The Uselessness of Contracts



It’s curious to me that some of the most hardcore anarchists I know here are still supportive of the idea of contracts being important in a free market. They’re not.  Even Rothbard himself said that contracts are not absolute (Ethics of Liberty, page 133).

What is a contract?

A contract is an agreement, typically in written form, between two individuals or groups.  The terms of the contract stipulate what both sides will do for one another: the “price” (in terms of dollars, product(s) or service(s) exchanged) and the performance (how fast, what quality, etc).  If any part of the contract isn’t kept, the contract is considered violated.  In modern contracts, enforced by the State, there can be financial penalties set if a contract is violated.  If John promises Dan 16 oranges in exchange for $5, the contract is violated if John only delivers 10 oranges or Dan only pays $3.

If a contract is executed properly by both parties, the contract is considered fulfilled.  In this situation, both parties generally come to the end of the contract with their own form of a profit.  In the same example above, John gets his profit of $5 (worth more than his oranges) and Dan reaps a profit of 16 oranges (worth more than his $5).  Capitalism is defined by this process: two parties who both reap a profit.  It’s not a zero sum game.

Prosecuting a Violated Contract

So what happens if John only delivers 10 oranges, or Dan only pays $3?  Typically, the two parties will negotiate a settlement that is still profitable to both — maybe John will take less money for this 10 oranges, or Dan will accept fewer oranges for his $3.  Still, neither party will be as happy with a settlement, although it is cleaner, quicker and easier than the next step.

In a community governed by a State, the next step would logically be to go to court.  Here’s a problem with that: if one party has inordinately more money than another, or a closer connection to the judicial courts, the stronger party can destroy the weaker party, regardless of who violated the terms of the contract.  Worse, the bigger the value of the trade, the more the lawyers will profit even if the contract is successfully completed.  Laws that provide the idea of equality are almost always unequal because the strongest and wealthiest party can always pay to fight endlessly.  I repudiate copyright on all I write because I know it’s unenforceable — if a big publisher wished to reprint my copyright-protected works, how could I ever afford to battle them?  If billionaire John only sold me 10 oranges for my $5, how could I fight him, and is it even worth it?

Contracts are contraptions of the State

Contracts can and should exist in an economy free of government — it always makes sense to get in writing all parts of a job to be completed, if only so both parties can review the words written down if there should be a disagreement.  Logically, though, a contract is only enforceable by law by the strongest, wealthiest party, so it makes little sense to make a contract any more official than a few sheets of paper and some signed signatures of the parties involved.

With the State, the strongest and wealthiest generally wins.  A strong party can probably win over dozens of lawsuits, just by having the capital necessary to deflect those lawsuits over a period of time needed to bankrupt the plaintiffs.

Without the State, it’s not so clear if the strongest can really win, since there is no judicial process.  You might have third party arbitrators, but even in that case a wealthy party can keep the arbitrator busy for an incredibly long time.

So what replaces the contract?

One word: reputation.  Think eBay’s private feedback rating system.

If your reputation is strong, you don’t want to violate a promise — that does happen from time to time, but it won’t be the usual happening. If your reputation is strong, third parties might even insure (for a small fee) that you’ll do what you promise on time and within budget.  That form of insurance could be purchased by any party within the agreement to protect their investment — it’s called Negative Outcome Insurance (and it’s typically illegal for many service markets in the U.S.)

If your reputation is strong, you’ll be able to capitalize on it by asking for the top dollar in your industry — people who know you have a strong reputation know you want to keep it strong, so you’re more likely to fulfill the agreement perfectly.

If your reputation is weak, you have to sell yourself cheap in order to build that reputation.

Negative Outcome Insurance

Imagine that John fell off his bicycle and injured his leg, requiring surgery.  At the same time, Dan also fell of his bicycle and injured the same leg.  John has plenty of funds as he’s wealthy, but Dan is limited in money.

Both are free to go to doctors to negotiate a price for surgery.  Since the law doesn’t exist in this example, and there is no option for malpractice lawsuits as contracts don’t exist, both John and Dan are free to negotiate with doctors based on the reputation each can afford.  John may decide to spend the most money on the doctor with the best reputation; Dan may want to take a little more of a risk and go with a newer doctor with a lower reputation who is willing to actually work harder to build that reputation.

Since there is no malpractice, the doctors can both charge less — they have no skin in the game other than their reputation.

If John’s legs are important for his high level of income, John is welcome to contact third parties and see if they will insure the operation.  Dan’s legs may be important, but not for the same financial level that John’s are — Dan may pass on the third party risk insurance.

John shops around for a negative outcome insurance provider — or even just a group who is willing to take 10% up front against John’s top ranked doctor’s near flawless reputation as a good surgeon.  John pays the price for the risk insurance, not the doctor.  It’s still in both John’s and Dan’s doctors to perform the surgery flawlessly: their own reputations will go up, which means future patients can see their reputation is solid due to low negative outcome insurance pricing.

How can private feedback systems even help the poor?

In any market or industry, promoting yourself can be costly: running advertising, a mailing campaign or even an ad on a service provider database website costs money.  By joining a private feedback system (or preferably, a few), you can perform your services for others with the agreement that you both would leave feedback for the other.  Even if you’re the smallest company in the city, having a 100% feedback rating for 10 small jobs will get you noticed.  If your ten perfect jobs are still priced lower than the bigger company with 93 perfect jobs and 7 failed ones, others will be willing to take a risk — because your reputation is so solid in such a short period of time.

In addiction, feedback is bi-directional: the new plumber in town may not want to accept doing jobs for people who have a bad reputation of paying — or they may charge more to offset some of that risk.  It’s a two way street, just like on eBay: you know who completes their jobs on time, and you know who pays their bills.  The more perfect someone’s feedback is, the less likely they are to drop the ball.

What about huge companies?

Since we’re assuming there is no law, and there is no court system to protect contracts, how does the little guy work with big companies?  In all examples, there is no difference between a huge megacorp and an individual service provider.  If you have a bad entanglement with a big company, you call up your negative outcome insurance provider and request a settlement, or you leave the big company bad feedback.  Since the feedback you leave for others is publicly accessible, it’s in your best interest to be HONEST about your feedback — the day may come that your toilet clogs, and no plumber wants to come fix it because 95% of the feedback you leave is negative in nature.

Of course, there are a million rare scenarios people can come up with as to why contracts are necessary as is the law necessary to enforce them.  Yet I’ve not found one of those scenarios that actually protects both parties’ interests.  If one party is stronger than the other, feedback/reputation systems bring them closer together in ability.  If one party tends to leave negative feedback more than others, that party will be penalize by a lack of people who want to do business with a constant naysayer.

It’s a self-healing process, one that doesn’t need lawyers or judges or police action to protect.  Each party can purchase optional risk insurance based on their ability and need, and private reputation system websites or companies can even help both parties create exceptional agreements based on millions of other similar transactions that reputation system has helped out on.

Overall, the only important part of a contract is the written agreement stipulating what both parties are going to do for each other.  The enforce-ability of a contract is useless — unless both parties are equal in power, clout and financial capacity; even then, only the lawyers end up winning.  The proper direction is to engage in the use of a reputation system upon project completion: John says that he did indeed receive $5, and Dan says he did indeed receiver 16 oranges.  Everyone is happy, everyone scored their own form of a profit, and everyone’s feedback goes up another notch for properly fulfilling the agreement they made.

Related posts to peruse:

  1. Blame the Shysters
  2. Assholes, A Theory; by Aaron James
  3. In Defense of Capitalism
  4. Progressive Privilege
  5. Obama’s Assholecare and the 80% payout requirement
About A.B. Dada

A.B. Dada resides in Chicago, Illinois and manages a multitude of businesses involved across a wide range of industries.

Comments

  1. The reputation system does well to stop contract violators from further violations but doesn’t provide restitution for the victim who has been short-changed. I see you’ve made a case against the state’s efficacy in providing a just ruling but are quick to dismiss third party arbitration. In a free market where Dispute Resolution Organizations are numerous and competitive I believe the kind of stall tactics wealthy persons use to delay the judicial process will not be tolerated. They, too, (DROs) have reputations to uphold and, as such, must work hard to provide fair and expedient service. They’re definitely worth giving a second look.

    • A.B. Dada says:

      I take no issue with DROs necessarily, and a functional market WILL likely provide them.

      The Private Reputation Systems would likely already offer insurance for either party to select during the PRS selection process:

      1. Two parties agree to use one or more PRS
      2. Both parties sign up
      3. PRS requests a copy of the signed contract — or even offers a contract well suited to this transaction (for a fee?)
      4. Both parties are offered Negative Outcome Insurance from the PRS at a fee based on the reputations of those involved
      5. If contract is violated, the PRS may also offer a DRO

      Pretty straight forward! Thanks for bringing it up, though — I definitely should’ve mentioned the use of a DRO.

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