The China Growth Miracle: The Role of the Formal and the Informal Institutions

• Author: Yuanhua Gao,Kenneth S. Chan,Xianxiang Xu
• DOI: http://doi.org/10.1111/twec.12193
• Date: 01 January 2015
• Published date: 01 January 2015

The China Growth Miracle: The Role of

the Formal and the Informal Institutions

Kenneth S. Chan

1,2

, Xianxiang Xu

2

and Yuanhua Gao

2

1

McMaster University, Hamilton, ON, Canada and

2

Lingnan College, Sun Yat-san University,

Guangzhou, China

1. INTRODUCTION

THIS paper addresses the perplexing question raised by many scholars, on why China, in

spite of its ordinary institutions, can grow so rapidly and for so long. This ‘China Growth

Miracle’ posts a challenge to the conventional wisdom (for example, Acemoglu and Johnson,

2005; Xu and Li, 2005; Du et al., 2008; Vieira et al., 2012; Lu et al., 2013 among others) that

there is a strong causation from the quality of institution to economic growth.

Cross-country regressions on growth and institutions could not provide an answer, but

could only suggest that China may be an outlier. It is therefore tempting to conclude that

institutions may not be that important for the case of China since it is still at its transition

stage of economic development. Alternatively, Bardhan (2002) and Xu et al. (2007) suggest

that the criteria for good institutions, such as property right protection and the rule-of-law,

may only be relevant to well-functioned mature market economies. For transitional econo-

mies, where the markets are still in their embryonic form, other criteria, such as a proper bal-

ance between centralisation and decentralisation of government to promote performance,

could be more useful indicators for effective or good institutions.

In this paper, we investigate whether or not ‘good’ institutions are important for economic

growth in China. Since each region in China has different regional institutional quality and

growth rates, we will look into provincial and city-level data for answers. We will use multi-

ple measures of government efficiency to gauze the regional government efficiency, and a

new set of instrumental variables.

Other than the formal institutions, the informal institution usually plays a significant role in

governance in the developing countries. A formal institution governs through a well-structured

organisation and is usually rule-based. An informal institution governs through relations/net-

work and reciprocity within the community, based on shared social values and norms (Wil-

liamson, 2000).

1

While the formal institution governs by direct coercion through the state

mechanism, the informal institution governs by consensual control and voluntary compliance

in the community. Williamson (2000) thinks that the informal institution is a more important

institution than the formal institution as the former constraints the action of the latter and that

We are indebted to two anonymous referees, Eden Yu, Vinh Dang, Yi Lu, Pinghan Liang and seminar

participants at CCER, Peking University, National Taiwan University and Guangdong University of For-

eign Studies for helpful comments of earlier drafts. Xianxiang Xu gratefully acknowledges the financial

support from national natural science foundation of China (No.71373290).

1

Some authors prefer to use the term social capital rather than the informal institution (see Nannicini

et al., 2010; Gorodnichenko and Roland, 2011). The definition of social capital, norms, cultural values

and the informal institution are not completely identical in spite of huge overlaps. A distinction between

these concepts is beyond the scope of this paper. But for convenience, we will use the term informal

institution here to include all of these concepts.

©2014 John Wiley & Sons Ltd 63

The World Economy (2015)

doi: 10.1111/twec.12193

The World Economy

it takes longer to change than the latter. Historically, China’s informal institution, based on

the Confucian communitarian ethos, was vital in governing China because of its huge land

mass and population which raised the monitoring cost of the central government. The social

values in China stress communitarian ethics rather than individualism. These social values

proved to be a useful mechanism to maintain law and order and effective governance in rural

or distant areas. Authority from the central government was supplemented by those from the

local elites/gentries, who had relied on the local social network and communitarian ethics of

the local population to govern. Hence, the informal institution improved the effectiveness of

the formal institution. China was governed quite successfully by this mixture of formal and

informal institutions for more than two thousand years.

By looking back into Chinese history, we see that the quality of the informal institution

must have played an important role in the governance of the Chinese society. Although the

informal institution persists for a very long period of time (Williamson, 2000), it is hard to

judge how much of the informal institution today come from China’s past. Nonetheless even

today, transactions in the Chinese economy rely more heavily on ‘guanxi’, a network of infor-

mal arrangements, than on the formal contracts (Su and Fung, 2013). To find out the recent

impact of the informal institution, we need to find a good measurement for the informal insti-

tution, an issue the present paper will address.

This paper finds that it is the strength of the informal institution which has aided China’s

growth and development over the last four decades in spite of its mediocre formal institution.

There are clearly mutual interactions between the formal and the informal institutions in

China (see Helmke and Levitsky, 2004). The treatment of these interactions will be discussed

in subsection 3bAre the formal and the informal institutions substitute or complement for

each other? Would the presence of the formal institution ‘crowd-out’ the informal institution?

In this paper, we find some evidence from the Chinese regional data that the formal and the

informal institutions are close complements.

A caveat in this paper is the weak theoretical relationship between institutions and growth .

As pointed out by Acemoglu and Robinson (2010), we only have a very preliminary under-

standing of the relationship between political power, institutions and economic performance.

We still do not know exactly why some dictatorships, such as those in Asia, are developmen-

tal, while others dictatorships, such as those in Africa and Latin America, are not. While the

theoretical literature may have produced ambiguous predictions, the empirical literature may

be able to offer some insightful empirical regularity. In a recent review of the empirical work

on institution and long-run growth, Vieira et al. (2012) concluded that, overall, the quality of

institutions matters in predicting long-run growth in cross-country studies. Our paper follows

this fruitful line of empirical investigation and tests the important contribution from China’s

informal institution, in addition to its formal institution.

2

The remainder of this paper is organised as follows. Section 2 lays down the theoretical

framework and predictions from the conventional growth model for empirical study. Section 3

tests of the predictions, using provincial and city-level data. New instrumental variables are

introduced in the 2SLS regressions. Section 4 extends part of the framework to panel regres-

2

Vieira et al. (2012) also review the empirical work by Glaeser et al. (2004) who are critical of the

institutional approach. They find that human capital (initial level of education) is more important for

growth than institutions. Perhaps, the significance of the human capital in their regressions is picking up

the impact from the informal institution or from the social capital, on which education has a deep

influence.

©2014 John Wiley & Sons Ltd

64 K. S. CHAN, X. XU AND Y. GAO