Friday, April 25, 2008

Role of Law and Politics in India’s Economic Growth

There is a recent paper titled “Law, Finance, and Politics: The Case of India” by John Armour and Priya Lele that has been posted on SSRN. The authors join the debate as to whether a country’s legal origins (e.g. common law or civil law) necessarily have an impact on the extent of its financial development, and in doing so, they examine India as a case study. The authors find that in India’s case, political explanations have a greater bearing in explaining India’s growth, and that its legal heritage as a common law country has not played a significant role towards that end.

Here is the abstract:

“The process of liberalization of India's economy since 1991 has brought with it considerable development both of its financial markets and the legal institutions which support these. An influential body of recent economic work asserts that a country's 'legal origin' - as a civilian or common law jurisdiction - plays an important part in determining the development of its investor protection regulations, and consequently its financial development. An alternative theory claims that the determinants of investor protection are political, rather than legal. We use the case of India to test these theories. We find little support for the idea that India's legal heritage as a common law country has been influential in speeding the path of regulatory reforms and financial development. There is a complementarity between (i) India's relative success in services and software, (ii) the relative strength of its financial markets for outside equity, as opposed to outside debt, and (iii) the relative success of stock market regulation, as opposed to reforms of creditor rights. We conclude that political explanations have more traction in explaining the case of India than do theories based on 'legal origins'.”
The paper also contains a useful background discussion about the development of various institutions in India’s business and financial sectors. These include the evolution and the roles of bodies like the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (BSE) as well as other self-regulatory bodies like the stock exchanges. The paper also offers some reasons why the capital markets in India have been growing at a fast pace and acquiring greater depth, while the debt markets (including for bank lending) have not been keeping the same pace.

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