An important school of thought in institutional economics (the "Rights Hypothesis") holds that economic growth requires a legal order offering stable and predictable rights of property and contract because the absence of such rights discourages investment and specialization. Without the security of expectations offered by such a legal order, according to the Rights Hypothesis, the risks of a great number of otherwise beneficial transactions far outweigh their expected return, and as a result such transactions simply do not occur. Society is mired in an economy of short-term deals between actors bound by non-legal ties such as family solidarity which by their nature cannot bind large numbers of strangers.
The history of China's post-Mao economic reform has provided interesting material against which to test the Rights Hypothesis. Two features of that history in particular stand out. First, the institutions by which rights are enforced, in particular courts, are perceived to be weak, and thus rights are perceived to be unenforceable. (It is perception, which determines whether persons are willing to invest and make deals, that counts for purposes of the Rights Hypothesis.) Second, China has indeed enjoyed substantial economic growth in recent years.
There are many ways to interpret these observations. First, the hypothesis could be right and the observation of weak legal institutions wrong: rights are enforced in the system, but in a way that is not immediately apparent. Second, the hypothesis could be right and the observation of growth wrong: either the statistics are misleading, or growth is actually low relative to what it would have been with stronger legal institutions. Third, the hypothesis could simply be wrong: there is no strong link between legal institutions and economic growth.
Each of the above interpretations has a certain plausibility. On the other hand, they cannot all be correct. In this paper I propose an understanding of Chinese legal institutions and their impact on economic transactions (and on investment in particular) that will allow us, if not to reconcile, at least to refine these different interpretations to make them less mutually inconsistent. More broadly, I will propose a reformulation of the Rights Hypothesis that retains the emphasis on security of property but substantially downgrades the importance of a formal legal system that provides effective enforcement of contract rights.
51 Am. J. Comp. L 89 (2003)