Endogenous Legal Traditions and Economic Outcomes

Carmine Guerriero is Assistant Professor of Economics at the University of Amsterdam. This post is based on a recent article by Professor Guerriero.

The “legal origins” theory claims that the two main legal traditions or origins, civil law and common law, crucially shape lawmaking and dispute adjudication and have not been reformed after the initial exogenous transplantation by Europeans. [1] Therefore, they affect economic outcomes to date. In particular, countries that received common law enjoy today “(a) improved financial development […], (b) […] better functioning labor markets […], and (c) less formalized and more independent judicial systems” [La Porta et al. 2008, p. 298].

Recent contributions, however, have criticized the ideas that transplanted legal traditions remained intact (Roe, 2004) and can be measured through legal origins dummies (Rosenthal and Voeten, 2007). Inspired by these studies, Guerriero (2016a) documents that in a cross-section of 155 transplants, which are countries that received their legal tradition externally, 25 reformed their lawmaking institution and 95 reformed at least one among their lawmaking and adjudication institutions. To illustrate, in countries that inherited statute law, reforms towards case law have been more likely the largest preference, and in particular both ethnic and genetic, diversity is and reforms towards a pure common law tradition, which is the mix of case law and some discretion in adjudication, are found where the quality of political institutions is the lowest. Symmetrically, in countries in which case law was transplanted, reforms towards a pure civil law tradition, which is the mix of statute law and bright-line adjudication rules, are found where the quality of political institutions is the highest. This evidence is consistent with the idea that appellate judges’ offsetting biases make common law unbiased but volatile and thus more efficient than the certain civil law only when the latter is sufficiently distorted by special interests, i.e., if preferences are sufficiently heterogeneous and/or the political process sufficiently inefficient.

This evidence raises three burning questions about the relationships between legal traditions and outcomes. First, how do legal traditions, preference heterogeneity, and the quality of political institutions interact in shaping outcomes? Second, how can we measure the whole bundle of institutions characterizing each legal tradition and deal with its endogeneity? Third, what outcomes should we consider? This last question is better understood through the following reasoning. Because of their tendency towards optimality, legal traditions should have no impact on proxies for social welfare. Yet, the measures considered by the development literature gauge only the technological efficiency of the law, which is the distance between the prevailing law and the technologically efficient legal rule maximizing social welfare in absence of heterogeneity. For instance, the unemployment rate speaks about the efficiency of labor markets to equate the marginal disutility of labor to its marginal productivity, but it does not say much about the psychological reward drawn by societies protecting more workers. Therefore, a credible inquiry into the economic impact of legal traditions has to take into account also what the proxy of interest is actually measuring.

In my paper, Endogenous Legal Traditions and Economic Outcomes, forthcoming in the Journal of Comparative Economics, I build on the theoretical framework put forward by Guerriero (2016) and data on 49 transplants to answer the above three questions.

If preference heterogeneity is limited, civil law is more technologically efficient being unbiased as common law but also certain. If preferences are sufficiently diverse instead, the distance between the biased civil law and the technologically efficient legal rule becomes wider the larger preference heterogeneity is and the lower the quality of the political process is. Thus, civil law loses its technological primacy when preferences are sufficiently diverse and/or political institutions sufficiently inefficient. Consistent with this prediction, a proxy for preference diversity interacted with a measure of the degree to which the transplant legal system in 2000 was nearer to a perfect common law tradition has a positive and significant impact on the stock market development, the extent of private credit, and the employment level. [2] The estimates also imply that reforms towards a pure common law tradition in developing transplants with smaller than average preference heterogeneity will significantly brake stock market development and the extent of private credit, whereas reforms towards a pure common law tradition in developing transplants with larger than average preference heterogeneity will significantly foster stock market development. [3] Finally, the two legal traditions fare equally well when compared with self-reported managers’ beliefs on how much the legal system is able to hit its efficiency targets and their satisfaction with the law. This last patterns squares with the idea that legal traditions have a tendency towards optimality and so should not differ when compared through a proxy for social welfare.

All in all, this evidence delivers conclusions quite different from those drawn by La Porta et al. (2008) and raises several concerns regarding the recent waves of reforms that, inspired by the legal origins literature, have introduced in developing countries institutions typical of common law (World Bank, 2012). This is particularly worrisome nowadays given the increasing demand for regulation created by the recent global economic crisis.

The full paper is available for download here.

Endnotes:

[1] They have been spread around the world through mainly colonization and occupation by a group of European countries and display very diverse structures. While indeed common law entrusts a key role to judicial precedents—i.e., case law—and allows some discretion to lower adjudicating courts, civil law relies on centralized legislation—i.e., statute law—and bright-line adjudication institutions (Guerriero, 2016a).
(go back)

[2] I measure the degree to which the transplant legal system in 2000 was nearer to a perfect common law tradition with the normalized first principal component extracted from a case law dummy and four proxies for institutions restricting the discretion licensed to lower courts and preference diversity with the genetic distance between the plurality ethnic group in the origins and that in the transplant.
(go back)

[3] Crucially, directly including preference diversity and the quality of the political process takes care of the omitted variable bias in the estimates of legal traditions, whereas using an instrument prompted by social evolution studies reckons with the possibly endogeneity between the quality of the political process and outcomes.
(go back)

Both comments and trackbacks are currently closed.
  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows