Saturday, February 27, 2010

The glorious revolution

In my title, I am of course referring to the event in England in 1688 which unintentionally led to the Bill of Rights, rule of law, and Western capitalism as we know it. As background for those unfamiliar with it, there are two short clips at the end of this piece worth viewing.

The now classic essay by Douglass North and Barry Weingast investigates the institutional innovations that accompanied the resolution of this conflict and relate them to developments in public finance. Their thesis is that without such constitutional and political underpinnings, England would not have achieved global success both militarily and commercially in the following century.

They purposely side-step the religious element that is often cited. Greater importance was placed on the dispute that had been brewing since early in the 17th C between the Crown and Parliament. Many of the same issues in this dispute hound developing and transitional economies today.

At the core of this was the structuring of incentives to control the coercive powers of the state. Previously the divine right of kings was invoked to justify the arbitrary use of such powers resulting in the expropriation of property from the wealthy who were represented in Parliament. Despite objections, the king continued to wield his prerogative by forcing loan contracts on the elite and reneging on the debts.

This unpredictability meant that the Crown was unable to tap private credit markets. Following the revolution, the new monarch acceded to the rights of Parliament over such contractual obligations. As a sweetener, the confidence this engendered opened unprecedented access to capital at more affordable rates. This allowed England to achieve military superiority while maintaining fiscal liquidity and provided the conditions needed for the Industrial Revolution.

It is in keeping with this seminal work that much discussion circles today around the enforcement of property rights and the rule of law in developing and transitional economies. At the heart of the debate is the question whether Western notions of governance particularly legal institutions should be transplanted elsewhere. The differential experiences found in China and East Asia cast doubts on whether a "one size fits all" approach is appropriate.

The Philippines is an example of a developing country that went through a "peaceful revolution" to topple a dictator in 1986, but which is still mired in corruption and political instability. It has enshrined "people power" in its constitution as a vehicle for removing tyrannical rulers. The vibrant NGO and activist business community have proven since then how potent a threat this institution can be.

But the high transactions costs entailed in mobilising popular uprisings has taken its toll. As a result of experiments over the last decade, there is a growing demand for the rule of law in the form of restraint on the part of both the central government and civil society in expropriating public and private wealth from one another. Should a government be formed that addresses this demand, it might pave the way for greater investments in productive sectors, the same way that mutual checks in England between the Crown and Parliament did.

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