The exception that is India

One of the central questions that interests political scientists, economists, legal theoreticians and public policy-makers is the exact manner in which existing “institutions” — things like rules, customs, and traditions, both formal and informal — affect growth and development.

One of the central questions that interests political scientists, economists, legal theoreticians and public policy-makers is the exact manner in which existing “institutions” — things like rules, customs, and traditions, both formal and informal — affect growth and development. This is necessary because without knowing this, reforming those institutions that may be holding back development is pretty difficult.

One link in particular between institutions and growth has received lots of attention. That’s the link between “legal quality” — a proxy for investor protections, enforceable contracts, property rights — and growth. Areas with higher legal quality will have more investors, a bigger financial sector and thus higher growth.

People have tried to look at numbers to prove or disprove a link: but it’s technically difficult to directly work out what the data means. So researchers now —following landmark papers from LaPorta, Lopez, Shleifer and Vishny, known universally as LLSV — look at “legal origins” instead. The idea is that if a country’s codes have Anglo-American or “common law” roots, they protect investors better than if they follow any of the other European legal traditions. Show that legal origins matter, then you’ve shown “quality of laws” matters. And, indeed, in several big studies, LLSV proved that legal origins were on average among the biggest determinants of investment and growth.

India, as a common law country, should do really well, then. But it doesn’t: the Indian financial sector — stock markets aside — is stunted. Why is that, and is there something that law-and-finance enthusiasts and policymakers can learn from? A working paper by two legal scholars — John Armour of Oxford and Priya Lele of Cambridge — has a few answers. The paper, extracted alongside, shows that when we deconstruct the common-law-to-finance argument, it’s easy to see where India’s unique characteristics break the connection. The massive backlog of cases, for example, as also public interest litigation, mean that courts don’t quite work the same way here. What they show is that completely new institutions, not our legal heritage, can help us. Something to keep in mind as pressure to reform finance builds.