Sunday, 9 November 2008

The need for governemnt

In a recent post, Think of what politics is, Liberty Scott says the following,
I would like politics to be peripheral. Government is essential. The state provides for law and order, to protect us from those who will do violence to us, who will defraud us. That is a given and the priority.
This is a common view, believed by many from all over the political spectrum. Milton Friedman for example once said
[...] government is essential both as a forum for determining the ‘rules of the game’ and as an umpire to interpret and enforce the rules decided on. (Friedman 1962: 15)
But is this right?

We do have examples of where government enforcement of the "rules of the game" was missing and yet the game went on. Medieval Japan (ca. 1100-1600) was a period of economic growth but growth took place without much of a central government to enforce claims to resources. A recent working paper Property Rights In Medieval Japan: The Role Of Buddhist Temples And Monasteries by Mikael Adolphson and J. Mark Ramseyer argues that with regard to government in medieval Japan,
Emperors it had, along with regents, courtiers, warriors, and eventually shōgun and shōgunal regents. Yet these men seldom offered citizens much stability. Certainly, they seldom offered the security that would have induced citizens to invest scarce resources in easily appropriable investments or to undertake long-distance trade. These were not years of stability or peace. They were centuries of intrigue, murder, predation, and war.
But they also point out that,
... the Japanese economy grew anyway. Despite the chaos, people cleared forests. They lent money. They built elaborate and expensive irrigation facilities. They constructed sake breweries. And they traded their goods over longer and longer distances.
How then were property rights protected? Adolphson and Ramseyer show that temples and monasteries undertook the role of rights enforcer.
To obtain a secure claim to real estate, for example, a local landholder might "commend" his land to a temple (or monastery). Through the process, the temple obtained an equity interest in the land (took a cut of the harvest), and the landholder obtained an exemption from tax. At least as important, the landholder obtained the ability to call upon the temple to (and the temple had an incentive to) protect his land from rival claimants. Artisans and merchants obtained analogous protection by joining temple-sponsored guilds. They paid their dues, and the temple enforced their contracts.
In addition to the tax exemption the temples and monasteries offered a landholder two other sets of valuable services. First, they would adjudicate disputes over trades and property between parties within their jurisdictions. So contracts could be enforced. Second, estates within a temple's or monastery's region of control would be protected against threats and intrusions from outside parties. While it is true that some private landowners has the ability to protect their own property, in many cases the temples and monasteries had under their control the resources necessary to more effectively protect property.

Not only that but the temples and monasteries competed with each other to such services to landholders.

What in effect occurred was that "government services" were provided not by central government but in a competition market by private suppliers. This private provision was effective enough to allow economic growth to take place.
In effect, the temples and monasteries competed with each other to provide landholders with what we usually consider basic government services. In effect, medieval Japan maintained a market in private governments. Imperfectly to be sure, the resulting arrangements gave landholders something close to the protection they needed to improve and maintain their land.
Another case of private law enforcement is Medieval Iceland as discussed by David Friedman in Private Creation and Enforcement of Law: A Historical Case. Friedman argues
[...] medieval Icelandic institutions have several peculiar and interesting characteristics; they might almost have been invented by a mad economist to test the lengths to which market systems could supplant government in its most fundamental functions. Killing was a civil offense resulting in a fine paid to the survivors of the victim. Laws were made by a "parliament," seats in which were a marketable commodity. Enforcement of law was entirely a private affair. And yet these extraordinary institutions survived for over three hundred years, and the society in which they survived appears to have been in many ways an attractive one . Its citizens were, by medieval standards, free; differences in status based on rank or sex were relatively small; and its literary, output in relation to its size has been compared, with some justice, to that of Athens.


Medieval Iceland, however, presents institutions of private enforcement of law in a purer form than any other well-recorded society of which I am aware. Even early Roman law recognized the existence of crimes, offenses against society rather than against any individual, and dealt with them, in effect, by using the legislature as a special court. Under Anglo-Saxon law killing was an offense against the victim's family, his lord, and the lord of the place whose peace had been broken; wergeld was paid to the family, manbote to the crown, and fightwite to the respective lords. British thief-takers in the eighteenth century were motivated by a public reward of [[sterling]] 40 per thief. All of these systems involved some combination of private and public enforcement. The Icelandic system developed without any central authority comparable to the Anglo-Saxon king; as a result, even where the Icelandic legal system recognized an essentially "public" offense, it dealt with it by giving some individual (in some cases chosen by lot from those affected) the right to pursue the case and collect the resulting fine, thus fitting it into an essentially private system.
The point? At least in the past, government was not essential. But what of today?

There are a number of countries around the world which can be classified as 'weak or failed'. In such countries, the state is so corrupt, fragile or otherwise dysfunctional as to create anarchic - eg Somalia - or 'near anarchic' conditions. Citizens in these places can not rely upon the civil magistrate to uphold contracts or protect individual property rights. In addition, international market activity, which now comprises close to a quarter of world GDP has no overarching supranational authority to interpret or enforce commercial agreements. In these markets as well, government cannot be relied upon to create or enforce the rules of the game required for exchange relationships to thrive. Despite this, markets in both 'weak and failed states' and internationally survive and flourish. The long-standing existence of markets under conditions of real or quasi-statelessness suggests that private 'rules of the game' must be possible without government. How is this possible?

To take the case of commercial law as an example, how can trade continue without the government to enforce contracts, guard against fraud and contractual violations. One reason is that if the interaction between a buyer and seller or a creditor and debtor, for example, is repeated then there are forces to stop people acting opportunistically. If in the case of, say, the creditor and debtor, the debtor or seller wants to enjoy the benefits of contracting with the other party again, he cannot cheat his exchange partner. If he did then clearly the other party would refuse any further deals. Thus, a trading partner's credible threat to terminate future dealing if the other party cheats credibly commits him to cooperation, making the contract self-enforcing without government or any other form of external coercion. But there will be situations where such bilateral punishment may not be enough to ensure contract are honoured. Other mechanisms are need in such cases. One such mechanism is multilateral punishment.

Under multilateral punishment, the punishment is carried out by not just one person but by a group of people. Under this type of strategy, if an agent violates his contract, a whole group of individuals refuses to deal with him again whether any individual group member specifically was the violated party or not. A common example of such a mechanism is the boycott or embargo. In the international trade arena, for example, the way it works is straightforward. Assume that an individual defaults on his contract with another person. In response, the cheated agent communicates this information through his relevant network of other international traders. International commercial associations and arbitration venues, such as the International Chamber of Commerce and the Stockholm Chamber of Commerce facilitate this communication. By sharing the information about the identity of the trader who cheated him, the cheated individual coordinates the responses of his network of other traders, who, not wanting to be cheated themselves, refrain from any commercial dealings with the cheater. This has the effect of cutting off the cheater not only from future dealings with the individual he cheated, but also from this individual's entire trading network. This imposes a much higher cost to creating.

But multilateral punishment is also an effective way of creating reputations for individual traders who are honest. Honest individuals have good reputations and are able to cash in on this through contractual relationships with many others who are willing to contract with them because of their good reputation. Cheating would be very costly for individuals with good reputations because doing so would destroy the value of their histories of good conduct and with it the value of their reputations and thus ability to trade with others in the future. Reputation creation therefore acts as a kind of bond that commits traders to behave honestly. If they do not, they sacrifice the value of their bond.

But such private mechanisms are not useful only in state without government but can also play a role even in states with government enforcement of commercial law. As Peter Lesson writes,
Private mechanisms like reputation are highly important for enforcing contracts even where government is present and functional. The reason for this is straightforward. Even where government exists and is highly functional, state contractual enforcement is costly and imperfect. For many contractual agreements, it is not profitable to seek state enforcement even if a party has certainty he will win the dispute. The value he would receive is lower than the cost of pursuing state enforcement. Given this situation, one might expect that no contracts below this critical threshold would ever be established because, without recourse to state enforcement, defection would be endemic. But this is evidently not the case. Where state enforcement is prohibitively costly and thus cannot provide practical protection, reputation coupled with bilateral or multilateral punishment, discussed above, secures contractual fulfilment. (Lesson 2008: 50)
So, Do markets need government? At the very least, the answer to this question is more ambiguous than you may normally think.
  • Friedman, Milton (1962) Capitalism and Freedom, Chicago: The Univeristy of Chicago Press.
  • Leeson, Peter T. (2008) Do Markets Need Government? In The Legal Foundations of Free Markets edited by Stephen F. Copp, London: IEA.

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