The Role of Formal Law in China's Economic Development

Abstract

Law and development scholars have downplayed the role of formal law in China's economic development in favor of informality. Through an analysis of the Chinese mortgage regime, this essay shows that formal legal institutions have in fact made a positive contribution to China's economic development. The economic theory of self-enforcing contracts suggests that a contract is self-enforcing if the expected future gains from adhering to the contract exceed the current gain from a violation of the contract. In addition, economists argue for the importance of using informal contractual means to enforce contracts. For example, contractual parties may take from the other contractual party to support exchange. (The term signifies valuable property transferred by one contracting party to the other that may be forfeit in the case of breach of promise or non-performance by the transferring party. In 1983, Oliver Williamson argued for the importance of using hostages to support exchange in informal contractual settings.) But hostage used in informal contracts normally only deals with two contractual parties. This essay uses evidence from China’s developing formal property law covering mortgages to argue that when built upon and enforced by the formal law, the device of mortgages can cope with conflicts of interest among a large number of creditors. Analysis of the Chinese mortgage regime shows that there are clear limits to reliance upon informal contractual arrangements in Chinese economic development.