Microsoft Word EcRefChina Oct06. doc

neiren
) and business outsiders (
wairen
). The former 
are identified in terms of family relations or “sameness”, for instance, among 
schoolmates, colleagues and neighbors. Such networks also involve informal financial 
markets (Allen, Qian and Qian, 2006). The networks of individuals sharing the same 
social norms are often extended by close ties to local officials – ties that are crucial in a 
society where legal rights are often enforced in a haphazard manner.
28
According to McKinsey Global Institute (2006, p. 32), the recovery rate of these assets has only been 
about 20 percent so far. 
29
See, for instance, Walder (1996); Chow (1997, 2002); and Peerenboom (2003). 

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Although the networks often facilitate economic transactions, they are not unproblematic. 
In particular, “kickbacks” and other types of corruption are difficult to avoid with close 
“clientele-like” relations among representatives of the public-sector, managers of state 
firms and private entrepreneurs. The two most obvious examples of corruption are 
perhaps (i) that politicians and public-sector administrators take bribes from firms that 
need various types of permits; and (ii) that public-sector representatives or managers of 
state firms transfer public-sector resources to themselves, so-called “asset stripping”. 
Indeed, during the reform period. China has been wide open for both types of corruption 
because of lingering regulations, permit requirements, large public-sector ownership of 
firms and assets, and a privatization process in the context of a weak legal system.
As would be expected, international studies suggest that corruption often distorts the 
allocation of resources, as compared to a hypothetical situation with a market economy 
based on the “rule of law”; see, for instance, Svensson (2005). However, if we look at the 
situation in specific countries, the overall consequences for economic efficiency and 
economic growth are often quite complex. In particular, the consequences seem to depend 
on a number of country-specific circumstances, such as the industrial structure and the 
political system, including the time horizon of government officials; even the sign of the 
overall association between corruption and economic growth seems to vary across groups 
of countries.
30
China is an example of the complexity. In particular, some elements of corruption have 
speeded up the 
transition
to private entrepreneurship by helping create a class of private 
capitalists, for instance, when public funds have been diverted to private individuals (asset 
stripping”), such as in the case of management buyouts. During the course of the reform 
period, corruption may therefore not have harmed economic growth, perhaps even the 
opposite. It has, however, contributed to serious social problems. For instance, as 
emphasized, for instance, by Zhang (2006), transactions in the context of existing 
networks have in some cases taken place at the expense of weak groups of citizens. An 
obvious example is the earlier mentioned expropriation of land-tenure contracts when 
30
See, for instance, Sleifer and Vishny (1993); Wedeman (2002); and Rock and Bonnett (2003. Indeed, 
the latter study finds a positive rather than a negative association between corruption and economic 
growth in large East Asian newly industrializing economies with stable governments. 

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local politicians and administrators (“cadres”) turn over land-lease contracts to developers 
in industry, retailing, and housing. Although such interventions have speeded up the 
reallocation of resources from agriculture to other sectors, this has occurred at the expense 
of farmers’ economic security. Social concerns have been relinquished for other purposes, 
such as a fast rate of structural change – and the enrichment of local cadres, who often 
share the capital gains of such reallocations of land-lease contracts. Such expropriation of 
agriculture land, without full compensation, is only one example of many of the misuses 
of powers by local cadres – other important examples being irregular payments of wages 
in connection with public works programs and an arbitrary imposition of levies of various 
types (Chow, 2006d).
Moreover, in a long-term perspective, we would expect a continuation of extensive 
corruption to have distinctively negative effects also on economic efficiency and growth 
in China. First, when the legal system improves, there is no need for having networks as a 
substitute for the rule of law. Second, when the transition to private ownership of firms 
and assets has been completed, asset stripping will no longer fulfill the function of helping 
create a class of private capitalists. Third, in a long-term perspective corruption is likely to 
contribute to social unrest, since large population groups may start questioning the 
legitimacy of the economic and political order. What would remain is a basically distorted 
allocation of resources and the risk of deficient legitimacy of the economic and political 
system. 
There is no lack of official (in particular verbal) commitments to fight corruption in 
China. Indeed, China has made considerable progress in improving the legal system since 
the late 1970s. As a result, the legal system already seems to be more developed in China 
than in a number of countries outside East Asia on a similar level of economic 
development.
31
Nevertheless, China has a long way to go in this field.
32
In particular, as 
long as public-sector politicians and public-sector administrators have something to 
“sell”, such as various types of permits, corruption is difficult to wipe out. This constitutes 
an additional argument for further deregulation of the Chinese economy – on top of the 
31
See, for instance, Peerenboom (2002) and Chen (2004), and the World Bank Evaluation Index of Rule 
of Law (World Bank, 2005). 
32
For instance, according to Transparency International Corruption Perceptions Index (2005), China 
ranks as country 77 (among 159 countries), where the least corrupt country ranks as number one. 

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conventional arguments in favor of improved economic efficiency.
33
Such deregulation is 
particularly urgent if corruption starts becoming part of the culture of business and public-
sector administration in a country, i.e. if social norms against corruption tend to brake 
down; indeed, Chow (2006d) argues that such a break down of social norms is already on 
the way. Presumably, quite strong legal measures against corruption would also be 
necessary. Moreover, international experiences and research (Svensson, 2005) suggest 
that independent mass media and political competition help contain corruption 
How, then, should today’s economic system in China be labeled? Some observers have 
called it “state capitalism”. While this label may have been appropriate in the 1980s, it is 
rather misleading today, since the bulk of production, export and output (as pointed out 
above) have recently been taking place in privately owned firms, including foreign ones – 
and even more so the recent expansion of these activities. The term market socialism is 
also misleading in the sense that dominating models of market socialism – such as those 
of Lange (1938) and Lerner (1934) – presuppose public ownership of firms, and in the 
case of Lange also government-determined prices. These models of market socialism also 
assumed that the government uses the price system as a method to take care of various 
types of externalities, including environmental degradation – a field where the Chinese 
authorities have not been particularly active.
For these reasons, the Chinese economic system is perhaps best characterized as a