Law, Growth, and Institutions in Economics

1. ESNIE European School on New Institutional EconomicsInstitut d’Etudes Scientifiques de Cargèse21 May 2008Hans-Bernd SchäferRule of Law and Economic Growth

4. Capital accumulation explains 30-35% of per capita growth Barro (1997), Hall/Jones 1999), Easterly (2001), Acemoglu/Johnson et. al (2003) Factor mobilisation explains growth in few countries Investment in human capital explains little of growth Good institutions which protect property rights and contracts are crucial for growth (Rodrick/Subramanian/Trebbi 2004) Glaeser/Laporta/Silanes 2004) Law and the Poverty of Nations

5. “Countries with corrupt government officials, severe impediments to trade, poor contract enforcement, and government interference in production will be unable to achieve levels of output per worker anywhere near the norms of western Europe, Northern America, and Eastern Asia”. Hall/Jones 1999 „QJE [1]R. Hall and C. Jones (1999), op. cit. p.4

6. Fig. Gross national savings (% of GNI) 1970-2003 World Development Indicators 2005 30 25 20 15 10 5 0 Middle income Low income High income OECD

9. Growth in Rich and in Poor Countries 1993-2003

10. State Led Growth Nationalization of key industries including banks and insurance companies Price distortions Import Substitution Planning, Industrial Policy

11. “The most important change in state policies in underdeveloped countries is the common understanding that they should each and all have a national economic development policy…Indeed it is also universally urged that each of them should have an overall, integrated national plan. All underdeveloped countries are now attempting to provide themselves with such a plan, except a few that have not yet been reached by the Great Awakening. Gunnar Myrdal 1957

12. Washington Consensus (around 1980) • Liberalization • Privatization • Free international trade, free international capital movements • Macroeconomic stabilization (low inflation) • (J. Williamson 1993)

13. Accumulated Growth of Per Capita GDP in Per Cent in Selected Countries from 1993 to 2003

14. GDP per capita (US$) GDP per Capita in Eastern Europe (population weighted averages) 6000 5000 4000 8 new EU members in 2004 3000 2000 12 non-EU post- Soviet countries 1000 0 1990 1992 1994 1998 2000 2002 2004 1996

15. Shock Therapy in Russia

17. Stagnation in Latin America

18. A shift from import substitution policy to free international trade implies a decline of import substituting industries and intends rapid growth of export-oriented industries. If however capital markets are imperfect and intellectual property rights are not protected, expanding becomes difficult. In many Latin American countries “numerous small and middle enterprises have been forced to close down, in many cases not as a result of their long-term inefficiency, but as a consequence of imperfect factor markets which precluded their access to long-term finance, engineering and managerial know-how[1]”. [1] J. Katz (2000),

24. “The cross-national literature has been unable to establish a strong causal link between any particular design feature of institutions and economic growth. We know that growth happens when investors feel secure, but we have no idea what specific institutional blueprints will make them feel more secure in a given context. The literature gives us no hint as to what the right levers are. Institutional function does not uniquely determine institutional form.”[1][1]D. Rodrick (2006)

25. The Barcelona Consensus (2004) • … both basic economic reasoning and international experience suggest that institutional quality -such as respect for the rule of law and property rights- plus a market orientation with an appropriate balance between market and state, and attention to the distribution of income, are at the root of successful development strategies. • Moreover, the institutions that put these abstract principles into reality matter, and developing countries should work hard to improve their institutional environments. But effective institutional innovations are highly dependent on a country´ s history, culture and other specific circumstances.

26. What Makes Law Reform so difficult? • Why do people with power accept limits to their power? An even more pointed formulation is: why do people with guns obey people without guns? An economic twist is: why would the rich even voluntarily part with a portion of their wealth? In legal theory, the parallel question runs: why do politicians sometimes hand over power to judges? Why do politicians allow judges, who control neither purse nor sword, to overturn and obstruct their decisions and sometimes even send office holders to jail?...Societies may approximate the rule of law if they consist of a large number of power wielding groups, compromising a majority of the population, and if none of them becomes so strong as to be able thoroughly to dominate the others. We may be able to loosen the grip of a few organized interests on power by forcing them to share political leverage with a variety of other groups. This is polyarchie; it is also rough justice, the only kind human beings will ever experience. Formulated differently, the balancing of many partialities is the closest we can come to impartiality. This may not sound particularly ideal, but it is nevertheless historically quite rare and very difficult to achieve.[1] • [1] S. Holmes, Lineages of the Rule of Law” (2003)

27. Neglect of finance and corporate governance in development economics What matters most • Property • Finance and corporate governance • Contract • Torts

28. Fig. Domestic credit to private sector (% of GDP) 1970-2003 From World Development Indicators 2005 180 160 140 120 100 80 60 40 20 0 Middle income Low income High income OECD

31. Market capitalization of listed companies (current US$) (bill) Data from World Dev. Indicators, 2005 35000 30000 25000 20000 15000 10000 5000 0 High income Low & middle income

32. Market capitalization of listed companies (current US$) (bill) Data from World Dev. Indicators 2005 700 600 500 400 300 200 100 0 China India Russian Federation

33. Enforcement of Shareholders Rights and Market Capitalization (from Claeessens/Klingebiel/Schmuckler, 2002)

36. The ex-post and ex-ante approach to corporate governance Regulation vs. Civil liability Rules versus Standards Qualification and loyalty of judges (Black, R. Kraakman, and J. Hay, 1996)

37. Crosslisting The institutional element of cross listing „rent a regulator“ The increasing number of cross listed companies in developing countries Cross listing and share prices (Karyoli 1998 Reese/Weisbach, Didenko 2005)

38. Large barriers to entry and to exit in developing countries -Licensing laws -overregulation -labor relations -dismissal, -bancruptcy procedure, -establishing a firm -tax law Consequence: development of a large informal sector which evades law altogether

39. Source: Schneider 2004