Susan Whiting University of Washington

1. When the Deal Goes Sour: Contracting and Dispute Resolution in China’s Transitional Political Economy Susan Whiting University of Washington

2. Dramatic increase in economic court cases

3. Hypothesis: In the rapidly changing context of China’s transition from socialism to the market, • Both the informal networks in which firms are embedded • and the bureaucratic structures by which firms are governed • fail to provide adequate information and sanctions for the resolution of disputes, • making the courts an increasingly important element in the process of dispute resolution

4. Why surprising and counter-intuitive based on existing literature? • Social bases of contracting and dispute resolution Contractual relations are grounded in informal social ties and not in legal rules and sanctions • Chinese communities —role of guanxi (关系) • Comparative studies —role of informal social ties

5. Why surprising and counter-intuitive based on existing literature? • Confucian tradition • Emphasis on harmony and mediation • CCP legacy • Official emphasis on mediation • Courts in China are problematic Courts suffer from a range of drawbacks • subordinate to the Communist party • incompetent judges • weak enforcement powers

6. Appears to be consistent with claims of Weber, North • Weber, North: Legal order offering stable and predictable rights of property and contract is prerequisite for sustained economic growth • Here, focus on contracts • Whiting (2001) focuses on property rights

7. Study fills empirical gap • “paucity of empirically based scholarship on the actual operation of the emerging legal system” (Pei, 2001)

8. Original data • Representative sample of 76 purchase and sales contract disputes (1999-2001) from one district court in Nanjing • Convenience sample survey with face-to-face interviews of 76 enterprise managers (2002-04) regarding contracting practices and dispute resolution

9. Additional data • World Bank “Study of Competitiveness, Technology, and Firm Linkages” • survey of 1500 enterprise managers (2000) with small battery of questions on contracting and dispute resolution

10. Summary of empirical findings • Steady evolution of legal basis for market economy, improving legal recourse for private firms • Contracting less grounded in social networks than expected • Greater use of courts associated with • relative absence of alternatives and • growing supply of legal services, • themselves related to strategies of political legitimation for CCP: “rule of law” and economic performance

11. Implications for comparative political economy • Law and economic growth: • Legal order not a prerequisite for economic growth, but conditions economic growth • Relationship between institutions and culture: • Institutions shape culture as much or more than culture shapes institutions

12. Evolution of contract law • Problematic elements of early contract regime: • private enterprises excluded • transactions controlled rather than fostered 1981 Economic Contract Law 1985 Foreign Economic Contract Law 1987 Technology Contract Law • Evolving contract regime better suited to market economy 1993 Amended Economic Contract Law 1999 Contract Law (unified)

13. Changes reflected in court records (Nanjing district court 1999-2001) Examples: • Private enterprise Plaintiffs in 34% of cases Defendants in 36% of cases • Oral contracts Oral contracts in 46% of cases Findings for plaintiffs 55% of these cases

14. MacCaulay (1963): “What good is contract law?”

15. Bases of contracting • What does the available data tells us about the social basis of contractual relations? • Zhou et al. (2003): Social networks (47%) and open information sources (47%) predominate • Shanghai/Nanjing data: Professional ties predominate over social ones

18. Bases of contracting • Few alternatives to social sources of information/monitoring to underpin contracting • Not: government • Not: trade associations • Not: credit bureaux • Result: managers scramble to evaluate customers’ creditworthiness and trustworthiness

21. Bases of contracting: credit bureaux “China’s credit system is underdeveloped. There is no unified system for [evaluating] enterprise credit; there’s no way to investigate an individual manager’s creditworthiness (中国的信用制度不发达,没有一个统一的企业信用体系,无法考查某个经营者的信誉) (Interview with lawyer nj020925p).”

22. Bases of contracting: credit bureaux • 2001 State Council set up “Group for Enterprise and Personal Credit Investigation” to propose legislation governing credit evaluation agencies • Only a few specially approved ones now exist • 2004 “Regulations for Managing Credit Evaluation (征信管理条例)” still only in draft form • Draft regulations set high barriers to entry • Su Ning, Deputy Governor of PBoC: government control will be “quite strong”

23. Bases of contracting: credit bureaux • How do managers evaluate creditworthiness of potential customers: • 9% credit evaluation agencies • 15% banks • 26% other suppliers of a potential client • 39% other (Shanghai/Nanjing data)

24. Bases of contracting: credit bureaux • 39% Other (from open-ended responses): • Managers personally visit potential clients 3-5 times on average • Restrict size of deals initially

25. Bases of contracting: credit bureaux • “We mainly look at a series of deals and ability to pay. Clients’ reputations develop; before we didn’t pay much attention to this and got burned. Now we’ve begun to pay attention… (主要看交易过程和付款能力. 客户的信誉是动态的, 以前我们不大注意这方面,吃过亏,现在开始注意了…(Enterprise Interview #61).” –this firm previously relied on state purchasing meetings (订货会)

26. Contract formality • Formal written contract provisions for specifying volume, quality, price, deadlines, and contractual safeguards are the norm • Shanghai/Nanjing data: 90.5% of contracts with suppliers 98.6% of contracts with customers • World Bank data: 82.2% of contracts with suppliers 90.1% of contracts with customers

27. Summary: Bases of contracting • Deals are less grounded in pre-existing social ties than expected • Yet, there are few good institutional alternatives to social networks for gathering information about potential customers • Use of formal, written contracts is the norm

28. Disputes and dispute resolution In the year 2000, • 31.1% of firms had one or more “major dispute” with clients • 21.9% had one or more “major dispute” with suppliers (World Bank dataset)

29. Dispute resolution: self-enforcement • Self-enforcing contracts (long-term cooperative solution based on anticipated value of future contracts) • “If a client is very late with payment, we stop (shipments of) goods (如果超过了信用期,我们 就停货) (Enterprise interview #39) • 90.6% of firms: end long-term reciprocal relations in event of serious dispute (Shanghai/Nanjing data)

30. Dispute resolution: self-enforcement • Self-enforcing contracts (long-term cooperative solution based on anticipated value of future contracts) • Length of contractual relations: average: 7.5 years median: 5.5 years • Reputation 74.2% of firms said: other businesses would know if a dispute arose with supplier or client (Shanghai/Nanjing data)

33. Dispute resolution: self-enforcement • Self-enforcing contracts • Partial pre-payment • 28% of firms require pre-payment • range of contractual terms for these firms: 30% in advance 40-60% upon delivery 10-30% within thirty days (Shanghai/Nanjing data)

34. Dispute resolution • Direct negotiation • Mediation • Arbitration • Litigation • Gang enforcement

38. Dispute resolution: negotiation • Direct negotiation “No matter what firm or what dispute, enterprises’ first [step] is direct negotiation. On the one hand, [this approach] minimizes costs, and, on the other hand, it maintains good relations (不管是什么企业,什么纠纷,企业首先的肯定是协商. 一方面可以节约成本,另一方面还可以保持好的关系) (Interview with lawyer nj020935p).”

39. Dispute resolution: mediation • Most striking finding: apparent lack of appropriate third parties

41. Dispute resolution: arbitration • Only 17.6% of firms use arbitration • Arbitration Law—1995 • Nanjing Arbitration Commission not even established until 1998 • Comments like “Where is there an arbitration commission? (哪儿有仲裁委员会)? (Enterprise interview #16)” are common. • First 5 years nationwide: 3,400 cases per year on average arbitrated; compared to 1.3 million litigated • Concerns about lack of appeal, enforcement

44. Dispute resolution: litigation • 36.8% of firms used the courts in their most recent dispute (Shanghai/Nanjing data)

45. Supply of legal services • 91.6% of firms had legal representation (Shanghai/Nanjing data)

48. Dispute resolution: litigation • Credible threat to use court leads parties to bargain “in the shadow of the law” (Cases withdrawn increased from 8% to 21%) • Litigants seek authoritative (有权威性的) resolution of dispute (Enterprise interview nj021127p; judge interview sh040817p) (Cases decided increased from 5% to 44%)

50. Dispute resolution: litigation • Court-sponsored mediation has been locus of government interference (Potter 1992) (Cases mediated by courts declined from 80% to 31%) • Respondents feel that interference in judgments in contract disputes is low (Shanghai/Nanjing data)