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Economic Development and Rule of Law

What are the simplest relationships between rule of law and economic development as applied, for example, to a country like China? I’ve been rereading parts of Kenneth Dam’s book, The Law-Growth Nexus (Brookings Institution). I think the most important findings can be summarized in four key points.

1. Legal institutions are a vital determinant of every country’s economic progress. Dam suggests this has now been recognized even by policymakers in China, which is not, as some others Western scholars insist, immune from the imperative to create a modern legal order for market regulation.

2. Although he argues that on balance the ‘causation runs from institutions to growth rather than vice versa’, Dam emphasizes that economic crises and expansion of markets create the appropriate and strong pressures for legal reform.

3. The weight of legal theory and historical evidence suggest neither common law nor civil law will be superior in the encouragement it gives to economic development. A country’s ‘legal origin cannot be changed’, and the difficulties and costs of changing a legal system or legal culture make conversion from one to another impracticable.

4. Enforcement of law is the critical variable. The quality of enforcement matters more than substantive content of law in developing countries. Good or good-enough law dealing with even sophisticated financial, corporate, or bankruptcy regulation is often already on the books. What is frequently absent is a credible expectation that law should and will work.

Effective enforcement depends in the first instance on the judiciary. Of course economic development is held back by weak judiciaries unable promptly, honestly, predictably, impartially, or transparently to perform key functions of protecting property and contract rights.

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It is often pointed out by specialists that the strength of the judiciary depends on operational factors, such as their remuneration and the physical, technical, and human resources at their disposal; but also, most importantly, on their independence from political and economic interests. Judicial effectiveness, Dam also points out, reflects the quality of procedural rules, which should be designed to increase the accuracy, fairness, and predictability of results without being so formal that they inhibit flexibility and speed of outcomes. 

A key measure of judicial efficiency is the time taken to dispose of a case.

Inefficiencies are not due only to problems of technical resources, budgets, or the quantity of judges. Important issues are the relative independence, impartiality, and honesty of the judiciary, which -- says Dam -- have ‘structural’ and ‘behavioural’ origins. Structural independence of the judiciary reflects the formal mechanisms by which government and the judiciary supervise each other, and relates closely to the famous Separation of Powers which characterizes all modern democracies. Behavioural independence is influenced by factors such as the education and prestige of the judiciary, and whether tenure of judges is fixed or arbitrary and politically determined.

Now to China:  Dam's analysis simply reinforces my suspicion that the seductive reasoning of those who question the indispensability of rule of law entirely on grounds that some countries experienced rapid economic growth for a decade or two without genuine rule of law should be resisted. China is now the most talked- about country whose future economic prosperity will depend on whether impartial legal institutions can replace personal and particularistic network- based mechanisms for ensuring compliance in exchange contracts.

A number of other authors offer China as an example of a dictatorship that achieves economic growth by prioritizing good-enough security for property rights. Others question whether China will improve economic governance fast enough to avoid disaster. These are familiar arguments. Kenneth Dam, on the other hand, detects a promising ‘guided evolutionary approach’ to rule of law that could allow China to avoid serious economic crises. Political leaders, he thinks, seem to be coming around to an awareness of the need to enforce market rules.

The momentum of reform is sporadic. Since there is no effective separation of powers in the Chinese state, the quality of the judiciary and law enforcement is very poor. Yet if one considers that China ‘had essentially no legal system when the economic reforms began in 1978’, progress since that date would appear to be ‘adaptive and intelligent'. Dam views the expressed interest of China’s leaders in the lessons of new institutional economics as possible evidence that ‘they know their institutions are not sufficiently strong for sustained growth’.