1 law and economic growth
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| II. Empirical Research on Law and Economic Growth
Empirical research on law and economic growth has burgeoned of late, with much of the work done by international economic organizations, such as the World Bank and International Monetary Fund. Before reviewing this research, some context is required. The law may be a necessary but not a sufficient condition for growth or it might be neither strictly necessary nor sufficient but just a contributing factor. Certainly, many other variables have an effect on growth, such as social capital (the relative level of interpersonal trust in a society), human capital (the relative level of a population’s education and skills), resources, and even climate. The existence of these factors will tend to obscure the true effect of law, so that it can be difficult to empirically extract even an authentic association between law and economic growth, amidst the noise of other influential factors. Hence, it will be difficult to identify even a true association, and one might expect to find results only for the most substantial legal and institutional variables, though other rules might still have some meaningful economic effect. While it is unlikely that we can find general economic growth effects from a particular antitrust doctrine, for example, an effect might be found for major legal variables, such as the presence of democracy, property rights, judicial independence, and the extent of government regulation. Such findings may also guide us on more specific legal questions. A finding that recognition of individual freedom is generally wealth-enhancing, for example, would suggest if not prove that positive economic benefits may result from particularized expansions of such freedom, even if those expansions are not in themselves so significant as to produce empirically identifiable benefits. Perhaps the most significant topic of ongoing empirical research is the effect of democracy on economic growth. While democracy is not readily quantifiable, it has been operationalized by measures of free electoral process, freedom of opposition parties, and the presence of more than one significant party.198 Democracy might be expected to contribute to legal transplants “seldom work in precisely the same way in the transplanted milieu as in their place of origin,” but that “does not mean they do not work at all,” so that transplantation may be the “most efficient” source of legal development). 197 The Applicability of Law and Economics to Law and Development, supra note 000, at 196. Like so many debates, the significance of law and economics is too often cast as a Manichean debate between those who view it as a cure-all and those who dismiss it as worthless. 198 A common tool used for quantitative measures of democracy is that of Freedom House, which considers such variables. See Raymond D. Gastil, FREEDOM IN THE WORLD: POLITICAL RIGHTS AND CIVIL LIBERTIES (1978 and ensuing years). These are sometimes referred to as the Gastil estimates, after their author. An alternative is known as the Polity data set. See Keith Jaggers and Ted Robert Gurr, Polity III: Regime Type and Political Authority, 1800-1994, Inter-University Consortium for Political Research, Study number 6695. 27 growth because authoritarian regimes may be predatory expropriators of wealth199 and because accountability and competitive political markets create an incentive for democratic leaders to increase the welfare of their constituents.200 Some, however, argue that democracy itself is predatory and redistributive and that democratic regimes lack the ability to make the long-term commitments necessary for true economic reform.201 Empirical evidence is needed to resolve the dispute over the economic effects of democracy. This evidence, though, does not produce consistent results. Przeworski & Limongi reviewed eighteen studies, eight of which found that democracies developed faster, eight of which found that authoritarian regimes grew faster, and two of which found no difference.202 It is intuitively difficult to believe, though, that such a central and important feature of governance as democracy has no economic effect. The inconsistent research may fail to account for complicating factors, or it may be that democracy may enhance economic welfare under some background circumstances but may be counterproductive under other circumstances.203 There is also a simultaneity or reverse causation difficulty in the empirical evidence – in the studies showing a positive effect, it may be that democracy produces growth but could be that growth produces democracy.204 A recent study by Jenny Minier appears to provide the best evidence for understanding democracy and economic growth.205 Her study focused on significant changes in a country’s level of democracy, rather than its absolute level, which enables a check on the reverse causation problem. Any time a regime changes, there is instability and a need to establish new institutions, which are generally bad for economic growth.206 However, she found that new democracies did 199 See Jack Donnelly, Human Rights, Democracy, and Development, 21 HUM. RIGHTS Q. 608
200 See POWER AND PROSPERITY, supra note 000, at 18-19 (suggesting that democratic governance provides a greater incentive to expand the overall economic pie); David A. Lake & Matthew A. Baum, The Invisible Hand of Democracy, 34 COMPARATIVE POL. STUDIES 587 (2001) (reporting evidence that competitive political markets promote efficiency in the provision of public goods and services). 201 See, e.g., Pranab Bardhan, Symposium on Democracy and Development, 7 J. ECON. PERSP. 45, 45 (1993) (noting that democracies “may actually be more susceptible to pressures for immediate consumption and other particularistic demands that may hamper long-run investment”). J. Benson Durham, Economic Growth and Political Regimes, 4 J. ECON. GROWTH 81, 82 (1999) (noting argument that dictatorship may “more effectively stimulate growth and investment by suppressing labor unions, wages, and consumer demand – very unpopular measures”). 202 Przeworski & Limongi, supra note 000, at 61 (summarizing results in Table 1). 203 One study has suggested that democracy and economic growth may be positively related at low
204 See Ross E. Burkhart, Economic Freedom and Democracy: Post-Cold War Tests, 37 EUROP. J. POL. RES. 237 (2000) (reviewing literature that suggests that capitalism promotes economic development); Law and Economic Development: A New Beginning, supra note 000, at 558 (noting that experience indicates that “political liberalization may indeed follow upon the heels (though not always immediately) of economic development”). 205 Minier, supra note 000. 206 Id. at 247. In addition, the upheaval associated with a shift to democracy may cause a “temporary worsening of property rights.” Christopher Clague et al., Democracy, Autocracy, and the Institutions 28 not suffer the expected slowing of growth but in fact did well economically.207 She also broke the countries of the world down into groups in a regression tree analysis, differentiating between poor and rich countries and varying levels of literacy, finding that democracies tended to have better education and more investment.208 In addition to finding that countries becoming democratic grew faster than expected, countries that saw a drop in their level of democracy grew more slowly in both the short run and long run.209 No study provides the final word on social scientific questions, but Minier’s well designed study does provide persuasive evidence that democratization of government enhances growth. Its persuasiveness is enhanced by other research finding that democracies tend to have greater property rights than do autocracies.210 Democracy appears to be a legal structure that contributes to a society’s economic welfare. While this macro-level finding does not directly inform us about the merits of more detailed democratic rules (such as particular laws governing elections and recounting), it could suggest that the more democratic among a choice of rules may likewise contribute to economic growth. However, one can imagine that there is some optimally democratic point, beyond which additional democracy (e.g., direct democracy and the elimination of representatives as intermediaries) would be contrary to economic wellbeing. Another well-studied legal determinant of growth is economic freedom. This concept is generally operationalized as the establishment of secure property rights and the freedom to engage in voluntary transactions and their enforcement by government.211 There are various scales that have been used to measure relative international levels of economic freedom.212 These indices, though, have a number of components that would not be considered legal rights, or even legal matters at all.213 An alternative measure uses investor guides, based on the expert opinions Supportive of Economic Growth, in INSTITUTIONS AND ECONOMIC DEVELOPMENT, supra note 000, at 108. 207 See id. at 253 (observing that the “countries that democratized were predicted to grow more slowly than their control groups; in fact they tended to grow faster”). 208 See id. at 260-261 (Tables 7 & 8). 209 See id. at 261-262. 210 See Christopher Clague, et al., Property and Contract Rights in Autocracies and Democracies, 1 J. ECON. GROWTH 243 (1996). Rather than testing the indirect association between democracy and growth, this study tested the relationship between democracy and the intermediate variable of property rights and contract enforcement. It found that democracies consistently outperformed autocracies in protecting these rights. Id. at 258. 211 See Steve H. Hanke & Stephen J.K. Walters, Economic Freedom, Prosperity, and Equality: A Survey, 17 CATO J. (1997) (reporting general agreement upon these elements of economic freedom). 212 One of the first indices was published in Daniel J. Slottje, et al., MEASURING THE QUALITY OF LIFE ACROSS COUNTRIES 206-260 (1991). The Fraser Institute in Canada has created a similar measure. See RATING GLOBAL ECONOMIC FREEDOM (Stephen T. Easton & Michael A. Walker eds. 1992 and ensuing years). The Heritage Foundation has a somewhat different index for economic freedom. See Kim R. Holmes, Bryan T. Johnson & Melanie Kirkpatrick, INDEX OF ECONOMIC FREEDOM 33- 48 (1977 and ensuing years) (describing the components of its index). And Freedom House has its own separate and very distinct measures. Richard E. Messick, WORLD SURVEY OF ECONOMIC FREEDOM (1996 and ensuing years). These indices are reviewed and compared in Economic Freedom, Prosperity, and Equality, supra note 000. 213 For example, they may include factors such as total government spending and national price stability. See ECONOMIC FREEDOM OF THE WORLD, supra note 000, at 7. The Heritage Foundation 29 of private professional consultants that assess the legal institutions of nations.214 Still another measure is “contract-intensive money” (CIM).215 This measures the extent of money held in banks or invested in other financial institutions or instruments and may be directly explained by the relative availability of government enforcement of contracts in a nation. All of the above measures have been used for empirical research on the effect of economic freedom on economic growth. Research by the Fraser Institute and Heritage Foundation authors have found that their indices are significantly correlated with growth.216 One study broke down the Fraser Institute index and found that property rights were especially important for growth, more important than limited government.217 Empirical research using the investor guides has likewise found that economic liberty was a significant determinant of growth.218 The same is true for CIM-based research.219 While this research has the same potential simultaneity problem as the democracy research, there is empirical evidence to suggest that it is economic freedom that produces growth.220 The research has not yet established, though that the relationship is a linear one and that more economic freedom will always contribute to greater growth. index includes monetary policy, but also breaks down the components with separate ratings for property rights. See THE INDEX OF FREEDOM (1995), supra at 11-21 (summarizing these elements). The Freedom House index is focused on the law but also incorporates more general liberties, such as freedom of speech. See WORLD SURVEY OF ECONOMIC FREEDOM 1995-1996, supra note 000, at 6-8. 214 See, e.g., Why Don’t Poor Countries Catch Up?, supra note 000, at 592 (noting the two main
215 See Christopher Clague, et al., Contract-Intensive Money: Contract Enforcement, Property Rights, and Economic Performance, 4 J. ECON. GROWTH 185 (1999) (describing concept and using it in research). 216 ECONOMIC FREEDOM OF THE WORLD 1975-1995, supra note 000, at xvii. See also id. at 89-110 (comparing the levels of economic freedom and economic growth with descriptive general statistics); See Kim R. Holmes & Melanie Kirkpatrick, Freedom and Growth, WALL ST. J., December 16, 1996, at A16 (summarizing results of study). 217 Leschke, supra note 000, at 277. 218 See Johan Torstensson, Property Rights and Economic Growth: An Empirical Study, 47 KYKLOS
219 See Contract Intensive Money, supra note 000, at 200-203. 220 See Why Don’t Poor Countries Catch Up?, supra note 000 at 599-600 (analyzing the possibility
30 Another important factor that has seen some legal research is the rule of law. This factor is a procedural one, independent of the substantive content of the law.221 It is also very difficult to operationalize for empirical research, though it is estimated in some of the investor guides. The World Bank has embarked upon a major research program on the importance of the rule of law, including a private sector survey of over 3800 enterprises in 73 countries.222 They produced a general government credibility indicator for variables such as political instability, the security of persons and property, the predictability of judicial enforcement, and corruption. When the credibility indicator was disaggregated into its components, the most robust predictor of growth was the predictability of judicial enforcement, which was significant in every regression.223 The rule of law appears to be particularly important to entrepreneurial enterprises.224 The structure of the judiciary may be critical to preserving the rule of law, but the precise structural requisites are not clearly established. Some suggest that an independent judiciary is an institution central to the preservation of the rule of law.225 The theory supporting this position is somewhat obscure, though. If democratic institutions further growth, why would a relatively nondemocratic independent judiciary be a positive? Truly independent judges may become arbitrary or corrupt and thereby undermine the rule of law. The functioning of the rule of law may also be dependent on the resources provided to the judicial branch, or the nature of the bar, or the structuring of the legal system as common or civil law.226 Researchers increasingly have studied the effect of government regulation on economic development. The new institutional economics may be caricatured as propounding a laissez faire ideology, where the primary role of government is to create property rights and enforce contracts and then get out of the way of the market. While some subscribe to this position, it is not a necessary one. Coasean theory calls for “government intervention wherever such intervention reduces transaction costs below those that would exist absent government intervention: it is a rationalization of regulation not a condemnation.”227 Free markets may not promote developmental efficiency for a variety of reasons, including information asymmetries. Empirical analysis is necessary to understand the effects of government regulation. 221 This institutional setting may be much more important than the substantive component of the laws
222 See Beatrice Weder, Legal Systems and Economic Performance: The Empirical Evidence, in JUDICIAL REFORM IN LATIN AMERICA AND THE CARIBBEAN, supra note 000, at 23-24 (describing questionnaire). 223 See Credibility of Rules and Economic Growth, supra, note 000, at 367. 224 BUILDING INSTITUTIONS FOR MARKETS, supra note 000, at 119 (reporting international
225 See Whitford, supra note 000, at 738 (declaring that judicial independence was “widely seen as critically necessary to the effective implementation” of a rule of law). 226 See infra at ___. 227 Trachtman, supra note 000, at 204. 31 The best-studied area of public regulation is securities law. A larger and more liquid securities market demonstrably contributes to economic growth.228 Some have argued, as a theoretical matter, that the U.S. securities laws, such as prohibitions on insider trading, interfere with a free market in securities and thereby hamper economic growth.229 However, there is considerable empirical evidence that the regulation of information found in federal securities law fosters economic growth.230 Research particular to insider trading laws have found that they also tend to support stronger equity markets.231 It seems clear that government regulation of securities fraud is conducive to the development of stock markets and the associated benefit of economic growth. Other forms of regulation have not been so well studied for their economic effects but there is evidence of value. A study of banking regulation in more than 100 countries found that “regulations that encourage and facilitate the private monitoring of banks tend to boos bank performance, reduce nonperforming loans, and enhance bank stability.”232 Antitrust and other competition laws may benefit economic development.233 Insofar as environmental laws protect against the externalization of costs and protect public goods, they too might be expected to provide economic benefits. Just as every successful world economy recognizes property rights and enforces contracts, “every successful market economy is overseen by a panoply of regulatory institutions, regulating conduct in goods services, labor, asset, and financial markets.”234 It would be closed-minded to blindly attribute economic growth to the former (property rights) but not the latter 228 See, e.g., Ross Levine & Sara Zervos, Stock Markets, Banks, and Economic Growth, 88 AM.
229 See, e.g., Stephen Choi, Regulating Investors Not Issuers: A Market-Based Proposal, 88 CAL. L. REV. 279 (2000) (contending that regulation of issuers is unnecessary); Paul Mahoney, The Exchange as Regulator, 83 VA. L. REV. 1453 (1997) (arguing that enforcement should be shifted from government to private stock exchanges). 230 Bernard Black has comprehensively reviewed the importance of securities regulation and emphasized that it enables companies to convey credible information to third parties, thereby enhancing the securities market. See Bernard S. Black, The Legal and Institutional Preconditions for Strong Securities Markets, 48 U.C.L.A. L. REV. 781 (2001). Researchers at the National Bureau of Economic Research have published a series of studies showing that legal investor protections foster growth. See, e.g., Rafael La Porta, et al., Legal Determinants of External Finance, 52 J. FIN. 1131 (1997). 231 See Laura N. Beny, A Comparative Investigation of Agency and Market Theories of Insider Trading, Harvard Law School Discussion Paper No. 264, September 1999, at 6 (reporting that regimes with weaker insider trading prohibitions “have, on average, less liquid equity markets”); Utpal Bhattacharya & Hazen Daouk, The World Price of Insider Trading, Kelley School of Business Indiana University Working Paper, January 2000 (reporting that countries with insider trading laws and prosecutions had lower overall cost of equity); Robert Prentice, Whither Securities Regulation? Some Behavioral Observations Regarding Proposals for its Future (forthcoming in Duke Law Journal) (reviewing evidence on value of securities fraud regulation). 232 BUILDING INSTITUTIONS FOR MARKETS, supra note 000, at 80. The study included such requirements as an audit by certified external auditors. Id. 233 Id. at 141 (describing benefits of such competition laws). 234 Institutions for High Quality Growth, supra note 000, at 7. 32 (regulation). There is reason, both theoretical and empirical, to think that some forms of government regulation of markets may contribute to economic development. Of course, government regulation also may seriously interfere with growth. Empirical analysis is needed to distinguish between beneficial and counterproductive regulatory approaches. |