Revue Européenne du Droit
Law, Wealth, and Inequality - Economy of Coding Capital
Issue #4


Issue #4


Katharina Pistor

Revue européenne du droit, Summer 2022, n°4

My recent book “The Code of Capital: How the Law Creates Wealth and Inequality” 1 aims to illuminate the basic principles of how law can be used as a tool for creating wealth for some, while leaving the rest much less well off. Importantly, I did not mean to suggest that the handful of legal institutions, which I identified as the basic modules of the code of capital are the only legal devices that can be used to create wealth; nor did I want to imply that the entire body of administrative and regulatory law should be left out of the equation when analyzing contemporary capitalist systems. Policing, as Adam Smith called the core functions of the state, has always co-existed with institutions of private law, which enable trade, commerce, and finance 2 . Moreover, the relation between these two bodies of law, the public and the private, has always been an uneasy one 3 . As much as traders, entrepreneurs, and financiers depend on sufficient state capacity to police, i.e., to provide for internal and external security and ensure that contracts are enforced and property rights respected, as much do they also resent state action that might limit their freedom 4 . Conversely, when the economy prospers, states benefit as well. They can increase their revenue by levying taxes and fees, attract capital as well as skilled workers to their shore, and benefit from the development of new technologies that might be used for security or the advancement of sciences. 

Yet, neither markets nor politics are stable and, contra standard economic models, rarely if ever trend towards an equilibrium. For this reason alone, states can simply not limit their role to guarding against market failure for very long. The inherent fragility of financial markets can put the entire system at risk 5 ; excessive market concentration undermines competition, the very motor for innovation and economic progress 6 ; and excessive income or wealth gaps undermines the fabric of democracies 7 . There are other reasons as well for states to play a more proactive role in the economy. In constitutional democracies, the people are the sovereign and ‘the state’ is only a shorthand for the organizations and agents that exercise state power on behalf of the people 8 . It is easy to dismiss this as wishful thinking and to instead argue that politicians and bureaucrats are ultimately selfish individuals as well who operate in their own, and not necessarily in the public’s interest 9 . This view, espoused by the public choice theory, effectively denies the very possibility of a public interest. If all are selfish individuals, then a public interest cannot exist. It follows that there is no public agency to address even the most basic market failures, much less develop institutions in support of markets, including a functioning legal system. Without this legal infrastructure, however, complex markets cannot exist 10

If the state and markets are imbricated, indeed, if markets depend on law and agencies of the state to protect them against abuse or self-destruction, and if in constitutional democracies the people are the sovereign, then it only makes sense for the people as a collective to set the ground rules for their social, political, and economic life. No doubt, collective decision making is cumbersome. Polities are heterogenous and their members have different, often conflicting objectives. This means that every decision takes time and often involved horse trading across different policy objectives. This is why political decision making is often compared unfavorably to the market mechanism 11 . With the price revealing most relevant information, in efficient markets even all publicly available information, all that is necessary is to respond to the price signal 12 . Critically, however, the pricing mechanism works only under well specified conditions. First, all market participants have a common point of reference, a shared currency, or at least a currency that is convertible into another currency that is shared by others 13 . This money system is, like the legal system, a collective product. Only state issued money retains its nominal value even in times of crisis, and only state money can be used to meet one’s obligations with the state 14 . Even when banks and other financial intermediaries issue most of the money in circulation, they do this qua a government franchise 15 . Absent such authorization, their currencies would find far fewer takers, because their convertibility into state currency would be much less certain. Witness the run on repos and other complex financial instruments in the Great Financial Crisis: When the value of these assets declined, they become toxic, because investors realized that they had no clear path to convert them into state-issued currency 16 . This is also why central banks can stabilize markets by simply announcing that they would be a willing buyer of last resort for any assets, including the ones that had been issued without a government franchise 17 . In short, the pricing mechanisms works, because they monetary system works, and the most stable monetary systems are the ones that are backed by state issued currency 18

There is also another reason for why the comparison of political decision making with the pricing mechanism is misleading. Not all issues of individual or social value can be quantified, but without quantification the pricing mechanism does not work. Even if more people prefer apples over pears, they may still wish to have pears on offer at least once in a while or would support measures that protected pears from extinction should demand for them decline relative to apples. In capitalist economies, capital is often given the treatment of pears in the above example. It is privileged in law and regulatory treatment over other assets, but without admitting that these privileges are the primary source of private wealth creation. Capital, as I argue in my book, is coded in law. 

Capital enjoys several attributes that give it a comparative advantage over competing assets, namely priority, durability or convertibility, and universality 19 . Priority implies that certain claims to the same asset are stronger than others; durability means that the assets are legally protected from liability or certainty claimants; convertibility provides durability to financial assets by given them a put option on state issued currency vis-à-vis a private agent or (preferably) vis-à-vis the issuer of that currency. Universality, finally means that rights that are recognized as legal enjoy the full protection of the law, including access to the centralized means of coercion by way of litigation and, if necessary, execution of the obtained award. Of course, not every interest enjoys these legal protections. Only interests that have been coded in law to trigger them do. A simple idea does not enjoy priority when others come up with the same idea later on just so. Only if the idea meets the legal requirements for an intellectual property right, and in the case of patents or trademarks is registered as such, will it enjoy these protections. Neither does every organizational form protect the assets of that organization from its members of their personal creditors and thereby confers durability on them. Only the corporate form or the trust do. Nor can any claim against a debtor be converted into cash at all times, including after the debtor has become insolvent. Only assets that enjoy special treatment in bankruptcy, or have been safe-harbored, do. Lastly, not all interests are equally enforceable in a court of law. Standing rules and other procedural hurdles limit access to dispute resolution in a court of law and access to the centralized means of coercion, which in principle require court endorsement. As a generally rule, collective interests are more difficult to litigate than individual interests, and for individual interests, civil procedure law creates a number of default rules that prioritize some interests over others: Disputes over property will typically have to be litigated in the jurisdiction where the asset is located; tort claim where the harm occurred or is still felt; contractual claim where the gravitas of the contractual relation lies, and so forth 20

All these rules are somewhat technical and few of them are well known of publicly debated. They do, however, set the stage for savvy parties to mobilize the legal system to their advantage, while leaving others to fend for themselves. Critically, in complex economic and social systems the complexity of rules tends to increase 21 . This is not necessarily the result of some government over-reach, but in large parts reflects the increased division of labor, which inevitably increases agency costs 22 . It also emerges from the back and forth between attempts to curtail socially undesirable behavior and the sophistication of lawyers in helping their clients to circumvent these constraints, which results in a renewed attempt of regulating the behavior and another round of legal arbitrage 23 . In addition, the latest generation of capital assets are themselves fashioned in law. Intellectual property rights and financial assets are the primary case in point. Today, they account for the greatest share of the market capitalization of firms 24 . Not surprisingly, the law itself has become the prime instrument by which wealth is created 25 . If I can ask my lawyer to increase wealth by shifting accounts to different jurisdictions, creating new financial assets, or ensure that my patent will be extended yet again by swapping out some minor compounds, why bother produce much, if anything? 

Coding capital does not benefit everyone equally. True, there may be some spillover effects for others who do not own assets, or if they do, do not have access to lawyers to put their assets on legal steroids. Most constitutional democracies endorse the principle that everyone is equal before the law, but this does not entail that everyone has the same means to strategically utilize the law to their own benefits. Forty years after trickle-down economics was declared the new mantra in major democracies, the UK and the US, the income gap between the rich and the poor has widened dramatically 26 . This is all the more surprising, because the past four decades have been accompanied by a series of crisis, which could have operated as a corrective, just as the Great Depression did in the 1930s. Yet, most of these crises were caught before they could wreak havoc, mostly by stabilizing asset prices to the benefit of capital holders. The savings-and-loans crisis and the collapse of Long-Term-Capital-Management in the US, as well as the collapse of BCCI in the UK could all have easily morphed into a full-blown crisis, had the state not stepped in and softened the blow. Given the apparent fragility of the system that has been created and the discrepancy between promises made about prosperity for all and observable increase in inequality in income and wealth, we should ask, why democracies endorse and actively create a system that runs counter to the interest of most. 

Several plausible explanations are on offer. Capture is one, both in its cognitive and material dimensions 27 . Most politicians in most democracies have a hard time imagining anything other than the system as is and if they have any doubts, they are dissuaded from thinking about real alternatives by the “captains of finance and industry” 28 .  In fact, cognitive capture often extends to the judiciary, especially in common law jurisdictions, in which judges are recruited from the practicing bar 29 . The revolving door between government posts and top jobs as well as directorships in the corporate sector is a well-known phenomenon, as is at least in some countries the revolving door between regulators and the regulated 30 . Not simply the self-interest of the individuals that serve, but the concerted efforts of lobbyists is at work in forming the public interest. Another explanation is that legislatures lack the capacity to monitor the evolution of the economy and intervene in a timely manner. With the increasing complexity of the economy, their task has become even more daunting They often delegate this task to regulators, but their powers are purposefully curtailed to ensure that they do not exercise too much legislative power. Moreover, as noted, many regulators maintain close ties to the regulated. While this may enhance their ability to monitor, their impartiality and independence is at risk. The strong influence of the regulated is also evident in advice and comment procedures that precede any major regulatory efforts in many countries today 31 . The ones with the greatest stake in not being subjected to regulation are often over-represented in comparison to those in whose interest a regulatory proposal is advanced 32 . In the event that new laws or regulations are passed, this does not mean that they are effective. With the right legal advisors on their side, private actors can often avoid the reach of regulation by recasting their activities, or shifting their accounting business, not necessarily their real business elsewhere. The efficacy of laws and regulations, it turns out, is not just a question of good or bad institutions, but of the interaction between laws and regulations on one hand, and coding practices on the other. Last but not least, given the complexity of many legislative and regulatory tasks, legislatures often outsource the drafting of new laws to major law firms, the same firms that otherwise work primarily for asset holders and code their capital.

In short, the political economy of coding capital goes much further than simply molding new capital assets in old laws, which I highlighted in my book. It has deeply infiltrated the operation of ordinary legislative, regulatory, and judicial processes. In the last consequence, it is undermining the very idea of democratic self-governance. 


  1. Katharina Pistor, The Code of Capital: How the Law Creates Wealth and Inequality (2019).
  2. Adam Smith, Lectures on Jurisprudence (1982).
  3.  Note that the Soviet theorist of socialist law argued that the duality of private and public law is a core characteristic of law in capitalist systems. Evgeny B. Pashukanis, Law and Marxism: A General Theory. Towards a Critique of the Fundamental Juridical Concepts (1929).
  4. The German sociologist, Max Weber, noted that entrepreneurs always bargained for exceptions from the rules that were binding on everybody else. He called this the new “legal particularism”. Max Weber, Economy and Society (1978).
  5.  Hyman P. Minsky, The Financial Instability Hypothesis: An Interpretation of Keynes and an Alternative to “Standard Theory”, in Can “It” Happen Again? Essays on Instability and Finance 59–70 (Hyman P. Minsky ed., 1977).
  6. Joseph A. Schumpeter, Capitalism, Socialism and Democracy (1942).
  7. The basic argument can be found in Karl Polanyi, The Great Transformation: The political and economic origins of our time (1944).
  8.  Jean L. Cohen, Globalization and Sovereignty: Rethinking Legality, Legitimacy and Constitutionalism (2012).
  9. George J. Stigler, The Theory of Economic Regulation, 2 The Bell Journal of Economics and Management Science 3–21 (1971). This line or argument is followed more generally in the public choice literature. 
  10. The basic argument is developed in Katharina Pistor, A Legal Theory of Finance, 41 Journal of Comparative Economics 315–330 (2013).
  11. Robert C. Ellickson, Order Without Law – How Neighbors Settle Disputes (1991).Timothy Frye & Andrei Shleifer, The Invisible and the Grabbing Hand, 87 American Economic Review 354–358 (1997).
  12. Eugene Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 Journal of Finance 383–417 (1970).
  13. Christine Desan, Making Money: Coin, Currency, and the Coming of Capitalism (2015).
  14.  Morgan Ricks, The Money Problem (2016).
  15. Robert Hockett & Saule T. Omarova, The Finance Franchise, 102 Cornell L. Rev 1143–1218.
  16. Gary Gorton & Andrew Metrick, Securitized banking and the run on repo, 104 Journal of Financial Economics 425–451 (2012).
  17. Perry Mehrling, The New Lombard Street: How the Fed Became the Dealer of Last Resort (2011).
  18. Clemens Jobst & Stefano Ugolini, The Coevolution of Money Markets and Monetary Policy, 1815-2008, in Central Banks at a Crossroads 145–194 (Michael Bordo, Oyvind Eitrheim, & Marc Flandreau eds., 2016).
  19. For details see Pistor, supra note 1; Chapter 1.
  20.  John H. Langbein, Comparative Civil Procedure and the Style of Complex Contracts, 35 American Journal of Comparative Law (1987); Bradley Bryan, Justice and the Advantage in Civil Procedure: Langbein’s Conception of Comparative Law and Procedural Justice in Question, 11 Tulsa Journal of Comparative and International Law 521–555 (2004).
  21. This has been recognized by authors as different as Ostrom and Smith. See Elinor Ostrom, Beyond Market and States: Polycentric Governance of Complex Economic Systems, 100 American Economic Review 641–672 (2010); Henry Smith, Property as Complex Interaction, 13 Journal of Institutional Economics 809–814 (2017).
  22. On the importance of the division of labor for economic development, see Adam Smith, The Wealth of Nations (1776); Emile Durkheim, The Division of Labour in Society (1984). On agency costs, which are often discussed without reference to the division of labor, see Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 Journal of Financial Economics 305–360 (1976); Trond Olsen, Agency Costs and the Limits of Integration, 27 Rand Journal of Economics 479–501 (1996).
  23. Victor Fleischer, Regulatory Arbitrage, 89 Texas Law Review 227–290 (2010); Annelise Riles, Managing Regulatory Arbitrage: A Conflict of Laws Approach, 47 Cornell International Law Journal 63–117 (2014).
  24.  Jonathan Haskel & Stian Westlake, Capitalism without Capital: The Rise of the Intangible Economy (2018).
  25. Katharina Pistor, The Value of Law, 49 Theory and Society 165–186 (2020).
  26. Thomas Piketty, Capital in the 21st Century (2014).
  27. Michael E. Levine & Jennifer L. Forrence, Regulatory Capture, Public Interest, and the Public Agenda: Toward a Synthesis, 6 Journal of Law, Economics & Organization 167–198 (1990); I. Ayres & J. Braithwaite, Tripartism – Regulatory Capture and Empowerment, 16 Law and Social Inquiry 435–496 (1999); Joel S. Hellman, Geraint Jones & Daniel Kaufmann, Seize the state, seize the day: state capture and influence in transition economies, 31 Journal of Comparative Economics 751–773 (2003).
  28. Morris R. Cohen, Property and Sovereignty, 13 Cornell Law Quarterly 8–30 (1927).
  29. Richard Posner, What do Judges Maximize? (The Same Thing Everybody Else Does), 3 Supreme Court Economic Review 1 (1993).
  30. Susan Rose-Ackermann, Corruption and Government: Causes, Consequences, and Reform (1999).
  31. Jose Edgardo Campos, Legislative Institutions, Lobbying, and the Endogenous Choice of Regulatory Instruments: A Political Economy Approach to Instrument Choice, 2 Journal of Law, Economics, and Organization 333–353 (1989); Pieter Bouwen, The Logic of Access to the European Parliament: Business Lobbying in the Committee on Economic and Monetary Affairs, 42 Journal of Common Market Studies 473–496 (2004).
  32. Katharina Pistor, Host’s Dilemma: Rethinking EU Banking Regulation in Light of the Global Crisis, in Festschrif für Klaus J. Hopt (Harald Baum et al. eds., 2010).
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