Impersonal Exchange without Impartial Law: The Community Responsibility System

ABSTRACT Impartial legal enforcement provided by the state is considered necessary for impersonal exchange,1 implying that the scope of enforcement determines the extent of the market and hence the division of labor and related efficiency gains. Yet, the development of effective impartial legal systems provided by the state to govern exchange relationships is a rather recent phenomenon. What were, if any, the institutions that enabled impersonal exchange prior to that development? This paper addresses this question by examining the European experience. It utilizes a game theoretic framework and historical analysis to examine the Community Responsibility System ("CRS") that enabled exchange characterized by separation between the quid and the quo over time and space that was impersonal, up to one's community affiliation. The CRS built on self-governed communities, intra-community (partial) enforcement institutions, and non-contractual joint communal liability in inter-community disputes that induced communities to care about their collective reputations. The analysis touches upon issues central to institutions: the optimal size of the legal responsibility unit as a function of different units' ability to identify, monitor, and punish wrongdoers; the endogenous elicitation of impartial justice from partial courts; the role of self-governed organizations that fall between the ways in which we model the state and communities; the complementarities between reputational mechanisms and those relying on coercive power; the importance of the distinction between personal and communal identities; how institutions endogenously determine if agents condition entering an exchange on the revelation of information regarding personal and communal identity or past actions or both; and the importance of overlapping generations' organizations, such as communities, in facilitating inter-organizational impersonal exchange based on reputation despite each individual's finite life span. (JEL Classification: N0, N2, C7.) I. INTRODUCTION Impersonal exchange is central to economic growth; however, we know surprisingly little about the historical development of the institutions that supported it. In considering the institutional foundations of exchange, the economic literature has emphasized reputation-based personal exchange on the one hand and impersonal exchange based on an impartial legal system on the other. Reputation-based institutions support personal exchange by enabling repeatedly interacting economic agents to commit ex ante to adhere to contractual obligations ex post based on the (correct) expectations that misconduct will lead to a loss of future gains from exchange. Law-based institutions support impersonal exchange based on a third-party impartial enforcer with coercive power, ex post verifiability of actions, and legal sanctions.2 Impartial and effective legal systems, however, are a relatively recent development, and, more importantly, impersonal exchange seems to have historically preceded their development. During the Late Medieval Commercial Revolution, long-distance trade substantially expanded, and merchants from different corners of Europe extensively entered into what seems to have been impersonal exchange characterized by a separation between the quid and the quo over time and space: credit, contracts for future delivery, negotiable securities, and maritime insurance are a few examples.' What institutions, if any, facilitated impersonal exchange in the absence of impartial, third-party contract enforcement provided by the state and its legal system? This paper addresses the question by examining the nature and endogenous dynamics of institutions that supported impersonal exchange characterized by a separation in time and space between the quid and the quo in pre-modern Europe from the late medieval period. Addressing this question relates to a central issue in understanding the process of development and the role of contract enforcement institutions in this process. …