Every day brings news of intrusions by government into the rapidly contracting area reserved to private enterprise. To fans of the Zeitgeist, surfers on the wave of the future, the future of capitalism looks as bright as the future of the dodo. They are wrong. The counterattack is moving forward. Wherever there is a government monopoly there is inefficiency, bad service, and an opportunity for profits. Capitalism is striking back.
The most publicized such monopoly is the Post Office. There the advancing forces of capitalism have forced the government monopoly, in spite of its massive federal subsidy, to take legal action to limit private competitors.
There exists a government monopoly bigger and more inefficient than the Post Office. It is a service industry run so inefficiently that customers frequently wait in line for years before receiving any attention and spend years more waiting for the government to finish a job that should require a week or two. It is not surprising that eighty to ninety percent of the customers give up, go home, and do the work themselves.
I refer, of course, to the service of arbitrating and enforcing private contracts. This service is now performed primarily by the civil courts. It could be performed better by private institutions. Sometimes it is.
Those who compete with the courts in this business are called arbitrators; the largest organization in the business is, I believe, the American Arbitration Association. Corporations, especially those operating internationally and therefore subject to the complications of international law, sign contracts in which they agree that any dispute over the meaning of the contract will be arbitrated by the AAA. Normally such contracts cover matters where it is more important that a decision be immediate than what the decision is. If such a matter goes to court, both parties will forget what the disagreement was about long before the case is settled. Arbitration provides a faster and cheaper way of resolving such disputes.
Arbitration arrangements without some enforcement mechanism are a satisfactory substitute for the courts when the problem is merely an honest disagreement and the matter being settled is less important than continued good relations between the two parties. In other cases, arbitration may be unsatisfactory if the arbitrator, unlike the court, has no way of enforcing his decisions. If one party refuses to accept a decision, the other’s only recourse is to go to court in the hope that the settlement, when it finally comes through, will be of some use to his grandchildren.
A large part of the potential business for arbitration involves contracts for which some enforcement mechanism is needed. An entrepreneur able to provide such enforceable arbitration should be able to make a great deal of money. Billions are spent now on buying the same service from the court system; a good private institution should be able to turn a substantial fraction of those billions into profits.
I can think of two ways in which such enforceable arbitration could be provided without involving the government court system. Both require that arbitration agencies, like present arbitrators, not only have a reputation for being no more corrupt than the courts but go far beyond this, to the point of being known to be positively honest. There is evidence that corporations with such a reputation will develop if there is a market for them. Some years ago, for instance, American Express assumed someone else’s debt, amounting to a substantial fraction of its profits for that year, although it had no legal responsibility to do so. American Express did so because it was arguable that American Express was morally responsible and since the firm is in the business of producing money (which it does better than the government, incidentally), its reputation for scrupulous honesty was worth more to the company than the cost of assuming the debt.
The first method of enforcement would be for the two contracting parties to turn over to the arbitration firm a sum equal to the maximum penalty provided for under the contract. The arbitration firm would have complete discretion to do what it wished with the money. In case of a breach of contract, it would allocate an appropriate amount of one firm’s money to the other. When the contract expired, it would return the money, plus interest, to the contracting parties after deducting a prearranged fee. There would be no court-enforced contract between the contracting firms and the arbitrator; there would thus be no legal bar to prevent the arbitration firm from keeping both deposits for itself—once.
The second form of enforcement is already in use, although not by arbitration firms. In its present form it is called a credit rating. Any firm which agreed to have a contract arbitrated and then refused to go along with the arbitration would be blacklisted by the arbitration agency—forbidden to use its services again. Before two firms signed an arbitration agreement, each would first check with all the reputable arbitration agencies to make sure the other firm was not on such a blacklist, since there would be little point in signing an arbitration agreement with a firm that had reneged on such agreements in the past. Thus a blacklisted firm would be forced to make its contract enforceable in the courts instead of by arbitration. With the courts as bad as they now are, the unavailability of the arbitration mechanism would be a serious cost. Thus the threat of blacklisting would be an effective sanction to enforce compliance with arbitrated contracts.
Under such a system there would develop two sorts of firms, those that had virtually all their contracts arbitrated and had a reputation of always abiding by the arbitration and those that used court-enforced contracts instead. The first group would have an obvious competitive advantage. Honesty does pay.
Such free enterprise mechanisms need not be limited to civil cases involving explicit contracts. Many personal injury cases could be covered by arbitration agreements among insurance companies, as could other kinds of civil cases. To some extent this already happens; present insurance companies not only provide the service of pooling their customers’ risks but also provide, by negotiations among themselves aimed at settling out of court and thus avoiding legal costs, a partial substitute for the courts. This job could perhaps be done better by firms whose sole business was such arbitration.
A potential arbitrator has a multibillion dollar market now almost completely in the hands of a government monopoly selling low quality services at an exorbitant price. All you need to go into business is honesty, ingenuity, hard work, and luck.
[Chapter 66 describes how a version of this approach could be implemented online using tools provided by public key encryption.]