The Legal scholar Katharina Pistor examines the hidden legal layer propping up our modern economic system.

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Laws enable economic progress and prosperity, endowing assets with specific rights that allow their owners to profit. Yet the very laws that produce economic well-being also leave many behind in society, argues professor Katharina Pistor in this enlightening episode of The Ezra Klein Show podcast hosted by senior editor Rogé Karma. Their conversation highlights how, given that law can confer distinct privileges on assets, it can also affect positive social change by creating a more level playing field. Executives, investors, and students of law and economics will find this a thought-provoking discussion.

Take-Aways

• Along with labor, capital is an input of production with specific hallmarks.
• Laws form the basis of wealth creation.
• The forces that drive prosperity also give rise to inequities and wealth destruction.

Summary

Along with labor, capital is an input of production with specific hallmarks.

The law endows capital with four traits that are essential to its ability to create wealth: “Priority” assigns stronger rights to a piece of property that has several claims to it. “Durability” – a legal device – shields this property from a multitude of different parties petitioning for it. The law may enable the asset owner to keep certain items from tax collectors or personal creditors.

“The law is the source from which capital is cut.”

“Convertibility” allows property holders to change property into a safer instrument during tumultuous times and return it to more lucrative holdings when stability returns. “Universality” places the three foregoing attributes under the aegis of the state, which enforces them against claimants. This enforceability enables the creation of global markets. Strangers can transact, secure in the knowledge that laws protect commercial transactions.

“England established a register for land to really look up the titles only in the 1920s.”

The 17th-century enclosure movement in England began the process of legal titling, apportioning land with usage rights to certain individuals and excluding others. The exclusive rights to use the property allow the holder to benefit from his or her investment. The land has priority rights and may be sold or mortgaged, which enables a third party to claim it in the event of the borrower’s default.

Laws form the basis of wealth creation.

The creation of wealth derives from a communal system governed by law. Intellectual property creators may patent their inventions, thus conferring legal rights on them. This process is an extension of the creation of property rights over land. The law enables capitalism to expand through the discovery of new resources, natural or otherwise.

“And I’m basically saying the creation of wealth itself is already a process by which some harness the legal system, which is actually not a private good but a social resource, to produce their private wealth.”

The corporation provides a telling example of capitalism’s expansion. The law creates a separate legal entity with an indeterminate life span – exemplifying durability. The state confers limited liability on this entity, protecting the personal assets of owners and managers in the event of the company’s collapse. Investors and shareholders thus externalize risk, losing only what they invest.

The forces that drive prosperity also give rise to inequities and wealth destruction.

As devices of law create wealth, they engender inequality. The process of generating wealth and inequality has been cyclical. Generations that succeeded the 17th-century enclosure movement saw the disenfranchisement of Native Americans, who lost their lands through a similar process of misappropriation.

“Let’s just start looking at how wealth is created, and then we can decide what policy tools do we want to use to minimize inequality or at least keep some check on it and whether redistribution is the best means to achieve that.”

The 2007–2009 Great Recession highlighted capitalist excesses through instruments such as mortgage-backed securities, whose private sector abuse exemplified moral hazard. Limited liability turned on its head and powered excessive risk taking. For example, Lehman Brothers, the failed investment bank, created a Byzantine corporate structure to lay off risk that investigators revealed as chicanery. The abuses of the Great Recession dislocated millions of people, who lost their jobs and their homes. Only government intervention forestalled the collapse of global finance. The law may limit the personal liability of shareholders and investors, but it does not limit the liability of sacked employees or creditors.

“I still would say corporations can own assets, but they should not necessarily get the same kind of constitutional protection for ownership that individuals do, or only their shareholders behind that in a pro-rata fashion, which would change the argument quite radically.”

This dual system of law, which enables private actors and regulates excesses, should strive for the common good. With rights must come responsibilities, and the law is a social resource that can help the less well-off. Private and public power must face increased checks and balances. A more equitable system would permit competition and profit, but hold participants to a greater social accountability.

About the Podcast

Professor of comparative law Katharina Pistor is the director of the Center on Global Legal Transformation at Columbia University. The Ezra Klein Podcast showcases interviews with leaders in politics and media.

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