Law, finance, and economic growth in china*

Law, Finance, and Economic Growth in China*

Franklin Allen†
Finance Department The Wharton School University of Pennsylvania Philadelphia, PA 19104

Jun Qian
Finance Department Carroll School of Management Boston College Chestnut Hill, MA 02467

Meijun Qian
Finance Department Carroll School of Management Boston College Chestnut Hill, MA 02467

Last Revised: February 3, 2004Abstract 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. We compare growth in the State Sector (state-owned firms), the Listed Sector (publicly listed firms), and the Private Sector (all other firms with varioustypes of private and local government ownership). With poorer applicable legal and financial mechanisms, the Private Sector grows much faster than the State and Listed Sectors, and provides most of the economy’s growth. This suggests that there exist effective alternative financing channels and governance mechanisms, such as those based on reputation and relationships, to support this growth. JELClassifications: O5, K0, G2. Keywords: Law and finance, economic growth, private sector, corporate governance, reputation and relationships.
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We appreciate detailed comments from an anonymous referee that significantly improved the paper, and assistance from Qiao Yu and Wuxiang Zhu in conducting the firm survey. We received helpful comments from Dan Bergstresser, Loren Brandt, Dong Chen,Gregory Chow, Julan Du, Jie Gan, Li Jin, Sung Wook Joh, Simon Johnson, Ross Levine, Lijun Lin, Anthony Neoh, Tom Rawski, Yihong Xia, and seminar/conference participants at the American Economic Association meetings, the Asia Corporate Governance Conference in Korea, Boston College, Fudan University (Shanghai, China), Harvard Business School and Law School, IMF/World Bank, New York Fed, MIT, the 1stTsinghua International Finance Conference in Beijing, China, and the Wharton Conference on “The Future of Chinese Management.” Financial support from Boston College and The Wharton School of the University of Pennsylvania is acknowledged. The authors are responsible for all remaining errors. Corresponding author: Finance Department, Wharton School, University of Pennsylvania, Philadelphia, PA19104.

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I. Introduction Several related strands of literature on law, institutions, finance, and economic growth have emerged in financial economics in recent years, and their impact on other areas of research has been significant. First, La Porta, Lopez-de-Silanes, Shleifer, Vishny (LLSV hereafter) and others have produced a substantial body of empirical evidence that links the origin of acountry’s legal system to the country’s institutions and financial and economic “outcomes.” One of the central results of this literature is that, countries with English common-law origin (French civil law origin) provide the strongest (weakest) legal protections to both shareholders and creditors (LLSV 1998, 2000a). Countries with English origin also seem to have better institutions, includingless corrupt governments (LLSV 1999), more efficient courts (Djankov et al., DLLS hereafter, 2003a), and more informative accounting standards (LLSV 1998). Better legal protections and better institutions, in turn, seem to lead to better outcomes for the financial system, both at the aggregate and firm levels.1 Related to the LLSV results, there is a recent literature attempting to understand whyand how a country’s legal origin affects the country’s institutions, and how legal origin and institutions, both jointly and separately, affect economic and financial outcomes.2 The second literature champions the view that the development of the financial system that includes a stock market and intermediation, contributes to a country’s overall economic growth (e.g., McKinnon 1973). Recently,...