The Incentive Complementarity between Formal and Informal Enforcement
63 Pages Posted: 17 Apr 2018 Last revised: 27 Nov 2023
Date Written: January 31, 2021
Abstract
We introduce a model in which people exchange some goods and services informally in their community and others formally on a market. We show that enforcement by informal communities and a formal market are complements: if communities ostracize individuals who are caught cheating on the market, this bolsters incentives to comply with exchanges in both settings.
Although transactions within a community generate lower gains from trade than those on the wider market, the enhanced incentives from simultaneously transacting in communities and on the overall market can be welfare-enhancing compared to either extreme. We discuss the implications of informal community exchanges in a country's development as well as how moral or religious beliefs enhance the complementarity between community and formal enforcement.
Keywords: Community, Government, Contracts, Reputation, Enforcement, Laws, Courts, Trust, Religion, Corruption, Norms, Privacy
JEL Classification: C72, C73, D23, D73, H11, K12, O17, P48, P51, Z12
Suggested Citation: Suggested Citation