China As a Test Case: Is the Rule of Law Essential for Economic Growth?

Kenneth Dam
Kenneth Dam Max Pam Professor Emeritus of American & Foreign Law - University of Chicago Law School

January 1, 2006


China is the fastest growing country in the world. Moreover, its economy has already become one of the most important in the world. Many commentators predict that China will surpass the size of the U.S. economy some time in the second decade of this century (although it will, to be sure, still be at a much lower per capita income level). Though these predictions are for most purposes quite misleading, China’s prowess in manufacturing is already a challenge to the manufacturing sectors of the most advanced economies, at least in labor intensive industries. Moreover, China is going beyond lowwage manufacturing and entering the high technology arena (from the top down, so to speak) through high-level research backed by a growing army of highly educated scientists and engineers completing graduate studies and through the outsourcing to China of research and development activities from some of the world’s most accomplished high technology firms.

Yet the level of China’s adherence to the Rule of Law is frequently criticized.

How should one put together China’s growth rate with its Rule of Law profile? Does the coexistence of the two mean that, contrary to the now prevailing view, institutions are not important after all to economic growth? Should we conclude, at the very least, that legal institutions, and the Rule of Law in particular, are not important? One group of scholars, Allen, Qian and Qian (“AQQ”), has reached more than half way to that conclusion:

China is an important counterexample to the findings in the law, institutions, finance, and growth literature: Neither its legal nor financial system is well developed by existing standards, yet it has one of the fastest growing economies.

In arguing that China was a counterexample to the legal institutional approach, AQQ gave China scores on corporate and creditor rights law following the LLSV Law and Finance methodology developed by LaPorta and his colleagues in their Law and Finance article. In corporate law China was assigned by AQQ a shareholder rights score of 3 (out of 6) and a creditors rights score of 2 (out of 4). This result put China’s shareholder rights score below the English-origin average (4) but above the French-origin average (2.33). For creditors rights the AQQ score for China of 2 was below the Englishorigin score (3.11), but above the French-origin score (1.58) (and, by the way, above the U.S., Canadian and Australian scores of a mere 1). (China’s creditor rights score is nonetheless far below many of its neighbors: Hong Kong, India, Malaysia, and Indonesia all scored a perfect 4.) In any case, if China had been in the LLSV list of countries, it would have ranked right at the average of all LLSV countries (developed and developing) for shareholder rights.