Presentation on theme: "Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Trader’s Coalition By Avner Grief."— Presentation transcript:
1Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Trader’s Coalition By Avner Grief
2ObjectiveKnowledge about the historical institutional developments that enabled exchange relations to expand can throw light on nature and evolution of modern institutions and facilitate the understanding of the institutional transitions that developing economies still face
3Paper OutlineEconomic Institution of 11th century traders: Maghribi TradersCoalition, which governed relations between merchants and tradersIt operated on a reputation mechanismAnalyzed based on historical recordsStudy highlights:Interaction between social and economic institutionDeterminants of business practicesMerchants Law
4Maghribi TradersIn the 10th century, as the social and political environment in Baghdad became increasingly hostile to Jews, some Jewish traders emigrated to the Maghreb. Over the following two or three centuries, such Jewish traders became known as the Maghribis, a distinctive social group who traveled throughout the Mediterranean World. They passed this identification on from father to son. Their tight-knit pan-Maghreb community had the ability to use social sanctions as a credible alternative to legal recourse, which was anyway weak at the time. This unique institutional alternative permitted the Maghribis to very successfully participate in Mediterranean trade.
5Economic Trade Environment Trade was free, private and competitiveMerchants: who want to trade( receiver of residual revenue)Overseas Agent : (compensated) to handle goods abroad, involved in decision making as wellSaves merchant time and risk of travelingTrust Problem- agents can act opportunistically and embezzle the merchants goodsNeed for supporting institution to establish agency relations and attain efficient cooperation (qualitative assessment) by overcoming commitment problem
6Historical Data Geniza (“deposit place”) Maghribi Traders had the custom of depositing in the geniza every document that was written in Hebrew charactersIt contains thousands of contracts, price list, trader’s letters, accounts.It is assumed to contain a representative sample of their commercial correspondence
7Commitment Problem: Reasons Complexity and Uncertainty of long distance commerce- eg: prices and weather condition not verifiable ex-post, bribes given, goods stolen, cost of delivery etc.Slow technology leading to untimely communication and non verifiable data generationPossibly Legal system not of much help due to asymmetric information, limitations of applicability of law, time consuming and delayed justice
8Solution Evolved: Coalition Paper HypothesisCoalition: Defined as a group of traders whose member merchants are expected to hire only member agents, and these agency relations are governed by Multilateral Punishment Strategy(MPS).Internal informal information transmission mechanism enables merchants to monitor agents and makes cheating known to all.Geniza Document Suggest that:That a reputation mechanism governed agency relations and in particular that merchants conditioned future employment on the past conduct, practiced community punishment and ostracized agents who were considered cheaters until they compensated the injuredAn agent who has been accused of cheating were to receive agency services from another Maghribi traders, they could cheat him free from community retaliation
9Model Description Perfect and complete information economy M merchants , A agents , living for infinite no. of periodsAgents have time discount factor δEach unemployed agent could be hired by only one merchantA merchant who does not hire any agent receives a payoff of κ >0If agent is honest, the merchants payoff is γ-w and agents payoff is wIf the agent cheats his payoff is α and the merchants payoff is 0.Probability of merchant terminating agents services due to exogenous variable is τUnemployed agent receives the reservation utility of ϖ >=0Assumption γ> κ + ϖ : cooperation is efficientAssumption γ> α > ϖ : cheating entails a loss, agent prefers cheating over receiving his reservation utility.Assumption κ > γ- α : merchant prefers to operate by himself if the agent is to cheat him or to receive a wage αthe probability that unemployed honest agent(when last employed) will be rehiredthe probability that unemployed cheater agent(when last employed) will be rehired
10Proposition 1 Assume that , The optimal wage, the lowest wage for which it is an agent’s best response to play honest, isand w is monotonically decreasing in and monotonically increasing in
12Multilateral Punishment Strategy - MPS A merchant offers an agent a wage W*, rehires the same agent if he has been honest (unless forced separation has occurred), fires the agent if he has cheated, never hires an agent who has ever cheated any merchant, and (randomly) chooses an agent from among the unemployed agents who never have cheated if forced separation has occurred.
13Why MPS WorksAn agent is motivated to be honest by the carrot of a premium over his reservation utility and the stick of firing.The optimal wage decreases as the honest agent is more likely to receive future wage premiums (higher ) can gain less by cheating (lower α) , is more likely to remain employed if he is honest (lower τ), has worse opportunities elsewhere (lower ϖ ), and has a smaller chance of being hired if he is cheater (lower ) and as agent values his future income more (higher δ)Merchant find it optimal to hire agent if wages are low enough
14Proposition 2 Assume the δ ϵ (0,1) and under MPS merchant strictly prefers to hire a honest agentSo it is not the compulsion of MPS due to whichhe can not hire the cheat agent (socially labeled)rather a individual rationality.
15Proposition 2: Proof We know Also, w* is monotonically increasing in and monotonically decreasing inUnder MPSProposition 1 implies that
16Bilateral Punishment Strategy - BPS Identical to MPS but merchants do not condition hiring decision on agents past behavior (because such information is not gathered, given that nobody is expected to use it)
17Why MPS preferred to BPS History and theory lend support to the main hypothesis that coalition relations are governed by MPSWhy MPS is self enforcingWhy two different coalitions do not mergeBecause MPS is more efficient that BPS
18Proposition 3 MPS supports cooperation when BPS fails. Take the limits of W* as δ goes to 1 using the fact thatUnder BPSUnder MPSPlug these in proposition 1
19Sustainability of Coalition MPS enhances its efficiency compared to BPSEfficiency gains generated by coalition encourage its emergenceMPS not applied in intercoalition due to nature of the network of information transmission and strategic considerationsIntracoalition preferred to intercoalition, intracoalition is self enforcing.
20Merchants LawTo bring in coordination and threat of collective punishment credible, consensus should be reached what is considered as cheatingDetailed contracts were not possible since they require high negotiation costs.Instruction list was shared by the merchant with the agentSet of cultural rules of behavior were employed for circumstances not mentioned in instruction list sent by merchantFailing to follow instructions or set of cultural rules lead to agent being considered cheater.
21ConclusionThe evidence suggests that the coalition was a response to problems of contract enforceability, although not optimal responseIntergenerational transfers ensured the horizon long enough to support the operation of a reputation mechanismOriginal social structure lead to economic institution which in turn preserved initial social structure.The factors which ensured the sustainability of coalition prevented the coalition from expanding in response to welfare enhancing opportunitiesEconomic growth in different economies may be diverse due to distinct institutional framework of historical origin