An essential aspect of economic life is the ability to enforce contracts and resolve intractable disputes. How can a stateless society provide these functions in the absence of a government?
The first thing to understand about contracts is that they are a form of insurance, insofar as they attempt to minimize the risks of noncompliance. If I enter into a five-year mortgage agreement with a bank, I will attempt to minimize my risks by requiring that the bank give me a fixed interest rate for the time period of the contract. My bank, on the other hand, will minimize its risk by retaining ownership of my house as collateral, in case I do not pay the mortgage.
In a world without risk, contracts would be unnecessary, and everyone would do business on a handshake. However, there are people who are dishonest, scatterbrained, manipulative and false, and so we need contracts which basically spell out the penalties for noncompliance to particular requirements.
In modern statist societies, contracts are generally enforced not through the court system, but rather through the threat of the court system. I was in business for many years, at an executive level, and I never once heard of a contract being successfully enforced through the state court system, although I did on occasion hear litigious threats – which is quite different. The threat was not so much, “I am going to use the court to enforce this contract,” but rather, “I am going to use the threat of taking you to court in order to enforce this contract.” The prospect of expensive and time-consuming legal action was always enough to force a resolution of some kind. No actual court compulsion was ever required.
It is quite easy to see that when a process that is designed to mediate disputes becomes itself a threat which causes disputes to be mediated privately, it has largely failed in its intent. State court systems have become like the quasi-private car insurance companies – the threats and inconvenience of using them has caused most people to settle their disputes privately, rather than involve themselves in something that they are forced to pay for, but can almost never use.
This bodes very well for anarchic solutions to contract disputes.
In a stateless society, entrepreneurs will be very willing and eager to provide creative solutions to the problems of contractual noncompliance. As a nonviolent solution, the profits will be maximized if noncompliance can be prevented, rather than merely addressed after the fact.
To take a simple example, let us pretend that you are a loans officer at a bank, and I come in requesting $10,000. Naturally, you will be very happy to lend me the money if I will pay back both the principal and interest on time, since that is how you make your profit. However, such a guarantee is completely impossible, since even if I have the money and the intent to pay you back, I could get hit by a bus while on my way to do so, leaving you perhaps $10,000 in the hole.
What questions will you need to answer in order to assess the risk? You will want to know two things in particular:
1. Have I consistently paid back loans in the past?
2. Do I have any collateral for the loan?
These two pieces of information are somewhat related. If I have consistently paid back loans in the past, then your need for collateral will be diminished. The more collateral that I am able to provide for the loan, the less it is necessary for me to have a good credit history.
The reason that a good credit history is so necessary is not just to establish my credit worthiness, but also to help the bank assess how much I have currently invested into my good reputation. If I have taken out loans for hundreds of thousands of dollars in the past, and repaid them on time, then it scarcely seems likely that I would have gone through all of that just to steal $10,000.
If we say that my good credit rating saves me two percentage points on my interest payments, and that I will need a further $500,000 of loans over the course of my life, then my good credit rating will be saving me at a bare minimum tens of thousands of dollars. Thus, I would end up losing money if I took out a $10,000 loan and did not pay it back, since the cash benefit would not cover the losses I would incur through the destruction of my credit rating. Physical “collateral” is thus less required, since I have the very real “collateral” of a good credit rating.
These kinds of economic calculations occur regularly in a statist society, and would not vanish like the morning mist in a stateless society.
However, there are certain kinds of loans that some financial institutions would be willing to make, despite the high level of risk involved. Young people just starting out – who have no family to provide collateral – would be in a higher risk category, as would those who had failed to make loan payments in the past. As we can see from late-night television commercials for cars, no credit history – or even a bad credit history – does not make one permanently ineligible for loans.
There are two main ways to manage risk in any complex situation – hedging, and insurance. The “hedging” approach is to bet both for and against a particular outcome. In the world of currency trading, this means betting a certain amount that the dollar will go up, and another amount that the dollar will go down. In the world of horse racing, it means betting on more than one horse. This is also why people diversify their stock portfolios.
The “insurance” approach tends to be used where hedging is impossible. When I was an executive in the software world, my employees would often take out insurance in case I got sick or died. It was relatively impossible to “hedge” this risk, because keeping “backup employees” in a basement is not particularly cost-efficient, let alone moral. Life insurance is another example of this.
These strategies are already well-established in the current quasi-free market. However, in one-to-one contracts, state courts retain their monopoly. If I am an employee, I have a one-to-one contract with my employer; I cannot “hedge” the risks involved in this contract, and currently neither can I buy insurance to mitigate the risk that my employer will go out of business, while still owing me pay and expenses.
In the absence of a government, the need for the rational mitigation of risk in contracts would still be there, and entrepreneurs will inevitably provide creative and intelligent solutions to address this.
Let us take a relatively small example of how contract disputes can be resolved in a stateless society.
Let us say that I pay you $15,000 to landscape my garden, but you never show up to do the work.
Ideally, I would like my $15,000 back, as well as another few thousand dollars for my inconvenience. In a stateless society, when we first put pen to paper on a contract, we can choose an impartial third party to mediate any dispute. If a conflict should arise that we cannot solve ourselves, we contractually agree in advance to abide by the decision of this Dispute Resolution Organization (DRO).
Since I am not an expert in pursuing people and getting money from them, if I had any doubts about your motives, capacity and honesty, I would simply pay this DRO a fee to recompense me if the deal goes awry. If you run off without doing the work, I simply submit my claim to the DRO, who then pays me $20,000.
When I first apply for this insurance, the DRO will charge me a certain amount of money, based on their evaluation of the risk I am taking by doing business with you. If you have cheated your last ten customers, the DRO will simply not insure the contract, thus implicitly informing me of the risk that I am taking. If you have a spotty record, then the DRO may charge me a few thousand dollars to insure your work – again, giving me a pretty good sense of how reliable you are.
On the other hand, if you have been in business for 30 years, and have never once cheated a customer, or received a complaint, then the DRO is simply insuring against delays caused by sudden madness or unexpected death. It may only charge me $50 for this eventuality.
This form of contract insurance is a very powerful positive incentive for honest dealings in business. The cost of insuring a contract is directly added to the cost of doing business, and so if it can be kept as low as humanly possible, the financial benefits to both parties are clear.
The cost of insuring a contract can be kept even lower if you are willing to provide collateral upfront. What this means is that if you cheat me out of the $15,000, and the DRO has to pay me $20,000, you promise to pay the DRO $25,000. If you cheat me, the DRO can then take this money directly out of your bank account.
In this way, contracts can be enforced without resorting to violence, or lengthy and incredibly expensive court battles. The risks of entering into contracts are clearly communicated up front, and honest people will be directly rewarded through lower enforcement costs, just as non-smokers are directly rewarded through lower life insurance costs.
Suppose I have contracted with a DRO to pay restitution if I cannot fulfill my business obligations in some way, and end up owing them $100,000. What happens if I cannot pay, or simply refuse to pay?
Currently, the State will use violence against me if I do not pay. While this may be a satisfying form of medieval vengeance gratification, it scarcely helps me cough up $100,000 that the DRO actually wants from me. In a stateless society, what options are available for the DRO to get its money?
In any modern economy, individuals are bound by dozens of obligations and contracts, from apartment leases to gym memberships to credit cards contracts to insurance agreements. The costs of doing business with people who are known to honor their contracts is far lower, which is why it seems highly likely that a stateless society produce both DROs, and Contract Rating Agencies (CRAs).
CRAs would be independent entities that would objectively evaluate an individual’s contract compliance. If I become known as a man who regularly breaks his contracts, it will become more and more difficult for me to efficiently operate in a complex economy. This form of economic ostracism is an immensely powerful – and nonviolent – tool for promoting compliance to social norms and moral rules.
If an individual egregiously violates social norms – and we shall get to the issue of violent crime below – then one incredibly effective option that society has is to simply cease doing any form of business with such an individual.
If I cheat my DRO – or another individual – out of an enormous sum of money, the CRA could simply revoke my contract rating completely.
DROs would very likely have provisions which would simply state that they would not enforce any contract with anyone whose contract rating was revoked. In other words, if I run a hotel, and an “outcast” wants to rent a room, I will be immediately aware of this, since I will enter his credit card, and be promptly informed that no contract will be honored with this individual. In other words, if he sets fire to my hotel, steals or destroys property, or harasses another guest, then my DRO will not help me at all. Will I be likely to want to rent a room to this fellow, or will I tell him that, sadly, the hotel is full?
In the same way, grocery stores, taxicabs, bus companies, electricity providers, banks, restaurants and other such organizations will be very unlikely to want to do business with such an outcast, since they will have no protection if he misbehaves.
Economic interactions, of course, are purely voluntary, and no man can be morally forced to do business with another man. People who cheat and steal and lie will be highly visible in a stateless society, and will find that other people will turn away from them more often than not, unless they change their ways, and provide restitution for their prior wrongs.
An outcast can get his contract rating restored if he is willing to repay those he has wronged. If he gets a job and allows his wages to be garnished until his debts are paid off, his contract rating can be restored, at least to the minimum level required for him to hold a job and rent an apartment. A DRO, which is always interested in preventing recurrence, rather than dealing with consequences, may also reduce his burden if he is willing to attend psychological and credit counseling education.
In this way, contracts can be enforced without resorting to violence – the tool of economic and social ostracism is the most powerful method for dealing with those who repeatedly violate moral and social rules. We do not need to throw people into economically unproductive “debtor’s prisons” or send men with guns to kidnap and incarcerate them – all we need to do is publish their crimes for all to see, and let the natural justice of society take care of the rest.
Ah, but what if an “outcast” has been treated unjustly, and is being blackmailed by a DRO or CRA?
Well, remember that anarchism is always a two-sided negotiation. In order to get people to sign up to your DRO or CRA, what checks and balances would you put in your contracts to calm their fears in this regard?