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Democracy and Economic Development


Chapter 7

Democracy and Economic Development

7.1 Introduction
While Chap. 6 focuses on the factors affecting democracy in China, this chapter is to examine the impact of democracy on economic development. To achieve this objective, the author will review the existing literature on the relationship between democracy and economic development. If there is such a direct linkage between democracy and economic development, what are the implications for China? If democracy has no direct impact on economic development, it is necessary to inquire into the indirect impacts of democracy on economic development. The chapter then raises the question of whether these indirect positive effects can be realized under the existing political and economic system in China. If changes are required, what are the necessary changes? For this purpose, Sect. 7.2 of this chapter will analyze the existing literature on the relationship between democracy and economic development. Section 7.3 will examine the indirect effects of democracy on economic development. Section 7.4 will discuss the issue on how China is to utilize the indirect positive bene?ts of the mechanisms found in other matured democratic countries.

7.2 The Relationship Between Democracy and Economic Development
The literature with respect to the impact of democracy on economic development can be divided into three categories. The ?rst category reveals that democracy has a negative impact on economic development. For instance, Helliwell (1994) has examined the relationship between economic development and democracy. Regarding the effect of democracy on economic development, his regression study (Helliwell 1994: 240) shows that democracy has a negative effect on growth “although the effect is not statistically signi?cant at the usual levels.” Helliwell’s
G. Yu, The Roles of Law and Politics in China’s Development, 145 DOI 10.1007/978-981-287-002-5_ _7, ? Springer ScienceCBusiness Media Singapore 2014

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empirical study is largely consistent with an early review of 13 studies conducted by Sirowy and Inkeles (1990). The result of the review of Sirowy and Inkeles (1990) shows that democracy has unquali?ed negative effects in three studies, negative effects in some circumstances in four studies, and no effects in the remaining six studies. The second category suggests that democracy has no direct impact on economic development. For instance, Przeworski and Limongi (1993: 60) examined 18 studies that generated 21 ?ndings. These authors reviewed arguments of whether authoritarian regimes or democratic regimes are more relevant to economic growth. Neither the theoretical analyses nor the statistical assessments conducted by Przeworski and Limongi (1993: 51–60, 60–64) have enabled them to draw clear conclusions on whether democratic regimes or authoritarian regimes foster or hinder economic growth. All Przeworski and Limongi (1993: 51, 65) could suggest is that regimes do not capture the relevant differences even though politics matter. Similarly, Leblang (1996) has examined the relationship between property rights, democracy, and economic development. His regression analyses have tested cross-national panel data from 1960 to 1990 within the endogenous growth model. Once the economic factors are controlled, “the degree to which a polity is democratic does not have a statistically signi?cant effect on a nation’s growth rate” (Leblang 1996: 17). In other words, regime type does not explain cross-national variations in growth rates (Leblang 1996: 18). Using a regression model, Burkhart and Lewis-Beck (1994) have analyzed a sample of 131 nations from 1972 to 1989, also to test the relationship between democracy and economic development. While their major focus was on the debate whether economic development causes democracy, their test result also supported the conclusion that “democracy does not cause economic development’ (Burkhart and Lewis-Beck 1994: 907). Burkhart and Lewis-Beck (1994: 907), however, did clarify that democracy does no harm to economic development. Using a different approach, Doucouliagos and Uluba? so? glu (2008) have employed a meta-analysis which included 84 studies on the relationship between democracy and economic growth to examine the effects of democracy on economic growth. The result of their regression (2008: 68) analysis is that the direct democracy-growth effect is zero. The third category tends to focus on the indirect effect of democracy on economic development. Scholars who focus on the indirect effect of democracy on economic development tend to be positive although many of them have concluded that democracy has no direct effect or even negative effect on economic development. For instance, Leblang (1996: 17) revealed that democracies offer better protection of property rights. Helliwell (1994: 246) also suggested that the direct negative effect of democracy on economic development is offset to some extent by the indirect effects of democracy on the economy through investment and education. Baum and Lake (2003) used a data set consisting of a 30-year panel of 128 countries from 1967 to 1997 in their regression analysis. They analyzed both the direct effect and the indirect effect of democracy on economic growth. The result of their test did not support any direct positive effect of democracy on economic growth (Baum and Lake 2003: 343). Baum and Lake (2003: 344–345), nevertheless, concluded that

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democracy has indirect positive effects on economic growth through improvement of life expectancy in poor countries and secondary education in non-poor countries. Similarly, Doucouliagos and Uluba? so? glu (2008: 75–76) concluded that democracy has positive effects on economic growth through indirect effects including investment on human capital, price stability, political stability, and government size. The research of Yi Feng (1997) focused on the relationship between democracy, political stability, and economic growth. His research indicated that major regular government change has a positive and signi?cant effect on growth while irregular government change has a negative and signi?cant effect on growth (Yi Feng 1997: 407). Despite the fact that the empirical results of Feng’s regression test (1997: 406) indicated that democracy has a direct negative effect on growth, democracy has an indirect positive effect on growth as it induces major regular government change and inhibits irregular government change (Yi Feng 1997: 409, 414). Mobarak (2005) also examined the role of democracy on the economy through the lens of stability. Claiming that democracy has less to do with growth, Mobarak (2005: 359), however, demonstrated that growth performance in democracies is more stable. I will leave the examination of the indirect effects of democracy till the next section. Other than the above three categories, some scholars are not very precise on the conception of democracy. These scholars’ de?nition of democracy refers more appropriately to the conception of rule of law rather than democracy in terms of multiparty election of higher-level legislative or executive of?cials. The research of Gerring and his colleagues and the research of Olson fall into this category. Gerring and his colleagues (2005: 349) recon?rm the result that democracy has no statistically signi?cant effect on economic growth. Nevertheless, they argue that it is a country’s political experience (Gerring et al. 2005: 328) or democracy stock that brings positive effect on economic growth (2005: 337, 356). Gerring and his colleagues (2005: 337) even boldly claim that “the argument for a “democratic growth effect” is quite possible if regime is considered through a historical lens: democracy C time D economic development.” A possible counter argument is that repeating things overtime does not generate greater stock of experience if a society does not innovate or lacks dynamic ef?ciency. Gerring et al. (2005: 332) also use an example that it takes voters time to pay attention to economic performance. A similar argument, however, can be made that leaders in one-party regimes may also pay greater attention to speci?c mechanisms which promote economic growth when they start to realize the consequences of different economic policies or institutions. The stronger argument by Gerring and his colleagues is that institutionalization is more dif?cult in authoritarian regimes. They (2005: 336–337) provide:
: : : the institutionalization of power in a democratic regime is closely linked to the establishment of rule of law. The same forces that rationalize channels of power also tacitly endorse the rule of law—so much so that a fully institutionalized democracy (as described above) is impossible to imagine in the absence of rule of law. : : : Thus, it may be argued that there are two necessary conditions for the ?rm establishment of the rule of law: democracy and a well-institutionalized public sphere.

While Gerring and his colleagues are correct that democracy requires the support of a system of rule of law, it is not obvious that democracy is a precondition of

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a rule of law system. For decades, Hong Kong and Singapore had a very strong rule of law system and a very successful economy in the absence of democracy. The proposition by Gerring and his colleagues that “democracy C time D economic development” also fails to explain the cases of India and China. For decades, India has been the world’s largest democracy and China has been the world’s largest authoritarian regime. Evidence does not suggest that India outperforms China either in terms of economic development or in terms of other important human development indicators such as literacy rate, infant mortality rate, and life expectancy rate (Ross 2006: 868).1 Therefore, what is more important is a rule of law system which better de?nes and protects property rights, facilitates contractual arrangements, promotes other institutions that provide direct ?nance to private ?rms, and expands investment in education (Pryor 2005: 476), at least during the early stage of economic development. Unclear writing on democracy and rule of law can also be found in the research of Olson. Olson (1993: 569–571) compared autocracy and democracy and pointed out, among other things, that a major problem explaining the lack of stable economic development in an autocracy is the expropriation of greater wealth by the autocrat in the country, while in a democracy the expropriation of wealth will be to a lesser extent as the leader caring for the majority in addition to himself has a more encompassing interest in the productivity of the society. After concluding that economic development requires “a government that is believed to be both strong enough to last and inhibited from violating individual rights to property and rights to contract enforcement” (Olson 1993: 572). Olson (1993: 572) speci?cally provides:
Interestingly, the conditions that are needed to have the individual rights needed for maximum economic development are exactly the same conditions that are needed to have a lasting democracy. Obviously, a democracy is not viable if individuals, including the leading rivals of the administration in power, lack the rights to free speech and to security for their property and contracts or if the rule of law is not followed even when it calls for the current administration to leave of?ce. Thus the same court system, independent judiciary, and respect for law and individual rights that are needed for a lasting democracy are also required for security of property and contract rights.

The ?rst problem in the above quotation is that there are only two regimes. One is autocracy without serious legal constraints and the other is democracy with competitive election for top political leaders. It shall be pointed out that a oneparty system incorporating a broad-based substantive deliberative democracy (to be extensively discussed in Chap. 7) is also able to rely upon a strong rule of law system to protect individual political rights and civil rights. The second problem is the equation between democracy and rule of law. As has been discussed, a country or region may have a strong rule of law system, yet without being democratic in the form of multiparty election for the top-level legislative or executive leaders. While a rule of law system is necessary for economic development, democracy in

1

Ross’s research result is that the true infant mortality gap between dictatorships and democracies is close to zero.

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the form of multiparty election is not, unless the lack of democracy adversely affects the establishment of the mechanisms with indirect positive effects on economic development. Among the mechanisms having indirect positive effects on economic development examined in this section, rights to property, ?nancial market, rule of law, and education are the relatively clear mechanisms. Stability is a much less clear variable as stability may be in?uenced by factors other than regimes. For this reason, the next section will be devoted to the examination of these four mechanisms which exert positive indirect effects on economic development.

7.3 The Indirect Effects of Democracy on Economic Development 7.3.1 Rights to Property
The importance of property rights to economic development can be analyzed from the perspectives of universality of ownership, exclusivity, and transferability. The right of ownership is important. This is so because unclear property rights are closely associated with the threshold question of who is entitled to use the property. If nobody owns a particular property under the condition of scarcity, the property is likely to be the subject of dispute. When the threshold question of who owns the property is solved, the next important question is exclusivity. If the owner is able to exclude others in using the property, he/she is able to determine how to use the property. Normally the owner has the best incentive to appropriate the economic value of the property. It is from this perspective that people argue that private property leads to the full internalization of the costs and bene?ts of the property (Demsetz 1967: 348–349), while communal property leads people to push social costs onto society as a whole (Hardin 1968: 1245). In addition to the features of universality of ownership of property and exclusivity of property, transferability of property is also crucial. When the owner of an asset is able to sell or transfer an asset to others, the asset can be moved from less ef?cient users to more ef?cient users (Deininger and Feder 1999: 6). While the above features deal with the de?nition of property rights, the issue of protection of property rights is equally important. When property rights are not secure, individuals may attempt to steal or appropriate the property of others. To respond to this potential threat, owners of property have two options. One is to reduce investment in the property. This option reduces returns from the asset. The other option is to devote resources to prevent theft. This option causes deadweight social loss (Tullock 1976: 228–232). To address the threat to private property from other individuals, Locke (1960: 395–396) developed his theory of the state, arguing that the primary purpose of the state is to protect individuals’ property, i.e. their life, liberty, and estate. Although a strong state is able to provide the protection

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of private property, a remaining thorny question is how to prevent the strong state from expropriating the wealth of individuals. North and Weingast’s research (1989: 808–819) shows that an equally strong legislature representing the wider interest of society and an independent judicial system to balance the strong executive government are essential. Economists have long emphasized the importance of property rights (West 2003: 20). North (1981: 6) considers strong property rights to be the most important institutions for economic growth. Similarly, Posner (1998) is of the view that a modernizing state’s economic prosperity needs at least a modest legal framework to protect property rights. Knack and Keefer (1995: 207) also argue that “few would dispute that the security of property and contractual rights and the ef?ciency with which governments manage the provision of public goods and the creation of government policies are signi?cant determinants of the speed with which countries grow.” De Soto (2000: 218) argues that strong protection of property rights is the key factor, explaining why capitalism succeeds in the West and fails everywhere else. Quantitative results strongly support the position that strong institutions of protecting property rights are important for economic development. Leblang (1996) has analyzed data from 50 countries over three decades to assess whether property rights are more important or democratic regimes are more important to economic growth. The evidence of his research (Leblang 1996: 18) suggests that “the presence of private property rights has a signi?cant and positive effect on growth, regardless of regime type.” Rodrik and his colleagues (2004: 157–158) also reveal a linkage between strong property rights and economic development. Acemoglu and Johnson (2005: 953) similarly ?nd that countries with strong property rights have superior economic outcomes.

7.3.2 Investment and Finance
When property rights are relatively well de?ned and strongly protected, people will use their assets ef?ciently. This means that investment, both in the short term or in the long term, will be made. The next important issue is whether ?nancing affects investment and therefore economic development. The recent literature of ?nancial economics suggests that ?nance does promote economic development. Speci?cally, Levine (1997: 691) explains the mechanisms of functioning ?nancial systems are to facilitate the trading, diversifying, and pooling of risks, allocate resources, monitor managers (agents), mobilize savings, etc. The relationship between liquidity and investment is true because long-term investment requiring large-scale investment may not be carried out when people with money do not want to relinquish their control of their money for long periods (Levine 1997: 692). If a ?nancial system, however, provides the liquidity so that people with money can easily convert their investment into cash, long-term

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investment projects will be made (Levine 1997). According to Levine (1997: 693), liquidity can be provided either by the stock market or by the banking sector. In addition to reducing liquidity or trading risk, ?nancial systems may also be able to reduce the risks of diversifying and pooling of risks of individual projects, ?rms, industries, and countries (Levine 1997: 694). Naturally, ?nancial systems are able to enhance the ef?ciency of resource allocation. Furthermore, ?nancial systems have the ability of monitoring managers or agents. Compared with individuals, ?nancial intermediaries are better able to identify investment projects because of their specialization. Economizing on information acquisition costs helps division of labor so that passive investors and active investors are able to play their roles respectively. Again both the banking sector and the stock market can perform this task (Levine 1997: 695–696). Besides, ?nancial systems contribute to the task of reducing monitoring costs (Jensen and Meckling 1976). This is done through the delegation of monitoring roles to ?nancial intermediaries from a large number of uncoordinated individuals (Levine 1997: 697). By reducing the risks of trading, diversifying, and pooling and by economizing on information acquisition costs and monitoring, ?nancial systems are further able to mobilize savings. Sirri and Tufano’s ?nding (1995: 81–128) is that mobilization of savings from multiple or disparate investors is able to increase the ef?cient scales of investment projects. Firm level and country level quantitative studies of ?nancial systems con?rm the above theoretical observation. At the ?rm level, Demirguc-Kunt and Maskimovic (1998) examine the proportion of ?rms whose rate of growth exceeds the growth which could have been obtained only by relying upon internal sources of ?nancing. Their cross-country regression (1998) results indicate that this proportion is positively related to the stock market turnover. Rajan and Zingales study (1998) whether industrial sectors that rely more on external ?nancing grow proportionately faster in countries with greater developed ?nancial markets. Their ?nding is that “?nancial development has a substantial supportive in?uence on the rate of economic growth and this works, at least partly, by reducing the cost of external ?nance to ?nancially dependent ?rms” (Rajan and Zingales 1998: 584). In a cross-country study, Levine et al. (2000) examine the role of ?nancial intermediaries in promoting economic development and evaluate how legal and accounting rules affect ?nancial development. Their conclusion is that “the degree to which ?nancial intermediaries can acquire information about ?rms, write contracts, and have those contracts enforced will fundamentally in?uence the ability of those intermediaries to identify worthy ?rms, exert corporate controls, manage risks, mobilize savings, and ease exchanges” (Levine et al. 2000: 35). In a different study, Greenwood and Jovanovic (1990) analyze the relationship between ?nancial intermediaries and economic development. One of their ?ndings is that ?nancial intermediaries can invest more productively than individuals because of their better ability to identify investment projects (Greenwood and Jovanovic 1990). Furthermore, in a 1993 study, King and Levine (1993) assess whether the value

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of ?nancial depth2 in 1960 predicts the rate of economic development, capital accumulation, and productivity growth over the next 30 years. The regression results of their research (King and Levine 1993) answer their question positively. Levine and Zerove analyze the relation between stock market liquidity3 or the level of banking development and economic development. Their regression results (Levine and Zerove 1998) show that stock market liquidity and banking sector development are both good predictors of economic development, capital accumulation, and productivity improvements.

7.3.3 Rule of Law
While very important, the conception of rule of law can be very controversial. As scholars have examined thoroughly the thin conception of rule of law and the thick conception of rule of law (Peerenboom 2002: 3–6; Trebilcock and Daniels 2008: 16–23) and the ambiguity of the de?nition of rule of law (Nardulli et al. 2013: 140– 141), this chapter adopts the de?nition of rule of law along the line of Fuller without engaging in a lengthy evaluation of the various versions. Fuller (1969: 39) characterizes a functional legal system in a way that laws should be general, public, prospective, understandable, coherent, capable of being followed, stable, and enforceable. Classical writers such as Plato and Aristotle emphasize the social utility of rule of law in terms of preserving social order and constraining the discretion of rulers (Nardulli et al. 2013: 140). Hobbes (1968) also considers rule of law essential for the protection of life and the establishment of social order. Similarly, Locke (1960) emphasizes the role of rule of law in the preservation of property. Many contemporary thinkers tend to focus on the instrumental role of rule of law in economic development. From this perspective, rule of law are closely related to the protection of property rights and the facilitation of contract enforcement essential for a market economy. In addition, rule of law is fundamental to the establishment of ef?cient ?nancial markets. Naturally, the system of property rights, ?nancial markets, and rule of law are mutually reinforcing. Chapters 1 and 2 have examined the important role of formal law in contract enforcement and Chap. 3 has discussed the increasing role of formal law in de?ning and enforcing property rights in China. As such, this section will only brie?y elaborate on the importance of law in building an ef?cient ?nancial market. Demirgü?-kunt and Maksimovic’s research (1998) shows that countries with more ef?cient legal systems are more likely to encourage ?rms to utilize long-term external ?nancing. Similarly, Levine’s study (1997: 598) reveals that enforcing law is just as important as the law itself. His regression results (Levine 1997:
2

Financial depth is de?ned as the liquid liability of the ?nancial system divided by the gross domestic product. 3 Stock market liquidity is de?ned by both the value of stock trading relative to the size of the market and the size of the economy.

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611) suggest that “countries with legal systems that rigorously enforce laws and contracts have better-developed banks than countries where enforcement is more lax.” The quantitative research of La Porta et al. (1997) also concludes that countries with better legal protection, measured by both the character of legal rules and the quality of legal enforcement, have a more liquid and ef?cient stock market. Since the preceding section has demonstrated that ?nance promotes economic development, the role of law in promoting the development of the ?nancial market necessarily stimulates economic development. There is empirical evidence, supporting the theoretical observation that countries with better rule of law systems stimulate economic development. For instance, Kaufmann (2004: 145) provides:
an improvement in the rule of law by one standard deviation from the current levels in Ukraine to those “middling” levels prevailing in South Africa would lead to a fourfold increase in per capita income in the long run. A larger increase in the quality of the rule of law by two standard deviations in Ukraine (or in other countries in the former Soviet Union), to the much higher level in Slovenia or Spain, would further multiply this income per capita increase.

The bene?ts of rule of law go far beyond the instrumental role on economic development. Rule of law is also closely related to the moral order of societies. It provides the social conditions essential for human development or ?ourishing. For instance, under a rule of law regime, freedom of speech and freedom of the media are normally guaranteed. Freedom of speech and freedom of the media are further necessary for a broad-based substantive deliberative democracy. I will leave the examination of substantive deliberative democracy to the next chapter. The ultimate goal of rule of law is, however, to respect human dignity and enhance human freedom. Articles 1 and 2 of the German Constitution therefore rightly capture this ultimate goal on human dignity and freedom.

7.3.4 Education and Human Capital
The role of human capital is still another important factor to economic development. The literature analyzed in Sect. 7.2 attributes the enhancement of human capital or education to democracy as an indirect factor, promoting economic development. Whether human capital is important depends very much upon the rate of return on investment. If the rate of return on investment and the rate of growth of per capita output are decreasing functions of the level of per capita stock as assumed by neoclassical growth models (Ramsey 1928; Cass 1965), income equality and equality in growth rates will converge around the world. This decreasing function on the rate of return on investment and the rate of growth of per capita output is, however, not true. Romer (1986) shows that, in a fully speci?ed competitive equilibrium, per capita output can grow at an increasing rate. Romer then applies the statistical evidence in the research of Maddison (1979) to support his model. The evidence collected by Maddison indicates that the rate of growth of human

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productivity increases from virtually zero in the Netherlands in the eighteenth century to 0.5 % in the United Kingdom during the later eighteenth century and early nineteenth century to 1.4 % in the United Kingdom in the nineteenth century to 2.3 % in the United States in the later nineteenth century and most of the twentieth century (Romer 1986: 1009). Lucas’ study (1988) further supports the position that the rate of human capital growth can be an increasing function. According to Lucas (1988: 40), “if different goods are taken to have different potentials for human capital growth, then the same considerations of comparative advantage that determine which goods get produced where will also dictate each country’s rate of human capital growth.” The results of Lucas’ research imply that resources devoted to research and development and to the development of new products with the characteristics of on the job training or learning by doing tend to improve the rate of human capital accumulation. Empirical studies also show that human capital contributes to economic development (Levine and Renelt 1992; Sala-i-Martin et al. 2004). While Romer and Lucas mainly focus on human capital in ?rms, human capital accumulation is also closely related to education in society if we take Lucas’ point (1988: 19) that human capital accumulation is a social activity, involving people as groups. Although, on an individual level, education is subject to diminishing marginal return in the sense that education in the early life brings greater bene?ts to individuals, education has increasing return if human beings are taken as a social group from a historical perspective. Resources spent on the current generation of human beings in a society will bring back higher rates of human productivity in the future generation as knowledge transfers in a continuous and non-interrupted way in societies. Quantitative research con?rms the role of education in economic development. Leblang’s research (1996: 15) reveals a “positive and signi?cant coef?cient on proxy for primary educational attainment” to economic development. Baum and Lake’s data (2003: 128) consists of a 30-year (1967–1997) study of 128 countries. The regression results of Baum and Lake (2003: 344) lead to the conclusion that “at least among countries with a per capita GDP greater than $2,500, some signi?cant portion of the total effect of democracy on growth is indirect, through secondary education’s effect on growth.” These two studies indicate that both primary education and secondary education have positive effects on economic development. Obviously, the role of higher education is even greater given the research and innovation activities carried out in universities in every country and the positive spillover impact of research on society.

7.4 Indirect Effects and One-Party Rule
Reasonable people are likely to differ on how China shall reform its political system even if democracy does not have any direct positive effect on economic development. Some people would argue that democracy in the form of multiparty

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election of higher-level legislative and executive of?cials shall be adopted so long as democracy has indirect positive effects on economic development. They might further argue that democracy is intrinsically good. Democracy is categorically good, however does not receive universal empirical support. A survey (Ross 2006: 860) in Latin America suggests that 54.7 % of the respondents would prefer a dictatorship to a democracy if it would help resolve their economic problems. A different survey (Chu et al. 2008: 22) in East Asia similarly reveals that East Asians give a lower value to democracy than economic development, with China having a score of 40.3, Hong Kong 19.6, Taiwan 23.5, and Korea 30.1. Zakaria’s observation of India is also remarkable. He (Zakaria 2003: 251–252) provides: “For all its democratic glories, [India] has slipped further and further behind on almost every measure of human development: life expectancy, infant mortality, health, literacy, and education. : : : Surely it is time to ask whether democracies such as India, so lauded by Western intellectuals, are working for their people.” People arguing along the line of quick adoption of democracy so long as there are indirect bene?ts, however, also fail to pay adequate attention to political economy factors in China. When the ruling party-state regime, controlling political, military, and economic resources, is unwilling to adopt Western-style democracy in the form of competitive multiparty election, drastic reform proposals are unlikely to be placed on the agenda, not to mention adoption (de Lara et al. 2008). Moreover, when the mechanisms having indirect positive impacts on economic development examined in the previous section have not been well established, the outcome of radical political reforms is unlikely to be positive as expected. Additionally, those advocating this line of thinking fail to consider the sequence issue. Persson and Tabellini’s research (2006) has shown that democracy after liberation has better results. Democracy after liberalization has a positive outcome while democracy before liberalization has a negative outcome (Persson and Tabellini 2006: 321). Given the political feasibility in contemporary China, sequence, and uncertainty factors, are such that alternative solutions are likely to achieve better results. One possible alternative is to devote or continue to devote resources to establish the mechanisms which have positive indirect effects on economic development. If this is the option, an important question to be addressed is whether building and strengthening these mechanisms or institutions is compatible with one-party rule in China. Only when this question is carefully analyzed will it be realistic to examine potential political reforms or options China may consider or choose. If it is politically feasible and economically necessary to establish or strengthen these mechanisms with indirect positive effects on economic development, the next task is to point out the necessary changes for further development of these mechanisms or institutions to be carried out. This section therefore will analyze how to establish or strengthen the mechanisms on the de?nition and protection of property rights including contract enforcement, on the establishment of a more ef?cient and liquid ?nancial market, on the improvement of rule of law, and on the enhancement of education under China’s political economy reality. Chapters 1 and 2 have assessed the role of formal law on contract enforcement in China’s economic development. Since the end of the 1970s, China has considerably

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liberalized or expanded people’s rights to establish business enterprises, choose their personal careers, consumption choices, and, to a lesser degree, mobility. These rights provide an ever-increasing scope for people to engage in various types of contractual activities. With the expansion of personal autonomy and the liberalization of the economy, people now have a great degree of freedom in entering into various types of commercial activities. Speci?cally, Chap. 2 has discussed the development of formal legal mechanisms to respond or adapt to China’s everincreasing demand for securing contractual expectation and solving contractual disputes. Chapter 3 has further examined the increasing capacity on the supply side to meet the ever-increasing demand for formal means of facilitating the expansion of contractual freedom. Chapter 4 has examined efforts made to improve the de?nition and protection of property rights, with a particular focus on the device of mortgage. Although the real property system in urban China is still not perfect, it has provided conditions for a functioning market. Further improvement can be made to solve the uncertainty as far as residential property of land-use right is concerned. There are only two feasible options. One is to provide automatic renewal of urban land-use rights for the same period of 70 years. Under this option, local governments may determine whether to charge a small land-use right fee at the time of renewal. The other option is to grant permanent property rights to urban residents. Under this option, local governments may decide to impose a property tax. While the ?rst option appears to provide governments greater room for future land allocation, the second option is more likely to gain popular support and therefore win legitimacy of the party-state ruling regime. With respect to property rights to land for commercial purposes in urban areas, a regime with permanent property rights subject to property tax is also far more desirable according to the criteria discussed in the previous section. If this option is not politically chosen, a land-use right system similar to the current system but with a longer term of 70–100 years is the next best option. Under greater security of property rights in land in urban areas and coupled with easy transferability of land property, there will be improvements both in personal autonomy and in social welfare. The recent Communist Party of China (CPC) Central Committee Decision on Some Important Issues Concerning Comprehensive and Deepening Reforms (Decision 2013), however, has not treated these crucial issues. While ownership of land in rural areas belongs to collective bodies, the current land system in rural areas is even less desirable. Farmers only have a lease right of using a very small piece of land for a limited period of 30 years. Given the density of population, the economic return from rural land will continue to keep farmers at a very low level of living. Lack of ownership right makes it impossible for farmers to transfer land. Non-transferability prevents land assets moving from less ef?cient use to more ef?cient use. In addition, lack of transferability makes it dif?cult to achieve economies of scale. Another consequence of lack of ownership in land on the part of farmers is the dif?culty of using land as mortgaged asset to secure loan obligations. This inef?cient consequence reduces incentives or possibilities of farmers to engage in commercial activities.

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The government seems to face a dilemma in granting farmers the ownership right and the right of transferability. First, granting the ownership right in land to farmers and permission of transferability of land in rural areas will result in the inequality of wealth in rural areas just as the move towards market-oriented economy in China has witnessed the increasing per capita income gap between urban and rural residents. Second, land reform to change the ownership system may affect the stability of the supply of some of the major rural products such as rice, wheat, cotton, etc. These products are of vital importance not only during peacetime but particularly during wartime. With the ease of restrictions on birth planning announced in the Decision (2013, Part 12, Article 46(3)), governmental control of land use in rural areas will remain tight. With respect to the ?rst concern, keeping farmers at a low level of living to deal with the potential problem of income inequality is not a desirable long-term governmental policy. Chinese people had experienced the equal but poor living standard for too long a period from 1949 to the end of the 1970s. Furthermore, maintaining equal but low level of living standard in rural areas will further increase the income per capita gap between residents in urban and rural areas. Land reform in rural areas with respect to ownership rights of land and transferability of land will greatly improve total welfare of farmers. Under a reformed regime, people are also more likely to make long-term investment in rural areas. Under the reformed system, those who are not interested in farming may sell their land and move into urban areas to seek employment. Under China’s urbanization program, these people are more likely to become better off. Other farmers who have the ability of specialization in using land will increase the scope of land ownership and greatly improve the ef?ciency of land use. When more people start to follow similar ways of doing things in learning by doing, the income gap between urban and rural residents will narrow. Moreover, the concern of growing income gap in rural areas may be eased by those who adopt the form of corporations in carrying out agricultural activities. Such corporations may employ people to engage in farming or other activities just as corporations in urban areas employ people to produce goods and provide services. Therefore, using corporations in rural areas is another way to improve ef?ciency and at the same time keep the income gap between people in rural areas at an acceptable level. To ensure the security of those who sell land and may fall into the category of poverty, local governments may impose a fee on land transfer transactions. While part of the fee may be used to maintain a basic functional registration system, a small part can be used as social security fund to provide those who may fall into the category of poverty due to unexpected problems of serious illness or accidents in life. As for the second concern, the issue can be addressed by governmental regulation during wartime if the need for such products including rice, wheat, and cotton is very urgent and great. Additionally, the government may also establish a reserve system for these and other strategic agricultural products. Reserved products may be used during wartime but may also be used during bad years. Still another measure to deal with the issue is to establish a future market for these important agricultural commodities.

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The above discussion shows that improving the system of property rights de?nition and protection and of contractual enforcement is unlikely to impose a threat to the ruling Communist Party such that the building and strengthening of the mechanism or institution of contract enforcement or property right protection is infeasible. To the contrary, the party-state ruling regime will be able to claim credit and legitimacy for such reforms. The recent Decision, however, still falls short of the reform suggestions provided in this section. This does not mean that there are no improvements. For instance, the Decision (2013, Part 3, Article 11) has speci?ed that rural collective operational construction land is now treated similarly as stateowned land, allowing greater autonomy for the rural collective body. Moreover, the Decision (2013, Part 6, Article 20(1)) has permitted the transferability of the lease right of land of individual farmers. The previous section has also examined the mechanism or institution of ?nancial market. While this mechanism or institution has been claimed to exert positive impacts on economic development, it is not necessarily true that only a democracy with a multiparty election system is compatible with a functional ?nancial market. A one-party system is equally able to establish an ef?cient ?nancial market to bene?t the economy. China has made enormous progress in improving the banking sector and in establishing a stock market to better allocate ?nancial resources since the end of the 1970s. As there is a very large body of literature on this point, this section will not provide any further treatment of China’s developing ?nancial market. What China can do is to make further changes to improve its ?nancial market. The key to reform change is to correct the misunderstanding that only a state-dominated ?nancial market is consistent with one-party rule. Under this misunderstanding, the current ?nancial market in China is defective. According to Allen and his colleagues (2005: 70), despite the favor received by state-owned enterprises (SOEs) in China’s banking sector and the stock market, the growth rates of industrial output and investment in ?xed assets by SOEs is much worse than those of private ?rms. Yu’s research (Yu 2004; Yu and Shao Li 2007) reveals that the political goal of controlling the stock market is also inconsistent with legal enforcement of takeover provisions and disclosure rules. If the party-state regime corrects this misunderstanding and keeps the role of the state legislative and regulatory agencies to the making and enforcing of rules and the executive to policy making, the ?nancial market in China will be more ef?cient. The party-state regime is better able to claim legitimacy for its efforts of building and strengthening the ?nancial market in China than the current way of governmental entanglement in the ?nancial market. In other words, an ef?cient ?nancial market can be compatible with a one-party regime just as well as it is compatible with a multiparty democracy. Unfortunately, the recent Decision (2013, Part 2) has not changed the role of the dominant position of state-owned sectors or enterprises in the economy. As for non-state-owned enterprises, their role is mainly con?ned to the establishment of small-and-medium sized banks and other ?nancial institutions (Decision 2013, Part 3, Article 12(1)). The issue of whether a rule of law regime can ?t well with a one-party rule is more complicated. Peerenboom (2002: 10) has the view that “a single party

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system is compatible with rule of law, albeit not a liberal version of rule of law.” Peerenboom (2002: 65), however, considers that “rule of law requires at minimum that the law impose meaningful limits on state actors, as re?ected in the notions of a government of laws, the supremacy of law, and the equality of all before the law.” Referring back to Fuller’s criteria adopted in the previous section, China still needs to make a great effort to ensure that law is enforceable. The criterion of enforceability goes far beyond the capability of a strong state to provide a legal order for the citizens. Obviously, clear de?nition and protection of property rights require a strong rule of law regime. A low-cost and ef?cient thirdparty regime of enforcing contracts also needs a strong rule of law system. The establishment of a liquid and ef?cient ?nancial market similarly has to be based on a strong rule of law system. Enforceability further requires the supremacy of law, which is binding on state actors. Supremacy of law does not object to the use of party disciplinary rules to punish party members whether in their capacity as party leaders or in their capacity in various governmental positions. Supremacy of law does require that party members in whatever capacity are also subject to law. If party members breach the law, they shall be penalized by law just as ordinary citizens. Using party rules as a regime to separate party or governmental of?cials from ordinary citizens reduces the legitimacy of the party-state regime. Enforceability also dictates that the hierarchy of law shall be followed. There are many examples of governmental agencies or local legislatures in China that use administrative rules or local laws to change or override the positions of higher-level laws (Clarke 1997: 9–15).4 When the hierarchy of law-making authorities clearly speci?ed in the constitution and/or the legislative law is not respected, people are not able to follow the law. Allowing lower-level law-making bodies to adopt positions different from the legal position stipulated in the higher-level law only creates chaos and encourages lawlessness. A better way is always to amend the higher-level law if it does not respond to societal political or economic changes well. Such an approach is more conducive to deliberative democracy, a topic to be thoroughly treated in the next chapter. In addition, enforceability of law demands equality of all before the law. From this perspective, China has to make great efforts in treating all persons, natural or legal alike, equally. Currently, state-owned enterprises enjoy privileges in different areas. These privileges range from more favorable access to low-cost ?nancial

Here are some further examples. The Ministry of Science and Technology, together with the State Administration for Industry and Commerce, issued a Notice in 1998, permitting the proportion of equity related to the results of science and technology to be greater than the 20 % limit on intellectual property rights in the 1993 Company Law. The Ministry of Science and Technology and several other ministries speci?cally raised the equity contribution related to the results of science and technology to 35 % in early 1999 before the national legislature formally amended the 1993 Company Law in 1999. When a court in Luo Yang City, He Nan Province, invalidated a local seed law on the ground of its contravention of a national seed law, the provincial legislature reacted strongly and put a great deal of pressure on the court, causing the dismissal of the relevant judges.

4

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resources, easier market access in establishing ?nancial enterprises such as banks and securities ?rms, to protected dominant market position in areas including telecommunications, ?nance, exploration of oil and natural resources, etc. The previous discussion has already pointed out the low ef?ciency of allocating ?nancial resources in the ?nancial market in favor of SOEs and the political dif?culty of enforcing securities regulation if maintaining the dominant position of SOEs on the ?nancial market is a political objective of the party-state regime. From a political perspective, the party-state regime may withdraw from the control of the market. If this is indeed the choice, China will be able to improve the ef?ciency of the ?nancial market. The ruling regime is able to claim credit and legitimacy for building a more ef?cient and liquid ?nancial market. A more dif?cult issue faced by the ruling party-state regime is the expansion of freedom of speech and freedom of the media under a rule of law system. A major concern of the Communist Party of China (CPC) is that a greater scope of freedom of speech and freedom of the media may weaken the ruling regime. Control of people’s freedom of speech and freedom of the media, however, gives the impression that the political regime is always fragile or unstable. A realistic solution is to use the constitution to maintain the rule of the CPC while carrying out further reform to strengthen the rule of law. Currently, the ruling position of CPC is speci?ed in the Preamble of the most recent constitution (2004). This ruling position is gained, pursuant to the Preamble, through the leadership of the CPC in the country’s socialist revolution and socialist construction in establishing a socialist nation. Naturally, Article 1 of the constitution stipulates that sabotage of the socialist system by any organization or individual is prohibited. As the CPC is not con?dent with a rule of law system, constitutional litigation in the judicial system either in ordinary courts or through a constitutional court does not exist in China. The speci?cation of the ruling position of CPC in the Preamble also makes it dif?cult to use judicial means to deal with concrete cases concerning the boundary of the legality of freedom of speech or of the media and illegal activities overthrowing the ruling regime. The experience of Germany provides a comparison. Due to its historical Nazi experience, Germany has chosen to establish a democratic and social federal state and makes that constitutional order non-amendable (Basic Law 2008: Articles 20 and 79). Unlike the constitution of China, the German Constitution is a functional constitution with the Federal Constitutional Court playing the leading role of interpreting and applying the constitution to deal with various constitutional disputes (Basic Law 2008: Article 93). If the CPC makes a bold political decision to expand the scope of freedom of speech and freedom of the media, it shall also consider amending the current constitution by adopting the following provision that “China is a socialist democratic state under the rule of the Communist Party of China. Amendment of such a constitutional order is in admissible. Actions of abolishing this constitutional order are illegal.” The current criminal law already has concrete provisions, supporting such a constitutional order. To have the constitution playing a functional role, China shall also consider establishing a constitutional court at the national level. A functional constitution enlarging the scope of people’s freedom of speech and freedom of the media will signi?cantly improve the existing institutions

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161

and make them more adaptable and endurable in the long run. While there will be dif?culties or challenges in moving along this line, the successful adjustment will greatly bene?t the ruling regime and enhance human dignity and freedom in China. A great progress made in the recent Decision (2013, Part 9, Article 30(1)) is emphasizing the importance of the constitution. Politics in China indicates, however, that it will take at least another 10 years to turn the constitution a potential functional one. After settling the issue on the proper role of the state in the establishment of various markets and in the construction of a strong rule of law system, China will be able to make great efforts in or devote more resources to providing public goods including the public good of education. As discussed in the previous section, the accumulation of human capital through education, on the job training, or learning by doing does not follow the law of diminishing return. Hence, strengthening education is crucial to ?rm’s utilization of human capital in the age of global competition. Compared with the case of rule of law, improvement of education does not impose any political challenge to the one-party rule. Emphasis on education is likely to bene?t the economy and increase the legitimacy of the party-state ruling regime. Compared with developed countries, China’s governmental spending on education accounts for a much smaller proportion of its GDP. While this proportion in most of the developed world is between 4.7 and 6 % (Hu and Tang 2010: 94–95), governmental spending on education in China remained at a low level of 3.04 % in 1990 to 3.83 % in 2011 (Percentage of Education Expenditure 2013). It took China virtually 20 years to realize the 1993 speci?ed goal that governmental spending on education shall reach four per cent of the national GDP (Ministry of Finance 2013). If China wants to make the best use of increasing return from education and ?rm innovation, it needs to further increase this proportion to at least 5 % rather than the 4.2 % to be realized in 2020 (Hu and Tang 2010: 81). In addition to the allocation of a very small proportion of governmental spending on education, Chinese governments at various levels have not devoted adequate resources to primary and secondary education. While university students accounted for only 10 % of all students in China in 2006, governments devoted 31.57 % of the total governmental spending to tertiary education (Hu and Tang 2010: 174). In contrast, primary and secondary students reached 80 % in total of all students, but governmental spending on primary and secondary education only accounted for 63 % of the total spending on education (Hu and Tang 2010: 174). It goes without saying that more resources are required for primary and secondary education in rural areas and for the education of children of migrant farmers who are employed in urban areas. The discussion in this section mainly focuses on the issue whether China is able to establish or strengthen the mechanisms on the de?nition and enforcement of property rights including contract enforcement, on the construction of an ef?cient and liquid ?nancial market, on the improvement of its rule of law system, and on the enhancement of education. The discussion has shown that China does not have any political challenge to devote more resources to enhancing education. If the success of economic reform in the past has liberalized human power in domestic and international trade along the line of utilizing comparative advantage in production

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and trade, China’s further realization of human resources depends critically upon the further accumulation of human capital through education and incentives for innovation. With respect to the establishment of a formal legal regime of better de?ning and protecting property rights, China does not have any political dif?culty strengthening the formal law and enforcement regimes. As a matter of fact, China has bene?ted enormously by building and adapting the capacity on the supply side to meet the ever-increasing need for dealing with contractual enforcement and property rights protection in very speci?c cases or transactions. What China should do is to further its process of reform in dealing with property rights on the land system both in rural areas and in urban areas. Related to property rights protection is the improvement of the ?nancial sector. In this area, the party-state needs to abandon the idea of controlling the market as a political goal of maintaining the dominance of SOEs. The party-state ruling regime is able to claim credit and legitimacy for building an ef?cient ?nancial market in the decades to come if the role of government is shifted to policy formulation, regulation of market failure or misconducts, and global cooperation. The strengthening of these two mechanisms also requires the improvement of its rule of law system. Obviously, the improvement of the mechanism of de?ning and protecting property rights and the strengthening of the ?nancial market requires the change of the rule of law system. The rule of law system, however, goes beyond the above two mechanisms. A functional rule of law system requires the protection of citizens’ constitutional right of freedom of speech and freedom of the media. Such constitutional rights further require that we should treat democracy as public reason. While it looks that the current party-state ruling may have dif?culty strengthening the protection of constitutional rights of freedom of speech and freedom of the media, the adoption of a regime of deliberative democracy (to be examined in the next chapter) is bene?cial to the ruling party at least during the next couple of decades. As China becomes more diversi?ed, the interest of the party itself may change. If this is indeed the case, China may still be able to consider in a couple of decades whether the form of democracy shall be limited to substantive deliberative democracy or also be extended to electoral democracy. On this point, I echo the view that democracy delayed is not likely to be democracy lost (Helliwell 1994: 246) as long as the Chinese government is still able to improve the mechanisms with indirect bene?ts on economic development. Furthermore, the route to democracy even in developed capitalist countries differed considerably and will certainly not be repeated elsewhere (Moore 1966: 5).

7.5 Conclusion
This chapter has examined the relationship between democracy and economic development. A very careful analysis of the existing literature has revealed that democracy in the form of competitive multiparty election of high-level legislative

References

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and executive of?cials does not have any direct positive impact on economic development. Despite this ?nding, scholars still argue that democracy has positive effects on economic development through other mechanisms indirectly. These mechanisms include protection of property rights and enforcement of contracts, ?nancial market, rule of law, and accumulation of human capital. Both theoretical analyses and empirical evidence support different claims that these mechanisms or institutions exert positive impact on economic development. The chapter then raises and directly deals with the question whether the establishment of these mechanisms or institutions is compatible with China’s one-party rule. Discussion of this chapter shows that except for the institution of rule of law related to political reform, China does not have any political dif?culty establishing or further strengthening these mechanisms or institutions claimed to have indirect positive impact on economic development. While China has done relatively well in the establishment of a rule of law system to support a market-oriented economy, building of a rule of law regime with expanded scopes of freedom of speech and freedom of the media requires constitutional amendments or adaptation in China. The author then analyzed the example of Germany and recommended that constitutional amendments to provide a socialist deliberative democracy under the rule of the CPC and to develop a national constitutional court will provide political room for the increase of freedom of speech and freedom of the media. While China will face dif?culties or challenges under the proposed political and legal reforms, the bene?ts of the reform of rule of law related to the political system are also considerable, just as the signi?cant bene?ts China has obtained in the area of reform of rule of law in supporting a market-oriented economy. As discussed previously, the recent Decision shows signs of emphasis on the role of the constitution although concrete measures still need to be worked out. The author leaves the discussion of the model of a broad-based substantive deliberative democracy to Chap. 8.

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