China's (Painful) Transition from Relation‐Based to Rule‐Based Governance: When and How, Not If and Why

• Date: 01 November 2013
• Author: Shaomin Li
• Published date: 01 November 2013
• DOI: http://doi.org/10.1111/corg.12023

China’s (Painful) Transition from

Relation-Based to Rule-Based Governance:

When and How, Not If and Why

Shaomin Li*

ABSTRACT

Manuscript Type: Perspective

Research Question/Issue: Relation-based governancehas helped China to achieve rapid economic growth in its early stage;

however, continuing to rely on it may hinder China’s further development. The research question is: given China’s cultural

heritage and other institutional settings, will China be able to transition from relation-based to rule-based governance?

Research Findings/Insights: I discuss this question based on theoretical and empirical evidence and conclude that, f‌irst,

from cost/benef‌it and social justice perspectives, China must complete the transition; second, cultural heritage is not the

main obstacle to the transition, for the main obstacle is the powerful political forces that havebeen deeply entrenched in and

benef‌ited from the relation-based system.

Theoretical/Academic Implications: I distinguish between the governance environment at the national level and the

governance choice at the organizational and individual levels. The governance environment – the set of dominant political,

economic, social, and cultural institutions – facilitates and constrains the choice of the mode of governance (e.g., rule-based

versus relation-based).

Practitioner/Policy Implications: Chinese government off‌icials must realize the inevitability of the transition and the dire

consequences of not completing it and take initiative to pursue the transition peacefully. For businesses, they must realize

that the relation-based way may be in decline and must be prepared to embrace the rule-based way.

Keywords: Corporate Governance, Governance Environments, China, National Economies, National-Level Governance

Outcomes

INTRODUCTION

After World War II, Asia, especially East Asia, experi-

enced phenomenal economic growth, creating the

“Asian Miracle.” One of the major advantages of the East

Asian model of economic development, in addition to the

high savings and investment rates, is the prevalence of

family businesses in which all family members work

together harmoniously and eff‌iciently without worrying

about who gets how much. Policy makers and academics

praised the model, calling it “dedicated capitalism” (Porter,

1996).

And then came 1997, during which a powerful f‌inancial

hurricane swept Asia, causing bank runs and currency and

debt crises, which in turn triggered an economic recession in

Asia that waslater to become known as the “Asian Financial

Crisis.” This crisis served as a watershed on the views on the

East Asian development model. Policy makers and scholars

began to rethink the East Asian model; after all, having the

CEO’s wife serve as CFO and sons as vice presidents seems

to be a poor governance practice, or a form of “crony capi-

talism” (Krugman, 1998).

What happened to Asia? How could the very same phe-

nomenon, namely, family members working together in the

same f‌irm, which was viewed positively before, now be

corrupt? There was a need to develop a more consistent

theoretical explanation of the causes of the Asian Miracle

and the Asian Crisis.

In the attempt to explain whatdistinguishes East Asia from

the West in terms of how economic activities are conducted,

Li and Li offered an explanation from a governance perspec-

tive that can more consistentlyexplain both the Asian Miracle

and the Asian Crisis, which they call “rule-based versus

*Address for correspondence: Shaomin Li, Department of Management, Old Domin-

ion University, Norfolk, VA 23529, USA. Tel: 1-757-683-4883; E-mail: sli@odu.edu

567

Corporate Governance: An International Review, 2013, 21(6): 567–576

© 2013 John Wiley & Sons Ltd

doi:10.1111/corg.12023