Ending Poverty By Legalizing Freedom

The American recently ran an interview with Robert D. Cooter, a law professor at the University of California, Berkeley, and co-author of the book, Solomon’s Knot: How Law Can End the Poverty of Nations. In the interview, Cooter talks about the need for laws that bolster freedom:

Freedom is the presence of good law, not the absence of all law. Innovative business ventures need effective laws of property, contracts, and business organizations. Legalizing business freedom allows innovation to carry us on an unpredictable journey to a richer world.

The article also includes an excerpt from Cooter's book, which focuses on the need for trust between innovator and investor:

Economies grow when business ventures develop innovations, which requires combining new ideas and capital. Combining them confronts a dilemma illustrated by this letter sent to a Boston investment bank: “I know how your bank can make $10 million. If you give me $1 million, I will tell you.” The bank does not want to pay for information without first determining its worth, and the innovator fears to disclose information to the bank without first getting paid. The obstacle to financing innovation is that an investor cannot evaluate an idea until after he knows what it is, and after its disclosure he has little reason to pay for it.

The problem for developing countries, Cooter notes, is that innovators can't rely on banks for investing, and this thwarts progress:

Today, the poorest countries have weak capital markets, so businessmen mostly borrow from family and friends. Starting from a condition of lawlessness, imposition of secure property rights can cause a spurt of growth based mostly on relational finance, as in China’s new industries after the 1980s. Some peoples, notably the Chinese and the Jews, have family networks that extend business relationships beyond the usual boundaries. However, the conditions of trust among relatives do not reach the scale of modern businesses. Relational finance keeps business small and local. No modern country became wealthy by relying exclusively on relational finance.

Read the entire article and excerpt here.

Jul 252012
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