Transcript Slide 1

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Reexamining China’s Economic Growth:
Law, Finance, and Political Economy
Franklin Allen
University of Pennsylvania
Jun Qian
Boston College
Advanced Summer Training Program in Finance
Chengdu, China
July 8, 2007
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Introduction
• Back in 1960s, developing countries chosen by
the World Bank and other experts’ to have the
highest economic growth in the next 40 years
• The economic achievements of China in the last
twenty-eight years have been quite remarkable
• It is one of the great economic transformations in
history
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The Largest 20 Economies in the World
GDP -- Simple exchange rates
GDP 2006
Rank Country
/Region
(US$ bil.)
GDP -- PPP*
Country
GDP 2006
/Region
(Int’l $ bil.)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
U.S.
China
Japan
India
Germany
U.K.
France
Italy
Russia
Brazil
Spain
Mexico
Canada
Korea
Indonesia
Taiwan
Australia
Turkey
Argentina
S. Africa
U.S.A
Japan
Germany
China
U. K.
France
Italy
Canada
Spain
Brazil
Russia
Korea
India
Mexico
Australia
Netherlands
Belgium
Turkey
Sweden
Switzerland
13245
4367
2897
2630
2374
2232
1853
1269
1226
1068
979
888
887
840
755
663
394
392
385
377
13021
9984
4171
4159
2559
2122
1935
1791
1727
1701
1215
1172
1156
1156
960
691
680
661
621
606
GDP growth -- Constant prices
GDP
GDP per capita
annual growth
annual growth
(1990-2006)
(1990-2006)
3.0%
1.8%
10.2%
9.2%
1.3%
1.1%
6.1%
4.2%
1.6%
1.4%
2.5%
2.1%
1.8%
1.2%
1.3%
1.2%
1.9%
1.5%
2.7%
1.1%
3.1%
2.2%
3.0%
1.6%
2.8%
1.7%
5.5%
4.8%
4.3%
2.9%
5.3%
4.5%
3.3%
2.1%
3.9%
2.2%
3.8%
2.6%
2.7%
1.1% 3
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When will China overtake the U.S.?
• Using IMF 2006 estimates:
– China: $10.1 trillion; growth rates from 1990-2005 of 10.1%
– U.S.: $12.9 trillion; growth rates during same period of 3.0
– Extrapolating (a big assumption!): China will become the world’s
largest economy in 2010.
• 2015: China PPP GDP = 1.5 × US PPP GDP
• 2020: China PPP GDP = 2 × US PPP GDP
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Other Successful Economies
Only three large economies have been as successful:
• Japan
• South Korea
• Taiwan
China can do better but no large country has done so by
a significant amount and in such a short period of time
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Other Successful Economies (cont.)
• In recent years India has also been
remarkably successful
• Not as successful as China
• Contrast with its own past (1950-1980) and
with China is informative
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Key Questions
• What economic lessons can be learned from the
remarkable performance of China and India?
• Are they simply applying the conventional
wisdom?
• Or are they doing something fundamentally
different that (Western) economists have yet to
fully understand?
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Conventional Wisdom
• What is needed for a successful economy
and a high growth rate is:
–
–
–
–
Good legal system
Good financial system
Good corporate governance
Good (non-corrupt) government (Acemoglu
and Johnson 2005)
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Conventional Wisdom (cont’d)
 Literature on law and finance:
– Stronger legal protection of investors is associated with more efficient
institutions and better financial and economic ‘outcomes’
(La Porta, Lopez-de-Silanes, Shleifer, and Vishny (LLSV; 97, 98, 99,
00))
• Literature on finance and growth:
– The development of financial system (stock market and
intermediation sector) contributes to overall economic growth
(McKinnon 73, King & Levine 93, Levine 97, Levine & Zervos 98)
– Evidence at industry- and firm-levels (Rajan and Zingales 98)
• Literature on law, finance, and growth:
– Country level evidence: Levine (99)
– Evidence at industry level (Beck and Levine 02) and firm level
(Demirguc-Kunt & Maksimovic 98)
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Alternative Views
Political economy factors
• Great reversals (Rajan & Zingales 03a): Argentina
• Legal system becomes captured by special interest
groups who obtain rents and they prevent change –
“Save Capitalism from the Capitalists” (Rajan and
Zingales 03b)
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Alternative Views (cont.)
• China as a counter-example to law, finance and
growth literature:
– One of the largest and fastest growing economies despite its poor legal and
financial systems and a corrupt and autocratic government;
– Alternative and informal financing and governance mechanisms have
substituted for formal channels and mechanisms
(Allen, Qian and Qian 05)
• India as a counter-example
– India inherited the best legal system in terms of investor and shareholder
protection
– Because of corruption and ineffective enforcement the legal system is not
used very much
– Again Alternative and informal financing and governance mechanisms
have substituted for formal channels and mechanisms
(Allen, Chakrabarti, De, Qian, and Qian 07)
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Lessons
• What lessons can we draw from these
alternative views?
• China is the extreme example of the “Eastern
Model”
• In the West people take it as given that finance
and commerce should be undertaken using the
law as the basis for contracts (“Western Model”)
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Lessons (cont.)
What should China do going forward?
“The modern corporation on a Western model
would be the essential vehicle for private
economic development”
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Lessons (cont.)
• This was not written today but rather was the
view of the drafters of China’s first Company
Law in 1904 (Gongsilu)
• It turned out to be very wide of the mark (Kirby
1995)
• Chinese firms on the mainland and later in
Taiwan did not use the provisions of the law but
again conducted commerce outside the legal
system
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Alternatives to the legal system in China
• Historically, China did not use the legal system
in commerce
• However, it had a highly commercialized society
(late 19th Century to early 20th Century)
• How did this operate?
• Other systems for dispute resolution were used
instead
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Alternatives to the legal system in China
(cont.)
Dispute resolution (see Kirby 95):
• Longstanding custom
• Regulation of Guilds and Families
• Local notables
We need to better understand modern equivalents
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Alternatives to the legal system in
China (cont.)
• The alternative to law in assuring performance
is other mechanisms such as
– Reputation
– Connections and networks
– Positive financial incentives
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Law, finance and commerce
• The alternatives that China has
traditionally used raises the issue of what
are the advantages and disadvantages of
making the law the basis for finance and
commerce
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Advantages
• Criminal law
– Can use criminal penalties such as imprisonment to
affect people’s behavior and provide high-powered
incentives
• Civil law
– Can use financial penalties to affect behavior
• The legal process can be anonymous and
transparent
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Disadvantages
• Political economy factors suggested by Rajan and
Zingales and others
– Difficult to change the system if circumstances change
and a new set of rules becomes optimal
– Any change must be passed by the government
– Interest groups may try to prevent such changes if it
affects the rents they obtain
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Disadvantages (cont.)
– In democracies the electorate has to be persuaded
that the change is desirable despite the fact that they
may have little information about the issues
– There is a limited amount of time each year that can
be devoted to financial and commercial laws
– The legislature has a monopoly and is the only body
that can make changes
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When is the use of the legal system
optimal?
• In a static environment where growth rates are
low the advantages of using the law can
outweigh the disadvantages
– The incentives that can be provided by the legal
system mean that efficient systems can be designed
that do not rely solely on positive monetary
incentives
– The fact that change is difficult does not matter in
such circumstances
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When is the use of the legal system
optimal? (cont.)
• In a dynamic environment barriers to change
can outweigh the static incentive aspects
– Rather than rely on incentives provided by legal
mechanisms it’s necessary to rely on reputation,
connections, and financial incentives
– However, private systems can change much more
quickly
– Competition between different systems is possible
and often the most efficient will prevail
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Why is China successful?
• The conventional view is that China is
successful despite it’s lack of Western
institutions
• The suggestion here is that China is
successful because of it’s lack of Western
institutions
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Examples of inefficiencies
• US Payments System
100%
80%
direct debits
credit transfers
credit/debit cards
checks
60%
40%
20%
USA
UK
Switzerland
Sweden
Netherlands
Italy
Germany
France
Canada
0%
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Examples (cont.)
Check Clearing for the 21st Century Act
• At the start of the 21st Century the US had a 19th Century
payments system relying on checks and the mail
• Checks had to be physically transported from where
they were deposited to a central operations center, then
to clearer and then back to the banks they were drawn
on
• September 11, 2001 acted as a catalyst for change
• Act signed in October 2003 that allows electronic image
to be a substitute
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Examples (cont.)
Google and the scanning of libraries
• JSTOR is a great academic innovation
• Google’s Print Library Project proposes to do a similar
thing for books by scanning in the libraries of Harvard,
Oxford, and Stanford Universities, the University of
Michigan, and New York Public Library
• Google has met tremendous opposition from
publishers and this has slowed down the project
considerably
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Examples (cont.)
Intellectual property
• Shanghai saying: “We can copy everything except your
mother”
• Chery QQ appeared six months before the Chevy Spark
which it was a copy of
• Shanghuan Automobile’s CEO model is remarkably
similar to a BMW X5
• Legal action by foreign firms has been nearly useless in
preventing this
• Good or bad?
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Examples (cont.)
India
• Economy is unbalanced relative to other emerging
economies in that 52% of output is from services, 26%
is from manufacturing and 22% is from agriculture
(67% of workforce)
• Manufacturing has not done well perhaps because it is
constrained by unions and traditional political
economy factors
• New industries like software do well because they are
not constrained by political economy factors
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Examples (cont.)
• Diamond industry (Bernstein 92)
• Mediaeval trade in the Mediterranean (Greif 89)
• Mediaeval Bills of Exchange
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Conclusions
• China and India’s success contains
important lessons
• Using the law in finance and commerce is
a Western idea
• It can be optimal in static environments
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Conclusions (cont.)
• In dynamic environments such as China and
India it may be better to use other mechanisms
that do not rely on the law because this reduces
the inefficiencies associated with political
economy factors
• Designing economic institutions that minimize
political economy problems by not relying on
the legal system is one of the keys to fast
economic growth
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