Weak Law v. Strong Ties: An Empirical Study of Business Investment, Law and Political Connections in China

Based on a large-scale survey of Chinese entrepreneurs, our study explores how legal and political institutions influence investment decisions made by private companies. The study finds that, consistent with the conventional view, a more effective legal system is correlated with short-term general investment, and that the judiciary is important mainly because of its restraint over the state. The role of effective courts, however, diminishes when private entrepreneurs consider making long-term investment. We find a positive association between the entrepreneurs’ political backgrounds and their R&D investment, suggesting that Chinese courts, in spite of decades of reform, are not yet viewed as reliable to protect long-term private investment from expropriation, policy instability, and a hostile regulatory environment. Rather, informal political connections constitute the premise for the protection of long-term investment. We also find evidence indicating that political ties are expensive resources to accumulate and maintain, so Chinese entrepreneurs tap into them only when substantial long-term interests are at stake. The findings contribute to the literature on law and economic development.