In arecent article, the economist Axel Leijonhufvud defines the market systemas a web of contracts. Because contracts arelinked with each other, one default can trigger an avalancheof broken promises, “[making] it possible to destroy virtually the entire webof formal and informal contracts which the market system requires for itsfunctioning.” The state’s role is to protect, enforce, and regulate thesecontracts and related property rights, as well as to interveneto prevent systemic failure.
This web of contracts – often taken for granted inmainstream economics, to the extent that it becomes almost invisible – embodiesthe formal and informal rules embedded in the market system that shape andconstrain individual and social behavior. They form the fabric of all human institutions.
Advanced economic systems have very complex webs ofcontracts, such as financial derivatives. For Europe,Leijonhufvud argues, this implies a three-prongedapproach that focuses on “levels of leverage,”“maturity mismatches,” and “the topology ofthe web,” – that is, “its connectivity and the presence of criticalnodes that are ‘too big to fail.’” This is because “[t]he web of contracts hasdeveloped serious inconsistencies.” To insist that all contracts be fulfilledwould “cause a collapse of very large portions of the web,” with “seriouseconomic and incalculable social andpolitical consequences.”
By contrast, emerging markets like China have lesssophisticated systems and evolve more complex contractual/institutional linksover time, particularly through globalized transactions. Under China’s plannedeconomy, most contracts were between individuals and the state, whereas moresophisticated market contracts have emerged or re-emerged only over the last 30years. Indeed, the widespread use of market contracts with publicly-ownedcompanies was a recent and important adaptation in the move toward a “socialistmarket economy.”
The web of contracts, however, can also be understood ascomplex adaptive market systems, which encompass the state and family relationsas well. To understand China’ssocialist market economy, it is essential to examine systematically thesedifferent forms of contracts and their institutional structures.
Family and kinship contracts,which govern marriage, adoption, cohabitation,inheritance, etc., form the basic unit of human society. These contracts arethe most ancient and remain the foundation of social relationships in China today.
Corporate contracts placethe profit-oriented legal person at the center of the transaction and bind allof its stakeholders. Chinese corporate contracts have grown exponentially over the last 30 years, but theyhave special characteristics that reflect the primary role of Chinesestate-owned enterprises.
Market contracts betweenproducers and consumers – and/or among producers in supply chains – linkindividuals, families, firms, governments, and public organizations throughlocal or global markets. Over the last few decades, China has begun to practice moderncontract law and joined the World Trade Organization, committing itself tointernational rules governing trade and investment.
Non-governmental and non-profit civil contracts bind people together for communal,religious, social, and political activities. These contracts are stillrelatively new and evolving in China.
Social contracts created by constitutional and administrative lawsdefine the powers and responsibilities of the state and its constituent bodiesvis-à-vis individuals and the private sector. They include the authority toimpose taxes and restraints on individuals and private entities throughcriminal, administrative, and civil law, as well as the state’s obligation toprovide public goods and services. China has strengthened its unitary state with important institutionalinnovations that have delivered growth and middle-income prosperity, but itstill retains the basic five-level administrative structure – central government on top, with provincial, city, town,and village bodies below – that first emerged two millennia ago.
Deciphering thestructure of the web of contracts holds the key to understanding how an economybehaves, including its dynamic non-linear adaptation to internal and externalforces. Following the physicist Fritjof Capra, one should regard livingorganisms, social systems, and ecosystems as an interconnected andinterdependent, complex adaptive system. This means that we should view theeconomy and society not as rigid hierarchies or mechanical markets, but asnetworks or webs of life, in which contracts, formal and informal, fulfilled orviolated, are the essence of human activity. Examining webs of contracts shouldbe similar to a biologist’s examination of cell structure and DNA.
China has created fourfunctioning global-scale modern supply chains in manufacturing,infrastructure, finance, and government services, thanks to itsevolving, expanding, and complex web of contracts. But how was Chinaable to build a modern industrial base within a relatively short period of timefrom its traditional, patrimonial familycontracts and archaic constitutionalstructures?
Through experimentation,adaptation, and evolution – a process that has been described as “crossing the river by feeling the stones” – Chinahas been able to evolve a higher-order, or fifth, supply chain in politicaldecision-making. This “top-level governance architecture,” as it is known in China, has beenessential for coordinating and orchestrating the different supply chains andthe overall web of contracts to achieve the delicate balance among individual, family, corporate, social, and nationalobjectives.
This top-level governance architecture is analogous to acomputer’s operating system, which orchestrates the other software and hardwarecomponents to form a holistic unity. Such a structure exists in many economies,but, in the Chinese context, where the state plays a central role in theeconomy, it is critical to the system’s effectiveness. How it is shaped willdepend on how China’shistory, culture, institutional context, and evolving web of contracts affectthe country’s social fabric.