Industrial Clusters, Personalized Exchange and Construction of Economic Institutions

Abstract: Our paper provides a detailed analysis of the development of endogenous institutional change and the bottom up construction of economic institutions in the rise of private enterprise-led capitalism in China. Our approach examines the social mechanisms that give lead to self-enforcing economic institutions sufficiently robust and durable to ensure contract enforcement without the involvement of the state. Specifically, our focus is on examining the emergence of economic institutions supporting the supply and marketing networks of private manufacturing firms. Critical to our argument is the confirmation of independent supplier and distribution networks through repeated exchange in networks and backed by social norms of the business community. We maintain that spatial proximity in industrial clusters in the Yangzi delta region facilitated the monitoring and enforcement of contractual agreements between manufacturers, suppliers and clients. Our findings show that in the Yangzi delta region, spatial concentration in industrial clusters facilitated the development of social norms and informal economic institutions decisive in allowing the private sector to de-couple from the state-owned and controlled economy. In sum, we explain the rise of private enterprise led capitalist economic development as a process that turns on endogenous institutional change characterized by first bottom-up construction of economic institutions, followed by formal rules legitimizing institutional arrangements already in place. The data comes from a stratified random sample of more than 700 private firms we have selected in seven municipalities in the Yangzi River Delta, one of China’s most dynamically developing private sector economies.