Greif, Milgrom, and Weingast: Coordination, commitment, and enforcement

Greif, Milgrom, and Weingast. 1994. Coordination, commitment, and enforcement: The case of the merchant guild. Journal of Political Economy 102 (4): 745-776.

Abstract

"We interpret historical evidence in light of a repeated-game model to conclude that merchant guilds emerged during the late medieval period to allow rulers of trade centers to commit to the security of alien merchants. The merchant guild developed the theoretically required attributes, secured merchants' property rights, and evolved in response to crises to extend the range of its effectiveness, contributing to the expansion of trade during the late medieval period. We elaborate on the relations between our theory and the monopoly theory of merchant guilds and contrast it with repeated-game theories that provide no role for formal organization."

Variables

• Y: formation of guilds
• X: credibility commitment problems

The Argument

The Problem

States want foreign merchants to come and import their goods. But there is a credible commitment problem rooted in a time inconsistency problem: if a ruler entices foreign merchants to come trade with his people, what is to prevent him from reneging on all promises and simply taking all the merchants' goods? In the time before nation-states, merchants certainly couldn't just run to their consulate and expect help. Thus, this credible commitment problem could prevent (profitable) trade. What to do?

The Solution

The authors point out that a reputation system could have developed (as in Greif's discussion of Maghribi and Genoese traders), but instead, an institutional system developed. If a ruler wronged a member of a guild, the guild would ensure that all its members enforced a punishment on the ruler. Because the ruler could credibly be hurt, he could credibly commit not to wrong the merchants. Rulers value this credibility; therefore, the model predicts that the rulers would actually encourage the formation of these guilds, with "specific rights and an effective organization."

Competing argument: Some say that merchant guilds arose as an effort to seek rents (as craft guilds did)--guilds are just cartels. If this were true, formation of guilds would lead to a decrease in trade. Instead, formation of guilds was followed by an increase in trade, supporting the theory here.

What became of guilds? As modern states developed, leaders gained the political, military, and economic power over a large enough area to guarantee merchants' security without guilds. Where guilds lingered on, they did often become rent-seekers.

Place in the Literature

Yet another example of a king empowering a weaker actor in order to make his commitments credible--and therefore benefitting both sides. (Other examples: the Glorious Revolution, French kings agreeing to let parliamant veto taxes, etc.)