Governance without government

The corporate governance of for-profit and not-for-profit firms is a well studied area in economics, but the governance of criminal enterprises is not nearly so well understood. The obvious problem for any criminal organisation is that they cannot rely on state enforcement of their governance structures. So how do such organisations hold themselves together?

In a new paper, An-arrgh-chy: The Law and Economics of Pirate Organization, in the current issue (Volume 115, Number 6, December 2007) of the Journal of Political Economy, Peter Lesson looks at internal governance institutions for the case of seventeenth and eighteenth-century pirates.

The "golden age" of piracy extended from 1690 to 1730. The period between 1716 and 1722 marks the height of the golden era. Pirate crews were quite large. Based on figures from 37 pirate ships between 1716 and 1726, Leeson can tell us, that the average crew was around 80 men and crews in the range 150-200 were not uncommon. Leeson writes that

To effectively organize their banditry, pirates required mechanisms to prevent internal predation, minimize crew conflict, and maximize piratical profit. Pirates devised two institutions for this purpose. First, I analyze the system of piratical checks and balances crews used to constrain captain predation. Second, I examine how pirates used democratic constitutions to minimize conflict and create piratical law and order. Pirate governance created sufficient order and cooperation to make pirates one of the most sophisticated and successful criminal organizations in history.

One problem for the merchant ship organisation is owner-crew principal-agent problem. The owners had to devise a system whereby the ship's crew hopefully acted in the absentee owners interests. This was not a problem for pirates since,

On a pirate ship, the principals were the agents. As one historian described it, in this sense a pirate ship was like a "sea-going stock company" (Pringle 1953, 106). As a result, pirates did not require captains to align the crew’s interests with those of the ship’s absentee owners.

This does not mean however that pirates did not need captains. They did.

Many important piratical decisions, such as how to engage a potential target, how to pursue when "chasing" a target or being chased by authorities, and how to react if attacked, required snap decision making. There was no time for disagreement or debate in such cases, and conflicting voices would have made it impossible to undertake the most essential tasks. Furthermore, pirate ships, like all ships, needed some method of maintaining order, distributing victuals and payments, and administering discipline to unruly crew members.

This need for a captain, as Leeson points out, created a dilemma for pirates.

On the one hand, a captain who wielded unquestioned authority in certain decisions was critical for success. On the other hand, what was to prevent a captain with this power from behaving toward his pirate crew in the same manner that predatory merchant ship captains behaved toward their crews?

As pirates jointly owned the stolen ships they sailed on, the owners were also the agents. Thus pirates needed captains but not autocratic captains. The crews got what they wanted by democratically electing their captains.

Since the pirates sailing a particular ship were both the principals and the agents, democracy did not threaten to lead to captains who served the agents at the principals' expense. On the contrary, pirate democracy ensured that pirates got precisely the kind of captain they desired. Because pirates could popularly depose any captain who did not suit them and elect another in his place, pirate captains' ability to prey on crew members was greatly constrained compared to that of merchant ship captains.

Leeson also shows that another method pirates used to prevent the captain from abusing and cheating them was to divide the power on the ship. This was done by, in the main, by giving the power

... to allocate provisions, select and distribute loot (there was rarely room aboard pirate ships to take all they seized from a prize), and adjudicate crew member conflicts/administer discipline to the quartermaster, whom they democratically elected.

The fact that captains and quartermasters were elected, and could be deposed, created competition between the officers for the positions and helped encourage those elected to serve in the crews best interests.

But as documented by Leeson problems still remained. In particular how did they prevent the quartermasters from abusing their authority even if the captains didn't.

After all, not only were pirates afraid of captain predation; they opposed any situation that threatened to jeopardize their ability to cooperate for organized banditry, including the institution of the quartermaster. To solve this problem, pirate crews forged written constitutions that specified their laws and punishments for breaking these laws and more specifically limited the actions that quartermasters might take in carrying out their duties.

There were several important features of these constitutions.

First, they created a democratic form of governance and explicitly laid out the terms of pirate compensation. This was to clarify the status of property rights aboard pirate ships and to prevent officers, such as the captain or quartermaster, from preying on crew members. In particular, making the terms of compensation explicit helped to circumscribe the quartermaster’s authority in dividing booty.

If the booty was indivisible or its value in question, it could be sold or auctioned and the proceeds divided among the crew according to the rules. This prevented conflict among the crew and it constrained the powers of the quartermaster with regard to loot which was indivisible or of ambiguous value.

Second, some activities which may have generated negative externalities were prohibited. Activities such as drinking, fighting and gambling were often prohibited or controlled. Some ships also forbade the firing of one's gun or smoking around flammable goods.

Third, constitutions often provided incentives for crew productivity and to prevent shirking.

One manifestation of this was their creation of social insurance for pirates injured during battle. As in the examples from Exquemelin and Roberts above, articles specified in detail what a lost arm was worth, a lost leg, and so on. They even went as far as to assign different insurance values depending on whether it was, for instance, the right or left appendage that was mutilated or lost, according to the importance pirates assigned to these body parts.

Another manifestation of these incentive provisions was the use of bonuses for crew members who displayed particular courage in battle, were the first to spot potential targets, and so forth. Because pirate crews were large, quartermasters could not easily monitor individual pirates' effort.

The share system that was used that was used for payment did create incentives for free riding. One mans laziness will reduce all incomes but his own income will fall only by a little. To deal with this bonuses were used. If you behaved courageously or performed a deed of valour or captured a ship a bonus could be paid. Also the first person who sees a ship which provides a prize would receive a bonus.

Finally, rules regarding the punishments for breaking any rule were stipulated in the constitutions. In addition, should a situation arise for which there were no written rules, the crew would gather to act as a kind of judiciary to interpret or apply the ship's articles to this new situation.

Leeson argues that the historical record points to the effectiveness of these constitutions in controlling quartermaster abuse and when abuse did occur the evidence indicates that crews successfully removed the quartermaster.

Leeson also makes the point that

The fact that pirate crews unanimously consented to the articles that governed them, ex ante, also plays an important role in explaining their success. Pirates recognized that "it was every one's Interest to observe them, if they were minded to keep up so abominable a Combination"(Johnson 1726–28, 210). Since pirates agreed to these rules before sailing, rules were largely self-enforcing once in place.

Thus pirates are a case were rules of internal governance could be enforced without relying on the power of the state and that these rules of governance created sufficient order and cooperation to result in pirates being one of the most sophisticated and successful criminal organisations known.

The above summary covers only part of the 45 page Leeson article, all of which is worth reading. According to Chris Coyne at the Austrian Economists blog, this article is just part of a larger research project exploring the economics and governance of criminal organizations. Leeson is also working on a book, The The Invisible Hook: The Hidden Economics of Pirates, History’s Most Notorious Criminals, which is under contract with Princeton University Press and is scheduled to appear in 2009. If this article is anything to go by the book will be a must read.