Introduction

Sustained growth occurs in developing nations through improvements in markets and organizations. Entrepreneurial innovation resembles a biological mutation that is unpredictable before it occurs and understandable afterward. It is unpredictable because it begins with an innovator who earns extraordinary profits from private information. It is understandable because its ends with the dissemination of the innovation, so everyone earns ordinary profits from public information. These characteristics of innovation have important consequences for law and policy to foster economic growth. Government officials who rely on public information cannot predict which firms or industries will experience rapid growth. Consequently, industrial policies are unlikely to succeed in promoting growth by picking firms or industries to receive tax advantages, subsidies, or tariff protection. Proponents of such industrial policies today make the same mistake as the mercantilists whose interventions Adam Smith attacked as a cause of national poverty. Instead of industrial policy, developing countries should secure property and contract rights, and create effective business law (especially the laws regulating financial markets). When the state legalizes entrepreneurial freedom, innovators create, and nations become rich.

Legalize Freedom

In the last two centuries, the wealth of the richest countries has risen above the poorest like Mount Everest rising above the Ganges Plain. The gap opened because the richest countries grew richer, not because the poorer countries grew poorer. Most poor countries today are somewhat richer relative to their past and much poorer relative to rich contemporary countries.

Many people believe that modernizing the law in developing countries requires comprehensive reform directed by politicians and state officials. For example, labor law must restructure employment relations to protect jobs, land reform must reorganize agriculture by redistributing rural property, antitrust law must suppress monopolies that obstruct development, and safety regulation must protect consumers and workers against defective products. Priorities vary, but reformers agree that political leaders and state officials must take the initiative to replace outdated laws with comprehensive statutes.

This article concerns an alternative approach to modernizing the law. Economic competition changes products and techniques, which in turn creates new problems of coordination and cooperation. Communities of people solve these problems by developing norms of behavior. Social norms impose obligations and coordinate expectations. The state raises some social norms to the level of law. To illustrate, consider safety on the steps of a family's house. Custom determines a standard of safety in maintaining steps. If someone is injured on the steps and sues the homeowner, the court in a common-law country will use the customary standard to determine whether the homeowner was negligent in maintaining the steps. Similarly, the American Bar Association imposes a code of ethical responsibility on lawyers and courts hold lawyers liable for some harms resulting from their unethical conduct.