Waiting for the opening of a speakeasy in 1921 (Wikipedia commons).
Black markets, markets in illegal goods and services, demonstrate that state recognition and protection of property rights are not required for a market to operate. Black markets exist where the state bans the sale and/or purchases of specific goods and services and, as a consequence, will not protect the exchanges, goods, services or assets involved in, or derived from, such commerce.
The state does not only fail to provide recognition and protection of property rights within the banned market, or any mediation or adjudication services; it actively denies such and seeks to suppress the trades and accompanying property rights. Yet, black markets exist. They can even flourish, generating great (if insecure and often violently contested) wealth.
As various economists, such as Ronald Coase, Harold Demsetz and Yoram Barzel have explored at length, a trade, an exchange, is actually a transfer of control over some attribute or bundles of attributes. If such control is formally recognised and enforceable, then they are legal or formal property rights. But, as we have seen, trades can and do happen regularly even when formal legal ratification of such control, and their transfer, is actively denied.
How can this be? Because the functional element in property is not formal ratification by a legal system or process, but mutual acknowledgement by the contracting parties and others that they interact with. Such acknowledgment may be active, or it may be passive acquiescence. Nevertheless, such mutual acknowledgement is all that is needed for people to exercise effective control over attributes and so for economic property rights to exist. Indeed, such mutual acknowledgement is what makes any property law functional in day-to-day operation. The old saw that “possession is nine-tenths of the law” points to the fundamental role of mutual acknowledgement in any property system.
At this level, property-as-mutual-acknowledgement is a matter of convention, something you do in particular ways because others do so. (Language and fashion are classic realms of convention.) Property-as-mutual-acknowledgement generates basic conventions of resource use. If you have something in your possession, if you are exercising control over it, the information-economising presumption that simplifies human interaction is that it is, indeed, yours in the senses that matter. This mutual acknowledgement, as is normal for effective conventions, works because it works for everyone as a general presumption. People can operate on the basis of a common set of mutually-reinforcing, because mutually-beneficial and mutually-aligning, expectations.
Property everywhere and always exists via such information-economising acknowledgement, creating mutually-reinforcing expectations. The key thing in property is not “mine!”, any silverback gorilla thumping his chest can claim that. The key thing in property is “yours!”: the acknowledgement by others that the thing is yours and remains yours until you pass it to another.
A trade is just the process of transferring mutually acknowledged control over goods or services. All parties to the trade agree because they are getting something out of the transfer. Each gets the value they perceive out of having what the other previously had, or is going to provide, in exchange for what they themselves previously had, or will provide. An exchange they undergo because they value the former more than the latter. Hence, gains from trade: in cases of voluntary exchange, if both sides did not feel themselves to be better off, they would not have agreed to the trade.
Even in cases of coerced exchange (providing goods or services to avoid some violent or other penalty), the coercion works because the transfer is judged better than the alternative by both parties. In the case of the coerced, it is judged better than the alternative after coercion is put into play. In the case of the agent applying the coercion, before doing so. It is the legitimacy and consequences of the coercion that drives our judgement about such coercive exchanges. Taxes and a mugging are both coerced exchanges, but they are not generally regarded as normatively equivalent.
The power of mutual acknowledgement (and of information-economising, expectation-aligning, common presumption) is such that it permits black markets to operate even in the face of the state denying formal recognition of such acknowledgment. Indeed, even though the state is seeking to actively frustrate such mutual acknowledgement.
Black markets can only operate because the state is unable or unwilling to make its ban fully effective. But the difficulty of doing so points to, and is part a result of, the willingness of the parties to make the banned exchanges. Trades based on mutual acknowledgement using generally convenient conventions of property.
Because the parties involved seek to avoid the prohibiting efforts of the state, black market exchanges tend to gravitate towards places that are not regularly policed by the state. The level of black market activity in a locality tends to say more about the patterns in the policing efforts of the state than the inhabitants of the locality. Nevertheless, it is very easy for the inhabitants of such localities to be tarred by the association with the local black market activity. Something that can be useful to obscure the level of state responsibility for its (lack of) effective policing. And even more useful for dividing residents, citizens and workers by locality, or by features associated with locality.
In practice, even the blackest of black markets is somewhat parasitic on the formal property rights structure endorsed or provided by the state, if only to more securely enjoy the benefits of income and assets acquired from illegal exchanges. Hence the appeal of money laundering: converting what is illegal into what is legal by moving assets and income out of the realm that the state seeks to ban into the realm that the state acknowledges (i.e. ratifies) and protects. Obviously, the intent of such laundering of money and assets is to avoid the risks and costs of hostile state action but successfully doing so also gains the benefits of state property protection and adjudication services.
Thus, that black markets demonstrate that markets do not need the support and acknowledgment of the state to function does not mean that there are not major benefits in such support and acknowledgment. Including the various services the state may offer. Even if the state is purely motivated by the pacification needed to secure its taxation base, that normally entails some protection of property rights. Moreover, the pacifying state is likely to provide, or create social space for, or otherwise support, adjudication services as part of ensuring the social pacification that enables and supports its revenue extraction.
Trade or raid
Black markets are, of course, notoriously connected to violence. This flows directly from the state refusing to protect and acknowledge black market exchanges. In the absence of state protection and adjudication, assets have to be protected, and disputes adjudicated, by private action. In the end, by private force.
Moreover, black market exchanges happen through mutually acknowledged control of property. Such acknowledgement can be withheld or withdrawn.
Exchanges outside the ambit of state ratification, protection and public adjudication are in the pre-state situation of the primordial trade-or-raid choice. Does one bargain to secure desired things that another has by trade or does one simply take by raid?
Much of the point, and a very large part of the value, of state pacification is to minimise the attractiveness, and so incidence, of the raid choice. Thereby elevating the frequency and scale of the trade choice. Which can also further encourage the making of things, the third choice in acquiring something you do not already have, after take or trade. To the potential benefit of the state’s revenue.
Reducing transaction costs
Elevating the frequency and scale of trades is the core benefit of effective systems of legal property rights. Clarity of property rights, ease of adjudication and reliability of their protection all lower transaction costs, potentially dramatically. Transaction costs being costs entailed in making an exchange or other interaction. Specifically, search and information costs; bargaining and decision costs; policing and enforcement costs.
The lower transaction costs are, including the lower the risks involved in transacting and in having assets, and the greater the clarity in who has what rights, the higher the scale of transactions are likely to be and the more willing people are going to hold, and invest in, commercial assets. The state-revenue and economic growth advantages of this situation are likely to be very large.
While the advantages of the reduction of transaction costs through an effective legal system are very real, this is very different from stating or implying that such a happy situation is required for commercial activity to occur. It is perfectly clear, from history and anthropology, that such a well-functioning system of property rights and law is absolutely not necessary for commercial activity, even considerable levels of commercial activity.
As, of course, the case of black markets starkly demonstrate. More generally, as history and anthropology demonstrate quite clearly, mutual acknowledgement generating property conventions — whether or not such is formally ratified by the state and regardless of how efficiently or effectively the state does so — can still support considerable levels of commercial activity. Especially if agents within the state provide functional acknowledgment of property, even if formal ratification is lacking. Indeed, the case of post-1978 China demonstrates that such acknowledgement within the state apparatus can be sufficient even though private commerce and ownership is formally illegal. As it was in China until 2004.
China in the period 1978–2004 was not so much a matter of black markets — as the state was clearly not enforcing its bans on private property and private exchanges in anything remotely resembling a systematic way — as grey markets. Markets whose existence and exchanges were formally banned but functionally permitted. That such markets could operate at all, points to the key role of mutual acknowledgement in functioning property systems, every bit as much as black markets do.
What made such markets functional was being acknowledged by agents within the state apparatus. Indeed, often engaged in by such agents. What evolved were patterns of acknowledgement by such agents that permitted markets to emerge based on conventions of property (including of the transfer of property). Markets that were not typical black markets, with their associated violence and often socially disruptive goods and services; but nor were they ratified by the state within a formal system of property law. Though they were parasitic both on formal state property systems and the social peace imposed by the Chinese state.
The path of the People’s Republic from command economy to market economy, under the continuing regime of the Chinese Communist Party, can perhaps shed some light on a recurrent pattern in Eurasian history, where land starts as being owned by the ruler and, over time, becomes the property (with varying degrees of completeness and recognition) of intermediary social actors. Possibly all the way down to individual farmers. Versions of this pattern can be seen in Indian, European, Japanese and Imperial Chinese history. The difficulties and inefficiencies of central control, and the pervasive power of, and tendency towards, acknowledged possession, of property-as-convention, are clearly a recurring tension within state societies.
Manageable transaction costs
Economic agents can use connections to reduce uncertainty and manage risks, further strengthening the conventions that generate mutually-acknowledged possession. (A connection being repeated, mutually acknowledged, interactions that both agents presumptively intend to continue, or that one agent can force to continue.) Connections provide a wide range of possibilities that, without achieving the level of uncertainty reduction (and so risk clarification) that efficient property-rights regimes generate, can nevertheless enable considerable commercial activity.
Markets emerge when there is sufficient mutual acknowledgement of possession to generate property-as-convention in situations where transaction costs, and other risks, are manageable. We can identify three key elements based on the normal resource-creation-and-risk-management triad of structured sharing, exchange, and connection (that both structured sharing and exchange are embedded in, and interact with), plus the value of signalling your value as a social interlocutor.
First, there is the element of a functional common space. Passive acquiescence in control of what others possess-and-so-control makes it much easier for everyone to act within the common social space. If the state does nothing more than block public violence, it effectively creates a common social space within which such passive acquiescence will be naturally ubiquitous. That alone is a powerful protector of functional property rights, even if the state does not formally ratify property rights or does not provide adjudication services (whether at all, or sufficient to cover the demand for such).
Many societies have had private providers of adjudication services covering property disputes. Which folk have been willing to use for the same reason that they acquiesce in the possessing(s) of others: it eases their social interactions.
Second, there is mutual signalling. Passive acquiescence signals that one is potentially a person easier to interact with. The more complete the mutual acknowledgement, the stronger the signal. Folk have a powerful incentive to acknowledge the possessing of others so that their own possessing will be acknowledged in turn.
Such patterns of mutual signalling can also increase the willingness to use private adjudication services. By using such services, and abiding by their decisions, folk establish their reliability as social and commercial interlocutors. More generally, the broader the ambit of one’s repeated trading activity, the more value there is in a reputation for fair dealing; which includes respect for the possessing of others.
The value of Sharia, and Sharia courts, in providing a shared system of commercial law and adjudication, had much to do with the spread of Islam along trade routes, particularly in the Malay world. More recently, the provision of such services also had much to do with how the Taliban was able to maintain networks of support within rural Afghanistan, leading to its recapture of the country.
One sign of how effective the suppression of violence in public spaces is, is how much effort those willing to violate the general pattern of presumptive possession put in to hide or obscure their doing so. What makes a riot a riot is the breakdown of such presumptive hiding of violence. Just as what makes looting, looting is the breakdown of presumptive acknowledgement of possessing by others. Though, at some point, looters will want a return to the presumption of possession so they can more securely retain their gains. A revealing instance of how much the violation of the presumptive possession by others is itself parasitic on a more general pattern of acquiescence in possession that generate the conventions of property. As previously noted, the general utility of possessing is a powerful motivator for ongoing patterns of mutual acquiescence in possession and the alignment of expectations to generate the conventions of property.
Thirdly, there is the role of connections. The need to maintain and protect connections important to oneself may further encourage mutual acknowledging of possession, and an abiding by private adjudication, by raising the social costs of failing to protect and sustain a reputation as a reliable interlocutor. Especially if such connections also protect one’s own presumptive possession. The atomised individual may be more willing to violate such presumptions but is also a more likely target of such violations.
The use of (typically kin) connections to provide protection-via-retaliation, which is a method for protecting life, person and property particularly common in horticultural and pastoralist societies, can set off cycles of feuding. One of the ways that states pacify is by breaking such patterns of retaliatory feuding.
Societies with strong kin groups often use private adjudication services quite extensively, as protection of one’s standing within the kin group often helps motivate use of, and abiding by, such adjudication.
Certain connections may also protect one’s violation of the presumptive possession of others. Hence the tendency of criminal gangs to form so as to protect, organise and enable such violations (and of the assets gained therefrom). They are also a very useful protective device when engaged in black market activity and may be necessary if operation within the black market involves significant issues of scale or complexity in provision. Every bit as much as other firms do, criminal gangs wrestle with choices of whether to transact externally through markets (or, being criminal, via taking) or internally through organisation (i.e. managed connection using pooled resources organised through some mixture of hierarchy and structured sharing). Boundary choices that depend, as with other firms, on questions of transaction costs and risk-coverage. (A transaction that one can profit from is also a transaction that one can lose from; covering the risk of loss is a fundamental factor in why firms exist and how they are structured.)
The value in protecting the ability to interact through conventions of ownership based on mutual acknowledgement is so strong that injunctions against stealing (at least within the relevant in-group, the relevant normative community) are a universal feature of human societies. The conventions of property are thereby reinforced by social norms against (in-group) theft.
Norms arise out of a sense-of-should based on the benefits of aligning expectations in a highly social species with considerable cognitive capacity due to having large, and metabolically costly, brains.
Social norms are injunctions to act as expected, with sanctions also being expected to be imposed if such expectations are not fulfilled. The mechanisms to enforce anti-theft norms can include shunning, expulsion, violence, or other penalties. Whether enforced personally, by wider action within the community or by some authority. The universal evolution of normative injunctions against stealing (at least within the in-group) point to the ubiquitous value of the conventions of property.
We can see that, even if there is no pacifying state, so that there is what one might call a pure trade-or-raid choice, there are many reasons that trades can and will still happen. There are many mechanisms for making transaction costs and risks sufficiently manageable that trades happen, even in the absence of any state. Indeed, even against the efforts of the state. Mechanisms that are viable because of the ubiquity of mutual acknowledgement as a basis for functional systems of property.
The mutual convenience of the conventions of possession can establish functional property rights without any state action or formal legal acknowledgement. The conventions of property evolve naturally because we are so much a social and normative species, regularly engaging in mutual signalling and seeking to benefit from aligning our expectations.
[An earlier version was posted on Medium.]
References
Yoram Barzel, Economic Analysis of Property Rights, Cambridge University Press, [1989], 1997.
Cristina Bicchieri, The Grammar of Society: The Nature and Dynamics of Social Norms, Cambridge University Press, 2012.
Cristina Bicchieri, Norms in the Wild: How to Diagnose, Measure and Change Social Norms, Oxford University Press, 2017.
R. H. Coase, The Firm, The Market and the Law, University of Chicago Press, 1988. Includes ‘The Nature of the Firm’ (1937) and ‘The Problem of Social Cost’ (1960).
Harold Demsetz, ‘Towards a Theory of Property Rights’, American Economic Review, Volume 57, Issue 2, May 1967, 347–359.
Jordan E. Theriault, Liane Young, Lisa Feldman Barrett, ‘The sense of should: A biologically-based framework for modeling social pressure’, Physics of Life Reviews, Volume 36, March 2021, 100–136.
Chenggang Xu, ‘The Fundamental Institutions of China’s Reforms and Development’, Journal of Economic Literature, 2011, 49:4, 1076–1151.
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