The China paradox: the endogenous relationship between law and economic growth

Abstract

An enduring paradox of China’s remarkable economic growth is the lack of a well-established legal system. By drawing on the credibility thesis, this paper proposes that legal and economic reforms give rise to, and reinforce, the other and the market is underpinned by evolving institutions that are shaped by the expectations of the actors in the economy. It is thus not the form of institutions but their function that is more important in assessing institutional performance. A comparative examination of the USA at a similar stage of legal-institutional development to China provides support for an evolutionary, endogenous process. This institutional analysis will focus on key issues of economic legislation, such as corporate law, patent law and securities. Analyzing the relationship as complementary processes can help explain the paradox of strong economic growth within an under-developed system of law with potential, critical implications for institutional development in other countries.

Keywords:

• Law
• credibility thesis
• endogenous economic growth
• China
• institutions

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Allen et al., “Law, Finance and Economic Growth,” 57–116; Cull and Xu. “Institutions, Ownership, and Finance,” 117–146.

2 North, Institutions, Institutional Change, and Economic Performance; Acemoglu and Johnson, “Unbundling Institutions,” 949–995.

3 Coase, “The Nature of the Firm,” 386–405.

4 Xu et al., “Politician Control, Agency Problems,” 1–24; Gan et al., “Decentralized Privatization,” 3854–3894.

5 See Jones (2003) for the modern day influences of China’s dynastic legal system.

6 Chen, “Capital Markets and Legal Development,” 451–472.

7 Coffee, “The Rise of Dispersed Ownership,” 1–82.

8 Ibid.

9 La Porta et al., “Legal Determinants of External Finance,” 1131–1150; La Porta et al., “Law and Finance,” 1113–1155. See also Acemoglu et al. (2005) for a similar argument regarding institutions and economic growth.

10 See note 7 above.

11 See note 6 above.

12 See note 9 above.

13 Allen et al., “Law, Finance and Economic Growth,” 57–116.

14 Ho, “In Defense of Endogenous,” 1087–1118.

15 Brock, “Foreign Direct Investment,” 349–360.

16 Jefferson and Rawski, “China’s Emerging Market,” 585–617.

17 Ho, Institutions in Transition.

18 Rodrik et al., “Institutions Rule,” 131–165.

19 See note 9 above.

20 Pistor et al., “Law and Finance in Transition,” 325–368

21 Glaeser et al., “Do Institutions Cause Growth?” 271–303.

22 Pistor and Xu, “Governing Stock Markets,” 184–127; Fan et al., “Institutions and Foreign Direct Investment,” 852–865.

23 Aron, “Growth and Institutions,” 99–135; Rodrik et al., “Institutions Rule,” 131–165.

24 See note 2 above.

25 Cull and Xu, “Institutions, Ownership, and Finance,” 117–146; Lu and Yao, “The Effectiveness of the Law,” 763–777; See note 15 above.

26 See note 1 above.

27 Yao and Yueh, “Law, Finance and Economic Growth,” 753–762.

28 Aron, “Growth and Institutions,” 99–135.

29 Ho, “The ‘Credibility Thesis’,” 13–27; Ho, Unmaking China’s Development.

30 Grabel, “The Political Economy,” 1–19.

31 Ho, “The ‘Credibility Thesis’,” 13–27.

32 Chang, Institutional Change and Economic Development.

33 Clarke, “Form and Function,” 902–912; Koroso et al., “Land Institutions’ Credibility,” 553–564.

34 Zhang, “The Credibility of Slums,” 876–890; McClymont and Sheppard, “Credibility without Legitimacy?” 102520; Oranje et al., “Rapid Urbanisation to Non-Metropolitan Urban South Africa,” 102487.

35 Celhay and Gil, “The Function and Credibility,” 102605.

36 Zhao and Rokpelnis. “Local Perceptions of Grassland,” 1206–1223; Fan et al., “Institutional Credibility Measurement,” 212–225.

37 Fold et al., “Grounding Institutions,” 922–931.

38 Gomes and Hermans, “Institutional Function and Urbanization,” 932–941.

39 Young, “The Razor’s Edge,” 1091–1135.

40 See note 18 above.

41 Du and Xu (2009) argue that administrative arrangements took the place of laws in creating China’s capital markets.

42 Du and Xu, “Which Firms Went Public,” 812–824.

43 See Thelen (2002) for a review of the historical institutionalism literature that points to the path dependence of institutions.

44 See note 7 above; Sun and Tobin, “International Listing as a Means,” 825–838.

45 La Porta et al., “Legal Determinants of External Finance,” 1131–1150.

46 Cull and Xu, “Institutions, Ownership, and Finance,” 117–146.

47 Long, “Does the Right Hypothesis,” 629–650.

48 Pistor et al., (2003) provide a historical review of common and civil law countries that finds that countries do not have strong rule of law at the inception of their laws. Instead, effectiveness as measured by shareholder protection develops over time. Acemoglu, Johnson, and Robinson (2005) instead argue that countries which inherited better institutions, i.e. those that protected against risk of expropriation, from colonial powers had higher growth rates in subsequent years due to the positive impact of those institutions.

49 Jones, “Trying to Understand,” 91–107.

50 Alford, The More Law,

51 Jones, “Trying to Understand”.

52 See note 9 above.

53 La Porta et al., (1998) draw the further distinction that civil law countries such as German and Scandinavian ones provide better protection than French civil law countries, though not as much as common law countries in a survey of 49 countries.

54 Levine, “Financial Development and Economic Growth,” 688–726; Levine, “The Legal Environment,” 596–613.

55 See note 7 above.

56 Ibid.

57 Ibid, 9.

58 See note 7 above.

59 Banner, “What Causes New Securities,” 849–855.

60 See note 21 above.

61 Acemoglu et al., “Institutions as the Fundamental Cause,” 385–472.

62 Pistor and Xu, “Governing Stock Markets,” 184–127.

63 Pistor et al., “Law and Finance in Transition,” 325–368; Berkowitz et al., “Economic Development, Legality,” 165–195.

64 Clarke, China: Creating a Legal System.

65 Maddison (2001) provides historical GDP per capita measures reported in 1990 US dollars.

66 There had been corporation law prior to the Delaware Act, though the dominance of Delaware as a preferred state for incorporation lends itself to be identified as a key article of U.S. company law (Hamermesh 2006).

67 Hansmann and Kraakman, “The End of History,” 439–468.

68 See note 7 above.

69 See note 6 above.

70 See note 9 above.

71 The steam engine, spinning and weaving machines, cast iron, and electric battery were among the key inventions of the 19^th century industrial revolutions. In the 20^th century, the international conventions on patents occurred during a time of inventions, such as the telegraph, telephone, and electricity, which coincided with a five-fold increase in per capita incomes in Western Europe as compared with the three-fold increase between 1700 and 1800 (Maddison 2001).

72 Yueh, “Global Intellectual Property Rights,” 436–448.

73 The 164 members of the WTO account for nearly the totality of world trade.

74 Per capita GDP for the U.S. is not available in 1790, so the next available data from 1820 is reported.

75 See Horwitz (1992) for the evolution of U.S. contract law during the late 19th and 20th centuries in response to the economic and social conflicts of the time.

76 The presumption of the U.S. federal system is that unless explicitly claimed in the Constitution or Act of Congress, an area of law was to be governed by state law. The “state’s rights” doctrine is embodied in the 10^th Amendment concluding the Bill of Rights to the U.S. Constitution, which states: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

77 Hamermesh, “The Policy Foundations,” 1749–1792.

78 Fan, “Incremental Change and Dual-Tack,” 99–122.

79 Clarke, “Corporate Governance in China,” 494–507.

80 Pistor et al., “The Evolution of Corporate Law,” 791–871.

81 See Sun and Tobin (2009) for the argument that innovative Chinese firms can enter and learn from international capital markets, which in turn can induce market-level improvements through regulatory competition and demands for a more standardized system of economic regulation.

82 See note 7 above.

83 See note 6 above.

84 Ibid.

85 Bernanke, Essays on the Great Depression.

86 See note 6 above. See also, Sun and Tobin (2009).

87 Du and Xu, Regional Competition.

88 Du and Xu, “Which Firms Went Public,” 812–824.

89 See note 6 above.

90 Kaufmann et al., Governance Matters VI.

91 Kaufmann et al., Governance Matters VI.

92 Maddison, The World Economy.

93 Maddison, The World Economy.

Additional information

Notes on contributors

Linda Yueh

Linda Yueh is Fellow in Economics, St Edmund Hall, University of Oxford, and Adjunct Professor of Economics at London Business School. She is also Visiting Professor at the London School of Economics and Political Science and was Visiting Professor of Economics at Peking University. She is Series Editor for the Routledge Series on Economic Growth and Development and served as guest editor of World Development and the Oxford Bulletin of Economics and Statistics.