As legal practitioner Wade Channell summarized the legal reform experience of Eastern Europe after 1990: “It is hard to imagine any rule of law aid specialist pursuing law reform in his or her own country in this fashion. If I assembled half a dozen recognized European or U.S. specialists to redraft the U.S. Code of Judicial Ethics and then tried to get it passed by the U.S. Congress with little or no input on the proposed draft from congressional committees, the judiciary, the bar, business interests, law schools, or other stakeholders, I would be looking for a new career rather quickly. Based on many current practices, however, that career could easily be found abroad ‘helping’ transition countries with the same process.45
Titling Toward Confusion in Kenya
Lord Lugard, the architect of British colonial rule in Africa, said land tenure follows “a steady evolution, side by side with the evolution of social progress.” This “natural evolution” leads to “individual ownership.” The Native Land Tenure Rules of 1956 privatized land in Kenya, advertising it as “a normal step in the evolution of a country,” under which “energetic or rich Africans will be able to acquire more land.”
The anthropologist Parker Shipton, one of the few outsiders who bothered studying the region in detail, looked at the consequences of land titling for the Luo tribe in western Kenya in the early 1980s.46 The traditional system among the Luo was a complicated maze of swapping plots among kin and seasonal exchanges of land for labor and livestock. There were both individual and family rights in cultivated fields and free-grazing rights for the community after the harvest. Each household’s claim to land included many plots of different soils and terrains, on which many different crops grew—not a bad system with which to diversify risk in an uncertain climate. The traditional land patron (weg lowo) would often give temporary land rights to the client (jodak). There were seasonal exchanges of plows and draft animals for land, or land for labor.
Land titling brought many uncertainties into this complex system. Would the government give the titles to the weg lowo or to the jodak? The system inclined toward the latter, fostering bitter conflict between the two groups. Sometimes the former weg lowo would wind up as the jodak of his former jodak. An unpaid adjudication committee, who expected both parties to provide a feast for them, made the decisions. The system favored whoever could bring more goats to the feast. Often claimants would not bother with adjudication as the costs of the feast exceeded the value of the property.
Although land sales increased after formal registration, neither the buyers nor the sellers wanted the high fees or red tape associated with registering the sales. The system of formal titles thus gradually lost correspondence with those who the locals knew owned the land. An increasing number of formal titleholders resided in the local graveyard.
The opportunistic behavior that bedevils market transactions also plagued land sales in Kenya. Sellers who had earlier pledged their land as collateral for a loan would fail to inform the buyer of this claim on the land. Banks found it politically difficult to auction off the collateral land after loan default, since land owned by kin of the defaulter surrounded it. Some sellers sold to several buyers at once, using different elders as witnesses.
The adjudication committees required that sellers retain enough land for the subsistence of their own families. Sellers sometimes exploited this rule by selling “too much” land, gambling that the land-control board would give back some of their land while the buyers would not recover the purchase price.
Ocholla Ogweng of Kanyamkago got a loan of thirty thousand Kenyan shillings from Barclay’s Bank in 1979. To raise collateral, he asked the help of his wife’s father, Ogwok Nyayal. Mr. Nyayal arranged with his sister’s husband, Mr. Alloyce Ohero, to pledge his land as collateral for Mr. Ogweng’s loan. Alloyce Ohero then sold part of his land to two strangers, without informing them of the Barclay’s Bank lien, and they settled on the land. Mr. Ohero died in 1981, and Mr. Ogweng defaulted on his loan. The two sons of Alloyce Ohero expected to inherit the unsold part of his land, equally unaware of the Barclay’s Bank claim. By 1982, a court broker prepared to auction off all of Mr. Ohero’s former land on behalf of Barclay’s, to the consternation of everyone involved. The two strangers blamed Mr. Ohero’s sons, who blamed their uncle Ogwok Nyayal, who blamed Alloyce Ohero, who, if he had been alive, would have blamed Ocholla Ogweng. Here was a deal with nothing for everyone.
What looks like opportunistic behavior could be the mingling of private property with traditional values, which place obligations to kin above those to strangers or banks. By imposing land titling on such complex social customs, “private property rights” may actually increase the insecurity of land tenure rather than decrease it.
Perhaps chastened by these experiences, formal land law in Kenya is now moving back toward recognizing customary rights. The government is allowing the paper titles to lapse.47 Reformers who want to increase the security of property rights have to search for what works in each locality. A more likely way forward for formal law would be building on the customary law rather than contradicting it.
Bottom-up Legal Evolution
Researchers have accumulated evidence that the bottom-up approach to law has proven to be superior for economic development to more top-down approaches. A series of studies compare development outcomes in countries with a common-law tradition to those with a civil-law tradition. The common-law tradition originated in England and spread to British colonies. In this tradition, judges are independent professionals who make rulings on cases based on precedents from similar cases. The principles of the law evolve in response to practical realities, and can be adapted to new situations as they arise. As the great American jurist Oliver Wendell Holmes said, “It is the merit of the common law that it decides the case first and determines the principles afterwards.48
The modern civil-law tradition originated under Napoleon, in France, and spread to French and Spanish colonies. (Spain was under the control of Napoleon at the time.) In this tradition, laws are written from the top down by the legislature to cover every possible situation. Judges are glorified clerks just applying the written law. This system of law lacks bottom-up feedback of the common law that comes from having cases determine law. As a result, the law is less well adapted to reality on the ground and has trouble adapting to new situations as technology and society change. Ironically, France itself proved more flexible in applying the civil law than French or Spanish colonies, who have followed a judicial formalism that was slow as well as poorly adapted to changing circumstances.
The differences show up in institutions. Systems that rely on case law have a positive-feedback loop between the law and the arrangements that economic actors need to facilitate markets. Case law countries thus wind up with a wider variety of formal institutions more supportive of prosperity—property rights, contract enforcement, rule of law, and even corporate accountability—than do civil-law countries. Australia, Canada, New Zealand, Pakistan, Uganda, and the United States are examples of former British colonies that have well-developed property rights protection for their level of income. Algeria, Colombia, Haiti, and Nicaragua are examples of former French or Spanish colonies that have poor property rights protection for their level of income.
Fig. 8. Institutional Outcomes and Legal Traditions
Source: Beck and Levine 200449
The search process of the common law was particularly important in supporting financial markets. Finance requires more complicated arrangements, such as legal protection of shareholders in companies and bankruptcy proceedings to give creditors their money. Indeed, it turns out that countries with British legal origins have better legal protections for shareholders and creditors than countries with French legal origins. The result is that case law countries have much more developed financial markets, as measured by indicators such as the share of private credit in GDP, and stock market capitalization and liquidity.
Finance Without Good Laws
Mexico is a civil-law s
tate that has failed to evolve good financial laws. Take the example of privatization of Mexican state banks beginning in 1991. Privatization is one of the staples of free-market reform urged by the World Bank and the IMF. But in the case of Mexico, things did not go according to plan. The problem began with the privatization program itself, in which buyers of the banks could use loans from the banks they were buying to purchase the banks. One buyer covered 75 percent of the purchase price with this trick. Normally, savers would not want to deposit in banks with such shaky financing, but savers had deposit insurance from the Mexican government. The newly privatized banks thus expanded credit rapidly, with little regard for risk. Lax banking regulations allowed them to roll over loans that borrowers did not repay without even having to declare the loans in default. Bank credit grew by more than 20 percent per year in real terms from 1991 to 1994, while past-due loans grew by more than 40 percent per year.50 If the banks did try to collect from borrowers, they ran into Mexico’s torturous (civil-law) bankruptcy laws, in which it took between three and seven years for banks to recover collateral from borrowers. The reckless credit expansion contributed to the collapse of the peso beginning in December 1994, in which the currency lost half of its value, and Mexico had a severe recession.
In the aftermath of the peso crisis, the government designed a bailout of the banking system’s bad loans. Unfortunately, the government (with World Bank and IMF acquiescence) dragged its feet on the bailout. With an anticipated bailout, the banks’ owners had incentives to lend to themselves and then default. During 1995–1998, the banks gave 20 percent of large loans to individuals on their own boards of directors. The looting of the banks raised the cost of the bailout to the government, which in the end amounted to 15 percent of the Mexican GDP.
Since 1998, regulation of banks has been much tougher, and the government has allowed foreign banks to enter in order to put competitive pressure on Mexican banks. The bad loan problem has finally been solved, but mainly because banks lend less to the private sector. Because of the still-shaky bankruptcy laws, banks are now extremely cautious about private borrowers—the share of private loans in bank assets declined from 49 percent in 1997 to 30 percent in 2003. Mexico has still not solved the problem of making financial markets work because of the difficulty in getting the bottom-up rules and incentives right.51 This story may give some insight into why the payoff to Latin America’s “free-market” reforms was disappointing.
Top-down Dreams
So the West cannot design a comprehensive reform for a poor country that creates benevolent laws and good institutions to make markets work. We have seen that the rules that make markets work reflect a complex bottom-up search for social norms, networks of relationships, and formal laws and institutions that have the most payoff. To make things worse, these norms, networks, and institutions change in response to changed circumstances and their own past history. Political philosophers such as Burke, Popper, and Hayek had the key insight that this social interplay was so complex that a top-down reform that tried to change all the rules at once could make things worse rather than better.
Economic theorist Avinash Dixit has a more recent example of why top-down reform may have unintended consequences. Suppose a society is facilitating market transactions mainly through networks. We have seen that such networks are self-enforcing in that any cheater can be expelled from the network and thus lose all future business opportunities. Now suppose that the World Bank twists the arm of a government to set up a system with formal rules overseen by courts. Suppose such a parallel system is at least partially effective, making some business opportunities possible through the formal rules. Some of the participants in the informal networks can cheat their partners, exit the network, and begin operating in the formal system. A society could get caught in a disastrous in-between situation in which the networks break down, disrupting the previous trades, but the formal system still operates imperfectly, limiting the scope for new trades. Having two sets of rules is often worse than having only one. A reform where the gradual introduction of formal rules reinforced the existing networks would work better than one that tried to replace them. A plausible story for the evolution of institutions in the West is that informal relationships and norms in networks gradually hardened into formal rules (which are still supported by informal relationships and norms).52
This is armchair speculation, but Dixit’s story may help explain why the transition from communism to capitalism in the former Soviet Union was such a disaster, and why market reforms in Latin America and Africa were disappointing. Even with severely distorted markets, the participants had formed networks of mutual trades and obligations that made the system functional at some level. Trying to change the rules all at once with the rapid introduction of free markets disrupted the old ties, while the new formal institutions were still too weak to make free markets work well. Gradual movement to freer markets would have given the participants more time to adjust their relationships and trades.
The main moral of the story is that free-market opportunity depends on bottom-up social choices that Planners usually don’t begin (or try) to understand. When researchers try a little harder (as did many of the hardworking researchers on whose work this chapter draws), there is hope for gradual, piecemeal reform and spontaneous efforts by Searchers among poor people themselves.
And things are not so impossibly complex that policymakers should just throw their hands up and say it’s hopeless. Poor people are resourceful despite the screw-ups by Planners.
Stagnant Economies, Dynamic Individuals
In fact, there have been positive bottom-up market trends in Africa, Latin America, and the ex-Communist countries, even though top-down structural adjustment and shock therapy failed. The younger generation is seizing opportunities to expand its horizons, with many more people getting advanced degrees both at home and in the West (which is part of the India and China success stories). Children in the new generation are coming of age knowing only markets, and there is hope that they will make markets work better than their parents did. New electronic technologies are spreading rapidly, such as computers, Internet access, cell phones, VCRs, and DVDs.
In 1992, Nigerian moviemaker Ken Nnebue released a film called Living in Bondage, a melodrama about a man who joins a secret sect that promises him great wealth if he sacrifices his wife. The film’s dialogue is in Igbo, with subtitles in English. Rather than showing the movie in theaters, which many Nigerians could not have afforded, Nnebue released the film directly to video. Thus was born the Nigerian movie industry, known as Nollywood, sometimes called the third most vibrant movie industry in the world after Hollywood and Bollywood. Shooting with a very low budget and a tight schedule, Nigerian moviemakers churn out thousands of titles affordable to poor Africans. The industry reaches the African mass market by emphasizing local cultures and themes most relevant to Africans. People in Nigerian video stores often pass up the latest Hollywood release in favor of one from Nollywood.53
Despite Africa’s economic stagnation, this is not to say that life is unchanging. New technologies have been spreading, giving Africans more information, more entertainment, more choices. The number of TV sets on which to watch Nollywood films has skyrocketed, following the previous explosion of radios. (See figure 9.)
There is another interesting indicator of the growth of bottom-up markets. I noticed sometime in the late 1990s the remarkable prevalence of cell phones almost everywhere, from Moscow to Prague to Accra to Soweto to La Paz. Sometimes it seemed to me there were more people walking on the street with cell phones in these places than in much richer places, such as the United States. The figure shows the growth of cell phone density in Africa, Latin America, and the ex-Communist countries (each unit increase on the graph represents an increase of tenfold in the number of cell phones per thousand people).
Fig. 9. Radios and TVs Per Capita in Africa
In Africa since 1996, the number of cell phones has been increasing by a factor
of ten every three years. The explosion of cell phones shows just how much poor people search for new technological opportunities, with no state intervention, with no structural adjustment or shock therapy to promote cell phones. These are not just consumer pleasures. Cell phones help farmers, fishers, and entrepreneurs check out prices, suppliers, and consumers; arrange meetings; transfer funds; and lots of other things that are logistical nightmares in societies without good landline phones, functional postal services, or adequate roads.54
Fig. 10. Cell Phones Per Thousand People
Entrepreneur Alieu Conteh started building a cellular network in the Democratic Republic of the Congo (formerly Zaire) when it was still in the midst of its civil war in the 1990s. He couldn’t get a foreign manufacturer to ship cellular towers into the country with rebel soldiers around, so he got local men to weld scrap metal into a makeshift tower. Demand exploded for Conteh’s phones, and in 2001 he formed a joint venture with the South African firm Vodacom. One illiterate fisherwoman who lives on the Congo River without electricity relies on her cell phone to sell her fish. She can’t put the fish in a freezer, so she keeps them live on a line in the river until customers call to place an order. Vodacom Congo now has 1.1 million subscribers and is adding more than a thousand a day.55
Fig. 11. Internet Users Per Thousand People
There has been a similar explosive growth in Internet users in Eastern Europe, Latin America, and Africa. On my first World Bank trip to Ghana in 1985, I had to make an emergency call to the States at the only working overseas phone line in Accra—through a pre–World War II switchboard in the basement of a hotel. Now there is a Wi-Fi Internet connection in my hotel room, where I can communicate back home every day. Whereas in 1996 the typical African country had only one Internet user for every 27,000 people, in 2003 there was one for every 138 people, and it is still climbing rapidly. Although the ex-Communist countries also started with virtually no Internet users in 1996, the rate of adoption has climbed steeply there and now surpasses Latin America and the Caribbean (even though the latter region has also had rapid Internet expansion).
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