Political Corruption and Private Investment: The Case of China

Abstract

The institutionalization of private property rights promotes economic development. Political corruption, it is widely held, retards development. During its reform and opening up period, China did not recognize property rights, became increasingly corrupt, yet broke world growth records. We resolve this paradox by highlighting the way systemic corruption can partly substitute for absent property rights by providing investors with implicit protection against expropriation. We use a principal-agent model to study the mechanism by which systemic corruption's impact on political risk affects individual investment decisions. We empirically assess this mechanism by examining the influence of aggregate corruption on the productivity of investments in China.