In Lawlessness and Economics Avanish Dixit draws on game theory to explain how the mutuality of contracts helps ensure respect for property rights in the absence of functioning legal systems. And in Reinventing the Bazaar John McMillan, examines how well-designed markets can be self-regulating and even social regulators when state frameworks fail.

Reviewed by Thomas Timberg

Avinash K. Dixit, Lawlessness and Economics: Alternative Means of Governance, Princeton, NJ: Princeton University Press, 2004.

Originally delivered as the Gorman Lectures at University College London, Lawlessness and Economics is a check on the law and economics field of study that attempts to understand how legal systems interact with economic systems to govern the production of wealth and the enforcement of justice. The late Mancur Olson, an insistent proponent of this field, used it to explain why some countries are wealthy and others poor.

Judge Richard Posner and other legal scholars in the United States argue that economic legislation should make economic sense and opine on how this might be done. Some commentators, such as John McMillan of Stanford, argue that economies function in the absence of effective legal systems.

Here, Avinash Dixit sets out to explain how they do so.

Drawing on game theory, Dixit explains how the inherent mutuality of contracts and economic rights and the reasonable concern of traders with reputation can force persons to abide by contracts and respect property rights and why traders might accept outside mediation and arbitration, even in the absence of court enforcement. He even deals with traders who accept private governments, such as Mafias, both for their informational services (e.g., telling whether someone is reliable) and their enforcement abilities.

Dixit interweaves his explanations with material drawn from empirical studies of markets as diverse as that of medieval traders, the contemporary diamond market, and the economy of Mafia-controlled Sicily. He readily admits that a functioning legal system might be better even though it sometimes complicates his game theory calculations but demonstrates how we can do without it.

Though interesting and useful, Dixit’s effort is incomplete. Clearly, the self-interested playing of games is important to the observance of contracts and respect for property rights; but social beliefs and norms, whether embodied in functioning legal systems or not, are much more important. The golden rule do unto others what you would have them do unto you is a game theory proposition; but Kant’s formulation so act that your rule of action should be a rule for all of mankind is not.

Economists have always recognized that mutuality and altruism, though often confused, are distinct.

Consider the extreme example of the honor we accord the dead even though they cannot repay us in this life. We may hope that others will be inspired to similarly honor us, but we are not motivated, precisely, by mutuality.

John McMillan, Reinventing the Bazaar: A Natural History of Markets, NY: W. Norton and Co., 2002.

In this collection of essays, John McMillan examines what markets are and what limitations they face. Though generally positive about the virtues of markets, he raises concerns about competition and intellectual and physical property rights, worrying whether we have gone too far in relying on markets to solve human problems. McMillan also considers the extent to which markets create their own frameworks, however inferior, when the state fails.

Like Avanish Dixit, he examines how self-interest supports economic commitments in the absence of a functioning legal system.

McMillan approaches the value of markets by way of examining the proper design of markets and contracts for everything from E-bay and the California electric power market, to the auction of broadcasting band length. He also addresses the question of transitions China (good), Russia (bad), and his native New Zealand (good). But what exactly he thinks on this matter, other than that the details of transitions should be tailored to individual cases, is not clear.

In fact, sometimes McMillan is too much of a two-handed economist, to use Harry Truman’s terms.

His arguments are so balanced that one is hard pressed to extract conclusions. Private ownership is good; but collective Town and Village ownership enterprises in China were almost as good.

Privatization is good; but not if carried out as in Russia or even Czechoslovakia versus Poland. Corruption is bad; but growth occurs despite it.

Nonetheless, McMillan addresses current issues with an open mindedness and common sense refreshing among contemporary economists, an attitude honed during his years editing the leading journals of the American Economic Association (AEA).

He also refers to an immense mass of literature that others have produced on the issues he discusses. I found myself adding numerous footnotes to my reading list.