The following guest post is the first part of an occasional series on the anti-corruption campaign in China. The authors are resident in the Hong Kong office of Dorsey & Whitney LLP. SECactions welcomes submissions from other interested authors. This article originally appeared in the Financial Fraud Law Report.
By David Richardson and Alesya Tepikina*
This article focuses on the social practices which allow corruption to thrive in China, and on economic reforms (and a developing legal system) which could reign in such corruption.
“I have seen corruption boil and bubble Till it o’er-run the stew.”—William Shakespeare, MEASURE FOR MEASURE
Corruption in the People’s Republic of China presents a major administrative and financial burden on businesses operating in China and creates an unfavorable business environment (by undermining the operational efficiency of businesses and raising the costs and risks associated with doing business in China). 1 As noted by some researchers, corruption is so widespread in China that it has become a norm, an unwritten law, and a way of living. 2 Corruption threatens the vitality and international credibility of China’s emerging new economy. 3 Out of 2,700 firms surveyed from November 2011 through March 2013, 19.2 percent reported that they were expected to give gifts to obtain import licenses, 18.8 percent said they were expected to give gifts to obtain construction permits, 10.9 percent reported they were expected to give gifts to tax inspectors and 10.7 percent said they were expected to give gifts to public officials “to get things done.” 4 Bribery incidence (i.e., a percentage of firms that experienced at least one bribe payment request) was 11.6 percent and bribery depth (i.e., a percentage of public transactions where a gift or informal payment was requested) was 9.9 percent. 5
Since President Xi Jinping announced a crackdown on corruption among government officials in China in November 2012, multiple anti-graft and anti-extravagance regulations have been passed by government agencies at the central and local levels. The regulations allowed the Xi administration to single out officials for punishment, starting at the local level and moving up the ranks of party hierarchy.This article focuses on the social practices which allow corruption to thrive in China, and on economic reforms (and a developing legal system) which could reign in such corruption.
Extent of Corruption
In 2013, the Transparency International’s Corruption Perceptions Index (the “Index”), which ranks countries based on the perception of corruption in their public sector, ranked China at 40, 6 placing it in the 80th place out of 175 countries surveyed, on a par with Greece. China was ranked less corrupt than El Salvador, Jamaica, Panama, Russia, and Peru, but more corrupt than Brazil and more developed countries. 7 Over the past 14 years, China’s rank remained at the lower range of the Index. For example, in 2008, China was ranked at 3.6 (on a scale of 0–10 used by the Index at that time), placing it in the 70th place out of 163 countries surveyed, and in 2000, China was ranked at 3.1, placing it in the 63rd place out of 90 countries surveyed. China historically ranked less corrupt than India, Russia, and Venezuela, but more corrupt than Zambia, Colombia, Mexico, Ghana, and South Korea.
As elsewhere, power over transactions and wealth in China appears to lead inevitably to corruption and corrupting behavior, or, in the words of Lord Acton, “power tends to corrupt and absolute power corrupts absolutely.” 8 These words seem to apply perfectly to China, where the Communist Party has had a monopolistic power on politics and economics of the country for a prolonged period of time. 9 In China, as is often the case elsewhere, corruption is also a consequence of deeper stresses and changes. Underlying corruption is a growing tension between new policies and economic realities on the one hand, and traditional values, customs and established political system on the other, in the context of a political and institutional framework poorly-suited to handle such tension.
Understanding the characteristics and reasons underlying corruption in traditionalChina is crucial to comprehending the nature of the relationship between politics and economics in contemporary China, and to envisioning the future direction of reforms. As described by some researchers, “post-reform corruption is a complex mixture of universal, transitional socialist and unique Chinese characteristics in its origins, consequences, as well as definitions.” 10
Definition and Characteristics of Corruption
One of the most general definitions of corruption, which seems to apply to China as well, describes it as ultimately “the use of public office for private gain.” 11 It is also commonly understood as “behavior which deviates from the formal duties of a public role because of private-regarding (personal, close family, private clique) pecuniary or status gains; or violates rules against the exercise of certain types of private regarding behavior.” 12 Corruption can be characterized by the following features:
• Power exploited for personal gain which includes monetary and nonmonetary rewards;
• An implicit contract concluded via a specific transaction, i.e. the transference of property rights, which because of its illegality is not subject to any officially legitimized institutional executive or sanctioning instance; and
• At least two economic subjects interacting in the above transference of property right; this explicitly excludes the theft or embezzlement of state property as well as influencing of the political process to preserve power.
Corruption has deep roots and a long history in China. To understand the phenomenon of corruption as it applies to contemporary China, the historical role of patron-client and instrumental-personal ties in traditional China must first be analyzed.
The spread of corruption in traditional China is often connected to the Confucian concept of renzhi, or “government of the people,” as opposed to “government of the law.” Chinese social behavior leading to corruption can be partly understood in terms of the hierarchical roles taught by Confucianism. 13 These roles dictate the obligations an individual has in five cardinal relationships. Among them is the filial responsibility of son toward father, which is the template for other hierarchical relationships in the system of Confucian ethics, such as that of subject-to-emperor and student-to-teacher. 14 This hierarchical system of ethics was transplanted into the workplace, where it became the basis of a pervasive “organized dependency” of society upon the communist state. 15 It evolved into an unofficial method utilized by workers to secure access to scarce goods and services (e.g., food, housing, or admission to schools) which were selectively distributed by shop officials. As benefits and resources were allocated directly by the planning bureaucracy in factories, workers relied on an informal “natural economy” of personal connections based on the exchange of gifts and favors in order to build privileged interactions with the gatekeepers who controlled them: factory officials. 16
Traditional Confucian values also emphasize consensus, lasting authority and clearly-defined personal relationships, a unity of state and society, and a socially encompassing moral order. These values led to social and cultural practices based on the extended personal-exchange and patron-client relationships encompassed by the term guanxi, which means interpersonal connections in order to secure favors in personal relations. 17
Guanxi networks can be seen as institutions that arose centuries ago to secure trade relations in an environment that was only insufficiently covered by the legal system. 18 An individual was able to expand his radius of economic relations, backed up by guanxi networks, to include various networks each with different resources. 19 A targeted expansion of an individual’s network to a counterparty which was regarded as useful for the pursuit of common interests could also be achieved by the giving of a gift or service. By accepting the gift or service, the counterparty obligated itself to perform an undefined reciprocal service at an unspecified time in the future. In this way, an implicit contract was concluded the fulfillment of which was linked to the particular network. 20
Guanxi networks can also be seen as clubs that guarantee their members the enforceability of available property rights in an institutionally disorderly environment, thus lowering transaction costs. 21 To a certain extent, guanxi networks through personal connections and cooperation over a long period acted as a substitute for the market and the legal-institutional environment that supported it. 22 At a later stage, connections served as a coordinating mechanism that allowed for a more efficient allocation of shortage goods than that provided by the fissures and fault lines of the communist economy. “This pattern is the result of structural features common to all communist factories: the workers’ economic dependence on the enterprise; political shop officials over promotion, pay, direct distributions, and sociopolitical services.” 23
Developed over centuries, guanxi networks were strongly anchored in traditional China and had an important function not only on an economic, but also on a political and social, level. They are still a factor in numerous areas in contemporary China, and virtually every Chinese person is connected to at least one guanxi network. 24 As noted by some researchers, guanxi networks stood in an antagonistic relationship to the Western system of legal rights. 25 In the West, Christianity combined with pre-existing institutions to produce clear jurisdictional lines of top-down personalized authority. In the economic sphere, this led to legal definitions of property and ownership. Chinese institutions, however, rested on relationships and not jurisdictions, on obedience to one’s own roles and not on bureaucratic command structures. “Both jurisdictional principles and the autonomous individuals are historically absent in the Chinese worldview, and thus were not incorporated in Chinese institutions. Instead, Chinese society consists of networks of people whose actions are oriented by normative social relationships.” 26
Guanxi Networks and Economic Reforms in China
With the advent of the “open-door policy” in China in 1978 and the subsequent reform period, guanxi networks underwent a gradual but substantial transformation from vertical relationships between officials and the rank and file to vertical relationships between officials and business. This change was brought about by the introduction of a market economy that was permitted to run in parallel with the old command economic mode. Following the implementation of the dual-track system, old central-administrative mechanisms were abandoned, often without putting in place new market-oriented substitutes capable of governing the transition. In this new hybrid system, the coexistence of guanxi networks and an emerging product market blurred the limits between regular economic transactions and corruption. 27 To a certain extent, guanxi networks advanced development of division of labor in the economic process and development in Chinese society over the centuries, and existed as complementary and parallel mechanisms for orderly economic interaction. In the reform period, organization of economic activities by guanxi networks regained Guanxi networks created governance structures that forced contract-honoring behavior of the transaction partners, analogous to vertical integration solutions. 29 Guanxi networks thus managed to provide an infrastructure in which the transactionpartners could safeguard themselves from the ex post opportunismof one side. For some time, guanxi networks appeared to be an efficient and transaction-cost-lowering coordination mechanism for regulating transactions in an environment characterized by high institutional uncertainty. 30
The reforms were aimed at the dissolution of established, central-administrative orderly mechanisms and development of the legal system. However, the first contract law did not take effect until July 1982, four years after the reform period had begun. The law was still strongly bound to the old central administrative system and quickly came into contradiction with subsequent laws and decrees, but was not revised until1993. A comprehensive contract law only came into effect in October 1999. Even more problematic than this delayed enactment of laws was the poor enforcement of the existing laws mainly due to the administrative interventions and insufficient training of the officials enforcing the law. 31
The continuing liberalization of the Chinese economy requires a developed legal system which would provide a well framed regulatory and institutional framework for regulating financial and commercial transactions, testing them against principles of anti-corruption and offering legal security at a supra-individual level beyond social relationships. Such legal system would remove uncertainty as to enforcement of contractual rights and would therefore eliminate reliance on guanxi networks to safeguard transactions. However, transaction partners would need to regard such legal system as performing more effectively than guanxi networks before they could view it as preferable for regulating transactions. In addition, as noted by some researchers, pressure by political decision-makers would be required in order for the legal system to displace guanxi networks. 32 Thereafter, as transaction costs for corrupt transactions would increase, guanxi networks would gradually lose importance and ultimately disappear, and incidences of corruption would decline.
1 According to the Enterprise Surveys conducted by the World Bank,http://www.enterprisesurveys.org/~/media/GIAWB/EnterpriseSurveys/Documents/Profiles/English/china-2012.pdf.
4 http://www.enterprisesurveys.org/~/media/GIAWB/EnterpriseSurveys/Documents/Profiles/English/china-2012.pdf; http://www.enterprisesurveys.org/Data/ExploreEconomies/2012/china#
6 The Index ranks countries on a scale of 0 – 100, where 0 means that the public sector of a country is perceived as very corrupt and 100 means it is perceived as very clean.
8 Comment of Lord Acton (1834-1902) in a letter to Bishop Mandell Creighton (quoted after
Bardhan, 1997), cited in http://www.icgg.org/downloads/contribution10_schramm.pdf.
10 Sun, Yan (2001) “The Politics of Conceptualizing Corruption in Reform China,” cited in http://www.albertodifelice.com/essays/corruption-china.php.
11 Bardhan, P. (1997) “The Role of Governance in Economic Development: A Political Economy Approach”, cited in http://wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf.
12 Ney, J.S. (1967) “Corruption and Political development: A Cost-Benefit Analysis”; Klitgaard,
R.E. (1988) “Controlling Corruption,” cited in http://wwwuser.gwdg.de/~uwvw/downloads/
14 Hsu, F.L.K. (1953) “Americans and Chinese: Two Ways of Life,” cited in http://www.bm.ust.
16 Walder, Andrew (1986) “Clientelist Bureaucracy: The Factory Social Order,” cited in http://www.albertodifelice.com/essays/corruption-china.php.
18 Carr, J.L. and Landa, J.T. (1983) “The Economics of Symbols, Clan Names, and Religion”;
Posner, R. A. (1980) “A Theory of Primitive Society, with Special Reference to Law,” cited inhttp://wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf.
19 Krug, B. and Polos, L. (2000) “Entrepreneurs, Enterprises, and Evolution: The Case of China,” cited in http://wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf.
20 Hsing, Y.T. (1998) “Making Capitalism in China: The Taiwan Connection,” cited inhttp://wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf.
22 Johnston, Michael (2001) “Corruption in China: Old Ways, New Realities and a Troubled Future,” citedinhttp://www.albertodifelice.com/essays/corruption-china.php.
23 Walder, Andrew (1986) “Clientelist Bureaucracy: The Factory Social Order,” cited in http:// www.albertodifelice.com/essays/corruption-china.php. www.albertodifelice.com/essays/corruption-china.php.
25 Hamilton, G.G. (1994) “Civilizations and the Organization of Economics,” cited in http:// wwwuser.gwdg.de/~uwvw/downloads/contribution10_schramm.pdf.
26 Hamilton, G.G. (1994) “Civilizations and the Organization of Economics,” cited in http://
29 Reja, B. and Tavitie, A. (2000) “The Industrial Organization of Corruption: What is the Difference in Corruption Between Asia and Africa,” cited in http://wwwuser.gwdg.de/~uwvw/
31 Tao, Z. and Zhu, T. (2001) “An Agency Theory of Transaction without Contract Enforcement:
The Case of China;” Wank, D.L. (1999) “Producing Property Rights: Strategies, Networks, and
Efficiency in Urban China’s Nonstate Firms,” cited in http://wwwuser.gwdg.de/~uwvw/downloads/ contribution10_schramm.pdf.