China’s economic landscape, once a powerhouse driving global growth, appears to be faltering. In the second quarter of 2024, the nation’s GDP increased at an annual rate of 4.7%, a notable dip from the decade-long average of 7%. Over the next two years, projections from the International Monetary Fund indicate a continuation of this subdued pace.

China’s recent economic downturn, often attributed to immediate factors like the heavily indebted real estate sector and a sluggish post-pandemic recovery, sets the stage for a more deep-seated issue—the gradual weakening of private property rights, as highlighted in a comprehensive study from Texas McCombs.

This research, spearheaded by Kishore Gawande, the head of the Department of Business, Government & Society, delves into the aftermath of China’s 2007 enactment of nationwide private property protection. This legislation significantly energised China’s commercial environment, creating approximately 39,000 additional businesses annually in the five years following the law compared to the period before its implementation. Within three years of the law’s introduction, about 1.3% of these new enterprises expanded into the export market, enhancing national productivity and compelling existing firms to heighten their efficiency.

Gawande explains that the survival and success of these firms under the new law were pivotal. Some of these companies evolved into industry leaders, a feat that would have been attainable with the legal protections of 2007. However, he now cautions that there has been a recent shift in the opposite direction regarding property rights in China, posing a significant threat to sustained economic vitality in potential economic stagnation and reduced growth.

Gawande warns that reversing the progress made could flip all positive outcomes to negative, describing it as a looming macroeconomic shock. He underscores the foundational role of private property rights in economics, stating that such rights are essential for basic financial activities like securing loans. Banks are hesitant to provide loans without clear ownership rights since they typically require property as collateral. These rights, often taken for granted in places like the U.S., had been absent in China post-1949 Communist revolution and only started to re-emerge in fragmented forms with the economic reforms of the 1980s.

In his study, conducted alongside Hua Cheng from Zhongnan University of Economics and Law, Gawande assessed the property rights environment across 341 prefectures using data from 1998 to 2012 covering over 14 million private and nearly half a million state-owned enterprises. They discovered regions with historically weaker property rights protections experienced the most significant growth following the 2007 law. Specifically, a 10% reduction in a prefecture’s security rating before the law correlated with a 6% increase in new private businesses and a 5.5% rise in business survivals, indicating a substantial unleashing of economic potential.

Yet, Gawande expresses concern over China’s recent policy direction since 2020, which reverses the liberalising trend. The government’s stringent measures against tech giants have wiped out significant market value, with prominent figures like Jack Ma facing severe repercussions. This regulatory tightening is part of a broader trend towards decentralising power that undermines economic decentralisation and could deter investment, reduce economic output, and lower tax revenues.

Gawande’s insights suggest that tampering with property rights has immediate adverse effects and sets the stage for a potentially prolonged period of economic stagnation. He emphasises that no short-term economic fixes can address the deep-seated impacts of such policy shifts, warning of a scenario that might suppress growth for a decade. This study is a stark reminder of the critical importance of maintaining robust property rights to foster long-term economic health and stability.

More information: Hua Cheng et al, Bringing Dead Capital to Life: Property Rights Security in China, Journal of Law and Economics. DOI: 10.1086/727444

Journal information: Journal of Law and Economics Provided by The University of Texas at Austin