China Above the Law; A poorly functioning legal system is supposed to hurt economic growth. But nobody told the Chinese.

Byline: Sarah Schafer

On Feb. 2, a Communist Party journal published a speech by Luo Gan, a Politburo member and China's top law-and-order official, that startled the country's burgeoning legal profession and foreign investors. Luo declared that the Communist Party should maintain its dominance over the nation's courts and resist "enemy forces" that were trying to Westernize its legal system. Just a week earlier, Beijing had announced that the country's economy was continuing to grow at a dazzling pace, hitting 10.7 percent last year. The two headlines pointed to an increasingly conspicuous paradox that is puzzling observers: how is China's economy managing to grow so quickly without an independent and modern legal system? And how long can it continue?

Western economists and legal scholars have long argued that a robust legal system and impartial courts are prerequisites for a mature market economy. Effective, transparent and predictable judicial institutions are deemed necessary to assure businesses and customers that investments will be protected, contracts enforced and disputes resolved equitably. The rule of law encourages innovation by establishing intellectual-property rights and ensuring that inventors--and the firms that back them--are rewarded for their efforts. Without these protections, it is assumed, stock exchanges, commodities markets and other hallmarks of a complex capitalist economy cannot function properly.

Many developing countries with weak judicial systems have been hobbled by corruption, waste and inefficiency. But China seems to be thriving despite its own rudimentary court system, which remains firmly under Communist Party control. Since Beijing introduced free-market reforms in the late 1970s, a booming private sector has emerged, hundreds of millions of people have escaped poverty and overseas investment has flooded in. The secret: entrepreneurs have found a variety of creative solutions to get around China's unreliable courts. These include seeking mediation for business disputes from sympathetic party officials, enforcing contracts by threatening to go elsewhere, and protecting trade secrets with heightened security--solutions aided by the pro-business slant of China's leadership.

Beijing all but abolished the legal profession during the Cultural Revolution. After Mao Zedong's death, it slowly began to rebuild the judiciary, adopting Western-inspired reforms. Today China's courts do function after a fashion, and its citizens are turning to them in record numbers--about 8 million cases were filed last year. Indeed, China's leaders now tout the rule of law as one of their guiding principles.

But in reality, legal reform has lagged far behind changes in China's economy. Though education levels are rising, for example, many judges, lawyers and prosecutors remain poorly trained. Cases are still often decided by bribes and political connections. And the party shows no sign of ceding its control--almost all judges are party members and required to obey its orders. Beijing still fears that an independent judiciary could undermine the party's monopoly on power.

In place of a proper legal system, however, other mechanisms have emerged to play its role. Large foreign and domestic firms, for example, have learned to resolve or avoid contract disputes by exploiting the country's hypercompetitive business environment. If a supplier fails to deliver on time, they simply threaten to give their business to someone else. And China does have rules, which are largely pro-business, though they are enforced differently than in the West. For example, the government recently imposed a new regulation requiring local officials to grant business licenses faster, leaving bureaucrats less time to demand bribes. "People from legal societies always underestimate the power to affect change through administrative, rather than legal structures," said Arthur Kroeber, managing director of the economic research firm Dragonomics in Beijing.