Opening-up or institutional development? Evidence from China

Abstract

‘Trade fundamentalists’ and ‘institutionalists’ disagree about whether openness or institutions are more important for economic growth. This paper would like to propose a new perspective: openness and institutional development interact with each other. The materialization of the effects of openness on economic growth depends on the existence of adequate institutions, and in the other way around openness may speed up institutional development in the direction of becoming more growth-enhancing. We analyze China's opening-up and institutional development in the past two decades to illustrate the interaction. We then empirically test for the interactions between openness and institutional development, using a panel of Chinese provinces over the past two decades. The results are positive.

Keywords:

• openness
• institutions
• economic growth
• China (Asia)

JEL Codes :

• F10
• O10
• P30
• P33

Acknowledgements

The author thanks the University of Macau for financial support (Grant RG048/05-06S/CY/FSH).

Notes

See Sachs and Warner (1995) and Edwards (1998).

See notably the cross-country studies by Dollar and Kraay (2002) and Rodrik et al. (2002).

Dollar and Kraay (2002) and Rodrik et al. (2002) included a variable of international trade and a variable of institutional development, separately and not interactively, in an equation explaining economic performance.

Institutions include both formal rules, such as the constitution and laws, and informal norms, such as customs, habits and traditions.

It is generally agreed in the literature that good institutions are those that protect property rights, enforce contracts, encourage fair market competition, and enforce the rule of law.

See for example Naughton (1994), Chen et al. (1992), among others.

‘Comprehensive’ in the sense that our measure of institutions, as explained below, may encompass the effects of various reforms, which were the subjects of different previous studies.

More details on TVEs can be found in Fan and Chen (2001).

Here, we are not advocating for ‘irregular’ government intervention. In a mature market economy, governments’ role should concentrate on the provision of public goods. However, in a transition economy, governments may have to perform certain unorthodox tasks by virtue of facilitating certain agents ‘escaping’ towards the market.

Institutions include formal and informal rules of the game in a society.

Tibet and Hainan are not included because of incomplete data.

With China's accession to the World Trade Organization in November 2001, the Chinese economy entered a new era: foreign trade surged, while the share of the non-state sector in the economy tended to stabilize at a certain level (which can be seen as normal, as even in an advanced market economy, the private sector does not take up 100% of the economy). Our estimation stops at 2001 as we would like to concentrate on the transition process.

We hesitate to use the share of the non-state sector in total fixed-asset investment as these statistics in China Statistical Yearbook are mainly collected from the banking system, which is still largely state-owned and lends little to non-state enterprises, so non-state sector investment is insufficiently recorded in the available statistics.

The availability of the Index is not long enough for our econometric estimation.

The variables are three-year averages, as is common for GMM growth equation estimation, so as to avoid identification difficulty due to a too large number of instrumental variables with annual data.

We also tried estimations using the Marketization Index to be the variable of institutions, although only for the short period of 1997–1999. The interacting term is also significantly positive.