Does the Rights Hypothesis Apply to China?

Abstract

Using firm-level data from a World Bank survey, this paper examines how legal development in China relates to various firm decisions. I find that a more active court system is associated with more investment, more adoption of technology, more innovation, and more complex transactions. Specifically, when a higher percentage of business disputes are resolved through the court system, firms tend to have higher investment rates, higher propensities to adopt new automated technology, and higher probabilities of developing new products. In addition, they tend to have more nonlocal sales. These findings are consistent with a sophisticated version of the rights hypothesis, in which the rule of law eventually replaces relation-based governance as a superior governance mechanism. I find two limitations of China’s legal system. The court system does a better job facilitating the growth of state-owned enterprises than of private firms, and it protects local firms better than nonlocal firms.