On the Evolution of Collective Enforcement Institutions: Communities and Courts
Abstract: Impersonal exchange has been a major driver of economic development. But transactors with no stake in maintaining an ongoing relationship have little incentive to honor deals. Therefore, all economies have developed institutions to support honest trade and realize the gains of impersonal exchange. We analyze the relative capacities of communities (or social networks) and courts to secure cooperation among heterogeneous, impersonal transactors. We find that communities and courts are complementary in the sense that they tend to support cooperation for different sets of transactions, but that the existence of courts weakens the effectiveness of community enforcement. By relating the effectiveness of enforcement institutions to changes the cost and risks of long-distance trade, driven in part by improvement in shipbuilding methods, our analysis also provides an explanation for the (endogenous) emergence of the medieval Law Merchant and its subsequent supersession by state courts.