EKIP– Expert Club for Economics and Politics A Different Opinion
The article is part of a series of publications dedicated to the fourth annual conference of European Students For Liberty, which will be held on 22.10 at 9 am at the Ramada Hotel in Sofia. For more information and free registration, see the official Facebook event.
In the field of social sciences, and economics in particular, one of the fundamental contemporary theories is that although markets and private enterprise are more efficient than the state in providing almost all types of goods and services, this does not apply to some strictly specific types of goods. Such are, for example, the administration of justice and, more specifically, the enforcement of contractual relations concluded in the market. Many economists are of the opinion that without the state, the free market could not exist simply because without it there would be no one to monitor the observance of the contractual relations that people conclude with each other, and the market would fall into complete chaos. Among most academic circles, the idea that state supervision is not necessary and that compliance with contractual relations can be regulated and guaranteed in the absence of state control is considered impossible and even absurd. Outside expert circles, this view is even more widespread.
There are numerous contemporary examples of private regulation of contractual relations.
In reality, however, the idea is not as absurd as it seems at first glance. In his book “Private Governance”, the American economist Edward Stringham describes and analyzes numerous historical examples of private forms of governance and arbitration in various types of contractual and legal disputes. To this day, various types of private clubs practically exercise a form of private governance parallel to the state. There are private clubs and various types of social organizations that are created and enforced by the organization at an internal level. An example of such a type of organization that is common in our everyday life are nightclubs. Nightclubs not only provide a physical space for entertainment, but also have specific rules of conduct that their customers must follow. And these rules are neither created nor enforced by state institutions. They are completely private and are enforced by a completely private organization.
The same applies to other private organizations and businesses such as shopping malls, housing complexes, stock exchanges, and financial and commercial brokerage companies such as PayPal, Ebay, Amazon, etc. The latter two are practically private clubs that facilitate trade between people from all over the world, relying on a reputation mechanism through which each customer of the site can evaluate the quality of the goods and services offered by the merchants. Companies that act as intermediaries for shared travel, such as Uber, rely on a similar mechanism. By using such evaluation mechanisms, these companies completely bypass the need to provide a state guarantee (in the form of licenses and the like) for the quality of the goods and services that are exchanged through their platform. In addition, all of these companies operate quite successfully as arbitrators in case of disagreements between their.
Despite the complete absence of state control, fraud was extremely rare on stock exchanges in the 17th and 18th centuries.
One of the most striking examples of a completely private form of management and enforcement of contractual relations are the early stock exchanges in the Netherlands and England in the 17th and 18th centuries. During those times, most forms of trading and exchanging shares of private companies were prohibited by law, because statesmen considered them dangerous speculation and even a form of gambling. This even included practices that are completely standard today, such as the so-called short selling. In order to carry out various trading operations, traders on the exchanges entered into contractual relations that were practically outside the law and that the courts refused to enforce. However, the stock exchanges in the Netherlands and England in the 17th and 18th centuries not only functioned smoothly, but also underwent enormous development. This was possible because, although the state refused to guarantee the performance of most of their contracts, the stock traders themselves regulated their transactions.
To ensure that contracts between two or more brokers were respected, exchanges used a very simple reputation mechanism, similar to the one used by trading websites today. If you wanted to trade on the exchange, other traders had to know that they could trust you, otherwise no one would agree to trade with you. Precisely because the state refused to monitor the respect of most contracts concluded on the exchange, the career of any broker depended on his reputation. If he failed to respect his contractual relations with someone even once, his career was over. Relying only on this very simple reputation mechanism, the Dutch and English exchanges experienced incredible growth in the 17th and 18th centuries and became the main source of financing for the colonial expeditions of these two countries. All of this happens in the complete absence of any state administration of justice within these private exchanges, which later even create and enforce their own "constitutions" that describe the rules that must be followed by anyone who wants to participate in their trading.
Private entrepreneurship sometimes does the police's job too
All these examples clearly show that at least at the micro level, private mechanisms for enforcing contracts and administering justice are not only possible, but have been and still are a fact in many sectors of the economy. We simply do not notice them because we are taught to think that the only reason for contractual relations to be respected is that state institutions are always there to monitor their implementation. However, the reality is much more complex. State justice institutions, to this day, very often do not have the necessary knowledge, as well as the necessary incentive, to prevent fraud and monitor compliance with contractual relations that are strictly specific to certain sectors.
For example, in 2001, the digital payments company PayPal encountered a serious problem with the spread of credit card fraud through its platform. The company initially turned to the authorities, but even the FBI was unable to deal with the problem because it did not have the necessary expertise in the field of digital transactions, which were an exceptional innovation at the time. Therefore, PayPal eventually developed its own solution – software that operates as quasi-artificial intelligence and, with the assistance of programmers, monitors the actions of each client on the platform, analyzes their transactions and, in case it detects suspicious activity, automatically locks the corresponding account. In this way, PayPal developed its own mechanism for detecting and catching criminals and solved the problem of fraud.
As we see very often, private organizations and businesses practically do the work of state institutions. They fill all the gaps in the enforcement of contracts and even the administration of justice that are left, or even opened, by the state. All this shows that the idea of private governance, regulation of contractual relations in society, and even the administration of justice, is not at all as unrealistic an idea as it seems at first glance and has even been practiced at a micro level in society for quite a long time.
Private regulation of contractual relations is apparently entirely possible, at least at the micro level.
The description of the various forms of private regulation and management in combination with the in-depth analysis of their mechanism and functioning applied by Stringham in his book can seriously strengthen the arguments of the supporters of the complete decentralization and privatization of the justice system. The examples not only from history, but also from our time, by themselves, are unlikely to dispel all doubts on the subject. Although there are clearly forms of private regulation of a variety of contractual and commercial relations, all the examples we have are still at a relatively micro level, within individual companies, private clubs and organizations even when their members and customers are millions of people all over the world (as in the case of Ebay, Amazon and PayPal). There is no answer to the question of whether it is possible for these forms of private regulation to be expanded to a scale similar to that of state institutions, and thus effectively compete and push the state in this area not only at the micro, but also at the macro level. This is the next key question that Stringham and other economists like him need to answer.
