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Law and Economic Strength

3. When is a state economically strong or weak and what is the role of law in this determination?

Economists use a number of factors to determine the size and economic strength of a state. The most common of these measures are gross domestic product (GDP) and the purchase power parity (PPP) between currencies. GDP represents “an aggregate measure of production equal to the sum of the gross values added of all resident, institutional units engaged in production (plus any taxes, and minus any subsidies, on products not included in the value of their outputs).” In contrast, PPP normalizes currencies and compares the purchasing power of each at a given point. One other measure of economic productivity is the per capita income of the individuals within the state. Taken together, these metrics help leaders or planners take action to maintain or improve conditions within the state. Important for this course, we focus on the role of law in the economic development of a state.

A commonly accepted theory about the economic strength of a nation regards the influence of law and the legal system. Many theorist believe that a strong legal system is the foundation for a functioning economy. That is, a strong legal system, through the clear delineation of individual rights and enforcement methods, provides confidence to individuals when undertaking productive activities. In nations with such a system, individuals will trade or undertake transactions with the confidence that they can enforce their rights against the other party. Not having to take extensive measures to protect her interests lowers transaction costs associated with an activity. The result is more and continued business relationships.

•    Example: An individual or business may lend you money without taking physical position of your belongings to secure payment of the debt. In the event you fail to pay the debt, the lender can use legal channels to recuperate the funds lent. This confidence allows you to possess and make productive use of the property while you are paying for it.

•    Discussion: How big is the US economy in terms of GDP? Which country has the largest GDP? Which country has the largest economy based upon PPP? Have you ever thought about what is happening when you purchase a share of stock in a corporation? Let’s use Apple, Inc. (Apple), as an example. Suppose you go to a stockbroker and request to purchase one share of Apple stock. You are effectively giving over some form of currency in exchange for a piece of paper that says you own a given percentage of the Apple. You may have never seen the Apple headquarters and you may be completely unaware of the assets that Apple owns. Nonetheless, you feel confident in exchange your currency for this certificate of ownership with the understanding that you will be able to enforce any rights granted by that piece of paper. If the share entitles you to vote for corporate directs, you have a means and method of enforcing that right. If the piece of paper entitles you to a dividend from corporate earnings, you can enforce that right against the corporation. A strong legal system provides the security one desires when purchasing an interest of a corporation. In turn, Apple uses your invested funds to trade or undertake transactions. This sort of economic activity strengthens the economy. Would any of this be possible if you and the millions of other owners of Apple stock did not have the confidence to purchase that piece of paper?

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