Legal Institutions and the Structure of Informal Networks
38 Pages Posted: 16 Jun 2003
Date Written: April 2003
The relationship between government-provided contract enforcement and informal trade networks raises important sociological, political, and economic questions. When economic activity is embedded in complex social structures, what are the implications of governmental contract enforcement for the scope and nature of economic relations? What determines whether individuals rely on formal legal institutions or informal networks to sustain trade relationships? Do effective legal institutions erode informal networks? To address these questions, we develop a model in which a trade-off exists between size and sustainability of networks. By adding the possibility of enforceable contracts, we provide a theoretical explanation for the coexistence of legal contract enforcement and an informal economy. We find that legal enforcement has little effect on networks unless the cost of law drops below a certain threshold, at which point small decreases in the cost of law have dramatic effects on network size and the frequency of use of the legal system.
JEL Classification: K12, C72, Z13
Suggested Citation: Suggested Citation