ARTICLES WHAT'S LAW GOT TO DO WITH IT? LEGAL INSTITUTIONS AND ECONOMIC REFORM IN CHINA Donald C. Clarke* TABLE OF CONTENTS I. INTRODUCTION ................................. 2 II. BACKGROUND TO REFORM .................... 4 A. Economic Reform in China ...................... 4 B. Center Versus Region in the Chinese Polity ....... 13 III. THE ROLE OF LAW IN ECONOMIC REFORM.. 15 A. What's So Special About Legal Rules? ........... 15 B. Institutionsfor Making and Enforcing Rules ..... 17 IV. CHARACTERISTICS OF LEGAL RULES ......... 23 A. Who Is Supposed to "Obey" the Rule? ........... 23 B. Who Promulgated the Rule and How Authoritative Is It? ........................................... 26 C. Who Is to Enforce the Rule and How? ........... 30 D. Can the Rule Really Be Enforced?............... 33 Assistant Professor of Law, University of Washington School of Law. Princeton University, A.B., 1977; School of Oriental and African Studies, University of London, M.Sc., 1983; Harvard Law School, J.D., 1987. This Article began as a paper written as part of an American-European-Chinese joint project researching reforms in the ownership system of Chinese state-owned enter- prises. The project is supported by the Ford Foundation and the Institute of Economics of the Chinese Academy of Social Sciences. Citations in the footnotes make apparent but understate my debt to Barry Naughton of the University of California at San Diego for my understanding of the Chinese economy. I also wish to thank Cyril Lin of St. Anthony's College, Oxford, for having brought me into the project. I am grateful to William Alford, Jerome Cohen, John Haley, Nicholas Lardy, Frank Upham, and Louis Wolcher for their attentive reading of earlier drafts and their detailed comments. Re- maining errors are mine alone. Finally, I wish to thank the staff of the University of Washington Law Library, and particularly Mary Whisner, for the extraordinary level of research support provided as part of a day's work. PACIFIC BASIN LAW JOURNAL [Vol. 10:1 V. EFFECTIVENESS OF PARTICULAR RULES: THREE CASE STUDIES ........................... 36 A. The Right to Resist Exactions (tanpai) ........... 37 B. The Right to Hire and Fire Employees ........... 43 C Bankruptcy Legislation .......................... 51 D. Sum m ary ...................................... 55 VI. RELEVANT INSTITUTIONAL FEATURES OF CHINESE SOCIETY ............................... 57 A. The Weakness of Courts ......................... 57 B. The Role of the Enterprise'sAdministrative Superior ........................................ 69 C. Sum m ary ....................................... 71 VII. CONCLUSION ..................................... 74 Ruling a big country is like cooking a small fish.' I. INTRODUCTION The dramatic autumn of 1989 in Eastern Europe showed that real political change can come with astonishing rapidity. Yet re- ports of the death of state socialism are greatly exaggerated. While the political .structure may be withering, the economic institutions have proved much hardier. Governments in one country after an- other have discovered that the transition from a largely planned economy to a largely market economy is an enormously complex and painful process, and democratic political institutions do not 2 necessarily make it any easier. How far economic reform can go in the absence of political and other institutional reforms is still an open question. For political reform, and especially legal reform, bears crucially on the means available for attaining the ends of economic reform. From China to Czechoslovakia, the currently and recently socialist countries face many similar problems in their efforts at economic reform. Yet their attitudes toward political and legal reform are quite different. This Article is an effort to explore in one country the interaction between policies of economic reform and the political and legal in- stitutions that are available to implement those policies. 1. LAO Tzu, ch. 60, translatedin WING-TSIT CHAN, A SOURCE BOOK IN CHI- NESE PHILOSOPHY 168 (1963). 2. The sharp distinction sometimes drawn between "planned" economies and "market" economies is, of course, false. Many of the so-called planned economies have significant non-planned sectors, such as agriculture in Poland. In the United States, on the other hand, agricultural markets are subject to significant government intervention. Nevertheless, there is a difference between an economy where a few state-owned institu- tions must do most of their buying and selling at market prices and an economy where a few non-state actors must operate in a world of fixed prices bearing little relation to supply and demand. 1991] ECONOMIC REFORM IN CHINA In 1978, the People's Republic of China (PRC) began a major program of economic reform. The reforms were prompted by dis- satisfaction with the results of the traditional system of collectivized agriculture and planned industry and commerce. Their essential aim was the devolution of economic decision making power from higher to lower level governmental bodies and, in some cases, the transfer of such power out of the bureaucratic hierarchy altogether. So far, most scholarly analysis has been concerned with the con- tents of reform policies. Yet the means available to the government to effect these policies have been less well studied. 3 The most en- lightened policies are useless if for some reason they cannot be implemented. It is no accident that the period of reform has coincided with the period of "legalization": the effort by the government to en- hance the role of law and legal institutions in Chinese society. In- deed, a primary vehicle for reform has been the promulgation of a series of statutes and regulations prescribing the means by which economic change is to be effectuated. Yet passing laws is not enough. Statutes can be effective only within an appropriate institu- tional framework. Where that framework does not exist, statutes and the policies they embody will wither and die. This Article is a study of the use of law and legal institutions to effect industrial reform in China. It argues that the content of re- form policy is inseparable from the vehicle in which it is expressed. While law is often in principle the most appropriate vehicle for re- form policies, the effectiveness of particular statutes and regulations is compromised by the institutional environment in which they must operate. Without a fundamental reform of the legal system, which in many ways has yet to be accomplished, thorough indus- trial reform cannot be achieved. Part II of this Article presents some necessary background for the non-China specialist. It introduces the planning system, eco- nomic reform, the state-owned industrial enterprise, and the con- cept of the soft budget constraint. It also introduces a major organizing theme of the Article: the conflict between the central government and local authorities. Part III discusses the role of law in economic reform. It con- siders various possible approaches to policy implementation and the reasons why the government has stressed the role of legal institu- tions. This part then provides an overview of legal institutions in the PRC, looking at the formal structure of the state, various law- making bodies, and the courts, as well as informal elements of their functioning. 3. One excellent collection of studies is POLICY IMPLEMENTATION IN POST-MAO CHINA (D. Lampton ed. 1987). PACIFIC BASIN LAW JOURNAL [Vol. 10:1 Part IV sets the stage for the consideration of particular rules that attempt to further policies of reform. Proceeding from the as- sumption that not all rules will be equally effective, I propose a set of questions that could be asked about any rule. The hypothesis of Part IV is that to the extent we can answer these questions, we can predict the effectiveness of a rule. In Part V, I use case studies to make concrete the sometimes abstract ideas presented in Part IV. This Part examines rules for- bidding the unauthorized levying of fees on enterprises by local gov- ernments, rules purporting to give enterprise managers wide powers to hire and fire enterprise personnel, and rules providing that loss- making enterprises should go out of business. While Part V looks at rules themselves, Part VI takes a closer look at the key institutions involved in the implementation of legal rules designed to affect enterprise behavior: courts and the enter- prise's administrative superior. It argues that neither is well suited to enforce legal rules. Part VII reviews the connection between form and substance in reform policy and asserts that the failure to reform the legal sys- tem in certain necessary ways can fatally compromise the effective- ness of laws designed to implement reform. II. BACKGROUND TO REFORM A. Economic Reform in China Economic reform in China dates from the watershed Third Plenum of the 1 th Central Committee of the Chinese Communist Party (CCP) held in December, 1978. 4 There the CCP announced that the central focus of its work would shift from class struggle to economic development. 5 In the rural sector, the expansion of free markets for agricul- system have tural produce and the introduction of the responsibility 6 for all practical purposes done away with collectivized agriculture. 4. For an excellent and often-cited collection of articles on Chinese reforms in general, see THE POLITICAL ECONOMY OF REFORM IN POST-MAO CHINA (E. Perry & C. Wong eds. 1985). See also Perkins, The Prospectsfor China's Economic Reforms, in MODERNIZING