L. Fuller, THE PRINCIPLES OF SOCIAL ORDER 231-232 (1981).
142 See Russell Hardin, Law and Social Norms in the Large, 86 VA. L. REV. 1821, 1834 (2000).
143 See Ariela Gross, Beyond Black and White: Cultural Approaches to Race and Slavery, 101
COLUM. L. REV. 640, 688-689 (2001) (discussing the intersection of law and culture in the context of
race relations in the South).
144 See, e.g., Daniel S. Landes, Why Are We So Rich and They So Poor?, 80 AM ECON. REV.
PAPERS AND PROCEEDINGS 1 (1990) (observing that “values” are a problem for developers, because
they “tend to be reinforced by economic failure”).
145 Quoted in THE MYSTERY OF CAPITAL, supra note 000, at 225.
146 Id. at 226.
147 See UNINTENDED CONSEQUENCES, supra note 000, at 14 (discussing research in Fredric L.
Pryor, THE ORIGINS OF THE ECONOMY: A COMPARATIVE STUDY OF DISTRIBUTION IN
PRIMITIVE AND PEASANT ECONOMIES (1977)).
148 See UNINTENDED CONSEQUENCES, supra note 000, at 14
21
occur, albeit in a slightly different context..149 He describes how the law can influence a party’s tastes for civic participation and other values, for example, through expressions of intent by a “credible state.”150 It is of course faithful legal practice that lends credibility, so that legal rules and procedures may be central to the modification of cultural practices. Cooter notes that for “bad men” the import of the law may only be its deterrent effect but that society also contains “good people” who ethically adhere to the law.151 Although he suggests that the law may be especially effective when aligning itself with preexisting cultural attributes,152 when those attributes are perverse he also observes that such values “are sufficiently malleable for law and policy to influence them in ways affecting the working of the state.”153 “Culture” is not necessarily exogenous and immutable. Neither is it necessary worthy of respect, as local cultures have historically engaged in various despicable practices.
Economic difficulties in the nations of Africa may be attributed to cultural factors. In the African continent, land ownership has historically been considered “communal” rather than the individualistic approach associated with property rights.154 Yet despite this culture and the lack of legal institutions that guarantee individualistic property rights, parties have acted so as to create individual ownership of land.155 Moreover, the legal institutions in Africa have steadily but slowly evolved in the direction of individualism.156 Africa’s economic difficulties may be centrally attributed to weaknesses in their legal institutions.157
While some may ascribe East Asia’s economic success to its culture (called “East Asian exceptionalism”), the historic record in Asia is also contrary to such explanations. As Professor Chua notes, Confucianism was “touted as wealth promoting . . . until the recent Asian financial crisis.”158 It was actually “deviations from Japan’s Confucian past [that] in large part explain its extraordinary economic success.”159 Culture was not the basis of the East Asian “miracle economies” – they shared the same culture in the decades before their economic successes, and
149 Robert Cooter, Do Good Laws Make Good Citizens? An Economic Analysis of Internalizing
Legal Values, U.C. Berkeley Law and Economics Working Paper 2000-8.
Id. at 11.
Id. at 18.
Id. at 20.
Id. at 23.
Besley, supra note 000, at 904.
Id. at 906 (reporting that Africans have planted additional trees on their land in an effort to lay
150
151 152 153 154 155
individual claim to the land itself).
156 Id. at 904 (observing that the communal land tenure systems in Ghana “have gradually been
supplanted by individualistic property rights”).
157 See Adebayo Adedeji, An Alternative for Africa, in ECONOMIC REFORM AND DEMOCRACY
(Larry Diamond & Marc F. Plattner, eds. 1995) at 129 (urging that a “legal system that fully and fairly
enforces such standards is obviously essential”).
158 The Paradox of Free Market Democracy, supra note 000, at 342,
159 UNINTENDED CONSEQUENCES, supra note 000, at 139.
22
their relative levels economic success varied considerably.160 In Korea, the rate of economic growth clearly varied with government policies.161 An in-depth study of the recent record of six East Asian economies over thirty-five years set out to test whether law was important or irrelevant and whether different cultures should rely upon different legal structures.162 The authors found that the nations had undergone legal change, primarily associated with the importation of Western legal concepts.163 They further found that this change had apparently contributed to rapid economic growth among these countries.164 In Asia, as in the West, legal institutions are key to economic growth.
One of the common cultural characteristics that supposedly interferes with legal institutions and capitalist markets is ethnic division, and research has found an effect of such divisions on economic growth.165 It would be unsurprising that such ethnic division would have some adverse effect on a country, if only because it surely complicates governance to have populations deeply divided by background and language. This division may be captured by a variable called ethno-linguistic fractionalization, which “estimates the probability that two persons, randomly selected among a country’s population, will belong to two different ethnic groups.”166 A recent study of African nations found that, once institutional variables were accounted for, ethno-linguistic fractionalization had no statistically significant effect on growth.167 Indeed, the only equation in which ethno-linguistic fractionalization was significant found that it had a positive effect on growth.168 The study’s rule of law variable, by contrast, had a significant impact on growth.169 While there may be an apparent negative association between ethno-linguistic fractionalization and economic growth, it has disappeared when control variables are introduced.170
160 See Minxin Pei, The Puzzle of East Asian Exceptionalism, in ECONOMIC REFORM AND
DEMOCRACY, supra note 000, at 116 (noting that the “pace, depth, and viability of economic reform
vary enormously across the region”).
161 See UNINTENDED CONSEQUENCES, supra note 000, at 138 (observing that “social rates of
return improved in the early part of the period, when Korean policy moved toward openness, and fell (from
31% to 19%) in the second half (1974-1979) when dirigiste policies were adopted”).
162
See Pistor & Wellons, supra note 000, at 21 (discussing these hypotheses).
163 See id. at 278 Figure 8.1 (showing that the legal systems generally had moved from traditional
state-based discretionary structures to Western-style rule-basked market systems during the time period).
Though some differences remain, “Asia’s growth experience largely resembles the different paths of
economic and institutional change taken historically in the West.” Id. at 286.
164 See id. at 1 (reporting that “[l]aw played an important role in “Asia’s remarkable economic growth
during the second half of the twentieth century”).
165 See, e.g., W. Easterly & R. Levine, Africa’s Growth Tragedy: Policies and Ethnic Divisions, 112
Q. J. ECON. 1203 (1997).
166
Englebert, supra note 000, at 9.
See id. at 21 (Table 2).
See id. at 24 (Table 3).
Id. at 18.
See, e.g., The Quality of Government, supra note 000, at 245 (finding that negative effect became
23
There should be little doubt that cultural variables will have an effect on economic growth. For example, some cultures deny education and equality of opportunity to women. Those restrictions are the economic equivalent of a fighter tying one of his hands behind his back. Abandoning a vast pool of human resources must inevitably harm economic growth.171 But this cultural feature, like others, is not immutable. The extension of legal rights to women will alter such a culture and, coincidentally, enhance its economic welfare.172
There is relatively little persuasive evidence that culture has a predominant economic effect that overrides the importance of legal institutions. The effects of culture might readily be distinguished from the effects of institutions, simply by examining the behavior of immigrants. It is established that some immigrant groups have had greater success.173 However, that may only prove that the group is more quickly adaptable to a different set of circumstances, not that cultures are impervious to such circumstances. Some have asserted that cultural factors are crucial to individual savings, but a more rigorous study of immigrants had found no cultural effect on savings behavior.174 Many immigrants from other cultures have thrived under the legal institutions and free market system in the United States.175 This fact suggests that such institutions and markets may well have a positive effect in other countries.
Rather than undermining the effect of legal institutions, cultural issues may simply make them all the more important. Thus, “good institutions are most necessary and beneficial where there are ethnolinguistic divisions.”176 Legal institutions may provide the “social glue” for transactions that is necessary when society is so divided.177 A World Bank study found that high quality institutions, such as rule of law and property rights, mitigated the adverse economic consequences that have been associated with ethnolinguistic fractionalization.178 A very
171 See, e.g., The World Bank, ENHANCING WOMEN’S PARTICIPATION IN ECONOMIC
DEVELOPMENT 25 (1994) (discussing substantial economic benefits to educating women and how their
labor market participation “increases economic efficiency”).
172 See Nicholas D. Kristof, The Veiled Resources, N.Y. Times, December 11, 2001, at A27
(reporting that “[h]istory has repeatedly shown the economic advantages of education and autonomy for
women, and indeed the West pulled ahead of the rest of the world beginning in the 1400’s partly because it
was educating more girls”).
173
See supra note 000.
174 See Christopher D. Carroll, Byung-Kun Rhee & Changyong Rhee, Are There Cultural Effects on
Saving? Some Cross-Sectional Evidence, Q. J. ECON. 685 (1994) (finding no evidence of cultural effects
on saving).
175 See THE MYSTERY OF CAPITAL, supra note 000, at 226 (reporting that “Vietnamese, Cuban
and Indian migrants have clearly had few problems adapting to U.S. property law”).
176 Jo Ritzen, William Easterly, & Michael Woolcock, On “Good” Politicians and “Bad” Policies:
Social Cohesion, Institutions, and Growth, World Bank Policy Research Working Paper 2448 (September
2000) at 25.
177
Id.
178 See William Easterly, Can Institutions Resolve Ethnic Conflict?, World Bank Policy Research
Working Paper 2482 (November 2000). The lessened trust among different ethnic groups undermines the social cohesion necessary for informal legal substitutes. Id. at 6. Moreover, “[g]ood institutions may mitigate ethnically-based social conflict that lowers growth. Id. at 8. Using measures of ethnolinguistic fractionalization and ICRG scores for rule of law and related variables, the study concluded that “sound
24
comprehensive study found that legal systems transcended ethnolinguistic divisions and had a powerful effect on growth even with the fractionalization controlled.179 Yet another recent study
found that ethnic fractionalization showed no effect on growth, once policy variables were considered.180
A recent more rigorous cross-country study that found some effect of culture on economic growth.181 It employed sociological survey research that provided scores for various countries on features such as relative individualism, a “masculinity index,” a measure of inequality, and uncertainty avoidance.182 Of the cultural factors, the author found a significant negative effect for uncertainty avoidance.183 This result is certainly consistent with economic theory, as such cultures would be less likely to embark on the entrepreneurial risk-taking associated with growth. This finding of relevance for culture does not mute the significance of traditional legal institutions – it enhances that significance. By providing better assurances of property rights and contract enforcement, the law reduces the uncertainty that may be associated with investment and may help overcome cultural barriers to economic development.
Another cross-country study found an effect for “social capital.”184 Social capital was defined as the level of trust in a society, measured both in terms of trusting family members and trusting people in general.185 The author found that higher levels of trust correlated with higher economic growth rates.186 However, many other cultural factors such as Confucianism, corporatism, and values generally had no effect.187 While a society’s culture may matter, the importance lies in these cross-cutting features such as risk-taking and trust and not in the typical region-specific features commonly assigned to culture (e.g., Asian culture, Islamic culture, etc.)188
institutional arrangements mitigate the negative effects of ethnic diversity” and that “ethnic diversity has zero marginal effect on economic growth at maximum institutional development.” Id. at 9.
179 Thorsten Beck, Asli Demirguc-Kunt & Ross Levine, Law, Politics and Finance (April 2001).
180 See Craig Burnside & David Dollar, Aid, Policies, and Growth, AM. ECON. REV. 847, 856 at
Table 4 (2000).
181 See Oliver Dieckmann, Cultural Determinants of Economic Growth: Theory and Evidence, 20 J.
CULTURAL ECON. 297 (1996).
182 See id. at 305-306. The underlying research can be found in Geert Hofstede, CULTURE’S
CONSEQUENCES: INTERNATIONAL DIFFERENCES IN WORK-RELATED VALUES (1984).
183 Id. at 313-315.
184 Paul F. Whitely, Economic Growth and Social Capital, 48 POL. STUDIES, 443 (2000). A
separate study of African nations, though, found no independent effect of social capital. See Englebert,
supra note 000, at 25 (reporting that “social capital fails the test of accounting for variations in performance
across countries”).
185 For a discussion and study of the forces contributing to social capital and its positive effect on
economic growth, see Stephen Knack & Philip Keefer, Does Social Capital Have an Economic Payoff? A
Cross-Country Investigation, Q J. ECON. 1251 (1997).
186 Id. at 456.
187 Id.
188 While some attribute economic consequences to faith, such as Islam, researchers have suggested
that “given the protean nature of Islamic economic precepts, Muslims have been able to pick and choose
among them, and so Islam is irrelevant in explaining the fluctuating economic fortunes of Muslim
25
This research also found that the level of financial investment was much more significant than even the cultural social capital for economic growth.189 Other research has found some economic effect of a country’s race and religion but a significant independent positive effect of liberty and democracy after controlling for race and religion.190 Thus, cultural factors should be conceived of as more of a complement to traditional legal and economic explanations, rather than as a barrier to or substitute for such explanations.191
It would be foolish to say that a society’s culture was irrelevant to any aspect of that society, especially a significant one like economic growth.192 But the ultimate significance of these cultural factors has not been demonstrated.193 North has emphasized the importance of “culturally derived norms of behavior” and their interaction with the formal legal rules.194 However, culture is not destiny. The critical institutional legal rules and institutions for growth need not be precluded or obstructed by cultural barriers, as the empirical evidence shows. The implementation of certain basic principles of law and economics may have to be adapted to local situations.195 While it is undoubtedly true that transplanting legal institutions in new cultures will work imperfectly, the transplantation procedure may still be the most pragmatic and effective approach to development.196 Joel Trachtman suggests that those engaged in law and development
societies.” UNINTENDED CONSEQUENCES, supra note 000, at 56. Economic successes in a number of Islamic nations “show that it is not Islamic beliefs in themselves that have hindered development but dysfunctional etatism and dirigisme.” Id. at 66.
189 Id.
190 See Burton A. Abrams & Kenneth A. Lewis, Cultural and Institutional Determinants of Economic
Growth: A Cross-Section Analysis, 83 PUB. CHOICE 273 (1995).
191 See Joel P. Trachtman, The Applicability of Law and Economics to Law and Development: the
Case of Financial Law, in MAKING DEVELOPMENT WORK, supra note 000, at 204 (suggesting that
principles of law and economics succeed “not by ignoring local differences, but by evaluating local rules
against potential substitutes so as to determine which structure is more efficient to achieve local
preferences”).
192 A middle ground is suggested by A Legal Theory of Emerging Economies, supra note 000. Phil
Nichols suggests that formal contracting institutions need to be introduced into poorer nations but that this
introduction will be affected by local cultural factors and not result in institutional practices that are
“coincident with that of the West.” Id. at 296.
193 See, e.g., The Paradox of Free Market Democracy, supra note 000, at 301 (conceding that cultural
explanation often suffers from “ad hoc residualism and non-falsifiability”).
194 INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC PERFORMANCE, supra
note 000, at 140. See also Andrzej Rapaczynski, The Roles of the State and the Market in Establishing
Property Rights, 10 J. ECON. PERSP. 87 88-89 (1996) (discussing how a legal system cannot enforce all
property rights disputes and requires self-enforcing mechanisms as well).
195 See Knieper and Boguslavski, supra note 000, at 123 (reporting that a nation’s historic features
should be taken into account but that universal principles of commercial law are not altered by that history).
The necessary adaptation may have less to do with “culture” as it is commonly conceived than with the
legacy of political and economic structures of the nation in question. See, e.g., id.at 118-120 (reporting that
efforts to reform post-communist nations suffered for the failure to take into account their historic political
and judicial structures)
196 See Brian Tamanaha, A Pragmatic Approach to Legislative Theory for Developing Countries, in
MAKING DEVELOPMENT WORK, supra note 000, at 156 (reporting on Micronesian experience that
26
unfortunately “oscillate between arrogance and modesty,” when the best answer is to rely on the “confidence earned by methodologically sound and contextually sensitive analysis that will be used not to dictate solutions but to inform politics in the emerging market country.”197
The theoretical debate over the relevance of culture cannot ultimately answer the question. The ability of culture to render legal reform ineffectual should appear in the empirical evidence. If a change in legal institutions has a significant societal impact in different cultures, that is evidence that culture is not a barrier to the positive economic effects of law. The empirical data is also a test for whether legal substitutes can be effective in facilitating societal economic growth.
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