Common law vs Civil law : Economy

Civil Law vs Common law Pros and Cons

The economy of different countries grows at different rates. This is evident by comparing the real per capita Gross Domestic Product (GDP) of different countries. For example, Australia’s GDP growth rate from 2011-2012 was 3. 4% while New Zealand’s GDP growth rate was 3. 0%. Due to its significance on the national welfare, every country aims to increase their economic growth rate as economic growth means higher income, lower unemployment, lower government borrowing and improved public services and encourages investment (Brenner 1998).

Given the potential national benefit from achieving an efficient economy, economist have studied and suggested what factors drive growth. Due to the important role played by the law in the finance sector, economist and policy makers argued that the legal system can have a major influence on a country’s economic prosperity. This leads us to the main topic of this research essay. The aim of this essay is to compare the strengths and weaknesses of the common law system with the civil law system with reference to economic prosperity.

The first section will explain the connection between the legal origin of a country and its economic growth with reference to theories and hypothesis from various academic literatures. The second part will give an overview of the main difference between the two legal systems and compare the strengths and weaknesses of each. Lastly, to conclude the essay, this paper will weigh the pros and cons of each legal system and will conclude which of the two is a better system in the context of economic prosperity.

I. Since the connection between law and finance was introduced, there has been an emergence of literature claiming that a nexus between a country’s legal origin and economic growth exist. One of the well known theories that have been referred to by many researchers is the law and finance theory. This theory argues that the legal system is important in the way it is promoting or preventing financial development.

To explain this theory even further, Graff on his work on law and finance theory divided the casual chain into two major parts. The first link is between the legal system and financial development while the second link is between the financial development and the economic growth. (Graff 2005) With regards to the first link, financial economists have produced evidence that financial markets contribute to the economic growth.

Using evidence on 80 countries, King and Levine presented data consistent with Joseph Schumpeter’s view that financial system can promote economic growth as “measures of the level of financial development are strongly correlated with real per capita GDP growth, the rate of physical capital accumulation, and improvements in the efficiency with which economies employ physical capital” (King and Levine 1993, p. 2). This leads us to the second link between legal origin and financial development.

In most countries, the market is subject to the regulating laws imposed by the courts and legislative bodies. To encourage future creditors and shareholders to invest, policy makers aim to create a market that is favourable to these potential investors. Beck and Levine elaborates this further by diving the law and finance theory into two mechanisms (1) a political mechanism that works through the way that "legal traditions differ in terms of the priority they attach to private property vis-a-vis the rights of the State and …

The protection of private contracting rights", and (2) an adaptability mechanism, referring to the degree of formalism in the legal system that, if overdone, may impair the legal system’s capability to "minimise the gap between the contracting needs of the economy" and the normative status quo. (Beck and Levine 2005, p. 2) If economic growth can be achieved by financial development, financial development result in effective rules and rules that govern markets is explained by the legal origin, then what legal system best support the economic growth of a country.

This question leads to the next section of this essay which focus on the main features and the strengths and weaknesses of each legal system. II. As many scholars have noted, there are multitude differences between common law and civil law. The two main distinctions, as discussed by Beck and Levine, are the relationship between the State and the Courts and jurisprudence. With regards to the first context, common law is focused on “dispute-resolving” and “stressed the rights of private property owners by pertaining large estate holders as private property owners rather than tenants of the King” (Beck and Levine 2005, p.

2). In contrast, Civil law, which is traced back to Roman Empire, places the law above all individuals and is focused on “policy-making”. In terms of jurisprudence, Common law judges are given the power to broad interpretation and the right to modify and create new law as circumstances change. Their decisions become the 'rule of law' for all future cases that are factually similar. Conversely, in Civil law, the State is above the courts and jurisprudence is eliminated. Civil law judges cannot make law by interpreting statutes.

Legislation is codified and courts are bound to enforce the received law. There are also more formalistic requirements under the civil law and because updating a law is a lengthy process, civil law is seen as rigid (Beck and Levine 2005). Although the relationship the State and the Court is relevant, the role of the judiciary is the main factor that affects how laws are created and implemented. Therefore, this suggests that jurisprudence is the main factor that explains the growth differences between the countries.

Having discussed the main difference between the two legal systems, it is necessary to focus on the main topic of this essay which is the strengths and weaknesses of common law and civil law system. By comparing the GDP of 49 countries, La Porta and his colleagues found that conditions such as more judicial independence, better shareholder and creditor protection, less procedural formalism and less strict regulation of entry are associated with higher income per capita.

By relating this concept to the common law and civil law, they concluded that common law system provided the more favourable basis for financial development and economic growth than civil law (La Porta et al 2007). On ‘The Constitution of Liberty’, Hayek argues the same notion that the common law is superior to civil law due to the differing roles of individual and the state. Moreover, he states that the ability of judges to react to changing circumstances tends to improve the law’s quality over time (Hayek 1960). Beck and Levine also lead to the same conclusion.

As mentioned on Section 1, the writers draw two mechanisms from law and finance theory: political and adaptability mechanism. Graff (2005) applied the two mechanisms and concluded that the common law is superior. Under the adaptability mechanism, the common law system is more flexible in dealing with financial contracts, which are always uncertain due to risk. Under the political mechanism, common law system is more effective in ensuring private property rights as judges aim to limit the government and promote estate holder’s rights.

Alternatively, civil law is seen as rigid as laws are codified and to update laws, legislatures must create new laws. This process involves formalistic requirements and a considerable amount of time. Accordingly, the political mechanism is expected to produce inferior outcomes in all civil law systems as the emphasis under this system is the public welfare rather than the protection of private property rights (Beck and Levine 2005).

Most of the literature dealt so far arrives at the same conclusion that the common law system guarantees the most favourable environment to financial investors. To weigh the two, it is essential to look at the strengths of the civil law and weaknesses of the common law. It is expected that all kinds of rule-making are likely to fail in promoting the public good because the private interest of the individuals in the group will be pursued. However, because common law involves more judicial independence and is decentralised, it is likely to suffer more on cognitive departures.

In their framework, Arrunada and Andonova (2008) identified the main cognitive departures suffered under judicial rule making in terms of self interest, information, biased rationality and ecological rationality. Under self interest, the writers argued that because judicial rule making is decentralised, it is likely suffer from agency and collective action problems than civil law. Both of the writers recognised that some judges may have a conflict of interest or may pursue self-interest which can cause corruption and congestion of courts.

Second, with respect to information, the allocation of rule-making power between legislators and courts in a common law system also poses the typical problem with respect to the lack of motivation for judges to produce relevant information. Third, judicial rule-making may also result to biased rationality. Supporting this claim are Guthrie, Rachlinski, and Wistrich. They reported, by means of a questionnaire answered by federal judges, that judges suffer from anchoring effect, hindsight bias, overconfidence, framing effects and representative bias.“ (Guthrie et al. 2001).

They concluded that judge’s decision is affected by cognitive illusions that can produce systematic errors in judgment. Lastly, judicial rule making can cause ecological rationality and unnaturalness of market. Court may systematically fail to consider an evolutionary, outdated concept of justice and rely heavily on instinct. As a result, poorly-cultured judges may misunderstand the ever changing market relations, leading to misguided justice.

The paper’s main argument is that judges from common law, who are mostly insufficiently cultured about the market, keep sentencing as if they were living in a non-market economy. Legislators, on the other hand, do not suffer anti-market bias to a similar extent because the legislature generally rules in more abstract terms and for anonymous parties, without respect to specific cases, while judges have a personal contact with the parties (Arrunada and Andonova 2008) It is clear, therefore, that common law and civil law are different not only on their features but also on their strengths and weaknesses.

There is no clear cut on which legal system is superior in the context of economic prosperity. Judicial rule making, which was seen as the main distinguishing factor, may entail costs and benefits. Benefits, as seen in LLSV and law and finance theory, includes more favourable regulating laws that attracts potential investors and more adaptable to change. On the other hand, jurisprudence can also cause cognitive departures that can lead to misguided judgement and can also be rigid if judges are poorly cultured about the market.

Weighing the pros and cons of each legal system, in terms of economic growth, I believe that common law is superior. I argue that the benefit of judicial rule- making offsets its cost as the discretion of judges promotes creditor and shareholder’s protection. Moreover, if these rent-seeking parties weigh the cost and benefit of each legal system, their interest will still be emphasised on a common law system. This is because cognitive departures and failures are present in any rule making body.

It is an independent factor that will exist regardless of the legal origin as judges and legislatures, similar to any individual, are driven by self-interest. In addition, common law judges , unlike civil law judges, are more experienced as entry into the judiciary comes after completion of a first undergraduate degree in a subject other than law, a graduate degree in law, admission to the bar and fair lengthy period of practice as an attorney.

This means that the common law judges are more knowledgeable and experienced about the market than civil law judges and this can reduce the biased suffered by the common law. On the other hand, there is no need to limit economic growth with legal origin. There are numerous factors that can explain the differences in growth rate between countries.

References

  • Arrunada, B, Andonova Zuleta V, 2008, ‘Common Law and Civil Law as Pro-Market Adaptations’, Washington University Journal of Law and Policy, vol. 26 , p. 81-130.
  • Beck T, Levine R, 2005, ‘Legal Institutions and Financial Development’, Handbook of New Institutional Economics, No. 10126.
  • Graff, M 2005, ‘Law and Finance: Common-law and Civil-law Countries Compared’, Economica, Vol. 75(297), pp. 60-83.
  • Graff, M 2006, ‘ Myths and Truths: The "Law and Finance Theory" Revisited’, Review of Economics, vol. 57(1), pp. 51-76.
  • Guthrie C , Rachlinski J. ; Wistrich, A. , 2009 ,‘The "hidden judiciary": an empirical examination of executive branch justice’, Duke Law Journal, , Vol. 58(7), p. 1477(54).
  • Hayek F, 1960, The Constitution of Liberty, University of Chicago Press. Levine R, 1999, ‘Law and Finance, and Economic Growth’, Journal of Financial Intermediation, vol. 8(1), pp. 8-35.
  • King, R . Levine R, 1993, ‘Finance and growth: Schumpeter might be right’, Quarterly Journal of Economics, vol. 108(3), p. 717(21).
  • La Porta R, Lopez-de-Silanes F, Shleifer, A, 2007, ‘The Economic Consequences of Legal Origin’. Mahoney P, 1999, ‘The Common Law and Economic Growth: Hayek Might Be Right’, The Journal of Legal Studies, vol. 30(2), p. 503-525.