Legal Informality and Human Capital Development in China

Legal informality is widespread in China. SOEs tend to enter into substantial contracts with a high level of vagueness and lack of specificity. Moreover, regulators interact with enterprises and market intermediaries in an informal and off-the-record fashion. Such legal informality may have contributed to China’s past economic growth by reducing transaction costs in contracting and administrative costs in regulation, because the entities involved could be viewed as vertically integrated in terms of risk and loss sharing. However, China’s economic development has reached the stage where the state can no longer internalize the potential losses resulting from transactions and regulation. The chapter explores the thesis with the following examples: (1) sales of NPLs by state-owned banks to state-owned asset management companies (AMCs); (2) advances of loans by state-owned banks to the government’s LSAs secured with LSMs, and (3) a comparison of the regulatory approval process for IPOs in mainland China and Hong Kong.