The China Growth Miracle: The Role of the Formal and the Informal Institutions

Abstract This paper examines why China, in spite of its ordinary institutions, can grow so rapidly and for so long. Since each region in China has different quality of institutions and growth rates, we look into provincial and city data for this investigation. The variables formal and informal institutions are added into the conventional cross‐section growth equation. The quality of the formal (informal) institution is taken from an opinion survey on the effectiveness of city governance conducted by the World Bank in 2006 (can be measured by the share of township‐and‐village enterprise in each province during 1978–2002 or by the trust index from surveys). We conclude that it is the informal institution that drives the rapid growth in China. Further investigation, using panel data and Arellano‐Bond system GMM estimator, which controls for the missing fixed effect in cross‐provincial regressions and provides useful instrument, confirms.