ANGLOSPHERIC DOMINANCE IS NO COINCIDENCE:

Common Denominator: Using sophisticated mathematical models, a group of four economists has proven that a country's legal history greatly affects its economy. At least they think they've proven it. How their sweeping theory has roiled the legal academy. (Nicholas Thompson, Jan/Feb 2005, Legal Affairs)

MALAYSIA AND INDONESIA COULDN'T BE CALLED TWINS, but they might be called siblings. The adjacent Southeast Asian nations possess similar natural resources and their citizens speak similar languages and follow similar strains of Islam. But Malaysia's economy is prospering while Indonesia's is floundering. Malaysia's stock market is far more vibrant than its neighbor's, and its average resident is three times richer.

Economists might explain these divergent paths by pointing to the countries' different responses to the Asian financial crisis of the mid-1990s. Sociologists might find a cultural explanation in the close-knit community of Chinese immigrants who are the most powerful force in Malaysia's business community. Historians might point out that Malaysia's struggle for independence was much less bloody than Indonesia's.

Another explanation lies in the countries' legal systems, however. 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 British Empire for about nine centuries. Indonesia was a Dutch colony and its legal system derives from French civil law, a set of statutes and principles written under Napoleon in the early 19th century and imposed upon the lands he conquered, including the Netherlands.

According to research published by a group of scholars beginning in 1998, countries that come from a French civil law tradition struggle to create effective financial markets, while countries with a British common law tradition succeed far more frequently. While the scholars conducting the research are economists rather than lawyers, their theory has jolted the legal academy, leading to the creation of a new academic specialty called "law and finance" and turning the authors of the theory into the most cited economists in the world over the past decade. [...]

THE IDEA THAT LEGAL ORIGIN CAN EXPLAIN NATIONAL MARKET DIFFERENCES comes from four economists who are referred to in their field by the acronym LLSV: 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. [...]

LLSV's main tool was regression analysis, a mathematical technique in which many variables are plugged into a program that sorts out which ones are correlated and which ones are not. Using regression analysis, for example, you could plug in the heights, weights, and eye colors of 100 people. The results would show that height and weight are correlated (the taller you are, the more you're likely to weigh) but that weight and eye color are not.

Using this tool, "Law and Finance" showed that common law countries protect both shareholders and creditors better than civil law countries do, and they also tend to be less corrupt. LLSV took dozens of specific financial indicators--ranging from key gauges, like the odds that a company's assets will be confiscated by the state, to smaller measures, like whether shareholders can vote at company meetings--and regressed them all against legal origin. The regressions showed that the measures that indicate high investor and creditor protection or low corruption connect to common law origin, just as height connects to weight. The measures that represent low protection and high corruption connect to civil law origin.

The regression didn't show that common law necessarily makes people richer, but it did represent a crucial link in a chain of logic that could connect legal origin to prosperity. When shareholders have more rights, people are more likely to invest in markets, because they have more protections against dishonest executives. When creditors have more rights, they are more likely to lend money, which spurs markets to grow. And when countries are free from corruption, investors put more money into them. The LLSV scholars weren't the first to recognize that shareholder and creditor rights spur economic growth, or that corruption stunts it, but they were the first to connect these conditions to a country's legal system and to do so using cold, hard numbers. [...]

The most compelling theory they've developed has to do with the power both systems afford their judiciaries. Common law judges are, on balance, far more powerful than their counterparts in civil law countries. Since judges tend to be a country's most reliable check on the other parts of its government, common law countries grant less power to their executives than civil law countries do. And in developing nations, corruption is generally perpetuated from the top.

The difference in the power that the two systems grant their judges is rooted in their respective histories. French civil law derives from the Napoleonic code, published in 1804 by scholars eager to wrest power from the judiciary. Before the country's revolution, France's courts had earned reputations for elitism and corruption. Influenced by popular discontent with much of the judiciary, Napoleon attempted to write a statutory code that was essentially judge-proof. Judges draw their influence from their power to interpret laws. Napoleon's code stripped them of this prerogative; his code favored the writing of a new law over a judge's interpretation of an old one. Consequently, compared to common law countries, civil law countries have weak judiciaries�and long statute books.

Common law was similarly influenced by a violent revolution that pitted the people against the crown. But in the years leading up to England's Glorious Revolution in the late 17th century, the judiciary tended to side with the people and against the Stuarts, who had tried to eliminate an independent judiciary. When the revolution came, the new government gave the judiciary far more power than France did a century later. Courts could interpret laws and even overrule the executive branch.

Legal historians didn't need LLSV to tell them all this. They knew that common and civil law countries differ fundamentally in the roles that judiciaries play. But LLSV was hardly content just to recite the old histories and anecdotes. They went back to their calculators and, in a 2003 paper titled "Judicial Checks and Balances," they demonstrated mathematically that common law countries give judges more independence, which in turn correlates with the sound economic policies they had examined in "Law and Finance."

Which is why the damage the Warren and Burger Courts did, by claiming for themselves the power of superlegislatures, is so potentially catastrophic. People have to have faith that the courts will be fairly conservative in their exercise of power or they won't trust them with it.

Posted by Orrin Judd at December 26, 2004 12:00 PM