Prosperity requires more than rule of law; The requirements for a stable and wealthy economy go beyond property rights; while countries can learn from history, they cannot reproduce histories

April 9, 2013 5:29 pm

Prosperity requires more than rule of law

By John Kay

The requirements for a stable and wealthy economy go beyond property rights

The idea that “institutions matter” is a relatively recent amendment to the standard corpus of economic thinking. Only in the past two decades has it become a mantra of development economists.

The trigger was the recognition that plans to promote growth after decolonisation had failed. The continued poverty of many countries could not be fully explained by a shortage of capital or the legacy of foreign exploitation. Economic historians emphasised that the industrial revolution was the product not just of technological change and related investment in plant and machinery; it had also required the contemporaneous evolution of political and economic institutions.

A visit to Hong Kong is a reminder of how much institutions matter. A Chinese population under British administration created an island of prosperity, while the mainland stagnated under warlords and erratic dictators. When Chinese institutions achieved greater stability after the death of Mao Zedong, Hong Kong became a hub for the spectacular growth of the whole country.But to say institutions matter is to beg the question: which institutions? The conventional reply emphasises property rights and rule of law. This excludes the arbitrary rule of the mad dictator or the king who enjoys power by divine right – but provides little further guidance.

Is security of property rights either necessary or sufficient to promote investment and innovation? The perceived illegitimacy of the distribution of property rights has often obstructed the achievement of these economic goals – as in Latin America and post-communist Russia.

And it makes no sense to talk of the rule of law in isolation from the nature of the laws and the processes through which they are promulgated and enforced. Many of the nastiest totalitarian regimes have had legal codes and constitutions that would on paper win plaudits from the most demanding of human rights activists.

Joseph Tainter, the anthropologist, attributed the decline of civilisations to their inability to manage the complexity they accreted. And at the Institute for New Economic Thinking conference I attended last week in Hong Kong, historian Niall Ferguson described the economic disadvantage for the US of too many property rights and too much law.

The conference offered numerous illustrations of the problem. There was an address by a spokesman for a leading patent troll, which buys and asserts patents in the hope of forcing companies to pay royalties. Another talk reminded the audience that the value of outstanding derivatives contracts exceeds by a considerable margin the value of all underlying assets to which they might relate. The spiralling costs of litigation establish an environment in which the rule of law operates in favour of bullies and the rich and privileged – a process whose outcomes closely resemble those of dispute resolution in very primitive societies. The rule of law is to be welcomed, but not the rule of lawyers.

Of course, even with legal costs absorbing almost 2 per cent of gross domestic product, the US is an affluent country. But, like its European counterparts, it suffers from the impediments to growth identified by economic historian Mancur Olson; sclerosis arising from the conflicting demands of too many established vested interests.

So when the Chinese ask how to establish the institutions to support a stable, prosperous economy, it is not enough to mumble: “Property rights and rule of law – go to Denmark and see.” There are many versions of the successful formula of lightly regulated capitalism and liberal democracy, each with its own challenges. While there are common principles, there is no blueprint that can be enshrined in a Washington consensus or proclaimed “the end of history”.

Nor is there an established blueprint for a transition from anarchy or traditional society to the institutions that today’s development economists understand matter. Hong Kong in the 19th century experienced one such transition – the importing of institutions from another jurisdiction with the support of the Royal Navy and a garrison of troops. But that model for the most part did not prove acceptable, or permanent, elsewhere. Its resilience in Hong Kong was the result of a unique context. Institutions matter – but perhaps histories matter even more. And while countries can learn from history, they cannot reproduce histories.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: