An Alternative View on Law, Institutions, Finance and Growth

The spectacular economic growth in East Asian economies such as China, South Korea and Taiwan over the past five decades contradicts most of the existing research on law, institutions, finance, and growth. We propose an alternative view based on the comparison of legal institutions and alternative institutions outside the legal system. Despite well-known advantages, the legal system, as a monopolist institution, can be captured by interest groups and become a barrier to innovations. Moreover, in a dynamic environment alternative institutions can adapt and change much more quickly than when the law is used, as this process does not require persuading the legislature and the electorate to revise the law. We argue that in fast-growing economies and during early stages of economic growth, efficient alternative institutions are the main driver for finance, commerce and growth. In static environments with low and predictable growth, legal institutions can play a more important role in supporting finance and commerce. In these environments, however, viable alternative institutions and competition among different types of institutions remain keys to ensuring that the most efficient mechanism prevails and sustains long-term growth.