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Legal institutions and financial development

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Thorsten Beck
Ross Levine

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Abstract

A burgeoning literature finds that financial development exerts a first-order impact on long-run economic growth, which raises critical questions, such as why do some countries have well-developed growth-enhancing financial systems while others do not? The law and finance theory focuses on the role of legal institutions in explaining international differences in financial development. First, the law and finance theory holds that in countries where legal systems enforce private property rights, support private contractual arrangements, and protect the legal rights of investors, savers are more willing to finance firms and financial markets flourish. Second, the different legal traditions that emerged in Europe over previous centuries and were spread internationally through conquest, colonization, and imitation help explain cross-country differences in investor protection, the contracting environment, and financial development today. But there are countervailing theories and evidence that challenge both parts of the law and finance theory. Many argue that there is more variation within than across legal origin families. Others question the central role of legal tradition and point to politics, religious orientation, or geography as the dominating factor driving financial development. Finally, some researchers question the central role of legal institutions and argue that other factors, such as a competitive products market, social capital, and informal rules are also important for financial development. Beck and Levine describe the law and finance theory, along with skeptical and competing views, and review empirical evidence on both parts of the law and finance view.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3136.

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Date of creation: 01 Sep 2003
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Handle: RePEc:wbk:wbrwps:3136

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Keywords: Judicial System Reform Legal Products Gender and Law Labor Policies Legal Institutions of the Market Economy Legal Products Judicial System Reform Legal Institutions of the Market Economy National Governance Gender and Law

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Raghuram G. Rajan & Luigi Zingales, 2001. "The Great Reversals: The Politics of Financial Development in the 20th Century," NBER Working Papers 8178, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Rafael LaPorta & Florencio Lopez-de-Silane & Christian Pop-Eleches & Andrei Shleifer, 2003. "Judicial Checks and Balances," NBER Working Papers 9775, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Randall Morck & Bernard Yeung & Wayne Wu, 1999. "The Information Content of Stock Markets: Why do Emerging Markets have Synchronous Stock Price Movements?," William Davidson Institute Working Papers Series 44, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
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  15. Rene M. Stulz & Rohan Williamson, 2001. "Culture, Openness, and Finance," NBER Working Papers 8222, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Levine, Ross, 2002. "Bank-Based or Market-Based Financial Systems: Which Is Better?," Journal of Financial Intermediation, Elsevier, vol. 11(4), pages 398-428, October. [Downloadable!] (restricted)
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  17. Simon Johnson & John McMillan, 2002. "Courts and Relational Contracts," Journal of Law, Economics and Organization, Oxford University Press, vol. 18(1), pages 221-277, April.
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  18. Levine, Ross & Loayza, Norman & Beck, Thorsten, 2000. "Financial intermediation and growth: Causality and causes," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 31-77, August. [Downloadable!] (restricted)
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  19. Simon Johnson & John McMillan & Christopher Woodruff, 2002. "Property Rights and Finance," NBER Working Papers 8852, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 2000. "Agency Problems and Dividend Policies around the World," Journal of Finance, American Finance Association, vol. 55(1), pages 1-33, 02. [Downloadable!] (restricted)
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  21. Levine, Ross, 1998. "The Legal Environment, Banks, and Long-Run Economic Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 596-613, August.
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  22. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 717-37, August. [Downloadable!] (restricted)
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  23. Johnson, Simon & Boone, Peter & Breach, Alasdair & Friedman, Eric, 2000. "Corporate governance in the Asian financial crisis," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 141-186. [Downloadable!] (restricted)
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  24. Mahoney, Paul G, 2001. "The Common Law and Economic Growth: Hayek Might Be Right," Journal of Legal Studies, University of Chicago Press, vol. 30(2), pages 503-25, Part I Ju.
  25. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert, 2000. "Investor protection and corporate governance," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 3-27. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alex William Trew, 2005. " Finance and Growth: A Critical Survey," CDMA Working Paper Series 0507, Centre for Dynamic Macroeconomic Analysis, revised Apr 2006. [Downloadable!]
    Other versions:
  2. David de la Croix & Clara Delavallade, 2007. "Growth, Public Investment and Corruption with Failing Institutions," Working Papers 61, ECINEQ, Society for the Study of Economic Inequality. [Downloadable!]
    Other versions:
  3. Beck, Thorsten & Demirguc-Kunt, Asli & Martinez Peria, Maria Soledad, 2006. "Banking services for everyone ? Barriers to bank access and use around the world," Policy Research Working Paper Series 4079, The World Bank. [Downloadable!]
  4. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2004. "Finance, Inequality, and Poverty: Cross-Country Evidence," NBER Working Papers 10979, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Michael D. Bordo & Peter L. Rousseau, 2006. "Legal-Political Factors and the Historical Evolution of the Finance-Growth Link," NBER Working Papers 12035, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2004. "Law and Firms' Access to Finance," NBER Working Papers 10687, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  7. Mathias M Siems, 2006. "Legal origins: reconciling law and finance and comparative law," ESRC Centre for Business Research - Working Papers wp321, ESRC Centre for Business Research. [Downloadable!]
  8. Granlund, Peik, 2008. "Regulatory choices in global financial markets – restoring the role of aggregate utility in the shaping of market supervision," Research Discussion Papers 1/2008, Bank of Finland. [Downloadable!]
  9. Michael Graff, 2005. "Law and Finance: Common-law and Civil-law Countries Compared," Working papers 05-99, KOF Swiss Economic Institute, ETH Zurich. [Downloadable!]
  10. Menzie D. Chinn & Hiro Ito, 2005. "What Matters for Financial Development? Capital Controls, Institutions, and Interactions," NBER Working Papers 11370, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  11. Ross H. McLeod, 2006. "Doing Business in Indonesia: Legal and Bureaucratic Constraints," Departmental Working Papers 2006-12, Australian National University, Economics RSPAS. [Downloadable!]
  12. Beck, Thorsten & de la Torre, Augusto, 2006. "The basic analytics of access to financial services," Policy Research Working Paper Series 4026, The World Bank. [Downloadable!]
  13. Beck, Thorsten & Rahman, Md. Habibur, 2006. "Creating a more efficient financial system : challenges for Bangladesh," Policy Research Working Paper Series 3938, The World Bank. [Downloadable!]
  14. Eduardo Siandra, 2005. "Uruguay Capital Market: Law-in-the-books or Law-in-action?," Documentos de Trabajo (working papers) 0205, Department of Economics - dECON. [Downloadable!]
  15. Michael Graff, 2006. "Myths and Truths: The «Law and Finance Theory» Revisited," Working papers 06-122, KOF Swiss Economic Institute, ETH Zurich. [Downloadable!]
  16. Hiro Ito & Menzie Chinn, 2007. "East Asia and Global Imbalances: Saving, Investment, and Financial Development," NBER Working Papers 13364, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Wendell Samuel & Laura Valderrama, 2006. "The Monetary Policy Regime and Banking Spreads in Barbados," IMF Working Papers 06/211, International Monetary Fund. [Downloadable!]
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