Published — Wednesday 17 October 2012
Last update 17 October 2012 7:50 am
This book underlines the essential role of law in growth economics. The authors, however, remind us that both subjects diverged in the 20th century only to be reunited during its last quarter thanks to a powerful scholarly movement.
The authors, Cooter and Schafer, skillfully avoid economics verbiage and complicated legal terms, providing instead a plethora of anecdotes, appropriate examples and studies. Specialists and general readers will discover how law and economics deal specifically with the challenges of growth.
Growth is the motor of the economy. A mere 2 percent annual growth increases wealth more than seven times and a 10 percent annual growth (which has been approximately China’s growth rate during the last 30 years) increases wealth 14 thousand times.
Business ventures boost a country’s growth that needs to be sustained by the appropriate legal rules and institutions. With numerous examples, the authors explain “how insecure property, unenforceable contracts, uncollectable debts, financial chicanery and other legal problems stifle business ventures and cause national poverty”.
One example features a family in Ecuador, owner of a thriving shrimp farm in the coastal mangrove swamps on the gulf of Guayaquil. To grow in the 1990s, the business needs more capital, either from a loan or selling stock. But if the family sells stock, investors receive dividends when shrimp prices rise, and nothing when shrimp prices fall. The small size of the Ecuadorian stock market precludes selling stock, and the family regards a loan as too risky, so it foregoes outside finance and grows more slowly.
“A stock market cannot flourish unless corporate and securities laws effectively protect noncontrolling investors”.
India is a case in point. When India gained its independence, it established a state-led-economy and public law gradually replaced private law. By 1980, India enjoyed the presence of independent court as well as good written laws of property and contracts. After 1980 India distanced itself with state planning and initiated small steps toward privatization, deregulation and free trade. As the state took away its economic controls, private property and freedom of contract strengthened. The country enjoyed high growth rates for more than 20 years.
“The pattern of events suggests that countries surged ahead where improved laws effectively supported innovative business ventures and countries lagged where law failed to provide this support” say the authors who also, justly remark that writing down a law does not make it effective. If written laws are less effective in India, Nigeria, and Peru than in England or Spain, it is because a law ultimately draws its effectiveness from society and the state.
Effective laws such as property laws, are indeed necessary to reassure people can keep what they make. The world almost lost one of its greatest theatrical legacy because Shakespeare only wrote a few copies of every play he wrote. He refused to publish his plays to prevent others performing them. Due to the absence of effective copyright laws, he made money from selling tickets to performances of his plays and not from publications.
J.K. Rowling, on the contrary, sold 8.3 million copies of Harry Potter and the deathly hallows on the first day of its publication. Rowling reaped the benefits of an effective copyright to secure the ownership of her literary creation.
In countries like China and Brazil where people can copy freely, savvy businessmen endorse other people’s creations and thus bypass the costs of creating such as research and development costs. However, if copying slows creativity, patents and copyright boosts creativity.
Ideas need capital to produce growth and business requires freedom through law. The authors therefore conclude that the state’s first role in economic development is to build the legal foundations for markets. With the legal foundations in place, liberalization will promote innovation.
Enacting laws however is not enough. Laws and social norms must braid into institutions that strengthen each other like the strands in a rope. Trust develops from a history of cooperation and fair competition. By solving trust problems, law provides the framework for economic innovation to tend the poverty of nations.
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