Law, Economic Development, and Institutions: Between Theory and Praxis

Chantal Thomas - Cornell Law School

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In his 1993 Nobel Laureate lecture, the leading theorist of institutional economics, Douglass North, emphasized the relevance of his life’s work for economic development policy.1  Twenty years prior, in his book authored with Robert Thomas and titled The Rise of the Western World, North laid out the theoretical connection between institutional economics and development: economic growth cannot occur without efficient institutional arrangements and property rights, and the “rise of the West” can be explained in these terms.2  In another influential book, Institutions, Institutional Change and Economic Performance, published just a few years before he received the Nobel Prize, North again argued that institutional economics had primary significance for economic development.3

By the time North accepted the Nobel Prize, two decades after his original exposition in The Rise of the Western World, his hypothesis about the relationship between law and economic growth had won extraordinary recognition in development policy.  North’s “neoclassical theory of the state,” in which appropriate laws and institutions supported the market ideal of efficient transactions among private actors, provided the conceptual basis for a new era of development programming in which principles of “good governance”—in particular, the establishment of the “rule of law” and the implementation of property rights—became key focal points of policy reform efforts.

In the 1990s, the goals of legal and institutional reform modified the menu for the transformation of the developing-country macroeconomic regimes that had come to be known as the “Washington Consensus.”  Beginning in the 1980s, the Washington Consensus was a blueprint for the implementation of the neoclassical economic policies of the Chicago School: liberalization of trade, privatization of investment, fiscal austerity, and monetary stabilization.  These “structural adjustment” reforms of the 1980s, which focused on pure macroeconomics, were theoretical relatives of the later “turn to institutions” of the 1990s.  In the former era, laws figured primarily as instruments to achieve economic policy reform, whereas in the latter era, legal reform was to serve as an end in itself towards economic growth.

First, the Essay upon which this Editorial is based demonstrates the genealogical connection between these two eras of law and development, beginning with the Coase Theorem, through rent-seeking analysis and public choice theory, to the institutional economics of North and others.  Neoclassical understandings of the market informed both models, and each model constituted the progeny of neoclassical theories of the relationship between markets and institutions.  Although legal and institutional development programs have been portrayed as the result of a learning process in which development practitioners realized that the desired macroeconomic policy reforms were ineffective without appropriate institutions and laws, that learning process has been bounded by the theoretical constraints of neoclassicism.

More recently, concerns over human rights and justice have played an explicit role in shaping law and development priorities, although the impact of those concerns on underlying neoclassical priorities remains indeterminate and a subject for further study. The Essay upon which this editorial is based, as part of a larger intellectual history project, concerns itself with delineating the bedrock of the neoclassical law and development paradigm, those aspects of it which persist despite more recent modifications, and the ways in which those aspects could be improved.

Second, the Essay argues that a key opportunity to move beyond macroeconomics to laws and institutions arose out of a crucial shift in the legal interpretation of the World Bank charter’s prohibition against interference in the “political affairs” of borrower states. The redistribution of power among members of the international community that occurred at the end of the 1980s supported a reinterpretation of that provision that, in turn, enabled the adoption of programs which previously would have been considered impermissible interferences in sovereignty.  As a consequence of these events, the New Institutional Economics (NIE) could and did join the New Political Economy (NPE) as a basis for international development policy.  What followed was an explosion of programs for the reform of legal institutions in developing countries that has been termed “rule-of-law revival.”  This paradigm for thinking about law, economic development, and institutions programmatically implemented the neoclassical “revolution” in economic theory, which was carried out in particular corridors of the economic and legal academies.

The neoclassical institutionalist paradigm in law and development, however, has proved resistant to some forms and sources of knowledge.  Some of these critiques are particular to neoclassical law and development, but others may be generalized to the field more broadly.  Some point to theoretical inconsistencies; others point to difficulties in application.  One serious drawback, which the legal literature has not yet sufficiently discussed, stems from the difficulties proponents have encountered in showing that the causal relationship defining the hypothesis—that better institutions lead to stronger economic growth—can be empirically demonstrated.

Finally, the Essay considers the implications of both the construction and the critique of contemporary law and development discourse.  The theoretical and practical challenges described above suggest the need for a framework that would improve the quality of information available to law and development analysts and provide strategies for correcting the influence of powerful interests in donor and beneficiary countries on development policy, as well as the powerful effects of ideational constructs.  As such, the Essay suggests that law and development discourse should be more responsive to its conceptual and empirical limitations, identifying specific areas for analytical improvements in theoretical and practical law and development frameworks premised on institutionalism.

Institutionalism propounds a particular set of theoretical assumptions about the role of law in economic growth.  In unpacking the development of those assumptions, this Essay adopts a model of intellectual history based on the Kuhnian argument that scientific knowledge evolves through key historical moments—“scientific revolutions”—that establish theoretical paradigms.  These paradigms are replaced only when awareness in the field of anomalies—problems that the existing theoretical paradigm cannot solve—presents a crisis for that paradigm that coincides with the emergence of an “alternate candidate.”

The paradigm shift in law and development was enabled by dynamics in both the academy and the field. In the academy, the emergence of neoclassicism as an alternate candidate coincided with an internal intellectual crisis arising from the limitations of Keynesianism and, in development economics, statism.  The emergence of neoclassicism mirrored this shift in the field as a political movement that engendered accompanying changes in the personnel and policy of the development institutions.  As such, theory and practice in law and development were linked and mutually reinforcing in describing the arc from modernization to neoclassicism.

In adapting an historiographic method to its purposes, the Essay seeks to contribute to economic as well as legal histories of neoclassicism.  In doing so, it seeks to specify how influential theories of law in development grew out of a highly idealized conceptual framework wedded to a particular economic policy agenda.  Improving law and development discourse will require addressing the theoretical and practical particularities stemming from the field’s genealogical origins.

Acknowledgments:

Chantal Thomas, Professor of Law, Cornell Law School.

This editorial is based on the essay, Chantal Thomas, Law, Economic Development, and Institutions: Between Theory and Praxis, 96 CORNELL L. REV. 968 (2011).

Copyright © 2011 Cornell Law Review.

  1. Douglass C. North, Economic Performance Through Time, Nobel Lecture (Dec. 9, 1993), in Nobel Lectures in Economic Sciences 1991–1995, at 112 (Torsten Persson ed., 1997) (emphasis added) “Economic history is about the performance of economies through time.  The objective of research in the field is not only to shed new light on the economic past but also to contribute to economic theory by providing an analytical framework that will enable us to understand economic change.  A theory of economic dynamics comparable in precision to general equilibrium theory would be the ideal tool of analysis. . . .  A theory of economic dynamics is also crucial for the field of economic development.”
  2. See DOUGLASS C. NORTH & ROBERT PAUL THOMAS, THE RISE OF THE WESTERN WORLD: A NEW ECONOMIC HISTORY 1 (1973) (“Our arguments central to this book are straightforward.  Efficient economic organization is the key to growth; the development of an efficient economic organization in Western Europe accounts for the rise of the West.”).
  3. See DOUGLASS C. NORTH, INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC PERFORMANCE 9 (1990) (“[I]f I describe an institutional framework with a reverse set of incentives to those [that are efficient and conducive to economic growth], I will approximate the conditions in many Third World countries today as well as those that have characterized much of the world’s economic history.”).

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