with the degree of development of the relevant market. Stronger shareholder rights are, on a cross-country basis, associated with a greater number of listed firms and with higher stock market capitalization; stronger creditor rights are associated with a higher level of bank credit and bond finance.<sup>21, 22</sup> Looking behind the national aggregates to the performance of individual firms, Beck, Demirgűç-Kunt and Maksimovic (2002) draw on a recent survey of some 4,000 firms – small and large – in 54 countries that were asked for their perception of financing, legal and corruption constraints to their growth. The responses allow one to pinpoint where in the economy these constraints are biting. Uniformly, while all sizes of firms report constraints, uniformly it is the smaller firms whose growth is being more affected by a given level of self-reported constraint. Disappointingly, the answers to more detailed questions on the specific nature of the constraint (11 specific questions about legal constraints, for example) fail to predict firm growth rates, making it difficult to draw detailed inferences on what are the most damaging legal difficulties.<sup>23</sup> Interestingly the main explanatory power comes from comparing average experience across countries: the within-country variation in self-reported legal (and other) constraints is not highly correlated with individual firm performance. Thus (even though the systemwide “law and order” variable from the abovementioned KKZ database does not add much explanatory power to the self-reported legal constraints in predicting differences in firm growth), it does seem to be cross-country differences in legal conditions that matter rather than just the idiosyncratic experiences varying from firm to firm.<sup>24</sup> 21 These papers have led to an explosion of research refining and deepening the results. For example, Emre Ergungor (2002) shows that it is mainly in common law countries that creditor rights explain variations in banking sector development (and he also explains why this should be expected).

22 An ongoing debate concerns the primacy of legal origin and geographic endowments in creating the environment for subsequent financial and wider economic development. Using a sample of 70 former colonies, Beck, Demirgűç-Kunt and Levine (2003) find evidence for both hypotheses. However, it is initial endowments that are more robustly associated (than legal origin) with financial intermediary development and they also explain more of the cross-country variation in financial intermediary and stock market development than does legal origin. But this debate does not affect the validity of legal origin as an instrument. Just why legal origin should matter is discussed by Beck, Demirgűç-Kunt and Levine (2002), perhaps because some legal traditions do a better job at defending private interests against the state, or perhaps (and what evidence there is favors this one) law in some traditions is better able to adapt itself to varying commercial conditions. Political – and as such time-varying – influences from interest groups on the policies determining financial development are emphasized by Rajan and Zingales (2002).

23 Details of the self-reported financing constraints are more informative in this regard: high collateral requirements, banking bureaucracy, high interest rates, need for the borrower to have a special connection with the bank, and “banks lack money to lend” all correlated with firm growth.

24 Note a hidden assumption here, namely that defining good-for-finance legal systems is unproblematic. We already highlighted the fact that different legal systems attach different priorities to the main players. Most writers on this topic assume that enforcement of creditor rights is the key thing, but a respectable theoretical proposition can be made to the effect that lenience in this regard might encourage entrepreneurship: however, the empirical evidence, including that cited here, seems to argue against such a soft proposition. In developing countries policy discussion focuses as much (or more) on the judicial and administrative enforcement of the law as on how to tilt the legal protections in law: few would disagree with the importance of enforcement.

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