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Development and the Rule of Law

April 4, 2008


Corruption is one of the surest ways to undermine development. Almost every country at the bottom of the economic pyramid suffers from corrupt government, which is the reason that decades of foreign aid have produced little of lasting consequence. The elimination of corruption requires both the rule of law and transparency, — two of the pre-requisites I have often discussed when writing about Development-in-a-Box™. The Economist notes, however, that the very term “rule of law” is not well understood even if it is important [“Order in the Jungle,” 15 March 2008 print edition].

“‘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.”

Laws, of course, are important in order to maintain order (traffic laws, criminal laws, etc.), but they are also important for the protection of investments (property laws, for example). Regulations also play an important role in the rule of law. Just as important as laws on the books, however, is enforcement in the community. The focus of The Economist article is rule of law as the framework for good governance and policymaking.

“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.”

Importantly, economists were able to judge roughly a real benefit associated with improved governance. They noted a positive correlation between governance and GDP per head — a metric The Economist is pushing as a better measure of a country’s real economic health [see my post The Global Economy through a Different Lens].

“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. Every rich country with the arguable exceptions of Italy and Greece scores well on rule-of-law measures; most poor countries do not.”

One of things that those in the development community have started focusing on is building institutions that are capable of sustaining development. As the capacity of such institutions increases, so does a country’s ability to govern.

“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.”

Notice that the institutions listed are more involved with enforcing laws, regulations, and policies than in establishing them. It’s a relatively simple matter to look around the globe and select good laws, regulations, and policies. It is a great deal more difficult to change a culture of corruption from ignoring to enforcing laws.

“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.”

All that sounds very impressive; but, The Economist asserts that the term “rule of law” appears to be more of a bumper sticker slogan than a well-understood political, legal, and economic doctrine.

“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.”

As noted above, the problem may have been that experts were concentrating more on “law” than on “rule.” By that I mean, they were concentrating on enacting laws, regulations, and policies, but not nearly as much attention on enforcing them. Further study needs to done to understand better the forces that undermine how enforcement. If enforcement were an easy thing to do, there would be no crime (either white or blue collar) in countries that have a long rule of law tradition. Of course, that isn’t the case. There are wide differences in crime rates and how enforcement is carried out. Culture plays a major role in how laws are enforced and that is an area where lessons in one setting cannot necessarily be applied in another. Nevertheless, the article notes, studies continue to be undertaken on the subject of rule of law.

“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. 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. … 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. … 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.”

My colleague Tom Barnett insists that economic reform often precedes politic reform. The best case in point is China, where economic reform has raced ahead of political reform. Yet no one could argue against the fact that China has enjoyed tremendous development. If China’s case is not idiosyncratic, then it appears that the “thin” definition is one that best fits the empirical data. The Bush administration, which has continually argued that democracy must be established in country’s where it does not now exist, would argue that even if the “thin” definition is the place to start, it must eventually move from thin to thick if development is to be sustainable. I suspect the debates on the subject will continue to rage. In the end, however, I believe the thin to thick argument will probably prove correct.

“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.”

In the long run, practical experience will teach us more about what works and what doesn’t than will decades of theories and debate. The article notes that improved monitoring should help practitioners learn these lessons more quickly.

“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.”

The article compares what has happened in central Europe (bold reforms) to what happened in Latin America (gradual reforms) and in Putin’s Russia (failed reforms).

“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.”

In business change terms, this is referred to as alignment. Without top to bottom alignment change is really difficult to achieve. The article agrees that there is a correlation between wealth and the rule of law, but argues that most wealthy countries have accumulated that wealth over decades (or longer). Short-term gains associated with improved rule of law, it asserts, is much more difficult to prove. It even argues that China is “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.” But The Economist does concede that China does “guarantee some property rights and its government is good at formulating and implementing policies.” This supports the “very thin” theory of rule of law.

“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. … 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.”

Although, in the end, the article argues that studies “do not really bear out the assertion that the rule of law is an underlying prerequisite for growth” it does admit that “the more economists find out about the rule of law, the more desirable it seems.” Any other conclusion, I would argue, would have been counterintuitive. Eventually, I believe the assertion that rule of law is a prerequisite for sustainable development will be proven. Economic growth requires trust and trust is built by the adherence to accepted rules.

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