Law, Trust and Credibility

It is a matter of some embarrassment for lawyers that the main reason people seek legal advice is because they don't trust their business partners not to try and swindle them. Or, they 'trust' each other 100%, but they want a legal contract 'just in case'. The law provides a remedy that you can pursue if the person you 'trust' betrays you. This function of law turns out to be surprisingly important in economic growth and progress, by providing a remedy for breach of contract and vindication of property rights. In fact this legal function is so important that no serious economic growth can occur in countries where basic contractual and property rights are not consistently and reliably upheld by a robust legal system. 

It is possible, of course, to prove your integrity and credibility to the satisfaction of those you deal with, and in that way to avoid the need for a 'just in case it all goes wrong' legal contract to back up your promises. But most people don't know each other well enough to establish such credibility, and it would take an incredible amount of time and energy to achieve that level of essential trust with everyone you want to deal with. Also, human beings can be surprisingly inept at figuring out who is or is not trustworthy. So it's easier and cheaper to resort to the law. Lawyers are not 'expensive', when you consider that it would cost much more to try and achieve sufficient levels of trust in open markets with no back-up legal system.

As long as everybody remembers their role, this should work quite well. This means remembering that the lawyer is simply there to define the remedies available if the plan goes belly up, but the law is not there to define what the plan should be, how the plan should unfold, what kind of society should be constructed by those plans, etc.

In Solomon's Knot: How law can end the poverty of nations, Cooter and Schafer describe how nations remain poor because of failure to understand this very basic but very important function of the legal system. It is a failure on two fronts:

• failing to understand the significance of contract and property rights for economic growth and productivity;
• failing to understand the limits of what law can realistically achieve: law cannot create an innovative and industrious society - all it can do is provide remedies when people try to steal the products of other people's industry or fail to pay for products they have agreed to buy. 

One example of how secure legal rights would ameliorate the situation:

In central Africa, producing and transporting diamonds in recent years occurred in conditions that approached anarchy. Central Africa produced few diamonds and got paid much less than the world price for them. If anarchy were replaced by secure property rights, central African nations could produce diamonds with better technology, export them through the regular channels of trade, and receive the world price. And the profits would not go to thugs who commit unspeakable cruelties and heinous abuses of human rights.
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Solomon's Knot: How law can end the poverty of nations, p.6.
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This shows how weak the legal systems are in many poor countries, and what an exponential difference it would make if there were secure and enforceable contractual and property rights. 

To compensate for lack of a reliable set of basic legal rights, business transactions in poor countries rely disproportionately on family and close friends. In a world where you have no reliable legal remedies against anybody who betrays you, it is rational to prefer doing business with family and friends because at least you have more knowledge and information about their integrity and credibility, plus the sanction of family disfavour if they choose to betray you.

Thus the poorer the country, the more important are the ties of family and friends in business transactions. By contrast, in rich countries, you can do business with strangers on the internet without having to conduct any investigation as to their credibility, for instance buying stuff from sellers on Amazon. If a seller on a platform like Amazon tries to cheat, the avenues for seeking a remedy are predictable and reliable. You can therefore forge a path through life without personally knowing anybody, much less being their friends. This is really cool, because you can enter into transactions with anybody anywhere in the world through the internet, and you don't have to make friends with any of them unless you want to.

In countries with weak legal institutions, economic cooperation usually involves people with personal ties, especially relatives and friends.

Most people, however, do not have enough relatives and friends to achieve the scale of activity required for affluence. 

Weak contract law can keep trade local and organisations small. Property and contract law lower the cost of monitoring and extend cooperation to strangers, which facilitates dispersed production, larger organisations, and wider markets.

Solomon's Knot, p. 7,8.

This suggests how very simple ideas - strengthening contract and property law - can help markets to thrive and create conditions for rising prosperity. Instead, the law in poor countries often takes the opposite approach, and goes on the attack against such rights, then compounds the error by legitimising theft in a misguided attempt to introduce 'dignity' and 'equality'. In this situation the legal system has abandoned its proper function, and to make things worse has instead adopted extraneous and quite irrelevant goals that are inimical to what should have been its proper function.

Then everyone wonders why some countries are rich while others remain poor, but instead of trying to understand the causes of economic stagnation, they just moan about inequality, unfairness and historical grievances. Complaining about unfairness is a universal human weakness and quite easy to sympathise with: we all find it easier to focus on other people's moral failures and what others should be doing to help make the world more fair to everyone, rather than to do the difficult work of taking action to improve our own conditions. Yet the beauty of law does not lie in using it to address complaints; it lies in creating the conditions for human interactions to be more productive and more rewarding.