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(IN)FORMAL CONTRACT ENFORCEABILITY · PDF file(IN)FORMAL CONTRACT ENFORCEABILITY RAUL S ANCHEZ DE LA SIERRA November 17, 2017 Abstract Through their command over the

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  • (IN)FORMAL CONTRACT ENFORCEABILITY

    RAUL SANCHEZ DE LA SIERRA

    November 17, 2017

    Abstract

    Through their command over the threat of force, states enforce contracts, which is oftenassumed to be welfare enhancing. However, non-state social organization can provide evenbetter contract enforcement, particularly in the presence of weak or captured states. In thispaper, I experimentally test two propositions about the relative efficacy of state and socialorganization in enforcing contracts. The first is that when the state administration is cap-tured by one social group, contract enforcement is biased in favor of that group, which hasimplications for trade. The second is that the effect of expanding contract enforcement bythe state depends on how it interacts with social organization, which already governs manyagency relations outside the state and can be complemented or instead crowded-out. I useexperimental variation to test these propositions, randomizing moral hazard and contractform in household sales across trader-customer pairs. First, I find that in the absence ofstate enforced contracts, a specific form of social organization (co-ethnicity) increases tradeand mitigates moral hazard, largely through the threat of lynching and social exclusion. Sec-ond, I find that state-enforced contracts have only mild crowding-out effects and also increasetrade and mitigate moral hazard, but this effect is only found in the groups that control thelocal judiciary. This suggests that formal institutions may have limited efficacy relative toinformal institutions in fragmented polities. The results are consistent with a view of a weakstate not as lacking enforcement potential, but in which social organization governs manyagency relations, including the state administration itself.

    JEL classification: D02, D23, H11, J41, N47, P48Keywords: Contracts, Property rights, Ethnicity, State

    The work of Avner Greif, as well as long conversations with him, greatly inspired this paper. I am thankfulto Christopher Blattman, Pierre-Andre Chiappori, Donald Davis, Macartan Humphreys, Suresh Naidu, BernardSalanie, and Eric Verhoogen for guidance. I am grateful to Philippe Aghion, Charles Angelucci, Natalie Bau,Roland Benabou, Matilde Bombardini, Guillermo Caruana, Benjamin Enke, James Fearon, Avner Greif, JonasHjort, Supreet Kaur, Gauthier Marchais, Monica Martinez Bravo, Joel Mokyr, Eduardo Montero, Nathan Nunn,Torsten Persson, Bernard Salanie, Mariano Sanchez Talanquer, Shanker Satyanath, Monica Singhal, FranziskaSchwingeler, Guido Tabellini, Francesco Trebbi, Hans-Joachim Voth, Noam Yuchtman, Fabrizio Zilibotti, andseminar participants at the Canadian Institute For Advanced Research Zurich meeting 2017 of OrganizationsInstitutions and Growth, Columbia, NYU, the Harvard Development Faculty retreat, CEMFI, NEUDC 2014, theNorwegian School of Economics, the University of British Columbia, and to the students of the UC BerkeleyPHDBA279C graduate course on Political Economy for invaluable comments. Aimable Amani Lameke, Jean-Paul Zibika, provided excellent management support, and Carlos Schmidt Padilla provided outstanding researchassistance. This project was supported by Private Enterprise Development in Low-Income Countries exploratorygrants (PEDL), Russell Sage Small Grants in Behavioral Economics, and the Center for the Study of DevelopmentStrategies at Columbia University. Email: [email protected]

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  • 1 Introduction

    Consider a typical economic exchange relation: an agency relationship, with an inherent commit-

    ment problema merchant and an agent, who can sell the merchants good. Trade is mutually

    beneficial, but the agent has an incentive to defect, hence trade often collapses. Without state

    enforcement of contracts, trade may be sustained through social organization, which can gov-

    ern the agents incentives to defect (Greif, 1993). Through their command over force, states can

    threaten the agents who defect, which is often assumed to be more efficient. However, the view of

    the state as an autonomous bureaucracy that can be leveraged to solve moral hazard is often not

    warranted: the state itself is often governed by social organization, which can bias enforcement.

    Furthermore, when social organization governs trade without state enforcement, expanding state

    enforcement can complement it, or crowd it out. Yet, the effect of state contract enforcement on

    economic exchange, let alone how it is shaped by social organization, is not well understood.

    In this paper, I propose and experimentally test a framework that accounts for social organi-

    zation to study the effect of introducing the state into agency relationshipsrelationships with

    an inherent commitment problem. First, in contrast to views of the state as an autonomous

    bureaucracy, I allow social groups to control the administration. This introduces a bias in the en-

    forceability of state contracts in favor of such groups, which trading partners anticipate when they

    decide to whether trade and whether to defect. Second, the effect of the state depends on whether

    contract enforcement by the state, substitutes, complements, or crowds-out the mechanisms that

    govern agency relations in the absence of state enforced contracts (Benabou and Tirole, 2003,

    Bowles and Polania-Reyes, 2012). A challenge to examine the effect of state contract enforcement,

    however, is that social organization and the state are endogenous.

    As a foundation for this paper, I create a home delivery sale with an inherent commitment

    problem that can lead mutually beneficial trade to breakdown. The sales take place in Sud Kivu,

    Democratic Republic of Congo (DRC), where relationships are mostly governed informally. This

    allows me to experimentally vary moral hazard and contract type across trader-customer pairs.

    To tailor the study design to the context, I first describe the relevant social organization. First,

    the so-called autochtonous (native) groups have captured the provincial administration, which

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  • they use as a vehicle for their interests (henceforth, state group). The other groups (the Tutsi) are

    largely prevented from accessing positions in the provincial administration (henceforth, nonstate

    groups). I conduct a survey of the administration, which confirms this pattern. Second, important

    social (ethnic) divisions between the state groups exist which, despite the recovery by the state of

    many of its functions, have crystallized into a culture of informal ethnic governance of trade. This

    paper does not aim to establish that ethnicity matters. Instead, it uses it as a well-documented

    form of social organization to examine formal and informal contract enforceability.

    I organize the paper in three parts. In the first part, I examine the principals decision to

    trade in trader-customer pairs belonging to multiple state groups, as a function of moral hazard,

    pair composition, and contract type. In the second part, I confirm that the agents decisions to

    defect are consistent with the principals implied beliefs. In the third part, I introduce principals

    of nonstate groups to measure the implication of administrative capture on moral hazard.

    In the first part of the paper, I examine the decision to trade when there is an inherent com-

    mitment problem. I recruit traders of different state groups to administer home sales in 1,860

    households, also of different state groups. Traders offer to deliver a household good at reduced

    price in a given time frame. In exchange, customers must pay immediately (Sales on Debit).

    This generates an agency relationship, since the trader (the agent) has an incentive to defect by

    reneging to deliver the good, which the customer (the principal) anticipates.

    I use the sales introduced in this first part to quantify the effect of social organization of the dif-

    ferent state groups (henceforth, co-ethnicity) on trade. To ensure that co-ethnic trader-customer

    matches are not systematically different, I randomly assign traders to customers. I find that when

    trader and customer are from the same group, customers are 22% more likely to buy. To iden-

    tify whether such effect reflects homophilic tastes for in-groups, or instead, the customers belief

    that shared ethnicity curbs traders defection, I experimentally eliminate trader moral hazard in a

    subset of sales (Sales on the Spot). The findings from this design rule out homophilic tastes, and

    establish that co-ethnicity increases trade only by inducing customers to expect lower likelihood

    of defection. Furthermore, customers matched to an in-group trader are more likely to report that

    they expect the trader to be lynched and to lose relationships if he defects. They are also more

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  • willing to pay so that the trader is caught. This suggests that social organization governs social

    sanctions and in-group norms of reciprocity and revenge (Fehr and Gaechter, 1999).

    Using these sales, I then introduce contract enforcement by the state. In randomly selected

    customer-trader pairs, the trader signs a contract, which endows the customer with the right to

    take the trader to court if the trader defects (legal contracts). I find that trade is 20% more likely

    to occur in pairs where the trader signs a legal contract. Furthermore, legal contracts increase

    trade only in pairs in which there is trader moral hazard, thus showing that state contract enforce-

    ment, even in a weak state, increases trade because customers expect the trader who has signed

    a legal contract to be less likely to defe

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