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

Having grown to one of the largest in the world in just over two decades, the stock market of China 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 market 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 hence seems to suggest that law and market growth are in a bi- rather than unidirectional causal relation, and the course of development is “growth-law-further growth”. Nevertheless, this virtuous circulation is not a guarantee and market growth may not lead to stronger law in all instances, evidenced by the fact that serious mismanagement is still widespread among listed SOEs in China. Political and ideological constraints are the root obstacle. Politics and ideologies are fundamental to financial market development, for they not just explain the stagnation of law despite market growth, but also growth in the first place. On the other hand, the strength of law in a country is not predetermined by its legal origin, as law improves on certain occasions even in China, a country without the tradition of rule of law.