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Law and Economic Strength

Cite this article as: Jason Mance Gordon, "Law and Economic Strength," in The Business Professor, updated January 1, 2015, last accessed April 2, 2020, https://thebusinessprofessor.com/knowledge-base/law-and-economic-strength/.
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Law and Economic Stength of a Nation
How does the development or law and the legal system affect the economic stength of a Nation?

Next Article: What is the Rule of Law


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 theorists believe that a strong legal system is a 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 possession 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?

Discussion Input

  • The US economy is the biggest in the world with a GDP of $19.39 trillion, edging out China which comes in second place. In terms of PPP, though, China is the world’s largest economy with a GDP (PPP) of $23.15 trillion closely followed by the U.S.A’s $19.39 GDP (PPP). In the growth of economies, buying of shares of stock in corporations plays a huge role. Stockbrokers make it easy for members of the public to decide on what corporations to invest, and the stock market has been a significant contributor to the modern economy. Stock market trading fosters economic growth primarily through mobilization of capital, risk sharing and transfer. Whenever members of the public buy shares of stock of a certain corporation, say Apple, they are able to accumulate capital to fund their activities or invest in various projects which return profits in the long run. Primarily, the pooling of funds for the business activities of a corporation plays a significant role in the growth of economies.

Academic Research

Hylton, Keith N., Law and Economics Versus Economic Analysis of Law (March 30, 2018). European Journal of Law and Economics, Forthcoming; Boston Univ. School of Law, Law and Economics Research Paper No. 17-40. Available at SSRN: https://ssrn.com/abstract=3024605. This article distinguishes positive economic analysis from normative economic analysis, and positivist legal analysis from nonpositivist analysis. It takes the debate of what is law and economics versus economic analysis of law further.

Pargendler, Mariana and Salama, Bruno M., Law and Economics in the Civil Law World: The Case of Brazilian Courts (2015). Tulane Law Review, v. 90, p. 430-470, 2015 ; FGV Direito SP Research Paper Series No. 117. Available at SSRN: https://ssrn.com/abstract=2580490 or http://dx.doi.org/10.2139/ssrn.2580490. This article explores the role and existence of law and economics in Brazil.

Cooter, Robert D. and Gilbert, Michael, Constitutional Law and Economics (January 24, 2019). Forthcoming in Research Methods in Constitutional Law: A Handbook (Malcolm Langford & David S. Law eds., Edward Elgar).; Virginia Public Law and Legal Theory Research Paper No. 2018-08; Virginia Law and Economics Research Paper No. 2018-02; UC Berkeley Public Law Research Paper. Available at SSRN: https://ssrn.com/abstract=3123253. This article addresses the use of economics in the research and analysis of constitutional law.

Parisi, Francesco, Positive, Normative and Functional Schools in Law and Economics. European Journal of Law and Economics, Vol. 18, No. 3, pp. 259-272, December 2004; George Mason Law & Economics Research Paper No. 04-22. Available at SSRN: https://ssrn.com/abstract=586641. This articles addresses the divergent schools of thought on economic analysis of law, including positive and normative approaches.

van Aaken, Anne, Behavioral International Law and Economics (October 19, 2013). Published in: 55 Harvard International Law Journal (2014), pp. 421-481.; U. of St. Gallen Law & Economics Working Paper No. 2013-21. Available at SSRN: https://ssrn.com/abstract=2342576 or http://dx.doi.org/10.2139/ssrn.2342576. This article addresses the need and use of economic analysis within the international law context – particularly in conjunction with the field of psychology as a predictor.

Posner, Eric A., Agency Models in Law and Economics (2000). University of Chicago Law School, John M. Olin Law and Economics Working Paper No. 92. Available at SSRN: https://ssrn.com/abstract=204872 or http://dx.doi.org/10.2139/ssrn.204872. This article addresses the use of agency law and models within economic analysis.

Donohue, John J., Some Thoughts on Law and Economics and the Theory of Second Best (February 1998). Stanford Law School, John M. Olin Program in Law and Economics Working Paper No. 156. Available at SSRN: https://ssrn.com/abstract=168612 or http://dx.doi.org/10.2139/ssrn.168612. This paper addresses the implications of the Theory of the Second Best for law and economics scholarship.

Hylton, Keith N., Calabresi and the Intellectual History of Law and Economics (May 17, 2004). Boston Univ. School of Law Working Paper No. 04-04. Available at SSRN: https://ssrn.com/abstract=547082 or http://dx.doi.org/10.2139/ssrn.547082. This article deals with Calabresi’s “The Costs of Accidents”. It provides addresses positive vs normative law and economics, positivist vs anti-positivist thinking, and the assumption of rationality.

Carbado, Devon W. and Gulati, Gaurang Mitu, The Law and Economics of Critical Race Theory. Yale Law Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=409360 or http://dx.doi.org/10.2139/ssrn.409360. This article asserts that Law and Economics, and Critical Race Theory, can be better understood through law and economic research.

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