Adaptive Efficiency and Financial Development in China: The Role of Contracts and Contractual Enforcement

Abstract

The existing literature on China's economic development has focused so far more on economic reform, decentralization, and the clarification and protection of property rights. There is, however, inadequate attention being paid to the adaptive efficiency of economic actors, in general and to experimenting with informal and formal contractual arrangements, in particular. In this article, the authors document and analyze the informal contracts developed in Wenzhou, and three types of formal contractual arrangements increasingly used in China. The authors argue that both informal and formal contractual mechanisms play important roles in China's economic development. The general pattern appears to be that economic actors rely first on self-enforcing, informal contractual arrangements and later adopt more formal arrangements when these are feasible. The authors, by focusing their analysis on the development and adaptation of selected contractual arrangements, submit that the process of legal development in China is consistent with the notion of adaptive efficiency. The implication from the study is that the development of a formal contract regime will become increasingly important as economic development reaches a more advanced stage. When economic actors are able to rely on more formal contractual arrangements, more complex, riskier transactions with higher technological content will be pursued.