Private Order Under Dysfunctional Public Order

Abstract

People's concern for their own reputation can support contracting between a pair of trading partners when one or both are locked in, and among multiple trading partners in close-knit communities where information flows freely. In communities where people can hide behind their anonymity, private order, if it is to operate at all, must be organized. Private-order organizations in notably diverse settings, from medieval Europe to present-day Mexico, work in similar ways. An organization such as a market intermediary or a trade association disseminates information about contractual breaches and coordinates the community's response to breaches. The usual sanction is to boycott the offender.

In countries making a transition from planned to market economies, private order acts in place of the inadequate legal system. We use data from a survey of firms in five transition economies in Eastern Europe and the former Soviet Union to show that in these transition economies social networks and informal gossip substitute for the formal legal system, while business networks and trade associations work in conjunction with the formal legal system.

JEL Classification: P21