Economics of Guanxi

The Guanxi way of doing business in China is important to understand for those hoping to do business in China.

This theoretical paper gives some economic justifcation. This paper will be rather heavy going for non-economists.

The economic problem is that "loyalty takes precent over ability". Is there a rational reason for this? What are the implications for capitalism with Chinese characteristics?


Economics of Guanxi as an Interpersonal Investment Game

Shi Young Lee

Review of Development Economics, Vol. 14, Issue 2, pp. 333-342, May 2010

Abstract:
The purpose of this paper is to provide a simple model of guanxi given stylized facts. I first outline the intrinsic characteristics of guanxi to draw the stylized facts, and then use these facts to model it as an interpersonal investment game. I find that the degrees of the ability and loyalty of the Recipient must be reasonably high enough for the interpersonal investment to take place. After the investment has occurred, the degree of loyalty must be higher than that of the ability to guarantee stable gaunxi relationships. When the interpersonal investment is made, it is a signal of trust in the ability and loyalty of the Recipient. However, if the ability factor dominates, then the Recipient will not always feel loyal enough to return the favor. This indicates that loyalty counts for more than ability. A related result is that a stable guanxi relationship is unlikely to occur for a highly able person given the equal chance of the two characteristics. This paper also presents some interesting implications for corruption and lock-in relationships.

Accepted Paper Series