Law, Finance, and Politics: The Case of India
Armour, John, Lele, Priya, Law & Society Review
The liberalization of India's economy since 1991 has brought with it considerable development of its financial markets and supporting legal institutions. An influential body of economic scholarship asserts that a country's "legal origin" - as a civilian or common law jurisdiction - plays an important part in determining the development of its investor protection regulations, and consequently its financial development. An alternative theory claims that the determinants of investor protection are political, rather than legal. We use the case of India to test these theories. We find little support for the idea that India's legal heritage as a common law country has been influential in speeding the path of regulatory reforms and financial development. Rather, we suggest there are complementarities between (1) India's relative success in services and software; (2) the relative strength of its financial markets for outside equity, as opposed to outside debt; and (3) the relative success of stock market regulation, as opposed to reforms of creditor rights. We conclude that political economy explanations have more traction in explaining the case of India than do theories based on "legal origins."
A growing literature emphasizes the importance of legal institutions for economic development. Within this tradiüon, an influential claim is that a country's "legal origin" significantly affects the evolution of its legal rules, in particular as they relate to finance. An alternative claim asserts that the development of legal rules is more closely influenced by national political choices and interest group lobbying. This article uses the case oflndia, one of the world's most significant developing economies, as a case study for exploring the applicability of these theories.
The Indian economy, subject to central planning from independence in 1947, liberalized dramatically in 1991. Since then, there have been rapid and far-reaching law reforms intended to ensure that legal institutions keep pace with the needs of the growing economy. To shed light on the mechanisms by which these legal changes were brought about, and their relationship with the needs of investors, we conducted interviews with a range of Indian lawyers, policy makers, regulators, judges, businesspeople, and investors. We focused our enquiries on changes to the legal protection of outside investors: that is, shareholders and creditors. These yielded interesting findings as regards both the modalities of legal change and its relationship with development.
As regards the modalities of law reform, the most effective institutions for producing improved legal rules have been regulatory agencies to which rule-making power for specific sectors have been delegated: for example, the Securities and Exchange Board of India (SEBI) and, to a lesser extent, the Reserve Bank of India (RBI). By contrast, statutory changes have been implemented more slowly: coalition politics and very activist judicial review mean that legislation can be an erratic process. Moreover, in contradiction of the "legal origins" claim, the Indian judiciary has not played a significant role in "adapting" the substantive law to the changed needs of an open economy. Very long delays in Indian civil procedure mean that courts have simply been too slow to play a significant role in updating law.
There is a correlation between effective legal protection of investors and the development of markets for outside finance in India. Laws protecting equity investors have been dramatically improved, and equity markets are flourishing; much less has been achieved in the way of legal protection for creditors, and markets for corporate bonds are much weaker. This complements sectoral trends in Indian industry: "new economy" sectors for which equity finance is more complementary (e.g., software, pharmaceuticals, and high-tech manufacturing) have been relatively successful, whereas "old economy" sectors such as heavy manufacturing, traditionally more reliant on debt finance, have seen rather more limited growth. …