1. Law and Economic Development in China: The Case of Stock Market Growth Dr. Zhong Zhang School of East Asian Studies University of Sheffield

2. Outline Introduction The growth history of China’s stock market Legal developments The role of law in the growth The causality between law and market growth Causes for market growth Conclusion

3. Introduction Law and economic development – Optimists: Personal security; law and order; incentive for wealth creation (property law); facilitating commerce (contract law); limiting government power and bureaucracy; controlling corruption – Sceptics: What is the rule of law? which components are important than the others? Inconsistent empirical evidence The direction of causality Informal institutions Failure to promote the rule of law

4. Introduction The experience of China – Sceptics “Little explanatory power” “An important counterexample” “Because of weak law” – Optimists Progress in the rule of law Stages of economic development “Middle income trap” Strengthening the rule of law to sustain economic growth

5. Introduction The stock market of China

6. Introduction

8. Questions – Is China a counterexample? Are investors not concerned that their investment might be lost? – Is growth sustainable if law remains weak? – What cause/impede the improvement of law? – What can the experience tell about law and economic development in China in general?

9. The history of growth Before 90: emergence of shareholding system and establishing the stock exchanges 1st stage (90/01): rapid growth 2nd stage (01/05): stock market in crisis 3rd stage (06/09): boom, bust, stimulation 4th stage (10/14): prolonged bear market

10. The history of growth Stages of growth

11. The history of growth

13. Legal development Before 1993: no national legislation; rudimentary local operational rules; no specialized regulator; 1993/2000: establishing the legal and regulatory framework – Regulatory framework 1992: CSRC 1997: CSRC taking over control of the stock exchanges 1999: centralisation and specialisation – Major legislations: Company Law 1993; Provisional Regulations on Issuing and Trading Shares 1993; Securities Law 1998; Regulations on Stock exchanges 1996; criminal legislation (1995, 1997, 1999) 2001-: improvements – Legislation: CG Code 2001; Independent director 2001; company law 2005; securities law 2005; criminal legislation 2005; Special regulations for minority shareholder protection 2004 – Enforcement: Inputs and outputs

14. The role of law The first stage: irrelevant – Rudimentary, in the process of establishment – Enforcement: few activities – Lawlessness: misappropriating corporate funds (737/1287); false disclosure (72%), stock manipulation (80%) – “worse than a casino”; “a notoriously corrupt place” Why growth when law extraordinarily weak? – Behavioral explanation: bounded rationality – Time lag – Government bailouts – Lack of alternative investment opportunities

15. The role of law The second stage (01/05): stock market in crisis – Macro economy in best shape – Market performance: indices lost more than half; market cap/GDP: 48%-18%; investor withdrawal (30%); IPO suspensions; the securities industry: in red for 4 years – Bitter debates: “worse than a casino”; “scrap the old and build a new one from scratch” Why the crisis? – Bubble: P/E > 55 – Corporate profitability: loss-making companies (19%); ROE: 14.68%-5.35% – Frauds (market manipulation, misappropriation, false disclosure) and scandals: widespread (212); outrageous Weak law and the crisis – Weak law and corporate profitability – Weak law and frauds

16. The role of law The third stage (06/09): market revival – The improvement of law: Crisis-forced Legislations Investor protection indices: ADI: 3-5; ASDI: 0.76; SPI: 6th/20 Enforcement – Inputs: new enforcement units and branches; personnel: 32-600 – Outputs: enforcement actions from single figure to over 100 A degree of law and order: traditional market manipulation; misappropriation; false disclosure; insider trading “The most transparent and efficient market with the highest degree of rule of law in China” – Market revival and the improvement of law

17. The role of law The 4th stage (10/14): Prolonged bear market – Reasons Macro economy Poor investment return: dividend yield: 0.75%, lowest; (1- year deposit interest rate: 3.25%; risk-free rate of return: 5%) Why?: low corporate profitability: ROA 5.58%, lower than 1- year bank loan interest rate Weak law and low corporate profitability – The dominance of SOEs: 47%; 90%; 86%; 74% – Poor corporate governance of SOEs: corruption, waste, over- investment and mismanagement – Law is weak

18. The role of law Summary – Law was indeed insignificant in the first stage – But weak law eventually led to crisis – Market revived, after investor protection strengthened and a degree law and order established – Weak law: one reason for the post-2010 bear market The role of law: critical to sustaining market growth

19. Law and growth: The causality

20. Market growth/lack of it: The causes Liberalization: ideological, political and economic Economic growth: demand for and supply of capital Other factors – Alternative investment opportunities – SOE dominance – SOE monopoly/oligopoly: finance, mining, energy, telecommunication – Business environment: bureaucracy and cost (96th/189, 158th, 185th, 120th) – Lack of technology, brand names, innovation: Apple vs. Foxconn

21. Conclusion China is not a counter-example Bidirectional causal relation between law and market growth and law first followed by law But the virtuous circle of “growth-law-further growth” is not a guarantee The first-order causes: liberalisation and economic development Policy implications: political and economic liberalisation

22. Conclusion What can the experience of stock market development tell about law and economic development in general? – Law is necessary for sustaining economic growth – Law is a result of economic growth – But economic growth does not always lead to the improvement law – Ideological, political and economic liberalisation is fundamental