Svetlana Semykina 0731860

written under exam conditions

Legal origin is the primary determinant of the differences in the development of financial markets between countries.

The legal origin of a country, whether it belongs to the Common Law or the Civil law, is widely believed to at least partially determine the financial structure of this country. Civil law, having originated from law during Roman and Napoleon conquest, is mostly codified and is associated with more rigid laws regarding financial market development, whereas Common law, based on English law, is precedent based and usually accentuates property and investor rights protection. Whether the development of financial markets is truly influenced by the legal origin of a country is a long debated issue. The strength of the grip of the state on judiciary system and control of business operations is thought to affect ownership concentration and unofficial economy size. For example, civil law countries, e.g. Germany, are showed to have more formalised judicial systems and less contract enforcement, which could contribute to higher ownership concentration, lower income per capita and slower economic growth. Countries such as France also known to have more corruption and more entry and labour regulation, which in turn, is thought to lead to less multinational firm activity, lower labour turnover and productivity growth. Common law countries, such as England, may just allow more flexibility in dealing with financial contracts and better shareholder protection, which seems to contribute to supporting private market outcomes. Prevention of self-dealing by stricter laws is a logical explanation to why there are more investors willing to invest into countries like UK in comparison to some civil law countries, like Russia. If there is more dividend payouts enforced by law, it is also relevant to how attractive a country is for business set-up. Though due to increasing globalisation, there is a faster transfer of legal knowledge, which could have led to adoption of the most effective laws and strategies to ensure a competitive edge in the chase for foreign investment. Nonetheless, it is still believed that even if a common law country adopts some of the civil law legislation, it may still enforce the laws the common law way. Lower ownership of banks is also associated with higher income per capita, which is consistent with common law family. However, these conclusions are based on carefully selected data, which may present with a lot of omitted variables. England and France are the two most extreme cases of common and civil law, respectively and always used to demonstrate negative correlation. However, it may be that it is the long history of countries disagreements and battles that somehow led to them adopting opposing strategies and ideologies. Also, despite legal origin, countries like Belgium and France achieved high living standards, so the relationship between the legal system and financial development is not linear, yet the reasons why are not thoroughly investigated.

Moreover, the Endowments Theory adds to the proposed explanation of the Legal origins theory. It states that during conquering of some countries, settler mortality and thus whether the settlers had 1

Svetlana Semykina 0731860

written under exam conditions

the intention of exploiting the colony or settling there, is what also affected whether the legal system was adopted and whether property rights were strengthened. Thus it is plausible that this also affected stock market development. Surely, social and economic circumstances are just as important in affecting the economic growth of any country. Even sharp differences in national political ideologies may have affected the law system and not just where it originated from. And if the implementation of the laws is different within the same legal family, it may lead to different outcomes regarding economic growth. Reverse causality may also be the case. We cannot be sure whether there is a direct link and the way the stronger property rights lead to a more developed financial market. Besides, it may be that it was the quickly growing stock markets that led to more creditor protection laws being made and not the other way around. Even so, the amount of statistically significant data is overwhelming and appears to be representative enough to conclude that even after controlling for endowments and ethnic diversity, legal origin does seem to explain the cross-country differences in property rights and thus the financial structure. There is a lot of evidence demonstrating how the legal system in place affects varieties in capitalism structure but mutual influence of countries prevents us from having pure common or civil law type countries but it is unclear whether this means the financial markets are affected solely by the legal origin of a country.