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GUEST OPINION: China Needs Rule Of Law To Take Root For Sustainable Growth - Matthews Asia

Andy Rothman

Matthews Asia

13 November 2014

A clear and reliable legal system, particularly around enforcement of contract and property rights is a bedrock of a successful economy and yet for large parts of the world, ill-defined, or non-existent, property rights and robust legal structures are a serious barrier to growth. The Peruvian economist, Hernando de Soto, for example, in his book The Mystery of Capital, famously highlighted the crucial need for robust property rights. In China, a country that is still under Communist rule, an important question for its future is how to ensure legal protections develop in a way that can be trusted by domestic and foreign investors alike. In this article, Andy Rothman, who is investment strategist for construct a line of Socialist rule of law work teams who are loyal to the Party, loyal to the country, loyal to the people, and loyal to the law.” It was not random placement that “loyalty to the Party” came well before “loyalty to the law” in that sentence.

Does China need the rule of law?
“Countries with greater constraints on politicians and elites and more protection against expropriation by those powerful groups have substantially higher income per capita, greater investment rates, more credit to the private sector relative to GDP and more developed stock markets,” according to a study by economists Daron Acemoglu and Simon Johnson.

But this conventional wisdom among political scientists and legal scholars is challenged by the extraordinary success of China’s authoritarian capitalist system. Without the rule of law, the Chinese have experienced rapidly rising income growth, booming investment, falling poverty, higher grain yields and lower infant mortality.

“In sum, the experience of the reform era in China seems to refute the proposition that a necessary condition for growth is that the legal system provide secure property and contract rights,” according to scholars Donald Clarke, Peter Murrell and Susan Whiting. “Passably secure property rights . . . were a product of the political-economic equilibrium, in which important ingredients were the central government’s transparent desire for a growing economy rather than class struggle . . .”

It is, however, far from certain that the status quo can survive the challenges of a society that now enjoys greater personal freedom and wealth, and is increasingly aware of how the rule of law protects property rights in other countries. The current system will surely be stressed by the continued deceleration in economic growth rates, and that stress level will rise further when China experiences its first recession to occur when most of its people are working in the private sector and are homeowners. While I do not believe that a recession is on the horizon, it is inevitable over the long run.

As Acemoglu and Johnson point out, “When property rights institutions fail to constrain those who control the state, it is not possible to circumvent the ensuing problems by writing alternative contracts to prevent future expropriation, because the state, with its monopoly of legitimate violence, is the ultimate arbiter of contracts.”

This problem is already visible in rural China, where local officials often violate the property rights of farmers, leading to frequent protests and periodic violence. Changing China’s legal system and institutions to prevent this problem from becoming more widespread, and to support continued economic growth, is the Party’s chief challenge in the coming decades.

Will China get the rule of law?
There are, at this moment, no signs that the Party is preparing to establish the rule of law. The Party appears to want to continue to use the legal system to exercise its political control over the population, rather than to move toward a system that is designed primarily to protect the rights of individuals by limiting the government’s power.

We do need to acknowledge, however, that back in the mid-1980s, when I first worked in China, it was not apparent that the Party was prepared to significantly relax its control over people’s daily lives. But, a decade later, the Party stopped telling its citizens where to live and what to farm. In the mid-1990s, we did not expect the Party to dramatically shrink the state sector and pave the way for private firms to become the engine of growth. Private home ownership was not on the horizon. Today, most urban Chinese work for private companies and own their homes.

During the past two decades, the Party has surprised in many ways. It has taken a path that is unique among authoritarian regimes: relaxing day-to-day control over people’s lives and commercial activities while strengthening the Party’s control over the political and legal systems. This is a key reason why the Chinese Communist Party has outlived other authoritarian regimes. Constant, pragmatic reform of economic policy is also why GDP growth averaged 10 per cent for two decades before cooling to an average of 8.5 per cent over the last four years.

Establishing the rule of law would require the Party to take another unique and dramatic step: to cede to its citizens some of the Party’s control over the political and legal systems. Failure to take this step is not a short-term risk for investors, but I believe it will be key to China’s economic prospects over the next 10 to 20 years.