Comparing financial systems.
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..., McMillan, 1995, 1997; Allen and Gale, 2000b). What we see from the success of Private Sector firms in WenZhou and other surveyed firms suggests that it is only those firms that have the strongest comparative advantage in an industry (of the area) that survive and thrive. DLLS (2002) examine entry barriers across 85 countries including China. Entry barriers are a relevant factor for the growth of China’s Private Sector, as lower entry barriers foster competition. DLLS find that countries with heavier (lighter) regulation of entry have higher government corruption (more democratic and limited governments) and larger unofficial economies. With much lower barriers to entry compared to other countries with similar (low) per capita GDP, China is once again an ‘‘outlier’’ in the DLLS sample. The outlier status is even stronger considering that China is one of the least democratic countries, and such countries tend to have high barriers to entry. Based on our survey evidence, we conclude that there exist non-standard methods to remove entry barriers in China: First, 16 out of the 17 firms applied for a license (required) before the business started, with 50% of them indicating that it takes two weeks to one month to go through the procedure and 37.5% say it takes one to two months. The main problem for the application for a license seems to be dealing with government bureaucracy. To ease this problem, most of the firms’ founders/executives ask the friends of government officials to negotiate on their behalf, or the firms can offer profit sharing to government officials. But these methods are consistent with our results that alternative mechanisms based on reputation and relationships provide the most important support for the growth of the Private Sector. There are other effective corporate governance mechanisms. First, Burkart et al. (2003) link the degree of separation of ownership and control to different legal environments, and show that family-run firms will emerge as the dominant form of ownership structure in countries with weak minority shareholder protection, whereas...
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..., Allen and Gale, 2000a). It is often argued that one of the reasons the U.S. has been so successful in developing new industries in recent years is the existence of a strong venture capital sector (e.g., Kortum and Lerner, 2000). Consistent with our previous findings, China’s venture capital industry, since its inception in the 1980s, is underdeveloped and its role in supporting the growth of young firms is very limited. Moreover, based on interviews conducted with 36 venture capitalists in 24 venture companies, Bruton and Ahlstrom (2002) find that the limited formal rules and regulations are often ineffective, while alternative mechanisms based on reputation and relationship are the norm in all stages and phases of the industry....
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...Second, Allen and Gale (2000a) show that if cooperation among different suppliers of inputs is necessary and all suppliers benefit from the firm doing well, then a good equilibrium with no external governance is possible, as internal, mutual monitoring can ensure the optimal outcome....
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...The second most important mechanism is competition in product and input markets, which has worked well in both developed and developing countries (e.g., McMillan, 1995, 1997; Allen and Gale, 2000b)....
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...Second, Allen and Gale (2000a) show that if cooperation among different suppliers of inputs is necessary and all suppliers benefit from the firm doing well, then a good equilibrium with no external governance is possible, as internal, mutual monitoring can ensure the optimal outcome. We have shown trade credits are an important form of financing for firms during their growth period. Third, the common goal of sharing high prospective profits can align interests of local and foreign investors with entrepreneurs and managers to overcome numerous obstacles and achieve their common goal. Under this common goal in a multiperiod setting, implicit contractual agreements and reputation can act as enforcement mechanisms to ensure that all parties fulfill their roles to make the firm successful. Profit sharing also makes it incentive compatible for officials at various levels to support the growth of the firm. Finally, there is a strand of literature studying transitional economies, such as Russia, China, Vietnam, and Eastern European countries, from Socialist systems to market systems. It is important to point out why China differs from other transitional economies. First, with the exception of Russia, China’s economy is much larger and more diversified than other transitional economies. With a small and homogenous economy, a country can adjust its legal and financial systems to the strengths of its economy much easier than a large country can. The recent economic struggle in Russia illustrates this point (e.g., Shleifer and Treisman, 2000). The success of China’s Private Sector demonstrates that alternative mechanisms can work wonders even in large and diversified economies. Second, it is probably easier for other countries to adopt drastic reform measures in the short run. China, under the influence of Confucius’ views, is different in that people hold the belief that fundamental changes in society should be gradual and should be fully implemented only after they are proven correct. This view, however, does not prevent regional experiments conducted at a smaller scale. Accordingly, China adopted a gradual, ‘‘dual track’’ path in its economic reform, where the continued enforcement of the existing planning system goes alongside with the fast-paced development of financial markets, as compared to the ‘‘big bang’’ approach taken by some other countries (e.g., Lau et al., 2000). Third, the role played by the government during the reform process is very different in China than in most other transition economies, and in particular, Russia (e.g., Blanchard and Shleifer, 2001). In a broader context, LLSV (1999) find that governments in countries with French or socialist origins have lower quality (in terms of supporting economic growth) than those with English common laws and richer countries....
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