TWENTY YEARS AGO liberals thought they knew how to make a country rich: self-government, public education, and loads of World Bank infrastructure grants. Free-market conservatives also had a simple nostrum. “Privatize, privatize, privatize,” said Milton Friedman. Today they both know better. What they missed was something so obvious that it escaped their attention: the rule of law.
In time we all came to recognize the crucial need for a legal regime that promotes growth. Privatization isn’t enough, recognized Friedman. “The example of Russia shows that. Privatization is meaningless if you don’t have the rule of law.” It’s been estimated that a rule-of-law improvement from relatively poor to merely average would result in a fourfold increase in people’s earnings. Along with that would come the spillover benefits of a wealthy society: better health, higher literacy, stronger safety nets, happier people.
But just what does the rule of law mean? When politicians talk about the rule of law, they mean democratic elections. When newspapers talk about it, they mean a free press. All well and dandy, but these miss the more important ways that the rule of law contributes to economic progress. What makes a country rich is private, not public, enterprise, and what private enterprise requires is a legal system that protects and encourages private ordering through stable property rights and enforceable promises.
Wealth doesn’t come from the stuff people own—the oil reserves, minerals, and real estate—but from the promise of a future earnings stream from those assets. And that earnings stream will run dry when it can be diverted by trial lawyers and corrupt politicians. Its font is a private law regime that protects the expectations of honest businessmen and permits them to coordinate their activities around mutually advantageous projects.
So how well does America do on the rule of law? Let’s look at the evidence. In recent years America has suffered from a remarkable economic decline. For the 60 years prior to 2007, America enjoyed GDP increases of 3 to 4 percent a year. From 2008-13, however, we’ve seen average increases of 0.73 percent. In part that’s a reflection of the annus horribilis of 2008. But over the last three years we’ve averaged less than 2 percent annual growth. After a recession there’s supposed to be a recovery, but over the last four years America has experienced its worst four consecutive growth years since the Bureau of Economic Analysis started compiling data in the 1930s.
We owned the 20th century, but since then new rivals, such as China, have emerged, and we are less than confident that we will have a proprietary claim over the 21st century. In recent years China has enjoyed an annual growth rate of 10 percent, and if these trends continue, the United States will be quickly overtaken. As it is, the IMF projects that in three years America’s share of world GDP will fall to 17.7 percent, less than China’s share.
What has fueled China’s emergence from the murderous poverty of its Maoist past has been its adherence to a thin, and not a thick, form of the rule of law. A thin rule of law enforces contracts and protects private parties from looting by the state or other private parties. A thick rule gives people democratic government and constitutionally protected civil liberties. Countries that adhere to a thick rule of law are attractive places to live; countries that adhere to a thin one are at least attractive places to do business.
China seems to be adopting a thin rule of law without embracing a thick version. As for the U.S., an adherence to the rule of law, thickly defined, has obscured America’s relative weakness on a thin definition. This is a pleasant place to live, but we are shipping business and jobs offshore, often to first-world countries that adhere as closely as we do to a thick definition of the rule of law.
I don’t want to claim that America’s current economic malaise can be attributed solely to a rule of law deficit. There is a rich set of villains here: Obamacare, the debt crisis, runaway spending, crony capitalism. But I think the rule of law is part of the story, as evidenced by cross-country rankings that think tanks produce. They’re all pretty subjective, but Cato’s Economic Freedom in the World survey is about as good as it gets. On its metric for “Legal System and Property Rights,” the U.S. is 33rd in the world today, down from number one in 1980.
“We’re number 33!” doesn’t have much of a ring to it, and even that might be too generous. The economists and policy wonks who make up the figures aren’t lawyers, and don’t have a lawyer’s insights into the judicially sanctioned robberies of American tort law or the excuse factory of American contract law, which permits parties to walk away from their promsies. Other first-world countries simply do a better job of fostering economic growth through their legal systems.
Multinational companies report that they spend a disproportionate amount on litigation in the United States, relative to their expenditures in foreign jurisdictions. These concerns are echoed by the International Trade Administration at the U.S. Department of Commerce, which reports that “many foreign investors view the U.S. legal environment as a liability when investing in the United States.” That helps explain why U.S. multinationals shed 864,000 U.S. jobs in the first decade of this century. The jobs are coming back, mind you, just not here. During the same period, U.S. multinationals increased employment overseas by 2.9 million.
AMERICAN LAW, AND especially its rules of civil procedure, seem to take it for granted that one of life’s chief joys is the opportunity to sue someone else. Getting to court in other first-world countries isn’t easy, but broad is the way to the American courthouse.
Lawyers have a constitutional right to advertise in the U.S., but lawyer advertising is heavily regulated or banned elsewhere.
Unlike in America, plaintiffs elsewhere must plead the facts to support their claim, which limits fishing expeditions.
While discovery—orders for defendants to produce documents—is tightly restricted elsewhere, American plaintiffs can hold up defendants by asking them to bear millions of dollars in discovery expenses, and then follow up with an offer to settle for a smaller sum.
The rest of the world makes losers pay for a portion of the successful party’s costs. That doesn’t happen in the U.S., and this gives unmeritorious American plaintiffs a greater incentive to sue.
The right to have civil cases adjudged by a jury is afforded constitutional protection in the U.S. Elsewhere, civil juries never got off the ground or were abolished as a sensible reform measure.
Class actions, where lawyers bring a claim on behalf of thousands or millions of unnamed plaintiffs (who seldom see any part of the recovery) are rare outside the U.S.
It’s not surprising that litigation rates are so much higher here than elsewhere. Subsidize something and you get more of it. Differences in legal ethics matter. In America, much more than elsewhere, lawyers are encouraged to advance their client’s interests without regard to the interests of justice in the particular case or broader social concerns. American lawyers’ professional culture is unique in permitting and implicitly encouraging them to assert novel theories of recovery, coach witnesses, and wear down their opponents through burdensome pretrial discovery. Great stuff if you’re a trial lawyer, but non-lawyers pay for this through higher consumer prices and foregone jobs.
America’s substantive tort law also makes it something of an outlier. Current law permits damages awards that are greater by an order of magnitude than those imposed in other countries. For example, the Canadian Supreme Court capped damages for non-pecuniary losses (e.g., pain and suffering, wrongful death) at $100,000 in 1978 (adjusted subsequently for inflation). State legislatures in the U.S. have also enacted damages caps, but remarkably these have been struck down by American courts as too unfair to plaintiffs. Sensible limits mandated by the courts in Canada are proscribed by the courts in the U.S.
Then there are punitive damages, where a plaintiff’s lawyer who gets lucky can win an award of hundreds of millions of dollars. Since it only takes one big win to pay off a lot of false starts, trial lawyers have an incentive to bring implausible claims to court in hopes of a jackpot at the big casino. A Japanese chemical company once decided not to market an air freshener in the U.S., which it sells plenty of in Japan, because it was worried about being sued. Just how an air freshener might injure anyone, no one could say, but the Japanese manufacturer thought that American trial lawyers might be able to come up with some absurd theory of liability.
If American tort law imposes greater costs, it might be worthwhile if it made people safer. However, liability awards have increased at the same time that accident rates have declined, and there is no evidence that higher liability awards result in safer products. They might even have made things worse, since manufacturers are hit when they innovate and introduce new, safer products. New safety technologies should be encouraged, but American law punishes the innovator.
NOTHING BUILDS WEALTH so much as trust—the trust that permits parties to rely on each other in a joint project—and nothing cements trust better than enforceable contracts. But contracts aren’t really enforceable if one side gets to walk when things don’t turn out as he likes. That’s why a successful law of contracts cannot have a thick set of excuses from performance. A party can’t be permitted to walk from a deal when it goes sour. More than most countries, however, America permits parties to exit from contracts under doctrines of mistake, frustration, and impracticability.
Another culprit is the way contracts are interpreted. It’s pretty easy for a party who isn’t happy about the way things turned out to say “that’s not what we agreed to.” That’s why people use written contracts that (in “merger clauses”) tell courts to look only to the writing and exclude non-written oral communications: They’re too easy to fake. However, many American courts, especially in California, ignore merger clauses and make a mess of contract interpretation.
A decade ago the New York Stock Exchange launched half the world’s new public companies. By 2006 this had dropped to one in 12, as firms moved to the London Stock Exchange and other venues. Much of the blame lies with Paul Sarbanes and Mike Oxley, sponsors of the Sarbanes-Oxley corporate reform legislation (“Sarbox”), whose photographs (as their favorite Americans) are displayed by London brokers. They know whom to thank for legislation that drives the American securities industry to Britain and other countries.
While Sarbox greatly and inefficiently increased the reporting duties of U.S. public firms, it is not the only thing that drives securities business offshore. The prospect of litigation based on federal securities law is another reason for the decline in the American securities market. Firms are less exposed to shareholder suits and pay less for directors’ and officers’ insurance in other countries. For smaller companies in particular, the savings are significant.
TWO CHANGES IN federal criminal law have made potential criminals of all of us. First, the scope of the law has expanded and the number of federal crimes today is literally unknowable. The result, according to a leading criminal law academic, the late William Stuntz, is that we are moving closer to a world in which the law on the books makes every American a felon. Second, legislators and regulators have abandoned the mens rea requirement, under which people can’t be found guilty unless they have a guilty mind. This means that one can carry on business innocently and still end up in jail. It also gives ambitious prosecutors extraordinary leverage to go after people they dislike.
For businessmen, the chances of going to prison would appear to be higher here than in other first-world countries. That takes the risk of doing business in America to an entirely different level. It also means firms have to invest much more in legal advice here than in other countries, which helps explain the ossification of legalized business practices and the decline in risk-taking.
There’s no great secret to the kind of legal regime that grows an economy. All that is needed are laws that preserve a space for private ordering, respecting the sanctity of property and the enforceability of contracts. With that, parties might be able to bargain around inefficient laws. They can’t do so without the rule of law, however, which is why the misrule of law in America is such a silent killer of economic progress.