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EXTRA CREDIT: 1st Junior and 1st Senior Econ student
to adequately explain this cartoon to me
FEATURED ARTICLE OF THE WEEK FROM
THE ECONOMIST REGARDING THE "RULE OF LAW" (IB
Section 5, Development)
The rule of law has become a big idea in economics.
But it has had its difficulties
JAC  “AM I the only economist guilty of using the term
[rule of law] without having a good fix on what it
really means?” asks Dani Rodrik of Harvard University.
“Well, maybe the first one to confess to it.”
The rule of law is usually thought of as a political
or legal matter. The world's newest country, Kosovo,
says its priority is to improve the rule of law in order
to reduce corruption and build up the state. But in the
past ten years the rule of law has become important in
economics too. Indeed, it has become the motherhood and
apple pie of development economics—which makes Mr
Rodrik's confession the more striking. The rule of law
is held to be not only good in itself, because it
embodies and encourages a just society, but also a cause
of other good things, notably growth. “No other single
political ideal has ever achieved global endorsement,”
says Brian Tamanaha, a legal scholar at St John's
University, New York.
But as an economic concept the rule of law has had a
turbulent history. It emerged almost abruptly during the
1990s from the dual collapses of Asian currencies and
former Soviet economies. For a short time, it seemed to
provide the answer to problems of development from
Azerbaijan to Zimbabwe, until some well-directed
criticism dimmed its star. Since then it has
re-established itself as a central concept in
understanding how countries grow rich—but not as the
panacea it once looked like.
Economists became fascinated by the rule of law after
the crumbling of the “Washington consensus”. This
consensus, which was economic orthodoxy in the 1980s,
held that the best way for countries to grow was to “get
the policies right”—on, for example, budgets and
exchange rates. But the Asian crisis of 1997-98 shook
economists' confidence that they knew which policies
were, in fact, right. This drove them to re-examine what
had gone wrong. The answer, they concluded, was the
institutional setting of policymaking, especially the
rule of law. If the rules of the game were a mess, they
reasoned, no amount of tinkering with macroeconomic
policy would produce the desired results.
This conclusion was strengthened by events in the
former Soviet empire. Many post-communist countries got
their policies roughly right fairly quickly. But it soon
became clear this was not enough. “I was a traditional
trade and labour economist until 1992,” says Daniel
Kaufmann, now head of the World Bank Institute's Global
Governance group. “When I went to Ukraine, my outlook
changed. Problems with governance and the rule of law
were undermining all our efforts.”
Pretty quickly, “governance”—political accountability
and the quality of bureaucracy as well as the rule of
law—became all the rage. Economists got busy calculating
what it was, how well countries were doing it and what a
difference it made. Mr Kaufmann and his colleague Aart
Kraay worked out the “300% dividend”: in the long run, a
country's income per head rises by roughly 300% if it
improves its governance by one standard deviation. One
standard deviation is roughly the gap between India's
and Chile's rule-of-law scores, measured by the bank. As
it happens, Chile is about 300% richer than India in
purchasing-power terms. The same holds for South Africa
and Spain, Morocco and Portugal, Botswana and Ireland.
Economists have repeatedly found that the better the
rule of law, the richer the nation. (The chart below
shows the results of three studies, put on a comparable
basis by Mr Kaufmann.) Every rich country with the
arguable exceptions of Italy and Greece scores well on
rule-of-law measures; most poor countries do not.
Mr Rodrik reviewed the contributions to growth of
governance (“institutions”, he called it), geography and
openness to trade. He concluded, to use the title of an
article he published in 2002, that “Institutions Rule”.
Writing from the perspective of a political scientist,
Francis Fukuyama of Johns Hopkins University concurred:
“I believe that the institutionalists have won this
argument hands down.”
Partly because of this, and also because the rule of
law is desirable for its own sake, governments and aid
agencies began splurging money on rule-of-law reforms,
such as training judges, reforming prisons and setting
up prosecutors' offices. Such reforms had begun in Latin
America in the mid-1980s. Now they became universal.
The European Union insists that all its members
satisfy standards for the rule of law. It requires
applicants to commit themselves to legal reforms to meet
those standards and dispatches armies of lawyers to
advise them how to bring their legal systems up to
scratch. America's Millennium Challenge Corporation, set
up in 2004 to improve the effectiveness of American
official aid, confines its largesse to countries that
have committed themselves to minimum rule-of-law
standards (one of three basic requirements). Western
donors have poured billions into rule-of-law projects
over the past 20 years. The World Bank is now running
such projects (narrowly defined) worth almost $450m; on
a wider definition, almost half the bank's total lending
of $24 billion in 2006 had some rule-of-law component
(for example, advice on conflict resolution in
village-development projects, or on bankruptcy law in
privatisation programmes). In roughly a decade the rule
of law has gone from a specialist political and legal
topic into a staple of economic thinking and the subject
of a vast aid-giving effort.
So it came as an unwelcome surprise when, in 2003,
one of the world's acknowledged experts on governance
wondered aloud whether the emperor had any clothes.
Thomas Carothers of the Carnegie Endowment for
International Peace, a think-tank in Washington,
DC, wrote a paper politely
entitled “Promoting the Rule of Law Abroad: The Problem
of Knowledge”. According to Mr Carothers, the problem
was, as William Goldman said of Hollywood, that nobody
knows anything.
Mr Carothers argued that the intrinsic difficulty of
defining the rule of law, combined with the problems of
knowing how specific laws work in practice, meant that
“the rapidly growing field of rule-of-law assistance is
operating from a disturbingly thin base of knowledge at
every level.” Many of the difficulties are inherent, he
said. But not all: aid organisations always look forward
to the next project, rather than back to the lessons of
experience; lawyers who carry out the work are not much
interested in development; university professors are not
gripped by applied policy research. As a result,
according to one rule-of-law promoter, “deep down, we
don't really know what we are doing.”
The shock of Mr Carothers's argument was salutary. In
response, there has been a flurry of rule-of-law
studies. A new body of work has appeared, which could be
called the economics of the rule of law. It shows the
rule of law can indeed be improved. It has made clearer
what economists and others mean when they talk about the
rule of law. It has laid down some guidelines about
reforms, helping show what works when, say, training
judges or policemen. What it has not yet shown beyond
doubt is that the rule of law is a precondition for
economic growth everywhere. In the process, the subject
of law as an economic matter has begun to grow up. It
has passed from vigorous childhood into more troubled
adolescence.
Unruly law
In “The Rule of Law and Development” (to be published
next month by Edward Elgar), Michael Trebilcock of the
University of Toronto and Ron Daniels of the University
of Pennsylvania tackle the question of what economists
mean by the rule of law. A report by a new research
group, the Hague Institute for the Internationalisation
of Law, does the same thing. Both publications argue
that people routinely use two quite different
definitions, which they call “thick” and “thin”.
Thick definitions treat the rule of law as the core
of a just society. In this version, the concept is
inextricably linked to liberty and democracy. Its
adherents say a country can be spoken of as being ruled
by law only if the state's power is constrained and if
basic freedoms, such as those of speech and association,
are guaranteed. The “declaration of Delhi” drawn up by
the International Commission of Jurists in that city in
1959 followed this line in saying that the rule of law
“should be employed to safeguard and advance the civil
and political rights of the individual” and create
“conditions under which his legitimate aspirations and
dignity may be realised.” Among other proponents of a
thick definition are Friedrich Hayek, an Austrian
economist, and Cass Sunstein of the University of
Chicago. In their view, the rule of law includes
elements of political morality.
Thin definitions are more formal. The important
things, on this account, are not democracy and morality
but property rights and the efficient administration of
justice. Laws must provide stability. They do not
necessarily have to be moral or promote human rights.
America's southern states in the Jim Crow era were
governed by the rule of law on thin definitions, but not
on thick.
The existence of competing definitions of something
may seem fatally to undermine its usefulness. If you
argue that the rule of law is vital to growth, which
version do you mean—the one that defends human rights or
the one that guarantees property rights? But economists
love competition. Their differing definitions of the
rule of law reflect competing explanations of what
drives economic growth.
One account of growth—associated with Douglass North
of Washington University in St Louis, Missouri—is
“institutional”. It focuses on the importance of
property rights, transaction costs and economic
organisation. On this view, stable, predictable laws
encourage investment and growth. Thin definitions of the
rule of law fit this well. The other—associated with
Amartya Sen of Harvard—says that if you expand people's
“capabilities” (Mr Sen's term), they will do things that
help countries grow rich. Freeing people to take
advantage of their capabilities usually means lifting
the oppressive burden of the state and guaranteeing
certain basic rights—a much thicker concept.
The distinction between thick and thin versions of
the rule of law overlaps another distinction between
legal traditions. Starting in 1997, a group of
economists led by Andrei Shleifer of Harvard and Robert
Vishny of Chicago started to compare the economic
performance of common-law countries (such as America and
Britain) with that of civil-law ones (France, Germany
and Scandinavia). They argued that common-law countries
have more secure property rights, better protection of
shareholders and creditors, more diversified share
ownership, and tougher disclosure and liability laws—to
the benefit, they claimed, of stockmarket performance.
Like the initial claims for the rule of law, those on
behalf of the common law were subject to harsh criticism
at about the same time, mostly from continental
economists. Some claimed the differences between common
and civil law were not as sharp as they seemed, and were
proxies for differences of politics, history and
culture. Others pointed out that a country's legal
origins do not seem to explain much about how it is
faring economically or in terms of the rule of law.
North and South Korea have the same legal origins.
But just as rule-of-law scholars have responded to
criticism with more research, so have the legal-origins
crowd. In a stream of papers they have found strong
evidence that civil-law countries encourage government
ownership of the media and banks, a higher burden of
entry into business, more labour-market regulation and
greater formalism of court procedures—to their
detriment, they claim.
Perhaps such arguments can never be resolved. As
Rainer Grote of the Max Planck Institute for Comparative
Public Law and International Law in Heidelberg says, the
rule of law “belongs to the category of open-ended
concepts which are subject to permanent debate.” This
part of the new economics of the rule of law clarifies
its role, but no more. Other findings, though, are more
constructive.
Scales of justice
There have been huge improvements in monitoring and
measuring the rule of law, even though people cannot
agree exactly what it is. “Fifteen years ago, we didn't
talk about this stuff,” says Steve Radelet of the Centre
for Global Development, a Washington think-tank. “Ten
years ago, there was no data.” Now, the Worldwide
Governance Indicators project—“one of the best kept
secrets at the World Bank”, believes Gordon Johnson, a
grand old man of aid-giving—is the state of the art. It
gathers data on more than 60 indicators (the extent of
crime, the quality of police, judicial independence and
so on) to create rule-of-law and governance measures for
virtually every country in the world. Aggregating like
this (and being honest about the margin of error), says
Mr Kaufmann, is far from perfect, but is a decent
approximation.
These measures confirm what is clear anyway: some
countries have been able to improve their legal
framework even in a short time. In 2000 Mikhail
Saakashvili, then Georgia's minister of justice, sacked
two-thirds of his country's judges for failing to pass
an exam. Four years later as president, he fired all the
country's traffic police. Georgia's World Bank
rule-of-law score rose from nine out of 100 in 2002 (in
the bottom 10%) to 33 at the end of 2006—low, but
better. Central European and Baltic countries are doing
better still: the radical legal changes required by
membership of the EU improved
their economies as well as their judicial systems.
In general, the measures suggest, bold reforms work
better than gradual ones. Latin America modernised its
penal codes and made trials more transparent. Chile, for
instance, established a new public-prosecution system
beginning in 2003. But many of its officials lack
experience and have met resistance from the police.
Russia implemented some judicial reforms in the 1990s
and raised spending on the courts in 2000—to no avail:
its rule-of-law scores have fallen in five of the past
seven years.
The difference between central Europe and Latin
America may be one of political backing. Messrs
Trebilcock and Daniels divide countries into three:
those where politicians, legal professionals and the
public all support reform (central Europe after the fall
of communism, South Africa after apartheid); those where
politicians support reform, but lawyers and police do
not (Chile and Guatemala); and those where lawyers want
change, but not politicians (Pakistan). Only in the
first group, the professors say, does rule-of-law reform
get far.
Consistent with that rather gloomy finding, some new
research finds only a weak link between the rule of law
and economic growth. The connection with wealth is well
established (see chart again) but that is different: it
has been forged over decades, even centuries. The link
with shorter-term growth is harder to see. China appears
to be a standing contradiction to the argument that the
rule of law is needed for growth. It is growing fast and
is the world's largest recipient of foreign investment,
yet has lots of corruption and nothing that most
Westerners would recognise as a rule-of-law tradition.
(It does, though, guarantee some property rights and its
government is good at formulating and implementing
policies.)
On the other hand, there is surely a connection
between the legal reforms carried out in central Europe
and the Baltics and their fast growth rates, or between
Spain's post-Franco legal opening and its long boom. And
there are proxy indicators connecting legal reform with
growth in other areas. The value of rural land in
Brazil, Indonesia, the Philippines and Thailand
increased sharply when people were given title deeds,
because owners were more willing to invest. One
independent study for the World Bank a decade ago found
a surprising link between projects the bank financed and
civil liberties: projects in countries with strong civil
liberties had far higher rates of return than those in
countries with weak traditions of liberty.
But such links do not tell you anything about
causation. Perhaps growth helps the rule of law, not
vice versa. Perhaps countries can afford the luxury of
the rule of law only after they have grown rich. The
persistence of “frontier justice” into the 1930s in
America gives a colour of plausibility to that idea.
Yet it is not Mr Kaufmann's view. He argues that
rule-of-law improvements tend to help growth; that few
countries have sustained gains in growth without
improving their rule of law; and that places that have
grown without such improvement have subsequently lurched
backwards (Argentina used to be one of the ten richest
countries in the world). The real puzzle is to explain
the exceptions: why crony capitalism has flourished in
parts of fast-growing Asia or Kremlin banditry in
Russia. The answer, he says, is that, without a rule of
law, well-connected crooks can grab an unfair share of
the spoils of growth, especially if these include
windfall gains from oil and raw materials.
The existence of crony capitalism and “state capture”
by robber barons is, of course, an argument for trying
to strengthen the rule of law where you can, since it
suggests growth will not necessarily create law
automatically. There are other arguments, too: the rule
of law is desirable for its own sake—to improve human
rights or to increase citizens' chances of justice
against predatory governments. As John Locke wrote in
1690, “wherever law ends, tyranny begins.” Plainly, in
some countries, such as Myanmar and Zimbabwe, legal
abuses and over-mighty regimes are direct obstacles to
growth. Reforms would help—if they could be implemented.
But as a generalisation, the efforts of the past few
years have thrown up mixed messages. They suggest the
rule of law can be improved sharply; that rule-of-law
reform is at root a political not a technical
undertaking; and that it is linked to growth, if weakly
in the short term. But they do not really bear out the
assertion that the rule of law is an underlying
prerequisite for growth. Rather, the more economists
find out about the rule of law, the more desirable it
seems—and the more problematic as a universal economic
guide.
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