This paper examines the importance of contract enforcement as a source of comparative advantage across Chinese provinces. We find that industries differ in their reliance on relationship-specific investments. Provinces with better contract enforcement specialize in industries where relationship-specific investments are more important. Following LLSV(1998), we separate our proxies for contract enforcement into two groups: those measuring the legal rules and those measuring the quality of contract enforcement. Our results indicate that contract enforcement based on official legal rules plays a modest role in shaping the patterns of industrial specialization. In contrast, the ease and reliability of law enforcement, which to a large extent, explains the patterns of industrial production in China.

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He Qing, Senior Research Fellow of IMI, School of Finance & China Financial Policy Research Center, Renmin University of China

Xue Chang, Department of Economics, The Chinese University of Hong Kong

Chong Terence Tai Leung , Department of Economics, The Chinese University of Hong Kong