Law and development: Economic analysis of law, financial intermediaries, and economic development in Eastern Europe

This dissertation pursues three major goals: (1) to summarize the theoretical understanding of the complex relationship between law, financial intermediaries, and economic development (chapter 1); (2) to review and analyze econometrics-based studies devoted to this relationship (chapter 2); and (3) to model the relationship in a new way, with the use of newer generations econometrics techniques (chapter 3). The results from the last part are the focus of the dissertation and this abstract.; The dissertation models the relationship between law and economic development using a second-generation econometrics technique (PLS-Graph), which allows for simultaneous estimation of all levels of a model (law, financial intermediaries, and economic development) and a criterion-based aggregation of indicators into indexes. All estimated models (three world and two Eastern European) indicate that shareholders' protection is more important than creditors' protection and that the rule of law is the most important among the legal determinants, which, however, influences the world's economic development through the financial intermediaries, yet influences the Eastern European economic development directly, without influencing the financial system (possible reason: a lag). Furthermore, the models indicate that between the banking and the capital market system, the banking system is the one that has a greater causal implication on economic development (in the different models the difference varied between 1.5 times and three times higher coefficient for the banking factors), yet the capital market system is the one that has a greater causal implication for economic growth. This conclusion, if correct, has a very far-reaching importance: it means that if a country has a choice between developing a strong banking system and a strong capital market system, and if the country is still underdeveloped, it should err in favor of the banking system, but if the country is developed, it should transfer from a bank-based to a capital-market-based system. Therefore the normative implication of the dissertation is that an Eastern European country should use the German-Japanese bank-based model as its major financial reallocation tool until it develops, and then should switch to the US-British capital-markets-based model because of its greater flexibility and propensity for quick reallocation of resources.