“The rule of law can generate economic reform and unlock the social, political and economic potential that exists in societies,” asserts Henry Horbaczewski, Corporate General Counsel to Reed Elsevier Inc. Some go even further and claim that the rule of law is essential if well-rooted economic development is to take place. However, Antonio Maria Costa, head of the United Nations Office on Drugs and Crime (UNODC), credits the rule of law with being yet more important, and a means to achieving all eight Millennium Development Goals: “There was a clear correlation between weak rule of law and weak socio-economic performance,” he says. “As a result, the ‘bottom billion’ of the world’s poorest people were suffering the most from the effects of crime and corruption.”
Huge differences exist in gross domestic product per capita from country to country, and these cannot be explained simply by the abundance or lack of natural resources. Japan, for example, has few natural resources, yet it is one of the richest countries in the world. The efficiency with which a country turns its capital and natural resources into goods and services, leading to high levels of per capita income, appears to be a key factor and one which is aided by good governance and strong rule of law. It has, for instance, been shown that countries with better civil liberties, resulting from the rule of law, tend to be more successful in carrying out World Bank-funded investment projects.
Law and economic change
Amartya Sen, the distinguished economist-philosopher and winner of the 1998 Nobel Memorial Prize in Economic Sciences for his work on welfare economics, states, “It is hard to understand the history of economic change, for example the rise of capitalism as an economic system, without acknowledging the role of non-economic influences, among which legal changes figure prominently.” He asserts that, “capitalism did not emerge until the evolution of law and order and the legal and practical acceptance of property rights had made an ownership-based economy feasible and operational. The efficiency of exchange could not work until contracts could be freely made and effectively enforced, through legal as well as behavioural reforms. Investment in productive businesses could not flourish until the higher rewards from corruption had been moderated, and in this too, legal and behavioural changes played their part. The financing of businesses could not run smoothly until credit institutions had developed, and borrowers were standardly inclined to repay loans, rather than absconding away.”
Similarly, another Third Worlder, the Peruvian economist, Hernando de Soto, known for his work on the informal economy, also credits the development of property rights as being key to economic development: “The origin of the rule of law,” he says, “— which will allow a modern nation to grow and so bring peace, stability, and prosperity to the world—is property rights. And the rule of law will actually generate prosperity.” Indeed, land reform has been integral to high growth rates and economic expansion in many countries, particularly, for example, in Japan, Korea and Taiwan, as well as countries such as China and Thailand.
To de Soto, a nation’s wealth is the result of the efforts of entrepreneurs to bring resources together and divide labour effectively in order to raise productivity. Without the rule of law this is not possible. He points out that property is very important to the poor trying to make money from trading, and it is only when the right to such property is recognised in law that it can be preserved and exchanged nationally or even internationally. The need in societies where the rule of law is weak to “satisfy tribal chiefs, crooked cops, corrupt politicians, bad judges, difficult neighbours and even the terrorists” seriously dilutes property rights hampering the creation of wealth through enterprise. Corruption, by seriously undermining the rule of law and, thereby, weakening property rights, creates a much higher level of risk for investors such that any returns are likely to prove inadequate, thus deterring investment and dampening economic growth. It is for this reason that countries with less corruption tend to have higher levels of GDP per capita. Furthermore, once people become aware of the important role of the rule of law in reducing the risk of arbitrariness and creating greater predictability through reducing corruption, thereby improving their lives, they begin to take an interest in the workings of the judicial system and in the political process to enact laws, thus stimulating and deepening participation in governance.
Unlocking the assets of the poor
De Soto points out the vast extent of the assets of the poor, and in so doing indicates the huge scale of their potential if they were to be converted into capital by virtue of the rule of law: “In Egypt,” he says, “the poor own outside the law 92 percent of all the buildings and 88 percent of all the enterprises, which are worth $248 billion. That’s equivalent to 55 times the value of all foreign direct investment in Egypt since Napoleon left, including the Suez Canal and the Aswan Dam and 70 times all the bilateral aid that they have received.”
However, without property rights, assets such as these cannot be used as collateral to raise credit or be allocated to different parties such as shareholders and creditors, so that the factors of production – land, labour and capital – can be properly combined to create enterprises that implement the division of labour in order to significantly raise productivity.
Legal systems also provide the legal instruments and entities that are required for economic development, such as legal tender, shares and debentures, and legally recognised corporate entities with limited liability. In turn, it is the strong legal protection for investors that has brought about the development of sophisticated financial markets enhancing an economy’s ability to bear risk. This ability to spread risk over a multitude of investors is critical for entrepreneurship and economic growth. To achieve this, intelligent political and economic solutions are essential and fundamental to these is the notion that a market economy is based on the rule of law. “Our real enemies,” states de Soto, “are the people who do not believe in the potential of human beings liberated by the rule of law.”
Constitutive parts of a whole
Amartya Sen, echoes de Soto’s view that the great value of the rule of law in creating wealth can be far reaching. “Legal and judicial reform,” he says, “is important not only for legal development, but also for development in other spheres, such as economic development, political development, and so on, and these in turn are also constitutive parts of development as a whole. This is like a thickly interwoven textile.”
In order, for instance, for labour to be productive it needs to be educated and, here again, the rule of law has an important part to play. In many countries legal reforms gave people the right to free state-provided education and obliged parents to send their children to school, thereby equipping future workers with skills that could be used, or that could be built upon, for use in industry. As society became more sophisticated the rule of law helped ensure such things as social security, unemployment benefit, public health care and so on; and these are now almost taken for granted as constituent parts of contemporary Western economies.
The development of education played a critical part in Asian economic expansion . This has been particularly evident in Japan where educational priorities and the right to school education had a leading role in initiating speedy economic expansion. In Japan as a whole, between 1906 and 1911, education accounted for up to 43 per cent of municipal and local authority spending, and books had assumed a far more prominent role in society than in either Britain or the US. Learning from this example, South-east Asian and other East Asian nations have developed the skills of their populations in order to drive economic growth. While these developments, that had such an impact on the lives of ordinary people, were both social and economic, they, in being dependent on rights and duties, were also legal.
Amartya Sen, in support of his contention, also makes reference to the very rapid growth of India’s computer software industry, which is now second only to that in the US. He asserts that, “This process has been facilitated not only by the earlier expansion of technical education in India, but also by the comparatively flexible legal arrangements that govern these businesses compared with the much more rigid regulations that apply to more traditional commerce and industrial production, in which progress has been much slower.”
He also points out that legal rights conferred on women have been important not only for reasons of gender equality, but also for their benefits to society as a whole, because of, for example, reductions in child mortality and the birth rate. Justice for women, he says, is far-reaching and “influences nearly every aspect of economic, social, political and legal development”.
Transplants and dysfunction
The extent to which laws are effectively enforced depends very much on the effectiveness of the judiciary, the absence of corruption, and the low risk of both contract repudiation and government expropriation. The way the law was initially transplanted to and received by a country is an important determinant of these factors. Countries that developed their legal orders internally, adapted a transplanted law from, for instance, an erstwhile colonial power, and/or had a population that was already familiar with the basic principles of the transplanted law, generally have more effective legality than those that did not and, therefore, a greater positive, economic developmental impact. In the nineteenth century Ecuador, for instance, adopted French law without significant adaptation and without most Ecuadorians having any familiarity with it. It is thought that, had Ecuador been in a position to develop its own legal system internally or to adapt the transplanted law better, in 1994 its GNP per capita would have been ten times higher than it was.
Where a legal system is seriously dysfunctional, perhaps, because transplanted law does not sit well with features of the feudal-like society in which it has been required to take root, corruption, violence and poor legal competency are likely to be pervasive. So too will be the deleterious consequences of this, such as injustice, human rights abuse, conflict and distorted scarce resource allocation, manifested by poverty, unemployment, disaffection, environmental destruction and, perhaps, extremism.
It is often felt that there is a serious conflict of interest between entrepreneurial capitalistic activity and human rights; but, for the most part, the law and economic development are complementary and synergistic. While being aware, therefore, that abuse, exploitation and other excesses can and do occur in enterprises, we should not lose sight of the fact that robust economies depend on clear laws that govern societies and commerce, as well as a strong, independent legal system that impartially enforces laws and contracts. These ingredients that help ensure investors are not subject to arbitrary forces and can risk investing capital, make for greater legal predictability and equality before the law, which is very much the basis of, rather than being at odds with, rights that support human dignity.