Contract with a Chinese Face: Socially Embedded Factors in the Transformation from Hierarchy to Market, 1978-1989 


JOURNAL OF CHINESE LAW
VOL. 5 FALL 1991 NO. 2

Contract With A Chinese Face:
Socially Embedded Factors In

The Transformation From
Hierarchy To Market,

1978-1989

LucIE CHENG* AND ARTHUR RosErr**

This article examines how contract law came to play an important
new role in the organization of the Chinese economy during the
decade of reform in the People's Republic of China ("PRC'), 1978-
1989. Crucial to the movement for reform was the effort to create new
institutions to expand, regulate, and channel economic transactions.
These institutions were designed to complement centralized planning
as the basic means of allocating goods and services. They emphasized
limitation and decentralization of planning decisions, the creation of
economic incentives, and the increased responsibility of economic
actors for the consequences of their actions. These new institutions
were introduced in response to a variety of organizational problems in
agriculture, industry, and commerce. Nonetheless, they shared common
features: the responses in all cases emphasized notions of contract, the
legal responsibility of economic actors to perform their agreements, and
the value of individual autonomy in setting the terms of economic
transactions and relationships.

This article is the product of seven years of joint observation by
a China-born sociologist, who has interests in migration and the

© Copyright 1991 by Lucie Cheng and Arthur Rosett
* Professor of Sociology, University of California, Los Angeles.
** Professor of Law, University of California, Los Angeles.



JOURNAL OF CHINESE LAW

transfer of people and ideas among cultures, and a New York-born law
professor with an interest in contract and trade law. With the help of
Chinese friends and collaborators, we began in 1985 to focus on the
growth of contract law and related institutions in Shanghai. Through
the generosity of a group of lawyers, teachers, judges, scholars, and
administrators, under the leadership of the Shanghai Faxue Hui
(Shanghai Jurisprudence Association), we were permitted to conduct
several series of interviews during 1985 and 1986 of participants in
every phase of the contract law process in Shanghai. Our observations
and interviews were supplemented in another large Chinese city,
Tianjin, during a sabbatical leave visit in 1987.1 We make no pretence
of having a comprehensive understanding of how things are done
everywhere in China, although we strongly suspect that no single
system is found everywhere. Certainly we will never be able to
encompass all of China in a teacup.

The roots of contract law - cooperative economic agreements,
binding promises, and sanctions enforced judicially and socially on
failures to perform - can be found deep in the Chinese experience.2

Contract played a role in China's socialist economic organization
before reform began in 1978. The decade of reform has transformed
these aspects of the Chinese experience, however, producing something
different. It is this phenomenon that deserves examination in this paper.
We write this article with several distinct audiences in mind. Much of
what we have to say here will be familiar to some readers. We
apologize to those readers who find parts of our story too well-known
or who may find our introductions to some legal concepts rather
elementary. We urge these readers to move on quickly to more

1. Although we cannot list all of the informants who over the years have contributed to
our information, we are especially grateful to President Xu Panqiu and our colleagues at the
Huadong Zhengfa Xueyuan [Eastern China Institute of Politics and Law], and the Shanghai
Faxue Hui [Shanghai Jurisprudence Assoc.]; our colleagues at Nankai University, the Tianjin
Shehui Kexue Yuan [Tianjin Academy of Social Sciences], and the Tianjin Shangye Daxue
[Tianjin Business University]; Dean Zheng Duanmu and our friends at Zhongshan Daxue
[Central Mountain University], Guangzhou; Xiong Jining and friends at Zhongguo Zhengfa
Daxue [Law and Politics University of China] and Jingji Gaige Yanjiu Suo [Economic Reform
Institute] in Beijing. We sincerely appreciate the detailed critical readings of our manuscript by
our friends, Professors William Alford, Stanley Lubman, Mark Ramseyer, and Hugh Scogin. We
have been heavily dependent on a superb group of research assistants and the financia and
moral support of CLEEC, the UCLA Law Faculty Dean's Fund, the University of California
Systemwide Pacific Rim Grant, the UCLA Law Faculty Colloquium, the UCLA Workshop on
Pacific Rim Legal Studies and the Harvard Law School East Asian Law Workshop.

2. Professor Hugh Scogin traces the roots of contract in the Han Dynasty and promises in
future articles to carry the story forward to the Song and later dynasties. Hugh T. Scogin,
Between Heaven and Man, 63 S. CAL L. REv. 1325 (1990).

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interesting material; this is the price we pay for trying to present an
analysis that attempts to transcend disciplinary lines.

Part One of this paper introduces the limited role of contract law
in the PRC before 1978. We look at traditional Chinese social and
economic organization and the institutions that served as alternatives
to contract law, particularly the reliance on networks of relationships,
connections, and influence outside state structures summed up in the
nontranslatable Chinese term, guanxi We also will examine the
structures of socialist economic planning and the use of contract in the
service of planning prior to the period of reform.

Part Two traces the emergence of contract law in China since
1978, its motivations, and major features. Contract law depends on
supporting institutions - the existence of legal rules, courts or other
adjudicative agencies - and the availability of large numbers of
professionals to make contracts and to deal with disputes as they arise.

Parts Three and Four turn to two central issues that we rely upon
as prime examples of contract law's social embeddedness. In Part
Three we look at the question of legal personality in China: who gets
to make a contract with whom. In Part Four we consider the remedial
dimension that distinguishes an agreement from a contract. A contract
is a legally enforceable promise, and any discussion of legal enforce-
ment must turn to the process of dispute resolution and the influences
that shape it. Finally, in Part Five we sum up our views of contracts
with a Chinese face and attempt to place in perspective the experience
of a decade of reform.

Beginning with agricultural reform late in the 1970s and continuing
through industrial and commercial reform during the 1980s, Chinese

3. The significance of guanxi or social relationships in Chinese society before the
establishment of the PRC has been noted by a number of anthropologists, for example, Fei
Xiaotong. Guanxi differs in several important respects from the social netwoiks observable in
many Western cultures, including contemporary America. Guawd linkages ae always d)-adic and
hierarchically ranked in relation to ego. Moreover, the relationship is maintained primarily by
specific personal obligations based on norms of reciprocity. See FROM E SOIL: FouNDATIONS
oF CHINESE SOCrTy AS VmIWED BY Fat XiAoToNa, Introduction (Gary Hamilton & Wang
Zheng trans., forthcoming 1992) [hereinafter FROM THE SOIL]. In contrast, a Western netwo&
(say the familiar "old boys network") is likely to be polycentuic, based on relative equality of
the members, dependent on voluntaristic choice of its members for its p:rpetuation, and less
dependent on specific and transactional reciprocity. For an excellent recent discussion of guarxd
and its continued importance in the PRC, see Mayfair Mei-hui Yang, The Gift Economy and
State Power in China, 31 COMP. Siu. iN Soc'Y AND Hisr. 25 (1989).

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JOURNAL OF CHINESE LAW

leaders sought to replace one type of organization - that of transac-
tions and enterprises based on hierarchical commands - with an
organization based on agreements between somewhat equally empow-
ered actors. The leadership also sought to provide a bigger role for
local, as opposed to central or national, management and control of the
economic sector involved. The tension between local and central that
typifies so many aspects of Chinese life persisted, but the reformers
consistently sided with the decentralization of control, attempting to
replace central command with horizontal relationships said to be based
on the agreement between the economic actors, rather than the
command of a superior authority.

The emphasis on contractual responsibility was created by the
Chinese leadership to enhance the opportunities and incentives for
economic enterprise. This apparent connection between contract and
production is evidenced by the reorganization of rural agricultural
production in the late 1970s and factory management agreements in the
mid-1980s. In the first case, the government allowed rural households,
by contract with the collective or the state, to assume responsibility for
the use of land and other assets, and for the attainment of production
goals. In the second instance, responsibility for management of
industrial enterprises devolved from supervisory governmental and
Communist Party ("Party") departments to the enterprises' managers,
who agreed, again by contract, to meet set production goals. The
managers were given incentives to increase production and efficiency
in the form of bonuses, authority to sell production in excess of
quotas, and limited discretion to innovate in operations. Contract was
also used to transfer unprofitable state enterprises from one govern-
mental unit to another in order to consolidate, invigorate, or some-
times, apparently, to liquidate the underperforming enterprise.4 The
impact of these changes has been undercut by continued reliance on
planning in significant sectors of the economy and by the conversion
of planning administration into negotiations between officials and
managers on the amount of taxes the enterprise will pay.

At the same time, the need for hard currency and advanced
technology led to a new emphasis on foreign trade and investment.

4. The process of industrial reform in China has been described from a variety of
disciplinary perspectives: see, e.g., CINA'S INDUSTRIAL REFORM (Gene Tidrick & Chen Jiyian
eds., 1987); THE POLmcICAL ECONOMY OF REFORM IN POST-MAO CHINA (Elizabeth J. Perry &
Christine Wong eds., 1985) [hereinafter POLITICAL ECONOMY OF REFORM]; TRANSFORMINO
CHINA'S ECONOMY IN THE EIGTIES: VOLUME II: MANAGEMENr, INDUSTRY AND THE URBAN
ECONOMY (Stephan Feuchtwang et al. eds., 1988); EZRA VOGEL, ONE STEP AHEAD IN CHINA:
GUANGDONG UNDER REFORM (1989).

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CONTRACT WITH A CHINEYE FACE

This in turn demanded the adoption of contract forms that would
enable these transactions to be put into a framework acceptable to a
foreign partner. Agreements in domestic transactions also were
transformed from their limited role as administrative instruments of
planning into a central role in exchange by contract.S

The Economic Contract Law was the product of a rapid evolution
that by 1981 was ready to supplement interagency administration of
transactions between state enterprises with a legal system based on
contract. The allocation of resources by planning order was to some
extent displaced by allocation through trade initiated by enterprise
managers, rather than by administrative supervisors. These uses of
contract were matched by a growing institutional framework: economic
contract law; the beginnings of a civil code that would recognize the
general enforceability of consensual obligations; new civil courts and
innovative adaptations of other enforcing agencies; and recruitment,
training, and professionalization of notaries, lawyers, and legal advisors.
All of these steps to create a legal infrastructure proceeded at a rapid
pace; nonetheless, the institutions remain weak. For example, courts are
subservient to the local government and Party organs to which they are
attached.6 The codes are incomplete and confusing. The proportion of
trained personnel remains low. Public expectations of the capacities of
these institutions for objective expertise are justifiably modest.

Remarkably, these changes were introduced primarily by state
command in a social and economic setting where contract law and
institutions previously had been extraordinarily weak or absent We still
do not know the details of the reformers' motivations during the
crucial period when power was transferred from Mao Zedong during
the mid-1970s. The thoughts and internal discussions of the Chinese
leadership remain quite opaque to outsiders. It is clear, however, that
the specific content of Chinese economic reform in commerce and
industry was dictated from the top levels of government and Party and

5. Zhonghua Renmin Gongheguo Jingji Hetong Fa [The Economic Contract Law of the
People's Republic of China] (adopted Dec. 13, 1982), arts. 17-26 [hereinafter the Economic
Contract Law or ECL], 1981 ZHONGHUA RmN.,iN GONGHEGUO GUOWuYuAN GONGBAO
[GAZETIE OF THE STATE COUNCIL OF THE PEOPLE'S REPUBUC OF CHINA] 864 [hereinafer
GuOWtJYUAN GcONGBAO] describes ten types of economic contracts: 1) contracts for the purchase
and sales of goods; 2) construction contracts; 3) contracts for processing, manufacturing, or
repairing; 4) contracts for goods transport; 5) contracts for the supply and consumption of
electricity; 6) contracts for storage; 7) contracts for leasing property, 8) loan contracts; 9)
property insurance contracts; 10) contracts for scientific and technical cooperation.

6. See Hikota Koguchi, Some Observations About 'Judicial Independence' in Post-Mao-
China, 3 B.C. THIRD WORLD U.L 195 (1987); Margaret Y.K. Woo, Adjudication Supervision
and Judicial Independence in the P.R.C., 39 AMi. . ComP. L 95 (1991).

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was not the result of public debate or popular practice. This was not
some gradual blossoming of evolving social practice,7 although such
practice was not unfamiliar to the Chinese people! The use of
agricultural production, commercial, and managerial contracts grew in
China during the reform period because the state found these forms of
agreement to be effective to stimulate production, increase services,
and facilitate distribution.

Reform began with conscious, specific decisions from the top that
were diffused throughout the system, but the shape these changes took
on in practice depended on how they were understood by persons at
the periphery who had to apply and live with them. This understanding
was heavily conditioned by cultural values and expectations. The
movement toward contract in China took place against the background
of an extraordinarily rich cultural tradition that included complex legal
institutions, a long history of commerce and trade, and a number of
sophisticated transactional forms for a variety of economic activities.
Many elements of this tradition had been weakened and rejected during
the century of unrest and decline that preceded the Communist
accession to power in 1949. Others had been rooted out during the
Great Leap Forward in the late 1950s and the Great Proletarian
Cultural Revolution in the late 1960s. Reform during the 1979-1989
period was shaped by the often divergent pulls of models drawn from
China's historical experience on the one hand, and, on the other, by
models based on the experience of industrialized capitalistic nations of

7. In contrast, the English, and then the American, common law growth of contract ideas
occurred over centuries. The English experience from medieval to modem times is traced in
A.W.B. SIMPSON, A HISTORY OF THE COMMON LAW OF CoNTRACr: THE RISE OF THE ACTION
OF AssuMPSrr (1975). Much of this story is marked by judicial rule-making, as courts
confronted specific cases in an increasingly rapidly changing economic and social environment.
Morton Horwitz, The Historical Foundations of Modem Contract, 87 HARv. L. REV. 917
(1974). The common law story is one of gradual and often grudging response to change, and
the very slow emergence of broad legal doctrine, unlike the Chinese experience described in this
article, where contract law is a proactive governmental policy designed to motivate economic
reorganization. There are inevitable uncertainties in identifying causes and effects, chickens and
eggs, but this basic characteristic comes through clearly in the two best recent tellings of the
English and American stories: PATRICK S. AnYAH, THE RISE AND FALL OF FREEDOM OF
CONTRACT (1979), and LAWRENCE FREDMAN, CONTRACT LAW IN AMERICA: A SOCIAL AND
ECONOMIC CASE STUDY (1965).

8. Justin Yifu Lin, An Economic Theory of Institutional Changes: Induced and Imposed
Change, 9 CATO J. 1 (1989); David Zweig et al., Law, Contracts, and Economic Modernization:
Lessons from the Recent Chinese Rural Reforms, 23 STAN. J. INT'L L. 319 (1987). The
agricultural responsibility system that began in the countryside and then was legitimated by
officials was similar to prerevolutionary tenant farming practices. Frederick Crook, The Baogan
Daohu Incentive System: Translation and Analysis of a Model Contract, 102 CHINA Q. 291
(1985).

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the West and the newly industrialized nations of Asia.
The Chinese decade of reform appears to have entered a period of

pause, if not reaction. By all indications, the current leaders of China,
while fearing political and economic chaos, still want economic reform,
but in a more limited and controlled way.9 They desire to realize the
economic benefits of reform while avoiding the dispersion of power
that reform implies. The leadership seems to believe that economic
reform can be achieved without fundamental political change, although
not without some changes in legal structure. The momentum for legal
reform seems to be continuing as indicated by the revision of the civil
law in December 1990 to include more specific provisions on
economic cases; :° the training of county-level representatives regard-
ing law;" the continued expansion of legal institutions such as notary
bureaus; 2 and continued emphasis on the education of lawyers and
legal workers.' 3 At the same time, the reported decline in the number
of economic law court cases in 1990 may suggest a lower level of
interest in the legal enforcement of claims.' 4

The complex factors that fed and shaped the decade of reform
present a daunting challenge to our attempts at scholarly analysis. The
motivations for reform were economic and political: the desire for
development, greater wealth, relief from the inefficiency of central
socialist planning, and political legitimation of the regime. Understand-
ing these motivations is helpful to explaining what reform was trying
to escape. It is less helpful in explaining why a particular choice, such
as the choice of contract, was made.

As we have watched contract ideas develop in China, often in
unique and counterintuitive ways, we have tried to understand the
choices that were made. Sometimes the contract institution that
emerged was quite clearly imitative of foreign practice. In the early
stages at least, Chinese draft laws seemed to draw heavily on the
experience of an older generation of scholars trained in Europe and
America. The marks of nineteenth century European and Japanese

9. Communique of the Seventh Plenary Session of the 13th Central Committee of tha
Communist Party of China, trans. in BIING Rsv., Jan. 7-13, 1991, at 31-33.

10. RmeiN RIBAO - HAIWAI BAN [PEOPLE'S DAILY - INT'L ED.], D=. 21, 1990
[hereinafter RMRB-HB].

11. RMRB-HB, Dec. 17, 1990.
12. RMMB-HB, Dec. 24, 1990.
13. RA.B-HB, Dec. 13, 1990.
14. Chang Hong, Business Disputes Dropping, CHINA DAILY, Feb. 2, 1991, at 1; Ren

Jianxin on Work of Supreme People's Court, Foreign Broadcast Information Serice-Daily
Report, China [hereinafter FBIS--China], Apr. 3, 1991, at 25-26; and Ren Jianxin Addresses
Meeting of Higher Courts, FBIS-China, Feb. 7, 1991, at 19-20.

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codes and Common Law case influences are apparent. Ideological
commitments, and a desire not to depart too radically from socialist
values, suggested reliance on Soviet law ideas. Some of the choices
are politically motivated in the sense that they seem designed to please
the bureaucratic interests of a politically powerful constituency. Some
of the choices seem almost accidental, perhaps the product of the
principle of entropic dispersion, which decrees that if choices are
available somebody will choose to be different. At the same time,
many choices seem economically rational, motivated by a calculation
of the benefits and costs of the apparent options.

In this article we will emphasize several instances where the path
of reform and the growth of contract law was influenced by cultural
values and established institutions and the requirements of the world
capitalist system, in addition to rational choice by economic actors. We
believe that these socially embedded practices channelled the course of
reform in significant ways. Our exposition may interest general readers
curious about the construction of a new legal system in China, and
those interested in how everyday legal institutions like contract are
linked to economic concerns and human values. The Chinese experi-
ence also may be of interest to American academics because it
illuminates the process of choosing between both markets and
hierarchies that has been masterfully described by Oliver Williamson 5

and Mark Granovetter. 16 The Chinese experience also illustrates the
role of relational contract in social organization that has been the work
of Ian Macneil17 and the relation between institutional change and
economic performance discussed by Douglass North. 8 Economists and
sociologists have struggled in recent years to understand the process
of choice typified by the alternatives of market and hierarchy. Oliver
Williamson describes the "bounded rationality" within which actors
make these choices. Mark Granovetter argues for greater recognition
of their socially embedded character.

The tension between market and hierarchy certainly is an important
theme of our work, as it will be of any analysis of modem political

15. OLIVER E. WILLIAMSON, MARKETS AND HIERARCHIES, ANALYSIS AND ANTITRUST
IMPLICATIONS (1975); OLIVER E. WILLIAMSON, THE ECONOMIC INSTIuTIONS OF CAPrTAuSM:
FIRMs, MARKErs, AND RELAIONAL CONTRACrlNG (1985).

16. Mark Granovetter, Economic Action and Social Structure: The Problem of Embedded.
ness, 91 AM. J. Soc. 481 (1985).

17. IAN MAcNEL, THE NEW SOCIAL CONTRAcr: AN INQUIRY I-to MODERN CONTMRACI-
AL RELATIONS (1980).

18. DOUGLASS NORTH, INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC
PERFORMANCE (1990).

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economy. We shall argue, however, that it should not be seen as a
battle between polar opposites. It is simplistic to see the organizational
changes associated with the growth of contract law as the rejection of
hierarchy in favor of markets composed of autonomous actors. In Parts
Three and Four we shall discuss instances where the Chinese appear
to have sought solutions to their problems that will serve both
interests.

It is a mistake to set up rigid dichotomies between market and
hierarchy, or between cultural and economic determinants of social
choice. To some extent the dichotomies are false, and the differences
are more in defining vocabulary than in the underlying phenomena. Of
course contract is a socially embedded institution. How could a
concept so steeped in such ideas as intention, expectation, and
interpretation, not draw heavily on the social context within which the
parties form their agreement? Of course, economic rationality is a
necessary condition for the choice of an economic practice. Over the
long haul, if an economic institution does not minimize costs and
mazimize benefits, it is unlikely to attract many adherents. But pointing
out the economic efficiency of a solution often fails to explain why
that solution, rather than other alternative choices, was adopted.

The falseness of such a dichotomy is demonstrated by the ease
with which cultural determinants can be stated in economic efficiency
terms. A practice's compatibility with familiar social patterns is a
factor that will influence the ease of its adoption and use. The more
a practice is socially embedded the lower its transaction costs should
be. Social experience shapes the pool of potential institutional
alternatives and innovations, and institutions affect the performance of
the economy through their impact on the costs of exchange and
production. In political terms, social acceptability is an aspect of
building constituency alliances. The best path toward building viable
coalitions for change is to choose institutions that people know and are
at least willing to live with.

I. CONTRACT LAW'S LIBMED RoLE IN CHINA BEFORE 1978

A. What do you mean, Contract?

The classic American legal definition emphasizes the elements of
promise and legal enforcement as the defining characteristics of

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contract.19 In the minds of most people, the term contract refers to
a document, but in the minds of lawyers, it has a broader meaning that
includes the totality of an agreement, encompassing both express,
conscious terms, their implications and the unspoken assumptions that
reasonably underlie them, together with a host of terms that the law
imposes, by statute and through the courts, on parties, without regard
to their agreement.2" Viewed broadly, the contract includes the entire
relation between two parties.21

However broad the sources of contract obligation may become
through judicial interpretation, the emphasis in these definitions is
always on finding the "intention of the parties" and the concrete legal
obligations to perform or compensation that flows from such an
expression of intention. This emphasis on specific obligation may not
adequately capture the more positive aspects of commitment that
underlie alternative visions of contract commonly encountered in both
Western and Asian legal systems. A contract is likely to be more than
a recital of obligations and negative sanctions for failure to perform.
Beyond providing a statement of "this is what we will make you do
if you fail to perform," an agreement often is a simple acknowledge-
ment of the existence of an ongoing relationship, a commitment to the
implementation of common goals, and a statement of intention to
resolve whatever difficulties may be encountered by cooperative
consultation.22 This perspective on the role of contract emphasizes the
extent to which people create new things by contract - individuals
and enterprises use contract to structure new social relations, to create
markets, and to solve problems together. Persons more at home with

19. The REsTATEMENT (SECoND) OF CoNTRACMS § 1 (1981) provides "[a] contract is a
promise or a set of promises for the breach of which the law gives a remedy or the
performance of which the law in some way recognizes as a duty."

20. The Uniform Commercial Code (1990) recognizes this when it defines contract in §
1-201(11) to mean "the total legal obligation which results from the parties' agreement as
affected by this Act and any other applicable rules of law." Agreement, in turn, is defined in
§ 1-201(3) to include the "bargain of the parties in fact as found in their language or by
implication from other circumstances including the course of dealing or usage of trade or course
of performance."

21. The confusion can be compounded because the word "contract" is used both as a noun
and as a verb (e.g., mealy bugs in the garden contract when they are touched, travellers contract
infections, gangsters put out a contract on those who cross them, and some of us contract to
make three no-trump).

22. Hiroshi Wagatsuma & Arthur Rosett, Cultural Attitudes Toward Contract Law: Japan
and the United States Compared, 2 UCLA PAC. BASIN LJ. 76 (1983); Albert D. Angel, The
Use of Arbitration Clauses as a Means for the Resolution of Impasses Arising in the Negotiation
of, or During the Life of, Long-Term Contractual Relationships, Address at the Annual Meeting
of the American Bar Association (Aug. 16, 1972) in Bus. LAw., Jan. 1973, at 589-92.

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this perspective may be uncomfortable with the familiar American
commercial contract, replete with boilerplate and detailed clauses that
seek to provide in advance for every possible unhappy contingency.

The central source of difficulty with definitions of contract is that
the term usually suggests more than an agreement or consensual
cooperative behavior. It connotes obligation and legal enforceability,
but the link between agreements and the law is persistently problem-
atic. Most legal systems do not claim to enforce all agreements, yet
the substantive earmarks of a legally enforceable promise are difficult
to state simply because there is no single generally accepted basis of
promise enforceability.' Some legal systems, such as China's, use
agreements, but, until the recent events we are describing in this
article, have provided no institutional framework for their enforcement.
It took English Common Law many centuries until, in the seventeenth
century, it arrived at an approach to the general legal enforcement of
agreements. The result remains a conflicting and confusing melange of
ideas.

It is also confusing to talk about contract as a legally enforceable
promise because agreement is usually seen as a powerful source of the
law itself, which then makes agreements binding. For millennia,
Western legal cultures have understood that the legitimacy and binding
power of government itself is based primarily on some notion of social
compact, covenant, or contract.24 In this sense, contract is an
antecedent and a source of law, as well as its beneficiary. If American

23. Most legal systems at some stage establish a formal contract in which compliance with
the formality provides the essential marks of enforceability. E. Allan Farnsworth, T7e Past of
Promise: An Historical Introduction to Contract, 69 Cow.,i. L REv. 576 (1969). Such ideas
live on in European use of the Notarial contract or the peculiar American insistence that some
inds of promises, to be enforceable, must be embodied in a written agreement that complius
with the Statute of Frauds. Another alternative is to treat agreements dealing vith particular
kinds of subject matter as specially deserving of legal enforcement. Examples of this attitude
can be found in the Common Law's infatuation with the bargain supported by consideration as
the mark of enforceability or in the Chinese adoption of the socialist concept of economic
contrctL

The trouble legal systems have with enforcing promises usually does not extend to
difficulties with enforcing obligations that have ripened into a debt. Them is often a circular
element here, for the source of the obligation forming the debt is likely to be intimately tied
up with promises, particularly the promise to repay. One confusing aspect of trying to
understand the history of Chinese promise enforcement is that there are clear signs that d:bts
and loans have long been routinely enforced, but it remains unclear how important the
promissory aspects of these transactions were understood to be.

24. "That to secure these rights, Governments are instituted among Men, deriving their just
powers from the consent of the governed,.. ." The Declaration of Independence, para. 2 (U.S.
1776); Sturm, American Legal Realism and the Covenantal MAik World Visions in the Praclce
of Law, 31 MERCER L. REV. 487 (1980).

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law defines contract as a legally enforceable promise dependent on the
law for its obligatory power, European law seems to see contract as
a form of law, a private law between the parties."

Finally, the emphasis on legal enforcement in the definition of
contract seems strange because few contracts in fact are enforced
legally and, in most legal systems, the legal remedies available for
complaints of contract breach are notably weak and ineffective. Non-
legal sanctions for agreements are frequently more powerful than the
formal remedies provided by law. Social condemnation, reputational
loss, and moral suasion are more common and often more powerful.

The costs of legal enforcement are always high and limit the
usefulness of legal remedies. The law rarely enforces promises directly.
What it does is award a sum of money as damages for some of the
losses resulting from the breach. The definition of legally cognizable
contract damages is ungenerous in every legal system we know about
and usually excludes many important kinds of loss.26 Often, contract
law produces no remedy at all for the admittedly wronged promisee.
As we shall see, Chinese leaders have found it very difficult to resolve
the puzzles of contract remedies in the context of a socialist and poor
society. This has led them to seek to create some remarkably
innovative incentives to contract observance to reinforce the weak
remedies of the law.

When compared to competitive organizing principles for economic
activity, contract offers several distinct advantages. Despite its
weaknesses, legal enforceability is valued to the extent that it provides
a residual remedy when social constraints fail. It also provides a more
objective and rational expectation of enforcement that assists the
calculation of risks, costs, and benefits at the time parties enter a
transaction. This potential may be related to the preference expressed
by Chinese leaders during the decade of reform for legal enforcement
over other forms of social or authoritarian sanction.27 If the aim of

25. See Georges Rouhette, The Binding Force of Contract in French Law, in DONALD
HARRIs & DENIS TALLON, CONTRACT LAW TODAY: ANGLO-FRENCH COMPARISONS 38, 38-67
(Oxford Univ. Press ed., 1989) [hereinafter CONTRACT LAW TODAY].

26. See generally G.H. TREITEL, REMEDIES FOR BREACH OF CONTRACT: A COMPARATIVE
ACCOUNT (1988); JOSEPH LOOKOFSKY, CONSEQUENTIAL DAMAGES IN COMPARATIVE CONTEXT
(1989).

27. The preference is expressed in the following:
In order to safeguard people's democracy, it is imperative to strengthen the socialist legal
system so that democracy is systematized and written into law in such a way as to ensure
the stability, continuity and full authority of this democratic system and these laws; there
must be laws for people to follow, these laws must be observed, their enforcment must
be strict and law breakers must be dealt with.

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the policymaker is to broaden participation in an overly centralized
regime, contract supports this choice by providing a way of doing
business with an expanded set of actors. If the aim of the policymaker
is to create incentives for economic activity by offering rewards to
those who show initiative and take an active role in entering new
transactions, again contract has advantages over its competitors.

At the same time, the decision to use contract makes new demands
on the legitimacy and reliability of government institutions. If people
have to depend on the largesse of the official to enforce their deal,
they will have less confidence in the agreement. In short, there has to
be some faith that the judge or other enforcing person can be relied
upon to be fair. The significance of legal contract sanctions is
especially strong in a market-based economy. The effective functioning
of markets depends on the presence of many competing actors and on
the possibility of deals among strangers. The efficiency of such deals
among strangers is likely to depend, in turn, on the possibility of legal
enforcement.

Legal and non-legal sanctions for agreements are certainly not
mutually exclusive. The law may not be applied often, but its presence
channels and frames behavior. Most disputes are resolved informal-
ly, but the settlements and negotiations take place in the shadow of the
law.29 What the law will make someone do is a powerful defining
feature of what parties will informally bargain among themselves to do
without invoking the law. However, the current Chinese perspective on
the role of law goes beyond the idea of negative sanction or institu-
tional constraints. The Chinese leadership now sees the law as playing
a positive role for social change, supporting a commitment from the
Chinese citizenry toward the implementation of common goals. New
forms of economic organization are deliberately erected by contract.
Less deliberate, but equally significant, are the new social relations
structured through the use of contract.

Communique of the Third Plenary Session of the llth Central Committee of the Communist
Party of China, BEIING REv., Dec. 29, 1978, at 6, 14 [hereinafter Communique of the Third
Plenary Session].

28. John Haley describes the Japanese view of the law which compares the law to a rusty
old sword in its scabbard that hangs on the wall, but continues to influence behaviour although
rarely drawn. John Haley, The Myth of the Reluctant Litigant, 4 J. JAPANESE STUD. 359 (1973).

29. Robert H. Minooken & Lewis Kornhauser, Bargaining in the Shadow of the Law. the
Case of Divorce, 88 YALE L.J. 950 (1979). This is related to Holmes' suggestion that the law
is simply what a judge will make a bad man do. OLIVER W. HOLMS, The Path of the Law,
in COuECrED LEGAL PAPERS 170 (1920).

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B. Traditional China Made Limited Use of Legal Institutions for
Commercial Organization

Contemporary attitudes toward commerce .and government
participation and regulation of economic activity have deep roots in the
Chinese past. At the end of its long struggle with Nationalist
competitors and encroaching foreigners, the Communist Party assumed
power in 1949 over a society remarkably untouched by the values and
institutions that were common in the West. The predecessor regime
had borrowed from European legal codes and had established the
foundations of a legal profession, but modem legal thought had not
penetrated very deeply into the Chinese consciousness. The reformers
of the late 1970s and early 1980s emphasized how important it was
that their work not be slavishly imitative of Western models. They
sought to capture and recreate a Chinese system of law.3"

The Chinese approach to commercial contracts is connected to the
relation between central authority and local units of community. It also
reflects a hierarchical moral and social vision that assigned a low
position to those who engaged in trade. The vast and diverse
geography of China has helped form a territorial and family-based
social structure. It also has given rise to a political regime that, while
at times has been able to impose military hegemony over the whole
nation, rarely has been able to exercise close political supervision over
the provinces, or to foster easy trade or an active national market."
Moreover, suspicion of those who engage in commerce and acceptance
of very broad governmental control of economic activity has its
sources in the Confucian tradition.32 These attitudes, as absorbed by
Chinese elites, have been embodied for many centuries in mechanisms

30. Vice Premier Qiao Shi called upon Chinese jurists "to forge ahead with the study and
research of law with Chinese characteristics" and stressed that legal study should not blindly
copy from the experience of other countries. Legal Study Must Seek Chinese Path, CHINA
DAILY, May 22, 1986, at 1.

31. See G. William Skinner, Marketing and Social Structure in Rural China (pts. 1-3), 24
J. ASIAN STUD. 3, 195, 363 (1964), reprinted in Bobbs-Merrill Reprint Series, S-204, S-627,
S-628; See also J.C.H. Fei, The "Standard" Market of Traditional China, in CHINA'S MODERN
ECONOMY IN HISTORIcAL PERSPECTIVE 235 (D. Perkins ed., 1975).

32. See ZHANG WEIAN, ZHENGZHI YU JINGH: ZHONGGUO JINSHI LIANG GE JINcui ZUZHI
ZHI FENXI [POLTICS AND ECONOMICS: AN ANALYSIS OF Two PREMODERN CHINESE ECONOMIC
ORGANIZATIONS] Ch. VI (1990); see also DOROTHY SOLINGER, CHINESE BUSINESS UNDER
SoCAusM: THE POLrnCS OF DOMESTIC COMMERCE, 1949-1980, at 130-35 (1984) ("Close
interconnection between a primitive technology and state defined market 'corruption' meant that
the technological supports for such behavior had to be transformed before the merchant's
position could be truly undermined." Id. at 134-35).

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of state control that shaped the institutions of contract in traditional
China, although there always was distance between the Confucian
value statements that were opposed to commerce and Chinese social
practice, which was very concerned with trade.

C. Law, The State, and Relational Communities in Traditional China

Chinese thinkers have wrestled with the appropriate role of law in
the Confucian, Taoist, and Buddhist strands of the tradition.33 During
some periods, antinomian naturalists spurned legal rules. They taught
that good government depends on educating people to behave in
conformity with the spirit of the great Way, the Tao. In other periods
of Chinese history, legalists insisted on the need for formal rules to
control people's badness!' From its remote beginnings, an important
Confucian strand of Chinese thought has emphasized the centrality of
harmonious order in the universe, in the government of societies and
families, and in the behavior of every cultivated person. By organizing
their lives in conformity to this order, parents and children, husbands
and wives, and siblings sustained lives that were in virtuous balance.
In particular, it was this harmonious virtue that reinforced the
appropriate relation of the Emperor to the nation and gave legitimacy
to the state.

The transcendent harmony of the natural world has inner aspects,
forming a moral law felt by every sensitive human. People fulfill their
highest potential when they conform their lives to that moral order and
live in harmony with it. When they do so, there is no need for
coercion to right behavior. People become self-regulating in an orderly
and appropriate way of life that perpetuates itself.3 Law from this

33. See generally BJAMIAN SCHWARTZ, THE WORLD OF THouGrr IN ANCI2- CHINA
(1985).

34. See Wium THEODORE DE BARY Er AL., SOURCES OF CHINEss TRtmoN 100-35
(1960). De Baty provides the following translation of the Legalists' views from Han Feizi:

When the sage rules the state, he does not count on people doing good of
themselves, but employs such measures as will keep them from doing evil. If he counts
on people doing good of themselves, there will not-be enough such people to be
numbered by the tens in the whole country. But if he employs such measures as will keep
them from doing evil, then the entire state can be brought up to uniform standard.
Inasmuch as the administrator has to consider the many but disregard the few, he does not
busy himself with morals but with laws.

Id. at 141.
35. DERK BODDE & CLARENCE MORRIS, LANW IN '.hIPERIAL CilNA: EXEMPLMFED BY 190

CH'ING DYNASTY CASES 19-29 (1967). Confucius said:
Lead the people by laws and regulate them by penalties, and the people will try to keep
out of jail, but will have no sense of shame. Lead the people by virtue and restrain them

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perspective is not simply a set of specific commands and prohibitions,
but instead is a set of relationships and interactions that produce order
and harmony. The tasks of law and of moral education are of necessity
closely linked.

A different attitude toward law among Confucian philosophers
grows out of the recognition that some rules of social behavior are a
necessary feature of any human society. Specific rules that are
announced in law structure the functions, roles, and behavior of family
members and enable the group to interact and prosper. Many legal
rules are conventional and quite arbitrary in content. It really does not
matter on which side of the road the law tells us to drive our
automobiles, but it is very important that we all know what the rule
is. Organizational rules of government often are conventional in this
sense, providing useful clues on "how we do things around here,"
although there is little intrinsic logic behind their specific content. The
Chinese creators of the state and inventors of paper fully understood
the role of formal law as an aspect of government administration,
through which the all-powerful Emperor could provide order and
regularity to the behavior of those who served him. Law in this sense
is simply the agent of constructive social order and control of people's
potentially destructive instincts.

These different attitudes regarding law would present no serious
problems if they could be brought together comfortably. Then the
formal rules of the state and the directions of family and community
would meld in a grand synthesis, joining the natural and inner moral
order with the social and governmental order in mutual reinforcement.
The problem, of course, is that for many great Chinese thinkers, as for
many ancient and modem Western thinkers, the pieces do not fit
together so easily. The moral spirit of the inner law gives life and

by the rules of decorum, and the people will have a sense of shame, and moreover will
become good.

Analects 11:3, in DE BARY, supra note 34, at 32.
This attitude is also found in the Taoist view of the role of government:
A leader is best
When people barely know that he exists,
Not so good when people obey and acclaim him,
Worst when they despise him.
'Fail to honor people,
They fail to honor you;'
But of a good leader, who talks little,
When his work is done, his aim fulfilled,
They will all say,'We did this ourselves.'

LAO TU, in THE WAY OF LIFE ACCORDING TO LAOrzu 34-35 (W. Bynner trans., 1944).

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harmony, but emphasis on the formal logic of external rules kills that
spirit and destroys the possibility of a truly virtuous human life. The
rules are stultifying, lead away from moral sensitivity, and cause
people to focus on how they can get away with as little commitment
to the spirit behind the law as possible. Following closely in the wake
of the formal law, one always finds people chiseling around the edges,
looking for loopholes, and hypocrites, who are out of touch with the
moral spirit of their behavior. Not far away are sure to dwell large
bands of pettifogging lawyers giving tax advice, teaching people how
to make black seem white, and generally justifying the failure to honor
obvious obligations? 6

Throughout all periods, the reigning imperial bureaucracy
developed large bodies of legal rules to instruct officials how to
discharge their functions. In his observance of the formal ceremonies
of the state, the Emperor sought to instruct the people by providing a
model of emulation of the harmonious order that would be appropriate
for their lives.37 The imperial hierarchy of the state was a model for
the smaller clan and family hierarchies by which the lives of ordinary
Chinese were supposed to be governed. Through the playing out of
these divergent views of the role of law, China developed impressive
bodies of public law, rules that detail the administration of the state
and the behavior of officials. Substantial bodies of land law also
developed, closely tied to the interests of the unitary state in taxes and
bureaucratic control over the countryside. Some dynasties adopted large
bodies of criminal law through which the state maintained peace and
suppressed unrest. During the three centuries of the Qing Dynasty, the
penal and coercive aspects of the law were especially prominent, for
China was in effect an occupied nation, ruled by the Manchus, who
systematically repressed and discriminated against the Chinese (Han)
majority?

36. The more prohibitions there are, the more ritual avoidances, the poorer the people
will be,
The more sharp weapons there are, the more pernicious contrivances will be invented;
The more laws are promulgated, the more thieves and bandits there ill be.
Therefore a sage has said:
So long as I do nothing, the people will of themselves be transformed.
So long as I love quietude, the people will of themselves go straight.
So long as I act only by inactivity the people will of themselves become prosperous.
So long as I have no wants and the people will of themselves return to the state of the
Uncarved Block.

LAO Tsu, DAODE JING, BooK VI q 57.
37. See DE BARY, supra note 34, at 156-65.
38. BODDE & MORRIS, supra note 35, at 3-51 (1967).

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Despite these impressive examples, it appears that there was little
systematic promulgation of legal rules for other areas of law, including
much of what we would call civil, commercial, or economic law. The
ordering of group and individual commercial relations was left to clan,
family, guild, customary, and local rules that were administered by
elders who held no formal imperial office, although their decisions
might be generally supported by imperial magistrates and other
officials at the local level.3 9

At the highest levels the state claimed to be committed to
inculcating values primarily by example and education, not by the
enforcement of legal rights or the adjudication of personal claims.
Officials are said to have discouraged litigation and imposed penalties
on those who attracted official attention by presuming to bring a law-
suit. Invocation of the machinery of the state for such matters was
considered a clear sign of failure by the clan and family authorities,
who were supposed to teach and maintain harmonious orderliness.
Some legal avenues existed by which subjects could petition the throne
to correct erroneous decisions made by lower officials, but the focus
in these proceedings was primarily on maintaining correct imperial
administration, not upon the vindication of the rights of the subject.4"

During the Republican Period, between 1911 and 1949, the regime
sought to introduce civil law codes from Europe, borrowed through
Japan and directly from Switzerland, but these codes and the ideas
behind them did not penetrate very deeply into the society. Only in the
commercial communities of coastal cities and in a few inland centers
where foreign influence and industry had developed would one be
likely to encounter such laws.41 Even in such places, most Chinese

39. For a good description of commercial practice and administration of magistrates in an
outlying province of pre-revolutionary China, see Rosser Brockman, Commercial Contract Law
in Late Nineteenth Century Taiwan, in ESSAYS ON CHINA'S LEGAL TRADmON 76 (Jerome
Cohen et al. eds., 1980). But see Phillip Huang, Lawsuits, Disputes, and Conflicts in North
China Villages During the Qing and the Republic, in CIVIL LAW IN CHINESE HISTORY (P.
Huang ed., forthcoming ) [hereinafter CIVIL LAW]. See also Scogin, supra note 2.

40. William Alford, Of Arsenic and Old Laws: Looking Anew at Criminal Justice in Late
Imperial China, 72 CAL L. REV. 1180 (1984).

41. The interaction between the law and courts brought by Westerners into Shanghai after
1849 and traditional Chinese courts and institutions is traced in Tahirih Lee, Risky Business:
Courts, Culture, and the Marketplace, 46 U. MIAMI L. REV. - (forthcoming Dec. 1991). See
also WII=AM ROWE, HANKOW: COMMERCE AND SOCIETY IN A CHNESE CIY, 1796-1889, at
158-210 (1984). William Jones has described the limited extent that Western legal concepts and
"rights consciousness" had penetrated traditional Asian societies during this period:

In an ultimate sense, individuals did not have rights; they had duties to the state
which pursued its own interests in accordance with its own rules. On the other hand, the
state took little interest in large areas of society, notably the areas of contract and

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entrepreneurs followed millennia of tradition and did not expect to
enforce their claims against strangers by legal means. Instead, they
pursued their enterprise along the lines established by clan and family
ties or through guilds and merchants' organizations that offered their
own methods of enforcement for claims and transactional security.42

The merchants' reliance on a network of personal ties to provide
information and sanction for rules, necessarily limited the number of
trade partners. Potential partners were confined to those with whom
these relationships existed. When dealing with a stranger the merchant
was wholly dependent on the goodwill of the officials. Only the rash
would enter commerce in an unfamiliar community or without
propitiating the officials. This, in turn, gave state officials greater
personal power and discretion in determining who could be the players
in the local market.

The hierarchical social structure expressed as a positive value the
kinds of education and cultivation that led to appointment as an
imperial official. Not surprisingly, those at the top of this hierarchy
saw their virtues as superior to the diligence of the peasant who
labored on the land, and saw both as superior to the grasping
materialism of the parasitic merchant, who grew rich by buying and
selling the products of others' labor. This ideology contained a
puritanical dimension which supported the view that the hierarchical
matrix serves as a moral harness to keep people happy and prevent
them from losing their heads and hearts to Mammon. It remains
unclear, however, how extensively these views were shared by those
who were assigned lower positions in the hierarchy.

Structural preferences are embedded in these values as well. The
emphasis on harmony leads dominant groups to prefer vertical
hierarchies in which everyone has a clearly defined place. Groups at

commercial law: sales, loans, and banking. These areas of life could be regulated, and
were if any state interest became involved. The result was potential toal state control over
every aspect of human life. Yet, in practice, large areas were left open to private
management so long as no government interest, including maintenance of the peace, was
affected. This could be said to have been true of both China and Japan as of the
time--circa 180-when Japan began to introduce western institutions including law.

Of course much of the western legal appartus as quite consciously fictitious.
William Jones, Reflections on the Modem Chinese Legal System, 59 WASH. U. LQ. 1221, 1226
(1982).

42. See FROM TlE Soi., supra note 3, ch. 4-12. See also Gary Hamilton, Why No
Capitalism in China? Negative Questions in Historical Comparative Research, 1 J. DEvELOP.
Soc. 187 (1985); Landa, A Theory of the Ethnically Homogeneous Middleman Group: An
Institutional Alternative to Contract Law, 10 J. LEGAL SMTD. 349 (1981); K.-C. Liu, Chinese
Merchant Guilds: An Historical Inquiry, 4 PAC HIST. REV. 1 (1988).

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the top will prefer systems of communications that go up and down
these long vertical chains. Persons lower down are addressed through
the person at the top of their chain, and superiors thus avoid dealing
directly with individual members of another unit. This simplifies
dissemination of decisions by enabling a superior to give instructions
to those directly under him in the hierarchy, leaving it to those lower
in the chain to carry the word down. From the perspective of the
superior, directions from above are preferred to horizontal communica-
tions between equals.

Yet several consequences follow from the difficulty inherent in
communication up and down vertical chains of authority. The assertion
of any claim by a subordinate is likely to be interpreted as disorder
and an indication that superiors have failed to set a good example. The
appropriate response is likely to be the punishment of both litigants
and their boss. Additionally, actors lower in the chain have no
convenient way to assert claims against those in other chains. Since
formal communications are difficult and uncertain, it becomes vital to
create informal links that facilitate horizontal communications. Personal
ties and the networks upon which they are based thus create their own
demands that compete with the values of the formal system and blend
into corruption.

D. Contract and Socialist Planning

Westerners tend to associate contract and contract law with
individualism, autonomy, and private agreement. But to a considerable
extent contract is ambivalent in these respects. The link between
contract law and market structure is subtle and potentially confusing.
Use of contract law to structure economic transactions does not neces-
sarily imply an open market structure in that economy. Contract law
has been used in a variety of nonmarket economies, including English
feudal society,43 and even in Soviet' and Chinese socialist planned

43. The role of contract law in English feudal society was described as follows:
The master [Maine] who taught us that 'the movement of the progressive societies has
hitherto been a movement from Status to Contract,' was quick to add that feudal society
was governed by the contract. There is no paradox here. In the really feudal centuries men
could do by a contract, by the formal contract of vassalage or commendation, many things
that can not be done now-a-days. They could contract to stand by each other in warfare
'against all men who can live and die'; they could (as Domesday Book says) 'go with
their land' to any lord whom they pleased; they could make the relation between king and
subject look like the outcome of agreement; the law of contract threatened to swallow up
all public law. Those were the golden days of 'free,' if 'formal,' contract. The idea that

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economies.4 5 Many forms of contract can be found in societies and
economies that lack strong theories of individual autonomy or liberal
enterprise. For example, English medieval contract forms were
embodied in the ceremonies of homage and fealty that organized a
military system and land tenure. Even in America and Europe today,
contractual forms are used as a means of bureaucratic organization for
mass transactions. An eminent legal scholar has estimated that 99% of
the contracts made in America today are form contracts of adhesion
that are neither negotiated nor the expression of substantial individual
autonomy.* We sign the form on the dotted line, make the payments
on the first of each month, and only the most curious or bored among
us would think of reading the fine print on the back of the form. It
would do us little good if we did read the gobbledegook and even
miraculously could understand what the language means. There are few
realistic opportunities to cross out or renegotiate the standard terms to
make them more to our liking. Mass contracts are autonomous acts of
voluntary will only in form.

A kind of contract served as a tool of legal organization in
Stalinist Russia and appeared in post-1949 China. Russian contract law,
as well as the system that prevailed in China during the first genera-
tion after 1949, used the forms of contract to embody written planning
orders. The contracts were largely unnegotiated and in no substantial
sense reflected choices on the part of the enterprises that were bound
to deal together by the contract order. In this sense, "contract" can be
adopted to serve a socialist system of central planning almost as
readily as it can be used to support a capitalist system of free

men can fix their rights and duties by agreement is in its early da)s an unruly, anarchical
idea. If there is to be any law at all, contract must be taught to know its place.

2 FREDERICK POLLOCK & FREDERIC W. .AAND, THs HISTORY OF ENGLiSH LAW 232-33
(S.F.C. Milsom ed., 1968) (2d ed. 1898).

44. OLIMPIAD IOFFE & MARK JAmS, SOVIsT LAW AND ECONOMY 15-22 (1986); Jacek
Kurczewski & Kazimierz Ftieske, Some Problems in the Legal Regulation of the Activities of
Economic Institutions, 11 LAw & Soc'y REv. 489 (1977); Dietrich Loeber, Plan and Contract
Performance in Soviet Law, in LAW IN SOVIEt SocIE 128 (Wayne LaFave ed., 1965).

45. See SOUmGER, supra note 32, at 206-42. Contract use in socialist planning:
In Capitalist societies, it is not important whether a contract is performed, the real purpoce
is whether people can make money by performing the contract. But in China, contract
performance is of the utmost importance, because it is tightly related to socialist planning,
the way to guarantee supply of necessities.

ZHU XIAOQIANG, QrYEuIA YU GONGSHANG XINGZHIENG GUANU [ErtEREN7EuRS AND THE
MANAGEMENT OF INDUSTRY AND CoiMCE ADM IISTRATION 189 (1986).

46. David Slawson, Standard Form Contracts and Democratic Control of La%- Making
Power, 84 HARv. L. REv. 529, 529 (1971).

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enterprise. At the very least, contract techniques make it easier to
decentralize the planning process by allowing the parties at the
operating ends of the system to create a binding form of obligation,
the contract order. Although the central planner may remain in control
of the operation, everything does not have to stand still and wait for
the issuance of detailed commands from the center before the plan is
translated into specific transactions.

Subsidiary units of the state can deal with each other in a system
of socialist planning through the forms of contract, but contract implies
economic liability for the consequences of nonperformance, and this
undermines the apparent monolithic solidarity of the socialist state. A
major aim of recent Chinese reform has been to devise a system that
will operate in a self-correcting way, reducing the reliance on the
heavy hand of administrative regulation to keep the economy going.
One aspect of Chinese reform has been to separate the government
planner and Party official from the operation of specific transactions,
and thereby to free and expand such transactions. Contract law can
operate this way by imposing liability on nonperformers and motivating
performance of agreements. But it is hard to see how you can have
market-based price and production decisions, in distinction to hier-
archical command or planned transactions, unless economic actors are
free to agree to enter or stay out of transactions and to rely on the
agreements of others in making their own commitments.

1. Socialist Planning Before 197847

During the early years following the consolidation of power in
1950, the new regime was confronted with tremendous economic
troubles inherited from a century of war, imperialistic exploitation,
dynastic decay, invasion, and revolution. Pursuant to its socialist
commitment, the new regime confiscated land and other major
economic assets from their capitalist owners. A system of socialist

47. This section is based on a number of impressive studies that have attempted to trace
the tangled story of Chinese economic management after 1949. See, e.g., AUDRE3Y DONNI-
THORNE, CHINA'S ECONOMIC SysTEM, 176-218, 457-95 (1967); DwioHr PERKINS, MARKET
CONTROL AND PLA'NING IN COMMUNIST CHINA (1966); BARRY RICHMAN, A FIRSTHAND
STUDY OF INDUSTRIAL MANAGEMENT IN COMMuNIsr CHINA (1967); CARL RISKIN, CHINA'S
POLITICAL ECONOMY: THE QUEST FOR DEVELOPMENT SINCE 1949 (1987); Thomas Rawski,
China's Industrial System, in JOINT ECON. COMM., 94TH CONG., 1ST SESS., CHINA: A
REASSESSMENT OF THE ECONOMY 175 (Joint Comm. Print 1975); Peter Schran, Economic
Management, in CHINA: MANAGEMENT OF A REVOLUTIONARY SOCIETY 193 (John Lindbeck ed.,
1971) [hereinafter REVOLUIONARY SOCIETY].

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accounting was established, and gradually a planning and allocation
system for the production and distribution of goods was put into place.
The system that emerged was one marked by socialist ownership of all
significant means of production and an economy managed primarily by
state planning of economic inputs and outputs. State ownership and
management of the economy was extensive, and most sizable
enterprises became units of the state.

The system of planning that emerged was based on the expectation
that each economic unit in society would create a plan for its future
activity, coordinated at each level of government to provide resources
(i.e., materials, labor, and capital) to accomplish the goals of the plan
and the outlets through which the product will be distributed. In this
way, the creators of the new regime expected that allocative decisions
would not be made selfishly, on the basis of the wealth and power of
economic actors, but through rational social choices regarding the
wisest use of scarce resources.

Commitment to socialist planning thus is founded on the belief that
officials can rationally plan the economic activity of workers and
managers and can control uncertainties by reason. The process also
depends upon the belief that there is some rational way to balance and
accommodate conflicting economic preferences within society. For
example, we may have the labor and materials to build only one
railroad this year, but there are four interprovincial railroads that are
proposed to improve the economic situations of those four regions. The
faith of the planner is that there is a logical way to make a social
decision concerning which railroad is to be built. Every government in
the world engages in some forms of planning to allocate scarce public
goods. At the very least, the leadership makes decisions regarding the
construction of public roads, school buildings, post offices, and the
like. In most places such decisions are marginally rational, with the
contending interests fought out in a political forum. Frequently,
achieving agreement on priorities proves elusive and paralysis results.
Nongovernmental economic managers also engage in extensive
planning. The Ford Motor Company is already hard at work deciding
how many of what kinds of automobiles it will build five years from
now. It must plan the construction of factories, the purchase of
machinery, and the hiring and training of workers far in advance. Such
decisions are grounded on its expectations regarding the national
economy five years hence, how much money how many people will
have to purchase automobiles, and what their preferences for automo-
biles are likely to be.

Planning, therefore, is not the exclusive property of socialist

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economic systems. What is different is the degree of reliance upon and
the centralization required by the plan. The essential characteristic of
the Soviet model of planned economy, imitated in China, is that the
planning process is so coherent and all-encompassing that it can claim
to control economic activity in a complex society.

On a national level, a long-term (five or seven years) plan is
developed that will include, for example, the decision that a railroad
is needed to connect two provinces. The task of the planners is to find
and allocate the needed labor, materials, and capital to build the
railroad. The locomotive factory must be given an order to deliver
eight locomotives four years hence, when the railroad will be built.
The steel mill must be ordered to produce three years from now
special steel for roller bearings that can be delivered in time to the
locomotive factory so it can build the locomotives and deliver them to
the railroad. If the system worked as advertised, the result of all this
planning would be that every economic actor works in a coherent and
rational manner to achieve social goals.

It is this all-encompassing coherence of the state plan that enables
it to claim to provide an alternative to capitalistic markets. Only
because it is said to possess this capacity to supplant profit-driven
markets can planning claim to fulfill the communist promise of
providing an escape from the exploitation and alienation of workers.
Indeed, unless planning is complete enough to displace the power of
competitive market forces, it is hard to see how a socialist regime can
fulfill its ideological promises to return the dominance of the economy,
and of society in general, to the workers and producers. Only by these
means can the system's supporters claim that the exploitation of selfish
profit-seekers has been avoided.

Discussion of the planning process in China is complicated by our
uncertainty whether the system was ever put firmly in place. A strong
indicator that the system did not work as designed is furnished by the
small number of products for which input-output allocation categories
were established. To return to our locomotive example, for the system
to work the plan must allocate to the factory the materials it needs to
build the locomotive. These materials are likely to fall into a large
number of nonsubstitutable categories. To most people it may look as
though the locomotive is made primarily of steel, but someone who
knows about locomotives will tell you that there are many kinds of
steel, that you can't use cold rolled sheeting to build locomotive
wheels that require high carbon alloys. At the height of the era of
Soviet planning there were tens of thousands of categories of materials,
each of which was separately provided for in terms of production and

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allocation under the plan. Yet available information indicates that the
Chinese planning process never progressed beyond roughly 600
categories.4 8 Other commodities were distributed administratively or
through rudimentary markets.

As the example suggests, the process of planning goes on at many
levels. The national government has a plan on transportation which
includes a section on new construction. This plan is developed in
consultation with the provinces, local governments, and with the
ministries who need the transportation to accomplish their goals. It
must also be drawn in consultation with those units that provide the
resources used in the planned activity, and with those who are to
receive the output. The planning process may produce a document that
is designed to present a picture of some aspect of the plan at a given
moment (e.g., a National Five Year Plan or The Construction Plan for
Hebei Province, 1992-1993), but the process is a constantly developing
one. Each time a new priority for a project is established, planning
decisions must be made to accomplish that goal.

Planning decisions at the highest governmental level are coordi-
nated through the State Planning Commission (Guojia JiweO. The plans
developed by the ministries will be more detailed, with specificity
increasing in the local and enterprise plans. Goals must be set, needs
identified, priorities established, resources identified and allocated, and
finally the plan must be translated into economic transactions. Since
planning and management are two aspects of a single process, the
planner at each level occupies a central position, making or at least
recording the decisions and priorities, discovering and allocating the
resources, and monitoring the ultimate compliance. Enterprises are seen
as subjects of the plan and must limit their activities to those that are
planned. Little decisional discretion is given the enterprise manager to
do things his or her way, since planned activity must be coordinated
and subordinate to the dictates of the plan. It is the planner who is
primarily responsible for matching needs and resources and introducing
suppliers to consumers, and distributors to manufacturers.

When an economy is in crisis, markets will not work well, and the
needs for social control of economic activity will be compelling.
Revolutionary regimes and those at a very primitive economic stage

48. Xue Muqiao, A Study in the Planned Management of the Socialist Economy, BEUNG
REv., Oct. 26, 1979, at 14, 15; Barry Naughton, Economic Reforms and Decentralization:
China's Problematic Materials Allocation System 5 (1984) (unpublished paper); Gordon Vlhite,
The Role of the State in China's Socialist Industrialization 213 (1985) (unpublished manuscript,
on file with authors).

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are likely to start with the expectation that there will be a high level
of government intervention in the economy. They will also be
confronting a crisis in which relatively simple allocative decisions will
appear to vastly improve the situation. As the crisis is successfully
surmounted and economic development proceeds, the planning
decisions become increasingly complex, interrelated, and less clear-cut.
The capacity to communicate, upon which the system rests, becomes
clogged and the capacity to encompass the whole, upon which rational
choice depends, becomes flooded. Decisions become slower and less
certain. Putting it crudely, if half the nation is starving, the appropriate
economic goal will seem clear: feed the hungry, prevent little children
from starving. It may be difficult to accomplish that goal, but that will
appear to be a detail of management.

Success will complicate the picture. Once everyone is fed and
housed, epidemic disease has been controlled, and the disastrous
summer floods have been contained by dams, to what degree should
we direct our efforts next year toward giving every household a color
television set? Perhaps we should invest less in that direction, leaving
most homes with a black and white set while we invest more heavily
in urban parks, art museums, and sports stadiums. It was easy to plan
cotton cloth production so that every citizen received a new dark blue
set of clothes each year, but now that we are richer, how many cotton,
wool, and silk dresses should we plan for next year? What colors
should they be and how long should the skirts be, how wide should
we make the lapels? On what basis do we decide how much scarce
investment funds we should take away from other uses for this
purpose? In short, the kind of planning process that may produce
dramatic short-term improvements in a crisis becomes too crude to
manage a more affluent and diverse society.

2. Contract in the Service of Planning

The leadership of the PRC in the 1950s needed a technique to
make planning decisions concrete and specific. The aim of the system
was to make allocative decisions and distribute goods by plan, not by
price. Yet, inevitably, planning was not expected to be perfect and all-
encompassing. It was anticipated that some minor routine purchases
would be made outside the plan and in emergencies some exchanges
would have to be made while the plan was being adjusted to reflect
the new circumstances. In practice, it appears that these off-plan
transactions remained substantial, although the official view was that
they were relatively insignificant. Within the scope of the plan, the

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assumption was that the planning and the supervising agencies would
allocate the materials necessary to enable the enterprise to fulfill its
production quota. Planning directives ordered suppliers to provide
materials; similar directives dictated where the enterprise was to deliver
its production. Procurement outside the planning mechanism when there
was input-output planning effect was viewed as serious deviance and
was severely punished.

To make planning decisions concrete and specific, the planners
drew upon the Soviet experience and created a kind of contract law in
the service of the plan.49 Under this system, ministries and supervis-
ing agencies sponsored periodic meetings, sometimes referred to as
"goods-ordering conferences," to which were invited all those who
were to produce and deliver products under the plan. At these
meetings, suppliers for materials would be matched with consumers of
those materials, and specific delivery plans would be negotiated. The
results of these meetings were embodied in written documents that
were referred to as contracts, but which essentially were written
planning orders to the enterprises. "Dancing partners" were assigned
by the relevant ministry to ensure that there was a supplier for every
requirement and an outlet for every product. The terms of these
contracts were determined by the orders of the supervising agencies,
not by the negotiations of the parties to the transactions.

Most significantly, these contracts were understood to create
obligations in the parties who signed them, but few meaningful rights.
If the goods that were subject to the contract failed to arrive or were
below grade, the problem would be adjusted by the buyer's manager,
who would ask the supervising agency to complain to the breaching
party's superior in an effort to require performance. Since the
supervising agency is likely to be unable to achieve this result, the
consequence of the failure to deliver is that the disappointed enter-
prise's plan will have to be adjusted to reflect its inability to produce
and deliver the product planned.

A ripple effect follows as every failure to perform is likely to
trigger a loss of production downstream in the course of economic
distribution. This effect is an inevitable consequence of the monopoly
created by the plan. Since there is no market and the goods can be
obtained only from the sources identified by the plan, there are few
opportunities for substituted performance. If the nuts and bolts are not

49. See RICHARD PFEFFER, UNDERSTANDING BusINEss COxACrS IN CHINA, 1949-1963,
at 10-28, (1973); Gene Hsiao, The Role of Economic Contracts in Communist China, 53 CAL.
L. REv. 1029, 1042-49 (1965).

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delivered, assembly of the goods must stop until they come. There is
no way to go to a hardware supplier, buy other nuts and bolts, and
then make the supplier who failed to deliver pay the difference in
price as damages. This feeds an economy built on scarcity as each
enterprise hoards the goods it has since it cannot find substitutes if
they are lost. An enterprise that is disappointed by the failure of its
supplier to deliver cannot pay a premium to persuade another
enterprise which has goods of this kind but no immediate need for
them, to surrender them for a price. Shortages persist while goods sit
in warehouses. The system does not encourage the flow of goods
toward those uses in which they would be most valuable. 5

E. Socialist Economic Organization Before 1978

The organizational tasks of building a socialist economy were
immense and were accomplished in stages, each of which was also
marked by severe political struggles, new slogans, and new heros.
Given the magnitude of these problems, the enormous size and
diversity of the nation, and the tendency for political programs to shift
radically every few years, it is not surprising that the administrative
structures and processes that emerged were not always systematic and
coherent. Throughout the history of the PRC and up to the present,
substantial variation can be observed in the treatment of different
regions, between cities and countryside, between provinces and the
special administrative regions for the three largest cities (Beijing,
Shanghai, and Tianjin), and in other special zones. Nonetheless, at the
risk of great oversimplification, we can describe the overall govern-
mental structure within which most substantial economic activity was
organized in a way that will enable the reader to understand the
impetus they provided reform after 1978.

50. See JANOS KORNAi, THE ECONOMICS OF SHORTAGE (1980). See also Christine Wong,
The Economics of Shortage and Problems of Reform in Chinese Industry, 10 J. COMP. ECON.
363 (1986).

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1. Center and Locality5 '

Since 1949 the PRC has been run by a small group, consisting at
any given time of about 25-35 persons, who form the leadership of the
Government and the Party. These people can be identified by their
physical location at the Zhongnanhai compound at the edge of the
Forbidden City in Beijing, or in their personal location in a relational
network around the "Paramount Leader" (Mao Zedong from 1949 to
1976; Deng Xiaoping from 1978 to the present). Formal office titles
are a sign of membership in the group, but can be misleading. Some
who bear important sounding titles are fronts or out-of-favor has-beens.
Some officials who bear an obscure title, such as deputy director, may
in fact be in charge. The sine qua non of power is participation in a
network of contacts that connects important forces in Chinese society
outside Zhongnanhai to the Paramount Leader within.

Authority moves to and from this group of leaders through at least
three sets of structures: the national government, the Communist Party,
and local governments. It seems likely that there are other important
structures controlled from the center, such as the military, police and
state security, etc., but they stand outside this description. Life
and process inside the center are essentially opaque mysteries to all
foreigners and to all but a few Chinese. One point is clear- This small
group is the central link in all chains of authority and the source of
all claims to legitimate power.

The central institution of national state power is the State Council
(Guowuyuan) under which a large number of ministries, state
committees and departments exercise authority on a national level 52

Some of these State Council organizations operate directly throughout
the nation, but many are replicated by provincial, municipal, and local
agencies that report for some purposes to their national counterpart, but
are responsible for other purposes to the municipal mayor or provincial
government. The result is parallel but intersecting chains of hierarchical

51. The tensions between a highly unified central authority and diverse and far-flung local
societies that make up China is a persistent and crucial theme. See, e.g., DAVID GOODMAN,
CENTRE AND PROVINCE IN THE PEOPLE'S REPUBUC OF CHINA: SICHUAN AND GUIzt 1955-
1965 (1986); SUSAN MAN, LOCAL MERCHANTS AND THE CHINESE BUREAUCRACY, 1750-1950
(1987); RIsKIN, supra note 47; VIVIENNE SHUE, THE REACH OF THE STATE: SKECHES OF TIE
CHINESE BODY POtTC (1988); Frederick Teiwes, Provincial Politics in China: Themes and
Variations, in REVOLUIXONARY SOCIMTY, supra note 47, at 116.

52. This description draws heavily on KENNETH IEDERTHAL & MIC1iEL OSEMBERG,
BUREAUCRAnC PoLrIcS AND CHNESE ENERGY DEVELOPMENT (1986), as supplemented by
informants.

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organization that extend from the center of power down to a local
enterprise or organization. One chain of command extends from
national government to local government to enterprise; the other chain
extends a bureau's jurisdiction from the national level to subordinate
agencies. Our impression is that the tangled structure is puzzling to
participants, as it certainly is to outsiders.

The national government, local governments, and the Party display
substantial organizational similarities. Each has a formal structure that
is constitutionally defined, and at the top of each structure is a
ceremonial body with little real power (the National People's Congress
and the National Party Congress). Real power is concentrated in a
much smaller body (the State Council or the Party Central Committee
Political Bureau).

A large number of subordinate agencies, falling into three main
categories, report to this smaller body. First, there are a number of
ministries that are agencies of sectoral competence (e.g., Ministry of
Water and Electricity, Ministry of Chemical Industries). In the Party
structure, departments serve roughly comparable functions (e.g.,
propaganda, organization of personnel, relations to foreign Socialist
parties). The ministry is at the upper end of what is likely to be a
long chain of supervisory authority and professional responsibility that,
with intermediate links, extends to the local cell, unit, enterprise, or
factory.

The work of the ministries in key problem areas that are confront-
ed by all ministries (e.g., Planning, Management, Science and
Technology) is coordinated by a commission, that in some respects is
equal in rank to ministries, but possesses power of supervision over
ministries within the commission's area of special competence. Thus,
the State Planning Commission is charged with developing the plan by
coordinating and supervising the planning activities of the national
ministries, as well as the planning organs of provincial and municipal
governments. Some of these organizations are given special status for
bureaucratic convenience. For example, many ministries and local
governments operate educational institutions in China. To coordinate
education at the national level, the Education Commission has a special
status that enables it to supervise and issue directives to ministries and
provinces. Its chief carries the prestigious rank of Vice-Premier.
Similarly, the National Science Academy and the Academy of Social
Sciences operate directly under the State Council. Special agencies for
inspection and audit of other agencies also enjoy this special status.

In addition to these commissions and special groups, the members
of the top leadership often create small agencies to coordinate their

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personal responsibilities or to tackle ad hoc problems. Some of these
groups are described as research institutes. As long as the leader holds
power, these personal organizations may possess remarkable influence
and power. The rapid eclipse of several of these bodies after the fall
of Thao Ziyang in 1989 testifies to the fragile nature of life at the top
in this system.

Viewed from the outside, China at first appears to be a very
authoritarian and centralized state, with a heavily systematic and rule-
oriented approach to the problems of government. Yet each of these
features is inevitably limited by powerful practical necessities. The
central authorities can extend their control to vast reaches of the nation
only by making alliances with the leadership of the regional communi-
ties and the countryside. These alliances are mutually necessary and
are important sources of political power for both central officials and
local authorities. The practical limits of remote rule from the center,
the poor state of transportation and communications, and the tremen-
dous variation in the material circumstances in different parts of the
nation demand a balance between central and local authority. The
result is an apparently contradictory emphasis on local self-reliance
within a unitary state. What appears initially to be a very systematic
and rule-oriented system is, in fact, dependent on a particularistic and
very personal style of administration, emphasizing the crucial role of
the alliances, connections, and influence of individual officials.

2. Relations Among the Parts-The Grid

Any substantial activity in China can be located as a point in a
three-dimensional grid of supervisory control. One dimension of this
control is Party leadership. Some Party unit is always responsible for
a given activity and has authority over it. The relevant Party unit can
make all matters its concern, but in practice it is most notably
involved with ideological issues and the appointment of important
personnel. The activity also can be located at the intersection of two
distinct chains of governmental authority. One system of line authority
connects the relevant central ministry under the State Council to the
subordinate unit (e.g., every chemical factory ultimately reports to the
National Ministry of Chemical Industry). The second dimension of the
grid is based on physical locality (i.e., every factory reports, for at
least some purposes, to the county, municipal, or provincial govern-
ment in which it is located). The result is a pattern of crossing
vertical and horizontal lines of authority that run to the central
government and to local agencies. This pattern is replicated at the

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provincial, municipal, and county levels. This system is highly
concentrated at the top, but confronts the unit at the end of the chain
with a large number of potentially competing supervisors. Tension and
opportunities for conflict among the intermediate officials are
numerous.

Authority and responsibility are fragmented because any unit
always reports to more than one superior. A factory, for example, will
have a leadership relation to one agency and have a different
professional or business relation to another. The factory may "belong"
to the city or province that created and built it, but produce goods that
are the concern of a national ministry. Other factories nearby may have
been built at the instance of the ministry or its subordinate agencies
and look to the ministry for both leadership and professional business
supervision.

Relations among intermediate officials are further complicated by
the vertical character of the bureaucratic hierarchy. Power is highly
centralized at the top, but then is divided into competing chains of
authority, operating largely independent of each other. Since all power
emanates along a number of chains of command from a single center,
an official at an intermediate position in the chain looks to the boss
above him for direction, and looks to those beneath him for absolute
obedience. There are strong channels of communication and command
up and down the chains, but there are likely to be few official links
between agencies below the center. Communication, and the ability to
coordinate among officials at about the same level in different chains,
is weak. Since internal operations within each organizational chain are
considered confidential, they are largely outside the ken of officials in
other organizations. Links do form at these intermediate levels between
agencies with frequently overlapping concerns, but these links depend
heavily on the personal relations between the individuals who may
share a relation with a patron, have gone to school together, or who
have worked together before, since they tend to remain at these posts
for many years. One can trace the roots of this organizational structure
to the tenth century, when Chinese government was first organized
with these competing functional bureaus balancing each other out and
also balancing a parallel set of local-based military and magistrates that
by their conflicting pressures upon each other ensured the Emperor's
central authority.53

53. ZHONGHUA FAWAN SIQIAN NIAN [FOUR THOUSAND YEARS OF CtINESE LAW] 132-52
(Ni Zhengmao ed., 1987) [hereinafter ZHONGHUA FAWAN].

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At first glance this system may resemble the familiar system of
checks and balances between levels of state and national government
and among coordinate branches of government that underlies American
constitutional law. Both systems are designed to keep each agency
moving in the right direction by creating a degree of cross-checking
on each agency's operations and a certain competitiveness among
agencies. Both systems also suffer from a tendency for the checks and
balances to become absolute vetoes, complicating coordinated action
and inducing paralysis. Despite these apparent similarities, the
motivation and effect of the two are quite different. The Chinese
system divides power and makes subordinate officials compete in order
to maintain the supremacy of the power concentrated at the center. For
subordinate officials it is of supreme importance to maintain both
access to and approval from the center. The American system is
divided for a diametrically opposite reason - to disperse power and
to prevent its concentration in any single, central authority.

3. The View From the Top

Viewed from the perspective of the supervisory agency, there is a
pressing need to coordinate planning and management activities
between the competing sets of authorities described above. At the
national level, this is the work of the State Planning Commission, an
agency whose function is replicated at each level of local government
and within the ministries. The planning agencies serve as conduits
through which information on resource priorities and needs are
collected, policy choices are formed and embodied in plans, and
allocations of resources and requisitions of production are communicat-
ed back down to the production units.

The plan is constantly being revised and modified to meet
circumstances. The process of planning thus often is indistinguishable
from the process of management. Before 1980, there was a sharp
organizational line drawn between planning and management, with the
latter being assigned to another special commission, the Economic
Commission (Jingwei). Under that structure, the Planning Commission
was the major economic policymaker and the Economic Commission
was the Chief Executive Officer. The function of the Economic
Commission was to coordinate the activities of the industrial ministries
and local government supervisory agencies. It monitored performance
of the plan, made and administered budgets, evaluated management
performance, and served as general manager of the economy. In some
cases it dealt directly with specific enterprises in allocating money for

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special purposes, such as machinery acquisition among industrial
ministries.

The State Council articulates broad national policies. The Planning
Commission then supervises the transformation of these policies into
plans and the Economic Commission manages the plan; through its
supervision of budgets, the Economic Commission ensures that
subordinate agencies and enterprises execute the program. The
industrial ministries specialize in the particular concerns of an
individual industry and direct the enterprises within the ambit of their
expertise. Most enterprises are under the direct supervision of local
government planning and economic bureaus that supervise the specifics
of their planning and management. Parallel networks of Party
organizations maintain revolutionary values and oversee the whole
operation, paying particular attention to the selection, promotion, and
discipline of leadership personnel.

The Economic Commission's Economic Regulation Bureau was a
major rulemaking body, drafting economic laws and regulations for
state-owned enterprises. It also possessed power to review and
coordinate the regulations created by the industrial ministries. The
National Economic Commission, like the National Planning Commis-
sion, occupied a professional supervisory role over local economic
commissions and planning commissions, but local agencies were
primarily under the leadership of the local government, rather than the
national commission.

In 1980, the Economic Commission lost many of its functions at
the national level, the aim being to eliminate excess agencies and
officials and to combine functions as part of economic reform. Some
of the Economic Commission's functions were transferred to the
Planning Commission; others were transferred to industrial ministries
and enterprises to remove one level of supervision. However, Premier
Li Peng is reported to support rebuilding the Economic Commission,
in part to serve as a competitive power balance to the Planning
Commission. As is to be expected, the line between planning and
management is hazy at best, and planners and managers often compete
over the large penumbral areas of concern. The Paramount Leaders
find it politically useful to maintain both in a state of tension,
preventing either from becoming too powerful.

From the point of view of those at the center, this structure
has distinct advantages. It reflects and supports longstanding Chinese
attitudes regarding appropriate social hierarchies and relationships.
Rulers have found it useful to have their subordinates and viceroys in
the provinces competing with each other and dependent on the central

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government. The multiple lines of authority radiating from the center
create incentives for competition among the subordinate groups,
increasing the likelihood that those at the center will be alerted by the
others to the failings of any subordinate.

The system creates the appearance of a very stable, even static,
monolithic authority. The system also lends itself to the creation of
networks of influence and informal ties that cross lines. Those who
know how to manipulate the monolithic structures and rigid borders of
authority possess a valuable and flexible asset for personal advance-
ment. Those in a lower position in such a network can borrow
authority from possessors of bureaucratic competence that is likely to
exceed their formal authority in the system. A strong and sophisticated
leader within such a structure can quickly mobilize his or her
subordinates and allies to move in a new direction. Some of the most
impressive accomplishments of the PRC regime exemplify this
remarkable capacity to mount what looks from the outside like a mass
movement that rapidly changes direction to attain a clearly defined and
specific goal.

4. The View From the Operating Level

From the perspective of an enterprise manager, the system used
before 1978 was quite constraining. Within the factory, the manager's
authority was substantially limited by the power of the Party secretary,
who had the final say on all important personnel decisions and was the
crucial voice on most other important decisions as well. Production
goals and targets came down from the planning agencies through the
responsible business authorities. Materials were supplied under the plan,
prices were set by the Bureau of Price Management, and labor was
allocated by the Bureau of Labor and Wages. Capital construction was
determined by the Central Capital Construction Commission, while
budgets were fixed by the Economic Commission and capital was
allocated by the State Bank.

The very structure of the system complicates horizontal communi-
cation and coordination. Agencies and officials have ranks and
positions, but their real power relations depends on authority they
borrow from the leadership in whose network they operate. Official
titles prove to be an unreliable source of guidance; the only source of
information regarding the official with whom you are dealing is likely
to be the official himself. Bureaucrats at intermediate levels are often
uncomfortable dealing with officials in other chains of command
because they have limited information about them and cannot be sure

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whether they are superior or inferior.
The common response to these problems has been to avoid the

formal paths of communication, decision, and control by developing
informal personal connections that enable an enterprise manager to
make direct contact with officials in other organizational chains. These
connections provide an alternative that lubricates the rigidities of the
formal structure, allowing it to work. The personal career patterns of
officials create opportunities for other kinds of networks to form. Like
many Western social and governmental bureaucracies, the top levels of
Chinese officials change positions relatively often with political change,
but the middle levels tend to stay in the same position for long periods
of time. These middle level officials are the permanent civil servants
that the political ministers must rely upon for expertise in doing their
job.

Middle level officials tend to form connections and networks with
their counterparts in other agencies with whom they deal frequently
over the years. This form of personal influence is relatively innocuous;
the ties are collegial and not inevitably corrupt (although they may be
confirmed by an occasional banquet or other goody). Such connections
are a potent source of power for the middle level officials who control
reliable and effective communications links among agencies that must
do business together. This form of connection is intimately related to
the personal political networks and coalitions that hold the whole
system together. The connecting factor may be a relationship to a
mentor or former supervisor who has now moved up to a higher
position. That official depends on his contacts with his former
subordinates who now serve as his eyes and ears at the operating
level. The subordinates depend on the protection of the mentor, the
borrowed authority of his position, and the usefulness of their links to
each other. As the network grows and becomes more influential, it
promotes the position of the mentor and of the subordinates. At the
highest levels of the system, it becomes a major source of the power
behind those who become the paramount leaders.

The use of connections to short-circuit the system is known as
"using the back door" (houmen). Those adept in its operation possess
power that enables the rigid formal system to operate, but which at the
same time corrodes the capacity of the formal state structure to rule.
Use of the back door is not itself corrupt, although it is deviant from
announced norms. As in all societies, it is alright to do a favor for a
friend out of friendship or out of confidence that the friend is capable
and deserves the boon. It is not corrupt to do a favor for someone,
reciprocating with kindness past favors or hoping for future reciprocity.

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There is a line between favors done by one organization for the other,
and favors that benefit the officials, rather than the organization. Even
in a puritanical regime it is not seen as serious corruption to take your
opposite number in another organization out to dinner once in a while.
This is a slippery slope, however, and China has always been marked
by favors that soon become bribes, that in turn often are obtained by
extortion. Matters of degree become differences in kind. At some point
the alternative connection is not simply lubricative and facilitative; it
becomes competitive and corrupting.

More importantly, safety for all officials lies in pleasing the
superiors in their own line of command. There are few incentives for
being creative or venturesome in ways that will produce agreements
across agencies that superiors in either agency may disfavor. Such
agreements certainly are necessary, but when viewed from above they
represent a short circuit that implicitly threatens the absolute authority
of the official who is bypassed.

In such a structure, the safest course for everyone is to insist that
everything is always operating just as it is supposed to. Those who
inform superiors on the shortcomings of others are likely to find
similar reports being made about their own activities. Those who store
up favors due from others are likely to find that others will forebear
from exposing them. Neither the Center nor the Periphery are equipped
for direct confrontations and neither has strong incentives to address
directly the inconsistencies between conflicting norms or the divergence
between norm and practice. Instead, the safer course is to exercise
great care in dealing with those outside the familiar chain of command,
and to insist loudly on the amazing virtues of the boss' abstractly
stated policies, principles, and theories. In this way, expressions of
loyalty to the leaders can be maximized, while confrontation with
problematic operational specifics can be minimized.

Managers and officials at the operating level work out problems
that arise every day among themselves, but they are likely to cut the
center out of the communications loop and to insist that they have
been following directions at all times, when in fact they were not. In
such a system, disclosure of a practical administrative solution of a
problem is likely to be perceived as deviance. Locals are bound by a
conspiracy of silence or hypocrisy. One deleterious effect is that there
are few opportunities for superiors to become educated on the needs
for practical adjustment or for policy to improve.

This structure imposes heavy costs on long-term enterprise
management. When confronted with a problem in dealing with another
unit or enterprise, it can be difficult just to pick up the telephone and

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resolve the disagreement with an official at a comparable level in the
parallel organization. The two officials are likely to be in coordinate
organizations, neither of which has general authority to order the other
one about. Communication between the two officials depends less on
their personal rank or organizational position than upon the relative
status of their organizations in the informal power network. In many
cases neither official will possess confident knowledge of the other's
status.

The correct, formal way to deal with conflict between two agencies
is to refer the problem upwards in the organizational chain until it
reaches an official who forms a common link between the two
agencies. This official should resolve the matter and then pass
directions down the two chains of command to the operating officials
who are having the problem. Resolution of disputes by this method is
likely to be slow, uncertain, and distorted by the process of communi-
cation itself. Since the system is built on competing long lines of
command, a dispute is likely to have to travel through a number of
levels to find a common link between organizations. Often the lowest
common superior will be the State Council. As the problem and the
decision move up and down the chains they become the concern of
officials increasingly removed from the specific information and
practical experience with the situation. Movement slows as officials are
called upon to deal with situations they know nothing about and find
it more convenient to let the file sit on their desks while they deal
with more interesting matters. Communication is repeated at each level
up and down the chain and at each level the file becomes thicker. The
issue is likely to appear more complex and to be distorted by the
interests and limits of intermediary officials. The situation may
resemble the party game in which members of a team pass a message
by repeating it to the next person in line. Usually the message that
reaches the end of the line is significantly changed by the process. As
the problem moves within the bureaucracy the agency position is
reinforced, commitments to a particular policy are strengthened, and
deviance from the view first expressed is likely to be perceived at least
as "backing down" and more likely as institutional disloyalty. It is hard
to resolve conflict that way.54

54. In addition to the use of connections and the "back door", two other approaches have
been taken to deal with the limitations of this form of communication and problem solving.

a. Build a Local System. If the chains of decision and communication become onerously
long, higher officials may simply cut them by creating a new local system that replicates the
gridiron pattern at the local level and permits freer communication within the new, smaller,

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1991] CONTRACT WITH A CHINESE FACE

1. THE EMERGENCE OF CoNTRACr sINCE 1978

A. Motivations for Change in the Contract System

Few would deny that a primary motivation leading to the reform,
which began in 1978, was the fact that, despite its impressive triumphs
in many areas, China's economic performance compared unfavorably
with that of its neighbors. Japan, Taiwan, Singapore, South Korea,
Hong Kong and even India - they all were doing much better. One
consequence of the "opening" of China during the 1970s was that as
the West began to learn about China, the Chinese people became
aware that inexorably they were becoming poorer while everyone
around them was becoming much richer. The ruling elites of the
regime, like those of Taiwan and South Korea, sought to legitimate
their rule through economic reform. Some way had to be found to feed
the large population and increase their material well-being as the vision
of a prosperous and egalitarian society threatened to fade into oblivion.
As part of the process of reform, the contract system was expanded in
three ways to deal with the inadequacies of socialist planning and
traditional institutions of economic exchange in industry and commerce:

a) through contract exchanges, markets would be created and
incentives expanded to improve and increase the volume of
goods;

gridiron. This is one way to understand the tendency for provincial, municipal, and county
governments to replicate the general pattern of the national regime. If an enterprise in a county
or large city has a problem with a unit across the street it is no longer necessary to go up the
chain of command to Beijing to find a common link. Instead the enterprise reports to the local
Economic Commission which deals with the other unit with few intermediate steps.

b. Build your own Society. This strategy avoids long chains of communications to decrease
reliance on strangers. Each unit tends to build its own little society. The manager places a high
premium on finding ways to control supplies and outlets within a single unit's own resources
or with related units. This is what American managers and antitrust lawyers refer to as vertical
integration. A cement factory ensures its materials by developing its own quarries for sand and
gravel, it builds schools, hospitals, and housing for its workers, it guarantees its markets by
purchasing trucks and establishing its own distribution system for its products. This assures the
manager that problems can be dealt with inside the organization. This strategy also is likely to
prove inefficient economically and to result in substantial inequalities in access to public
services between those lucky enough to be part of a large rich unit and those who are stuck
with the low level of governmental services generally available.

When the strategy works, it is praised as a model of self-reliant development. For varying
reasons Imperial China, Republican China, and Maoist China all emphasized the importance of
freestanding local economies that live on their own resources and engage in commerce only as
a sideline. In many ways self-reliance often means bare subsistence, a life without the benefits
of variety or the efficiency produced by commerce and comparative advantage.



JOURNAL OF CHINESE LAW

b) through contract exchanges, Chinese economic activity
would be brought in closer linkage with the world system,
increasing foreign trade and Chinese access to capital and
technology; and
c) through contract exchanges and the creation of markets to
supplement central state planning, the efficiency of economic
activities would be enhanced and allocative decisions would be
rationalized.

1. Contract As a Means To Increase Production by Providing
Rewards For Producers

The first tentative changes in the organization of the work lives of
the 800 million Chinese who live in the countryside occurred in 1978-
80, when collective units of agricultural production were replaced by
a system of household responsibility contracts. Major production
decisions were returned to the family that worked the land. By most
accounts this reform succeeded in dramatically increasing the produc-
tion and availability of food. A visitor to China who recalls how
things looked in the early 1980s would be struck with a strong visual
impression of how much better off many Chinese appeared in the
streets of large cities and towns soon after this reform. Better nutrition,
more abundant and stylish clothing, and other consumer goods became
available to a substantial portion of the population. A foreign traveller
to those parts of the countryside open to visitors would observe similar
signs of higher living standards: fuller faces, better clothed bodies,
numerous locally-run brick kilns producing the materials for the newly
constructed houses that were visible everywhere. Even in the far
reaches of Western China the peasants' traditional homes were likely
to be topped by the ubiquitous television antenna. In some places
reliable electrical supplies had not yet arrived, but the silent TV set
proudly displayed on the central table was an eloquent statement of
confidence in the inevitability of the march of material progress.

In 1977, Chairman Hua Guofeng announced a new national Party
program that committed the nation to the "Four Modernizations,"
including massive long-term investments to develop agriculture,
industry, defense, science and technology. But only with further
changes in leadership did the content of the new program take shape.
In late December 1978, the Central Committee of the Communist Party
Congress issued a communique setting the framework for the changes
to come. The three central features of this program were the reorgani-
zation of agricultural production and rural land tenure; the opening of

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China to trade with the rest of the world, particularly increased export
of manufactures and greater imports of foreign technology; and the
restructuring of domestic industrial and commercial enterprises to
increase the share of consumption in national income. Each of these
programs was to have a substantial legal and contractual dimension.

a. Agricultural Reform

During the immediate post-revolutionary period, land had been
confiscated from landlords and wide scale redistribution to producer
peasants occurred. By 1955-56, however, agricultural producers'
cooperatives had been formed throughout China with an average size
of about 200 families. Further waves of collectivization during the late
1950s resulted in the creation of large communes consisting of perhaps
5,000 families. Production was organized on a collective basis and
individuals received as compensation work points based on their time,
effort, skill, and political attitude. Farmers were permitted to maintain
private plots on about 5% of the land and the production of these plots
could be sold on an open market at prices above that received for state
quotas on collectivized land. By 1962, after several disastrous years
during which millions starved, the system had reverted to essentially
its earlier form. The communes remained in existence as administrative
units of local government, but the basic unit for organizing labor and
determining the value of peasants' work points became a subunit
known as the production team, consisting of only 20 to 30 families.
About 7% of arable land was left for private plots and limited open
markets were permitted for some commodities. 5

The net result of all these changes - and the political campaigns
and purges that accompanied them - was stagnant food production,
tied to serious disorganization and weakened work incentives for
agricultural producers. Wide scale local rationing of food was
introduced in many cities in the mid-1970s for the first time in more
than a decade. Despite technological changes, including the introduction
of new high yield dwarf rice in 80% of the fields, and infrastructure
investments in irrigation and roads, China was importing more than
one third of its grain for urban consumption.

The rural reforms between 1978 and 1983 had two major features.
First, markets for most agricultural commodities were opened and

55. Elizabeth J. Perry & Christine Wong, The Political Economy of Refom in Post-Mao
China: Causes, Content and Consequences, in POLITICAL EcONo O REFoR , supra note 4.
at 1, 11.

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farmers were permitted to sell their production beyond state quotas
more freely on these markets. Second, the collective work point system
was largely replaced by a "contract responsibility" system that
amounted to household farming. The commune and production team
disappeared as land was allocated to household units under long term
agreements that provided for crop deliveries to the state under a quota,
with state-fixed prices and tax payments. Compensation for state crop
deliveries was raised, but these payments were maintained at a level
lower than the market value of the produce. Beyond this basic
production, the household unit was free to make production decisions
and to sell its product on the newly opened markets.

Food production increased dramatically in the years following these
reforms and the wealth of the countryside visibly increased in many
fertile areas. Prices for above-quota market grain actually fell for
several years and the abundance of grain enabled the State to
repeatedly reduce grain delivery quotas to farmers, thus increasing the
share of total production that was distributed on the market. Production
of meat, poultry and other commodities increased dramatically during
the early years of reform. Income soared in the countryside, at least
in those areas with good land and resources. It has been estimated
that between 1978 and 1981 real per capita rural income grew at an
annual rate of 11.4 percent.56 New houses, consumer goods, and
clothing were seen everywhere and, as cash income accumulated, the
countryside became a major site for new enterprises started by peasant
investors.57

The picture was not one of unmixed joy, however, for the changes
had several adverse effects.58 New competing opportunities for cash
income made it more difficult for local leaders to mobilize labor for
socially necessary, but non-cash producing, activities. Less attention
was paid to maintaining community irrigation, roads, public health, and
education. Teachers quit for better paying jobs, irrigation channels

56. Id.
57. Dwight I Peikins, Reforming China's Economic System, 26 J. ECON. LIT. 601, 607-13

(1988).
58. See JuDrmH BANIsTER, U.S. BUREAU OF CENSUS, CENTER FOR INTERNATIONAL

RESEARCH, STAFF PAPER No. 23, CHINA: RECENT TRENDS IN HEALTH AND MORTALITY (1986);
MICHAEL CHOSSUDOVSKY, TowARD CAprrALST RE RATION? CHINESE SOCIAuSM AFTER
MAO (1986); William Hinton, A Trip to Fengyang County: Investigating China's New Family
Contract System, MONTHLY REV., Nov. 1983, at 1; Richard Latham, The Inplications of Rural
Reforms for Grass-Roots Cadres, in POLITICAL ECONOMY OF REFORM, supra note 4, at 157.
For an economic analysis of the gains and social costs associated with this innovation, see
Justin Y. Lin, The Household Responsibility System Reform in China: A Peasant's Institutional
Choice, 69 AM. J. AGRIC. ECON. 410 (1987).

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clogged, and standards of infant health apparently declined. The
reforms exaggerated the disparities in the endowments available to
different households, communities, regions, and provinces. The lucky
and the well-endowed grew rich, emphasizing the unhappy lot of those
less fortunate. The countryside's transformation to the new system
involved a social revolution that was completed with amazing speed
and ease considering the size of the operation. It remains unclear how
so mammoth a transfer of land to particular families could be
conducted without serious unrest.

The legal structure through which these profound changes in land
use and social organization occurred is said to be contractual. The
success of these changes was a significant source of support for
contract as a cornerstone of economic reform. The land continues to
belong to the State, but the use of the land is transferred to a
household by a responsibility contract. These contracts have very
important legal consequences, including limited power to transfer the
right to the land to other family members upon death and transfers to
other persons by subleases.

In many respects, however, these agreements do not resemble
familiar commercial contractual arrangements. In some places land
apparently was divided into plots of approximately equal value and
then lots were cast to decide which family received what piece of land.
Whatever the process used, there were few serious opportunities to
negotiate the terms; the households took what they were given. In this
respect the responsibility contracts are more akin to status documents,
giving the household a legal claim to use the land. Apparently the
draftsmen of these documents relied heavily on the tenant farming and
sharecropping lease agreements they remembered from pre-revolu-
tionary days.59 There are reported cases in which households have
successfully asserted their legal rights under these agreements when
local officials have sought to take their land away or deprive them of
its benefits. The contract dimensions of these agreements have grown
slowly, and there are few reported court decisions that have applied
principles of contract law to them.6 Indeed, it is reported that in

59. The comparison is traced in Crook, supra note 8. See also Y.Y. Kueh, The Econondcs
of the "Second Land Reform" in China, 101 CHINA Q. 122 (1985).

60. Phyllis Chang reports that these disputes were first accepted by courts in 1982 and by
1985 accounted for over 10% of all economic disputes in the courts, or between 20 to 30
thousand disputes per year. She goes on to note that court intervention remains the exception
rather than the rule in such disputes and that Party policy rather than law has largely shaped
these proceedings. Phyllis Chang, Deciding Disputes: Factors That Guide Chinese Courts in the
Adjudication of Rural Responsibility Contract Disputes, 52 LAw, & CONMI'P. PROBS. 101, 102

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1987 alone there were more than ten million such disputes between
village committees and farmers. In a legal circular, dated April 14,
1986, the Supreme People's Court decreed that disagreements over the
performance of these agreements are not cognizable in lawsuits in the
People's Courts, but are to be resolved as administrative matters
through the village committees. One of the issues that confronted the
National People's Congress in 1989 in adopting an Administrative
Procedure Law was whether decisions of local agencies in disputes
involving rural responsibility contracts would be subject to review by
the Administrative Courts to be created under the new law. 1 The fear
was expressed that inclusion of these disputes, which approach ten
million per year, would overwhelm the new administrative court
system; they were therefore excluded.

2. Contract As a Means to Foster and Enlarge Markets

The geographic and cultural diversity of China complicates
communications and transportion and leads scholars to debate whether
China ever formed a national economy.62 To this day, trade between
enterprises in different provinces often presents features we are likely
to associate with trade between foreign nations.63 A high proportion

& n.6, 113-14, 115-30 (1989). The ambiguities presented by reported rural disputes arise on
several levels: whether the dispute arises out of the household responsibility contract or under
a distinct but related purchasing agreement for the agricultural products produced on the land;
whether the dispute is resolved by the court as a "lawsuit" or by less formal mediatory
intervention; whether the court resolves the dispute on the law or under non-legal Party policies;
and whether the resolution is an imposed decision or a compromise settlement. These
ambiguities are presented and explored in the context of six cases in Zweig, supra note 8, at
340-55. Lester Ross' more recent study of a county in Shandong places little emphasis on the
role of court litigation or on agricultural responsibility contracts themselves. Lester Ross, The
Changing Profile of Dispute Resolution in Rural China: The Case of Zouping County,
Shandong, 26 SrAN. J. INT'L L. 15, 37-42 (1989).

61. There is some uncertainty whether such village committees, which are understood to
be one of the parties to the agricultural responsibility contracts, are administrative units of the
state under the Administrative Litigation Law adopted in 1989. Deputies Interviewed on
Litigation Law, FBIS-China, Mar. 31, 1989, at 17-18. Edward Epstein, Administration
Litigation Law: Citizens Can Sue the State But Not the Party, CHINA NEWs ANALYSIS, June
1, 1989, at 1.

62. See Skinner, supra note 31.
63. A leading economic reform journal reports editorially on situations where county

officials restrict "imports" of bicycles, radios, shoes and about one hundred other items. Some
places put advertisements in the newspaper falsely identifying goods from other communities
as "shoddy goods". Tear Down the Wattled Wall and Setting Up the Big Market, 1990
ZHONGGUO JiNGJI TIZm GAiGE [CHINA'S ECON. STRiuCn REFORM] No. 8, at 6. Heilongjiang
province is reported to have imposed an absolute ban on 20-30 categories of goods and limits
on the entry of more than one hundred other products. Beggar Thy Neighbor, FAR E. ECON.

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of commerce follows major river systems, while road and rail networks
remain weak. Traditionally, central state penetration into the lives of
local communities has been limited, and within communities a heavy
price was exacted from those who were strangers.' Although state
penetration of the local community has been more extensive in the
PRC, the stranger still is more vulnerable because laws and policies-
are enforced by local officials, who have to be concerned about on-
going social relations. State revenues continue to rely heavily on
income from monopolies and practices that resemble tax farming.

In this setting, commerce, like many other aspects of civil society,
has come to be organized on the basis of specific personal connections
between economic actors. Family, clan, guilds, and locality remain
central sources of connection for economic actors who are unable to
rely upon the state and the law to support and enforce their expecta-
tions. Connections and relationship provide the only secure basis for
entering commercial transactions that pose the risks of time and space.

Contract law provides additional sanctions for performance and
compliance through legal enforcement that offers strangers greater hope
of being able to enforce obligations. To the extent that contract law
can deliver on this hope, it supports transactions between strangers and
thus encourages the expansion of markets. There will always be
advantages to playing on one's home turf, just as there will be costs
associated with straying far from home. Nonetheless, the potential of
legal enforcement, designed to provide compensation for disappointed
expectations through institutions that can put money for damages in the
injured party's pocket, can reduce the "home court advantage". 6s

REv., Oct. 18, 1990, at 89. Sometimes the limitations are on exporting food to other provinces,
rather than the import of manufactures. In 1988 farmers in Guanxi and Hunan were reported
to have engaged in daily confrontations with local officials who were trying to prevent the
farmers from taldng advantage of higher produce prices in richer Guangdong. Business As
Usual, FAR E. ECoN. REV., Dec. 8, 1988, at 61.

64. See HslAo KUNG-CHUAN, RURAL CHmqA: IMPERIAL CONTROL IN THE NI -EE'H
CENTURY (1960).

65. Two Chinese judges detail the evils of 'local protectionisim" in the courts and attribu
many of the problems to unlawful administrative interference by local authorities:

A small number of party or government leaders at the county or district level rudely
interfere with the law-enforcement activites of courts, without considering the overall
situation and for the sake of the narrow interests of their localities. Some lead.rs openly
declare that the local court is not allowed to accept entrustments from another court and
to grant local property to a nonlocal litigant through legal action. If the local court maches
a decision to the advantage of a nonlocal litigant through legal action . . . it vill be
criticized as "disobedient" in less serious cases or censured as "living off the locality
while helping other places" in serious ones. This may lead to a cut in office expenditure
and, more seriously, removal from office, dismissal, or transfer from the court of relevant

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The programs of economic reform since 1979 have created
incentives for actors to use contract forms drafted by the government
in their transactions. In the beginning contract certainly operated as a
formality, providing transactional structure in a society where the
expectation is that every activity somehow must be regulated by the
state. The underlying organizations of control over the substance of the
transactions by the state and the Party remained in place, although
great energy was expended in teaching literally millions of people how
to use the forms of contract. In some of the books published early in
reform it almost looks as though making a contract is essentially a
matter of filling in the blanks correctly.66

In time, however, there have been clear signs that the availability
of contract has supported expansion of the number and kinds of
potential economic actors by making it safer to deal with strangers.
Contract can turn outsiders into insiders and vice versa. When the
mechanisms that sanction contract performance are credible, it becomes
possible to do business with and ultimately to trust strangers. The
objective external relationships created by contract slowly begin to
displace economic ties based on personal networks and influence.

Both planning and personal networks have trouble pairing new
partners and expanding the number of players in a market, but this
expansion is precisely what development requires. Contract suggests a
safer way to do business between strangers, who, lacking authority or
relational sanctions for performance and security, depend heavily on
the legal sanctions provided by contract law. Legal enforcement of

personnel.
Yuan Yongliang & Wu Chingbao, Analysis Views Local Protectionism, JINOII CANKAO
[ECONOMIC REFERENCE], Apr. 1, 1990, at 4, trans. in FBIS-China, May 3, 1990, at 27.

66. Professor Hugh Scogin, to the authors, states that the interest in government-provided
contract forms goes back to the Northern Song and is a continuous feature of Chinese state
involvement with commerical transactions. The tension appears to be between those officials
who are attracted to a scholarly and somewhat abstract set of contract law principles that must
be judiciously applied in particular cases and those administrators who are attracted to the
promulgation of forms that fix the content and legal impact of agreement. It certainly is true
that ministries appear attracted to contract forms and promulgate a number of such forms for
specific types of transactions, while courts and other legally oriented officials prefer legislatively
stated general contract norms.

Although it is not common to collect or publish judicial opinions in cases, during our
study we encountered a number of interesting collections of contract case decisions that appear
designed as teaching materials. See, e.g., JINOJI HETONG JIUFEN ANU XUANBIAN [SEIECEIID
CASES OF ECONOMIC CONTRACT DISPUTES] (1982); JINGJI HETONG ANu FENva [ANALYSIS OF
ECONOMIC CONTRACT CASES] (Qiu Guotang & Chen Gan eds., 1984); Wuxi Municipality,
Gongshang Xingzheng Guanli Ju [State Administration of Industry and Commerce], ANU FENXI
[ANALYSIS OF CASES] (fourteen unpublished manuscripts collected between Oct. 1983 and May
1984).

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contracts provides shape to the new socialist order, establishing a new
kind of control and avoiding the chaos of an unregulated market. It is
unclear whether all reformers believed that they were building
socialism through this program. It is clear, however, that this
perspective created an acceptable style of political discourse for reform
that could claim consistency with basic socialist principles. Socialism
may not be the ideology that guides Chinese development policies, but
it continues to be the shared vision of the ruling elites. Over the
decade of reform, contract has moved from being merely a formal
technique to being a significant supplement to planning in the service
of socialism. It became increasingly apparent that contract had the
potential to support the establishment of markets, expand the cast of
characters, and convert hierarchical and network relations into legal
relations.

3. Contract To Promote Participation In the World System

Another central strand motivating change since 1978 has been the
desire to open China to broader contact with foreign nations, including
the major Western trading powers of Europe, America and North Asia.
Previously, China and these nations had perceived each other as
dangerous enemies and excluded each other from trade. Now, however,
government policy contemplates a pattern of export-driven develop-
ment, in which foreign capital and technology are key ingredients.
Coastal cities and provinces and special zones have been opened to
foreign contact, trade, and investment. China has joined a number of
international economic and commercial organizations and seeks to
become a significant player in the world economic and trade system.67

During the first generation of the People's Republic, China had
followed a fiercely independent and self-reliant path. After the
breakdown in relations with the Soviet Union late in the 1950's, the
nation was without major political or economic allies. The reform
movement and the adoption of contract transactions reflected the
leadership's recognition that rapid economic development in other
nations had been supported by their participation in a global economic
system. The government wanted to attract foreign capital to fuel its
development; it hoped for access to foreign markets that would enable
it to earn capital through an export-driven development strategy of the

67. RoBERT KLEIBTERG, CHINA'S "OPENING" TO THE OutswE WORLD: INE ETEPiUENr
wrTs FOREIGN CAPrTAuSM (1990); NicoLAs LARDY, CHINA'S ENrRY INTO THE WORLD

ECONOMY: IMPUCATIONS FOR NORTHEAST ASIA AND THE UNrED SrATm (1987).

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kind that was working so well for its neighbors. The success of this
policy is indicated by the tremendous growth in foreign trade from
$14.8 billion in 1977 to $73.8 billion in 1986. Direct foreign
investment also jumped from $649 million in 1982 to $2.15 billion in
1986.68

To do business in the world system, one must do business the way
everyone else does. Since the mid-nineteenth century, a powerful driver
for legal development in Asia had been the necessity to use interna-
tionally-recognized transactional forms to ensure that foreign business-
persons felt secure and comfortable. To secure this comfort, imperial-
istic commercial interests had subjected China's major centers to the
indignity of foreign courts and concessions. Courts and codes had been
adopted in Japan so that foreign governments would agree to rescind
treaties that had granted extraterritoriality to foreign nationals. China
had resisted these pressures as best it could, and when legal codes
were adopted during the Republican era, social hostility limited their
penetration into Chinese life. During the second half of the twentieth
century the legal rules and procedures of world commerce and
investment have been largely internationalized and harmonized to the
degree that it is difficult to find major substantive differences from
nation to nation. China stood as an exception, outside the world system
and its legal aspects, which were predominantly built on treaties and
conventions that emphasized the autonomy of contract-based transac-
tions.

To join the world and gain foreign exchange for development,
China needed to make its legal system consistent with world standards.
To trade with foreigners and to attract their investments, China has had
to reassure potential partners that it will provide the familiar security
of a legal regime. To communicate with foreigners, it has had to talk
the special language that is universally used in world trade, a language
closely connected with the legal requirements of the world system.

The Chinese government would prefer to limit the adoption of this
vocabulary to foreign trade. One strategy to this end has been to
attempt to separate domestic contract transactions from international
transactions and to adopt distinct legal regimes for the two. There is
an inevitable tension between these two systems. 69 As China joins the

68. LARDY, supra note 67, at 4, 37.
69. In a helpful comment to an earlier draft of this article, Stanley Lubman reminded the

authors that the interplay between Chinese and world trade practice moves both ways:
[NIot only is there a question of allowing domestic transactions to be influenced by
internationally recognized legal concepts, but in practice there is also the danger that

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world system, it is increasingly confronted with the indivisibility of
that system and with the infeasibility of selectively choosing to adopt
some aspects of that system and to reject others. The world system
turns out to be composed of interconnected parts, it provides valuable
opportunities for a developing country, while at the same time
threatens that country's sense that it is the autonomous master of its
own policy choices. Whereas Mao Zedong opted for autonomy, Deng
Xiaoping seized the opportunity.!'

4. Contract As a Means of Rationalizing Allocative Decisions

For the first time since the Revolution that created the People's
Republic of China in 1949, a new tolerance for private individual and
group economic activity is now embodied in laws that explicitly
encourage such enterprise. Chinese socialism, drawing both upon
Marxian and longstanding Chinese attitudes, generally has been hostile
to commerce and has tended to see those who profit by buying and
selling what others produce and consume as parasites! t Now ideolog-
ical theoreticians are busy learning new songs that chant the virtues of
"commodity socialism", "scientific management", and the importance
of developing the communications and trade infrastructure suitable for
the "moderately wealthy society" that China is promised to become.

At the same time, connections based on family, clan and locality
seem to be reasserting themselves more strongly as familiar ways of
doing business, but now are tolerated by the revolutionary regime.'

international contracts in trade and investment transactions, despite their ostensible
dependence on recognized international principles, come to be influenced by fluid, flexible
and anti-legal Chinese notions. I'll show you my scars sometime.

70. For a discussion on China and the world system, see Richard Kraus, Withdrawing from
the World System: Self-reliance and Class Structure in China, in TIE WORLD-SYSrEM OF
CAPrrALsM: PAST AND PREsENr 237-59 (Walter L Goldfrank ed., 1979); Joan Sokolovsky,
States, Classes, and the Chinese Socialist Transition, in SocLAUIS STATES IN THE WORLD-
SYsTr= 157-80 (Christopher Chase-Dunn ed., 1982).

71. See SOLINGER, supra note 32, at 12-18, 130-35.
72. SULAWff H. POTIER & JACK M,. POTER, CHINA'S PEASANTS: TIE AuntROPOLOGY

OF A REVOLUTION 256-69 (1990). As a society where access to resources, labor and the maiket
is limited and under the control of different groups of officials, China developed an elaborate
gift economy based on guanxi. Yang's study clearly shows the redistributive function of guanxd
in Chinese economic life. Yang, supra note 3. An official with good guanxi is able to get
things done when other officials with lesser guanxi fail. The Chinese Petroleum Corporation
complained about how government departments use their authority to gain extralegal petroleum.
Responses from officials point to their need to take care of an extensive guanxi network. Peng
Bo, "Xueye" de Liushi [Bleeding Away], MlINZHU YU FAZRt [De-IOCRACY AND LAW], Dec.
1990, at 2. The fact that children of Party and government leaders are given lucrative positions
in newly established corporations in Hong Kong, Shanghai, and other large cities where their

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The leadership has recognized that incentive and foreign exchange
were needed for faster development, but other structural shortcomings
of the Chinese system also provided motivations for reform. There are
important interconnections between the two most prominent of these:
the desire to create a national market to expand potential productive
transactions for enterprises and the desire to expand the role of
contract to enable socialist planning to work more effectively.

The perception that contract provided an organizational mechanism
that would correct and balance the perceived weaknesses and excesses
of the Chinese economic planning system was a strong impetus to use
contract as part of reform. As has been pointed out earlier in this
article, contract was not seen as incompatible with socialism or
planning. On the contrary, the Maoist planning system, like its Soviet
model, had employed a system of "contract" to implement planning
orders. Once the central planners established goals for inputs and
outputs, these decisions had to be made specific by bringing suppliers
and customers together. This was done by assigning "dance partners",
who provided resources and marketing outlets for products to each
other, but who possessed very limited power to set the material terms
of their exchange.73 These "contracts" were not the product of the
parties' agreement or exchange and were of only limited significance
in defining performance obligations. Moreover, they furnished no
expectation of a legal remedy in case of breach. As the transaction
unfolded during performance and disappointments occurred, the parties'
recourse always was to the supervising official, not to the agreement
itself and its legal enforcement.

a. Industrial Reform

The program of reform in the industrial sector had several central
objectives. Investment policy was to be reversed, eliminating the
Stalinist priority of heavy over light industry. The forced diversion of
resources and savings to build large basic industries would be
supplanted by a more balanced production program that would increase
the availability of manufactured goods for domestic consumption and
export. This change was to increase levels of personal consumption
and improve living standards. Another objective was to reduce the
wasteful consumption of energy that was a major contributing cause

biggest asset is good guanxi is widely acknowedged in China, and has been the target of anti-
corruption campaigns.

73. See supra notes 49, 50 and accompanying text.

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of shortages and stagnant productivity. Finally, increased production
was to be accomplished primarily by plant modernization, improved
management, and higher efficiency in existing enterprises, rather than
by new capital construction. By increasing efficiency, consumption and
growth could increase at the same time, while new capital accumula-
tion could actually decline.74

The key to this program was to be a set of incentives linking
rewards to performance. As in the case of agricultural reform, the
reformers took the basic approach of providing incentives for efficiency
within the enterprises and creating a greater role for market mecha-
nisms to allocate resources and set prices. Both of these approaches
strongly suggested a reduced role for the central agencies of input-
output planning in allocating industrial goods and in enterprise
management.

The forms these incentives and markets would take remained quite
hazy for several years after 1978, and widely divergent views continue
to be held by influential leaders up to the present. At the very least,
this strategy implied that enterprises were to have some resources of
their own, a budget outside the plan. The planning process was
bifurcated into a mandatory plan, which continued to establish fixed
quotas and provide inputs for a few vital sectors of the economy, and
a guidance plan, which set only rough production goals for most other
sectors of the economy. These production goals under the guidance
plan were subject to adjustment after consultation with central and
local authorities. The material inputs and product outputs of items
subject to guidance planning were neither guaranteed by the state nor
requisitioned for delivery to the state. To an initially small but growing
degree, enterprises were to become responsible for acquiring their
materials and other inputs and selling their products on markets.
Enterprises that over-fulfilled their basic production quotas were
permitted to retain profits and could sell products on the market to
non-plan customers. Efficient producers could use retained profits for
worker bonuses, plant improvements, or supplies to increase produc-
tion. Markets for goods were expanded as a larger portion of
production fell outside plan quotas. As a result, a dual price system
has developed under which some goods are sold at low state quota
prices and others are sold at higher market prices. The aim has been

74. Perkins, supra note 57, at 613-21; Dorothy Solinger. Industrial Reform: Decentraliza-
tion, Differentiation, and the Dficulties, 40 J. IN 'L AFP. 105 (Winter 1986); Gene Tidrick &
Chen Jiyuan, The Essence of Industrial Reforms, in CHINA'S INDUSTRIAL REuoP.S, supra note
4, Ch. 1.

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to increase the role of markets and eventually bring the two price
levels together.

At the heart of the industrial economic reform program was a
clearer delineation of the identity of an enterprise and the corollary
attachment of responsibility for failures and rewards for success. The
preexisting system's rigid centralization and overlapping structures of
supervision and authority in the government and Party had created a
situation in which no one was in charge. No one could claim credit for
gains or be held responsible for failures. As the Communique of the
Third Plenary Session of the Eleventh Central Committee of the
Communist Party put the matter in announcing the reforms in 1978:

[O]ne of the most serious shortcomings in the structure of
economic management in our country is the over-concentration
of authority, and it is necessary boldly to shift it under
guidance from the leadership to lower levels so that the local
authorities and industrial and agricultural enterprises will have
greater power of decision in management under the guidance
of unified state planning; . . . it is necessary to act firmly in
line with economic law, attach importance to the role of the
law of value, consciously combine ideological and political
work with economic methods and give full play to the
enthusiasm of cadres and workers for production; it is
necessary, under the centralized leadership of the Party, to
tackle conscientiously the failure to make a distinction between
the Party, the government and the enterprise and to put a stop
to the substitution of the Party for government and the
substitution of government for enterprise administration.S

During the early phase of economic reform the basic expectation
was that planning and state ownership of enterprises would continue
to dominate the economy, but that the central state would be freed
from the miring preoccupation with detail that had prevented planners
from focusing on the big picture and paralyzed managers by denying
them the initiative to execute transactions. Reform through contract
would support the decentralization of economic supervision.

75. Communique of the Third Plenary Session, supra note 27, at 6, 12.

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CONTRACT WITH A CHNESE FACE

B. The Growth of Contract Institutions Post-1978

Revolutionary regimes often start with a strong commitment to
undoing the structures of the past, including the legal organization of
their predecessors. After enjoying a brief period of heady lawlessness,
they typically proceed consciously or unconsciously to recreate the
past. Oscillations in attitude toward law have been especially sharp and
wide in the case of the Chinese revolution that led to the establishment
of the PRC. The Communist revolutionaries gained their first successes
in the rural countryside; the mechanisms of law and government they
developed in that setting were very simple. When the People's
Republic was declared in 1949, one of its first acts was to declare
inoperative all the laws of the predecessor regime. Nonetheless, much
of the administration and judiciary remained in the hands of former
Nationalist officials for several years, and it appears that when they
were in doubt, the law most familiar to them was applied.

During its first seven years (1949-56), the new regime adopted a
number of new laws, including a land reform law and marriage law,
both of which had great influence. As socialist planning was estab-
lished, some laws were adopted to control economic transactions,
including contracts. A national constitution was adopted in 1954, along
with organic laws for the judicial, administrative and legislative organs
of government. These laws borrowed from Soviet models, but on a
piecemeal basis. The overall structure of the codes and legal system
of the Soviet Union were studied and admired, but were not adopted.
At the first session of the National People's Congress in 1954, Zhou
EnlaL, on behalf of the government, reported on the importance of
having a complete legal system. During this period work proceeded on
a new civil code, among other laws.76

The traumatic political events that began with the Anti-Rightist
campaign in 1957 brought successive waves of damage to the legal
system. Professionally trained lawyers and scholars, particularly those
trained in the West before the Revolution, were obvious targets for
these campaigns. Law schools were closed in 1957 and were not to
reopen for more than 20 years. Between the waves of the Anti-Rightist
Campaign, the Great Leap Forward, and the Great Proletarian Cultural
Revolution, tentative efforts were made by the government to revive

76. See HENRY ZHENG, CHINA'S CIVIL AND COr.IEtaA. LAW 19-24 (1988); Mhasanobu
Kato, Civil and Economic Law in the People's Republic of China, 30 AM. L CoMP. L 429,
433-37 (1982); Edward Epstein, CODIFICATION OF CHINESE CIVIL LAWY: HISTORY, FOU1.t AND
SUBSTANCE IN I- E RECEPION OF WESTERN PRIVATE LAW (forthcoming 1992).

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the legal system and adopt laws, but these inevitably were swept away
by the next political wave. For at least a decade during this period, the
National People's Congress did not meet and for a longer period its
legislative activity was paralyzed. Some draft laws that were brought
forward during this period were normative, although not formally
adopted by the legislature. For example, the Law Governing the Work
of the People's Communes remained in draft form, although it
functioned as positive law.

The position and authority of laws, legal institutions, and legal
professionals were uncertain at best. The Ministry of Justice was
abolished. The Cultural Revolution was a period of radical attack and
rejection not just of lawyers and particular laws, but of all positive law
and those responsible for it. The slogan was, "Smash the police, the
procuracy, and the judiciary." At the beginning of the decade of
reform in 1978, all that remained was the shell of legal institutions.
The people's court system was in place, but these courts were manned
predominantly by untrained persons and operated primarily as criminal
courts, with only the shadow of some vestigial civil jurisdiction.
Dispute resolution procedures described as arbitration and mediation
displaced adjudication, and those neighborhood committees that
operated were subject to few legal restraints. Political and Party control
over the courts and neighborhood organizations was very tight. Those
who had been trained in the law had long since been sent to other
activities. The paucity of laws, lawyers, and institutions of law was
reflected in the narrow set of activities in which law was invoked. The
courts continued to hear criminal charges and punish ordinary, political,
and economic crimes, but few would suggest that the punishment of
offenders was determined by a legal process during this period. Some
divorce and other domestic relations disputes found their way into
courts, but most were resolved by neighborhood committees and again
law played a small role, if any, in the process.

1. A Growing Concern For Legality and the Growth of Legislation

The transfer of power during the mid-1970s was accompanied by
a growing concern for legality expressed at different levels of the
regime. To some, legality may well have been connected to legitimacy
and law compliance served to support the regularity of the shift in
political power. For others, legality was connected with administrative
orderliness and the requirement that officials follow set procedures and
act within defined authority. These traditional concerns were reflected
in the repeated revision of the Constitution and various other organic

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laws that defined basic political institutions."
Related to both of these aspects of legality was increased

discomfort with the lawless procedures by which punishment, exile,
and often death had been imposed during the Cultural Revolution. The
specific content of whatever legal constraints were to be adopted
seemed less important than some guarantee that the chaos and
arbitrariness would not be repeated. Among the first new laws
announced were those dealing with criminal procedure and the
definition of crime. Probably a majority of the laws adopted during the
decade, however, dealt with economic matters, particularly foreign
trade 8 It is difficult to quantify the number of regulations and local
ordinances adopted during the decade of reform. A major project at
Beijing University Law Faculty is seeking to compile and index this
subordinate legislation in a computer data base.

The growth in legislation has emphasized the importance of the
research organizations that prepare this legislation within the Govern-
ment, the National People's Congress and the Consultative Assembly.
These organizations are not centralized within the Ministry of Justice,
which was reestablished in July, 1979, but are attached to the State
Council itself, or to other ministries and organs. Within these research
organizations substantial expertise and influence have developed that
shape the direction of the laws which emerge from the process. We
are informed, for example, that in some cases legal research institutes

77. See, e.g., Zhonghua Renmin Gongheguo Difang Geji Renmin Daibiao Dahui he Difang
Geji Renmin Zhengfu Jieshi Fa ['Te Law of the People's Republic of China for the
Organization of the Local People's Congress and the Local People's Governments] (adopted July
1, 1979) in ZHONGHUA RENmiN GONGHEGUO FAL) QUAN Snu [COLLECnON Op fIE LAWS OF
THE PEOPLES REPUBtIC Op CHINA] 33 (1989) [hereinafter FALO QUAN SHU]; Zhonghua Renmin
Gongheguo Quanguo Renmin Daibiao Dahui he Difang Geji Renmin Daibiao Xuanju Fa [The
Law of the People's Republic of China for the Election of the National People's Congress and
the Local People's Congresses] (adopted July 1, 1979) in FAIL) QUAN SHU 60; Zhonghua
Renmin Gongheguo Renmin Fayuan Jieshi Fa [The Law of the People's Republic of China for
the Organization of the People's Court] (adopted July 1, 1979) in FALO1 QUAN Siu 47;
Zhonghua Remnin Gongheguo Renmin Jianchayuan Jieshi Fa [The Law of the People's Republic
of China for the Organization of the People's Pancuracies] (adopted July 1, 1979) in FAL1
QUAN SHU 51; Zhonghua Renmin Gongheguo Xingfa [The Criminal Law of the People's
Republic of China] (adopted July 1, 1979) in PAL) QUAN SHU 97; Zhonghua Remin
Gongheguo Xingshi Susong Fa [The Criminal Procedure Law of the People's Republic of
China] (adopted July 1, 1979) in FALO QUAN SHU 207.

78. In 1989, the director of the Legislation Bureau of the State Council reported that, in
addition to international conventions dealing with commercial matters and some 24 bilateral
investment protection agreements, China had adopted about 250 laws and regulations dealing
with foreign economic matters. Sun Wanzhong on China's Foreign Related Economic
Legislation, ZHONGGUO XINWEN SHE [CHINA NEvs AGENCY], Mar. 31, 19S9, trans. in
FBIS-China, Apr. 4, 1989, at 49.

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have power to review ministry regulations to ensure their legal
correctness.

2. The Growth of Courts and the Judiciary

From its beginning, the PRC did not see being a judge as a
specialized position limited to the law-trained. During the revolutionary
period heavy reliance was placed on mediation of disputes within
families, villages, and communities. After the consolidation of power,
a nationwide system of People's Mediation Committees was estab-
lished, supplemented by a system of people's courts primarily for
serious criminal cases. There was tight political and ideological control
over the courts and mediation committees and Party influence was
strong. During the 1957-1972 period these organizations were all
subject to powerful attacks and effectively were disbanded.

Peoples' Mediation Committees were re-established in the early
1980s, and now about one million separate committees with over six
million mediators operate in virtually every village and neighborhood
in China.79 These committees undoubtedly hear very large numbers
of disputes, including many that would be considered appropriate for
litigation in other countries. The committees are also an integral part
of the local system of public control and supervise a range of
activities, including family planning and housekeeping chores that in
other societies might be considered private concerns.80

The People's Courts also reappeared, although personnel problems
remained formidable for a number of years and limited their activities.
Gradually, some trained judges were brought back from the places to
which they had been dispersed during the Cultural Revolution.

79. See generally Han Yue et al., People's Mediation Unique to China, BEaIIN REV., Nov.
30-Dec. 6, 1987, at 19; Stanley Lubman, Mao and Mediation: Politics and Dispute Resolution
in Communist China, 55 CAL L. REv. 1284 (1967); Michael Palmer, The Revival of Mediation
in the People's Republic of China: (1) Extra-Judicial Mediation, 1987 YEARBOOK ON SOCIALIST
LEGAL SYSTEMS 219 (1988); Michael Palmer, The Revival of Mediation in the People's
Republic of China: (2) Judicial Mediation, 1989 YEARBOOK ON SOCIAuST LEGAL SYSTEMS 145
(1989). It is reported that between 1982 and 1988 these committees settled some 50 million
civil matters. Gao Aming, China's Mediation System Unique, CHINA DAILY, Oct. 10, 1989, at
4. RENMIN TIAoE ZILIANG XUANBIAN [COLLEcrED WORKS ON PEOPLE'S MEDIATION] (China
Social Scien6e Academy ed., 1982); 1987 CHINA LAW YEARBOOK 46-47 (1989).

80. In some urban communities these committees are heavily identified with the elderly
women who dominate them and with a maternalistic or officious (depending on your
perspective) style of intervention in other people's problems. B. Zhao, Super Grannies Save a
Lost Soul, CHINA DAILY, Apr. 10, 1990, at 6; Ted Gup, Granny as Big Brother, FAR E. ECON.
REV., Aug. 17, 1989, at 34.

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Mammoth training programs were established to train tens of thousands
of existing court personnel. Now these court personnel are being
supplemented by law school graduates. In the mid-1980s large numbers
of demobilized army officers were assigned to the People's Courts as
judges. We were informed that every court in the nation received some
of these officers, who generally knew nothing about the law, but were
assigned to job positions equivalent to their army rank (e.g., former
majors became vice-chief judges, etc.)."1 Before 1985, court personnel
numbered 172,000, approximately 10% of whom were college
educated. In 1985, a big push took place to raise the quality of legal
workers. By 1991, 65% of court personnel are estimated to have a
college education, which includes a large number of graduates of TV
university, correspondence schools, college extension courses, and the
like. The goal for 1996 is to have 70% of all court personnel, 80% of
all judges and 90% of all heads and deputy heads of courts be college
educated."

A heavy emphasis on continued on-the-job training and the
division of the courts into specialized chambers has enabled a higher
level of expertise to develop, although it is our impression that in
some cities the judiciary continues to have a weak reputation and is
seen as being very sensitive to Party advice and influence by the
senior bureaucracy. At the same time, there are signs that the
professional character of the judiciary is growing as younger judges
with more education are appointed, and as Party and government
influence on specific decisions declines somewhat. In 1991 a non-Party
member, for the first time, was appointed to the Supreme People's
Court, suggesting that Party membership no longer is a sine qua non
for that office.

As of 1986 there were more than 3,000 People's Courts throughout
the PRC, staffed by about 150,000 judges, clerks, and other profession-
al personnel. About 90% of the courts and personnel are in the local
courts found in rural districts and in the neighborhoods of large cities.
The remaining ten percent form the intermediate and higher courts that
operate in metropolitan areas and at the prefectural, autonomous
regional, and provincial level. These higher courts are likely to have
an economic chamber where economic contract disputes will be heard
by judges considered specialists. Cases are heard by a panel of three

81. Stanley Lubman reports being told in the spring of 1991 by a mid-level judge in onz
of China's biggest cities that extensive numbers of such personnel are still being used in the
courts.

82. FAZHi RIBAO [LEGAL Sysr i DAILY], Aug. 27, 1990, at 1.

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to seven judges, who may sit with lay assessors. The proceedings are
likely to combine adjudication of disputes with several levels of
mediation and informal dispute resolution.

The People's Courts dealt with almost 3 million cases in 1990,
over 60% of which were civil cases. In recent years the civil cases
have consisted largely of divorces and claims on debts. In addition, the
courts have also disposed of about one half million criminal cases.
Approximately the same number of economic cases are heard by the
economic chambers. Ninety percent of these economic cases, or about
600 thousand cases, are contract disputes.83

3. The Administrative Bureau of Industry and Commerce (Gongshang
Xingzheng Guanli Ju)

Overlapping, if not parallel, sets of institutions were created to
oversee the administration of contracts. At first, the administration of
transactional agreements among state enterprises (which, with some
oversimplification, describes the core meaning of the term "economic
contracts") had been entrusted to the supervisory ministries and
agencies to which the contracting parties belonged for administrative
purposes. It appears that notaries based on the European and Russian
models were to have some role in drafting and authenticating
contractual documents, particularly in the countryside, but that role has
not developed in recent years and has never been large in the urban
areas with which the authors are familiar.

Instead, the Gongshang Xingzheng Guanli Ju (literally the
Commerce and Industry Administrative Management Bureau, which is
often referred to in English as the State Administration of Industry and
Commerce (SAIC), and which will be referred to here as the
Administrative Bureau) was given new authority to authenticate
contracts, to arbitrate disputes, and to mediate conflicts in contracts
between parties subject to different supervisory agencies.' The origins
of the Administrative Bureau are somewhat obscure. One predecessor
model is found in the bureaus established in areas under communist
control during the 1940s that registered and generally supervised non-

83. Economic Trials Increase in Courts, RENMiN R1BAO [PEOPLE's DAILY], May 12, 1991,
at 3.

84. The work of this agency in administering domestic commercial contracts is described
in John Spanogle, Jr. & Tibor Baranski, Jr., Chinese Commerical Dispute Resolution Methods:
The State Commercial and Industrial Administration Bureau, 35 AM. J. COMP. L. 761 (1987).

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state-owned commercial activity. 5 The range of market police and
supervision functions the agency has assumed also suggests ties to the
market supervision functions of the traditional magistrate.

Whatever its origins, during the 1950s the Administrative Bureau
was given general supervision of those enterprises that continued to be
privately owned. State-owned enterprises were supervised by ministries
that managed their operation, and the Administrative Bureau supervised
those enterprises the state did not directly manage. As the period of
transition to socialism proceeded, the Administrative Bureau diminished
in importance and eventually was limited to market policing (e.g.,
weights and measures), trademark, advertising regulation, and similar
functions.

Beginning in the late 1970s, the agency was revived and initially
given jurisdiction over contracts between parties who were not subject
to the same supervising authorities. It also became increasingly
important as free consumer markets were tolerated and became
concerned with the registration of enterprises and trademarks.
Gradually, the role of the Administrative Bureau in economic contracts
has grown, while that of the supervisory agencies has shrunk.

The model for the Administrative Bureau's contract activities has
at least five central features. One is educational and motivational; the
Administrative Bureau is active across the nation in teaching enterprise
cadres how to use contracts, in providing forms for common transac-
tions, and in awarding prizes to enterprises that distinguished them-
selves in reliable contract performance (this aspect of its work will be
discussed in Part Four).

Second, the local Administrative Bureaus register and investigate
the capacity of legal persons (discussed in Part Three). In addition to
registering enterprises with legal capacity, the Administrative Bureau
also registers those agents or managers of an enterprise that are
authorized to enter contracts on its behalf. In enforcing the rules
regarding those who are permitted to operate as economic actors, the
Administrative Bureaus serve an important informational function, since
there are likely to be few reliable sources of information both on the
enterprise or unit claiming to have capacity and on the individual
claiming to be authorized to act on behalf of the enterprise and enter
into binding contracts for it. The importance of this function has
increased, and today the Bureau is the only agency authorized to issue

85. DONG JIUCHANG & CAi LTAmC, ZHONGGUO GONGSANG XlNcGz1IENa GUANm'XUE
GAiLuN [A GENERAL INTRODUCTION TO CHINESE INDuSRIAL AND COw.EEL ,NAGe,ENr
STUDIES] 92-93 (1985).

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business licenses and register enterprise representatives with power to
contract. In this connection, the Bureau serves as a kind of credit
reporting agency, attesting to the bona fides and reliability of
enterprises under its supervision and enabling enterprises to do business
with strangers on the basis of the information provided by the Bureau.

Third, the Bureau claims the right to inspect enterprises to ensure
their compliance with contract rules. This is done through a combina-
tion of surprise audits and semi-annual written reports from enterprises.
Reports from subordinate enterprises are consolidated and forwarded
to the Administrative Bureau. Reports include tabulations of the types
of contracts, the amount of money involved, the performance status of
the transaction, any disputes that have arisen, and the party responsible
for the problem. We suspect that the Administrative Bureau in fact has
little capacity to carry out this function or to monitor in any significant
way the volume of contracts entered by enterprises under its jurisdic-
tion.

Fourth, the Bureau counsels and supervises the formation of
individual contracts by parties who come to them for help in a
transaction. If, after its investigation, the Bureau approves the contract,
it certifies its legality, a step that is particularly valued in transactions
between parties who are strangers or who do not have a lot of
experience with the particular kind of contract being used. In these
transactions the Bureau serves almost as a go-between, providing a link
between the parties that continues through performance of the contract.
We were told in both Shanghai and Tianjin that when the Administra-
tive Bureau participates in the formation of the contract, it expects to
be involved in mediation or arbitration should difficulties arise during
performance. The agency thus develops a stake in the deal and
considers itself a patron of its performance, although in practice the
arbitration arm of the Bureau is distinct from and involves different
personnel than those who counsel and certify contracts at formation.

There was an early movement in the direction of requiring
Administrative Bureau approval for all economic contracts above a
certain size, but this has not spread beyond a few experiments we
heard about in the early 1980s. As the sheer numbers and complexity
of economic contracts have grown, the practical possibility of
Administrative Bureau advance consideration of transactions dimin-
ished. It is simply not possible for any agency, particularly one that
has not enjoyed high status or especially talented personnel, to audit
all proposed contract transactions. Similarly, efforts by the Administra-
tive Bureau to create a system for post-transaction audit of enterprises
and periodic review of all of their economic contracts have bogged

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CONTRACT WITH A CHINESE FACE

down due to the same difficulties.
Finally, the Administrative Bureau offers a range of mediation and

arbitration services, particularly in connection with those contract
transactions it has certified (these functions will be discussed in Part
Four).

Judicial institutions were created alongside the Administrative
Bureau. In 1983 an economic chamber of the People's Court was
established to adjudicate lawsuits involving economic contracts. The
judicial approach is necessarily transactional and focuses only on those
contract deals that have gone sour to the extent that one side brings
the dispute to the court. The court and the Administrative Bureau
compete for much of the same business. The personnel of the two
agencies differ in quality, training, and orientation, with each appar-
ently stronger in some communities. Both resolve contract disputes;
although the Administrative Bureau promotes administrative style and
arbitration, while the court tends to support legality as a value and
settles in a judicial context most of its cases.

4. The Growth of the Legal Profession and Legal Education

By 1986 there were over 15,000 full-time and 20,000 part-time
lawyers in China, most of whom worked in 3,300 legal advisory
offices.8 6 These lawyers appear for clients in court, give legal advice,
and assist in transactions. In addition to the lawyers in legal advisory
offices, a growing number of enterprises have employed legal advisors,
as have some government bureaus. Most lawyers are salaried at very
modest levels of compensation. The status of "experimental programs",
under which some legal offices have been permitted to sell their
services directly to clients, has been unclear since 1989.

Law in China is a young profession. With the exception of a small
number of lawyers who were trained before 1957, the entire profession
has been trained since 1978. Most are under thirty years old and 75%
are under 45.87 Since 1986 entrance to the profession has been by a
standardized examination. Colleges and universities produce only about
4,000 law graduates per year and many of these do not become

86. Cheng Gan & Yang Xiaobing, Lavr'ers With New Acceptance in China, BEIJNG REV.,
July 11-17, 1988, at 18; Qualified Lanvyers to Increase to 80,000, CHINA DAILY, Jan. 16, 1991,
at 3. See generally, James Feinerman, Law and Legal Profession in the People's Republic of
China, Ch. 4 in MERLE GOLDMAN Er AL., CHINA'S INTELLECTUALS AND THE SrATS: IN
SEARCH OF A NEw RELATIONSHIp (1987).

87. Cheng & Yang, supra note 86, at 18.

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practicing lawyers. In comparison, more than 51,000 persons study law
by correspondence school and 76,000 more are reported to be taking
law courses offered by television and night schools. Graduates are
permitted to take the national qualifications test for lawyers every two
years, although only 10,000 of 90,000 test takers were found qualified.

With the possible exception of the small number of courses
specializing in international economic law, it does not appear that legal
education is a high prestige specialty for university students in China.
This is suggested by the modest entrance examination scores of
students in law at Peking University in 1979, which fall below those
of students majoring in international trade, economic management,
sociology, and economics.

5. The Growth of Contract Law

A striking feature of the laws on contracts that have been enacted
since 1979 is their diversity. Instead of creating a general system of
contract law to govern all legally enforceable agreements, at least three
distinct sets of contract rules have been established.

One is the set of agricultural responsibility contract rules that have
been used to organize the redistribution of rural land to households. As
we have noted earlier, these arrangements were put in a contractual
form that resembles the agreements used in traditional China for deals
between landlords and tenant farmers. The resolution of the millions
of disputes involving such cases is largely outside the court system.

A second set of contract rules concerns economic contracts; that
is, agreements between units of socialist production. This group of
contract rules was originally understood to provide the bureaucracy
with a more effective way to supervise the execution of the plan.

A third set of contract rules is found in the shadowy set of laws
on civil agreements between individuals. These rules were understood
to be peripheral and of limited significance because of the narrow
concept of private property and the limited role assigned to individu-
ally-owned enterprises that might enter into such agreements. Before
1987, it was unclear what legal foundation, if any, such individual
interests had and what law, if any, defined them. It was widely
anticipated that these civil agreements would be defined more clearly
as the projects to draft and adopt a civil code gathered momentum

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during the 1980s."8 Experts we consulted at the time expected that the
new civil code would bring under its wing all forms of legally
enforceable contracts in a single general law. Ultimately, a number of
provisions on civil contract were included in the General Principles of
Civil Law that were adopted by the National People's Congress in
1986 after the failure to adopt the more ambitious Civil Code. The
guidance provided by the General Principles is limited, however, since
they do not contain any provision that clearly defines the permissible
scope of civil contracts.

This three-way division is just the beginning of the fragmentation
of contract law that occurred during the early 1980s. Economic
contract law, in turn, is divided into two distinct sets of laws: the
Economic Contract Law" which deals with domestic contracts and
the Foreign Economic Contract Law, 1 which deals exclusively with
contracts with foreigners. The Foreign Economic Contract Law lives
alongside a set of special contract regulations that apply in special
economic zones established in the coastal provinces for trade and
investment with foreigners. To further complicate the picture, as of
1988, China acceded to the United Nations Convention for Contracts
for the International Sale of Goods. This Convention creates a distinct
set of legal rules that govern contracts of sale between persons in the
PRC with a place of business and persons in one of the other
countries that have adopted it. If one wishes to know what Chinese
rules apply to a sales contract between a Chinese enterprise and a
foreign seller, one will have to determine whether the seller's place of
business is in a nation that is a party to the UN Convention, and if
not, then whether there are special foreign trade zone rules that apply.
Only if the other sets of rules are excluded should one examine the
applicability of the Chinese national Foreign Economic Contract Law.

Looking at domestic economic contract law, the fragmentation
continues. In 1981 the National People's Congress enacted an
Economic Contract Law. This statute provides a very general
framework for contract making and enforcement, offset against detailed
provisions for particular kinds of contract transactions. The first sixteen
articles of the law state some basic principles in a high level of

88. See, e.g., ZHENG, supra note 76, at 43; BASIC PRINCIPLES OF CIVIL LAW IN CHINA
(William Jones ed., 1989) [hereinafter BASIC PRINCIPLES].

89. ECL, supra note 5.
90. Zhonghua Renmin Gongheguo Haiwai Jingji Hetong Fa [The Foreign Economic

Contract Law of the People's Republic of China] (adopted Mar. 21, 1985, effective July 1.
1985), 1985 GUOW-JYUAN GONGBAO 217 [hereinafter the Foreign Economic Contract Law or
FECLI.

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generality. The next nine articles provide a few rules each for a
number of special kinds of economic contracts: sales, construction,
processing, transport, electrical power sales, storage, leasing, and loans.
Beginning with Article 27, there are then five general articles on
modification and rescission. This is followed by a Chapter on Liability
for Breach, which follows the same pattern, six brief and general
articles on liability are followed by ten much more detailed articles
defining liability in the context of each type of economic contract. The
Law ends with ten general articles on dispute resolution, contract
administration, and jurisdiction. Curiously, hidden in these final articles
is Article 54 which provides: "Individual operator-households and
village commune members who contract with legal persons should
follow this law."91 This provision is clearly intended to deal with the
large number of rural households that have adopted the responsibility
system for agricultural production. We shall have more to say on this
issue in the next part of this paper.

These special categories of contract are likely to puzzle a foreign
reader, who may well question why they are singled out for special.
treatment. The answer appears to be that each of these categories
represents a class of transactions that are claimed as the special
concern of a different central government ministry. Special regulations
have been promulgated for most of these categories of contract to
preserve the bureacratic turf of the supervising ministry. 92

A final fragmenting dimension deserves mention. Most contract law
in China is national law enforced by the unitary state. In recent years,
with permission from the Central Government, several of the larger
cities have issued their own local ordinances on contract enforce-
ment93 which vary substantially from the national legislation.94

91. ECL, art. 54.
92. JEROME COHEN, CONTRACT LAWS OF THE PEOPLE's REPUBuC OF CHINA 61-159

(1988).
93. See, e.g., Tianjin Municipal Economic Contract Administration Regulations, reprinted

in TIANJmN RIBAO, Nov. 6, 1987, at 2 [hereinafter Tianjin Contract Regulations].
94. It is beyond the scope of this article to examine in detail the major legal issues raised

by the Economic Contract Law and its application in the courts. At least three important sources
of guidance for interpretation are provided for judges and parties: judicial decisions ae reported,
although often in truncated form in newspapers and collections of cases; municipal governments
and national ministries have published explanatory regulations for economic contracts in their
jurisdiction; and the Supreme People's Court and municipal high courts issue circulars
instructing judges how to treat difficult issues. Judicial decisions are undoubtedly also influenced
by Party organs, but no published material describes this process. The major substantive themes
for Economic Contract Law cases include:

1. Legal personality - the faren puzzle and who is authorized to enter into a
contract, that is, who is authorized to be an economic actor. ECL, arts. 2, 54.

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I. WHO GETS TO MAKE A CONTRACT WITH VHOM?-THE
EVOLUTION OF THE QUESTION OF LEGAL PERSONALITY

Anglo-American contract law tends to be rather abstract and
universal in describing the ambit of contract. The typical American
contract law treatise or contracts course in law school arranges cases
in doctrinal terms, rather than in terms of the kind of transaction
involved. A transaction between two large corporations is likely to
appear next to a case involving a surgeon and a patient to repair an
injured hand or beautify the patient's nose. 95 Deals between merchants
are placed next to promises by uncles to give nephews a trip to
Europe if they behave well at school 6 All are seen as contracts; all
are understood to be governed by the same general principles. The
broad generalizations of doctrinal rules tell us little about what sorts
of transactions should be organized by contract and which should be
built on other organizing models.

Coming from this background, it is instructive to consider some of
the puzzles now facing contract law in China. The Chinese example
reminds us that the generalizations of our law of contract only work
to the extent that they do because we have a very broad definition of
social personality and of persons who are recognized as appropriate
economic actors. The usefulness of contract as a tool of economic

2. Remedies - What are the consequences of failure to perform? What does "specific
performance" mean when the breacher cannot perform? What does "damages" mean whm
there is no market on which to buy substituted performance. Questions of restitution and
reliance expenditures and their measurement remain. This may explain the heavy use of
penalties. But what is the concept of fault in contract failure? Does this explain why
courts tend to split the difference? ECL, arts. 35-47.
3. Modification - Are the parties free to modify their deal? If contract is in service
of the plan it is hard to see how they can be. This should show the independent interest
of supervisors in the transaction. ECL, arts. 27-31.
4. Supervening Events - What kinds of contract performance failures are excued?
What is the scope of the contracting party's 'responsibility" ? What natural events excuse
non-performance? What acts of state and supervisors relieve the parties of responsibility?
Are the state or supervisors liable for their intervention? ECL, arts. 33, 34.
5. Fault and Breach - Does liability depend on fault? This is the mirror image of
excuse under 4. What kind of fault is needed? Negligence? What if there are failures of
performance on both sides? It appears that the Chinese courts prefer to alloc.te fault. ECL,
arts. 32-47.

95. Those lucky law students who avoid spending their first hours in the papr cha.
attempting to untangle the consequences of the "hairy hand" of Hawkins v. McGee, 146 A. 641
(N.H. 1929) are likely to have to deal vdth the vexed plaintiff in Sullivan v. O'Connor, 29S
N.E.2d 183, 185 (Mass. 1973), whose nose, the court tells us, "now had a concave lin to about
the midpoint, at which it became bulbous ... and the two sides of the tip h-A lost syTmetry."

96. Hamer v. Sidway, 27 N.E. 256 (N.Y. 1891).

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organization is conditioned by the presence of such socially-defined
notions as autonomous economic and social personality. Group
membership, the social definition of who is an insider and who is an
outsider, and the relational distance and proximity among actors
determine the appropriateness of contract between two parties.

How can one make a contract with a stranger when the mecha-
nisms of legal enforcement are weak? At the other extreme, a very
intimate relationship may be incompatible with the impersonal assertion
of legal rights. How can one make a contract with someone so close
that it is not possible to assert distinct, much less conflicting, interests?

The appropriateness of contract also is connected to the concept of
legal personality; that is, whether the party asserting a claim under an
agreement is a competent legal personality empowered by law to
engage in economic activity and to assert claims arising from it. This
may seem strange to an American lawyer bred in a system that long
has assumed the personality of individuals, and that has been very
liberal in permitting corporations, partnerships, trusts, and other fictive
legal personalities to form, do business, and assert claims. Unlike
English law (and perhaps that of Massachusetts), American law has
been sympathetic to claims raised not only by the parties who formed
an agreement, but to broadly defined classes of intended beneficiaries,
who claim the benefits of bargains they were not parties to and in
which they have furnished no consideration. These beneficiaries enforce
promises that were not made to them and for which they have not
paid.

A. Who Is Permitted to Make a Contract?

Chinese contract law comes out of traditional and socialist sources
that operate on quite different assumptions and greatly restrict the pool
of actors who are recognized as capable of asserting a legally
cognizable claim. The definition of social units and legal personality
has long been a complex problem in the Chinese system. In traditional
China, individuals were recognized by the state as part of a family,
clan, village, or guild. Their identities were embedded in these
hierarchically structured networks of relationships. At the top of these
organizations were persons whose considerable power was recognized
by the state. They were sui juris persons. The tendency to define
individual identity in group and relational terms persists in contempo-
rary Chinese societies.

When the Chinese Communist Party took power in 1949, a
concerted effort was made to place the population into class categories

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that would distinguish between enemies and friends - those who were
targets of the revolution versus those who were to be its beneficiaries.
Political and economic rights were allocated according to one's class
status, which follows the individual through life and even passes to the
next generation. Entitlements to education, jobs, housing, and other
benefits have been allocated since 1949 in significant part on the basis
of class background, which is understood to provide an index of civic
virtue and political reliability.97

An equally monumental task for the newly established regime was
the registration of individuals as members of a household and as part
of a work unit (danwei). This registered status has tremendous impact
on the capacity of the individual to move, change jobs, or participate
in economic activity. Under the system that was in place well into the
1980s, a worker could buy a train ticket to a city two hours away only
with the permission of the unit. The system continues to fix the
individual physically in one place and also establishes his or her
position socially and economically. Beginning in 1958, the importance
of collective identity was amplified and units became larger and more
encompassing. Rural residents, comprising most of the population,
became members of communes that might include tens of thousands
of individuals. The common interests of all members of society were
emphasized and they were seen as "eating from one big pot".

The period of reform since 1978 in part has been a reaction to the
excesses of this collectivist perspective. Greater flexibility has been
shown in the creation of new and often smaller units, and some
assertions of individual economic interests - attacked as "tails of the
bourgeoisie" during the Cultural Revolution - have been recently
recognized in Chinese law.9"

Shifts have occurred in the definition of these legal categories, but
it remains the case that Chinese law entertains a even more limited
concept of the capacity of natural persons and non-governmental
associations to engage in economic activity and to contract. From the
beginning of the reform period there has been widespread fear by
conservative elements that contract responsibility would be a major
step in the unwinding of socialism and the state ownership of the
means of production. To mollify these fears the contract law adopted

97. See RiCHARD KRAUS, CLASS CoNFLICr IN CINESE SocuAlsM (1981).
98. See generally PAT HoWARD, BREAKING THE IRON RICs BoWL 77-143 (1938); MARIA

YUDKEN, MAKING GOOD: PRIVATE BUSINESS IN SOCALIST CHINA (1936); Zho Zhongfu,
Enterprise Legal Persons: Their Important Status in Chinese Civil Law, 52 LVAW & CoNTr.EP.
PROBS. 1 (1989).

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was an economic contract law. The only lawful contracts are those
between legal persons, that is, economic units organized or recognized
by the state. By the law's terms, individuals generally cannot make
economic contracts; their agreements are governed by civil law, if they
are legally enforceable at all (which, in practical terms they usually
have not been).

There are several dimensions to these changes, and to an outsider,
the connections between them appear quite tangled and unclear. A first
set of issues centers on the general necessity for government permis-
sion to engage in economic activity and the bureaucratic attitude that
the number of autonomous economic actors should be limited. To
Western ears this first set of issues sounds like a matter of business
regulation, registration, licensing, and the like, except that as in many
American licensed occupations, there is a very strong element of
cartelization, seeking to control the activity by restricting the number
of participants.

A second set of issues turns on the degree to which natural
persons shall have capacity to make agreements that the state legal
machinery will enforce. The Chinese term, fa ren, is only imperfectly
captured by the literal English translation, legal person. By and large,
legal persons are now limited to state and collective units, although the
line is fuzzy when it applies to individual operator-households (geti
hu). The label "individual operator-household" almost always describes
a family household which usually has one individual member who is
the economic actor, although other family members may participate in
the work. These issues came to the fore in the debates over a Civil
Code that would define the legal status of individuals in a collectivist
society. It also is prominent in the development of a distinct body of
economic contract law, which from the outset limited the group of
economic actors to legal persons, but which has been under continuing
pressure to expand its definitions and allow other persons and
associations to participate. This shift represents recognition by the
leadership that once a privately owned and managed economy is
encouraged to develop, the profit incentive makes it impossible to
control those who can and those who cannot do business.

Yet a third set of issues asks how associations and groups are
formed in society, how the group gains the legal capacity to enter
contracts, and who has the power to act on behalf of that group. This
set of issues is perhaps the most cloudy of all, for it implicates matters
of intragovernmental organization, as well as the possibility of the
creation of privately owned business associations. Currently, all
enterprises and units in China are said to be either state agencies or

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collective associations, with a very limited role recognized for
household, individual, and privately-owned enterprises!' The rich
debates of the 1980s on the creation of private companies and other
business organizations not owned by the state, goes beyond the scope
of this article." 0 The process by which the state forms new units has
not been the subject of published law. Perhaps more surprising, we
have not found a Chinese informant who can coherently explain the
general process by which a unit is created. These issues might be
summed up by the simple question to whom one applies in the
government or the Party in order to establish a new unit. Clearly there
is a political and, therefore, a Party dimension to the process, but the
details remain obscure even to knowledgeable Chinese informants.
What we can say with confidence is that the system makes permission
to operate an enterprise valuable by making it scarce; it rations the
necessary permissions to enhance the power of those who can grant
this favor.

During the period of economic expansion of the mid-1980s, we
observed a variety of devices used to deal with the limits government
regulation placed on those who were not legal persons. In some cases
new units were established with official permission, although our
Shanghai informants (who were very much in a position to know)
laughed when we asked them to describe the official process by which
a unit is established. Many budding enterprises borrowed the identity
of a unit established for another purpose. Universities opened factories,
neighborhood associations operated knitting mills and profited by
permitting their name and identity to be used by an.entrepreneur.

A second device to circumvent the requirements of legal person-
ality was to use household and other collective identities. The system
always recognized some limited role of individual economic activity,
largely in the provision of personal services - barbers, peddlers,
clothing cleaning, and repair. During the period from 1968 to 1978, the
permissible ambit of such activities was severely restricted, as was
permission to enter these fields. In the 1980s, more permissive policies
prevailed, in part as a way to absorb large numbers of jobless urban

99. Howard Chao & Yang Xiaoping, Private Enterprise in China: The Developing Law
of Collective Enterprises, 19 INT'L LAW. 1215 (1985); Edward Epstein & Ye Lin, Individual
Enterprise in Contemporary Urban China: A Legal Analysis of Status and Regulation, 21 IT'L
LAw. 397 (1987); Thomas Gold, Urban Private Business in China, 22 SIMD. I4 Coip.
COMmUNISM 187 (1989); Zhao, supra note 98, at 1.

100. See generally Howard Chao & Yang Xiaoping, TVe Reform of the Chinese System of
Enterprise Ownership, 23 STAN. J. INT'L L. 365 (1987).

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youth who were "awaiting assignment" after leaving school. Since the
state was unable to find jobs for these people, they were encouraged
to open photo shops, provide repair services, and otherwise find their
own way. In form, if not in substance, the individual operator-
household was a kind of unit, not an individual. The definition of
permissible household economic activities expanded, however,
providing a way for the family to become the unit for activity barred
to the individual. To expand production, exchange, and services,
Article 54 of the Economic Contract Law provides that individual
operator-households and village commune members may contract with
legal persons. 0 1 This provision seems designed to encourage the
making of rural responsibility contracts without opening the floodgates
to all kinds of contracts between individuals who are not legal persons.

Uncertainty about the appropriate role of contracts by individuals
contributed to the political difficulties experienced in trying to adopt
a comprehensive Civil Code. As early as 1981, drafts of a thick Civil
Code were circulating among specialists in Beijing. The document went
through many drafts in the years of negotiation that followed before
it was ultimately presented to the National People's Congress in 1987.
The opposition effectively blocked the adoption of the Code, despite
powerful support within the government and the Party. Ultimately, a
compromise was struck in which the Congress adopted a short and
general version of General Principles of Civil Law."° By late 1987,
however, at least one major city had adopted a local contract ordinance
that was substantially more tolerant of contracts by individuals than the
national law."° The practical application of this enactment to the
commercial contracts of individuals has yet to be clarified on a
national level.

B. Why Does the State Want to Restrict the Persons Who Could Make
Contract?

There are several ways to explain the efforts by officials to limit
permission to engage in contract in China. During the Ming and Qing
Dynasties, a small, highly centralized bureaucracy supervised a vast

101. ECL, supra note 5, art. 54.
102. See generally BAsIc PRINCIPLES, supra note 88; ZHENG, supra note 76; Edward

Epstein, The Evolution of China's General Principles of Civil Law, 34 AM. J. CoMp. L. 705
(1986); Tong Rou, The General Principles of Civil Law of the PRC: Its Birth, Characteristics,
and Role, 52 LAw & CoNrEMP. PROBS. 151 (Spring 1989).

103. Tianjin Contract Regulations, supra note 93, at 2.

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and diverse empire that was understood to form a unitary state with
a unitary economy. To maintain control and to ensure the flow of
revenues to the state from its remote parts, the county magistrate, the
official at the lower end of the bureaucracy, had to rely on local
community leaders, such as retired scholar-officials and heads of
guilds, who were successful merchants."° The authority of the
official over the merchant-agent was based on the hierarchical
Confucian ideology, which assigned a low status to the merchant. In
fact, as one might expect, given their wealth and the meager salaries
of county magistrates, merchants had considerable influence over local
officialdom. The magistrate tended to play only a limited direct role
in the supervision of commerce, leaving most of the job to organiza-
tions of merchants. The magistrate, during the Ming and Qing
Dynasties, relied upon agents and runners to deal with the market
regulation aspects of his responsibilities.10 5

Cartels were established, dominated by merchant guilds and
brokers, ostensibly to control markets and limit access to them to
ensure the trustworthiness of those who were permitted to participate.
Of course, this strategy served the interests of the merchants whose
permission to trade represented a valuable economic asset, enabling
them to extract monopoly profits from those who dealt with them. Tax
collection was farmed to some of the same groups. From the
perspective of the person who wants to participate in this market the
rule seems to be "what is not permitted is forbidden"; you need
permission for everything. In this way the official was able to enhance
his position vis-a-vis merchants, fulfill his official duties, distance
himself from direct involvement in the grubbiness of business, and thus
appear to be acting out the hierarchical norms that placed him above
the merchant. At the same time, those merchants lucky enough to find
a preferred place were able to avoid the "chaos" of a market with
large numbers of "irresponsible" actors. Their profits and financial
ability to pay off the needs of officials were secure in this cozy non-
competitive situation. The preference for cartels and limited market
entry is tied to the association between cartel power and the alliance
between those merchants possessing that power and the officials who
granted it.

104. MANN, supra note 51.
105. HUANG LIu-HuNG, A COMPL-I BOK CONCERNING HAPPNEsS AND BENEvoLENcs

(Fu-mJI CH'OAN-ShU): A MANUAL FOR LOCAL MAGS'MIAT N SEVeM CENnTMY CHINA
107-25 (Djang Chu trans. & ed., 1984); CHU T'uNG-TsU, LOCAL GOVEI-NT IN CHNA
UNDER THE CH'ING (1988).

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The official who holds the power to grant participation in the
cartelized market has a continuing interest in the scarcity of that ability
to participate, since it amplifies his control. This control may claim
benevolent motivations on the theory that in a well-run, fully-super-
vised market, people will not be cheated in buying and selling. The
spur to the virtue of the merchant and the tax collector, however, is
the supervisory power of the official, not the pressure of competitive
buyers and sellers, or the consent of the citizens and taxpayers to the
system. The claim is that the state gets to intervene and control the
economy for the welfare of the nation without its virtuous officials
becoming too soiled by day-to-day contact with the potentially
corrupting influence of trade. In fact, the opportunities for collusion
between official and merchant and their joint capacity to extort
monopoly profits from trade without constraint are likely to lead to
corruption of all participants.

This formal structure based on connections between officials and
merchants, with its limitations on permission to engage in trade and its
grants of cartel power to those it favored, also facilitated the creation
of social relationships and informal channels of influence. From a
merchant's perspective the official system provided little trustworthy
protection, particularly as soon as one stepped outside one's local
community. For outsiders, courts and magistrates were of little help in
pressing claims against local merchants, who had close ties to the
officials in that community. Prudence dictated doing business only
within the family, within the clan, or within other relational networks.
There the sanction for honest behavior is based on the bonds of family
loyalty, a common connection to an ancestral home, or a common link
to a patron, superior, or teacher. In this way, the system of limited
authorizations to engage in commerce, served not only to reinforce the
official hierarchy, but also strengthen the informal influence networks
that complemented the official structures.

Merchants and officials each possessed one form of power, yet
they were mutually dependent to accomplish their central goals.
Merchants had low status ideologically, but had great economic power
and the knowledge and connections to use them. They needed the
protection and approval of the officials and derived much of their
wealth from tax farming and other delegated public functions. Officials
were at the top of the formal hierarchy, but needed merchants to raise
the money to support their regime.

Traditional ideas regarding the limitation of those permitted to
engage in commerce and the unsavory nature of trade found close
parallels in Marxian attitudes toward commerce and the role of the

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state. The trader, who makes money by buying and selling what others
produce, is seen as a parasite and class enemy.l"' Such activity can
only be made safe by state ownership of the means of production and
a state monopoly on the channels of distribution of goods.

What emerged during the Maoist period was an idealized and
rather undifferentiated vision of the community, in which class and
functional lines were blurred. Individual identity was connected to
membership in a large collectivity, and the distinction between insiders
and outsiders was seen as a "feudal relic" that must be rooted out with
revolutionary zeal. In economic terms, everyone was seen as eating out
of one big pot (daguofan) 7 Commercial activity was located within
this largely undifferentiated collectivity, and all attempts to establish a
distinct identity were to be resisted. Disputes between enterprises or
other parts of the state economy were to be dealt with as management
problems within the state. The assertion of distinct interests by claims
was seen as evidence of lack of commitment and identity with social
progress.

C. Insiders and Outsiders: Non-Legal Social Institutions that Have
Rules and Influence Whether People Are Likely to Make Contracts
With Each Other

Contract is an institution heavily influenced by the social
characteristics of the setting in which transactions occur. Within a
family unit, for example, affective ties are very close and there is
likely to be little if any room for contract. Husbands and wives,
parents and children make agreements all the time, but they can enter
into contracts only by putting aside their relationship and creating a
distance in their positions. The promises made in such close relation-
ships lack legal enforceability in most legal systems for two reasons:
people in such transactions are likely to feel that to invoke the law
will be bad for the relationship, and others will feel that legal
enforcement of these kinds of "private deals" would be bad for the
courts.

To invoke legal remedies in an intimate relationship may seriously
threaten the relationship. Antenuptial agreements make binding
arrangements for those about to enter matrimony, and separation
agreements provide for support and other economic links between those

106. See SOLGER, supra note 32, at 130-35.
107. HOWARD, supra note 98, at 17-44.

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in the process of dissolving their marital relationship. But, in general,
courts do not hear disputes between those currently married regarding
the agreements they make between themselves during their mar-
riage.' Only in America is a court likely to entertain even briefly
the possibility of a suit by a child against parents for child-raising
malpractice. The continental nature of American society and the weak
ties linking family members and members of other social groupings
mean that few strangers are too remote to sue, and few are too
intimate not to sue. Autonomy means that group ties are less likely to
be so important that a claimant would not risk disturbing them by a
lawsuit.

The heartland of Contract is the band of transactions that are made
between near-strangers. Here legal sanctions are feasible and may
marginally contribute to the reliability of the deal, but they do not
materially threaten the relationship. The tendency of contract law is to
create opportunities for persons and enterprises to become economic
actors. On a social level, this tendency is expressed in terms of with
whom one will be willing to do business. On a legal-structural level,
contract law expands the choices of the ways business will be
structured: by a deal around the kitchen table enforced by the family,
by a bargain among friends sealed with a handshake and the threat of
loss of intimacy, by a memo from the manager to the department head
enforced within the enterprise, or by a contract that looks ultimately
to state enforcement in the courts.

In contrast to the organizational mode of association characteristic
of the West, Chinese people create their society by the logic of cha
xu geju, or the "differential mode of association."'" As Fei Xiaotong
pointed out:

The Chinese pattern of social organization is like the circles
that appear on the surface of a lake when a rock is thrown
into it. Everyone stands at the center of the circles produced
by his or her own social influence. Everyone's circles are
interrelated. One touches different circles at different times and
places."n

The concentric circles thus formed are hierarchical in relation to

108. Balfour v. Balfour, [1919] 2 K.B. 571; McDowell, Contracts in the Family, 45 B.U.
L. Rev. 43, 47 (1965).

109. FROM THE SoIL, supra note 3, at 25-36.
110. l at 28.

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the individual, with the innermost circle being the closest. As Fei
explains:

Our social relationships spread out gradually, individual by
individual, resulting in an accumulation of personal connec-
tions. These social relationships form a network composed of
each individual's personal connections. Therefore our social
morality makes sense only in terms of these personal connec-
tions.'

11

Within such a relational network, invocation of legal enforcement
is also likely to be improper and probably less effective than the
sanctions furnished by the group itself. Contract use in China is
conditioned by social and physical proximity. The figure below
presents four distinct situations, each has implications for the use of
contract.

Insider Outsider

Contract is to Contract isbe avoided not needed

Distant Contract may be helpful, Contract is
but is irrelevant necessary

Insiders generally do not make contracts with each other;, to do so
would be insulting, especially when they are located in the same
community or are within easy reach. Invocation of the law may be
helpful when insiders live far from each other, but is irrelevant to the
parties if the social circle is intimate. In that situation reputational and
reciprocal losses are likely to be much stronger sanctions than contract
damages because other parties are involved in the network and
inevitably will become involved in the transaction. Those who do
business in such a network are likely to be tied by kinship or to have
been introduced to each other by another member. The transaction is
likely to be part of a series of transactions involving the same parties.
It is undesirable to invoke the law in such a setting for fear of
embarrassing the person who introduced you to the party on the other
side. These same relational concerns preclude bald cheating by either

111. Ma at 35-36.

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side. Many relational network ties exist in rather grey areas of ill-
defined obligations. These obligations are best kept vague lest they
conflict with vertical hierarchy requirements and come to be seen as
seditious conspiracies against superiors.'12

If social proximity is a limit on the use of contract, so is
remoteness, as the Chinese experience suggests. If the stranger is
within reach, a contract is not needed because social sanctions may be
quite adequate. If she is remote, then invoking legal enforcement is
often necessary. However, if the stranger is too remote, then Chinese
legal institutions are unlikely to provide ways to reach her and sue.
Remoteness was a problem in the past in Europe and America. It was
difficult to find and reach out and bring the stranger into court; the
problems of proof are complicated by distance and differences of local
custom, and if a judgment was obtained the difficulties of enforcement
in a distant community were likely to be insurmountable. Many of
these problems have been overcome only within the past generation in
the West. In China, everyone from over the hill is still likely to be
seen as a stranger, in part because it is likely to prove difficult to
enforce claims against them. Conversely, the party who does business
at home is likely to have a distinct advantage in disputing with a
stranger. A multitude of cases involving parties from different counties
and provinces indicate that there is a well recognized home court
advantage in China. These features are not limited to the formal or
official mechanisms for resolving disputes. It is dangerous to deal with
a stranger - that is, someone who does not fit neatly into familiar
hierarchies and relational networks. There is likely to be insufficient
information about the stranger and his trustworthiness, reputation, and
capacity to perform. Both official and informal sanction systems are
likely to work unsatisfactorily in such a situation. Making a deal with
a stranger involves assumption of substantial risks. Modem Western
law tries to reduce these risks and costs by establishing ways to reach
distant strangers and assert claims against them. Western society relies
even more heavily on institutions that provide information and reliable
credit for transactions between strangers. Banks and credit agencies
reduce risks by enabling a party to find out the reputation of the party
on the other side, by substituting the credit of a reliable party (usually
the bank) for that of the stranger, and by increasing the likelihood that,

112. Professor Hugh Scogin has pointed out to us that while this analysis is correct for
commercial contracts, it may not accurately describe labor contracts in China, which have
become more common and have developed since our period of field observation. Labor
agreements appear to use contract to establish an intimate relationship in the workplace.

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CONTRACT WITH A CHINESE FACE

if the stranger reneges, his reputation will be hurt in his home
community. China continues to have a long way to go in providing
these protections for doing business with remote outsiders.

The availability of contract has supported expansion of the number
and kinds of potential economic actors by making it safer to deal with
distant partners and strangers. Our interviews in Shanghai and Tianjin
led us to believe that individual entrepreneurs determine whether to use
contract to structure their economic relations on the basis of perceived
effectiveness of social sanctions. But contract does not merely structure
economic relations; it tends to structure social relations as well.
Contract sometimes transforms an economic relationship into a social
one and thus can turn outsiders into insiders. Individual operator-
householders interviewed in Shanghai often claimed that after doing
business with the same person for a while, they became zijiren
("family members") bufen bici ("making no differentiation between self
and other").

Conversely, contract may objectify a social relationship and turn
insiders into outsiders. Some entrepreneurs complained that relatives,
by asking for a contract, treat them as mere outsiders. 'My cousin
even negotiated the terms of the contract with me. He was so jiamvai'
(the personality characteristic of treating someone as an outsider).
Contract provides opportunities for objective external relationships to
displace ties based on social network and other grey areas. When the
mechanisms that sanction contract performance are credible, it becomes
possible to do business with and ultimately to trust strangers. Then
contract can transform social and group relationships into individual
relationships.

Over the decade of reform, contract moved beyond being simply
a formal technique to supplement planning in the service of socialism
and to keep the foreigners happy so they would buy, sell and invest.
Increasingly, it became apparent that contract has the potential to
support the establishment of markets, to expand the cast of characters,
and to convert hierarchical and guanxi relations into legal relations.

IV. THE SOCIAL EMBEDDEDNESS OF CONTRACT DIsPuTE
RESOLUTION

The legal procedure used to enforce promises defines the practical
usefulness and meaning of contract. Patterns and processes of dispute
resolution determine whether it is worthwhile to assert legal claims.
Legal norms often are stated in general or abstract terms; they gain
specificity in the concreteness of procedure as they are shaped by the

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expectations that grow out of shared social experience. When the
institutions for dispute resolution are centered in the family or the clan
rather than in the state, it is easy to see their cultural roots. But the
same connections are also observable even in the United States, where
there are over 3,000 largely independent county-based systems of
courts, most of which are locally selected, staffed by local residents,
funded primarily out of local taxes, and typically quite idiosyncratic in
practice. Only a rash lawyer will appear in a strange court assuming
that the practice there is similar to the way things are done at home.

Procedural rules often are of limited rationality, which also
suggests their local cultural basis. For example, the rules of evidence
used in an American jury trial hardly represent a rational scientific
choice of methods to approximate truth. Despite the genius of scholars
like Wigmore, who attempted to systematize the rules governing the
admission and exclusion of evidence in a jury trial at common law, the
power of the rules and their continued use is more closely connected
with longstanding social habits of storytelling than with the epistomo-
logical principles of scientific investigation. Similarly, the basic choice
of procedural law between a judge-centered system in European and
Asian countries or an advocate-centered system in English speaking
countries can be explained coherently only in terms of deeply held
attitudes toward authority and legitimacy within a particular society.

A. The Chinese Process of Disputing Inhibits Reliance on Litigation
for the Vindication of Contract Interests

The process of dealing with a dispute that arises during contract
performance is continuous with the interaction that led the parties to
come together and reach an agreement to transact business in the first
place. The pattern of disputation is shaped by the pattern already
assumed by the transaction. These patterns lead the disappointed party
either to identify a difficulty that occurs during contract performance
as "just one of those things" that must be accepted and endured, a
"problem" that calls for communication and adjustment with the other
side, or the occasion for appropriate outrage and a demand for legal
redress."'

Several features of Chinese organization that we have described
already play an obvious role here. The weakness of formal methods for

113. See generally William LF. Felstiner, Influences of Social Organization on Dispute
Processing, 9 LAW & Soc. Rsv. 63 (1974).

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CONTRACT WITH A CHINESE FACE

the vindication of claims, the crucial importance of informal network
relationships with duration over time, and the restrictions on legal
personality discussed in the last topic, all limit the attractiveness of the
vigorous assertion of a claim. Our Chinese informants express these
limitations when they repeat traditional aphorisms that describe disputes
and litigation as a serious disruption of harmony for which both sides
deserve to be punished. It also can be seen in disputing behavior that
avoids pressing an advantage too hard. Van der Sprenkel, in her study
of Qing legal institutions, emphasizes the great extent to which
conflicts were resolved through informal, nonjudicial mediation in the
family clan, craft or merchant guild, or neighborhood. 14 In Qing
China, the disappointed party was prohibited from going to court
before submitting the dispute to clan or guild hearing. The Qing Codes
contained no formal rules on contract disputes.

The remarkable discomfort of modem Chinese with the assertion
and declaration of rights that finds one side to be in the right and the
other side in the wrong is observable both in the behavior of parties
and in the reactions of officials in the PRC and elsewhere. The fear
of the kind of polarized solutions that legal procedures usually
produce, in which one side clearly wins and the other side clearly
loses, can be found in many cultures, including America. Participants
in lawsuits hurt each other's feelings. This is one explanation for the
widespread popularity of arbitration and conciliation in long-term
relational contracts, such as franchises and distributorships. Given a
limited market, litigation may mean that a supplier is effectively cut
off.

The reports of contracts cases by Chinese courts are remarkable for
the frequency with which even the formal court process ends up by
splitting the loaf to avoid having sore losers. Even when one side is
declared to be completely right, the remedy awarded will usually stop
short of awarding the full relief provided in the contract." 5 This is
particularly remarkable because, for reasons we shall discuss later in
this part, Chinese contracts often provide for penalty payments instead

114. Sybille Van der Sprenkel, LEGAL INS'ITUONS IN MANCHU CHINA ("he Athlorm
Press 1962). More recent research by Phillip Huang suggests that Northern Chin=es peasants
quite frequently resorted to the court system to settle civil disputes during the late Qing and
Republican periods. Huang, supra note 39. See also Mark Aliee, Code, Culture and Custm:
Fouindations of Civil Case Verdicts in a Nineteenth-Century County Court, in CIVIL LAW, supra
note 39.

115. This tendency is identified as the reciprocity norm in Roderick Macnell, Contract in
China: Law, Practice, and Dispute Resolution, 38 STAN. L REV. 303, 341-42, 360-61, 375-79
(1986).

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of compensatory damages based on the economic value of the promise
breached. The court often does not order the breaching party to pay
the amount that is specifically provided in the contract. Interviewees
say "ability to pay" is more important than what is written in the
contract. From the official Chinese point of view, "socialist coopera-
tion" should be the guide for behavior. The contract may say pay
RMB 10,000, but you will only get RMB 2,000, and are told to forget
about the rest because of "socialist cooperation."

1. The Process of Disputing: When is Less Than Perfect Tender
Defined As a Problem?

The objective situation of commerce in China, poor communica-
tions, weak markets, shortages, and disorganization reduce expectations
regarding promised performances. It is said that Chinese business
people are not so sticky about exact dates of delivery, exact quality,
and other specifications of performance. The idea of chabuduo
("almost the same"), discussed by Hu Shi, was seen during the
Republican Era early in this century as a national characteristic of the
Chinese that impeded modernization.' 1 6 Specifications precisely stated
in the contract are not understood to be precise, because there are too
many factors not under control of the contracting partners. Because of
these limited expectations, deviations of performance during the
transaction are less likely to be perceived as a breach and the occasion
for a serious dispute. Instead, the disappointed party expects these
things to happen and "lumps" them if it cannot like them. The
threshold for the identification of an occurrence as a problem is higher
in such a society. These characteristics are congruent with any less
developed economy and may have little to do with Chinese society as
such. Indeed, much higher standards of performance can be observed
in the Chinese societies of Taiwan, Singapore, and Hong Kong, where
different market circumstances create expectations of performance.

2. The Process of Disputing: Direct Communication Between Parties
Is Inhibited When Reliance Is on Network and Go-Betweens

Once the threshold that defines an event as a problem is reached,
relational features of Chinese commercial organization lessen the

116. Hu Shi, Chabuduo Xiansheng Zhuan [Biography of Mr. Almst] in HU Sill:
ZHONGGUO XIANDAI ZUOJIA XUANJI [Hu Stu: SELECrED WORKS OF MODERN CHINESE
WRrrERS] 39-40 (1987).

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likelihood of confrontational disputing between the parties. Weak
markets and weak legal enforcement of claims are connected with
heavy reliance on commercial relationships based on networks
facilitated by go-betweens. A less direct assertion of rights less often
leads to litigation. One can rely only on business partners one is
related to, one went to school with, or with whom one is connected
by a common relationship to an important friend. That friend is likely
to have directly or indirectly introduced the two parties to the
transaction. By implication the friend serves as a guarantor, and often
also is expected to serve as mediator for disputes that may arise during
performance. The link is trust based on relationship, but that means
that confronting the party who has caused the problem is a delicate
matter. First of all, it means admitting that something is wrong,
implying a lack of trust, and disrupting the harmony of the relation-
ship.'17 If there was not a go-between in the formation of the
transaction, it is likely that a third party will be sought who can be
informed of the problem and asked to act as a go-between in resolving
it. The go-between's job at this point is simply to ascertain whether or
not there is a problem.

The go-between is someone both parties know and respect.
Sometimes the link is not direct, but through another person. After a
potential dispute is perceived and the go-between is contacted, there
may be a number of outcomes. One is that there is no problem: the
other party performs the contract and immediately apologizes for
causing concern. The initiating party then is likely to deny that there
was ever any concern. Another possible outcome is that there is indeed
a problem: the party cannot perform the contract. Since contract
performance may be less important than maintaining the relationship,
a party that finds itself unable to perform may take steps to limit the
injury and try to preserve the relationship. The disappointed party also
may decide that the relationship is more important than insisting on
performance of the contract. This was stated very clearly to us by a
group of Shanghai knitwear enterprise managers:

Say I have signed a contract with Jia to deliver 500 sweaters
in October. When Yi, with whom I have no contract but who
is very important to me wants 300 sweaters from me, I am
likely first to stall and hope Jia won't ask me where the 500

117. Cf. Hiroshi Wagatsuma & Arthur Rosett, Cultural Attitudes Towards Contract Law:
Japan and the United States Compared, 2 UCLA PAc. BAsIN LIJ. 76 (1983).

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sweaters are. If he inquires or becomes concerned, I would tell
him that I only have 200 sweaters and hope he will under-
stand my problem. Yi's good will is more important than the
risk of losing Jia as a customer. But Jia usually will under-
stand, since there is some consensus on who is important,
especially if Jia is a friend or family. Family does not always
come first in the short-run. Family are people you can count
on to understand your problems, such as having to buy the
good will of an outsider. Family members are unlikely to
cheat you, but their honesty can be deadly.'18

If the disappointed contracting party believes that the other party
is capable of performing the contract, he is likely to seek the help of
a third party. At this stage, an intermediary who has some influence
over the other party is likely to be chosen. But the intermediary
chosen cannot be the immediate boss of that party, lest it be seen as
bribery. Typically after one identifies the appropriate person, one
approaches the person with a gift of some sort if one knows this
person oneself. The gift may range from a bottle of wine to a TV set.
If the parties don't know the go-between personally, they find someone
who does, give the secondary intermediary a gift, and ask this person
to give a gift to the go-between. The more individuals that one has to
go through to locate the appropriate intermediary the more costly the
resolution will be, therefore one's scope of relations or guanxi is very
important for not only social but economic reasons.

3. The Process of Disputing: Heqing, Heli, Hefa

When we asked Chinese economic court judges how they go about
deciding cases in a very incomplete legal framework, they cited to us
the old adage, Heqing, Heli, Hefa whose literal translation is "accord-
ing to people's feelings or affection, according to propriety or reason,
according to the law." This adage can be analyzed on at least two
levels. One level depends on whose point of view-is adopted: from the
disputing partners' point of view or from the judge's point of view;
and the other is at what stage in the resolution process it becomes
appropriate to apply each principle (i.e., first you deal with affection,
then you reason, and then you apply the law). One meaning of this
adage is "[i]n resolving disputes, first pay attention to the relationship

118. Interview with managers, in Shanghai (June 1989).

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between the parties, then consider what is right and wrong, and only
then worry about the law." A more likely reading is that all three
factors - relationship, rightness, and the law - must be integrated by
the judge in resolving the case. Yet a third possible reading is that law
is worthless unless its rules are informed by a sense of rightness and,
primarily, by sensitivity to normative relations between the two parties.
Judges believe that their decisions have to go beyond the technical
aspect of law, that is not only hefa. Their decision must also be
congruent to natural reason, heli, and appropriate to the feelings of
people, heqing.1 9

From the perspective of most of the economic court judges we
interviewed, contract enforcement is not best accomplished by too rigid
an insistence on the letter of the law and the precise terms of the
contract. The letter must be softened by deference to the relationship
of the party and the moral demands of accommodation. We think this
is one way of understanding the tendency that runs throughout the
processes of the court and the Administrative Bureau to suspend a
lawsuit in mid-course and attempt to resolve the dispute by informal
mediation. In this sense heqing, heli, hefa, serves as an everpresent
limit on the power of the formal rules and upon the power of the
terms of the contract to define the rights of the parties. In most legal
systems the precise enforcement of an extremely one-sided written
contract will be unacceptable to the judge. Enforcement at some point
becomes unconscionable, and a misuse of state power in the service
of injustice. The location of the point where a court will substitute its
judgment for that of the parties expressed in the terms of the
agreement is a major task that in American law often is understood as
a form of interpretation of the parties' agreement. Our observations and
discussion in China suggest that this point is reached much sooner in
China; that is, judges feel significantly less bound by the precise terms
of the contract and freer to soften and compromise the impact of
failure to perform on the breaching party.

Our interviews with Shanghai judges identified three situations
when they felt obligated to enforce the letter of the law and not free
to seek accommodation and compromise for the sake of relationship:

119. Heqing, heli, hera is the principle of judging upheld by Chinese magistrates for
centuries. See, e.g., Sybille Van der Sprenkel, supra note 111; ZHONGHUA FAWAN, supra note
53, at 416-18; Wang Huizu, Xuezhi Yishuo, in I WANG LONG HUANG YSmU 37-38, 50-51
(1970). Anthropologists also noted its operation in Republican China. MORTON FRIED, FABRic
OF CHINESE SocmrY: A STUDY OF THE SOCIAL LiE OF A CHINESE COUNTY SEAT 209-11
(1953). Fried found that residents' first preference in dispute resolution was to apped to
affection, and "appealing to the law" was treated as the least desirable and a last resort.

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a. Illegal Contracts

The law provides that certain contracts are contrary to the national
interest and must be declared invalid. When a party asks the court or
the Administrative Bureau to declare such a contract invalid our
informants felt that their discretion was very limited.

b. Specific Performance

When a plaintiff insists that the court order the breaching
defendant to perform the contract in addition to paying damages for
the breach, the court may feel inhibited from seeking a middle ground.
Three crucial circumstances are whether the defendant in fact has the
ability to perform (otherwise, ordering specific performance will not be
a vain act), whether the performance is available from another source,
and whether performance is crucial to the ability of the complaining
party to fulfil the state plan. If performance by the defendant provides
the only way that the plaintiff can meet the demands of the plan, the
judges told us they feel obliged to ensure that the contract serves the
plan.

c. Deliberate Breach

Contract liability is based on the simple failure to perform as
promised and does not depend on the intention of the breacher to
violate the agreement. When the court decides that a defendant is
deliberately breaching the contract, however, our informants indicated
that there was less room for a compromise resolution of the dispute.
In other words, the deliberate breach itself has injured the relationship
and diminished its value, so that it no longer overrides the value of
legality.

B. Western Strategies Regarding Contract Remedies Are Often
Inappropriate in China

Contract law is based on assumptions about the availability of
social infrastructure to support contract performance which China does
not yet meet. At a very basic level, contract law involves promissory
responsibility; if a party fails to perform a contractual obligation, that
party will pay the injured party the financial equivalent of performance.
This implies that contracting parties have access to wealth in the form
of credit or savings and can turn to that wealth to pay their obliga-

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tions.

1. Specific Performance

In Western nations that are part of the Civil Law tradition, the
code may claim that the basic remedy for contract breach is specific
performance, that is, a judicial order directing the breaching defendant
to perform as promised." Even in these legal systems that claim
specific performance is a primary remedy, courts more frequently order
nonperforming parties to compensate the party injured by nonperfor-
mance with damages rather than performance. As a practical matter,
the breaching party may not be able to perform, and that difficulty is
the cause of the breach in the first place. Unless a defendant clearly
has the ability to perform, the court is simply creating unpleasant
enforcement problems by decreeing specific performance. Little is
accomplished by such an approach.

Anglo-American law has a long tradition of distrust for specific
performance, in large part because of sensitivity to the enforcement
problems that will confront the court. Either the promised performance
is infeasible, in which case ordering specific performance will be futile,
or the promised performance is quite feasible, in which case it should
be easy to purchase it from someone else in the market. The basic
assumption of most western legal systems is that substitute contract
performance is available in the market." If the goods are not
delivered, the disappointed party simply finds another source of supply
and charges the breaching seller the difference between the contract
price and what the goods cost from the other source, which is referred
to as the "cost of cover". In the view now popular in American courts,
it often will increase the wealth of both parties for a high cost seller
to breach, avoiding the loss on the performance of what is for him an
unprofitable deal, but leaving the disappointed buyer not very
disappointed at all, because she can purchase the goods on the market
for less than the contract price. In this way contract serves the
efficiency of transactions and avoids waste of resources.

The assumption that cover is possible underlies modem American
attitudes toward contract and leads to a very conservative set of
contract remedies. Parties are encouraged to make contracts because the
consequences of failing to perform are not likely to be catastrophic.

120. CoNmTAcr LAW TODAY, supra note 25, ch. 6; TR~EL, supra note 26, ch. MII & IV.
121. E. Allan Farnsworth, Legal Remedies For Breach of Contract, 70 CoL.Ut. L REv.

1145, 1149-60 (1970).

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The party who finds it onerous to perform is liable only for the
difference between the agreed contract price and what it will cost to
find someone else willing to do the job. If the contract price reflects
market conditions, the disappointed party should be able to find a new
supplier at the same price and the damages will be zero. Only if the
market price has risen or the original agreement set the price too low
will there be any damages at all. If market prices are stable, the
situation will approximate that just described as typifying Chinese
courts, that is, judicial remedies will be limited and modest. Indeed,
one way of understanding the reluctance we attribute to Chinese judges
to award substantial sums as damages or penalties is that they assume
a high level of price stability. When the disappointed party ultimately
seeks substitute performance in a stable price market, it will be at or
about the price of the breached contract.

2. Who Pays the Damages?

The sanctions of contract remedies, particularly damages, make
sense only when the burden of liability falls directly upon the
nonperforming party. There is little incentive for injured parties to go
through the inevitably difficult process of litigation and contract
enforcement if the reward at the end is an abstract statement that they
were right and the other side is wrong. In most legal systems the
award of damages provides that incentive, and the successful claimant
is better off economically for receiving those damages.

Contract remedies assume that the parties to enforceable agree-
ments are autonomous actors with access to wealth. If such a party is
ordered to pay damages, its other behavior will be constrained by the
loss of wealth; it will cost that party something. Conversely, damages
awarded to an injured party are valuable to it, they give her wealth she
otherwise would lack. But these assumptions do not fit the socialist
system of capital allocation. If a socialist enterprise is profitable, it is
expected to remit profits to the State. If a state enterprise loses money,
the State is expected to replenish its capital in order that it can
continue production for socialist ends. Bankruptcy and unemployment
are avoided in such a "soft budget" system, but so is responsibility for
contractual nonperformance. If a State enterprise is ordered to pay
damages, it simply turns around and seeks to persuade its benefactors
in the state to make up the shortage created. If an enterprise recovers
damages, they go to the State. In such a system money goes in and
out of the same pockets with little impact on the enterprises, on their
managers, or on their behavior. A persistent challenge to the contract

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system is to find a way to motivate performance of contract by state
enterprises.

For that to happen in a socialist system of state-owned enterprise,
some way must be found to separate the interests and financial
position of the state from those of the enterprise. Only then will the
enterprise be responsible for its nonperformance and the other party
better off for having enforced the contract. Until that separation is
made, the independent contract law judge inevitably will be in conflict
with the official in the supervisory agency that oversees the enterprise.
Viewed this way, contract is more than a neutral form, an empty
vessel that can be filled to organize any kind of political system. From
this perspective, contract implies a degree of economic freedom for
enterprises and a corollary degree of economic responsibility, including
independence from the state budget.

3. Damages and the Judgment-proof

If parties possess little wealth and if markets are weak so that
alternative performances are unavailable, it may be difficult to give
meaning to concepts of contract responsibility. Yet these features are
particularly notable in a poor, centrally-planned, state-owned economy.
In China, capital is allocated by the state through banks under a plan.
Little illicit credit is available to enterprises outside this system.
Similarly, open markets exist for some, but not all, commodities. If a
contract is not performed, the disappointed party may not have any
practical way to purchase a substitute if awarded damages.

4. Damages Depend On Markets

The general assumption underlying contract remedies is that the
disappointed party can purchase the promised performance on a market.
To the extent this assumption does not apply, Western law is
confronted with difficult questions of calculating damages, particularly
the consequential damages that flow from the breach. The definition
of consequential damages has presented vexing difficulties to many
legal systems." The problems associated with damages that cannot
be avoided by cover often lead parties to commercial contracts to
provide in the agreement that damages will be fixed at a given
amount. These clauses are labelled liquidated damages when they are

122. See, e.g., LOOKOFSKY, supra note 26.

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tolerated. Anglo-American law has had many centuries of bad
experience with such clauses, however, which traditionally have been
viewed with hostility and labelled as penalties."z A major problem
with a penalty clause is that the amount of the penalty is likely to bear
no relation to the actual economic loss from the breach and may be
insensitive to the size of the fault. Small deviations from the promised
performance can visit catastrophic penalties on hapless parties. More
importantly for the economic system, the size of the penalties can lead
the parties to behave in ways that are undesirable for the larger
economy and perform agreements that result in the inefficient
allocation of resources, when everyone would be better if the
transaction were aborted and the performance purchased elsewhere on
the market.

Market structures are notably weak in China, and the proportion
of situations where cover will not be available is large as a practical
matter. Compensatory damages provide a sensible remedy in a smaller
proportion of cases. This reality forces the Chinese judge in one of
three directions.

One possibility is to emphasize specific relief and order the
performance of the agreement rather than award damages for the
breach. Chinese legal authorities claim that specific relief is primary,
although in our conversations, working judges recognized its limita-
tions. You can't get blood from a stone, and you can't get perfor-
mance of the impossible. Moreover, ordering performance involves the
court in a potentially lengthy process of supervision of a business the
judge may know little about; and it threatens a confrontation between
defendant and court that offends Chinese sensibilities (and everyone
else's too). Chinese enforcement of court orders is no stronger than
that of the rest of the world.

A second strategy is to rely heavily on penalty clauses as the
measure of damages. This in part reflects the necessity of finding a
substitute for the non-existent market price. So long as penalties are
relatively modest or are scaled so that they reflect the gravity of a
particular breach, they may provide a surrogate for the absent market
price. It appears from reported court decisions that Chinese judges
often reduce the amount of the penalty below that provided in the
agreement to arrive at a number that seems to reflect the actual loss
from the breach.

123. See, e.g., Ian Macneil, Power of Contract and Agreed Retedies, 47 CoRNELL L REV.
495, 499-513 (1962).

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This indicates the third strategy, which is for judges to soften the
penalty terms or avoid applying them altogether by steering the cases
into "informal mediation" and settlements. Every legal system in the
world depends on the draconian potential of the formal law to motivate
the vast majority of litigants to settle their claims outside a formal
court decision." Chinese court procedure provides an unusually rich
range of opportunities for judges to take this approach, even during the
course of trial. Preference for settlement and accommodation is one
way to understand the emphasis on equity and relationship expressed
in heqing, hel4 hefa. Only as a last resort need the court refer to the
rigid rules of law.

To the extent that markets are unavailable as a reference point for
remedies contract law in China has limited capacity to foster the
efficient allocation of resources. Penalty clauses, specific performance
and half-a-loaf settlements are likely to encourage the continuation and
performance of contracts that both sides and society at large might all
be better off breaching. Rather than disciplining contracting parties and
leading them to use the available resources efficiently, these practices
place a higher value on relationship.

C. Motivating Contract Compliance

Western contract law operates on the assumption that it is the
sanction of the law, particularly the award of damages and occasionally
ordering specific performance, that are primary social supports
motivating parties in society to observe their contracts. This is almost
certainly an exaggerated view of the importance of the law. We do not
know the extent to which people keep their agreements. Often contracts
are observed even though the law would impose no penalty for breach.
Interests in reputation and the maintenance of ongoing relationships
powerfully motivate us to keep our promises and the law's sanctions
probably do not add much force to those motivations in most cases.
In China the legal force motivating contract performance seems even
weaker than elsewhere. The threats of damages and specific perfor-
mance are likely to be ineffective in many cases. We have been struck
in our observations in China with the variety of motivations the regime
has mobilized in support of its programs of contract. Some of these
programs have cognates in the West, but many appear unique in scale

124. See, e.g., Arthur Rosett, Discretion, Severity and Legality in Criminal Justice, 46 S.
CAT. L REv. 12 (1972).

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and the vigor with which they are pursued.
Since the aims of the contract system and the techniques that

might be effective to motivate contract compliance may lead in
divergent directions, the choice of technique to motivate compliance
with contract will depend on whether the aims or compliance are given
priority. For example, one aim of the contract law system is to
encourage economic actors to engage in commerce by reducing the
transaction costs associated with doing business with unreliable people,
particularly strangers. This aim is likely to lead to emphasis on
protection of parties' economic expectations in transactions and to a
rather conservative measure of compensatory damages, much like that
observable in the West. The law assures that in the event of breach the
injured party will receive the financial equivalent of performance, but
no more. This leads to a system in which both the making of contracts
and their breach are quite cheap and carry little moral stigma. The
emphasis will be on substituted remedies (damages) rather than specific
performance, and those damages that are recognized will be narrowly
defined and limited to economic losses. But lowering the price on
contract breach undercuts the motivation of parties to perform their
contracts and reduces the pressures for contract compliance.

On the other hand, the aim of society might be to enforce morality
and to motivate people to keep their word. Concern for the morality
of promise keeping is likely to lead to a legal system that will punish
promise breakers and order them to perform what they promised on
pain of afflictive moral reeducation. It is also likely to lead to
emphasis on educational programs that will impress on citizens the
importance of promise keeping and mobilize public approval behind
those who do keep their word.

Another aim of the contract system, particularly in a socialist
system, is to ensure that the state plan is executed according to its
terms so that other transactions that are planned in reliance on this
transaction also will be able to go forward. In a non-socialist context
there may also be concern for the interests of others in those contract
performances that will effect their economic and social interests
(workers, suppliers, the larger community). This concern leads to
seeing these third parties as beneficiaries of the contract with legal
standing to assert claims under it. Concern for the state plan or for the
interests of third parties results in a system that limits the power of
parties to make their own deals, to modify or cancel these deals once
the interests of third parties have matured, or to adjust their disputes
by negotiated compromises that do not explicitly take into account the
interests of the non-parties. It is also likely to lead to a system that

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puts emphasis on penalties for nonperformance to secure the interests
of non-parties, even in situations when the failure to perform does not
create a direct economic loss to the other party.

1. The Continuing Role of Supervisory Agencies

Contract law as enforced through courts in China has not been
able to make concepts of economic damages work very well.
Explanations include the absence of a reliable market upon which a
disappointed party can obtain substituted performance, the difficulties
of separating enterprises from the state, and the problems of awarding
damages in a poor society where only the state has funds and only the
state suffers losses from nonperformance. The courts we observed use
penalties, mediation, and specific performance to circumvent these
shortcomings. The development of economic courts, contract laws, and
contract lawyers in China during the decade of reform has been
remarkable, but incomplete. We turn now to the part played by other
organizations to the totality of the significance of contract as an
institution.

The introduction of contract in the PRC has been matched by
modification in the planni- process including a reduction in compre-
hensive, centralized, mandatory, input-output planning. Despite the
emphasis on enterprise and transactional autonomy through contract,
the governmental institutions of the old system have not been
dismantled. Factories and enterprises remain under the supervision of
ministries at the national, provincial or municipal level. Economic
activities are coordinated at each of these levels by an Economic
Commission (Jingwei) that actively participates in planning, budget,
and executive management.

The supervising agencies and the Economic Commission determine
the enterprise's call upon state resources, set the payments the
enterprise must make to the State, and influence with parallel Party
organs, the personal careers of key managerial personnel. The
supervising agencies use these levers of control and influence to induce
enterprises to use the contract system, to educate key personnel on the
use of contracts, to promulgate contract forms for common transac-
tions, and to police contract performance. For example, in Shanghai
budgetary allocations to enterprises are decided by the Economic
Commission on the basis of a variety of stated measures of efficiency
and effectiveness. The aim is to reward and expand successful
enterprises and discipline the inefficient. Contract performance is one
of the measures used. Each enterprise must report to the Economic

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Commission the number of contracts entered during the reporting
period and what happened in these transactions. The expectation is that
contracts will be fully performed and the failure to carry the deal
through to completion as agreed is seen as a deviation. The official
with whom we discussed these reports saw it as a problem if
enterprise management entered into transactions they lacked the means
to perform or if they failed to deliver. The suggestion was that if the
enterprise was in doubt whether it could find the resources to perform
the contract, it should not undertake performance. Modification of a
contract or the entry of contracts that the parties later mutually may
decide not to perform would be reported as non-performed contracts.
It should not be too surprising that the supervising agencies see
contract as a tool for their control over the operations of the enterprise
and therefore that they discourage decisions by the parties to change
or cancel the deals undertaken as conditions change. They state this
interest in control in terms of the morality of contract performance.
The assumption appears to be that the party with whom the contract
is made will have no alternative source of supply and that a failure to
perform will create a cascade of defaults down the chain of distribu-
tion.

2. The Role of the Administrative Bureau

The multiple functions of the Administrative Bureau (Gongshang
Xingzheng Guanli Ju) were described in Part Two. The Bureau serves
as a market police, supervises free markets and peddlers, registers
enterprises, trademarks and regulates advertising. Only a modest portion
of the Bureau's personnel are concerned with contract matters. The
Administrative Bureau is organized at a national, provincial, municipal,
and district or county level. The local Bureaus report for some
purposes to the local Party organ and local government, and respond
for professional activities to the national agency. In Tianjin, for
example, cases that involve over RMB 5,000,000 are handled by the
Municipal Administrative Bureau, others are dealt with at the district
level. Most of day-to-day operations of the Administrative Bureau are
handled at district and county level. The Administrative Bureau in
Tianjin has about three to four thousand personnel, only about 130 of
whom are assigned to the municipal level Administrative Bureau.
Under the municipal level there are nineteen district and county
Bureaus, each of which has about 200 officials, most of whom are
concerned with market police, weights and measures. During our stay
in Tianjin in 1987, we observed large numbers of these market police

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sweep several times a week the free market that operated around the
bus terminal across the avenue from our university. Several dozen
officers would roust out the unlicensed peddlers, check scales for
accuracy, and appeared to be looking for vendors of stolen or illicit
goods.

We were informed by an official of the Bureau in Tianjin that
only about 10% of the Bureau's personnel were concerned with
contract matters, including those charged with arbitration of contract
disputes, as well as the certification and approval of contracts and
forms. This comes to 14 officials at the municipal level, all of whom
we were told are college graduates, most of whom majored in
economics. These officials go through short legal training courses
organized by the National Administrative Bureau. We were informed
that about two to three hundred contract cases are arbitrated by the
Bureau in Tianjin each year. Very few of these go to court after
arbitration and in very few cases does the court reverse the arbitral
award. In Tianjin, more contract disputes are referred by parties to the
court than to the Bureau. Most of the cases that do go to court are
resolved by mediation, not trial. The court does not use an arbitration
model.

3. Other Contract Supervision Programs

Four other kinds of supervising agencies deserve mention, although
we were not able to trace their contract enforcing activities in detail.
Until the period of reform the allocation of credit by banks was seen
as a political and planning decision, not primarily determined by the
likelihood of repayment or profitability. We were told by our Shanghai
and Beijing informants that contracts were evaluated by the banks
before the Reform, but this practice had been discontinued. Since 1989
banks again have been asked to check contracts before making a loan,
and contract performance is used as evidence of creditworthiness in the
emerging banking system. Those who fail to perform their contracts
are assumed to be less likely to fulfill their obligations to the bank.

In a socialist context, contract failure may be indistinguishable
from breaches of the plan, misuse of state resources, and ultimately as
a form of financial corruption. During the late 1980s, procurators at
the provincial and municipal level were reported in the press to have
instituted drives against economic criminal infractions that included
activities that sound to a western reader like contract breach. Under
Article 7 of the Tianjin Contract Regulations of November 1987,
signing an improvident contract causing loss can lead to economic and

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criminal responsibility. " Many of these cases involve failures to pay
debts. During the same period the powers of auditing agencies for the
government and the Party were amplified to emphasize an annual audit
of all enterprises that would include their contract activities. These
audits appear to have both governmental and Party discipline dimen-
sions.

Finally, it should be noted that many failures of contract perfor-
mance are dealt with by another set of political organizations, the
neighborhood people's mediation committees. There now are over a
million such committees throughout China, organized on a village basis
in rural areas, and in small neighborhoods in urban communities. 26

These committees are often identified with the elderly women and men
who form the backbone of the local organizations. They are a familiar
sight in city neighborhoods performing low level police, inspection,
and regulatory duties. These committees also serve as important
vehicles of mass mobilization for public programs, such as family
planning, informing the inhabitants of the neighborhood of rules and
laws with notices on public blackboards, and by personal contact. The
mediation committees also are important as the forum for the
disposition of millions of small civil and criminal complaints annually,
many of which involve debts and other credit disputes, housing,
inheritance, and similar transactions that are too small or otherwise not
within the jurisdiction of the People's Court system. Many of these
disputes involve the small service providers, peddlers and vendors who
form the core of the private sector of the Chinese economy. Each such
enterprise is likely to be small, and in total they form a minor segment
of the reported national product, but they employ in excess of twenty
million urban inhabitants and are a vigorous and rapidly growing part
of the economy.2

4. Contract Compliance Programs

a. Education to Contract Virtue

The Chinese leadership sees the introduction of contract as the
occasion for a massive educational effort that mobilizes a number of
government agencies. It is hard for an outsider to comprehend, much

125. Tianjin Contract Regulations, supra note 93, § 7, at 2.
126. See supra note 79. For a detailed description of dispute resolution in a county of rural

Shandong, see Ross, supra note 60, at 15.
127. Gold, supra note 99, at 196-98.

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less to evaluate, the scope of some of these programs. For example,
a recent report on general legal educational programs run under the
Party and State Council by the Ministry of Justice claims that in the
first law study program launched throughout China in 1986, 750
million Chinese citizens took part." At the other extreme, Universi-
ties and ministry institutes have trained tens of thousands of enterprise
legal experts, lawyers, and court personnel. The Administrative Bureau
has been primarily responsible for two intermediate forms of education:
the training of enterprise personnel regarding contract administration,
particularly the use of contract forms, and the use of contests and
awards to publicize enterprises that meet standards of contract
performance.

Our discussions with officials of the Shanghai and Tianjin
Administrative Bureaus highlighted the limits of the attempt to control
contract behavior by audits and limits on the use of forms. A
representative of the Shanghai Administrative Bureau described their
contract audit program to us in very glowing terms that produced
snickers from our more sophisticated Shanghai colleagues. It became
clear as the discussion progressed that large steel mills and other
industrial enterprises enter into hundreds of thousands of agreements
each year, making the kinds of audit procedures described by the
Bureau representative wholly unrealistic for an agency with very
limited trained personnel and little experience in the specific realities
of the transactions. In Tianjin, the 1987 Economic Contract Regulations
contain detailed provisions for the registration of contract forms by
enterprises with the Bureau and their detailed review. Bureau
representatives told us that the limited capacity to review these forms
led the Bureau to accept and file without further action forms
submitted by "expert' units like banks and transport companies.
Factories are permitted to print their own forms and just notify the
Bureau. General and incidental contract users are encouraged to adopt
the Bureau's printed forms for general use and for activities that cross
the jurisdiction of different supervisory agencies.

b. Contests, Awards and Certificates

Throughout the nation the Administrative Bureau is the sponsor of
contests that lead to enterprises being awarded certificates and other
prizes for their performance of contracts. This activity serves a dual

128. China Launches Law Education Drive, CWthNA DAILY, Feb. 26, 1991, at 1.

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educational function. To win the award the enterprise has to train its
personnel to meet the standards of performance. The awards themselves
serve a distinct educational purpose, for they are widely reported in
advertisements in local and national legal newspapers and provide
potential business partners of the winning enterprise with valuable
information regarding their trustworthiness. Such prizes and certificates
become the grist of the reputational mill, helping an enterprise build
a valuable reputation and disciplining its behavior to conform with
contract norms. National competitive campaigns of this sort have been
held since 1985. We were informed that the Economic Commission set
the criteria and policy concerning the campaign and the Administrative
Bureau is the implementing agency. Typical announced criteria include:

(1) Sincerely carry out the Economic Contract Law in
establishing contracts. Enter no illegal contracts or invalid
contracts.
(2) Enter contracts only within the enterprise's productive
capacity: that is, contracts are to be entered only within the
enterprise's production plan.
(3) Perfect the system of contract management. This requires
staff training, supervision and audit of contracts, and the
maintenance of archives on contracts.
(4) Achieve and maintain a 100% performance rate for all
contracts except for those not within the control of the
enterprise. We understood this exception to allow only for
changes in the mandatory plan by superior authorities and not
to permit a general excuse of changed circumstances.
(5) Sincerely respond to personal visits and letters from
customers.
(6) Raise economic efficiency; for example, by developing a
reasonable structure for inventory control through the use of
contracts material supply, management, and distribution of
goods. This campaign is an important way to increase the
competitiveness of the enterprises since the main elements for
competitiveness are quality, timely delivery, and service, all of
which are embodied in the terms of the enterprises' contracts.

Enterprises within the municipality can apply for designation as a
"Contract Observing Enterprise." The district or county Administrative
Bureau and the enterprise's business supervisory agency conduct a
preliminary investigation and accept the application. After a second
check the recommendation goes to the municipal Administrative Bureau

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for review before approval by the People's Government of the
Municipality are announced. Enterprises so designated may use the
award in their advertisements. This designation is given a prominent
place in television and newspaper advertisements. We were informed
that in Tianjin in 1985, over 200 enterprises applied for the designa-
tion, 104 won the title; in 1987, 280 applied, 182 won. Altogether,
Tianjin has more than 50,000 enterprises. The designation is given for
a year and renewed upon checking. So far, no one has been dropped.

D. The Courts, Administrative Bureau and the Private Resolution of
Contract Disputes

The resoluton of contract disputes may involve the courts or the
Administrative Bureau, but perhaps more commonly, dispute resolution
may be undertaken by the parties privately, sometimes through an
intermediary. There are two distinct situations when the Administrative
Bureau may be invoked in a contract dispute. One is when the agency
was involved in drafting, notarizing, or registering the contract. The
agency in this situation is expected to actively monitor contract
performance. As Bureau workload increases, however, this active role,
except during periods of mass campaigns, becomes impossible. Instead,
the agency waits until one or both parties bring the problem to it.

The second situation is when the parties to a contract that had not
previously been the concern of the Bureau bring a dispute that has
arisen during performance to it for resolution. The Administrative
Bureau mediates and arbitrates disputes as part of its functions to
manage and supervise economic contracts. But it is not the only
agency to do that. The parties' options include informal and private
mediation by third parties, as well as mediation through the parties'
supervisory agencies (which may be informal or formal), and the
courts. Informal mediation of any sort is generally preferred, and that
by private individuals is most desired. Courts and the Administrative
Bureau compete for clients, and there is regional variation in which
agency is preferred. The choice of Bureau or Court appears related to
the perceived effectiveness of the two bodies in a particular communi-
ty, the costs involved, and the competence and fairness of their
personnel. Our sample was very small, but our informants in Tianjin
appeared to have a much higher opinion of the Administrative Bureau
than our informants in Shanghai. Conversely, our informants in
Shanghai showed respect for the quality of the Economic Court, while
those in Tianjin were less impressed by their court, which they saw as
dominated by retired military officers and criminal prosecutors.

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A 1987 study of contract behavior in five cities by the China Law
Economic Reform and Legal Environment Research Group points to
the different preferred methods of dispute resolution adopted by
enterprises.129 It found that while the number of contract disputes has
increased tremendously from 1985 to 1986, the number of law suits in
general went down during the same period. Most enterprises chose to
settle their quarrels privately. Furthermore, as Table 1 indicates,
enterprises differ in their preferred means of contract dispute resolution
depending on their ownership status. State-owned units predominantly
went for private resolution (29%), while collective-owned firms tended
to seek help from the Administrative Bureau (23.8%). If we treat those
"not clear" responses as suggesting a non-formal resolution of the
dispute, then the overwhelming majority of cases were resolved in
private.

130

Table 1. Dispute resolution of Supply contracts by
Ownership Status of Enterprises13 1

Ownership Status

State Collective

Superior Agency 7.1 7.5

Courts 25.4 22.5

Administrative Bureau 8.0 23.8

Privately 29.0 22.5

Not Clear 30.3 23.7

Total 224 160

Two other points in Table 1 are worth mentioning.
(1) Formal mediation through one's supervisory agencies has

greatly diminished in importance. Regardless of type of enterprise, this
is the least used form of dispute resolution. While the hierarchical

129. XIONG JINING, ZUZHI Yu HUANJING DE HUDONG [THE INTERACIION OF ORGANIZA-
TION AND ENVIRONMENT] (1990).

130. l at 99.

131. Id

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control of enterprises dominant before the reform seems to be waning,
control by law courts does not dominate. This can be seen from the
large number of disputes settled privately.

(2) When parties elect to exercise their legal rights in a dispute,
some go to court and others choose the Administrative Bureau. The
Administrative Bureau is clearly favored by collective-owned enterpris-
es. One interpretation is that these enterprises are more closely
supervised by the administrative agencies, and there is an ongoing
relationship between the two, whereas courts are more impersonal. On
the other hand, the court is relied on by state enterprises for two
reasons. One is that state enterprises tend to have better knowledge of
law and the legal process, and better trained legal personnel, and
therefore are better equipped to deal with the courts. Another reason
may be that breach of contract under the plan damages the interest of
the state and therefore the authority and prestige of the court rather
than the Administrative Bureau is likely to be invoked.

Why did enterprises prefer to settle privately? Xiong's study found
that the overwhelming reason given by enterprises was "in consider-
ation of the working relationship with the other party," followed by
"law suits don't solve problems. 132 These are clearly interrelated. If
going to court cannot solve the problem, it is better to settle privately
to maintain an ongoing relationship. This pattern of response clearly
indicates the reliance of enterprises on fixed business partners, and
suggests the weakness of market opportunities to find other partners.

V. CONCLUSION

As we attempt to assess the results of the changes in contract law
in China since 1978, we see inconclusive and divergent trends. The
growth of contract law during the decade of reform was the result of
leadership decisions motivated by a desire to improve economic
performance and be incorporated in the world system. The leadership's
aim was to supplement socialist planning and bureaucratic control of
the economy with a limited market operating in large part through
contract mechanisms. The intention was to expand the set of economic
players, to decentralize planning controls, and to subject enterprise
management to a degree of market discipline through responsibility
contracts, all of which was to be accomplished without a drastic loss
of political control.

132. Id

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We argue that the leadership's choices were significantly influ-
enced by values and priorities embedded in the Chinese experience,
both before and since the founding of the PRC in 1949. For example,
the decision to create a separate Economic Contract Law and the
reluctance to establish a general civil law competence for individuals
to enter economic contracts seems motivated by such socially
embedded factors. These factors also exerted an influence on the
program that emerged, because its execution was in the hands of
subordinate and local officials whose perceptions of these new contract
institutions were heavily grounded in the same cultural experience.
Perhaps the clearest example is the agricultural responsibility contract
that was the first major step in reform in 1978. The devolution of
responsibility from the work brigade to the family working the land
was shaped by grassroots influences from below. The form these
responsibility contracts took clearly shows the* memory of pre-
revolutionary land tenancy contracts (baogan), which provided a
familiar model for local village and unit leadership. In this way both
the center and the locality has been influenced by socially embedded
factors in choosing the path of contract reform.

The result of this reform has been the creation of weak legal
institutions. Courts are creatures of the level of government (i.e.,
national, provincial, or county) that creates them, appoints the judges,
and which continues to supervise in detail their activities. It has proven
difficult to reach consensus on the formal norms of contract law,
producing statutes marked by their generality and vagueness and by
stubborn political opposition in the National People's Congress that has
blocked adoption of a comprehensive Civil Code. In a society still
dominated by state ownership of enterprises, contract law remedies
based on the payment of damages necessarily are weak and ineffective.

Persistent inconsistencies mark the definition of legal personality,
as officials try to expand the number of economic actors while
attempting at the same time to maintain control over the definition of
who may engage in economic activity. The emergence of contract law
undermines a traditional feature of Chinese social organization, for a
major lever of state power in the local community was control by
government of the number of economic actors. The process of dispute
resolution draws heavily on traditional practices and upon motivations
for contract compliance other than legal remedies.

Yet at the same time we see new trends in the way economic
activity is organized by contract in practice. New institutions,
organizations and professional personnel are growing up as the result
both of directives from the leadership and from pressure from below.

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We see people negotiating many millions of contracts in domestic
economic transactions each year, we see enterprises and their legal
advisors integrating contract practices into daily management of their
operations. Over one half million contract cases annually come to the
People's Court system and a comparable number are submitted for
resolution to the Administrative Bureau. Certainly a much larger
number of contract disputes are resolved privately, peacefully, and
without apparent bureaucratic intervention. Contract law and legality
have built substantial human constituencies as hundreds of thousands
of legal professionals (judges, notaries, lawyers) have been trained and
entered career paths that give them a stake in the legal enterprise.
Most sizable enterprises have recognized the importance of contract
expertise by bringing legal advisors into management. These are
substantial phenomena and suggest important change. In these respects
it might appear that legal change has been a driver of economic
transformation.

The contract system that has emerged is at least a means to
implement the plan and to expand economic activity by providing
transactional security through legal sanctions. It also regulates the
market as it expands, by assigning responsibility to economic actors.
Beyond these minimal effects of the use of contract, we see four other
consequences of the development of contract law that may be more
problematic.

First, the introduction of contract inevitably increases the number
of potential economic actors and, as the discussion of legal personality
demonstrates, limits the power of the state to select and control those
who may participate in the market. This potential undercuts basic and
longstanding patterns of political control over local communities.

Second, the increase in the number of actors and the weakening
of the hierarchical supervisory controls associated with planning
supports the decentralization of administrative control over the
economy.

Third, patterns of contract dispute resolution and remedies
encourage economic behavior that emphasizes the individual interests
of actors at the expense of collective interests. This feature tends to
support economic activity inconsistent with the communal assumptions
of the plan.

Fourth, contract law has the potential to limit and expose the use
of informal connections and abuses of the economic power of the state
for personal gain. The availability of impersonal contract law
institutions provides a competitive alternative to, and therefore
potentially undercuts, the networks of informal connections.

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We see these trends and institutions growing, but whether they will
become dominant in Chinese economic life depends on other dimen-
sions of reform. The state is using contract to create at least a partially
market-driven economy, yet at present the opportunities for contract are
limited by the restrictions on permissible economic actors. The
motivation of parties to take contract seriously is weakened by the
difficulties of fashioning credible remedies for breach that will fit the
realities of the parties' situation. These limits suggest that contract
institutions will gain the capacity to shape social behavior only as
economic markets become more dominant factors in setting the terms
of trade and more deeply penetrate the habits and expectations of the
community. Moreover, as the legal institutions of contract become
more effective, the transaction costs of using contract should decline.
If agreements can be reliably enforced legally at low cost, contract will
be able to compete better with influence networks as a means of
structuring economic relationships. At that point, longstanding
embedded notions of relationship should be displaced by contract and
a new social reality will be established. This seems to be a problem
of absorption: contract will not be a vital institution until what was
originally decreed by the leadership is integrated into social practice.
Until then, contract will be most meaningful in transactions with
foreigners and other strangers, those who are too remote to respond to
network ties, but not so remote that even legal sanctions and the
pressures of relationship are infeasible.

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