One allegedly necessary function of government is to enforce contracts. For this, some sort of court-and-thug system is necessary; the court to rule on cases brought before it, and the thugs to carry out the court's decisions.
However, such a system necessarily poses a moral hazard problem, for now the participants in a contract do not have to bear the costs of enforcement. "If he doesn't follow through," one thinks, "I'll just take him to court." The fact that there is a government backstopping all contracts results in people participating in more risky behavior. They don't perform due diligence on the people with whom they are transacting, or they do not structure a deal to maximize incentives for a deal's completion.
The typical anarcho-capitalist solution for government courts is to replace them with private courts (or for a libertarian, a court that enforces only "just law" and only funds itself through "just means"). Many anarcho-capitalists argue that a court-and-thug system could be provided by the "free market", and there might even be competing systems. However, while such courts may largely address the moral hazard problem (depending on how they were structured), I believe that such arguments are just a way to slip a government in through the back door. Enforcement of laws is, in my opinion, the primary characteristic of government.
There is an alternative to the dubious solution of restructuring existing court systems. This solution is to reframe how we think about contracts. Rather than thinking of them as a metaphysical transfer of property, think of them as an investment.
In an investment, you recognize that there is risk. The risk is that the investment fails, and you recognize going in that you would have no recourse in such an event. An investment is ultimately a claim on future events, and the future is inherently uncertain. It is this claim on future events that also characterizes contracts. One or both parties could be promising future cash flows, repayment, or labor.
No claim on a future event can truly be guaranteed. In one sense, then, a system designed to enforce contracts is a revolt against this "unfairness" of nature. Isn't it better then to recognize that any contract carries risk and treat it as an unenforceable investment, than to pretend there is no risk because you can always appeal to Daddy Government to bail out your poor decisions?
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There are two conflicting moral hazard problems here:
ReplyDeletea) I will enter into more risky contracts if I know there is an enforcement body willing to take up my case
b) without enforcement, there is information asymetry if party X knows its going to default on the contract and party Z does not.
Im not convinced by your post that b) is preferable to a). If you think about contracts as an investment, then wouldn't enforcement schemes count as insurance on that investment?
Hi Robert,
ReplyDeleteGlad to have a comment from you. I remember your always interesting and insightful comments from ASC years ago.
With references / background checks and creative contracts, I don't think the scenario outlined in b) would be that prevalent.
But even if there are a fair number of confidence men who are good at passing fake references, gaming reputation systems, and convincing others "they really need all the money up front now", I still have two moral qualms about the type of insurance I think you are referring to:
1. I am uneasy, to say the least, with the idea of an insurance company that relies on its ability to pay out claims based on its power to extract payment from counter-parties.
2. How do you differentiate the case of a dishonest counter-party versus an "honest" investment failure (this is especially relevant with loans)?
And lastly, even if this does not convince you and you can think of a better social structure for contract enforcement, your preference for that structure is entirely theoretical.
The approach I am advocating can be implemented by anyone now. The choice I see is not between it and a theoretical system of decentralized enforcement (which I am sure I would also prefer to the current government scheme). The choice is rather between the approach I am advocating and what you actually get now, which is that you need to use the government if you want "insurance" on your contracts.