Law and Capitalism: What Corporate Crises Reveal About Legal Systems and Economic Development Around the World.

Author:Vandermeulen, Jackie
Position:Book review

I INTRODUCTION SECTION I: LAW AND CAPITALISM AND THE LAW AND DEVELOPMENT LITERATURE Origins of the "endowment perspective" literature The New Institutional Economists The common law 'best' promotes economic development Policy implications Understanding economic development III SECTION II: A SUMMARY OF LAW AND CAPITALISM The Matrix Institutional Autopsies Findings i. Legal systems are flexible ii. Beyond the NIE framework iii. Benchmarking questioned iv. Legal transplants: A more nuanced approach IV SECTION III: A CRITICAL ANALYSIS V CONCLUSION I INTRODUCTION

Legal institutions create the boundaries, or "the rules of the game", in which economic activity can occur. (1) Law and economic development scholars suggest that studying these boundaries can help us understand why some countries develop while others remain stagnant. The basic argument for linking law and development is simple: without the protection of property rights and a system to enforce contracts, investors lack the means and confidence to invest; without investment, economies are unable to grow. The law thereby fosters economic growth by providing predictability and ultimately facilitating market activity. Beyond this general assertion, however, the precise attributes of legal institutions that fuel development continue to be vigorously debated (2) as scholars seek to unravel the relationship between specific legal models and development outcomes. Despite this uncertainty, policymakers advocate for a strengthened "rule of law"--spending billions (3) on legal transplant policies, whereby laws are taken from countries with high economic growth and extensive legal structures, and are transplanted into countries with low economic growth and weak economic protections.

In Law and Capitalism: What Corporate Crises Reveal about Legal Systems and Economic Development around the World, (4) Curtis J. Milhaupt and Katharina Pistor critique the prevailing understanding of the links between the law and economic development. In particular, the authors question the claim that a narrow focus on property rights and contract law is sufficient for understanding how law, and governance more broadly,s promotes market activity. They propose that we should consider the capacity of legal systems to balance competing interests beyond the private ordering generated by property and contractual rights (the 'coordinative' function) and the extent to which market actors participate in the shaping of the law (the degree of 'decentralization'). Furthermore, they argue that a complete understanding of the role of law in economic development requires consideration of how legal systems signal and enhance the credibility of a government's commitment to enforcing the law.

The authors propose a novel method of analysis for evaluating these factors: first, they invite us to visualize a matrix on which legal systems can be positioned according to the degree to which they can be defined by these variables--that is, as protective or coordinative, and centralized or decentralized. Second, they examine a series of high-profile corporate crises in various legal systems around the world, using these variables to conduct "institutional autopsies" of failed systems. The authors examine both the effectiveness of these legal systems before those crises and the institutional responses to the problems to which they have been exposed. In this way, the authors recognize that the law should not be regarded as a static endowment, like geography or natural resources. Instead, attention should be given to the responsiveness of the legal institutions to the demand for law. On the basis of these findings, the authors conclude that laws designed to promote economic development (6) must be tailored to specific governance regimes.

This contribution to the law and development literature is significant. First, Milhaupt and Pistor question the prevailing linear concept of the relationship between the enforcement of property and contractual rights and economic development. Second, their methodology provides important insight into the complexities inherent in legal reform. The authors' approach, however, is limited by their exclusive focus on the instrumental role of the law in achieving economic development. This limitation is attributable to Milhaupt and Pistor's failure to engage with the values underlying economic development. In particular, they sidestep the debates sparked by Amartya Sen which highlight the objectives and values underlying "development". Sen argues that development is best understood as freedom: freedoms in turn support the attainment of further freedoms because they advance the capabilities of individuals to act as agents of change. As a result of Milhaupt and Pistor's assumption of a one-dimensional role for economic development, their analysis supports legal policies that may promote economic activity, but may also be injurious to individual economic freedoms, without acknowledging the tradeoffs involved. The authors' focus on financial markets suggests that it was not their intention to create a framework that captures all aspects of development. Nevertheless, the tradeoffs that exist even within capitalist systems must be considered. This evaluation requires that the framework be grounded in the values and goals of development. In this vein, we endorse Sen's more robust concept of development and evaluate Milhaupt and Pistor's analysis in light of these values. We conclude that while their approach has value in what it reveals about the complexities inherent in legal transplants, an additional layer of analysis is required to effectively capture the true impact of the law on economic development.

This review will proceed in the three sections. Section II situates Law and Capitalism in the current law and economic development literature; this section will elaborate upon the scholarship explicitly addressed by the authors, as well as introduce the 'development as freedom' literature. Section III provides a summary of the book and examines the authors' key findings and contributions to the literature; throughout this section, we will discuss the potential for their framework to contribute to scholarship that adopts a more robust concept of development. Section IV examines the implications of the authors' incomplete set of values, focusing on China as a case study to elaborate the shortcomings of their approach. It suggests that Pistor and Milhaupt's framework, by starting from an incomplete set of values, is limited in its analysis of the link between the law and economic development. As it exists, their analysis supports the use of freedom-limiting systems that, while conducive to economic growth, may involve important trade-offs for economic development.


Milhaupt and Pistor's project emerged from a "shared frustration with the current state of the literature". (7) More specifically, the authors are critical of the prevailing view that the common law tradition provides more effective support for market activity than the civil law traditions, including the Scandinavian and the German. (8) The authors are concerned, given their reservations about that approach, about the real-world applications of this academic view: countries facing serious institutional challenges are being encouraged, sometimes forcefully, by organizations such as the World Bank to implement a set of standard legal norms--which are most often based on the American system. (9) Thus, Law and Capitalism represents a reaction and a challenge to an academic view that has been incorporated into practice by various organizations around the world. By means of a simple, yet highly effective, analytical framework, the authors question the prevailing view that any legal system can be promoted as inherently the "best" for furthering development objectives.

This section will situate Law and Capitalism in the context of the broader discourse surrounding the relationship between the law and economic development. The focus of this section will be on the scholarly context with which Milhaupt and Pistor explicitly engage: the 'endowment' perspective, including New Institutional Economics and the theory that the common law tradition is more conducive to economic development. The impact of these theories on development policy, a matter of particular concern to Milhaupt and Pistor, is also discussed. The final part of this section introduces the broader debate over the bases for economic development, noting in particular the contribution of Amartya Sen. We rely upon this literature in the sections that follow to test Milhaupt and Pistor's analysis.

Origins of the "endowment perspective" literature

Milhaupt and Pistor's work responds to a body of literature that relies on the works of the German political economist Max Weber for its foundation)[degrees] They describe Weber's concept of the law as an "endowment" (11) that facilitated the development of Western European countries during the time of the Industrial Revolution. (12) At the heart of Weber's theory are the twin necessities of private property rights and contract enforcement for promoting growth. (13) Property rights facilitate the ability for individuals to use privately held physical resources more efficiently. It allows individuals to prevent overexploitation and may create an incentive to promote long-term sustainable use over immediate consumption. (14)

In the context of capitalist financial systems, Hernando De Soto, for example, argues that property rights are essential to facilitate individuals' access to credit by providing collateral which can guarantee loans)s In essence, De Soto suggests that this process increases the supply of credit extended in the economy and gives individuals the opportunity to use this credit to improve the capital over which they exercise ownership rights, thus facilitating...

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