Social Contract, Free Ride. Anthony de Jasay

      1. The spot contract. Two actions are promised and performed with little or no time elapsing between promise and performance, and with the two performances being for all practical purposes simulta neous. An ordinary exchange is the standard case, where an offer and its acceptance constitute the two promises, delivering against the agreed consideration the two performances. The element of recipro cal promise may even be lost sight of if it is literally simultaneous with execution. However, the delivery of X against Y is logically always pos terior to an exchange of promises to give X for Kand Yfor X, respec tively, even if in a functioning market, with goods on offer at given prices, promises to buy and sell, and their executions, are instanta neous and merge into each other.

      A spot contract is intrinsically self-enforcing since, by the definition of a contract, neither party values what he has to give up by performing more highly than what he stands to get by inciting the other party to perform his half of the bargain.

      2. The half-spot, half-forward (also known as part-executed) contract.Two promises are made, as for a spot contract. However, they are not to be executed simultaneously. The second or forward performance is contingent on the first or spot one, but not, as in the spot contract, vice versa. The second performance is typically deferred consider ation, e.g., the repayment of a debt resulting from a first performance such as a loan or the delivery of goods on credit.

      A half-spot, half-forward contract is intrinsically not self-enforcing, for once the promised first act has been performed its desirability no longer provides the incentive to perform the second act—though there may well be other incentives, such as keeping one’s good name and credit intact for other contracts. However, they are external to the contract in hand.

      3. The forward (also known as wholly executory) contract. Two simul taneous deferred performances are promised, i.e., two parties commit themselves to execute a “spot” exchange at a future date. As the two performances are mutually contingent, this contract has some tendency to enforce itself without being intrinsically self-enforcing. For what is the parties’purpose in committing themselves today to a future exchange of performances, instead of biding their time?

      3.1 The classic reason is a divergence of expectations; the two parties both believe they can get better terms from each other today than at the future date foreseen for the actual exchange, and indeed better than at any future date between then and now, working backwards from the date of exchange towards today. Each party, in other words, expects the available terms of exchange to be moving against him over this period. But if this expectation turns out to be true for one party, it must prove to have been false for the other. When the date set for the actual performance comes round, the party whose expectation was proved false would be better off if he had not made the contractual commitment and may have an incentive to default.

      3.2 A less classic and less clear-cut reason for contracting forward has to do with the possible value (convenience, assurance, complementarity with some other contract) attaching to the perfect foreknowledge of the terms on which a future exchange will be carried out. This value, if there is one, is eroded over time at a rate which reduces it to zero on the day the exchange is to take place. If on this day the terms that happen to be available for the exchange in question differ from the ones that had earlier been contractually fixed, one of the parties will have a definite incentive to default even if no specific expectation of his has been falsified by events.

      3.3 Lastly, there are reasons for forward contracts derived from transactions costs in a wide sense. It may pay, in terms of search, information, and negotiating costs, to hire a man for a whole month rather than to hire one (even if he were the same man) by the day every working day of the month. Likewise it may (but probably does not) pay to own a motor car instead of forever calling taxis. “Vertical integration” instead of ad hoc recourse to bought goods and services, a household’s installed equipment, a firm’s owned and leased factors of production, are explained in these terms. Contracts concluded to economize search and bargaining costs tend to provide not for two mutually contingent discrete performances in the future but more typically for two mutually contingent streams of performances (e.g., work, and wage payments in return for work) running concurrently.

      

      Thanks to simultaneity, they have a strong tendency to enforce themselves, yet remain vulnerable to a marked deviation between newly available terms of exchange and the terms that had been originally contracted for—a deviation which makes default attractive to one of the parties.

      In sum, no forward, wholly executory contract is intrinsically self-enforcing. Item 3.1 has some bias to default, 3.2 may go either way, while 3.3 appears strongly biased towards self-enforcement. However, whether every forward contract is tendentially self-enforcing or not cannot be readily detected from its form—the configuration in time of promises and performances that it stipulates—but depends on the parties’motives relative to the facts of the case.

Defaults

      It is now readily apparent that “default” means two radically different events. Default in the half-spot, half-forward contract configuration means that performance by one party is not reciprocated by performance by the other. The first performer has made an unrequited delivery. He parted with the “consideration” (promise fulfilled, service rendered, goods handed over). By the default of the second performer, he loses both the consideration and the advantage he expected to derive from the execution of the contract (the surplus good, the “gains from trade"). In the fully forward configuration, the contract (or in the case of performance-streams, the part of the contract left to run, i.e., that is still to be fulfilled) remains “wholly executory.” There is no first and second performer. Neither party gives up any consideration without simultaneously receiving its counterpart in discrete “lumps” or in a continuous flow, lump matching lump, flow matching counter-flow. One’s loss if the other defaults is limited to the expected “gains from trade” that he forgoes, or, if he had discounted them, that he must surrender.

      The difference between the two kinds of default is fundamental, so much so that one wishes separate words existed to denote each. As the next-best thing, I will refer to default involving loss of the consideration by the first performer as “first-degree default,” while calling that involving solely the loss of contractually secured expectations of advantage “second-degree default.” The particularity of the half-spot, half-forward contract is that it carries risk of a greater order—for it is open to first-degree default—and a higher probability of the risk turning into actual loss—for the contract is intrinsically non-self-enforcing.

      Hobbes calls half-spot, half-forward contracts “pacts” or “covenants,” referring to wholly forward contracts as “covenants of mutual trust.” His main interest is in the latter, where two continuing streams of mutually contingent performances are promised—"I promise to keep the peace as long as you keep your promise to do likewise"—the very contract configuration which, next only to the spot contract, has the best chance of enforcing itself. Strangely enough, Hobbes seems relatively unworried about the intrinsic risk of first-degree default in mere “pacts,” yet he is deeply concerned about the much more conjectural risk of second-degree default in “covenants of mutual trust”³ so much so that he deduces the rationale of the social contract from it. It is because he conceives of covenants of mutual trust, i.e., forward contracts, as intrinsically non-self-enforcing in the state of nature that he can represent the surrender of arms to the contract-enforcing sovereign, and willing obedience to him, as the sole rational and moral solution to human coexistence.

      It would be fascinating to speculate about the shape Hobbes’s theory, and subsequent contractarian arguments, might have assumed had he not confounded the two types of default risk and the intrinsic tendencies of two distinct types of contract to be, or not to be, self-enforcing. We will revert to a somewhat different form of much the same question in Chapter 4.