Legal, Regulatory And Reputation Constraints

This article comes up with a frame based on trichotomy to analyze the disbalance among contract governance mechanisms during China's economic transition. Contract governance mechanisms function differently with inevitable imperfections. Therefore, there is no perfect contract governance mechanism in general, which implies that the balance and coordination between different mechanisms are of great importance in realizing contract benefit.The institutional context that contract governance is embedded in is crucial for understanding the variations between advanced market economies and China's transitional economy. Western economists usually apply dichotomy to the research on contract governance, which is justified by the fact that in mature market economies, contract governance is dominated by legal system while private enforcement based on reputational constraint serves as an effective supplement and government regulation strictly complies with legal rules. Whereas, the story is quite different in China's economic transition. The government's over-regulation either crosses out reputational mechanism or distorts its function in contract enforcement, which in turn creates the illusion of more needs for micro-regulation from the government; Over-regulation also endangers law independence and impairs its ability to check government's power, which leads to more over-regulation; The marginalization of legal system disables the law to shore up impersonal exchanges, thus further confines reputation mechanism to relational networks without spreading to open markets. Agents' distrust on law increases legal enforcement costs by shunning legal rules.To sum up, the toughest challenge confronting China's economic transition comes from contract governance. There is a long way to go to transfer from a relation-based governance to a rule-based governance. Compared with the perspective focused on one or two factors of private governance, law system and government regulation, it's more meaningful to explore ways of positive interactions among government, courts and individual agents in China's unique institutional evolvement.