Vol. XXXIX No. 2

Law and Finance: The Case of Stock Market Development in China

Abstract: Having grown to one of the largest in the world in just over two decades, China’s stock market is cited as a counterexample to the significance of law for financial market development. A thorough examination of the development of China’s stock market, however, finds that law is actually critical to sustaining growth. On the other hand, the trajectory of development in China is growth first followed by law, and the improvement of law is caused by market growth. The experience of China suggests that law and market growth exhibit a bidirectional rather than unidirectional causal relationship, and the course of development is “growth-law-further growth.” Nevertheless, this virtuous cycle is not a guarantee and market growth may not lead to stronger law in all instances, as evidenced by the fact that, although now better protected from market abuse, Chinese investors remain vulnerable to serious managerial misconduct at listed state-owned enterprises. Political and ideological constraints are the key obstacle. Politics and ideologies seem to be fundamental to stock market development, for they not only explain the stagnation of law in China despite market growth, but also, together with economic development, determine market growth, or lack thereof, in the first place. Furthermore, the strength of law in a country might not be predetermined by its legal origin, as law has improved in certain respects even in China—a country without the tradition of rule of law.

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