Southeast Asian neighbors Malaysia and Indonesia have always been similar in language and culture but (quite apart from the effects of December’s tsunami) very different in their economic fortunes. Malaysia has a much more vibrant stock market, notes author Nicholas Thompson, and the average Malaysian is three times better off than his Indonesian counterpart.

One explanation for the disparity, grounded in the origins of the two countries’ differing legal systems, comes from a group of economists known (from their last initials) as LLSV: Rafael La Porta of Dartmouth’s Tuck School of Business, Florencio Lopez-de-Silanes of the Yale School of Management, Andrei Shleifer of Harvard’s economics department, and Robert Vishny of the University of Chicago’s business school. “Malaysia was a British colony, and its legal system is based on the common law — the set of rules, norms, and procedures that has guided the legal system of England and the former British Empire (including the United States) for about nine centuries,” explains Thompson. “Indonesia, on the other hand, was a Dutch colony and its legal system derives from French civil law, a set of statutes and principals written under Napoleon in the early 19th century.”

The LLSV group theorize that countries with a common law tradition succeed far more frequently in creating effective financial markets than countries with a civil law tradition — and infuriate many members of the legal profession who maintain that LLSV know next to nothing about law.

LLSV applied their main technique, regression analysis, to concerns such as confiscation of a company’s assets by the state and the proxy rights of shareholders. The group’s first paper, “Law and Finance,” claimed that common law countries protect both shareholders and creditors better than civil law countries, and also tend to be less corrupt.

A common law tradition doesn’t necessarily make people richer, the LLSV group insist. Rather, when shareholders have more rights, markets attract more investors because their risk is mitigated by government regulation of company executives. Less corruption also tends to make investment more attractive.

LLSV’s theories are controversial in academia, to say the least. Some law scholars say the explanation of the supposed correlation between common law and financial performance is unconvincing, even “naïve.” As Thompson notes, “Correlation is not the same as causation, especially when you are looking at complicated global trends.” He concludes that “until [LLSV] can come up with a clear and convincing explanation for what precisely it is about common law that causes the differences they’ve found, scholars will continue to assail their theory.”

Common Denominator

from the January-February 2005 issue of Legal Affairs

More articles:

New Power for Old Europe

from the December 27, 2004, issue of The Nation

Largely outside the American public’s notice, the European Union has been developing into a “sophisticated geopolitical power with the teeth to back up its policies,” writes author Mark Schapiro. In the past decade, Brussels has assumed more governing and enforcement authority in areas ranging from environmental regulation and food safety to accounting standards and corporate mergers. “As a result, U.S. companies that do business in EuropeÂ…are quickly learning that “old Europe” is now wielding new world power.” That clout was felt last year especially by chemicals, car, and cosmetics manufacturers, which had to face a choice: conform to the E.U.’s standards of pre-emptive screening for toxicity — much more rigorous than U.S. standards — or lose the European market, which at 450 million people, is larger than the U.S. market. Schapiro looks at REACH, the “Cosmetics Directive,” and the “End of Life Vehicles Directive” — three programs that have presented rude compliance awakenings for U.S. companies in Europe.

America and the Coming Global Workforce

from the Winter 2004 issue of American Outlook

“The United States is already first in the competition to attract the world’s workers,” notes author Justin Heet; “maintaining this lead will be crucial to its future economic growth.” The challenge lies in future trends in population supply and demand: The wealthiest nations have reached their peak and will increasingly turn to labor from poorer countries where populations continue to grow. Less-developed nations, continues Heet, will tolerate the resulting emigration as a relief from the strains of overpopulation. “The resulting movement of people and jobs between nations will create a truly global workforce.” This is already happening, and as America’s population begins to decline, the U.S. will have to compete more than ever to attract foreign workers.

The World’s First Multinational

from the December 13, 2004, issue of The New Statesman

Corporate greed, market bubbles, corporate governance reform — all of these occurred centuries before Enron or the Internet bubble, notes author Nick Robins, during the rise and fall of England’s East India Company. “Like the modern multinational, [the East India Company] was eager to avoid the mere interplay of supply and demand.” Not satisfied with protecting its monopoly of Asian imports, the company sought to force down the prices it paid for goods by breaking the power of local leaders and eliminating competition. As the company grew into a powerful corporate force, East India Company executives became hungry for larger profits sooner. The result: an eighteenth-century share-price boom caused by outrageous acquisitions, including the takeover of Bengal’s entire tax system in 1765. The company also manipulated Bengal grain markets, driving the price of food beyond many poor Indians’ reach. As many as 10 million Indians may have starved to death.

As word of growing unrest in India reached London in 1769, the share price began a decline of more than 55 percent over the next 15 years — though as early as 1772, the East India Company was effectively bankrupt. Robins adds that the company was not only the precursor to today’s global firms; “it also stimulated one of the first movements for corporate reform.” As activists demanded that the company be held accountable for its abuses, Parliament implemented tools that are familiar today: codes of conduct for company executives, rules on shareholder abuse, government regulation. Robins stresses the importance of remembering the human tragedy caused by the company instead of celebrating the company’s executives as historical celebrities: “We need an honest reckoning with the human costs of its quest for market domination.”

Trade out of Whack


from the December 2004 issue of Policy Review

Author Steve Stein, a portfolio manager, observes that any of the nation’s top economists, including Alan Greenspan, maintain that the U.S.’s growing debt presents little immediate cause for concern. A common approach to addressing the trade deficit is to let the economy run its course, in the belief that passing legislation to rein in the debt artificially would do more harm than good. Stein, however, contends that this “benign neglect is not working.” The trade deficit, if left to its own devices, could adversely affect equity markets and the strength of the dollar. Among the legislative actions America could pursue are tort reform, better product-liability regulation, and, most important, tax reform that would improve the country’s rate of savings. Stein also notes that U.S. statutory corporate tax rates are higher than those of all of its major trading partners except Japan. He adds that tax reform alone won’t solve the trade deficit, “but intelligent tax reform is a vehicle whereby free traders can raise the profile of the trade deficit without giving support to protectionists.”

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