Rule Of Law V. Rule Of Terror

Copyright 2002 John Fairfax Publications Pty Ltd  
Business Review Weekly (Australia)
October 31, 2002
News and Features; Pg. 26
Henry Ergas,Managing Director Network Economics Consulting Group

Robert Barro is a Faculty Associate at CID

The appalling events in Bali have naturally been the focus of concern in recent weeks. As we take stock of these events and their significance, it is appropriate to review claims and inferences, drawn by some from the Bali bombings, that seem poorly founded and more likely to mislead than to help.

One claim is that because of the bombings, Australia should direct its foreign and defence polices more squarely on our region, paying less attention to the wider world. But surely the point is that terrorism, which has cost so many lives in Bali, is global, not regional. To deal with it requires consideration of its global dimensions. Any hope of containing it regionally will be in vain. A second claim is far more sweeping and, although it is made by many who adopt the "regionalist" approach set out above, it is inconsistent with it. This claim is that little can be done about terrorism and the regimes that back it unless the global issues of poverty and inequality are dealt with.

Even if it were ultimately true that these global issues had some link to terrorism, it does not follow that nothing can be done to tackle and contain terrorism and the states that give it support until these issues are addressed. But it is doubtful whether any such link exists. This claim seems to involve the crudest, and most obviously false, kind of economic determinism. Whatever may drive so many Saudis to support terrorism against the West, it is not poverty.

Additionally, and perhaps even more importantly, implicit in this claim is a view of history that makes the West responsible for, and capable of resolving, global problems of poverty and inequality. But if there is one thing that economists now know, it is that poverty and inequality are not externally determined. Rather, they are most directly linked to aspects of the economic, social and political framework that are within each country's control.

Fundamentally, global poverty can be dealt with only when poor nations adopt economic policies that allow and support growth. A key element in these policies is a governance framework that provides stable and predictable investment conditions, not only in physical assets but also in human capital and in organisational structures. Such a governance framework is profoundly at odds with the essence of totalitarian regimes, which, by their nature, retain the right to expropriate the assets of those who are out of favor. Rather, sustained economic growth needs the rule of law, which implies that the state and those who control it accept substantial limits on their powers.

The link between the political structure and sustained growth has been confirmed by many economic studies. The most notable of these, brought together in a book published in 1997, are by the Harvard University economist Robert Barro. Barro looked at data from 1965 to 1990 from more than 100 countries. He found that effective maintenance of the rule of law could increase the average annual growth rate by as much as 0.5%.

Barro's research has been extended by other economists. A 1988 study of 1960-80 data from 115 countries found a strong positive relationship between rates of economic growth and various measures of political, civil and economic liberties. A 1997 study of 49 countries found that a country's legal environment, as measured by the application of the rule of law, could account for the size of capital markets in that country. In essence, countries with better-respected civil and economic liberties produced higher-valued and broader capital markets, making them better able to access and use financial resources.

A 1999 study by the World Bank measured the "institutional quality" of governance in 27 Asian and Latin American countries. It found that high institutional quality had a very strong positive effect on the rate of economic growth in those countries.

Why might these correlations arise? In short, countries having law-respecting, accountable governments are likely to have lower transaction costs - that is, the costs associated with contracting and running businesses - so providing the conditions that encourage long-term investments and innovation.

Totalitarianism, in all its forms, is therefore not the result of poverty but rather one of poverty's most powerful and enduring causes. Totalitarian philosophies (including fundamentalist Islam), which justify the denial of liberties and encourage the state to intrude in all aspects of people's lives, are simply incompatible with the requirements of ending poverty and inequality. If we really want to ensure that millions of people in the world who are now poor, but need not be, have a chance to live better lives, combating totalitarianism is one of the best ways of doing so.

Contact * h.ergas@necg.com.au

Direct site comments or questions to CID's Webmaster.
Copyright ©2002 by the President and Fellows of Harvard College.
Last revised 11/04/2002