Contract Enforceability and Economic
Institutions in Early Trade:
The Maghribi Trader’s Coalition
By Avner Grief
1
Objective
Knowledge about the historical institutional
developments that enabled exchange relations to
expand can throw light on nature and evolution of
modern institutions and facilitate the understanding of
the institutional transitions that developing economies
still face
2
Paper Outline
• Economic Institution of 11th century traders:
Maghribi Traders
• Coalition, which governed relations between
merchants and traders
• It operated on a reputation mechanism
• Analyzed based on historical records
• Study highlights:
– Interaction between social and economic institution
– Determinants of business practices
– Merchants Law
3
Maghribi Traders
In the 10th century, as the social and political environment in
Baghdad became increasingly hostile to Jews, some Jewish
traders emigrated to the Maghreb. Over the following two or
three centuries, such Jewish traders became known as the
Maghribis, a distinctive social group who traveled throughout
the Mediterranean World. They passed this identification on
from father to son. Their tight-knit pan-Maghreb community
had the ability to use social sanctions as a credible alternative
to legal recourse, which was anyway weak at the time. This
unique institutional alternative permitted the Maghribis to very
successfully participate in Mediterranean trade.
4
Economic Trade Environment
• Trade was free, private and competitive
• Merchants: who want to trade( receiver of residual revenue)
• Overseas Agent : (compensated) to handle goods abroad,
involved in decision making as well
• Saves merchant time and risk of traveling
• Trust Problem- agents can act opportunistically and embezzle
the merchants goods
• Need for supporting institution to establish agency relations
and attain efficient cooperation (qualitative assessment) by
overcoming commitment problem
5
Historical Data
• Geniza (“deposit place”)
• Maghribi Traders had the custom of depositing in the geniza
every document that was written in Hebrew characters
• It contains thousands of contracts, price list, trader’s letters,
accounts.
• It is assumed to contain a representative sample of their
commercial correspondence
6
Commitment Problem: Reasons
• Complexity and Uncertainty of long distance commerce- eg:
prices and weather condition not verifiable ex-post, bribes
given, goods stolen, cost of delivery etc.
• Slow technology leading to untimely communication and non
verifiable data generation
• Possibly Legal system not of much help due to asymmetric
information, limitations of applicability of law, time
consuming and delayed justice
7
Solution Evolved: Coalition
Paper Hypothesis
• Coalition: Defined as a group of traders whose member merchants are
expected to hire only member agents, and these agency relations are
governed by Multilateral Punishment Strategy(MPS).
• Internal informal information transmission mechanism enables merchants
to monitor agents and makes cheating known to all.
Geniza Document Suggest that:
• That a reputation mechanism governed agency relations and in particular
that merchants conditioned future employment on the past conduct,
practiced community punishment and ostracized agents who were
considered cheaters until they compensated the injured
• An agent who has been accused of cheating were to receive agency
services from another Maghribi traders, they could cheat him free from
community retaliation
8
Model Description
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Perfect and complete information economy
M merchants , A agents , living for infinite no. of periods
Agents have time discount factor δ
Each unemployed agent could be hired by only one merchant
A merchant who does not hire any agent receives a payoff of κ >0
If agent is honest, the merchants payoff is γ-w and agents payoff is w
If the agent cheats his payoff is α and the merchants payoff is 0.
Probability of merchant terminating agents services due to exogenous variable is
τ
Unemployed agent receives the reservation utility of ϖ >=0
Assumption γ> κ + ϖ : cooperation is efficient
Assumption γ> α > ϖ : cheating entails a loss, agent prefers cheating over
receiving his reservation utility.
Assumption κ > γ- α : merchant prefers to operate by himself if the agent is to
cheat him or to receive a wage α
the probability that unemployed honest agent(when last employed) will be
rehired
the probability that unemployed cheater agent(when last employed) will be
rehired
9
Proposition 1
• Assume that
,
The optimal wage, the lowest wage for which it is an agent’s
best response to play honest, is
and w is monotonically decreasing in
and
monotonically increasing in
10
Proposition 1 : Proof
11
Multilateral Punishment Strategy - MPS
A merchant offers an agent a wage W*, rehires the
same agent if he has been honest (unless forced
separation has occurred), fires the agent if he has
cheated, never hires an agent who has ever cheated
any merchant, and (randomly) chooses an agent from
among the unemployed agents who never have
cheated if forced separation has occurred.
12
Why MPS Works
• An agent is motivated to be honest by the carrot of a premium
over his reservation utility and the stick of firing.
• The optimal wage decreases as the honest agent is more likely
to receive future wage premiums (higher
) can gain less by
cheating (lower α) , is more likely to remain employed if he is
honest (lower τ), has worse opportunities elsewhere (lower ϖ
), and has a smaller chance of being hired if he is cheater
(lower
) and as agent values his future income more
(higher δ)
• Merchant find it optimal to hire agent if wages are low enough
13
Proposition 2
Assume the δ ϵ (0,1) and
under MPS
merchant strictly prefers to hire a honest agent
So it is not the compulsion of MPS due to which
he can not hire the cheat agent (socially labeled)
rather a individual rationality.
14
Proposition 2: Proof
• We know
• Also, w* is monotonically increasing in
decreasing in
• Under MPS
and monotonically
• Under MPS
• Proposition 1 implies that
15
Bilateral Punishment Strategy - BPS
Identical to MPS but merchants do not condition
hiring decision on agents past behavior (because such
information is not gathered, given that nobody is
expected to use it)
16
Why MPS preferred to BPS
• History and theory lend support to the main
hypothesis that coalition relations are governed by
MPS
• Why MPS is self enforcing
• Why two different coalitions do not merge
• Because MPS is more efficient that BPS
17
Proposition 3
MPS supports cooperation when BPS fails.
Take the limits of W* as δ goes to 1 using the fact that
Under BPS
Under MPS
Plug these in proposition 1
18
Sustainability of Coalition
• MPS enhances its efficiency compared to BPS
• Efficiency gains generated by coalition encourage its
emergence
• MPS not applied in intercoalition due to nature of the network
of information transmission and strategic considerations
• Intracoalition preferred to intercoalition, intracoalition is self
enforcing.
19
Merchants Law
• To bring in coordination and threat of collective punishment
credible, consensus should be reached what is considered as
cheating
• Detailed contracts were not possible since they require high
negotiation costs.
• Instruction list was shared by the merchant with the agent
• Set of cultural rules of behavior were employed for
circumstances not mentioned in instruction list sent by merchant
• Failing to follow instructions or set of cultural rules lead to
agent being considered cheater.
20
Conclusion
• The evidence suggests that the coalition was a response to
problems of contract enforceability, although not optimal
response
• Intergenerational transfers ensured the horizon long enough to
support the operation of a reputation mechanism
• Original social structure lead to economic institution which in
turn preserved initial social structure.
• The factors which ensured the sustainability of coalition
prevented the coalition from expanding in response to welfare
enhancing opportunities
• Economic growth in different economies may be diverse due
to distinct institutional framework of historical origin
21
Thanks!
22