The Economics of Commitment

I’ve written here before about credible commitments, which I’ve come to see as severely under-studied by social scientists.

In an attempt to fill that lacuna, I’m in the very early stages of sketching a book on the topic. What follows is excerpted from my sabbatical proposal.

Suggestions welcome!

“…throughout history [commitment] is overwhelmingly the most pressing issue.”

~ Douglass North, 1993

Project Title

The Economics of Commitment

Project Overview

I have been thinking about commitment problems in economic life since my junior year as a student at Grove City College. My interest was initially sparked by considering the problems of quality assurance in medicine during a course on health economics. Since then, credible commitments have featured in some of my published research (Fuller and DelliSanti 2017; Fuller 2019). Additionally, a few semesters ago, I gave a talk through the Institute for Faith and Freedom’s “Freedom Readers” series on the role credible commitments play in facilitating cooperation in various contexts. 

 “Commitment”—and derivative problems, like “quality assurance”—are at once fundamental to our understanding of human behavior and under-studied by economists. I say “under-studied,” not “ignored,” as seminal papers like Williamson’s (1983) “Credible Commitments: Using Hostages to Support Exchange” have garnered thousands of citations.

Yet, relative to the attention it deserves, “commitment” has received disproportionately little scrutiny from the so-called “New Institutional” economists. “Commitment,” defined simply as “keeping a promise,” is fundamental to all human endeavors. Sometimes promises—commitments—are explicit, but just as often, and more intractably, they are implicit.

Why is commitment so fundamental to our understanding of the social world? Aside from isolated, purely autarkic actors (see Schelling 1996 for how commitment problems apply even to these), all other action involves interaction with others. Humans form associations with others because cooperation is highly beneficial (Mises 1949). Foremost among such benefits are the gains to productivity stemming from the division of labor, which Mises calls “the fundamental social phenomenon” (1949). If trust is lacking between exchange partners, then those parties curtail investment in favor of increased consumption. The parties will seize fewer gains from trade. Likewise, when transactors anticipate a third party may expropriate their surplus, they cut back on investment (North 1993; Higgs 1997). With less capital accumulation, the ability to generate additional rounds of saving and investment is also mitigated. With less capital widening and deepening, the division of labor shrinks. Society is poorer. Hence, commitment matters.

In what follows, I describe commitment problems in market contexts, other associative relationships, and finally in political economy settings.  

Spot Markets. In market contexts, commitment problems primarily show up in two ways. First, they can arise in simple “spot exchanges” due to asymmetric information between exchange partners. Information asymmetries can give rise to ex post psychic losses, as well as to contractions of exchange activity (Akerlof 1970). This occurs most often when the goods being traded are what Nelson calls “experience” or “credence” goods—goods whose attributes cannot be completely inspected prior to purchase (Nelson 1970; Barzel 1982; Png and Reitman 1995; Ekelund and Thornton 2019). In the absence of other constraints, it may be possible for sellers of these goods to systematically lower their quality to earn larger profits. Yet, even most “experience” and “credence” goods consistently meet the expectations of buyers. Markets for these goods often flourish. This quality assurance is achieved through a host of commitment mechanisms. However, these have not been catalogued.

Contractual Transactions. The second way commitment problems arise in markets is even more intractable. Most market activity is not a spot exchange, but instead involves the much more complex “contractual transaction” (Alchian and Woodward 1988). Contractual transactions involve the passage of time. Particularly for Austrian and New Institutional economists, the issue of “time” in economic life has received significant attention relative to mainstream counterparts, but these valuable analyses have tended to focus on issues such as time preference, the time structure of production, economic growth, or path dependence. Yet, as Alchian and Woodward put it: “In contract a promise of future performance is exchanged, and investments are made, the value of which becomes dependent on the fulfillment of the other party’s promises,” (1988, p. 66).

Thus, the passage of time introduces new exchange hazards that spot exchanges do not confront. These include additional chances for opportunism by both parties since the relationship is ongoing. One overlooked aspect of contractual relationships is that, in certain instances, gradual reductions in information asymmetry may even give rise to new openings for opportunistic behavior, as parties begin learning more about their exchange partners (cf. Langlois 1983). Even in the absence of opportunistic intent, however, the passage of time gives rise to shifting circumstances that may cause one party to change their behavior such that it is at odds with the other party’s goals (Klein 1996). However, once again, many long-term contracts exist, and yield large gains from trade for both parties. This is made possible through a host of credible commitment mechanisms (Williamson 1985).

Associative Relationships. Moving beyond “pure market” contexts, a third setting sees commitment issues arise whenever two parties interact in a way that gives rise to either dependency or mutual interdependency. The most obvious of these latter contexts is marriage. Indeed, there is a large and growing literature on the economics of family, and some of this literature does deal explicitly with commitment issues (Cohen 1987; Brinig 1990; Brinig and Crafton 1994). As Cohen (1987) argues, in the face of potential opportunism, marriage partners adjust their behavior in ways that amount to less “investment” in the family. These adjustments may include, for instance, having fewer children or developing more “outside” options at the expense of cultivating domestic skills or learning about one’s marriage partner.

Political Economy. A final and fourth context where commitment issues are prominent concerns the behavior of states (Coyne and Boettke 2009; Piano and Candela 2018). The question of how states credibly refrain from predation is one of the oldest questions humans have asked—far pre-dating the formal development of economics itself. Of course, the inquiry has not always been formulated in economic terms, but the substance of the question is consistent with how contemporary political economists engage this puzzle. The question of how to bind the state’s “grabbing hand” can be seen in some of the earliest written works, such as The Epic of Gilgamesh. The theme is taken up again by Madison in his famous “paradox of power,” described in Federalist 51. In economics, there is an ongoing debate regarding the extent to which “parchments” can effectively bind (Wagner 1993). Indeed, for the question of economic growth, there is likely no more important question than what facilitates effective constraints on states’ tendency toward predation.

Book Outline

My book would attempt a comprehensive examination of commitment in interactive contexts. It will begin by setting these problems in historical context. Historically, the way that economists would have thought about the forgoing commitment problems was to posit an exogenously-given institutional framework (a deus ex machina) that prevents expropriation and opportunism. Most importantly, this would have included a court system that perfectly interpreted and enforced contract terms that the interacting parties had perfectly enumerated (so-called Arrow-Debreu contingent-contracting).

However, the emergence of the New Institutional Economics in the latter 20th century seriously questioned the viability of these assumptions. For starters, all real-world contracts are necessarily incomplete (Grossman and Hart 1986). In some instances, the instances most relevant to commitment problems, the contractual terms are incapable of being specified in a way the courts can verify (Klein and Leffler 1981). Additionally, the older “complete contracting” view glossed over a host of potential problems with the courts themselves, including that they are costly to use (Williamson 1985), make errors, may override voluntarily chosen terms, and are prone to corruption (Benson 1989).

Because contracts are necessarily incomplete and because courts are always imperfect, interacting parties must devise other means of securing commitments. My book will document and describe the endogenous emergence of commitment mechanisms in voluntary contexts. Such commitment mechanisms assume a variety of shapes, including hostages, bonds, third-party contracting, investments, reputations, club membership, and unique organizational forms (see, for example, Williamson 1983; Schelling 1996; Hansmann 1996).  

After historical prologue, my goal will be to offer a comprehensive cataloguing of these commitment techniques. This is purely descriptive and taxonomic. Next, I hope to understand the conditions under which certain mechanisms are selected. For instance, do commitment techniques exhibit significant variation between the four commitment situations I described? Lastly, I wish to perform a comparative exercise that demonstrates the relative superiority of commitment in voluntary contexts compared to the persistent commitment problems that plague governments. What are the respective challenges confronted by attempts to stem opportunism in private vs. public contexts? Even in public contexts, though, I seek to understand why some governments have been better “committers” than others. This investigation will contribute to ongoing discussions in political economy of predation and the efficacy of constitutional constraints.

Overall, my book project seeks to contribute to a large and growing literature devoted to the economics of “self-governance” (Leeson 2014; Skarbek 2014; Stringham 2015; Richman 2017; Shortland 2019). When perfect creation and enforcement of contracts is absent, how do parties devise means of promise-keeping?

References

Akerlof, George A. “The Market for ‘Lemons:’ Quality Uncertainty and the Market Mechanism.” Quarterly Journal of Economics 84, no. 3 (1970): 488-500.

Alchian, Armen A., and Susan Woodward. “The Firm Is Dead; Long Live the Firm a Review of Oliver E. Williamson’s the Economic Institutions of Capitalism.” Journal of Economic Literature 26, no. 1 (1988): 65-79.

Barzel, Yoram. “Measurement Cost and the Organization of Markets.” The Journal of Law and Economics 25, no. 1 (1982): 27-48.

Benson, Bruce L. “The Spontaneous Evolution of Commercial Law.” Southern Economic Journal (1989): 644-661.

Brinig, Margaret F. “Rings and Promises.” Journal of Law, Economics, and Organization. 6 (1990): 203.

Brinig, Margaret F., and Steven M. Crafton. “Marriage and Opportunism.” The Journal of Legal Studies 23, no. 2 (1994): 869-894.

Cohen, Lloyd. “Marriage, Divorce, and Quasi Rents; Or, “I Gave Him the Best Years of My Life”.” The Journal of Legal Studies 16, no. 2 (1987): 267-303.

Coyne, Christopher J., and Peter J. Boettke. “The Problem of Credible Commitment in Reconstruction.” Journal of Institutional Economics 5, no. 1 (2009): 1-23.

Ekelund, Robert B., and Mark Thornton. “Extreme Credence and Imaginary Goods.” Atlantic Economic Journal 47, no. 3 (2019): 361-371.

Fuller, Caleb S. “Is the Market for Digital Privacy a Failure?” Public Choice 180, no. 3 (2019): 353-381.

Fuller, Caleb, and Dylan DelliSanti. “Spillovers from Public Entrepreneurship: A Case Study.” Journal of Entrepreneurship and Public Policy (2017).

Grossman, Sanford J., and Oliver D. Hart. “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration.” Journal of Political Economy 94, no. 4 (1986): 691-719.

Hansmann, Henry. The Ownership of Enterprise. Harvard University Press, 1996.

Higgs, Robert. “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War.” The Independent Review 1, no. 4 (1997): 561-590.

Klein, Benjamin. “Why Hold‐Ups Occur: The Self‐Enforcing Range of Contractual Relationships.” Economic Inquiry 34, no. 3 (1996): 444-463.

Klein, Benjamin, and Keith B. Leffler. “The Role of Market Forces in Assuring Contractual Performance.” Journal of Political Economy 89, no. 4 (1981): 615-641.

Langlois, Richard N. Internal Organization in a Dynamic Context: Some Theoretical Considerations. CV Starr Center for Applied Economics, New York University, Faculty of Arts and Science, Department of Economics, 1983.

Leeson, Peter T. Anarchy Unbound: Why Self-Governance Works Better Than You Think. Cambridge University Press, 2014.

Mises, Ludwig. Human Action. Yale University Press, 1949.

Madison, James. “The Federalist Papers: No. 51.” February 8 (1788): 1788.

Nelson, Phillip. “Information and Consumer Behavior.” Journal of Political Economy 78, no. 2 (1970): 311-329.

North, Douglass C. “Institutions and Credible Commitment.” Journal of Institutional and Theoretical Economics 149, no. 1 (1993): 11-23.

Candela, Rosolino, and Ennio Emanuele Piano. “Transition Economies: Rule of Law and Credible Commitment.” Encyclopedia on Law and Economics. New York: Springer (2018).

Png, Ivan PL, and David Reitman. “Why Are Some Products Branded and Others Not?” The Journal of Law and Economics 38, no. 1 (1995): 207-224.

Richman, Barak D. Stateless Commerce. Harvard University Press, 2017.

Schelling, Thomas C. “Coping Rationally with Lapses from Rationality.” Eastern Economic Journal 22, no. 3 (1996): 251-269.

Shortland, Anja. Kidnap: Inside the Ransom Business. Oxford University Press, 2019.

Skarbek, David. The Social Order of the Underworld: How Prison Gangs Govern the American Penal System. Oxford University Press, 2014.

Stringham, Edward. Private Governance: Creating Order in Economic and Social Life. Oxford University Press, USA, 2015.

Wagner, Richard E. Parchment, Guns, and Constitutional Order. Edward Elgar, 1993.

Williamson, Oliver E. “Credible Commitments: Using Hostages to Support Exchange.” The American Economic Review 73, no. 4 (1983): 519-540.

Williamson, Oliver E. The Economic Institutions of Capitalism. Free Press, 1985.

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