‘The Law Merchant,’ by Milgrom, North, & Weingast
In “The Role of Institutions in the Revival of Trade: The Law Merchant, Private Judges and the Champagne Fairs,” Paul Milgrom, Douglass C. North, and Barry R. Weingast take as their starting point a circumstance unusual for legal work: circumstances where effective enforcement does not exist.
Their motivating example is the “law merchant” or lex mercatoria that emerged in Medieval Europe—a specialized uniform set of standards across a wide range of locations, although some research casts doubt on its actual existence as a legal code. The reach of any official sanction could be quite limited: If Antonio cheats Bassanio by providing inferior goods and then skips town, there’s little Bassanio can do. The cheat has slipped outside the bounds of the jurisdiction; Antonio is beyond the reach of the law.
While the scope of modern legal institutions is far broader than towns in 11th century Europe, there are plenty of situations where the law is effectively unenforceable. International law and limited jurisdiction are ready analogues. One of the great challenges in politics is that there is little in the way of enforceable law or contracts. Current members of Congress cannot bind themselves to enact a law next term—at least, not in any judicially enforceable way—and the incentive structures are inherently quite blunt. Likewise, procedural rules like standing, summary judgment, or class certification can effectively close the courthouse doors.
The most common example of legal sanctions with limited reach is ubiquitous: when the formal legal system is simply too costly to utilize.
The fundamental problem facing the merchants is a familiar one: there is incentive to cheat, thus undermining the gains of trade. In short, Antonio and Bassanio face a prisoner’s dilemma. Legal institutions can resolve this, of course, by changing the payoff for cheating.
Cooperation—that is, honest trade—can be sustained even in a prisoner’s dilemma through repeated interactions. This reputational approach, however, has problems scaling up. If Antonio knows he will never see Bassanio again (or if the odds of doing so are low) then the temptation to cheat reemerges.
Milgrom, North, and Weingast build on this well-known iterated prisoner’s dilemma framework. And they show how it can be scaled up—how the same reputation- and information-based behavior can be generated outside of formal enforcement institutions—even if the merchants never meet again.
The problem of scaling up the iterated prisoner’s dilemma is that each merchant only knows their own history. Bassanio knows if Antonio has cheated him, but is ignorant about exchanges with Portia or Lorenzo. The absence of information about past behavior ruins the strategies used to sustain cooperation in an iterated prisoner’s dilemma.