Rule of law distinguishes China in growth race

The collapse of the Russian economy in the 1990s drew economists' attention, belatedly, to the importance of institutions that enforce the rule of law.

After the Yeltsin government rapidly privatized and marketized Russia's industry in 1992, GDP fell by over 50 percent and corruption boomed as politically connected oligarchs "self-privatized" formerly state assets.

The lesson learned was that marketization without a government strong enough to enforce the rule of law does not work.

The unique strength of China's reform and opening-up process has been that China's government has, for over 40 years now, steadily pushed the gradual institution-building that allows markets to work well. The Oct 28-31 Fourth Plenary Session of the 19th Communist Party of China Central Committee continued this reform push by explicitly setting, for the first time, "promoting modernization of the country's governance system and governance capacity" as the overall goal of comprehensively deepening reform.

After Western economists finally recognized the crucial importance of legal, financial, political, and social institutions to successful economic transformation, the natural approach was to look at how England, as the first industrializer, did it. In the Glorious Revolution of 1688-89, commoners and some nobles rose up against the arbitrary rule of King James II and expelled him from the country. He was luckier than his father, who had been beheaded in 1649 during the English civil war.

The reforms after the Glorious Revolution set up many of the legal and business institutions we associate with the economic transformation of Britain and, later, the United States and other British colonies. These include stronger property rights that cannot be revoked except by explicit legal procedures, patents, a central bank that aims to finance development, equal justice for all people, and a court system that can over-rule executive decisions. Most Western economists argue that these institutions, though imperfectly followed, were essential to the industrial revolution and later economic growth.

However, we have found that effective institutions and methods of governance are particular to each nation. The World Bank, the International Monetary Fund, and other development agencies have been singularly ineffective at copying US and UK-like institutions around the world.

Even the historical record is not really consistent with the idea that these institutions are the universal path to growth. Late 19th century Germany and Japan developed rapidly, but had very different institutions, with more direct state investment, than we saw in Britain. In England itself, the Glorious Revolution was followed by the long corrupt leadership of Robert Walpole, which lasted roughly from 1721 to 1742.

China is continuously developing its own institutions consistent with its history and governmental system. The nation's long record of rapid growth confirms the success of this reform and institution-building process. The Fourth Plenum has emphasized that creating more formal, consistent and institutionalized rule of law is the key to continuing growth.

Tsinghua University economist Qian Yingyi wrote a series of well-known articles arguing that China's economic growth in the 1980s was helped by a decentralized budget and administrative system that forced China's provinces to compete with each other to achieve economic growth. No doubt, this federalism was an important growth promoter at the time.

However, nation-wide goals require national rule of law that trumps the discretion of local officials. For example, spreading prosperity to the country's western and rural regions is an important national goal. And, companies and individuals need a consistent bureaucratic and legal system throughout the country. One key element of the rule of law is that local officials are more tightly monitored to ensure compliance with the law.

Fighting corruption by having clear laws is one key to economic growth. A research report from the Organisation for Economic Co-operation and Development that was requested by the G20 concluded that corruption imposed "significant negative effects on a host of key transmission channels, such as investment (including foreign direct investment), competition, entrepreneurship, government efficiency, including with regards to government expenditures and revenues, and human capital formation".

The Chinese government has been strenuously working to reduce corruption for at least the last six years. This year's Fourth Plenum reinforced the concerns and decisions of the October 2014 Fourth Plenum which also focused on the systematic legal and political reforms needed to establish good governance throughout China. Referring to the anti-corruption campaign, Vice-President Wang Qishan said at that time that the anti-corruption campaign dealt with "symptoms, not the root cause" but it could gain the necessary time to find a way to cure the disease in the future. As this year's Fourth Plenum confirmed, a stronger rule of law is the key to that long-term cure.

Strong, systematic rule of law is also crucial to achieving a greener China. A new environmental protection law that went into effect on Jan 1, 2015, was a huge turning point. The new law was reviewed four times by the Standing Committee of the National People's Congress, while the government solicited feedback from environmental law experts, government bodies, local environmental protection bureaus and the public.

The law created a more powerful enforcement bureaucracy, held officials responsible for the environment, and created a formal channel for public participation in environmental protection. Previously, local environmental protection bureaus reported to the local government and were dependent on local taxes for funding. Under the new law, they report to, and are funded by, higher levels of government.

Recent programs to increase legal protections for private and foreign businesses are another move to strengthen economic aspects of the rule of law.

The rule of law with equal protection for all is hard to establish and even harder to keep. In my own country, the United States, many big city governments are corrupt. Right now, filth is building up in New York subway cars because the transit authority fired cleaning workers while hiring million-dollar politically connected consultants, according to union allegations.

And, I'm afraid the elite class of politicians in Washington has become so entrenched and corrupt that they will quash future change and development. As we've seen, they arrange high-paying cushy jobs for family members and retirement jobs for themselves. Lobbyists, who are politically connected people paid to influence legislation, now spend about $3.5 billion per year to influence Washington - up from $1.5 billion in 1998 and only $200 million in 1983, according to data from opensecrets.org. Other estimates are much higher. This may be legal, but it is de-facto corruption that will limit future economic growth.

Mancur Olson, the late great economist at the University of Maryland, argued that economies and societies stagnate as special interest groups are able to protect their positions and prevent change.

China has been an exception to the Olson trap. Following intense study, consultation, and regional tests, China's government has been able to implement policy reforms that have enabled the process of economic upgrading. The Fourth Plenum's push for strengthened and formalized rule of law is the next essential step in the long process of economic growth and institution building.