Law and Political Economy in China: The Role of Law in Corporate Governance and Market Growth
October 16, 2023
The conventional premise for embracing law in the context of economic reform calls for a modern legal system as a prerequisite for economic development. The premise suggests that economic exchange between unfamiliar parties requires reliable and uniformly applicable norms and institutions, to protect the rights of economic participants and provide credible commitments for growth (secure contracts and property rights, specifically). Absent such a legal system, it is argued, investments will be discouraged and market development will dwindle.
Yet, important critiques of the premise show, China did not follow the same paradigm and challenges many of its underlying assumptions (Clarke, 2003; Ohnesorge, 2007; Upham, 2018, Yu ed., 2013). China achieved substantial growth and developed markets while preserving market control, state ownership, and relatively weak legal institutions.
This, of course, does not mean that China’s legal system is underdeveloped. The Party-state spent massive human resources and political capital (and real capital) to establish a voluminous number of sophisticated laws, regulations, and institutions. Yet, even today, it continues to govern markets by informal means and functional substitutes, while legal rights remain weakly secured. Not only have substitutions persisted even while the market grew strong, in fact they have been further reinforced in recent years.
Four decades of economic development in China are surrounded by this great puzzle. Consequently, skepticism about the importance of law in China is widespread. Popular opinion, practitioners, and academic studies by legal comparativists and China scholars across disciplines assess the role of law in China’s economic rise as a mere political instrument, a marginal governing tool, or simply window dressing.
“Law and Political Economy in China: the Role of Law in Corporate Governance and Market Growth” by Tamar Groswald Ozery (Cambridge University Press, 2023) calls to reevaluate this approach and proposes that the role of law in China’s economic development has been undervalued. Indeed, when one looks only to the rights-securing functions of law, a disregard for the role of law in supporting China’s growth becomes almost inevitable. Rather, the author argues, a renewed thinking is needed, one that takes a fuller account of the various functions of law and particularly its political functions.
Such rethinking is needed especially considering China’s intensifying push to “rule the country according to law”. This includes greater presence of law and legal institutions in governing markets, to better bend economic and political market participants to the law and increase their accountability. Such legal advancement is quite intriguing given that individual legal rights, even economic ones, are not fully secured. If economic law and institutions do not perform their rights-securing economic functions, how can we explain their massive rise? Even more intriguing is the parallel move in recent years to institutionalize and legalize substitutional mechanisms of political governance. Why would an authoritarian single-party regime turn to a “law-based governance” (yifa zhiguo) given that it can simply subvert its own laws (as the Chinese Communist Party is de-facto above the law) and easily revert to its path-dependent governance mechanisms? Do legal constructs contribute to China’s growth story in ways that are not contemplated by the traditional development and corporate governance thinking?
The book offers law & political economy as an alternative analytical framework through which to address China’s development puzzle and reassess the role of law in supporting growth.
This alternative framework analyzes the relationship between formal law and market development from the vantage point of political power dynamics. It reveals how law serves as an internal party-state instrument for allocating and directing political-economic powers, which then produce growth-supporting implications for market participants. The book’s primary methodology relies on textual legal analysis of a vast body of Chinese Communist Pary (CCP) policies, internal speeches, market laws and regulations (secondary and tertiary), and their legislative histories to reconstruct the role of law in China’s market development from 1978 to 2021.
The analysis highlights two intertwined functions of law – economic and political. Through this dual functionality of law, the law translates and secures political–economic shifts in an iterative process that shapes the incentives of political actors to support market economic activity. The law in China, therefore, supports market development on multiple levels, notwithstanding its slow-to-evolve, and at times limited, rights-oriented functions.
The suggested law & political economy framework is especially befitting China, where the legal system is, in fact, a “political-legal system” (zhengfa xitong) as is widely acknowledged by scholars in the field. And yet, the relations between law and politics receive little attention in writings about the Chinese market and the private (economic) law literature. Perhaps surprisingly, studies concerning Chinese economic law largely take the neutrality presumption that spread under liberal capitalism and is so commonly invoked in the economic analysis of law and the Law and Finance approach. Following such presumption, laws around the world are directed as politically detached, technocratic tools for increasing efficiencies and maximizing gain (Milhaupt and Pistor, 2008). Thus, while the Chinese public law sphere is traditionally more prone to “antagonistic contradictions” (the Maoist notion of duikangxing maodun), where the potential for social and political frictions brings direct political intervention to the fore and therefore produces rich scholarship that takes law & politics relations into account, private legal spheres, however, particularly market-related laws, are assumed to imbue more deference to neutral economic results.
As the political–economic fabric in China evolves and opens up for frictions, the neutrality presumption about economic laws requires closer scrutiny. The Party’s direct return to the market over the past decade, constructed through and by the law, should leave no doubt that politics, law, and economic development are deeply intertwined under the CCP’s rule. The challenge is to understand exactly how, and through that to open a door for a continuous reevaluation of the functions and various contributions of law to China’s growth story. This book aims to open that door.
The book employs two layers of analysis: a market development macro layer, and a corporate governance and capital market micro layer as a case study.
Part I delineates the conceptual and analytical frameworks underpinning the book. Chapter 1 explains the traditional framework that commonly guides thinking about the role of law in development and in financial markets specifically. Chapter 2 presents the difficulties with the traditional approach in the Chinese context and offers law & political economy as an alternative analytical framework.
Part II establishes the new framework by tracking the evolving role of law in China’s market reforms and identifying how the two functions of law – economic and political – have developed side by side, each supporting the other. Chapter by chapter, the legal configurations of political-power dynamics are examined. A three-stage shift in the allocation of market governance authorities within the Party-state’s system through the law, is unfolded:
Chapter 3 looks at the role of law during the Early Reform Era (Dec. 1978–1991), when the Party-state vested economic decision-making authorities with its local governments, giving them a relatively free rein to experiment with and administer economic activity by limiting law-making by central level authorities. Chapter 4 moves on to examine the subsequent Legal Modernization Era (ca. 1992–2009) – a golden age for legal reformers in China. During this era, market governance authorities were reconfigured and recentralized with the central state through a massive project of national-level institutional and legal reforms. This reconfiguration of powers via the legal system also set the foundation for what is known today as “China’s state capitalism”. Chapter 5 examines the current era, which I label the Legalized Politicization Era (2010–present). During this era, the consequences of state capitalism brought a new reconfiguration through law in two directions, intensifying the presence of the regulatory state in the market on the one hand, while shifting substantial market governance powers directly to the CCP itself, on the other.
Relying on these findings, Part III then applies the analytical framework of law & political economy at the micro level by delving deep into China’s corporate and capital market development puzzle as a case study.
Throughout Chapters 6-9, the book merges questions about the role of law in development with inquiries on the evolution of financial markets and corporate governance specifically. This Part of the book considers how law and political economic determinants entwine in shaping the business environment in which public firms operate. It demonstrates how the explanatory power of law & political economy can bring more clarity to China’s evolving corporate governance approach. Special attention is given to the politicization of corporate governance in the current era (Groswald Ozery, 2022), showing how the CCP advances its corporate governance capacities and its roles in governing markets more broadly, through the use of law.
The analysis illuminates how political-power shifts at each era of development resulted in the reconfiguration of the legal framework that governs firms, and how such reconfiguration, in turn, helped secure a new political economic equilibrium. These iterative dynamics also mobilized market participants (both economic and political) to develop and deploy various growth-promoting mechanisms in firms and in the market at large. Such mechanisms at times supported, at times impeded, and at times substituted for conventional corporate governance institutions.
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Taking an interdisciplinary analytical approach that weaves together law and development theories, political economy analysis, and expertise in corporate governance, the book offers new insights about the relationship between law, economic development, and politics in contemporary China. The book sheds a new comparative light on a long-standing debate about the role of law in economic development and about the possible varieties of growth-supporting governance mechanisms.