The Great Degeneration: How Institutions Decay and Economies Die

by Niall Ferguson

  In England, the rule of law in Bingham’s sense of the term is the product of historical evolution. In 1215 Magna Carta established the principle that all Englishmen were equal before the law and that the Crown could not raise taxation without the consent of the Great Council, later Parliament. It was in the medieval period, too, that the writ of habeas corpus (against unlawful detention) came into use, that around 500 towns acquired charters of effective self-government and – after 1295 – that these boroughs were also represented in Parliament. From the time of Henry III until the time of James II there was a protracted tug of war between the monarch and Parliament, in which the Crown’s tendency to sell off the royal demesne to finance wars steadily weakened its position. The culmination came, as we saw in Chapter 1, with the Glorious Revolution, which asserted the sovereignty of the king-in-Parliament. Also in the seventeenth century, torture was done away with; though it was not until a century later, with Somerset’s Case in 1772, that slavery in England was definitively declared illegal. Throughout this period, the common law courts effectively resisted encroachments on their jurisdiction by institutions under royal control. Still, it was not until the 1701 Act of Settlement that the independence of the judiciary was assured with the advent of life appointments.

  My undergraduate reading at Oxford persuaded me that the real point of English history was to establish, for the first time, three sacred principles. First, an Englishman’s home is his castle. In the case of Entick v. Carrington, Lord Camden ruled against the government for raiding the home of the radical journalist John Entick. ‘The great end for which men entered into society was to secure their property,’ declared Camden, quoting John Locke. ‘By the laws of England, every invasion of private property, be it ever so minute, is a trespass.’ Secondly, do what you like as long as you do no harm. ‘The privileges of thinking, saying, and doing what we please, and of growing as rich as we can, without any other restrictions, than that by all this we hurt not the public, nor one another, are the glorious privileges of liberty’: that was the formulation of ‘Cato’ (the nom de plume of John Trenchard and Thomas Gordon), writing in the early 1720s. Third, mind your own bloody business. ‘The taste for making others submit to a way of life which one thinks more useful for them than they do themselves’, John Stuart Mill explained to the French liberal Alexis de Tocqueville, ‘is not a common taste in England.’4 And these pillars of the English rule of law, as A. V. Dicey had pointed out in 1885, were the products of a slow, incremental process of judicial decision-making in the common law courts, based in large measure on precedents. There were no ‘grand declarations of principle’, just the interplay of judicial memory and statutory innovations by Parliament.

  I now realize that this was a rather naive reading of English legal history. As the greatest modern theorist of law in the English-speaking world, the late Ronald Dworkin, explained in Law’s Empire, there really are principles underpinning the common law, even when those principles are not codified as they are in the US Constitution. ‘We insist’, writes Dworkin, ‘that the state act on a single, coherent set of principles even when its citizens are divided about what the right principles of justice and fairness really are . . . Judges . . . decide hard cases by trying to find, in some coherent set of principles about people’s rights and duties, the best constructive interpretation of the political structure and legal doctrine of their community.’5 Behind the operation of the law lie two things: the integrity of judges and ‘legislation . . . flowing from the community’s present commitment to a background scheme of political morality’.6 Questions concerning legality (or ‘principle’) are for judges to decide; questions of policy are matters for executive and legislature. In this legal world, the judge engages in an authentically Herculean struggle to arrive at a best fit between the rule that he eventually defines and applies in order to resolve the case before him and the general corpus of rules, legal policies and reasonable expectations. So even England’s constitution-free common law is based (again in Dworkin’s words) ‘not only [on] the specific rules enacted in accordance with the community’s accepted practices but also [on] the principles that provide the best moral justification for those enacted rules . . . [including] the rules that follow from those justifying principles, even though those further rules were never enacted’.7

  Like democracy, the rule of law in this sense may be good in its own right. But it may also be good because of its material consequences. Few truths are today more universally acknowledged than that the rule of law – particularly insofar as it restrains the ‘grabbing hand’ of the rapacious state – is conducive to economic growth. According to Douglass North, ‘the inability of societies to develop effective, low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment . . .’8 Enforcement of contracts by a third party is necessary to overcome the reluctance of private sector agents to participate in non-simultaneous economic transactions, especially over long distances in both time and space. Contract enforcement can be provided by private sector agencies such as exchanges, credit companies and arbitrators. But usually, in North’s words, ‘third-party enforcement [means] . . . the development of the state as a coercive force able to monitor property rights and enforce contracts effectively.’9

  The problem is getting the state not to abuse its power – hence the need to constrain it. As Stanford’s Avner Greif has argued, if public contract-enforcing institutions reveal information about the location and amount of private wealth, the state (or its functionaries) may be tempted to steal some or all of it.10 Where states are not constrained by law, therefore, private contract-enforcing institutions are safer, like the network operated by eleventh-century Maghribi traders in the Mediterranean, which was based on their common Jewish religion and kinship ties, or the eighteenth-century Scottish diaspora, which had an almost global reach, or the South Asian traders of East Africa. We see such networks operating in many parts of the world today: think of the Chinese business communities operating outside China. Their defect, as with medieval guilds, is their tendency to raise entry barriers and establish monopolies, discouraging competition and reducing economic efficiency. That is why private contract enforcement tends to yield to public as economies become more sophisticated. But that process is dependent on constraining the state to use its power of coercion in such a way as to respect private property rights. In economics, that is the essential function of the rule of law. It is the property rights more than the human rights that are fundamental.

  Law and Economics – and History

  Few contributions to the literature on law and economics have had a greater impact than the argument of Andrei Shleifer and his co-authors that the common law system that evolved in the English-speaking world was superior in performing the twin roles of contract enforcement and coercion constraint to all other systems. Neither the French civil law system, originating in the Roman legal tradition, nor the German and Scandinavian legal systems, were as good, to say nothing of non-Western systems of law. What was it that made and makes common law economically better? In their seminal 1997 article, La Porta, Lopez-de-Silanes, Shleifer and Vishny argued that common law systems offer greater protection for investors and creditors. The result is that people with money are more willing to invest in, or lend to, other people’s businesses. And higher levels of financial intermediation tend to correlate to higher rates of growth.11

  In a succession of empirical studies, these and other scholars sought to demonstrate that common law countries:

  have stronger investor protections and provide companies with better access to equity finance than civil law countries, as manifested in larger stock markets, more numerous firms and more initial public offerings;12

  have better protection of outside investors relative to ‘insiders’, whereas French civil law countries have poorer protection;13

  make it easier for new firms to enter the market, as manifes
ted in the number of procedures, number of days and costs of setting up a new business;14*

  have more efficient (because less formalistic) courts, as measured by the time it takes to evict a non-paying tenant and to collect a debt after a cheque has bounced;15

  regulate their labour markets less and therefore have higher labour-force participation and lower unemployment rates than civil law countries;16

  have more extensive mandatory disclosure requirements, which again encourages investors;17 and

  have more efficient procedures in cases of insolvency, such as a hypothetical hotel bankruptcy.18

  Summarizing their theory of the determining role of legal origins, the authors write:

  Legal investor protection is a strong predictor of financial development . . . [as well as] government ownership of banks, the burden of entry regulations, regulation of labour markets, incidence of military conscription, and government ownership of the media . . . In all these spheres, civil law is associated with a heavier hand of government ownership and regulation than common law . . . [These are in turn] associated with adverse impacts on markets such as greater corruption, larger unofficial economy, and higher unemployment . . . Common law is associated with lower formalism of judicial procedures . . . and greater judicial independence . . . Common law stands for the strategy of social control that seeks to support private market outcomes, whereas civil law seeks to replace such outcomes with state-desired allocations . . . Civil law is ‘policy implementing’, while common law is ‘dispute resolving’.19

  This brings us back to where we began, with the notion that there is greater ‘flexibility of judicial decision-making under common law’, because ‘common law courts [can] use broad standards rather than specific rules’.20

  Like so many arguments in social science, this theory of legal origins implies a certain version of history. Why did French law end up being worse than English? Because the medieval French Crown was more assertive of its prerogatives than the English. Because France was less peaceable internally and more vulnerable externally than England. Because the French Revolution, which distrusted judges, sought to convert them into automata, implementing the law as defined and codified by the legislature. The result was an even less independent judiciary and courts precluded from reviewing administrative acts. The Gallic conception of freedom was more absolute in theory and less effectual in practice. In any case, as Alexis de Tocqueville shrewdly observed when comparing the United States and France in the 1830s and 1840s, the French preferred equality to liberty. This preference resulted in a strong central state and weak civil society. When the French exported their model to their colonies in Asia and Africa, the results were even worse.

  The theory of legal origins also has important historical implications for non-Western legal systems. We have already encountered Timur Kuran’s argument about the retarding effects of Islamic law on Ottoman economic development. A similar case can be made for China. As He Weifang has argued, in the imperial era Chinese government made ‘no arrangement whatsoever for the separation of powers’, so ‘the country magistrate exercised comprehensive responsibilities [including all] three basic functions, namely the enacting of rules . . . the execution of rules . . . and the resolving of disputes.’ Confucianism and Taoism deprecated lawyers and deplored the adversarial mode. Yan Fu, the Chinese translator of Montesquieu, fully understood the difference between the Chinese and the Western spirit of the laws. ‘During my visit to Europe [in the late 1870s],’ he wrote, ‘I once attended court hearings and when I came back, I felt at a loss. On one occasion, I said to Mr. Guo Songtao [the Qing ambassador to Great Britain] that, of the many reasons that make England and other European nations rich and strong, the most important one is the guarantee there of having justice done. And my view was shared by Mr. Guo.’21

  Yet attempts to import elements of the British legal system to China were a failure. Although the imperial Chinese state sought to provide all kinds of public goods, such as defence, famine relief, commercial infrastructure like canals and the distribution of agricultural knowledge, its highly centralized bureaucracy was quite skeletal in relation to the population. Property rights were relatively secure insofar as there was little variation over time in (by Western standards) low rates of taxation, but there was no commercial code of law and magistrates were steeped in literary and philosophical learning, not in law. They sought ‘compromises rather than legal rulings’, leaving contract enforcement to private networks. When the late Qing state belatedly entered the commercial sphere, it did so in a counter-productive way, over-taxing merchants and delegating power to monopolistic guilds without effectively constraining itself or its agents. The results were rampant corruption and economic contraction.22

  Law and the Victorians

  The legal-origins hypothesis is not without its critics. After all, it is hard not to overlook the fact that for much of the modern era France has had a successful economy, including a large financial sector, despite not being blessed with the common law.23 Similar things have been said about Germany and Brazil.24 Another line of argument is that common law systems compare less favourably with civil law systems when measures of social welfare – such as infant mortality or inequality – are the dependent variables.25 Yet for me the theory’s weakest point becomes apparent if we look at the state of the English common law as it was in the period when, by implication, it must have done the greatest good: the period of the Industrial Revolution, when the English and their Celtic neighbours radically altered the course of world economic history. Here is a contemporary description of an English court at that time:

  some score of members of the . . . bar . . . are . . . mistily engaged in one of the ten thousand stages of an endless cause, tripping one another up on slippery precedents, groping knee-deep in technicalities, running their goat-hair and horsehair warded heads against walls of words and making a pretence of equity with serious faces, as players might . . . the various solicitors in the cause, some two or three of whom have inherited it from their fathers, who made a fortune by it . . . are . . . ranged in a line, in a long matted well . . . between the registrar’s red table and the silk gowns, with bills, cross-bills, answers, rejoinders, injunctions, affidavits, issues, references to masters, masters’ reports, mountains of costly nonsense, piled before them . . . This is the Court of Chancery . . . which so exhausts finances, patience, courage, hope, so overthrows the brain and breaks the heart, that there is not an honourable man among its practitioners who would not give – who does not often give – the warning, ‘Suffer any wrong that can be done you rather than come here!’26

  It might be objected that Charles Dickens was not being entirely fair to the legal profession of his day in Bleak House. Yet Dickens had started his career writing court reports. He had seen his own father imprisoned for debt. His biographers confirm that he knew whereof he spoke.27 And historians of the nineteenth-century English legal system largely confirm his account.

  First, we must note the tiny size of the system. As late as 1854, the entire judiciary of England and Wales sitting in courts of general jurisdiction numbered just fifteen. These judges, distributed equally between three benches, sat individually to hear cases, either in London or at assize (sessions held in major provincial towns), for just two four-week terms a year. These same men convened as panels of three or four to hear appeals and then sat in larger panels (usually numbering seven) to hear appeals from the panels of three or four. Only appeals from the panels of seven would be heard by another institution, which was the House of Lords. True, the activity of the lower county courts increased as economic life gathered pace. But that was not true of the higher courts.28

  Second, until 1855 there were severe statutory restrictions on the ability of entrepreneurs to create limited-liability companies, a legacy of the time when the promoters of monopoly firms like the South Sea Company had successfully pulled up the ladder behind themselves to boost
the value of their own shares. As late as the 1880s, there were still only sixty domestic companies listed on the London Stock Exchange. So much for the benefits of common law for financial development. Third, in the single most important sector of the Victorian Industrial Revolution, the railways, modern research has revealed that ‘English common law and common law lawyers had a profound and largely negative impact.’ Solicitors were notorious as speculative railway-share promoters, judges were publicly accused of favouritism and the Parliamentary Bar ran a nice little racket, effectively selling statutory approval for new railway lines.29

  What are we to make of this? Does history essentially refute the legal-origins thesis that the common law trumps all other systems? Not quite. For despite the evident shortcomings of the English legal system in the industrial age, there remains compelling evidence that it could and did adapt to the changes of the time, perhaps even in ways that facilitated the process as well as accommodating it. This point is best illustrated with reference to the 1854 Exchequer case (well known to law students on both sides of the Atlantic) of Hadley v. Baxendale. The dispute was between two Gloucester flour-millers, Joseph and Jonah Hadley, and Joseph Baxendale, the managing director of the London-based carriers Pickford & Co. The Hadleys had sued Pickfords for the full amount of their losses – including forgone profits – resulting from late delivery of a replacement hand-crafted mill shaft. It is no coincidence that Pickfords are still around today and the Hadleys’ firm, City Flour Mills, is not. For although the local jury decided for the Hadleys, the appellate judges in London reversed their decision. According to the American judge and legal scholar Richard Posner, Hadley v. Baxendale enshrined the principle ‘that where a risk of loss is known to only one party to the contract, the other party is not liable for the loss if it occur’.30