One hypothesis (the ‘adaptability’ claim) concerns the way in which new rules are produced. Civilian systems are characterised by wide-ranging codification of legal rules, whereas common law systems are distinguished by their reliance on incremental change through the accumulation of judicial precedent. It may be that this ability to shape the law on a case-by-case basis helps to render legal regulation more adaptable. A second hypothesis (the ‘political’ claim) posits that judges in common law systems have greater power (as lawmakers) and independence from the other branches of government, and consequently may be expected to do a better job in protecting private property rights from encroachment by the state.

• Is the “adaptability claim” true in India?

If it were an accurate account, we would expect to see rapid development of judicial rules following significant environmental or technological changes. Post-liberalisation India therefore makes a good test case.

The defining feature of the Indian court system is the staggering delay involved in resolving a case by trial. With a typical delay of 10 years or more until a lawsuit is resolved, it seems hardly likely that judicial innovation in lawmaking can have been the main channel through which India’s substantive laws regarding investor protection were developed in the post-liberalisation era.

• What actually worked instead?

These findings challenge the notion that common law systems’ alleged advantages in terms of adaptability give them an inherent advantage for economic development. Where courts are chronically overworked—as is likely to be the case in many developing countries—then it is hard to see that they can be motors of legal reform. In contrast, the most successful mechanism for producing new laws in India has been delegation to regulators with quasi-legislative power. The real engines for development of the legal framework of corporate finance in India have rather been specialist regulatory bodies such as SEBI, and, to a lesser extent, the RBI.

• Is the “political” claim true, then?

There is some support in India’s constitutional history for the idea that a politically independent judiciary can assist financial development. The Supreme Court [before the Emergency] came up with many ingenious ways to protect private property from public takings. Although ultimately the legislature succeeded in putting the protection of property rights beyond justiciability, it seems clear that the independent and activist judiciary delayed this process for some time¿Thus it seems likely that the political independence of India’s judiciary has played a meaningful role in protecting property rights in the years since independence. Despite the problems of backlog, the Supreme Court has been willing to go to great lengths to ensure that cases involving issues of expropriation are heard. Yet whilst a powerful independent judiciary can clearly act as a constraint on rent-seeking legislative measures, this works as a double-edged sword—following liberalisation in 1991, strong judicial protection has acted as a brake on the rapid transformation of credit markets, owing to constitutional challenges to reforms to debt enforcement and insolvency laws.

• So what does it mean for theories about the role of law in financial development?

We have seen that two aspects of the ‘legal origins’ claim at best only partly explain the pattern which the development of India’s investor protection has followed since liberalisation. And to the extent that it does — through the ‘political’ channel — the implications are at least partly contrary to the manner predicted by the theorists: India illustrates that a politically independent judiciary may be a check on beneficial adaptation, as well as rent-seeking.

Together, these findings imply a significantly more modest role for law than is commonly understood in the ‘law and finance’ literature, which accords much weight to the civil or common law nature of a country’s legal system. Indeed, the pattern of complementarities between India’s legal, financial and economic structure do not appear to have been determined by the country’s legal origin. Rather, we find more support for the claim that economic structure is a determinant of financial structure.The pattern of India’s (relatively) service-oriented economy appears to be an unintended consequence of the policies pursued during the pre-liberalisation period.

• So how can we learn from that?

Those policies have also had an independent influence on legal reform, as the development of credit markets appears to have been delayed by the need to re-orient regulators and institutions from their former role in industrial policy to simply imposing a hard budget constraint. It seems that it may be easier to create new institutions from scratch (SEBI) than to reorient the culture and interest groups associated with an existing institution designed for a different purpose (RBI).

Extracted from “Law, Finance, and Politics: The Case of India”, by John Armour and Priya Lele. Available online at ecgi.org/wp