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Long Xiaoning:China is currently facing greater challenges on the journey of fur

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Many thanks go to the organizer for inviting me to attend today’s forum. Now I would like to briefly summarize and share with you my thoughts after listening to Professor Claude Menard’s presentation, based on the Chinese situation, and talk about the correlation between his topic and China’s ongoing economic reform.

 

In my understanding, Professor Menard's lecture conveys two most important messages that are highly relevant to China's realities, and it is particularly worthwhile to share with you. First, there are different most effective institutional arrangements for different types of transactions, So Professor Menard mentioned there is no universal standards or one-size-fits-all, and there should be different systems to solve different problems. Combined with the situation in China, I would also like to put forward an argument: for different stages of development, perhaps we also need to have different types of institutional arrangements. In other words, as time goes by, we will face different challenges when we reform the system, even the same problem may need different systems at different times. Second, Professor Menard also mentioned the mismatch between the various institutional arrangements and the embeddedness of the environment in which these institutional arrangements are applied respectively. In the light of China’s situation, I think it involves a matching issue between formal and informal institutional arrangements; more specifically, whether formal and informal systems are alternatives to each other or complementary? Likewise, the relationship between the two systems may change over time.

 

To discuss the issue of China, we need to try to answer the following questions, which is also a framework problem: is “power hypothesis" applicable in China? The so-called power hypothesis indicates that the sustainable long-term economic growth is based on a complete formal system to provide protection for property rights and contracts, such as the rule of law. However, what we see is that China's rapid growth over the past 40 years has occurred when formal institutional arrangements, such as the rule of law, were not yet fully in place. So the question is whether the power hypothesis is applicable or not in China, or is China a special case?

    

Many researchers have also put forward different arguments to respond to the above questions, and my answer is that there exists an alternative informal institutional arrangement to the formal system. But specifically, what other mechanisms are needed to replace the formal system? The first mechanism I have discovered is to use interpersonal relationships and social network, a culture-based governance model that helps to promote economic expansion by protecting property rights and facilitating contract execution in the early stages of development; another example is the competition between local governments, which, on the one hand, may help to prevent plunder from the government departments, and on the other, may drive the improvement of business environment; the third is that industrial clusters also help enterprises to overcome challenges in fundraising, fulfillment of contract, dispute resolution, etc.


But the new question we need to be concerned with now is whether the alternative informal institutional arrangements are still working effectively in the context of the ever-increasing and more mature Chinese economy today? We have recently conducted a new study, and the research question is the relation between innovation and relationship culture. We find that in areas where people depend more on interpersonal relations, the level of innovation tends to be lower. It can be seen that the governance model based on the relationship culture is no longer driving the growth of innovative economy. The first reason for our growing demand for a formal system is that as China's economy matures, various transactions cover more extensive regions and take longer time, and less business partners practice nepotism, i.e. they are no longer family members, but strangers; therefore, as the economy matures, there will be a higher demand for institutional arrangements, especially the formal system. The second reason is that China's economic development is increasingly dependent on innovation, and the emergence and development of innovation require a nationwide consistent, fair, neutral and transparent protection, which is crucial for our intellectual property rights.

    

The above discussion shows that China's economic status quo has a strong demand for the formal system and the rule of law. But to establish a formal system represented by the rule of law is a great challenge, which involves the interrelationship between the formal and informal institutional arrangements. Are they complementary or mutually replaceable?

 

The first challenge is to establish a formal system, of which the initial cost will be very high. The second challenge is that the effective functioning of a formal system requires informal institutional arrangements as a complement and Professor Claude Menard also mentions that institutional arrangements require a certain embeddedness. Let me give you two examples. The first is about social trust, including the trust between people, between enterprises, and the trust of the government. The second point is the degree of dependence on the relationship, and how much are we, in the economic activities, dependent on this interpersonal relationship? These two points will play an important role in the economic system.

 

 In response to the first challenge mentioned above, when we encounter the problem of high cost of institutional reform, we often get tempted to turn to government administrative orders or the discretionary approach to solve the problem, instead of really figuring out the formal system for long-term development. But this kind of government administration or discretionary choice often bring unexpected consequences, which may be effective in the short term, but in the long run may weaken the informal system, such as trust or more reliance on the relationship culture. And these informal rules are precisely the micro-foundation of the formal system, and they are also the key determinants for the effectiveness of innovation policies.

 

To sum up, it is very important that we hear Professor Claude Menard mention institution, but there is no one-size-fits-all or any universal solution, so what is the experience and lesson for China? Based on our own research, I have the following understandings: whether formal or informal institutional arrangements, they are alternatives for each other in the early phase of economic development, when problems are easier to solve, because the better one could always replace the other. In general, it is the formal system that is not sound enough, so the informal institutional arrangements could replace part of the formal system and work more effectively because of its spontaneous nature.

 

But as time goes by, the relationship between the two will change significantly, and to a certain time and a certain stage they will be mutually complementary, rather than alternatives. And based on the challenges we have mentioned above, it is very difficult to establish a complementary relationship of positive feedback between formal and informal systems. By this time, as they are supposed to be complementary, the weaker between the two will become the weakest part or the bottleneck of institutional reform and economic reform. Therefore, China is currently facing greater challenges on the journey of further reform and economic growth.

 

What are the solutions? I think we can focus on another topic Professor Claude Menard mentioned in this presentation, and perhaps we can find a mixed institutional arrangement that will solve the problem of formal and informal systems in China's reform practice, and further evolve and develop this mixed system. This is not only a new research proposition, but also a good solution for China to overcome new challenge. Thank you all!

 

 



◆please indicate the source if authorized: National Economics Foundation

◆photo:National Economics Foundation