UNIVERSITY OF VIRGINIA SCHOOL OF LAW Legal Studies Working Papers Series The common law and Economic growth Hayek might be right Paul G. mahoney Working Paper 00-8 January 2000 This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection http://papers.ssrn.com/paper.taf?abstractid=206809
UNIVERSITY OF VIRGINIA SCHOOL OF LAW Legal Studies Working Papers Series The Common Law and Economic Growth: Hayek Might be Right Paul G. Mahoney Working Paper 00-8 January 2000 This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection http://papers.ssrn.com/paper.taf?abstract_id=206809
The common law and economic growth: Hayek Might be right Paul G. Mahoney University of Virginia School of Law 580 Massie road Charlottesville. VA 22903 (804)924-3996;fax(804)924-7536 pgm9h(@virginia. edu I thank Kevin Davis. Ronald Barry Ickes, Ross Levine, Katharina Pistor, and participants at the University of Virginia Studies workshop and the Corporate Governance: Lessons to Ross Levine for access to some of the data used in the pape, Of Michigan. I am also grateful from Transition Economy Reforms conference at the University December 28 1999
The Common Law and Economic Growth: Hayek Might be Right Paul G. Mahoney University of Virginia School of Law 580 Massie Road Charlottesville, VA 22903 (804)924-3996; fax (804)924-7536 pgm9h@virginia.edu I thank Kevin Davis, Ronald Gilson, Barry Ickes, Ross Levine, Katharina Pistor, and participants at the University of Virginia Legal Studies workshop and the Corporate Governance: Lessons from Transition Economy Reforms conference at the University of Michigan. I am also grateful to Ross Levine for access to some of the data used in the paper. December 28, 1999
The Common Law and Economic growth: Hayek might be right ey Abstract Recent finance scholarship finds that countries with legal systems based on the common law provide better investor protections and have more developed financial markets than civil law countries. These findings echo Hayek's claims of the superiority of English to French legal institutions. In this paper, I present evidence that common law countries experienced faster economic growth than civil law countries during the period 1960-1992. I suggest that the difference reflects the common law's greater orientation toward private economic activity and the civil laws greater orientation toward government intervention
1 The Common Law and Economic Growth: Hayek Might be Right Paul G. Mahoney Abstract Recent finance scholarship finds that countries with legal systems based on the common law provide better investor protections and have more developed financial markets than civil law countries. These findings echo Hayek’s claims of the superiority of English to French legal institutions. In this paper, I present evidence that common law countries experienced faster economic growth than civil law countries during the period 1960-1992. I suggest that the difference reflects the common law’s greater orientation toward private economic activity and the civil law’s greater orientation toward government intervention
[T]he ideal of individual liberty seems to have flourished chiefly among people where, at least for long periods, judge-made law predominated"(Hayek, 1973, p. 94) Recently, economists have produced evidence that financial markets contribute to economic growth and legal institutions contribute to the growth of financial markets. King and Levine(1993) demonstrate that the rate of increase in per capita gross domestic product(GDP)is greater in countries with more developed financial markets. La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998; 1997)(hereafter LLSV, 1998 and LLSV, 1997) find evidence that the extent to which a country's corporate laws protect the interests of minority investors is an important determinant of the cost of external capital. They also, interestingly, find that countries whose legal systems are derived from the common law tradition provide superior investor protections on average, particularly in comparison to the French civil law tradition. Levine(1999)and Levine, Loayza and Beck(1999) find that better investor protections are associated both with more developed financial markets and faster economic growth Levine(1999), Levine Loayza and Beck(1999)and LLSV(1998 )treat legal origin as nstrumental variable for financial development. Legal origin is well suited to the purpose. It is largely exogenous, as most countries have had their legal systems imposed by colonization or conquest. Legal origin also correlates strongly with policies(such as creditor and minority shareholder protections) that on the basis of theory and empirical results should lead to greater financial market development. The authors do not, however, provide an explanation for the correlation. Corporate law seems an unlikely place to find a systematic difference between
2 “[T]he ideal of individual liberty seems to have flourished chiefly among people where, at least for long periods, judge-made law predominated” (Hayek, 1973, p. 94). I. Introduction Recently, economists have produced evidence that financial markets contribute to economic growth and legal institutions contribute to the growth of financial markets. King and Levine (1993) demonstrate that the rate of increase in per capita gross domestic product (GDP) is greater in countries with more developed financial markets. La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998; 1997) (hereafter LLSV, 1998 and LLSV, 1997) find evidence that the extent to which a country’s corporate laws protect the interests of minority investors is an important determinant of the cost of external capital. They also, interestingly, find that countries whose legal systems are derived from the common law tradition provide superior investor protections on average, particularly in comparison to the French civil law tradition. Levine (1999) and Levine, Loayza and Beck (1999) find that better investor protections are associated both with more developed financial markets and faster economic growth. Levine (1999), Levine Loayza and Beck (1999) and LLSV (1998) treat legal origin as an instrumental variable for financial development. Legal origin is well suited to the purpose. It is largely exogenous, as most countries have had their legal systems imposed by colonization or conquest. Legal origin also correlates strongly with policies (such as creditor and minority shareholder protections) that on the basis of theory and empirical results should lead to greater financial market development. The authors do not, however, provide an explanation for the correlation. Corporate law seems an unlikely place to find a systematic difference between
common and civil law countries. Compared to other areas of commercial law, such as contract or commercial paper, corporate law has been largely code- like in the common law countries from a very early date. This raises the question whether the tendency toward more efficient rules of corporate law in common law countries is a coincidence that might disappear or reverse in other areas of commercial law This paper explores an alternative possibility-that legal origin is not merely an instrument for financial development, but is causal in its own right. The motivation for the hypothesis is Hayek's(1960)argument for the superiority of English to French legal traditions. Hayek viewed the decentralized, judge-made common law as an example of spontaneous order, and a considerable amount of his later work returned to this idea( hayek 1960, 1967, 1973; see Ogus, 1989 for a critical survey ) Because, in Hayek's view, the spontaneous order represented by the common law is more consistent with individual liberty than the more rationalist and constructivist (and therefore more interventionist)tendencies of the civil law, the common law is associated with fewer government restrictions on economic and other liberties. If common law countries ndeed provide greater freedom to their citizens, they should experience more rapid economic growth Hayek's views are correct as a matter of legal history. Although legal systems are most often acquired involuntarily, they were an object of conscious choice in both England and France English common law developed as it did because landed aristocrats and merchants wanted a system of law that would provide strong protections for property and contract rights and limit the crowns ability to interfere in markets. French civil law, by contrast, developed as it did because the revolutionary generation, and Napoleon after it, wished to disable judges from thwarting
3 common and civil law countries. Compared to other areas of commercial law, such as contracts or commercial paper, corporate law has been largely code-like in the common law countries from a very early date. This raises the question whether the tendency toward more efficient rules of corporate law in common law countries is a coincidence that might disappear or reverse in other areas of commercial law. This paper explores an alternative possibility–that legal origin is not merely an instrument for financial development, but is causal in its own right. The motivation for the hypothesis is Hayek’s (1960) argument for the superiority of English to French legal traditions. Hayek viewed the decentralized, judge-made common law as an example of spontaneous order, and a considerable amount of his later work returned to this idea (Hayek 1960, 1967, 1973; see Ogus, 1989 for a critical survey). Because, in Hayek’s view, the spontaneous order represented by the common law is more consistent with individual liberty than the more rationalist and constructivist (and therefore more interventionist) tendencies of the civil law, the common law is associated with fewer government restrictions on economic and other liberties. If common law countries indeed provide greater freedom to their citizens, they should experience more rapid economic growth. Hayek’s views are correct as a matter of legal history. Although legal systems are most often acquired involuntarily, they were an object of conscious choice in both England and France. English common law developed as it did because landed aristocrats and merchants wanted a system of law that would provide strong protections for property and contract rights and limit the crown’s ability to interfere in markets. French civil law, by contrast, developed as it did because the revolutionary generation, and Napoléon after it, wished to disable judges from thwarting