Schama (1987) has drawn a portrait of civic culture among the Dutch burghers of the late 17th century to explain the remarkable prosperity the Dutch enjoyed during the following hundred years. For Schama, the burgher was a citizen first and homo economicus second. The author showed that the obligations of civic life conditioned the opportunities of economic prosperity.
If any one obsession linked together the burghers’ various concerns with family, fortunes of state, power of their empire, the condition of their poor, their standing in history, and the uncertainties of geography, it was the moral ambiguity of their good fortune. Schama’s account of Dutch prosperity turns on the way the nation’s burghers coped with that ambiguity.
205 Janoski (1998) is a treatise on the subject.
Chapter 6: Laws and Norms as Social Institutions
People are trustworthy to varying degrees. When we refrain from breaking the law, it is not always because of a fear of being caught; we refrain from doing it even when we know that no one will ever know. When we resist the temptation to take a closer look at an exotic plant in the forest it is not because others will rebuke us for trampling over fragile Nature, it is because we want to contribute to lessening the tragedy of the commons. The problem is that although pro-social disposition is not foreign to human nature, no society could rely exclusively on it. How is one to tell to what extent someone is trustworthy? If the personal benefits from betraying one’s conscience is large enough, almost all of us would betray it. Most people have a price, but it is hard to tell who comes at what price.
People everywhere have tried to establish institutions in which they have an incentive to
cooperate. The incentives differ in their details, but they have one thing in common: those who break agreements without cause suffer punishment. In contrast to the two sets of circumstances we have just identified, in which the punishment is internal to the person in breach of an
agreement, the punishment in the circumstances we next identify is meted out by a source external to the person. The next section studies how that is achieved.206
6.4 The Basis of Trust, 2
There are two ways. One is to rely on external enforcement, the other on mutual enforcement.
Each gives rise to a particular class of institutions. Depending on the nature of the engagement they would like to enter into, people invoke one or the other. The official term for one is the
‘rule of law’; for the other, it is ‘social norm’. Casual observation suggests that people in democracies rely heavily on the former, while elsewhere people depend greatly on the latter.
Some economists have argued that it is because they have been able to depend extensively on the former for centuries that Western democracies are now high income countries.207
6.4.1 External Enforcement
One possible way to ensure that the parties trust one another (and themselves!) to keep to their agreement is to have it enforced by an established structure of power and authority. In certain societies, tribal chieftains, village or clan elders, and warlords enforce agreements and rule on disputes. There are also examples where rural communities have created mini republics in certain spheres of life. Village panchayats in India assume that form. The idea there is to elect officials who are then trusted with the power to settle disputes, enforce agreements (they may only be tacit), communicate with higher levels of state authority, and so on. Robert Wade’s account of local enforcement of the allocation of benefits and burdens in sharing natural capital in rural South India described such a mechanism in detail (Wade, 1988). Forty-one villages were studied.
It was found that downstream villages (those suffering particularly from water shortage) had an elaborate set of rules, enforced by fines, for regulating the use of water from irrigation canals.
Most villages had similar arrangements for the use of grazing land. Wade reported that elected village councils (‘panchayats’) had appointed agents who allocated water among farmers’ fields, protected crops from grazing animals, collected levies and imposed fines. In a different setting, Baland and Platteau (1996) have written about ‘water masters’, who regulated the use of local fisheries in the Niger River delta.
Here we imagine that the external enforcer is the state and that the agreement is drawn up as a legal contract. We include on this list the implicit ‘social contract’ among citizens not to break the law. However, if contracts are to offer a viable means of doing things, breaches must be verifiable, otherwise the external enforcer would have nothing to go by if asked to rule on
206 Rewarding people for pro-social behaviour is implicit, in that, complying with the agreement is beneficial to the party.
207 North (1990) read the economic rise of the West in terms of a rising demand for well-defined and secure property rights. The role of authority in ensuring the latter was crucial.
Chapter 6: Laws and Norms as Social Institutions
it. To be sure, lawyers make a handsome living precisely because verification is fraught with difficulties.208 We leave aside the difficulties of verifying breach of contract (Chapters 7 and 8) and note that if the punishment the state imposes for a violation is known to be severe relative to the temptation each party to the agreement faces to violate it, then everyone will be deterred from going that route. If everyone is aware of the force of that deterrence, they will each trust the others not to be opportunistic.
In the modern world, the rules governing transactions in the marketplace are embodied in the law of contracts. A modern firm is a legal entity, as are the financial institutions through which employees are able to accumulate their pension, save for their children’s education, and so on.
Employees have employment contracts with their firm, the firm complies with environmental regulations at a cost to itself, and so on. The agreements people reach with financial institutions are also legal contracts. When someone goes to the grocery store, the purchases involve the law, which provides protection for both parties (the grocer, in case the cash is counterfeit or the card is void; the purchaser, in case the product turns out on inspection to be substandard).
Formal markets, from which people enter and exist when they need to or wish to, are able to function only because there is an elaborate legal structure that enforces the agreements known as ‘purchases’ and ‘sales’. Moreover, it is because the customer, the grocery store’s owner and the credit card company are confident that the government has the ability and willingness to enforce contracts that they do business together.
What is the basis of that confidence? After all, the contemporary world has shown that there are states, and there are states. Who, one should ask, keeps an eye on the guardian? One answer – in a functioning democracy – is that the guardians worry about their reputation. A free and inquisitive press, probing NGOs, and active citizens help to sober governments into believing that incompetence or corruption would mean an end to their rule, come the next election. This involves a system of interlocking beliefs about one another’s abilities and intentions. The millions of households in a country trust their government (more or less!) to enforce contracts, because they know that government leaders know that not to enforce contracts efficiently would mean being thrown out of office. In their turn, each side of a contract trusts the other not to renege (again, more or less!), because each knows that the other knows that the government can be trusted to enforce contracts, and so on, hopefully in an endless recursion of mutual, self-confirming beliefs. Trust is maintained by the threat of punishment (e.g. a fine, dismissal or incarceration) for anyone who breaks a contract, be it the legal contract (employment contract) or social contract (the contract between the voters and the government to maintain law and order). We are in the realm of beliefs that are held together by their own bootstraps (our earlier condition (b)).
What we have presented is only the sketch of an argument. The complete argument is similar to the one which shows that social norms also offer a way to enforce agreements. So we turn to that fourth context in which agreements are kept: the play of social norms. We will see that because societal norms can be a powerful weapon in disciplining external enforcers, they are more fundamental for cooperation than even the law.
6.4.2 Mutual Enforcement in Long-Term Relationships
Social customs differ from rulers’ dictates. The motivations they give rise to in us to behave one way rather than another are not the same. Anthropologists have studied the practice of
‘gift-exchange’ in classical societies (Malinowski, 1926; Sahlins, 1972). The practice involved the exchange of goods people regard as part of their social custom. Modern societies also practise
208 Rough estimates suggest that in the US, for example, gross value added of the legal profession (lawyers, judges, investigators), on people who work in insurance (loss adjusters, insurance agents), and on those in law enforcement (the police) make up more than 4% of GDP (Bureau of Economic Analysis, 2020); and that does not include the defensive measures people take against possible litigations, burglary, and theft.
Chapter 6: Laws and Norms as Social Institutions
gift-exchange. They take place on religious occasions and at family celebrations; and they are pervasive in subtle forms in modern societies in such relationships as those to be found between managers and workers (Akerlof, 1982) and landowners and peasants (Rudra, 1982).209 There are variations of the practice, for it is not restricted to ‘exchange’; a unilateral gift would come with an expectation that it will be reciprocated, even among people who are not engaged in a long-term relationship. That would appear to have been as true in ancient, even archaic times as it is today:
“The word ‘gift’ is not to be misconstrued. It may be stated as a flat rule of both classical and archaic society that no one ever gave anything, whether goods or services or honours, without proper recompense, real or wishful, immediate or years away, to himself or to his kin. The act of giving was, therefore, in an essential sense always the first half of a reciprocal action, the other half of which was a counter-gift.” (Finley 2002: 53)
Social norms differ from legal systems in channelling behaviour. Reciprocity is central to the meaning of social norms. Greif (1993) has used norm-guided practices to explain the emergence of institutions that facilitated the growth of trans-border trade in Medieval Europe. He showed that the Maghribi traders during the 11th century in Fustat (now part of Cairo, Egypt) and the Mediterranean acted as a collective to impose sanctions on those of their agents who broke their commercial codes. Elsewhere Greif, Milgrom and Weingast (1994) have provided an account of the rise of merchant guilds in late Medieval Europe. Guilds afforded protection to members against unjustified seizure of their property by city-states. Guilds determined if and when trade embargoes against such states were justified. In their account guilds are not be to viewed as rent-seeking organisations.210 In a related work, Milgrom, North and Weingast (1990) pointed to the role of merchant courts at the annual fairs in Champagne. The courts helped members to impose sanctions on those who had transgressed on agreements.
Although the law exists today in every country, there are places where people cannot depend on it. It could be that the legal system is corrupt. But even when it is reliable, it could be that the nearest courts are far away and there are no lawyers in sight. When roads are decrepit, villages are enclaves. Much economic life is then shaped outside a formal legal system. Nevertheless, people transact with one another. Saving for funerals in Ethiopia, for example, involves saying,
‘I accept the terms and conditions of the iddir’ (Box 6.4). As there is a lack of developed credit markets where they live, villagers also practise reciprocity to smooth consumption over time. Udry (1990) reported that in the sample of villages in Nigeria he had studied nearly all credit transactions were either between relatives or between households in the same village.
No written contracts were involved, nor did the agreements specify the date of repayment or the amount repaid. Social codes were implicitly followed. Fewer than 10% of the loans were in default.
Why would the villagers trust one another? They would if agreements were mutually enforced;
that is, a credible threat by members of a community that stiff sanctions will be imposed on anyone breaking an agreement would deter everyone from breaking it. This is a common basis for doing business in developing countries. Among the Kofyar farmers in Nigeria, for example, agricultural land is private, but free-range grazing is permitted once the crops have been
209 Reporting an interview he had conducted with a landowner (patron) and a farm worker (client) in West Bengal, India, Rudra (1982: 255) wrote of the relationship between them:
(Landowner): “I may require a labourer to come and help me in the middle of the night, for example, if it has rained and the living quarters and the paddy go down have got flooded. There are no rates for such work to be done at such an hour. Such a service cannot be purchased.”
(Farm worker): “I am a poor man and I do not even have enough to eat every day. I may require urgently some money for a funeral in the family. To whom shall I go?”
210 This should be contrasted with Ogilvie’s account of producers’ guilds in the duchy of Wurttemberg in the early-modern period (Ogilvie, 1997).
Chapter 6: Laws and Norms as Social Institutions
harvested (Stone, Netting, and Stone, 1990). Kofyar households are engaged in subsistence farming, so labour is not paid a wage. However, in times long gone the Kofyars instituted communal work on individual farms. Although some of this is organised in clubs of 8 to 10 individuals, there are also community-wide work parties. A household that does not provide the required quota of labour without good excuse is fined (as it happens, in jars of beer). If fines are not paid, errant households are punished by being denied communal labour and subjected to social ostracism.
How is mutual enforcement able to support agreements among members of a community?
It is all well and good for those with whom a person had reached an agreement to threaten that sanctions will be imposed on him if he breaks it. But why should he believe the threats?
He would believe them if sanctions were inscribed into social norms. That may read as simply a rewording designed to make one think that description amounts to explanation, but social norms carry a deep meaning. To uncover it, let us assume an agreement that has been kept by each party is observable by all parties. This is a strong assumption, but as with ‘verifiability’
(Section 6.4.1) it is a useful starting point. Once we draw conclusions from it, we will be able to infer how communities have modified practices in situations where the assumption does not hold even approximately. For example, even if you are unable to observe someone’s actions, you may be able to rely on someone else who can observe those actions. Trust in that someone is then built on trust in that someone else. That said, anyone who has visited villages in low income countries will have observed that there is often less insistence on privacy there. In tropical villages, cottages are frequently designed and clustered in such fashion that it must be hard for anyone to prevent others from observing what they are about. What is loosely called
‘social capital’ is the seat of cooperation sustained by the practice of social norms.
By a social norm we mean an accepted rule of behaviour. A rule of behaviour reads like so: ‘I will do X if you do Y; I will do Z otherwise’; ‘I will do P if Q happens; I will do R otherwise’; and so forth.211 For a rule of behaviour to be a social norm, it must be in the interest of each person to act in accordance with the rule if all others act in accordance with it; that is, the rule should correspond to a Nash equilibrium. To see how social norms work, it is useful to study whether cooperation based on long-term relationships can be sustained between various parties.
Imagine that all parties are far-sighted, that is, they discount future gains and losses at a low rate relative to current gains and losses. That means the private gain to a party from breaking the agreement unilaterally is less than the losses he would suffer if all other parties were to impose sanctions on him. Imposing sanctions could involve, for example, refusing to enter into any transactions with the erring party for some while, shunning the person in other ways for suitable numbers of periods, and so on. But as imposing sanctions is itself not costless, the threat of sanctions must be made credible.
To see how social norms solve the credibility problem, let us call someone a rule-abider if the person cooperates with those others who are rule-abiders, but imposes sanctions on those who are not rule-abiders. Although that sounds circular, it is not, because for a rule of behaviour to be a social norm requires all parties to start the process of cooperation by keeping their agreement. It would then be possible for any party in any period to determine which party is a rule-abider and which party is not. For example, if ever someone was to break the original agreement, he would be judged to be someone who is not a rule-abider; so, the norm would require all parties to punish the person. Moreover, the norm would require that punishment be inflicted not only on those in violation of the original agreement (first-order violation); but also on those who fail to punish those in violation of the agreement (second-order violation);
on those who fail to punish those who fail to punish those in violation of the agreement
211 Game theorists call rules of behaviour ‘strategies’. The theorem was proved in its general form by Fudenberg and Maskin (1986).
Mailath and Samuelson (2006) contains an excellent, formal explanation for why the theory of repeated games forms the basis of long-term relationships.
Chapter 6: Laws and Norms as Social Institutions
(third-order violation); and so on, indefinitely. The infinite chain makes the threat of punishment for errant behaviour credible, because if all others were to conform to the norm, it would not be worth any party’s while to violate the norm. Keeping one’s agreement would then be mutually enforcing.
All societies appear to have sanctions in place for first-order violations. Second-order sanctions are in play when members of an institution shun any member who continues to do business with someone who has cheated. That sanctions against higher-order violations have not been
All societies appear to have sanctions in place for first-order violations. Second-order sanctions are in play when members of an institution shun any member who continues to do business with someone who has cheated. That sanctions against higher-order violations have not been