The Great Degeneration: How Institutions Decay and Economies Die

by Niall Ferguson

  It was later said of the original assize judge, Sir Roger Crompton, that he ‘never recognized the notion that the common law adapts itself by a perpetual process of growth to the perpetual roll of the tide of circumstances as society advances’.31 That was certainly not the approach of the appeal judges, Barons Alderson, Parke and Martin, who – in the words of a modern commentator – ‘refashioned the substantive law of contract damages’. As Alderson reasoned, ‘the only circumstances . . . communicated by the plaintiffs to the defendants’ at the time the contract was made were that they were millers whose mill shaft was broken. There was no notice of the ‘special circumstances’ that the mill was stopped and profits would be lost as a result of delay in the delivery of the shaft. Moreover, it was ‘obvious [thus Alderson] that in the great multitude of cases of millers sending off broken shafts to third persons by a carrier under ordinary circumstances’, the mills would not be idle and profits lost during the period of shipment, since most millers would have spare shafts.32 Thus the loss of profits could not be taken into consideration in estimating damages.

  To put it crudely, this was a ruling that favoured big over small business – but that is not really the important point. The point is that Baron Alderson’s reasoning illustrates very well how the common law evolves, a process elegantly described by Lord Goff in the 1999 case of Kleinwort Benson v. Lincoln City Council:

  When a judge decides a case which comes before him, he does so on the basis of what he understands the law to be. This he discovers from the applicable statutes, if any, and from precedents drawn from reports of previous judicial decisions . . . In the course of deciding the case before him he may, on occasion, develop the common law in the perceived interests of justice, though as a general rule he does this ‘only interstitially’ . . . This means not only that he must act within the confines of the doctrine of precedent, but that the change so made must be seen as a development, usually a very modest development, of existing principle and so can take its place as a congruent part of the common law as a whole. In this process, what [F. W.] Maitland has called the ‘seamless web’, and I myself . . . have called the ‘mosaic’, of the common law, is kept in a constant state of adaptation and repair, the doctrine of precedent, the ‘cement of legal principle’, providing the necessary stability.33

  I believe this gives an invaluable insight into the authentically evolutionary character of the common law system.* It was this, rather than any specific functional difference in the treatment of investors or creditors, that gave the English system and its relatives around the world an advantage in terms of economic development.

  The Rule of Law’s Enemies

  That was then. What about now? How good in practice is the rule of law in the West – and in particular in the English-speaking world – today? There are four distinct threats to it that I would identify.

  First, we must pose the familiar question about how far our civil liberties have been eroded by the national security state – a process that in fact dates back almost a hundred years to the outbreak of the First World War and the passage in the UK of the 1914 Defence of the Realm Act. The debates after September 11, 2001, about the protracted detention of terrorist suspects were in no way new. Somehow it is always a choice between habeas corpus and hundreds of corpses.

  A second threat is the very obvious one posed by the intrusion of European law – with its civil law character – into the English legal system, in particular the far-reaching effects of the incorporation into English law of the 1953 European Convention on Fundamental Rights and Freedoms. This may be considered Napoleon’s revenge: a creeping ‘Frenchification’ of the common law.

  A third threat is the growing complexity (and sloppiness) of statute law, a grave problem on both sides of the Atlantic as the mania for elaborate regulation spreads through the political class. I agree with the American legal critic Philip K. Howard that we need a ‘legal spring cleaning’ of obsolete legislation and routine inclusion of ‘sunset provisions’ (expiry dates) in new laws.34 We must also seek to persuade legislators that their role is not to write an ‘instruction manual’ for the economy that covers every eventuality, right down to the remotest imaginable risk to our health and safety.35

  A fourth threat – especially apparent in the United States – is the mounting cost of the law. By this I do not mean the $94.5 billion a year that the US federal government spends on law making, law interpretation and law enforcement.36 Nor do I mean the spiralling cost of lobbying by businesses seeking to protect themselves or hurt their competitors by skewing legislation in their favour. The $3.3 billion cost of paying nearly 13,000 lobbyists is in fact rather small in itself.37 It is the cost of the consequences of their work that is truly alarming: an estimated $1.75 trillion a year, according to a report commissioned by the US Small Business Administration, in additional business costs arising from compliance with regulations.38 On top of that are the $865 billion in costs arising from the US system of tort law, which gives litigants far greater opportunities than in England to seek damages for any ‘wrongful act, damage, or injury done wilfully, negligently, or in circumstances involving strict liability, but not involving breach of contract, for which a civil suit can be brought’. According to the Pacific Research Institute’s study Jackpot Justice, the tort system costs a sum ‘equivalent to an eight per cent tax on consumption [or] a thirteen per cent tax on wages’.39 The direct costs arising from a staggering 7,800 new cases a day were equivalent to more than 2.2 per cent of US GDP in 2003, double the equivalent figure for any other developed economy, with the exception of Italy.40 One may argue about such figures, and of course spokesmen for the legal interest reject them.41 But my own personal experience tells a similar story: merely setting up a new business in New England involved significantly more lawyers and much more in legal fees than doing so in England.

  In their new book on the lessons for China of US legal experience, David Kennedy and Joseph Stiglitz cite three egregious defects of the rule of law in the United States today:

  Current ‘laws allowing financial firms to engage in predatory lending, combined with new bankruptcy laws, have created a new class of partially indentured servants – people who might have to give as much as 25 per cent of what they earn for the rest of their lives to the banks’.

  Intellectual property laws are excessively restrictive. For example, ‘the “owner” of the patent on the gene that indicates a strong likelihood of breast cancer [could] insist on a large payment for every test performed. The resulting . . . fee puts the test out of the range of most without health insurance.’

  ‘Under current laws concerning toxic wastes . . . litigation costs represent more than a quarter of the amount spent on clean-up.’42

  For Stiglitz, these illustrate the inadequacy of a narrow approach to law that simply assigns property rights and leaves markets to do the rest. My view is that such examples need to be seen in the wider context of over-complex or rigged legislation and rampant tort abuse.

  Experts on economic competitiveness, like Michael Porter of Harvard Business School, define the term to include the ability of the government to pass effective laws; the protection of physical and intellectual property rights and lack of corruption; the efficiency of the legal framework, including modest costs and swift adjudication; the ease of setting up new businesses; and effective and predictable regulations.43 It is startling to find how poorly the United States now fares when judged by these criteria. In a 2011 survey, Porter and his colleagues asked HBS alumni about 607 instances of decisions on whether or not to offshore operations. The United States retained the business in just ninety-six cases (16 per cent) and lost it in all the rest. Asked why they favoured foreign locations, the respondents listed the areas where they saw the US falling further behind the rest of the world. The top ten reasons included:

  the effectiveness of the political system;

  the complexity of the
tax code;

  regulation;

  the efficiency of the legal framework;

  flexibility in hiring and firing.44

  Evidence that the United States is suffering some kind of institutional loss of competitiveness can be found not only in Porter’s work but also in the World Economic Forum’s annual Global Competitiveness Index and, in particular, the Executive Opinion Survey on which it is partly based. The survey includes fifteen measures of the rule of law, ranging from the protection of private property rights to the policing of corruption and the control of organized crime. It is an astonishing yet scarcely acknowledged fact that on no fewer than fifteen out of fifteen counts, the United States now fares markedly worse than Hong Kong. Taiwan outranks the US in nine out of fifteen. Even mainland China does better in two dimensions. Indeed, the United States makes the global top twenty in only one area. On every other count, its reputation is shockingly bad.45 In the Heritage Foundation’s Freedom Index, too, the US ranks twenty-first in the world in terms of freedom from corruption, a considerable distance behind Hong Kong and Singapore.46

  Admittedly, these studies are based in large measure on survey data. They are subjective. Yet similar conclusions may be reached from other research based on more objective criteria, like the International Finance Corporation’s data on the ease of doing business. In terms of the ease of paying taxes, for example, the United States ranks seventy-second in the world. In terms of dealing with construction permits, it ranks seventeenth; registering a property sixteenth; resolving insolvency fifteenth; and starting a business thirteenth.47 The World Justice Project’s Rule of Law 2011 index ranks the United States twenty-first out of sixty-six in terms of access to civil justice; twentieth for the effectiveness of criminal justice; nineteenth for fundamental rights; seventeenth for absence of corruption; sixteenth for the limiting of government powers; fifteenth for regulatory enforcement; thirteenth for order and security; and twelfth for the openness of government.48

  Perhaps the most compelling evidence of all comes from the World Bank’s indicators on World Governance, which suggest that since 1996 the United States has suffered a decline in the quality of its governance in four different dimensions: government accountability and effectiveness, regulatory quality and control of corruption (see Figure 3.1).49 Compared with Germany and Hong Kong, the US is manifestly slipping behind. This is a remarkable phenomenon in itself. Even more remarkable is that it is happening almost unnoticed by Americans. One small consolation is that the United Kingdom does not appear to have suffered a comparable decline in institutional quality.

  Figure 3.1

  Source: www.govindicators.org.

  Legal Reform around the World

  If the rule of law, broadly defined, is deteriorating in the United States, where is it getting better? I have already mentioned the marked improvement in institutional quality in Hong Kong. This is by no means a solitary case. All over the developing world, countries are seizing the opportunity to improve their chances of attracting foreign and domestic investment and raising the growth rate by reforming their legal and administrative systems. The World Bank now does a very good job of keeping tabs on the progress of such reforms. I recently delved into the Bank’s treasure trove, the World Development Indicators database, to see which countries in Africa are ranked highly in terms of:

  the quality of public administration;

  the business regulatory environment;

  property rights and rule-based governance;

  public sector management and institutions; and

  transparency, accountability and corruption in the public sector.

  The countries that appear in the top twenty developing economies in four or more of these categories are Burkino Faso, Ghana, Malawi and Rwanda.

  Another approach I have taken is to look at the IFC’s Doing Business reports since 2006 to see which developing countries have seen the biggest reduction in the number of days it takes to complete seven procedures: starting a business, getting a construction permit, registering a property, paying taxes, importing goods, exporting and enforcing contracts.50 The African winners are, in order of achievement, Rwanda, Nigeria, the Gambia, Mauritius, Botswana and Lesotho. Other emerging markets apparently on the right track are Belarus, Croatia, Georgia, Malaysia, Bosnia and Macedonia (see Figure 3.2).*

  Figure 3.2

  Source: International Finance Corporation, Doing Business reports.

  Development economists like Paul Collier see the establishment of the rule of law in a poor country as occurring in four distinct stages. The first and indispensable step is to reduce violence. The second is to protect property rights. The third is to impose institutional checks on government. The fourth is to prevent corruption in the public sector.51 Interestingly, this sounds very much like a potted version of the history of England from the end of the Civil War, through the Glorious Revolution to the nineteenth century Northcote–Trevelyan reforms of the civil service.

  By contrast, the People’s Republic of China has achieved astonishing growth without good legal institutions and without much improvement in them. Followers of the new institutional economics have struggled to explain this seeming exception to their rule. Is it because the Communist Party somehow makes ‘credible commitments’ now that growth is the sole basis of its legitimacy? Is it because there are in fact ‘de facto property rights’? Is it because competition between the provinces has resulted in a kind of ‘market-preserving federalism’? Or is it because contracts in China are relational, not legal: in other words, contract enforcement is informal, via guanxi (connections or influence), rather than formal, through the law?52 Whatever the explanation, many scholars – notably Daron Acemoglu and James Robinson – argue that if China does not now transition to the rule of law, there will be a low institutional ceiling limiting its future growth.53 This is also the view of many Chinese legal activists, including (as we have already seen) Chen Guangcheng. And they are right.

  According to one study, the average rate for enforcing civil and economic judgments in China in the mid-1990s was 60 per cent at the basic-level court, 50 per cent at the intermediate-level court, and 40 per cent at the provincial higher-level court, meaning that roughly half of Chinese court rulings at that time existed only on paper. The sort of contractual dispute that is most likely to involve significant amounts of unpaid debt – disputes involving banks and state-owned enterprises – had an average enforcement rate of just 12 per cent, even according to official estimates.54 The case of Bo Xilai’s anti-corruption campaign in Chongqing illustrates how far China still is from the rule of law. As He Weifang has pointed out, the Chongqing judges essentially acted as an arm of Bo’s regime, accepting extorted confessions and omitting cross-examination. For years, He Weifang has campaigned for judicial independence, the accountability of the National People’s Congress, especially with regard to taxation, the freedom of the press and the conversion of the Communist Party into a ‘properly registered legal entity’, subject to the law – including the currently meaningless individual rights in Article 35 of the Constitution of the People’s Republic, which include freedom of association, of procession and demonstration and of religious belief. He also favours the privatization of state-owned enterprises because, as he puts it, ‘private ownership is the foundation of the civil law’. Like Chen Guangcheng, he believes that the rule of law is the only way for China to escape from its historical oscillation between order and dong luan – turmoil.55

  For those of us who live in the West, where lawyers often seem to have become their own vested interest, it is strange to encounter lawyers who aim at this kind of radical change. Today, however, Chinese lawyers – who numbered just 150,000 in 2007 – are a crucial force in China’s rapidly evolving public sphere. Surveys suggest that they are ‘strongly inclined towards political reform . . . and are profoundly discontented with the political status quo’ – though thi
s reflects not only the government interference they regularly have to endure but also the economic insecurity they suffer. Still, to read statements like the following, from a lawyer in Henan province, is to be reminded forcibly of a time when lawyers were in the vanguard of change in the English-speaking world (including in South Asian anti-colonial movements): ‘The rule of law is premised on democracy; rights are premised on the rule of law; rights defence is premised on rights; and lawyers are premised on rights defence.’56

  The fall of Bo Xilai in 2012 is one of a number of signs that elements within the Communist Party hear these arguments. In a speech in Shenzhen in June that year, Zhang Yansheng, secretary general of the academic committee for National Development and Reform, argued that ‘we should shift towards reform based on rules and law,’ adding: ‘If such reform does not take off, China will run into big trouble, big problems.’57 What we do not know is whether or not China’s next experiment with importing the essentially Western notion of the rule of law will be more successful than past attempts. With good reason, He Weifang warns against naive imitation of the English (or American) legal system. ‘In Shakespeare’s A Midsummer Night’s Dream,’ he writes in an engaging aside, ‘a person was changed into a donkey, and the other person cried, “Bless thee! Thou art translated!” The introduction of a Western system to China is just like this.’ Common law translated into Chinese might well turn out to be like Bottom: a donkey, if not an ass.58