China Above The Law
A Poorly Functioning Legal System Is Supposed To Hurt Economic Growth. But Nobody Told The Chinese.
NEWSWEEK
Updated: 4:25 PM ET Nov 5, 2007On Feb. 2, a Communist Party journal published a speech by Luo Gan, a Politburo member and China's top law-and-order official, that startled the country's burgeoning legal profession and foreign investors. Luo declared that the Communist Party should maintain its dominance over the nation's courts and resist "enemy forces" that were trying to Westernize its legal system. Just a week earlier, Beijing had announced that the country's economy was continuing to grow at a dazzling pace, hitting 10.7 percent last year. The two headlines pointed to an increasingly conspicuous paradox that is puzzling observers: how is China's economy managing to grow so quickly without an independent and modern legal system? And how long can it continue?
Western economists and legal scholars have long argued that a robust legal system and impartial courts are prerequisites for a mature market economy. Effective, transparent and predictable judicial institutions are deemed necessary to assure businesses and customers that investments will be protected, contracts enforced and disputes resolved equitably. The rule of law encourages innovation by establishing intellectual-property rights and ensuring that inventors--and the firms that back them--are rewarded for their efforts. Without these protections, it is assumed, stock exchanges, commodities markets and other hallmarks of a complex capitalist economy cannot function properly.
Many developing countries with weak judicial systems have been hobbled by corruption, waste and inefficiency. But China seems to be thriving despite its own rudimentary court system, which remains firmly under Communist Party control. Since Beijing introduced free-market reforms in the late 1970s, a booming private sector has emerged, hundreds of millions of people have escaped poverty and overseas investment has flooded in. The secret: entrepreneurs have found a variety of creative solutions to get around China's unreliable courts. These include seeking mediation for business disputes from sympathetic party officials, enforcing contracts by threatening to go elsewhere, and protecting trade secrets with heightened security--solutions aided by the pro-business slant of China's leadership.
Beijing all but abolished the legal profession during the Cultural Revolution. After Mao Zedong's death, it slowly began to rebuild the judiciary, adopting Western-inspired reforms. Today China's courts do function after a fashion, and its citizens are turning to them in record numbers--about 8 million cases were filed last year. Indeed, China's leaders now tout the rule of law as one of their guiding principles.
But in reality, legal reform has lagged far behind changes in China's economy. Though education levels are rising, for example, many judges, lawyers and prosecutors remain poorly trained. Cases are still often decided by bribes and political connections. And the party shows no sign of ceding its control--almost all judges are party members and required to obey its orders. Beijing still fears that an independent judiciary could undermine the party's monopoly on power.
In place of a proper legal system, however, other mechanisms have emerged to play its role. Large foreign and domestic firms, for example, have learned to resolve or avoid contract disputes by exploiting the country's hypercompetitive business environment. If a supplier fails to deliver on time, they simply threaten to give their business to someone else. And China does have rules, which are largely pro-business, though they are enforced differently than in the West. For example, the government recently imposed a new regulation requiring local officials to grant business licenses faster, leaving bureaucrats less time to demand bribes. "People from legal societies always underestimate the power to affect change through administrative, rather than legal structures," said Arthur Kroeber, managing director of the economic research firm Dragonomics in Beijing.
Corruption is widespread, but it has not hurt the economy as much as expected because the party has begun evaluating its officials based on economic development in their jurisdictions. Though many bureaucrats exaggerate local growth rates, many others strive to attract businesses to their areas and help them grow. "There is political motivation" to resolve disputes, says Richard Thoman, who spent two decades doing business in China as a top executive. "The local mayor can smooth things out for you. In a sense, it's almost like an arbitration process."
Similarly ad hoc solutions have developed for protecting property rights. Foreign businesses often complain about China's poor record in this area; pirated DVDs and knock-off luxury handbags are still easy to find. But this hasn't stopped Chinese and some foreign companies from innovating. Douglas Fuller, a visiting professor at the Chinese University of Hong Kong, points out that Taiwanese computer-chip design firms have succeeded on the mainland by adopting tight security measures at their factories and designing products that are difficult to reverse-engineer.
A spin on that strategy comes from Leonard Liu, founder of the U.S. software company Augmentum. Applying lessons he learned while managing two Taiwanese companies, he has protected Augmentum by requiring much stricter protections at its Chinese offices than exist at its U.S. facilities. Augmentum's computers in China have no removable disks and their USB ports are disabled. There is no externale-mail system, and any employee who attempts to connect to the Internet without permission is fired. "We make sure you cannot take anything away that is in bits and bytes," Liu says. "American style [intellectual-property] protection is very helpful for innovation, but I will not say it's necessary."
Of course, there's no guarantee that China's economy can continue to grow at its current pace with such jury-rigged solutions, and many experts expect it to falter unless an independent legal system emerges. These experts argue that the need for clear rules and procedures will grow as Chinese society and commerce become more complex, and the current workarounds--based on a hodgepodge of informal rules and personal relationships--will become less useful. Among those making this argument most forcefully are members of China's own burgeoning legal profession who favor Western-style reforms.
Giving impetus to their cause are increasing numbers of ordinary Chinese citizens, who have taken the Communist Party's rhetoric about the rule of law at face value and are starting to demand more from the country's courts. "Chinese bookstores are filled with quite good books about how the legal system can be used," says Jerome Cohen, an expert on Chinese law and a proponent of Western reforms who teaches at the NYU School of Law. "You're finding people who are really trying to make the system work like it does in other countries," he says.
But other pundits argue that China may well keep on defying expectations by continuing to grow without major legal reform. They point out that the government has proven deft at maintaining social order and encouraging other trends that could keep the economy humming. "Economic growth here depends [more] on cheap labor and a stable political environment, [and less on] the improvement of the legal system," says Pan Wei, a professor at Beijing University's law school. "And political determination is also very important."
Moreover, the sheer size of China's economy is likely to continue luring local and foreign investors, regardless of the legal environment. "China's a special case because there is still great faith in the Chinese market and its potential," says Michael Dardzinski, a Beijing-based corporate lawyer. "The rule of law is just one issue among many others that is weighed against the long-term potential to make money." Lawyers and academics may continue to argue about whether reform is necessary and how to make it happen. In the meantime, others are simply taking care of business--any way they can.
URL: http://www.newsweek.com/id/68381
© 2007
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