Information, Coordination and the Legal Order

Abstract: This paper examines what distinguishes legal order from other forms of social orders, under what circumstances legal order applies and what the legal order can achieve. We construct models of repeated interactions where, in every period, buyers and sellers are matched pairwise. The seller has an opportunity to cut cost, and this may or may not affect the value that a buyer derives from the transaction. We find that a legal equilibrium exists if and only if the cost cutting action to be deterred is sufficiently harmful. Such an equilibrium improves welfare than an individual order equilibrium if and only if the law embodies additional information about the ex ante efficiency of the cost-cutting action. A key feature is that it economizes on costly punishment by not letting victims decide about the imposition of sanctions.