In 1895, as part of the treaty of Shimonoseki, China ceded the island of Taiwan to Japan. The Japanese government wished to maintain the existing legal system; in order to do so it had to discover what that legal system was.
One feature of that legal system was the combination of elaborate contractual practice with an almost total absence of contract law. Imperial China had no equivalent of our civil lawsuits. A merchant who had sold goods on credit and not been paid could, if he wished, report his debtor to the district magistrate for the crime of swindling him-but once he had done so, the case was out of the merchant's hands. The magistrate, if convinced of the justice of the claim, might compel repayment-usually only partial repayment. He might do nothing. He might even conclude that the merchant was the one at fault and sentence him to a beating. The legal system enforced by the magistrate focused almost entirely on criminal acts and criminal punishment, with only a handful of provisions dealing with matters of contract and some, such as the statute specifying a maximum interest rate, appear to have been ignored in practice.
Nonetheless, Chinese merchants developed an elaborate set of contractual forms, including a variety of form contracts, supporting an extensive and sophisticated network of commercial relations. Part of the explanation of how they did so was presumably the existence of reputational enforcement, part the availability of state courts for dealing, when all else failed, with parties engaged in deliberate and obvious violations. But much of the explanation lies in the details of the private contract law that developed within that framework-a system of rules designed to minimize the reliance on courts and external enforcement.
Important elements in making the system work were the existence of a system of written forms using standard boilerplate terminology understood by the parties and others in the trade, and the use of seals-"chops"-to provide clear evidence of assent to a contract. So long as issues of fact were simple-whether a shipment of grain had been delivered and accepted, but not the precise quality or quantity-it was possible for third parties to determine, at a low cost, which party to a contract had violated its terms. Here the third party might be either another merchant interested in knowing who could be trusted or, in extreme cases, a district magistrate interested in who had committed a criminal offense and should be punished accordingly.
It is the thesis of this paper that the past of China is our future-that parties to online transactions will, over the next few decades, face essentially the same problem and find, mutatis mutandis, similar solutions.
Both the Chinese past and the cyberspace future are special cases of a more general problem--contract enforcement in the absence of state enforced contract law. That problem appears in a variety of other contexts, including criminal markets and political markets. Perhaps less obviously, it appears in markets where court enforcement, although legally possible, is impractical because performance is difficult or impossible to monitor. The marriage market is an important example.
Part II of the paper presents a general approach to private contract enforcement, some features of which are illustrated in the Chinese example. Part III sketches out the reasons why I expect that, for transactions in cyberspace, state enforcement of contracts will work worse and reputational enforcement better than in realspace today, including the technologies that provide an online equivalent of the seals used by Chinese merchants to establish the identity of a signatory party at a distance, in time or space. I go on to discuss how, in that environment, parties might structure their dealings, as well as the difficulties they will face due to the special nature of the cyberspace environment.
David D. Friedman,
From Imperial China to Cyberspace: Contracting Without The State
, 1 J.L. Econ. & Pol'y 349
Available at: http://digitalcommons.law.scu.edu/facpubs/6