Working Paper: NBER ID: w20309
Authors: Emily Breza; Arun G. Chandrasekhar; Horacio Larreguy
Abstract: In settings with poor formal contract enforcement, profitable investments are likely unrealized. While social closeness can mitigate contractual incompleteness, we examine how to improve the preponderance of cases where contracting parties cannot rely upon social ties. We ask if a community can enlist members to monitor transactions or punish offending parties. \n \nWe conduct a laboratory experiment in 40 Indian villages, with 960 non-anonymized subjects, where we have social network data. Participants play modified sender-receiver investment games, with and without third-party monitors and punishers. We examine whether network centrality of the third party increases efficiency of interaction. Furthermore, we decompose the efficiency increase into a monitoring channel (central third parties are valuable since they may influence reputations) and an enforcement channel (central third parties may be more able to punish without fear of retaliation). \n \nAssigning a third party at the 75th percentile of the centrality distribution (as compared to the 25th) increases efficiency by 21% relative to the mean: we attribute 2/5 of the effect to monitoring and 3/5 to enforcement. The largest efficiency increase occurs when senders and receivers are socially distant, unable to maintain efficient levels autonomously. Results cannot be explained by demographics such as elite status, caste, wealth or gender. \n \nOur findings show not every member is equally well-equipped to be part of a local institution. Knowing that a central third party observes their interaction increases sender-receiver efficiency. More importantly, to be able to punish someone, the third party must be important in the community.
Keywords: social structure; institutional design; network centrality; third-party enforcement; contract enforcement
JEL Codes: D02; L14; O17; Z13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| third-party centrality (D79) | transaction efficiency (G14) |
| monitoring channel (E50) | transaction efficiency (G14) |
| enforcement channel (K40) | transaction efficiency (G14) |
| social distance (Z13) | efficiency gains (D61) |
| demographic factors (J11) | transaction efficiency (G14) |