What Does the Rule of Law Variable Measure?

21 August 2009 at 9:32 am 2 comments

| Peter Klein |

Bill Easterly poses this question, referring to his NYU colleague Kevin Davis’s work on law and development. Davis has several papers criticizing economists’ use of rule-of-law variables in development research (1, 2, 3). As summarized by Easterly:

Kevin points out that two current measures of “rule of law” used by economists in “institutions cause development” econometric research are by their own description a mixture of some characteristics of the legal system with a long list of non-legalistic factors such as “popular observance of the law,” “a very high crime rate or if the law is routinely ignored without effective sanction (for example, widespread illegal strikes),” “losses and costs of crime,” “corruption in banking,” “crime,” “theft and crime,” “crime and theft as obstacles to business,” “extent of tax evasion,” “costs of organized crime for business” and “kidnapping of foreigners.” Showing that this mishmash is correlated with achieving development tells you what exactly? Hire bodyguards for foreigners?

What if “institutions” are yet another item in the long list of panaceas offered by development economists that don’t actually help anyone develop?

Easterly opens with a clever example of a legal rule that doesn’t make sense outside an informal, non-rule context. But overall I think he’s a little unfair to the development and financial economists working in this area, many of whom are sensitive to these problems but are doing the best they can with the data available. It’s true, however, that much of the early work, particularly in the LLSV tradition, conflated de jure and de facto rules (particularly in over-emphasizing differences between common-law and civil-law countries). Benito Arruñada’s critique of the Doing Business Project is also informative in this regard.

Entry filed under: - Klein -, Business/Economic History, Institutions, Myths and Realities, New Institutional Economics. Tags: .

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2 Comments Add your own

  • 1. Jesper Wittrup  |  23 August 2009 at 1:34 pm

    As reflected in the post, I think it is possible to put both a negative and a positive spin to the contributions from the rule of law school.

    The negative story is that the rule of law branch within economics, and especially LLSV, gained an extreme level of attention and popularity (e.g. based upon the number of scientific citations) mainly because of the ability of the authors within this school to meet the always popular demand for simple solutions to complex problems, and in addition their willingness to apply the persuasive power of simple regression. It then turned out, as indeed pointed out by Davis and Arrunada & Andanova but also by countless others, that the empirical analyses suffered from many and serious flaws.

    First, the concept of legal origin, which was the most important pillar of early LLSV research, is highly controversial. According to work by e.g. Mathias Siems and Jerome Sgard it appears that a) we have difficulties classifying a large number of countries according to legal origin; and b) within-family (origin) differences of institutional characteristics may be just as or even more pronounced than between-family characteristics. It appears that economists have chosen to embrace the concept of legal families at a time when most serious law scholars have abandoned it.

    Second, the attempt to replace the legal origin variable with other more “designable” institutional variables, like judicial independence or judicial formalism, does not appear to have been entirely successful. One important flaw is indeed that the indicators used are so astonishingly primitive. For example, the indicator for judicial independence applied in LLSV research has two basic components: 1) whether judicial (court) decisions are a source of law (the judiciary is considered more independent if it is); and 2) whether judges have tenure for more or less than 6 years, or lifelong. The first component does not really has anything to do with judicial independence as the concept is commonly used (but is instead considered one of the defining characteristics of common law systems), and while the second component may tell us something about judicial independence, to use it as the only proxy (thus disregarding all other issues related to appointment, promotion and management of judges) ought to make even the most myopic economist blush.

    Third, one easily gets the impression that the development of theory in this area has largely followed – not preceded – data-mining. The mocking commentary by West (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=318940 ) is a case in point. In addition, when one takes a closer look at the models and tinkles a bit with them, e.g. add some rather reasonable conditioning variables, several of the results do not appear to be robust.

    Summing up, we do not seem to know much about how judicial institutions impact judicial performance or economic performance, and economics of law research has not yet proven to be the cure for this lack of knowledge. Indeed, one may ask whether the whole thing has served any other purpose than to build the careers and fame of a number of economists – first those who promoted the law and economics approach, and now those who help tearing it down?

    On a more positive note, one may argue, that the situation is not so bleak. Shouldn’t we welcome that these researchers have actually had the courage to address one of the most acute real-world problems of today, how to organize the judiciary, even though this may not be the easiest subject to get reliable data about? Much too often (also within the law & economics literature) it appears that study subjects are chosen because data are easy to get, rather than because of the broader relevance of the subject. In addition, it may actually be a good sign that the sweeping claims made by early research have received so intense critique. This should allow for scientific growth, and I think there are some signs that improvements are about to be made with regard to conceptualizing and measuring important judicial variables.

    Finally, when Easterly talks about whether this kind of research has actually helped anybody, the answer appears (for now) to be no, if the criteria for success is that the models should pinpoint with perfect certainty and accuracy the institutional design for the best possible judicial system. Such criteria may be too ambitious, however. Has the theory of the firm ever helped anybody design a company in this way? Probably not! If has it indeed helped anybody, it may be by drawing attention to some of the social dilemmas involved in business, but it has never eliminated the need for thinking beyond that. In the same way rule of law research has helped drawing attention to some important dilemmas related to e.g. judicial independence and judicial formalism (bureaucracy), but actual system design continues to be a matter of complexity.

    So while I am attracted by cynicism of the first (negative) story above, I choose to believe mostly in the second.

  • [...] Para reflexionar sobre instituciones y desarrollo “Institutions are the secret to development, if only we knew what they were” (encontrado a través de aquí) [...]

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