When the Deal Goes Sour: Contracting and Dispute Resolution in China’s Transitional Political Economy Susan Whiting University of Washington

When the Deal Goes Sour: Contracting and Dispute

Resolution in China’s Transitional Political Economy

Susan Whiting

University of Washington

Dramatic increase in economic court casesCases Accepted by Court of First Instance

Economic Civil Criminal1983 44,080 756,4361984 85,796 838,3071985 226,695 846,3911986 322,153 989,409 299,7201987 366,456 1,213,219 289,6141988 508,965 1,455,130 313,3061989 690,765 1,815,385 392,5641990 588,143 1,851,897 459,6561991 563,260 1,880,635 427,8401992 652,150 1,948,786 422,9911993 894,410 2,089,257 403,2671994 1,053,701 2,383,764 482,9271995 1,278,806 2,718,533 495,7411996 1,519,793 3,093,995 618,8261997 1,483,356 3,277,572 436,8941998 1,455,215 3,375,069 482,1641999 1,535,613 3,519,244 540,0082000 1,297,843 3,412,259 560,4322001 1,155,992 3,459,025 628,996

Avg growth 18.8 8.3 4.7

Source: Source: 全国人民法院司法统计历史资料汇编; 中国法律年鉴

Hypothesis:

In the rapidly changing context of China’s transition from socialism to the market,

• Both the informal networks in which firms are embedded

• and the bureaucratic structures by which firms are governed

• fail to provide adequate information and sanctions for the resolution of disputes,

• making the courts an increasingly important element in the process of dispute resolution

Why surprising and counter-intuitive based on existing literature?

• Social bases of contracting and dispute resolution

Contractual relations are grounded in informal social ties and not in legal rules and sanctions

• Chinese communities

—role of guanxi ( 关系 )

• Comparative studies

—role of informal social ties

Why surprising and counter-intuitive

based on existing literature? • Confucian tradition • Emphasis on harmony and mediation • CCP legacy • Official emphasis on mediation • Courts in China are problematic Courts suffer from a range of drawbacks • subordinate to the Communist party • incompetent judges • weak enforcement powers

Appears to be consistent with claims of Weber, North

• Weber, North:

Legal order offering stable and

predictable rights of property and contract

is prerequisite for sustained economic growth

• Here, focus on contracts• Whiting (2001) focuses on property rights

Study fills empirical gap

• “paucity of empirically based scholarship on the actual operation of the emerging legal system” (Pei, 2001)

Original data

• Representative sample of 76 purchase and sales contract disputes (1999-2001) from one district court in Nanjing

• Convenience sample survey with face-to-face interviews of 76 enterprise managers (2002-04) regarding contracting practices and dispute resolution

Additional data

• World Bank “Study of Competitiveness, Technology, and Firm Linkages”

• survey of 1500 enterprise managers (2000) with small battery of questions on contracting and dispute resolution

Summary of empirical findings

• Steady evolution of legal basis for market economy, improving legal recourse for private firms

• Contracting less grounded in social networks than expected

• Greater use of courts associated with • relative absence of alternatives and • growing supply of legal services, • themselves related to strategies of political legitimation for CCP: “rule of law” and economic performance

Implications for comparative political economy

• Law and economic growth:

• Legal order not a prerequisite for economic

growth, but conditions economic growth

• Relationship between institutions and culture:

• Institutions shape culture as much or more

than culture shapes institutions

Evolution of contract law

• Problematic elements of early contract regime: • private enterprises excluded • transactions controlled rather than fostered 1981 Economic Contract Law 1985 Foreign Economic Contract Law 1987 Technology Contract Law• Evolving contract regime better suited to market

economy 1993 Amended Economic Contract Law 1999 Contract Law (unified)

Changes reflected in court records (Nanjing district court 1999-2001)

Examples:

• Private enterprise

Plaintiffs in 34% of cases

Defendants in 36% of cases

• Oral contracts

Oral contracts in 46% of cases

Findings for plaintiffs 55% of these cases

MacCaulay (1963): “What good is contract law?”

Bases of contracting

• What does the available data tells us about the social basis of contractual relations?

• Zhou et al. (2003): Social networks (47%) and open information sources (47%) predominate

• Shanghai/Nanjing data: Professional ties predominate over social ones

Figure 1

How Firms Identify Suppliers (Shanghai and Nanjing)

41.4

12.9 11.4

10.0 8.6 8.6

5.7

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

Business associates Trade conferences Advertising Self-initiative Government contacts Friends Trade associations

Percent

Figure 2: How Firms Identify Customers (Shanghai and Nanjing)

42.9

21.4

18.6

14.3

11.410.0 10.0 10.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

Businessassociates

Competitors Trade conferences Advertising Trade associations Self-initiative Governmentcontacts

Friends

Identifying customers

Percent

Bases of contracting

• Few alternatives to social sources of information/monitoring to underpin contracting

• Not: government

• Not: trade associations

• Not: credit bureaux

• Result: managers scramble to evaluate customers’ creditworthiness

and

trustworthiness

Figure 3: Functions of Business Associations (Shanghai and Nanjing data, 2002-04, N=73)

83.0

10.6 8.5

4.3 4.3 2.1

8.5

27.7

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

Technical information

Supplier/client contacts

Introduce government

policy

Supplier/client credit

information

Dispute resolution

Government supervision

No service at all Other services

Percent

Functions of Business Associations(World Bank Data, 2000, N=816)

81.2

48.346.2

41.5

31.628.9

19.2 19.0 18.1

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

Mar

ket in

form

ation

Acces

s cre

dit

Repre

sent

View

s

Define

stan

dard

s

Accre

dit m

embe

rs

Stabil

ize C

ompe

tition

Acquir

e inp

uts

Resolv

e Disp

utes

Provid

e Tec

hnica

l Ass

istan

ce

Percent

Bases of contracting: credit bureaux

“China’s credit system is underdeveloped. There is no unified system for [evaluating] enterprise credit; there’s no way to investigate an individual manager’s creditworthiness ( 中国的信用制度不发达 , 没有一个统一的企业信用体系 , 无法考查某个经营者的信誉 ) (Interview with lawyer nj020925p).”


• 2001 State Council set up “Group for Enterprise and Personal Credit Investigation” to propose legislation governing credit evaluation agencies

• Only a few specially approved ones now exist• 2004 “Regulations for Managing Credit Evaluation

( 征信管理条例 )” still only in draft form• Draft regulations set high barriers to entry• Su Ning, Deputy Governor of PBoC: government control will be “quite strong”


• How do managers evaluate creditworthiness of potential customers:

• 9% credit evaluation agencies

• 15% banks

• 26% other suppliers of a potential client

• 39% other

(Shanghai/Nanjing data)


• 39% Other (from open-ended responses):

• Managers personally visit potential clients

3-5 times on average

• Restrict size of deals initially


• “We mainly look at a series of deals and ability to pay. Clients’ reputations develop; before we didn’t pay much attention to this and got burned. Now we’ve begun to pay attention…

( 主要看交易过程和付款能力 . 客户的信誉是动态的 , 以前我们不大注意这方面 , 吃过亏 ,现在开始注意了… (Enterprise Interview #61).”

–this firm previously relied on state purchasing meetings ( 订货会 )

Contract formality

• Formal written contract provisions for specifying volume, quality, price, deadlines, and contractual safeguards are the norm

• Shanghai/Nanjing data: 90.5% of contracts with suppliers98.6% of contracts with customers

• World Bank data:82.2% of contracts with suppliers

90.1% of contracts with customers

Summary: Bases of contracting

• Deals are less grounded in pre-existing social ties than expected

• Yet, there are few good institutional alternatives to social networks for gathering information about potential customers

• Use of formal, written contracts is the norm

Disputes and dispute resolution

In the year 2000,

• 31.1% of firms had one or more “major dispute” with clients

• 21.9% had one or more “major dispute” with suppliers

(World Bank dataset)

Dispute resolution: self-enforcement

• Self-enforcing contracts(long-term cooperative solution based on anticipated value of future contracts)

• “If a client is very late with payment, we stop (shipments of) goods ( 如果超过了信用期 , 我们就停货 ) (Enterprise interview #39) • 90.6% of firms: end long-term reciprocal relations in event of serious dispute (Shanghai/Nanjing data)


• Self-enforcing contracts (long-term cooperative solution based on

anticipated value of future contracts) • Length of contractual relations: average: 7.5 years median: 5.5 years• Reputation 74.2% of firms said: other businesses would know if a dispute arose with supplier or client(Shanghai/Nanjing data)

Figure 5: Average Length of Business Relationship with Main Clients

(World Bank Data, 2000, N=1499)

8.5

12.7

16.8

12.8

49.2

0

10

20

30

40

50

60

< 1 Year 1-2 Years 2-3 Years 3-4 Years 4+ Years

Percent

Figure 5b: Average Length of Business Relationship with Major Suppliers

(World Bank Data, 2000, N=1473)

10 11.7

16.8 14.9

46.4

0

5

10

15

20

25

30

35

40

45

50

< 1 Year 1-2 Years 2-3 Years 3-4 Years 4+ Years

Percent


• Self-enforcing contracts

• Partial pre-payment

• 28% of firms require pre-payment

• range of contractual terms for these firms:

30% in advance

40-60% upon delivery

10-30% within thirty days


Dispute resolution

• Direct negotiation

• Mediation

• Arbitration

• Litigation

• Gang enforcement

Figure 6: Choice of Dispute Resolution Mechanism (Shanghai and Nanjing data, 2002-04, N=69)

92.8

11.8

17.6

47.8

2.9

0

10

20

30

40

50

60

70

80

90

100

Direct negotiation Mediation Arbitration Litigation Gang enforcement

Percent

Figure 7: Final Resolution of Disputes with Clients

(Percent using given mechanism in at least one dispute, World Bank Data, 2000, N=459)

87.1

12.0

38.8

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

Negotiation Arbitration Litigation

Percent

Figure 8: Final Resolution of Disputes with Suppliers

(Percent using given mechanism in at least one dispute, World Bank Data, 2000, N=336)

93.2

12.5

29.8

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

Negotiation Arbitration Litigation

Percent

Dispute resolution: negotiation

• Direct negotiation

“No matter what firm or what dispute, enterprises’ first [step] is direct negotiation. On the one hand, [this approach] minimizes costs, and, on the other hand, it maintains good relations ( 不管是什么企业 , 什么纠纷 , 企业首先的肯定是协商 . 一方面可以节约成本 , 另一方面还可以保持好的关系 ) (Interview with lawyer nj020935p).”

Dispute resolution: mediation

• Most striking finding: apparent lack of appropriate third parties

Figure 9: Third Parties in the Mediation of Disputes (Shanghai and Nanjing data, 2002-04, N=56)

3.6

8.9

5.4

0.0 0.0

14.3

26.8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Central government Local government Particular government bureau

Bank Trade association Other No third party

Percent

Dispute resolution: arbitration

• Only 17.6% of firms use arbitration• Arbitration Law—1995• Nanjing Arbitration Commission not even

established until 1998• Comments like “Where is there an arbitration

commission? ( 哪儿有仲裁委员会 )? (Enterprise interview #16)” are common.

• First 5 years nationwide: 3,400 cases per year on average arbitrated; compared to 1.3 million litigated

• Concerns about lack of appeal, enforcement

Shanghai Arbitration Commission

Number of cases

Total Value of

Contracts in Dispute

(10,000 rmb)

Average Value of

Contracts in Dispute (rmb)

1998 189 27180 1,438,1091999 253 58570 2,315,0242000 341 36400 1,067,4492001 431 72030 1,671,2302002 479 57879 1,208,3302003 649 128833 1,985,100

Avg Growth 22.8 29.6 5.5

Economic Contract Disputes Handled in the Court of First Instance

Number of Cases

Accepted

Total Value of


(10,000 rmb)

Average Value of


(rmb)

Change in Average

Value

Change in Number of

Cases Accepted

1983 36,274 171,055 51,5411984 69,204 149,659 24,443 -52.6 90.81985 206,582 897,804 48,611 98.9 198.51986 292,599 788,339 28,144 -42.1 41.61987 332,496 814,621 24,552 -12.8 13.61988 467,872 1,110,392 25,033 2.0 40.71989 634,941 1,935,130 31,426 25.5 35.71990 543,613 1,731,293 31,277 -0.5 -14.41991 516,507 1,987,858 37,101 18.6 -5.01992 598,610 2,970,257 49,878 34.4 15.91993 824,448 6,342,211 77,834 56.0 37.71994 971,432 9,727,423 100,875 29.6 17.81995 1,184,377 14,830,833 125,865 24.8 21.91996 1,404,921 21,406,425 153,641 22.1 18.61997 1,373,355 26,303,090 192,336 25.2 -2.21998 1,329,020 41,343,216 310,167 61.3 -3.21999 1,410,107 n/a n/a n/a 6.12000 1,184,613 n/a n/a n/a -16.02001 1,062,302 n/a n/a n/a -10.3

Source: 全国人民法院司法统计历史资料汇编 1949-1998 (民事部分)

Dispute resolution: litigation

• 36.8% of firms used the courts in their most recent dispute


Supply of legal services

• 91.6% of firms had legal representation


Expansion of Legal Education and Legal ProfessionalsGraduates at the Bachelor's Level

Philosophy Economics Law Education Literature History Sciences Engineering Agriculture Medicine Total

Law Share

(%)1994 2117 80981 17650 35234 92928 16794 87845 228922 27856 47090 637417 2.81995 2110 119042 23170 41898 115969 18117 100566 295839 32975 55711 805397 2.91996 1960 127018 25852 40620 120051 16423 97260 315005 33032 61417 838638 3.11997 1183 132988 28270 39595 116115 14559 90513 314418 30190 61239 829070 3.41998 1183 132900 29649 40716 119583 14179 92729 308574 28941 61379 829833 3.61999 1067 134258 31500 40271 120957 13374 90395 326180 28070 61545 847617 3.72000 916 159299 44124 42052 146997 13661 98200 354291 30370 59857 949767 4.6

Avg Growth -11.3 10.1 14.0 2.6 6.8 -2.9 1.6 6.4 1.2 3.5 5.9

Graduates at the Master's and Doctorate Levels

Philosophy Economics Law Education Literature History Sciences Engineering Agriculture Medicine Total

Law Share

(%)1994 454 1967 1296 540 1575 506 5521 12463 945 2780 28047 4.61995 460 2165 1370 577 1607 593 6039 14675 1111 3280 31877 4.31996 581 3666 1864 736 2228 745 6646 17621 1418 4144 39649 4.71997 664 4988 2258 902 2584 926 7625 19918 1788 4886 46539 4.91998 659 4740 2385 893 2795 859 7473 20681 1715 4877 47077 5.11999 649 6302 3257 1008 3310 970 8251 23369 1949 5605 54670 6.02000 775 7308 3820 1221 3714 1026 8077 24378 2282 6166 58767 6.5

Avg Growth 7.9 20.6 16.7 12.4 13.0 10.6 5.6 10.1 13.4 12.1 11.1

Sources: 中国科技统计年鉴 China Statistical Yearbook on Science and Technology (Beijing: China Statistics Press, 2000), p. 9; 中国教育统计年鉴 Educational Statistics Yearbook of China (Beijing: People's Education Press, 2001), pp. 28, 40.

Supply of Legal ServicesYear Law Firms Lawyers Law Firms Lawyers

(Units) (Individuals) (% Increase) (% Increase)1997 8441 989021998 8946 101220 6.0 2.31999 9144 111433 2.2 10.12000 9541 117260 4.3 5.22001 10225 122585 7.2 4.52002 10873 136684 6.3 11.5

Avg Growth 4.3 5.5Source: 中国法律年鉴 (2002:1253; 2003:1335).


• Credible threat to use court leads parties to bargain “in the shadow of the law” (Cases withdrawn increased from 8% to 21%)

• Litigants seek authoritative ( 有权威性的 ) resolution of dispute (Enterprise interview nj021127p; judge interview sh040817p) (Cases decided increased from 5% to 44%)

Economic Contract Disputes (Domestic)

Mediated by Court

Decided by Court

Transferred to Relevant

Bureau Withdrawn Other Total1983 79.3 5.5 4.2 8.5 2.4 100.01984 80.6 5.6 3.2 8.7 1.9 100.01985 81.8 5.7 3.1 8.5 0.9 100.01986 79.6 7.5 3.9 8.2 0.8 100.01987 77.3 9.5 2.8 9.6 0.8 100.01988 80.2 8.6 1.9 8.8 0.5 100.01989 76.8 10.5 2.0 10.2 0.5 100.01990 69.5 14.7 2.1 13.0 0.7 100.01991 61.6 20.0 2.2 14.7 1.5 100.01992 61.7 20.8 1.6 14.8 1.1 100.01993 63.1 19.5 1.5 14.9 1.0 100.01994 60.0 20.8 1.5 16.8 0.9 100.01995 57.7 22.1 1.3 17.9 0.9 100.01996 53.7 25.5 1.3 18.4 1.1 100.01997 49.9 29.1 1.5 18.3 1.3 100.01998 43.2 34.6 1.4 18.8 2.0 100.01999 41.3 35.5 0.0 19.3 3.1 100.02000 34.6 40.3 0.0 20.7 4.5 100.02001 30.8 43.8 0.0 21.3 4.1 100.0

Source: 全国人民法院司法统计历史资料汇编 1949-1998 (民事部分) 北京：人民法院出版社, 2000).


• Court-sponsored mediation has been locus of government interference (Potter 1992)

(Cases mediated by courts declined from 80% to 31%)

• Respondents feel that interference in judgments in contract disputes is low



• About 60% of judgments enforced (details from Nanjing court data)

• Government interference in contract disputes, when it occurs, occurs more often during enforcement

• Interference most common when enforcement of judgment would lead to financial difficulties resulting in lay-offs of employees

Attitudes toward business and legal systems

• Attitude toward: legal business

system people

High/very high 18.3% 4.1%

Average 56.3% 42.9%

Low/very low 25.3% 53.0%



• Attitude toward legal system “It’s better than it was before, and in the future it

will definitely be good; we’ve entered the WTO. The effectiveness of the courts is okay; in Nanjing, we’re fairly satisfied with the fairness. When companies do business they consider legal factors relatively often ( 比以前好 , 以后也肯定好 , 我们假如 . 法院的效率还可以 , 在南京么 , 公正性方面我们都搞定了 . 公司在做业务的时候考虑法律因素比较多 ). (Enterprise interview #39)


• Attitude toward business people “There’s no trust to speak of. The Cultural

Revolution destroyed the normal relations between people; there’s no more mutual trust. Under the planned economy, one wouldn’t even call it trust; just irresponsibility. The situation of trust is pretty bad. ( 没有信用可言 . 文革打破了人与人之间正常的关系 , 不再相互信任 . 计划经济时期那不叫信用 , 是不负责任 . 信用状况很差 ). (Enterprise interview #39)

Conclusion 1: law and economic growth

• Contra Weber and North • well functioning legal institutions

—not a prerequisite for growth• but absence of well functioning legal institutions—does limit growth

(Recall examples from legal regime for contracts during 1980s)

Conclusion 2: bases of contracting

• Contracts are often not grounded in pre-existing social networks

• But, rather, occur at arm’s length

Conclusion 3: role of courts

With respect to contract disputes,

• Institutional alternatives to the courts are unavailable or underdeveloped

• Courts are neither as completely flawed as they have been portrayed,

• nor are disputants as non-litigious as they have been portrayed

Conclusion 4: comparative institutions

• Comparative context:• “Myth of the reluctant litigant”

• Japan (Haley 1978)

• Taiwan (Winn 1994)

• Korea (Park 1997)

• Why “myth”?

• Reject non-litigious culture

• Highlight institutional incapacity

Conclusion 4: comparative institutions

• Contrast China: rapid development of institutional capacity at earlier stage of economic development

• Korea (2002) per cap income US$ 11,280

• China (2002) per cap income US$ 960

• Korea (2002) per cap lawyers 9,383

• China (2002) per cap lawyers 9,510

Conclusion 5: “rule of law” and legitimation

• Why rapidly develop institutional capacity? • “Rule of law” new element in CCP’s legitimation

strategy • 1999 Constitutional amendment: “The People’s

Republic of China exercises the rule of law, building a socialist country governed according to law.”

• Complements early reliance on economic performance in legitimation strategy

•“Rule of law” to gain benefits of market economy and deepen links to international economy

Conclusion 5: limits to “rule of law” and legitimation

• Instrumental approach to “rule of law” • Contract disputes among most common and least

politically sensitive • no direct spillover to other legal arenas • When contract disputes do become politically

sensitive (e.g. may lead to lay-offs, unemployment)

• “rule of law” does not always hold sway

Documents

When the Deal Goes Sour: Contracting and Dispute Resolution in China’s Transitional Political Economy Susan Whiting University of Washington