A related point is made in Siems (2008b).He examined how shareholder protection has developed in 20 countries from 1995 to 2005.For transplant countries,an important factor was whether systems continued to take developments in the origin countries into account and thereby modify their law over time.This kind of legal diffusion was facilitated within the common law world by the presence of shared values and a common legal language.However, this was not restricted to common law countries.Within the common law family,there was no 'natural'following of the English path while,conversely, there were examples of influence across systems in the civil law world,for example between Germany and Austria,and between France and Luxembourg 3.2 Property rights,rents,and constituencies Another plausible account of the role of path dependence focuses on the distributional impact of legal rules (see Bebchuk and Roe,1999;Stern et al, 2005;Rajan and Zingales,2006).Particular legal institutions create entitlements in favour of certain constituencies.Thus a country's legal institutions could serve as a powerful means of locking in,and themselves be locked in by,distributional patterns.This would not only exert a force of conservatism against a shift away from incumbent legal institutions;it would also tend to perpetuate and strengthen the distributional patterns associated with it over time.This is because those to whom the property rights gravitate may be expected to use these to shore up and extend their own influence,through rent- seeking activities.Where the 'privileged'group can increase its returns at least cost through productive enterprise,we might expect to see lobbying activity to protect further the entitlements of individuals involved in such enterprise. However,where the legal system instead permits the privileged group to transfer resources from other individuals to themselves at relatively low cost, we might expect to see efforts being devoted over time to increase the scope of that group's control. The 'political'channel theory imagines a stylised 'common law'system to give relatively stronger protection to the property rights of individuals,the expropriation of which would then require their consent.In contrast,a stylised 'civil law'system would give citizens at large relatively weaker property rights; the correlative of this is that those controlling the country-the political class- have an additional bundle of entitlements-that is,the ability to use the system to divert resources to themselves from individuals.If the system gives this group disproportionate influence,then they will be able to use this influence to hold up a shift towards a legal system that protects individual property rights more strongly. 12
12 A related point is made in Siems (2008b). He examined how shareholder protection has developed in 20 countries from 1995 to 2005. For transplant countries, an important factor was whether systems continued to take developments in the origin countries into account and thereby modify their law over time. This kind of legal diffusion was facilitated within the common law world by the presence of shared values and a common legal language. However, this was not restricted to common law countries. Within the common law family, there was no ‘natural’ following of the English path while, conversely, there were examples of influence across systems in the civil law world, for example between Germany and Austria, and between France and Luxembourg. 3.2 Property rights, rents, and constituencies Another plausible account of the role of path dependence focuses on the distributional impact of legal rules (see Bebchuk and Roe, 1999; Stern et al, 2005; Rajan and Zingales, 2006). Particular legal institutions create entitlements in favour of certain constituencies. Thus a country’s legal institutions could serve as a powerful means of locking in, and themselves be locked in by, distributional patterns. This would not only exert a force of conservatism against a shift away from incumbent legal institutions; it would also tend to perpetuate and strengthen the distributional patterns associated with it over time. This is because those to whom the property rights gravitate may be expected to use these to shore up and extend their own influence, through rentseeking activities. Where the ‘privileged’ group can increase its returns at least cost through productive enterprise, we might expect to see lobbying activity to protect further the entitlements of individuals involved in such enterprise. However, where the legal system instead permits the privileged group to transfer resources from other individuals to themselves at relatively low cost, we might expect to see efforts being devoted over time to increase the scope of that group’s control. The ‘political’ channel theory imagines a stylised ‘common law’ system to give relatively stronger protection to the property rights of individuals, the expropriation of which would then require their consent. In contrast, a stylised ‘civil law’ system would give citizens at large relatively weaker property rights; the correlative of this is that those controlling the country—the political class— have an additional bundle of entitlements—that is, the ability to use the system to divert resources to themselves from individuals. If the system gives this group disproportionate influence, then they will be able to use this influence to hold up a shift towards a legal system that protects individual property rights more strongly
As we have just seen,the claim that common law systems are inherently more protective of property rights than civilian ones has been disputed.However,the argument that certain configurations of legal institutions are more likely than others to generate rent-seeking by insider groups is one that can be tested separately from the legal origin claim,by looking more closely at the institutions themselves at country-level.Only then will it be possible to have a clearer idea of whether such configurations are associated with a particular type of legal systems or with a particular history of legal diffusion.Again,this points to a deeper empirical encounter with the historical experience of national legal regimes than has so far been attempted within the legal origin literature 3.3 Institutional complementarities The 'adaptability'and political'theories both view legal systems in strongly functionalist terms:in the first case,laws directly influence economic development,with high-quality legal rules being matched to efficient economic outcomes;in the second case,laws are the result of political coalitions which serve to express the interests of groups in society.Both theories seek to explain legal evolution by reference to factors external to the legal system itself,and thereby downplay the possibility that legal systems are,to some degree, autonomous social institutions,evolving according to their own internal logic. This third position-an 'institutional channel'explantation of legal origin does not reject a functionalist logic entirely,but it proceeds on the basis that legal rules are only partially functional with regard to their wider political and economic environments. The core of this theory is the concept of 'institutional complementarities'as applied to legal systems (Ahlering and Deakin,2007).This holds that legal institutions do not exist in a vacuum:they are interconnected with other social institutions-in particular,with social norms and co-ordinating conventions that are relied upon for the organisation of a society-which are in turn connected to patterns of production and modes of distribution (Milhaupt and Pistor,2008). Thus legal systems are,to a certain extent,endogenous to the economic and political context in which they are situated.This view implies that both the "legal infrastructure"or "regulatory style,"which La Porta et al.(2008) associate with legal origin,and also the substantive content of legal rules,are shaped to some degree by trends in the economy and the political system. However,the 'fit'between the legal system and the forms of production is likely to incomplete and possibly sub-optimal.Complementarities between institutions mean that a particular institution,or group of institutions-let us call it 'X'may be retained even if in isolation it might not be optimal.The existence 13
13 As we have just seen, the claim that common law systems are inherently more protective of property rights than civilian ones has been disputed. However, the argument that certain configurations of legal institutions are more likely than others to generate rent-seeking by insider groups is one that can be tested separately from the legal origin claim, by looking more closely at the institutions themselves at country-level. Only then will it be possible to have a clearer idea of whether such configurations are associated with a particular type of legal systems or with a particular history of legal diffusion. Again, this points to a deeper empirical encounter with the historical experience of national legal regimes than has so far been attempted within the legal origin literature 3.3 Institutional complementarities The ‘adaptability’ and ‘political’ theories both view legal systems in strongly functionalist terms: in the first case, laws directly influence economic development, with high-quality legal rules being matched to efficient economic outcomes; in the second case, laws are the result of political coalitions which serve to express the interests of groups in society. Both theories seek to explain legal evolution by reference to factors external to the legal system itself, and thereby downplay the possibility that legal systems are, to some degree, autonomous social institutions, evolving according to their own internal logic. This third position – an ‘institutional channel’ explantation of legal origin – does not reject a functionalist logic entirely, but it proceeds on the basis that legal rules are only partially functional with regard to their wider political and economic environments. The core of this theory is the concept of ‘institutional complementarities’ as applied to legal systems (Ahlering and Deakin, 2007). This holds that legal institutions do not exist in a vacuum: they are interconnected with other social institutions—in particular, with social norms and co-ordinating conventions that are relied upon for the organisation of a society—which are in turn connected to patterns of production and modes of distribution (Milhaupt and Pistor, 2008). Thus legal systems are, to a certain extent, endogenous to the economic and political context in which they are situated. This view implies that both the “legal infrastructure” or “regulatory style,” which La Porta et al. (2008) associate with legal origin, and also the substantive content of legal rules, are shaped to some degree by trends in the economy and the political system. However, the ‘fit’ between the legal system and the forms of production is likely to incomplete and possibly sub-optimal. Complementarities between institutions mean that a particular institution, or group of institutions—let us call it ‘X’ may be retained even if in isolation it might not be optimal. The existence
of a complementarity between institutions X and Y would mean that replacing X would have an adverse effect on the productivity of Y.Where the size of this adverse effect would be greater than the benefits from replacing X with another institution-say,Z-X will be retained.A key implication of the potential for institutional complementarities is that there will be certain 'tipping points'in history at which hard-to-reverse choices will be made.In the case of institutions X and Y,the adoption of either in isolation is readily reversible should it cease to be optimal,but once both are adopted together,then the resulting complementarities provide a source of cross-subsidy which can lock in an inefficient institution. Here it is relevant that differences between common law and civil law systems seem to track quite closely the distinction drawn in the 'varieties of capitalism literature between 'liberal market'systems and 'coordinated market'systems (Ahlering and Deakin,2007).That is,systems in which employee participation is largely voluntaristic in the sense of being left to contract,and which are characterised by dispersed share ownership and deep and liquid securities markets,can be opposed to systems in which employee participation is statutorily co-ordinated,and in which share ownership tends to be concentrated in the hands of blockholders and securities markets are smaller and less liquid. A plausible working hypothesis is that legal institutions share complementarities with these other institutions,and with various social norms and conventions that exist in the relevant societies. Comparative legal analysis has shown that distinct legal models of the business enterprise have developed in the laws of western European systems over the past two centuries:a contractualist'approach in the English common law, which emphasises the separation of labour interests from the firm and the priority of financial controls over management,can be contrasted with French and German 'integrationist'models in which,to differing degrees,workers are more fully integrated into the enterprise and the power of external financial interests is muted (Supiot,1994).It has been argued that the roots of this divergence between systems are not to be found in the supposed distinction, upon which LLSV rely,between a predominantly judge-made common law and a statutory or codified civil law (Ahlering and Deakin,2007).Many of the detailed rules relating to the business enterprise are statutory in origin in both the common law and civil law,and in both sets of systems there has been an intertwining'of legislative intervention and judicial innovation since the first few decades of the nineteenth century.Instead,it can be shown that the rules which emerged to meet the needs of business in each country were conditioned 14
14 of a complementarity between institutions X and Y would mean that replacing X would have an adverse effect on the productivity of Y. Where the size of this adverse effect would be greater than the benefits from replacing X with another institution—say, Z—X will be retained. A key implication of the potential for institutional complementarities is that there will be certain ‘tipping points’ in history at which hard-to-reverse choices will be made. In the case of institutions X and Y, the adoption of either in isolation is readily reversible should it cease to be optimal, but once both are adopted together, then the resulting complementarities provide a source of cross-subsidy which can lock in an inefficient institution. Here it is relevant that differences between common law and civil law systems seem to track quite closely the distinction drawn in the ‘varieties of capitalism’ literature between ‘liberal market’ systems and ‘coordinated market’ systems (Ahlering and Deakin, 2007). That is, systems in which employee participation is largely voluntaristic in the sense of being left to contract, and which are characterised by dispersed share ownership and deep and liquid securities markets, can be opposed to systems in which employee participation is statutorily co-ordinated, and in which share ownership tends to be concentrated in the hands of blockholders and securities markets are smaller and less liquid. A plausible working hypothesis is that legal institutions share complementarities with these other institutions, and with various social norms and conventions that exist in the relevant societies. Comparative legal analysis has shown that distinct legal models of the business enterprise have developed in the laws of western European systems over the past two centuries: a ‘contractualist’ approach in the English common law, which emphasises the separation of labour interests from the firm and the priority of financial controls over management, can be contrasted with French and German ‘integrationist’ models in which, to differing degrees, workers are more fully integrated into the enterprise and the power of external financial interests is muted (Supiot, 1994). It has been argued that the roots of this divergence between systems are not to be found in the supposed distinction, upon which LLSV rely, between a predominantly judge-made common law and a statutory or codified civil law (Ahlering and Deakin, 2007). Many of the detailed rules relating to the business enterprise are statutory in origin in both the common law and civil law, and in both sets of systems there has been an ‘intertwining’ of legislative intervention and judicial innovation since the first few decades of the nineteenth century. Instead, it can be shown that the rules which emerged to meet the needs of business in each country were conditioned
by the wider economic environment of those systems,in ways which influenced their evolution at decisive points(Deakin,2008). A critical factor accounting for the persistence of diversity is the timing of industrialization.England's early industrialization occurred before the point at which early modern forms of corporatist regulation had fully given way to a legal order based on modern notions of contract and property,whereas in France and Germany the codification movement of the early nineteenth century swept aside the vestiges of late-medieval regulation several decades before large-scale industry developed.As a result,the core legal institutions of the business enterprise,the contract of employment and the company limited by share capital,were somewhat slower to develop in Britain than on the continent; this meant that the English common law was less well adapted to the appearance of large vertically-integrated firms at the turn of the twentieth century than its French and German equivalents.Legal codification on the continent was also one of the factors,along with the wider political context, which ensured that the claims of organized labour received legal recognition at an earlier point in France and Germany than in Britain. Legal diversity in the way in which the business enterprise is conceptualized and regulated is the consequence of a range of different factors coming together, at points in the development of market economies,to influence the evolutionary path of the law.The way in which these factors combined to shape legal evolution during the formative period of industrialization in Western Europe was to a large extent contingent rather than structural;but once the predominant pattern was set,institutional lock-in meant that it was difficult to shift.To that extent,the different legal cultures of the common law and civil law have become the 'carriers of history',perpetuating diversity through their wider diffusion around the world as a result of legal transplantation in the course of the nineteenth and twentieth centuries. Most developing countries obtained their legal systems through colonial settlement;there is no reason to expect,in these cases,a degree of complementarity between transplanted legal institutions and indigenous economic ones.However,we might well expect to find that developing countries draw on models of legal regulation from parent systems because of the affinities of legal thought and language0 which operate within given 'legal families':in this case,path dependence in the legal and regulatory styles emerges as an efficient adaptation to the previously transplanted legal infrastructure'(Botero et al.,2004:1346).Thus the French legal tradition of embedding labour and social rights in constitutional texts is one which has 15
15 by the wider economic environment of those systems, in ways which influenced their evolution at decisive points (Deakin, 2008). A critical factor accounting for the persistence of diversity is the timing of industrialization. England’s early industrialization occurred before the point at which early modern forms of corporatist regulation had fully given way to a legal order based on modern notions of contract and property, whereas in France and Germany the codification movement of the early nineteenth century swept aside the vestiges of late-medieval regulation several decades before large-scale industry developed. As a result, the core legal institutions of the business enterprise, the contract of employment and the company limited by share capital, were somewhat slower to develop in Britain than on the continent; this meant that the English common law was less well adapted to the appearance of large vertically-integrated firms at the turn of the twentieth century than its French and German equivalents. Legal codification on the continent was also one of the factors, along with the wider political context, which ensured that the claims of organized labour received legal recognition at an earlier point in France and Germany than in Britain. Legal diversity in the way in which the business enterprise is conceptualized and regulated is the consequence of a range of different factors coming together, at points in the development of market economies, to influence the evolutionary path of the law. The way in which these factors combined to shape legal evolution during the formative period of industrialization in Western Europe was to a large extent contingent rather than structural; but once the predominant pattern was set, institutional lock-in meant that it was difficult to shift. To that extent, the different legal cultures of the common law and civil law have become the ‘carriers of history’, perpetuating diversity through their wider diffusion around the world as a result of legal transplantation in the course of the nineteenth and twentieth centuries. Most developing countries obtained their legal systems through colonial settlement9 ; there is no reason to expect, in these cases, a degree of complementarity between transplanted legal institutions and indigenous economic ones. However, we might well expect to find that developing countries draw on models of legal regulation from parent systems because of the affinities of legal thought and language10 which operate within given ‘legal families’: in this case, ‘path dependence in the legal and regulatory styles emerges as an efficient adaptation to the previously transplanted legal infrastructure’ (Botero et al., 2004: 1346). Thus the French legal tradition of embedding labour and social rights in constitutional texts is one which has
significantly impacted on the development of labour law in Africa and,via Spanish and Portuguese influences,Latin America.The centralizing influence of the colonizing power in directing legal change may also,more straightforwardly be a factor.There is evidence that this is the case,for example,with the diffusion of norms of British 'master and servant'law throughout the common law world from the eighteenth century onwards,a process that continued up to the middle decades of the twentieth century (Hay and Craven,2004). On this view,some sort of 'legal origin'effect might be expected to persist into the present day,and could account for a degree of divergence across systems. But the strength of this effect might be weak when compared to other forces tending towards convergence,such as moves to develop internationally applicable standards in such areas as corporate governance,the harmonizing efforts of transnational entities such as the European Union,and the willingness of countries to borrow legal rules and institutions which appear to work well in other systems,regardless of their common law or civil law origins.Nor would we expect a legal origin effect which had such a weakgravitational force'to be a major break on economic development,or,conversely,to be an important stimulant of it.However,the strength or weakness of the legal origin effect cannot,on this approach,be determined a priori;it must be empirically investigated. 4.Constructing panel data on legal rules The first step in such an investigation is the construction of indices tracking different dimensions of the law across time.This allows us to generate panel data on the evolution of legal institutions.In this section we present new indices tracking different aspects of the legal rules affecting the business enterprise.Our approach to index construction involved two stages.First,relatively long series of legal data were collected for a small number of countries:the UK,the US, Germany,France and India.These are of particular interest because they include three common law and two civilian countries;the three 'mother countries'for the common law and the French and German civil laws;one economically significant developing country which is also the world's largest democracy,and the country which is the world's largest economy.The legal data collected comprised indicators relating to the protection of shareholders creditors and workers However,so as to minimise the risk of replicating the selection problems inherent in LLSV's early indices,new indices,covering a much wider range of variables (between 40 and 70 in each index,as opposed to 4-5 in the first LLSV indices),were constructed. 16
16 significantly impacted on the development of labour law in Africa and, via Spanish and Portuguese influences, Latin America. The centralizing influence of the colonizing power in directing legal change may also, more straightforwardly be a factor. There is evidence that this is the case, for example, with the diffusion of norms of British ‘master and servant’ law throughout the common law world from the eighteenth century onwards, a process that continued up to the middle decades of the twentieth century (Hay and Craven, 2004). On this view, some sort of ‘legal origin’ effect might be expected to persist into the present day, and could account for a degree of divergence across systems. But the strength of this effect might be weak when compared to other forces tending towards convergence, such as moves to develop internationally applicable standards in such areas as corporate governance, the harmonizing efforts of transnational entities such as the European Union, and the willingness of countries to borrow legal rules and institutions which appear to work well in other systems, regardless of their common law or civil law origins. Nor would we expect a legal origin effect which had such a weak ‘gravitational force’ to be a major break on economic development, or, conversely, to be an important stimulant of it. However, the strength or weakness of the legal origin effect cannot, on this approach, be determined a priori; it must be empirically investigated. 4. Constructing panel data on legal rules The first step in such an investigation is the construction of indices tracking different dimensions of the law across time. This allows us to generate panel data on the evolution of legal institutions. In this section we present new indices tracking different aspects of the legal rules affecting the business enterprise. Our approach to index construction involved two stages. First, relatively long series of legal data were collected for a small number of countries: the UK, the US, Germany, France and India. These are of particular interest because they include three common law and two civilian countries; the three ‘mother countries’ for the common law and the French and German civil laws; one economically significant developing country which is also the world’s largest democracy, and the country which is the world’s largest economy. The legal data collected comprised indicators relating to the protection of shareholders creditors and workers However, so as to minimise the risk of replicating the selection problems inherent in LLSV’s early indices, new indices, covering a much wider range of variables (between 40 and 70 in each index, as opposed to 4-5 in the first LLSV indices), were constructed.11