Daniel Sokol on evolution, law, and institutions

Here is Daniel Sokol at the Conglomerate in 2008:

I believe that LLSV makes certain assumptions about history and political economy in legal origins that are not exactly supported by the underlying historical record.  A number of scholars have attacked LLSV on these grounds. Nevertheless, I still find myself strangely attracted to LLSV. In many ways, the results are what you would intuitively expect if you were on your own to attempt to rank countries based on investor protection or other similar features. More importantly, a number of the variables that LLSV uses are a bit squishy but we have yet to come up with better cross country measurements. Indeed, as a result of the critiques, LLSV have gotten better as to how they measure shareholder protection. From a policy perspective, the key to change to various bottlenecks requires not merely a top down approach in the change of the legal system but a bottom up approach by the users of these legal systems to overcome various bottlenecks that are regulatory. This makes me believe that over time the common law/civil law distinction will be seen as a rather false one where instead you will find countries lumped into categories based on their ability to respond to local and changing conditions (even the United States, which in recent years may have created increased regulatory bottlenecks such as SOX). This evolutionary approach is what I believe holds the key to understanding how to think about law and institutions.

LLSV refers to the seminal papers by La Porta, Lopez-de-Silanes, Schleifer, and Vishny in 1997 (Legal Determinants of External Finance) and 1998 (Law and Finance) which establish a thesis linking common, civil, and hybrid legal regimes to economics development and financial growth. The internal story has to do with the different kinds of investor protection that emerges under these regimes.

Sokol’s argument here resonates with me quite a bit and while it means that policy work that tries to draw conclusions of strict classification runs into some fairly tangible walls, I think the intuition that says that markets and institutions work together in complex and adaptive ways provides some rather good insights into where analytical work might be useful. I’ll be developing this in a post later this week so stay tuned…

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3 thoughts on “Daniel Sokol on evolution, law, and institutions

  1. […] This post was mentioned on Twitter by eapenthampy. eapenthampy said: Here is a good excerpt from Daniel Sokol on the evolutionary nature of the interaction between institutions and markets http://bit.ly/d7c9Zj […]

  2. Dan says:

    Complexity and adaptibility are rather broad and therefore not very constructive ways of thinking about this problem in my view…

    Most literature on law and markets, including the paper you cite, speaks of different regulatory frameworks and how these laws provide the appropriate carrots and sticks to foster investment.

    But let’s face it, the latest financial crisis, as well as much of history of development, arguably took place because, well, agents in the economy work according to their own rules — legislation very rarely gets in the way, and when it helps, well… When necessary, some economic agents find ways of controlling the existing legal framework (such as the impact high-powered financial institutions on the bond ratings agencies) to achieve their goals. A historical example is the development of canals in early U.S. history. Legal historians such as Morton Horwitz (at Harvard) have shown how canal development infringed on water use rights of surrounding small mill owners without any compensation. It’s classic eminent domain, but it was framed by the courts in terms of increasing public welfare. And is it efficient? Well it’s easy to see New England merchants and farmers felt.

    In other words, whether economic agents are completely ignoring the legal system, OR whether they are using the legal system for certain means, the central point is that the law isn’t about passively setting up the right incentives — law plays a quite active role (in either case) in shaping the dynamics of economic development.

    I look forward to reading more of your thoughts on this issue.

  3. Eapen Thampy says:

    Dan,
    I don’t think anything you say is inconsistent with the notions of complexity and adaptability. In fact I think that the last comment you make “law plays a quite active role” is precisely the point that emerges from LLSV et al. I’m working on a series of posts that will be more precise about exactly how that functions.

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