Perspectives from New Institutional Economics
Edited by Claude Ménard
Chapter 16: The state and the diversity of third-party enforcers
213 the costs involved, the joint value of the interaction is negative. Both parties expect to gain from long-term interactions. Such interactions, however, require an investment in reputation and incur costs in policing the relationships. Moreover, direct long-term interactions are not sufﬁcient to accommodate all jointly valued projects. Consider ventures that have a positive present value at their inceptions. Such ventures may be negatively valued to one party or the other at different points in time. The more likely it is that a party believes that the value of the venture will become negative, the less likely it is that the agreements will be self-enforced, and the more likely it is that the parties will beneﬁt from thirdparty enforcement. 4 Some ventures that have a positive present value are certain to become negatively valued during their lives; the most prominent such case is that of loans. As is well known from the literature on sovereign debt, loans are deﬁnitely not self-enforced. Under self-enforcement the borrower is expected to renege immediately after the loan is granted.5 The parties would gain from the assistance of a third party in ensuring that the ventures will be undertaken and continued as long as their joint value remains positive. The third party induces the principals to perform where the value of the project may become negative to one or the other during the life of the agreement. It is well understood that, under such circumstances, a party will perform even when his...
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