Creating Order in Economic and Social Life

“Just as economic discovery requires the competitive process of the market to provide information and feedback to correct errors, competition in the provision of governance is essential to discovery of optimal rules.” — Edward Peter Stringham

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In this book, Edward P. Stringham makes the case for private governance. By “governance”, many different services are implied, from the creation of effective regulations to the adjudication of disputes and the provision of security. Two main models are discussed for this, namely polycentrism and clubs.

Polycentrism is the case when there are different service providers in a same jurisdiction. As an example, the author cites the development of common law, much of which developed from decisions in medieval and early modern England, made by local, manorial, merchant and ecclesiastical courts that were mostly independent from the royal courts.

Another way to approach the private provision of public goods is by considering them as club goods with different optimal sizes. A private club, such as a Homeowners Association or a Proprietary Community, is still a territorial jurisdiction — which in a sense has an executive “monopoly” — but since they are private organizations, their incentives are much different than those of traditional public institutions. Moreover, clubs allow the internalization of externalities, and because they seek to maximize the value of club membership, they engage in market competition to provide a value-maximizing set of rules.

But where can market governance thrive? The author identifies three conditions that can help answer this question: When there is a problem that government regulators, police and courts either do not have the ability to solve in a low-cost way, do not have the knowledge to solve or do not have the incentive to solve, then there will potentially be important unmet needs in society. If there is something that can be done about it (as not all everything has a solution), private parties can attempt to gain something by solving or ameliorating the situation.

Throughout the book the author then shows how many market needs were met through private governance mechanisms, from the creation of the first stock exchanges and share mechanisms to private policing in San Francisco, from eBay and PayPal fraud prevention and detection to Wall Street’s advanced swaps and collateralized debt-obligations. An interesting aspect is that many of the examples cited flourished despite lack of regulation or even existing regulation outlawing their existence.

The author concludes the book by demonstrating how governance is also a market, in which a spontaneous order arises from bottom-up processes of knowledge exchange, instead of top-down rulings. In this setting, the role of providers of law is the discovery of the regulations that most benefit society at large. However, as is similar for other markets, traditional centralized decision-making has problems of knowledge and accountability when it comes to providing these services. For this, private governance could serve as an effective solution.

The book is split into 3 parts with 14 chapters in total, in which Edward explains the motivations for private governance, explores various historical and modern examples of such developments and lastly lays out the lessons we can learn from them.

Creators of zones and societies will profit from reading chapters 1 to 3, as there the potential markets are laid out and the relation between private governance and the economic theory of clubs is explained.

Policymakers and analysts are advised to read chapters 12 to 14 for their explanation of hot public debate topics involving the subject, how government can end up crowding out valuable governance markets and how to avoid that.

Scholars and experts can delve into chapters 4 to 11, in which several examples of endogenous market governance development are analyzed, and their successes and failures discussed.

The book can be found here.

Written by: Francisco Litvay