Banking on the Confucian Clan: Why China Developed Financial Markets So Late

Abstract

What made finance develop in the West but not in China? We argue that long before modern finance, China chose to rely on the kinship-based Confucian clan, whereas the West chose the corporate entity combined with impersonal instruments, to deal with the challenges of interpersonal risk sharing and resource pooling. That difference in choice led to two distinct institutional-development paths. Pre-modern China was ordered hierarchically around patrilineal clans that each served as an informal internal financial market for members, where intra-clan pooling and sharing obligations were rigidly enforced through Confucian rules and rituals. For more than two millennia, institutional innovations focused almost exclusively on solidifying the clan system to minimise the uncertainty and transaction costs of implicit intra-clan exchange. By the early nineteenth century, the clan as an internal financial market and as a business corporation served China well. However, it came at the cost of ignoring the development of the impersonal institutions needed for formal finance. Even when formal finance was transplanted in the late nineteenth century, its adoption was not smooth. We provide empirical evidence that the Confucian clan competed with and indeed inhibited the development of modern banking in the early twentieth century, and that Confucianism continues to limit finance in contemporary China.