The limits of private governance

I was invited to respond to Ed Stringham’s new book and lead essay on Cato Unbound. Here is a snippet.

The success of private governance depends on whether the previous actions of participants are easily identifiable. If so, cheaters will be avoided and cooperators will be interacted with again. However, there are a class of people for whom their previous actions are not easily identifiable.

Imagine you are an entrepreneur in the third world. You have started a business, but cannot grow it because you are capital constrained. Banks are unwilling to lend you money because the government cannot be trusted to recover capital if you are late during repayment. Because you are a new entrepreneur there is not enough information about your ability and willingness to repay loans for the bank to simply trust you.

If we ignore the government failure of enforcing the banking contract, it is also apparent that a private governance mechanism cannot solve this need. And a recent paper by David McKenzie suggests it is stronger than usually recognized.

McKenzie examines the results of a business competition in Nigeria where a randomized selection of 729 firms were given an average of $50,000. After three years he found, “Surveys tracking applicants over three years show that winning the business plan competition leads to greater firm entry, higher survival of existing businesses, higher profits and sales, and higher employment, including increases of over 20 percentage points in the likelihood of a firm having 10 or more workers. These effects appear to occur largely through the grants enabling firms to purchase more capital and hire more labor.”

The conversation will continue and I will likely add additional commentary here. After the conversation has ended I plan to summarize it here.

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