1. Commitments’versus Threats
Credible commitments and credible threats share this common attribute: Both appear mainly in conjunction with irreversible, specialized investments. But whereas credible commitments are undertaken in support of alliances and to promote exchange, credible threats appear in the context of conflict and rivalry.63 The former involve reciprocal acts designed to safeguard a rela- tionship, while the latter are unilateral efforts to preempt an advantage. Efforts to support exchange generally operate in the service of efficiency; preemptive investments, by contrast, are commonly antisocial. Both are plainly important to politics and economics, but the study of credible commitments is arguably the more fundamental of the two.
Interest in credible threats is much more widespread, and the credible threat literature is more fully developed,64 however, than is the interest and economic literature dealing with credible commitments. The disparity is con- sistent with the treatment accorded to each in Thomas Schelling’s classic essay (1956) on bargaining, where the main emphasis is placed on tactics by which one party can realize an advantage in relation to a rival by credibly “tying one’s hands.” But Schelling.also, albeit briefly, addresses the matter of promise. He observes in this connection: “Bargaining may have to concern itself with an ‘incentive’ system as well as the division of gains” (p. 300) and adds in a footnote that the exchange of hostages served incentive purposes in an earlier age (p. 300, n. 17).
That the study of credible commitments has been relatively neglected is explained by the aforementioned assumption, common to both law and eco-nomics, that the legal system enforces promises in a knowledgeable, sophisti- cated, and low-cost way. Albeit instructive, this convenient assumption is commonly contradicted by the facts—on which account additional or alternative modes of governance have arisen. Bilateral efforts to create and offer hostages are an interesting and, as it turns out, economically important illustration. Absent a recognition of and appreciation for the merits of private ordering, the suggestion that hostages are used to support contemporary exchange is apt to be dismissed as fanciful. I submit, however, that not only are the economic equivalents of hostages widely used to effect credible commitments, but failure to recognize the economic purposes served by hostages has been responsible for repeated policy error.
To be sure, pure private ordering is extreme. As Robert Mnookin and Lewis Komhauser put it, private ordering invariably operates in “the shadow of the law” (1979).4 As between contracting fictions, however, the private ordering fiction is at least as instructive as is that of legal centralism. Indeed, for purposes of studying transaction cost issues, it is more so. (A more balanced view, however, will make shadow of the law provisions.)
Lester Telser characterizes a self-enforcing agreement as one which, if “one party violates the terms the only recourse of the other is to terminate the agreement” (1981, p. 27). Contrary to legal centralism, the courts and other third parties are assumed away. Benjamin Klein and Keith Leffler are explicit on this: “|W|e assume throughout . . . that contracts are not enforceable by the government or any third party” (1981, p. 616). Commercial contract law in late- nineteenth-century Taiwan evidently approximated this condition (Brockman, 1980). Stewart Macaulay’s remarks about the informality of contract in buiness are likewise in this spirit: “Often businessmen do not feel they have ‘a contract’—rather they have ‘an order.’ They speak of ‘cancelling the order’ rather than ‘breaching our contract’ ” (1963, p. 61).
Both this chapter and the next adopt that orientation. Also, although hostages can have both ex ante (screening) and ex post (bonding) effects, the ex post contract execution consequences are of principal interest to the self- enforcing agreement literature and are the main focus here. Additionally, like both Telser and Klein and Leffler, the intertemporal contracts of concern here feature both uncertainty and transaction-specific capital. But whereas Telser deals with “a sequence of transactions over time such that the ending date is unknown and uncertain” (1981, p. 30), because any finite sequence of trans- actions using his model will unravel (p. 29), the transactions 1 consider can be (indeed, normally are) finite. The Klein and Leffler analysis also maintains that self-enforcing contracts are of indefinite rather than finite duration. A further difference between the hostage model and Klein and Leffler’s very insightful treatment of quality assurance problems is that theirs applies to final product markets while the main applications of the hostage model are in intermediate product markets (at least those are the main applications herein described). The efficiency sacrifice that Klein and Leffler associate with quality assurance, moreover, is avoided.
Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.