Finally – a point Bagehot did not need to make because in his time it was a matter of course – we must ensure that those who fall foul of the regulatory authority pay dearly for their transgressions. Those who believe this crisis was caused by deregulation have misunderstood the problem in more than one way. Not only was misconceived re -gulation a large part of the cause. There was also the feeling of impunity that came not from deregulation but from nonpunishment.
There will always be greedy people in and around banks. After all, they are where the money is – or is supposed to be. But greedy people will only commit fraud or negligence if they feel that their misdemeanour is unlikely to be noticed or severely punished. The failure to apply regulation – to apply the law – is one of the most troubling aspects of the years since 2007. In the United States, the list of those who have been sent to jail for their part in the housing bubble, and all that followed from it, is risibly short. In the United Kingdom, the harshest punishment meted out to a banker was the ‘cancellation and annulment’ of the former Royal Bank of Scotland CEO Fred Goodwin’s knighthood.
Bagehot never got the powerful deputy governor that he proposed; instead the governor became the kind of permanent and powerful official Bagehot had envisaged. However, since being deprived of his regulatory role, which was handed to the Financial Services Authority by Gordon Brown, the governor has been in the unenviable position of running a monetary policy research department (combined recently with an emergency moneyprinting works). The Federal Reserve System, too, has no real teeth. The agencies supposed to prosecute fraud have performed miserably. The result is that very few malefactors have been brought to justice in a meaningful way.
I will cite just one of many possible examples. In October 2010 Angelo Mozilo reached a settlement with the Securities and Exchange Commission in which he agreed to pay $ 67.5 million in penalties and ‘disgorgements’ to settle civil fraud and insidertrading charges relating to his time as CEO of Countrywide, the failed mortgage lender. At least part of this fine was paid not by Mozilo himself but by Bank of America, which acquired Countrywide in the depths of the financial crisis, and by insurers. Between 2000 and 2008 Mozilo received nearly $ 522 million in total compensation, including sales of Countrywide stock: nearly ten times more than the fine.37 If there was nothing criminal in his conduct, it is surely only because the criminal law is defective in this area.
Voltaire famously said that the British periodically executed an admiral pour encourager les autres. All the detailed regulation in the world will do less to avert a future financial crisis than the clear and present danger in the minds of today’s bankers that, if they transgress in the eyes of the authority on whom their business ultimately depends, then they could go to prison. Instead of exhausting ourselves drawing up hopelessly complex codes of ‘macroprudential’ or ‘countercyclical’ regulation, let us go back to Bagehot’s world, where individual prudence – rather than mere compliance – was the advisable course, precisely because the authorities were powerful and the crucial rules unwritten.
I began this chapter by contradicting the proponents of stricter regulation, only to end it by advocating the exemplary incarceration of bad bankers. I hope it is now clear why these positions are not contradictory but complementary. A complex financial world will be made less fragile only by simplicity of regulation and strength of enforcement.
To repeat: among the most deadly enemies of the rule of law is bad law. The next chapter will consider at a more general level the ways in which the rule of law itself, broadly defined, has degenerated in Western societies – and especially in the United States – in our time. In the realm of regulation, as I have said, we ought to be going back to Bagehot. But has the rule of law in the Englishspeaking world inadvertently gone back to Dickens? Has the rule of law degenerated into the rule of lawyers?
c In the United States by (among other measures) the International Lending Supervision Act of 1983, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and the Federal Deposit Insurance Corporation Improvement Act of 1991.
3 . The Landscape of Law
The Lure of Law
The fundamental question the Chinese government must face is lawlessness. China does not lack laws, but the rule of law ... This issue of lawlessness may be the greatest challenge facing the new leaders who will be installed this autumn [of 2012 ] ... Indeed, China’s political stability may depend on its ability to develop the rule of law in a system where it barely exists.1
These are the words of Chen Guangcheng, the blind lawyer who was allowed to leave China to study in the United States after successfully escaping from his Communist Party persecutors in April 2012 . Less well known in the West, but more influential in China, is the legal scholar He Weifang. In an essay entitled ‘China’s First Steps towards Constitutionalism’, published in 2003, He rather more tactfully observed: ‘The Western legal landscape does make an interesting and illuminating contrast to China’s legal situation, revealing many discrepancies and inconsistencies between the two ... although China’s modern system was borrowed from the West ... things often proceed in diff erent ways between China and the West.’2
The theme of this chapter is the landscape of law. I want to ask what, if anything, developing countries like China can learn from the West about the rule of law. And I want to cast some doubt on the widespread assumption that our Western legal systems are in such good health that all the Chinese need to do is replicate our best practice – whatever that may be.
The English Way of Law
What exactly do we mean by the rule of law? In his book of that name,3 the late Lord Chief Justice, Tom Bingham, specified seven criteria by which we should assess a legal system:
1 the law must be accessible and so far as possible intelligible, clear and predictable;
2 questions of legal right and liability should ordinarily be resolved by application of the law and not by the exercise of discretion;
3 the laws of the land should apply equally to all, save to the extent that objective diff erences [such as mental incapacity] justify diff erentiation;
4 ministers and public officers at all levels must exercise the powers conferred on them in good faith, fairly, for the purpose for which the powers were conferred, without exceeding the limits of such powers;
5 the law must afford adequate protection of fundamental human rights;
6 means must be provided for resolving, without prohibitive cost or inordinate delay, bona fide civil disputes which the parties themselves are unable to resolve; and
7 adjudicative procedures provided by the state should be fair.
Under heading 5, Bingham lists no fewer than fourteen different rights that the rule of law should be expected to protect: the right to life, protection from torture, protection from slavery and forced labour, the right to liberty and security, the right to a fair trial, protection from punishment without law, the right to respect for private/family life, freedom of thought/conscience/religion, freedom of expression, freedom of assembly/association, the right to marry, freedom from discrimination, protection of property and the right to education. (He might have gone further, since some countries today explicitly acknowledge rights to housing, healthcare, education and a clean environment. Why not a right to drinkable wine, too?)
In England, the rule of law in Bingham’s sense of the term is the product of historical evolution. In 1215 Magna Carta established the principle that all Englishmen were equal before the law and that the Crown could not raise taxation without the consent of the Great Council, later Parliament. It was in the medieval period, too, that the writ of habeas corpus (against unlawful detention) came into use, that around 500 towns acquired charters of effective selfgovernment and – after 1295 – that these boroughs were also represented in Parliament. From the time of Henry III until the time of James II there was a protracted tug of war between the monarch and Parliament, in which the Crown’s tendency to sell off the royal demesne to finance wars steadily weakened its position. The culmination came, as we saw in Chapter 1, with the Glorious Revolution, which asserted the sovereignty of the kinginParliament. Also in the seventeenth century, torture was done away with; though it was not until a century later, with Somerset’s Case in 1772, that slavery in England was definitively declared illegal. Throughout this period, the common law courts effectively resisted encroachments on their jurisdiction by institutions under royal control. Still, it was not until the 1701 Act of Settlement that the independence of the judiciary was assured with the advent of life appointments.
My undergraduate reading at Oxford persuaded me that the real point of English history was to establish, for the first time, three great principles. First, an Englishman’s home is his castle. In the case of Entick v. Carrington, Lord Camden ruled against the government for raiding the home of the radical journalist John Entick. ‘The great end for which men entered into society was to secure their property,’ declared Camden, quoting John Locke. ‘By the laws of England, every invasion of private property, be it ever so minute, is a trespass.’ Secondly, do what you like as long as you do no harm. ‘The privileges of thinking, saying, and doing what we please, and of growing as rich as we can, without any other restrictions, than that by all this we hurt not the public, not one another, are the glorious privileges of liberty’ : that was the formulation of ‘Cato’ (the nom de plume of John Trenchard and Thomas Gordon), writing in the early 1720s. Third, mind your own bloody business. ‘The taste for making others submit to a way of life which one thinks more useful for them than they do themselves’,.John Stuart Mill explained to the French liberal Alexis de.Tocqueville, ‘is not a common taste in England.’4 And these pillars of the English rule of law, as A. V. Dicey had pointed out in 1885, were the products of a slow, incremental process of judicial decisionmaking in the common law courts, based in large measure on precedents. There were no ‘grand declarations of principle’, just the interplay of judicial memory and statutory innovations by Parliament.
I now realize that this was a rather naive reading of English legal history. As the greatest living theorist of law in the Englishspeaking world, Ronald Dworkin, explained in Law’s Empire, there really are principles underpinning the common law, even when those principles are not codi-fied as they are in the US Constitution. ‘We insist’, writes Dworkin, ‘that the state act on a single, coherent set of principles even when its citizens are divided about what the right principles of justice and fairness really are ... Judges ... decide hard cases by trying to find, in some coherent set of principles about people’s rights and duties, the best constructive interpretation of the political structure and legal doctrine of their community.’5 Behind the operation of the law lie two things: the integrity of judges and ‘legislation ... flowing from the community’s present commitment to a background scheme of political morality’.6 Questions concerning legality (or ‘principle’) are for judges to decide; questions of policy are matters for executive and legislature. In this legal world, the judge engages in an authentically Herculean struggle to arrive at a best fit between the rule that he eventually defines and applies in order to resolve the case before him and the general corpus of rules, legal policies and reasonable expectations. So even England’s constitutionfree common law is based (again in Dworkin’s words) ‘not only [on] the specific rules enacted in accordance with the community’s accepted practices but also [on] the principles that provide the best moral justification for those enacted rules ... [including] the rules that follow from those justifying principles, even though those further rules were never enacted’.7
Like democracy, the rule of law in this sense may be good in its own right. But it may also be good because of its material consequences. Few truths are today more universally acknowledged than that the rule of law – particularly insofar as it restrains the ‘grabbing hand’ of the rapacious state – is conducive to economic growth. According to Douglass North, ‘the inability of societies to develop effective, lowcost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment ...’8?Enforcement of contracts by a third party is necessary to overcome the reluctance of private sector agents to participate in nonsimultaneous economic transactions, especially over distances in both time and space. Contract enforcement can be provided by private sector agencies such as exchanges, credit companies and arbitrators. But usually, in North’s words, ‘thirdparty enforcement [means] ... the development of the state as a coercive force able to monitor property rights and enforce contracts effectively.’9
The problem is getting the state not to abuse its power – hence the need to constrain it. As Stanford’s Avner Greif has argued, if public contractenforcing institutions reveal information about the location and amount of private wealth, the state (or its functionaries) may be tempted to steal some or all of it.10 Where states are not constrained by law, therefore, private contractenforcing institutions are safer, like the network operated by eleventhcentury Maghribi traders in the Mediterranean, which was based on their common Jewish religion and kinship ties, or the eighteenthcentury Scottish diaspora, which had an almost global reach, or the South Asian traders of East Africa. We see such networks operating in many parts of the world today: think of the Chinese business communities operating outside China. Their defect, as with medieval guilds, is their tendency to raise entry barriers and establish monopolies, discouraging competition and reducing economic efficiency. That is why private contract enforcement tends to yield to public as economies become more sophisticated. But that process is dependent on constraining the state to use its power of coercion in such a way as to respect private property rights. In economics, that is the essential function of the rule of law. It is the property rights more than the human rights that are fundamental.
Law and Economics – and History
Few contributions to the literature on law and economics have had a greater impact than the argument of Andrei Shleifer and his coauthors that the common law system that evolved in the Englishspeaking world was superior in performing the twin roles of contract enforcement and coercion constraint to all other systems. Neither the French civil law system, originating in the Roman legal tradition, nor the German and Scandinavian legal systems, were as good, to say nothing of nonWestern systems of law. What was it that made and makes common law economically better? In their seminal 1997 article, La Porta, LopezdeSilanes, Shleifer and Vishny argued that common law systems offer greater protection for investors and creditors. The result is that people with money are more willing to invest in, or lend to, other people’s businesses. And higher levels of financial intermediation tend to correlate to higher rates of growth.11
