January 11, 2005


Laws (and wealth) of nations: A controversial theory blames countries' lagging economies on Napoleon (Nicholas Thompson, January 9, 2005, Boston Globe)

WHY DO SOME countries prosper while others falter? It's one of the world's trillion-dollar questions.

Consider the case of Malaysia and Indonesia. They are adjacent Southeast Asian countries with similar natural resources (and similar vulnerability to natural disasters), and populations that speak similar languages and adhere to similar forms of Islam. But even before the recent tsunami devastated parts of Indonesia, Malaysia's economy has been prospering while Indonesia's has been floundering. Malaysia's stock market is far more vibrant than its neighbor's, and its average resident is three times richer.

Economists might explain the divergence by pointing to the countries' different responses to the Asian financial crisis of the mid-1990s. Sociologists might find a cultural explanation in Malaysia's powerful community of Chinese immigrants. Historians might point to Indonesia's bloody struggle for independence.

But another fascinating, and hotly contested, explanation lies in the origins of the countries' legal systems. Malaysia was a British colony and its legal system is based on the common law -- the set of rules, norms, and procedures that has guided the legal system of England and the former British Empire (including the United States) for about nine centuries. Indonesia, on the other hand, was a Dutch colony and its legal system derives from French civil law, a set of statutes and principals written under Napoleon in the early 19th century.

According to research published by a group of economists beginning in 1998, countries with a British common law tradition succeed far more frequently in creating effective financial markets. The theory has jolted the legal academy and turned the authors -- Rafael La Porta of Dartmouth's Tuck School of Business, Florencio Lopez-de-Silanes of the Yale School of Management, Andrei Shleifer of Harvard's economics department, and Robert Vishny of the University of Chicago's business school -- into the world's most cited academics on business and economics topics over the past decade.

It has also had reverberations far beyond the ivory tower, as developing nations consult heavily with the scholars, collectively known in their field by the acronym LLSV. In early December, Brazil overhauled its bankruptcy laws in part because of the scholars' recommendations. Even France, the cradle of civil law, has begun funding research into what it can learn from their theory. [...]

[F]or all its mathematical sophistication, LLSV's research has not gone unchallenged by their fellow number-crunchers. According to Luigi Zingales of the University of Chicago, the economic differences among countries may not come from something intrinsic to common law or civil law, but rather from some other correlated factor. Common law countries, for example, tend to speak English, tend to be Protestant, and tend not to have been decimated by World War II. The English, furthermore, may have done a better job than the French of finding economically viable locations to set up colonies.

"What LLSV has done is a very clever re-labeling of things," said Zingales. "We all know that the Anglo-American countries are different. You can call it the English language, the English tradition, and you can code in all sorts of ways."

The LLSV scholars counter that their regression models try to take all of these variables into account, showing for example that civil law origin has much more of an impact on markets than religion does. They also note that at least they've found something that can be reformed. Legal origin may not explain everything, but changing laws is much easier than converting a country from Catholicism to Protestantism.

In the end, what LLSV has done is provide a giant statistical brief in support of the ideas of John Locke, James Madison, and Adam Smith, and they've updated those ideas for a world that's as interested in economic success as in liberty. Creating a judicial branch that can check the executive and the legislature doesn't just protect individual rights and prevent political persecution. It also improves your stock market and can transform your future. At least, that's the theory.

The equation couldn't be simpler: subtract egalitie.

Posted by Orrin Judd at January 11, 2005 10:29 PM
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