‘Importing’ law for development!

The policies for development of a legal framework for global markets through the 'import' of laws from outside, favoured and promoted by international organisations including the IMF, has been sharply criticised by an American academic in a study for the G24.

by Chakravarthi Raghavan

Geneva, 13 Sep 2000 -- The policies for development of a legal framework for global markets by importing ‘well-designed’ laws from outside, promoted by international organizations in developing countries, has been sharply criticised by an American academic in a study prepared for the Group of 24, the developing-country group before the International Monetary Fund and the World Bank.

The study by Katharina Pistor at the Kennedy School of Government at Harvard University has joined issue with the concept of imported laws for law development, promoted and favoured by international organizations including the International Monetary Fund.  While the study focuses on the “import” of laws from outside to provide a legal framework on corporate and financial institution laws, and cites the IMF support for this, the practice appears to be part of a wider Washington-inspired drive—as far-reaching as Lord Macaulay’s writing of laws and application of English common law, overriding all domestic customary laws, for India and other colonies in the 19th century British era of liberal order and globalization.

There have been reports about a three-way or a four-way arrangement, with separate agreements, involving the World Bank, the UN Development Programme (UNDP), the US State Department and the American bar association (and US lawyers and jurists) -- all under the rubric of this now fashionable word ‘good governance’. Under this, the Bank and/or the UNDP promoting good governance and some ‘funds’ to the developing countries get their agreement, and by separate arrangements between the US State Department and American bar associations, young American lawyers are deputed to countries, firstly to survey and assess their legal systems and laws and administration, and then write and frame new laws for enactment as part of the ‘good governance’ campaign.

The effort is being pushed particularly in Africa, as part of the effort to eradicate corruption and bring good governance - though the process itself, in a sense, is corruptive, if corruption is understood to mean more than direct bribery, but involving influence-peddling and lobbying (including financing of elections through hard and soft money).

Even some institutions of the South governments—regional, subregional or global—are funded from aid budgets of the major developed countries of Europe, and directly or otherwise, provide technical assistance for framing laws—ranging from financial frameworks to trade regimes, intellectual property rights, investment, competition policy etc.

No doubt at some point, in the kind of ‘revolving door’ atmosphere characteristic of these institutions and the Washington/Brussels establishments, the lawyers and technical experts will return to the private sector, and may even take briefs from TNCs to lobby the governments or file briefs and help firms fight local laws and administrations.

And the attempts to use the WTO’s General Agreement on Trade in Services to force developing countries to open up their professional service markets for foreign service providers and enable western accountancy and legal firms to practice in domestic courts and tribunals on a par with local professional expertise seems to be part of this grand design for globalization.

The Pistor paper, published as a G-24 Discussion Paper by the UN Conference on Trade and Development (UNCTAD), notes that the supply of well-designed laws from outside is a widely used tool in law and development programmes. This method has been embraced by international organizations as a way to improve the legal framework for global markets. The IMF has now endorsed attempts by various organizations to develop legal standards with special emphasis on corporate and financial institution laws.

The common idea behind these attempts, says Pistor, is that “the supplied laws once incorporated into domestic legal systems will improve the existing legal framework, and thus further economic development.”

Joining issue with this approach, Pistor argues that for developing effective legal systems, “the contents of supplied laws is only of secondary importance to the process of law development and compatibility of the new laws with pre-existing conditions, including existing legislation and legal institutions.”

This is because only a few rules are ‘free standing’, and can be fully understood and enforced without reference to other legal terms and concepts. Law is a cognitive institution, and the application and enforcement of rules is determined by the perception of the new rules by users and enforcers in the receiving country. And, effective law enforcement is a function of the extent of voluntary compliance and available resources in a given country.

Pistor notes that the integration of markets has gone hand-in-hand with a proliferation of efforts to harmonize key aspects of law relating to finance and trade. In the wake of the recent financial crises (in Asia, Russia and Latin America), the IMF has embarked on improving the international financial architecture - with special emphasis on the legal framework for corporate finance and corporate governance.

And the vehicle for building this legal architecture for global markets is the harmonization of law around the globe by developing legal standards. The idea seems to be that convergence towards international legal standards will improve institutional environment in the receiving country. In this perspective, the standards proposed have a “clear normative agenda” and at least at face value, their purpose is not simply to harmonize in order to reduce transaction costs and to benefit from economies of scale, but “to improve domestic legal institutions.”

But the quest for developing an optimal set of legal rules ignores a central feature of economic development, namely, constant change, innovation, and adaptation of institutions and organizations in a competitive environment.

“The standardization of ‘best practice’ or ‘efficient’ law,” says Pistor, “replaces the Schupeterian process of ‘creative destruction’ with the ideal of ‘perfect construction’ of law. Instead of improving domestic legal systems, standardization or harmonization may in fact undermine the development of effective legal systems.”

This is due to two essential features of legal systems: the interdependence of legal rules and concepts comprising a legal system, and law as a cognitive institution.

There are only a few legal rules that can be understood and applied without reference to other rules or concepts. Standardized rules and concepts can be realized and applied only if other bodies of law already exist in the standard receiving legal systems, or if additional reform efforts are made. Without complementarity between new law and pre-existing legal institutions, harmonization may distort rather than improve the domestic legal framework.

And for law to be effective and actually change behaviour, it must be fully understood and embraced not only by law enforcers, but also by those using the law—its ‘customers’ or legal intermediaries including courts, judges etc.

The external supply of best-practice law, while facilitating more radical change than might be feasible without external pressure, sterilizes the process of law-making from political and socio-economic development, and thus distancing it from the process of continuous adaptation and innovation. This last in turn depends on availability of information not only about contents of legal rules - provided by international legal standards - but also their functioning in the context of a living legal system.

The “perfect construction” of law by legal experts for wide dissemination can deprive law makers and law enforcers in the receiving countries of the knowledge of the living law, which is context-specific. And the imposition of rules from outside - not a new experience for most developing countries, as the history of colonialism exemplifies, may also lead to domestic resistance.

The development of effective domestic institutions is crucial for the governance of global markets, because without a supranational enforcement system, law enforcement is dependent on local institutions.  Even where disputes are settled by international arbitration tribunals, in accordance with international arbitration standards, domestic courts will need to recognize the award. Domestic bailiffs, law enforcers, sheriffs etc will need to seize assets, freeze bank accounts or take other actions to execute the award, should there be no voluntary compliance. Thus standardization of law does not solve the problem of transnational transactions governed by multiple jurisdictions. At best it may reduce uncertainty about the substance of applicable law, but is no guarantee for uniform interpretation and enforcement of set standards, Pistor adds.

The legal standardization efforts identified by the IMF to be of primary importance for the international financial architecture, in addition to banking regulations, include accounting, auditing, bankruptcy, corporate governance, insurance regulations and securities markets regulation. And a number of professional interest groups and entities are involved, as also UN bodies like UNCITRAL, the OECD (which has adopted standards for corporate governance, and has a separate set of principles in this area for transition economies) and the World Bank in its lending countries for improving corporate governance.  One common feature is that these are non-binding, and tend to be general in nature, leaving ample scope for interpretation to law makers and law enforcers. But the non-binding voluntary nature reduces the degree to which the law will actually be harmonized across jurisdictions, and thus reduces the possible savings for transnational investors. However, it gives countries greater scope for taking an active role in the reception of these standards and transformation into domestic laws.

The generality of standards in supplied law may disguise the fact that they involve a substantial reallocation of rights, with important implications for the political economy of enforcing them within a domestic setting. But their generality opens up the possibility of subscribing to them without implementing - making not only monitoring of compliance difficult, but also misguide investors. These last may either believe that a country subscribing is implementing the standards or may take it to be a formal or creative compliance with international standards. They may realize that this does not necessarily increase the security of their investments in the long-term, but may have covered their backs vis-a-vis their superiors and investors.

Developing international legal standards and adapting legal systems around the world to them is a costly undertaking. The harmonization of standardization of laws can be questioned on principle grounds, irrespective of the area of law in question. This is the topic of the debate over costs and benefits of harmonization versus regulatory competition in producing better rules from an economic efficiency point of view.

In terms of implications for developing countries, Pistor points out that “harmonization or standardization of law is not necessary for international trade and investment to take place.” Most transactions take place using law that has not been harmonized or standardized.

While the areas of law at the core of the IMF standardization effort are claimed to be important for portfolio investments, “their relevance to FDI is less evident,” says Pistor.

Again, underwriting of international standards may serve as a signal to foreign investors; when a crisis hits, investors will put out if they have serious doubts about the effectiveness of legal institutions and their ability to protect claims. They will not be misled by formal indicators, but would take a closer look at ability of countries to implement them.

And the signalling purpose of international legal standards will erode if too many countries practice formal, rather than real, compliance.

The key to success for any given country would be the establishment of effective legal institutions - which in part depends on available resources, financial and human. Where these are not available, or other obstacles stand in the way of effectuating financial law, “a country should consider whether it is ready to expose itself fully to the winds of international financial markets,” says Pistor.

The Pistor paper advocates a new approach to reforming legal systems in developing countries and emerging markets. Instead of having legal standards developed by legal experts or professional interest groups, law makers around the world should be given access to alternative legal solutions found in living legal systems.

And irrespective of their initial conditions, all countries should have access to information on how different legal systems create mechanisms of accountability for common problems.

To be effective, law needs local constituencies with a strong interest in and understanding of the laws. This is a pre-requisite for new laws to become part of the continuous process of legal change, without which formal legal systems will remain irrelevant. It is also important for ensuring high levels of voluntary compliance with the law, and thus its effectiveness.

Legal standards should not be viewed as a panacea for building effective legal standards around the world, the Pistor study warns.-SUNS4739

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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