Informal institutions and foreign investment in China

Abstract

During the reform era, China has been very successful in attracting foreign direct investment (FDI) for its economic development. That this has taken place despite a rather weak legal system in China challenges conventional institutional theories, which emphasize the centrality of effective state institutions to economic development and international cooperation. This article suggests that the solution to the puzzle lies in the informal institutions underlying FDI development in China. On the basis of extensive interviews in the mid- and late 1990s, I find that networks of personal connections (guanxi), which are pervasive in Chinese society, have played a major role in facilitating FDI flows to China. They have done so by complementing and compensating for the weak Chinese legal system. This article dispels a number of misconceptions about the nature of guanxi, discusses its relationship with friendship, bribery, and social capital, and analyzes the conditions underlying the transnationalization of guanxi networks. It concludes with some important caveats to the major thesis and a discussion of possible future scenarios of institutional development in China.