A Conversation on How Capitalist Excesses are Enabled by the Legal System

This conversation is with Katharina Pistor, a legal scholar, around her new book

Katharina Pistor is a professor at Columbia Law School. She is a leading scholar writing on corporate governance, money and finance, property rights, and comparative law and legal institutions. This conversation is around her new book “The Law of Capitalism and How to Transform It” published by Yale University Press.

Below you’ll find an Abstract of the book, followed by my questions and her answers.

Book Abstract: Capitalism seems unstoppable. Laws and regulations that are meant to contain its excesses can slow its expansion but are unable to contain it. How is it that a system that relies extensively on the law to code assets as capital is so resistant to legal constraints is the big question this book addresses. The answer lies in the fact that capitalist law is Janus-faced: Its private law side empowers non-state actors to use law as a tool to build private wealth and power over others; the public law side seeks to rein in some actions, but it also protects private actors against state interference through constitutional constraints on state power. This is how private actors rule over others with impunity, shift the risk of their actions on society at large and the environment. I conclude that private law needs a reset to ground it in principles of mutual respect and support among private actors rather than exploitation and power.

Pranab Bardhan (PB): 1. You make the important distinction between private law and public law and that the normative ideas behind them are different. You also say that private law has been under less public scrutiny and requires a normative foundation different from what is currently in use. For readers who are not familiar with the legal literature can you please illustrate the distinction and elaborate a bit on the normative issue?

Katharina Pistor (KP): To put it most simply, private law is the law that governs social and economic relations among private actors (individuals and organizations). It includes contract, property, and organizational law. Public law is the law that governs the relation between the state and its subjects. It includes constitutional and administrative law, as well as the growing body of regulatory law for finance, the environment, etc. Of course, there are many hybrid domains, the nature of which as public or private is contestable. It is sometimes said that essentially all law is public, because the power of private law rests on enforceability, that is, the ability to enforce a claim against someone else in a court of law. In contrast, Evgeniy Pashukanis, a socialist legal theorist of the early 20^th century, suggested that one might just as well say that all law is private, because the origins of private law date back to Roman law, which was largely private.

The important point for the argument I advance in the book, that private law precedes modern constitutional law and was embraced without further scrutiny of the different normative foundations on which these two bodies of law rest. For private law, the autonomy of individuals and organizations is foregrounded at the expense of considerations of the collective or the common good. Pushed to the extreme, private law is about maximizing one’s own interests irrespective of the implications for others. Any constraints have to be imposed from above – that is from the state through public law. In contrast, public law is about empowering but also constraining the state and its agents. Constitutions divide power and create checks and balances for fear that public power can be abused. No such accountability mechanisms are built into private law, which simply assumes that consent is voluntary and that formal equality is all that is needed, disregarding differences in resources and power.

(PB): 2. You say that the core features of capitalist law are three: (a) private legal empowerment, (b) decentralized access to the centralized means of coercion, and (c) legal arbitrage or the ability to repurpose or reinterpret the law. Again, please elaborate with examples, and maybe stress how these core features allow private actors to dismantle some of the guardrails of capitalism and how finance capital in particular gets to ‘privatize the profits, socialize the losses’.

(KP): Private legal empowerment captures the fact that the law, which is a social resource, empowers individuals as well as entities (including corporations) to take the law into their own hands when organizing their relations with other individuals or entities. Contract law is a good example: contracts shall be enforced is an old mantra, which implies that if one consents – even if only by clicking to agree on a website – one is bound by all the conditions of the contract that one may have never read and realistically speaking has no time to read.

Decentralized access to the means of coercion stands for litigation in civil or private matters. The state is often described as the embodiment of the consolidation of the means of coercion. Whereas in earlier times, clans and communities governed themselves and used force against one another, the state suppressed these customs and took it upon itself to determine who may when and under what conditions mobilize the means of coercion to what ends. Civil procedure law is the body of law that sets the parameters for accessing the means of coercion through litigation but so do contracts that imposed private arbitration on the other party and thus deny it access to state courts.

Lastly, legal arbitrage stands for the proposition that law is never entirely precise; it is incomplete and can be interpreted in many ways. Moreover, there is always more than one legal order: local, state, and national law, the multiplicity of national laws, and international law. There is also public (regulatory) law, and private (empowering law). Frictions and contradictions among these different legal orders can be used to arbitrage around regulatory mandates (by pretending that a transaction is not the one that was meant to be regulated), taxes (by locating assets in tax havens through legal entities that are formally separate from the taxed individual or entity), or by exploiting loopholes in the law to create new financial assets that may in spirit be similar to regulated ones, but escape the regulatory reach.

These three features of capitalist law can be jointly exploited to escape attempts by the collective (represented by the state and its regulatory agencies). A few examples: After World War II capital controls were put in place to avoid the destabilization of the financial system. Within years, private law transactions known as currency swaps allowed sophisticated actors to get around them. Property law is typically governed by the state on whose territory a good or asset is located. But assets that do not have a location – intellectual property rights and financial assets – do not fit into this scheme. By using the place of incorporation of the asset-issuing entity (which is a matter of choice), private parties were able to choose their own property law as well. And when banks are regulated to ensure the stability of the financial system, so called “non-bank financial intermediaries” emerge that do banking for all intent and purposes, but because they are not called banks and they do not create deposits, they escape banking regulation.

(PB): 3. Even though your approach to law gives primacy to social justice and thus seems of the ‘leftist’ variety, you differ from Marxists as you understand capitalism itself as a legal regime, and law is part of the material conditions of capital, not in what Marxists call ‘superstructure’. Is that a valid description of your approach?

(KP): Yes, it is. In the world of financial capitalism, it is very difficult to draw a line between the materialist and the legal. Every financial asset is effectively an “I owe you”, or a legal claim to future payment. There is no other “materialist” base to it, but the law. The same holds for intellectual property rights, which in some languages and legal systems are referred to as “immaterial property rights”. They are creatures of the law and exist only to the extent they comply with the law and as long as the law affords them protection. In short, not only are material assets, like land, coded in law to become capital, but the main ingredient of capital assets are legal claims.

(PB): 4. The second half of your book is on strategies of transformative change in law, particularly on democratizing private law. You have proposed some significant changes even at the margin of the current legal system to make it more socially responsible--like moving from tort law to the precautionary principle in the case of environmental damage, moving away from limited liability, toward arbitration in a public forum rather than behind closed doors, and so on. Could you elaborate on these for a general readership?

(KP): In my earlier book, “The Code of Capital: How the Law Creates Wealth and Inequality”, I argued that capitalism is not a market economy, but a market economy on legal steroids. This is to say that the law protects certain interests more than others and balances rights and interests in ways that are not necessarily conducive to broader claims of justice, including environmental justice. Take tort law: under general principles of private tort law, the plaintiff must show that she suffered damages by the defendant, showing that she did in fact occur bodily injury or monetary damages, and that the defendant caused these damages. In the case of pollution, this is a very tall order, which is why environmental regulation has at times tried to proactively limit the amount of pollution. In production liability law, courts and legislatures have imposed strict liability on producers, because it was impossible for a consumer to show what exactly had gone wrong inside the production facility or warehouse where the products became defective only to later cause damages to the consumer.

Limited liability adds insult to injury, because it protects the investors in polluting companies from ever facing claims for liability that would affect them beyond the money they spent when they bought the company’s shares. Limited liability may have been a useful strategy for broadening the investor base in the 19^th century when capital was scarce. Today it has become a license to externalize the costs to others and the environment that a company creates, while allowing shareholders to benefit from the profits of producing these damages.

Lastly, as mentioned earlier, when corporations use contracts to deny their customers or employees (both legal under US law) access to the courts and force them into arbitration, they effectively deny them access to justice. Few customers or employees avail themselves of private arbitration, because it is difficult to predict what might happen in light of the fact that the rulings of arbitral tribunals are private. At the same time, we need to recognize that courts are overwhelmed, and few societies are ready to mobilize sufficient resources to ensure that all have equal access to them. This is why I argue that private judges are not per se evil, but that we need transparency and a meaningful governance structure to ensure that they operate fairly (something the EU is trying to do in its version of arbitration in consumer contracts).

(PB): 5. In discussing the normative shift that you advocate, you spend some time in invoking the philosophical approach of Amartya Sen and Martha Nussbaum, which rightly takes us away from the efficiency obsession in the Law and Economics literature. But in view of the formidable opposition that is likely to come from entrenched capitalist business and the financial oligarchy to any such shift, you do not spend as much time on how to organize socio-political movements to counter such opposition and how political economy-minded legal scholars can help there. Is that unfair? Democracy has both procedural and participatory aspects. Maybe the latter, particularly in the form of democratic deliberations at the local level (like the citizens’ assembly in Ireland resolving the controversial abortion issue in recent years, the very active digital democracy that operates in Taiwan, Iceland or Barcelona resolving local community problems, etc.) can provide some democratic guidelines for judges?

(KP): Your critique is fair. I am not an expert on social movements, but I am a reader of some literature that seeks to understand the link between social movements and legal and institutional change. My takeaway from this literature is that we need a basic agreement on the normative principles that help us build an “architecture of inclusion” as my colleague Susan Sturm has suggested, to give just one example. Moreover, the social glue that has often held disparate reform projects in the past, including family ties, are no longer as strong or carry as far as the system that needs reform. What I am proposing is that a common normative foundation can provide the glue for a multiplicity of change strategies that are embedded in local context and fueled by social movements. Absent such agreement, they might all fizzle out. I put my bets on decentralized reform strategies, because I do not see the political possibility at the current moment to enact major reforms top down. Polities are divided domestically and globally. This is why we need bottom-up approaches, but we need some direct or indirect coordination among them.


(PB): 6. You rightly emphasize the environmental problems that arise from capitalism’s battle with nature. But the environmental problem is not just due to capitalism. Just think of the destruction of Aral Sea (once the fourth largest lake in the world) under the Soviet regime. Maybe more than capitalism the logic of industrial growth itself is involved. Do you agree?

(KP): Yes. Excessive growth and a disregard for the environment is not unique to capitalism; Soviet style socialism has done the same. Both are systems that enabled and emerged from industrialization, so perhaps this is not surprising. However, there are different cultures that have made it a normative virtue to care and protect the plants, animals, and environment on which humans depend – to live withing the boundaries of a naturally bounded planetary system. The more fundamental question is what we mean by growth. GDP growth per capita is measured only in terms of measurable outputs but disregards care work and any other contribution to society or nature that is not captured in the systems that exist. Obviously not. I think we agree that we have reached the limits of industrial growth. I would add that we have also reached the limits of financial expansion, as it renders our global financial system ever more fragile and prone to crisis. But I would not rule out the possibility and positive impact of other forms of growth. This ties up nicely with the capabilities approach. A lot of these forms of growth are needed to ensure that all humans and arguably non-human animals (as Nussbaum has argued) have the right to live the lives they have reason to value.

(PB): 7. You do not discuss it, but your discussion of democratizing norms behind private law reminded me of a well-known proposition by Milton Friedman, often cited in the Finance literature, that shareholders should concentrate on share value maximization and ignore other social causes or stake-holders--after that share value has been maximized, if they want they could contribute more to those social causes than otherwise. Recently some economists (for example, a paper by Oliver Hart and Luigi Zingales) have shown the fallacy in Friedman’s proposition-- just to give one example, if in the process of share value maximization environment is irreversibly damaged, post-maximization donations may not help. Any comments?

(KP): I could not agree more with the notion that giving a license to externalize is not a good idea when the damages that are produced cannot be rectified ex post. Many scholars in the law and economics literature have pointed this out much earlier. In the book I discuss, for example, the seminal article by Calabresi and Melamed “Property Rules, Liability Rules, and Inalienability: One View of the Cathedral”, published in 1972, in which they make the case that we need not only liability rules but outright prohibitions when the burden of damages on future generations will become too great and they explicitly mention environmental harm. We have known all of this for over half a century. The real question is, how much of academia has been swept away by Friedman’s slogan and needs to recover old learning at a time when it is almost too late.

(PB): 8. Finally, in your book you do not discuss developing countries much except in the global core-periphery or colonizer-colonized context. Do you expect your approach to law to vary in the domestic context of a developing country? Let me give an example from poor countries where the legal system may not serve its usual purpose. Take the case where an explicit contract enforced by a legal system crowds out informal implicit contracts. In the context of environmental management of the village commons it has been pointed out that attempts to enforce private property rights may weaken the mechanisms of cooperation that previously existed among the resource users, who may have shared implicit non-contractual rights in the common property resource. Similarly, in small peasant communities where the scale of economic activity is not large informal relational contracts may be more efficient than rule-based contracts supported by costly legal-judicial procedures. Breaches of relational contracts are often observable by other community members even when not verifiable by courts, and punishment is usually through social sanctions and reputation mechanisms. Do you have any opinion on possible modification of the legal literature in such cases?

(KP): I agree with your analysis at least in part. Informal relations can go a long way in ensuring that problems are solved through cooperation rather than coercion and that the complexity of informal rights is often the best guarantee of at least some form of inclusion of weaker members in the governance of resources. However, there is also a dark side to informality, especially when the denial of rights to women, to the disabled, or to lower-caste members is part of the normative foundation of informal systems of ordering. There is also a scale issue: Informal norms require mutual monitoring, which impose limits on scale. This is why the Norwegian sociologist Bart has suggested that development is or consists of the breaching of existing spheres of exchange. What we need therefore is a system of social ordering that fosters cooperation and problem solving, but that is also scalable. Here again, I believe that the normative foundation should come from the reciprocal commitment to ensure that each and every one of us has the right to live the life he or she has reason to value.