Contract enforcement in China: theory and facts

Abstract

While there is still a debate on the role of formal law in economic development, the dominant body of literature tends to dismiss the role of formal law in China’s economic development. China is also frequently cited as a case of fast economic development in the absence of rule of law, or inconsistent with the conventional wisdom. So far, however, there is very little empirical evidence supporting the case that formal law in China has not played very important roles in China’s economic development. This article pays close attention to the relative roles of formal law and informal trade associations in enforcing business contracts. The survey data shows that business firms rely heavily on formal law in protecting their contractual expectation and in solving their contractual disputes. While both the formal legal system and informal trade associations have the chance to develop different means to protect the contractual expectation of business firms and to solve contractual disputes between business firms after China’s adoption of the economic reform policy, the survey has revealed that business firms dominantly rely upon formal law. The article then provides a demand-side analysis and a supply-side explanation to explain the business firms’ heavy reliance upon formal law in protecting their contractual expectation and in solving their contractual disputes. The result of the research has rectified a misconception in the literature that China’s formal law has not played important roles in its economic development during the last two or three decades.