Liberalized bankruptcy laws would be a further boon to developing markets

Lost amidst the case for long-term, fundamental-based investing in emerging and frontier markets–namely increased growth potential through consumption underpinned by favorable demographic and wealth-spreading trends, as well as strong fiscal balances expressed through low debt ratios, and in many cases the exporting of increasingly-dear commodities–is the point that in most developing markets, bankruptcy laws are still dreadfully draconian, to the detriment of would-be entrepreneurs. Economist’s Schumpeter from last week, however, argues that this situation may be changing:

Many governments are trying to shake up their lethargic legal systems in order to speed up bankruptcy proceedings. The reforms also touch upon the more fundamental question of trying to save viable businesses from premature liquidation. Dozens of countries are trying to give companies more opportunities to reorganise before they finally reach for the revolver. France and Germany were among the first to do this. But the idea has also spread to eastern Europe and Asia and may even be reaching the bankruptcy-averse Muslim world (last year ten Middle Eastern and north African countries signed a joint declaration on planned reforms).

Why liberalize at all if it may encourage further inefficient profligacy? The answer lies in a paradox of “free” markets, whereby an actor’s freedom to grow, granted by the state, must also be countered, or balanced, by the freedom to fail, i.e. a safety net of sorts. “The best way to get more people to start businesses is to make it easier to wind them up,” Schumpeter states.