Financial systems and development

(an issue closely related to the assignment and
transferability of property rights), to rationalize
Box 6.1 Civil and commercial law company legislation (especially with regard to disin
Korea
closure of information and bankruptcy and reor-
Korea is one of the few countries that have intro- ganization proceedings), and to strengthen law enduced
a comprehensive Western system of law on forcement. Contract performance can be improved
their own initiative. Like China, Korea was tradi- by making breach of contract more costly. Provitionally
a Confucian society in which relations sion of security, such as pledged or mortgaged aswere
structured not according to law but accord- sets and third-party guarantees, is one approach.
ing to ideas of familial hierarchy, with the king or Lenders can ensure repayment in other wavs too:
emperor at the top. After a period under Japanese b
. . ~~~~~~~~~~bv attachin,, covenants to the loan contract, by apdomination
(and Japanese civil law), the newly .
independent Republic of Korea set out to devise pointing a representative to the board of directors,
an entirely new legal framework. New civil and through contingent ownership of assets (by means
commercial codes were enacted in 1958 and 1962. of convertible debt securities, for example), and by
Both were modeled largely on the German civil closely monitoring the borrower.
and commercial codes but contained significant
changes to reflect local customs and traditions, Property rights and collateral
particularly with regard to family law and succession.
The Korean codes introduced some interest- T
ing innovations. For example, Korean law permits The legal recognition of property rights-that is,
the use of mortgages on real property to secure rights of exclusive use and control over particular
future advances under a line of credit-a useful resources-gives owners incentives to use redevice
that is not usually allowed by civil law. sources efficiently. Without the right to exclude
Like most other civil codes, modern Korean law others from their land, farmers do not have an
distinguishes between ordinary people and mer- incentive to plow, sow, weed, and harvest. Withchants;
the commercial code applies onlv to the, ,
chants; tecm riloeout land tenure, thev have no incentive to invest in
latter. Contractual obligations are more clearlv defined
than in most other developing countries, irrigation or other improvements that would repay
and enforcement is swift. Reorganization and the investment over time. Efficiency can be further
bankruptcy are modeled on the U.S. bankruptcy served by making property rights transferable. A
code, which emphasizes the rehabilitation of a farmer might then sell his land to a more produccorporate
debtor rather than the distribution of its tive farmer and take up another occupation for
assets to creditors.
which he is better suited. Together, these rights to
use, benefit from, and freelv dispose of an asset
constitute ownership.
China's rural economic reforms consisted mainly
of restoring land tenure to households. Farmers in
ical conditions when the new codes were intro- China do not own their land, but tenure is now
duced were quite different from those prevailing in fairly long term; it amounts to the leasehold conthe
countries whose legal systems were used as cept of common law. Farmers can use this leasemodels.
But the need to furnish their economies hold as collateral. The success of the reforms drawith
a legal infrastructure that would facilitate ex- matically illustrates the benefits that can spring
change and financial intermediation was pressing. from changes in an economy's legal infrastructure.
All three governments adapted the foreign codes Property rights are not usually absolute. The
to local customs (particularly with respect to family state claims a share of the benefits from the use of
law) and to economic circumstances.
resources in taxes-to pay for, among other things,
In some countries inherited legal systems have the protection of property rights from external and
not been updated to meet the changing needs of internal threats. Societies recognize many other rethe
economy. In addition, commercial laws may be strictions on property rights for the common good,
weakly enforced because of cumbersome proce- including the right of eminent domain to build
dures or because inadequate resources are devoted roads, harbors, power lines, and other infrastructo
the task. But just as too few rules can create ture. Property rights may also be limited in timeuncertainty,
so can too many-especially if they for example, through leasehold of land rather than
keep changing.
absolute ownership or (less directly) through in-
To make their legal systems more effective, gov- heritance taxes applied to a broad range of assets.
ernments need to provide for acceptable collateral Changes in the value of resources as a result of
S6