As the Chinese economy slows we still have much to learn from this emerging market’s phenomenal economic transition and its increasing reliance on the rule of law

As the Chinese economy slows we still have much to learn from this emerging market’s phenomenal economic transition and its increasing reliance on the rule of law

by Professor Simon Deakin & Dr Boya Wang, Centre for Business Research

The slow-down in the growth of China’s economy from double digits to single figures is now the focus of world attention, but has the impact of the recent stock market crash in the summer of 2015 been over estimated? China has successfully transformed itself into the second largest economy in the world today after the USA, and its double-digit growth was expected to slow down sooner or later.

Simon Deakin, Director of the Centre for Business Research at the University of Cambridge, and Professor of Law, and researcher Dr Boya Wang, have been using databases and face-to-face interviews with China’s business leaders in various provinces and industries to study the recent transformation of China’s economy.

Their ESRC-sponsored research has looked at the progress that China has made in moving from a system of conducting business that relied on guanxi-based transactions, or trust, which often goes hand in hand with corruption, to a more formal, legally driven economy.

Their qualitative research paper (based on interviews conducted during 2013/14) is called Different Legal Institutions for Different Economic Settings: Evidence from Interviews in China by Ding Chen, Simon Deakin, Mathias Siems and Boya Wang.

Their quantitative research working paper is called Corporate Governance, Institutional Environment and Firm Performance: Cross Provincial Evidence of Chinese Firms during the Financial Crisis 2008/09 by Simon Deakin and Boya Wang.

In this two-part podcast series Deakin and Wang first debate the recent stock market crash in China, and in part two, they look in more depth at the historical development of China’s business economy, the strength of the rule of law in China today, and how its institutions, business leaders, judiciary and regions interpret those rulings.

Part 1: Recent stock market turmoil

In part 1 Boya Wang says: “I think the 2008/9 crash was quite different from China’s recent problems. In 2008/9 the troubles were the result of economic turmoil elsewhere in the world, but this time it is more about the slow-down of the Chinese domestic market. The government is using different policy instruments this time. Also it has refrained from issuing a stimulus package, and it is using institutional development rather than fiscal measures to tackle the problems.

“However we know that during the last crash the responses to the government’s stimulus package varied. Some regions, mainly the coastal regions, were able to maintain their growth through the crisis period more successfully than others.

“China has changed since the last crash but the progress has been slow as there has been a lot of opposition to change from vested interests. The transition to a more market-oriented style economy will not be smooth, and we can’t look for an immediate result but it is making positive progress.”

In part 1 Simon Deakin says: “China is an important story to study for the global emerging transition economies. As a late industrialiser and even with the recent economic slow-down China still has a strong economy with high levels of growth, which others have not enjoyed. We need to look at how China develops in the future, if it will be driven by capitalism from below, or a powerful State from above? China is only just developing a rule of law, and property rights, and has relied on the old ways of an activist state, trust or guanxi and interpersonal relations.

“China still doesn’t have a rule of law state in the sense that we have in the West where the law is above politics and very powerful private interests, but some would say this absence of a rule of law has helped China grow quickly. It has had an activist state, which can help overcome private interests which has been working alongside interpersonal trust and guanxi at the local level. This has played a critical part in China’s growth so far.

“China now needs to move towards a system to encourage not just clan-based trade but trade for and between relative strangers, and to move from trust to a rule of law based capitalism.”

Part 2: The new China and its corporate governance

In part 2 Boya Wang says: “Corporate governance rules apply in both the private and state-owned sectors in China, both are subject to the one company law but clearly the practices in both sectors are different. The enactment of the Company Law in 1993 and also the amendment of the Company Law in 2002 – these are the major changes and both apply but at the same time there are also many regulations, and many administrative measures.”

Wang goes on to say: “The Chinese government is much less monolithic than many outsiders would imagine. China has a federalist style of administration with power delegated to local officials. Since China’s economic reforms in the 1980s the government has delegated the fiscal and administrative autonomy to the localities as a means of gaining support for the reformist leadership. But all these local officers are now part of the vested interests and have become the major obstacles for the further reforms. Different provinces are subject to the one legal system but local judges have decision making powers and court decisions differ across different regions. Judges are appointed by the local politicians.

“Weak investor protection remains a major concern, for many public investors, but there is progress in changing this in a positive direction. There is a major effort in cracking insider trading but more reforms are needed on the public-private relations and how the country will reform its SOE system.”

In part 2 Simon Deakin says: “I think in China’s case we identified a need for transparency, and for fair and impartial enforcement of the law on the part of business leaders, and a determination on the part of judges and officials to move to that world. The idea that China is better off with guanxi and without the rule of law is completely wrong. People in developing economies like China and also Russia want to have a Western-style rule of law and would prefer to have, than a world in which they have to operate often semi-clandestinely, or one where they cannot always rely on the courts to enforce rules fairly. This cannot happen overnight.”

Deakin went on to say: “Unlike Russia, China, has had a gradual approach to privatisation and liberalisation and sequenced and planned for its changes. China has the advantage over many middle income countries of a superior state capacity, and a willingness of the state to invest in institutions but it doesn’t happen overnight. What we have to see is a demand for change on behalf of business leaders and officials. Our interviews suggest that in some sectors you see this happening more clearly than in others and in some market contexts, more clearly than in others.

“As markets deepen – both the financial and product markets – there will be less need to rely on guanxi and legal rules will be more effectively enforced. But also the markets themselves will operate in a more transparent way. The people we interviewed in 2014 – some months before the turbulence – were telling us that they had more confidence in the pricing mechanism and in the courts. As China grows there will be a demand for law enforcement.

“I would expect China to make a transition to a rule of law state, more like a Western liberal state but with traditional Chinese characteristics. It is a very long term process and we will have to see how it goes.”

Emphasising the need for further research into the law in emerging economies, Simon Deakin said: “We need a debate about what the rule of law implies for the way the state is organised and for the public private divide.

“Economics as a field explains how markets work once they exist but has been very bad at explaining how markets and institutions develop in the first place. Understanding how that process occurs is critical for the West and Global North as we are still developing and changing, and when we look at other countries we also learn about our own.

“China’s record of economic growth over 30 years has been extraordinary and it is reducing global poverty and inequality too. We need a more sober assessment of what China has achieved and what is yet to be achieved. We need more even development. Uneven development is a fundamental problem for the world economy.”

Boya Wang said: “You can’t just impose the understanding of the rule of law in the West to transitional economies, like China, India or Russia, without taking into account their different economies and contexts.”

Further reading

Chen, D., Deakin, S., Siems, M. and Wang, B. (2015) “The rule of law: China’s rapid growth seems to have been achieved without formal contract and property rights. But as China moves to a market economy, the rule of law will become increasingly important for continued growth.” Society Now, Autumn: 22-24

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