| Abstract: | Business networks are a feature of the organizational landscapeof many countries, though they vary in magnitude. This articledevelops a theory of business networks where they are endogenousto the reliability of the legal system. Networks are a substitutefor reliable institutional support that guarantees written contracts.The existence of networks exerts a negative effect on the functioningof the anonymous market. This is because the network absorbshonest individuals, raising the density of dishonest individualsengaged in anonymous market exchange. Since this lowers thepayoff from market exchange, larger networks may be easier toenforce. We find that networks are economically inefficientunless they are relatively large. This is consistent with theview that informal contract enforcement institutions may beinefficient in general equilibrium even though they enhanceefficiency in partial equilibrium. |
