How private contract enforcement mechanisms can succeed where public institutions

The enforcement of contracts is necessary for efficient exchange and investment in economic activities. Contracts can be enforced through a variety of mechanisms, both public and private. However, in many developing and transitional countries these public institutions are either absent or ineffective in ensuring contract enforcement. Under such conditions, private enforcement mechanisms may provide a suitable replacement for public enforcement institutions. This may be done externally through a third party or internally through self-enforcing agreements. This paper analyzes the use of "self-enforcing" arrangements or "internal" private enforcement mechanisms. Using a case study of an agri-business in a transition economy — Juhocukor a.s., a Slovakian sugar processor — we show that the use of "internal" private contract enforcement mechanisms can have a significant positive effect on output and efficiency for both partners to the exchange transaction in an environment characterized by the absence or ineffectiveness of public enforcement institutions.