Working Paper: CEPR ID: DP3272
Authors: Martin Brown; Armin Falk; Ernst Fehr
Abstract: We provide experimental evidence that contractual incompleteness, ie, the absence of third party enforcement of workers? effort or the quality of the good traded causes a fundamental change in the nature of market interactions. If contracts are complete the vast majority of trades are initiated by public offers. Most trades take place in one-shot transactions and the contracting parties are indifferent with regard to the identity of their trading partner. Moreover, the short side of the market attempts to appropriate the whole gains from trade, which causes much disagreement about contract terms. If contracts are incomplete the vast majority of trades are initiated by private offers. The contracting parties form long-term relations and the provision of low effort or bad quality is penalized by the termination of the relationship. The threat of terminating the relation turns out to be an extremely powerful discipline device. Markets with incomplete contracts resemble a collection of bilateral trading islands rather than a competitive market. The short side of the market shares the gains from trade with the long side of the market so that there is little disagreement about contract terms. Our results support theories of the labour market that are based on the idea that unemployment is a worker discipline device.
Keywords: contract enforcement; fairness; preferences; incomplete contract; involuntary unemployment; market interaction; repeated transaction
JEL Codes: C70; C90; D20; D40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| contractual completeness (D86) | trading behaviors (G41) |
| contractual completeness (D86) | market interactions (L14) |
| incomplete contracts (D86) | private offers (D44) |
| private offers (D44) | long-term relationships (L14) |
| long-term relationships (L14) | reduction in disagreements over contract terms (J52) |
| incomplete contracts (D86) | disciplinary mechanism (Y80) |
| disciplinary mechanism (Y80) | effort levels from workers (J29) |
| long-term relationships (L14) | effort levels from workers (J29) |
| absence of third-party enforcement (P14) | market dynamics (D49) |