Appreciating the Success of Voluntary Institutions

Should advocates of liberty focus on convincing others of the moral superiority of liberty over competing political values, or should they focus on attempting to build, in the words of Jason Kuznicki, “new, voluntary institutions and practices that a society would need if it were to become significantly more private, more decentralized, and more free”? Kuznicki believes that with the former approach, the battle for the “high ground is worth winning, and the war itself cannot be won without it,” but he also believes building voluntary institutions is crucial. Although I likely attach more weight than Kuznicki to the importance of convincing enough people to support property rights and markets (Stringham and Hummel, 2010), I generally support his call to create actual voluntary institutions.

Consider a problem as basic and crucial as contract enforcement, which most people think must be done by the state. I will refer to that standard, government-friendly point of view as legal centralism. Libertarians who want to argue against legal centralism can take two approaches. The first approach is to talk about how in theory protection agencies could form and create a court system that looks like our current courts but is private. When asked a specific question about how a particular problem would be solved, the libertarian theorizer outlines exactly how the problem should be addressed. The approach can address any problem, including those in science fiction.

The second approach is to look for real-world examples of how a specified problem or a similar problem was solved by voluntary associations. My recent book Private Governance gives numerous examples of private parties getting together to solve problems others assume must be solved by government. Consider a problem faced by payment processers, which have to deal with quasi-anonymous hackers and fraudsters from around the globe. To a legal centralist, the solution is easy: a payment processor simply needs to call the police, and their problems will be solved. It turns out, however, that law enforcement by American governments has little ability to track down quasi-anonymous fraudsters and even when they do, they lack jurisdiction over fraudsters such as those located in the former Soviet Union. To the libertarian theorizer, payment processors would simply need to call their protection agency, which would send agents to the doors of the fraudsters, apprehend them, hold a trial, and then recover the funds. Here we get into the realm of science fiction very quickly. When asked about a specific problem, the libertarian theorizer is apt to respond, “That would be illegal in my ideal world.”

Notice that legal centralism and libertarian theorizing are of little use to pioneers in online commerce such as PayPal. Instead, PayPal devised a real-world solution to deal with the problem of online fraud. Rather than viewing fraud as a legal problem, as a legal centralist and a libertarian theorizer would be prone to do, PayPal viewed fraud as a risk-management problem. At the time and to this day, brick-and-mortar merchants have had ways to attempt to verify whether someone in their store is a legitimate or fraudulent customer. They could check the ID of the customer before cashing a check or could simply only accept cash. Such steps are not an option for PayPal, but it was able to program a fraud-prevention system that attempted to predict whether transactions were fraudulent. If a transaction is suspicious the system might require extra verification, deny the transaction, or freeze the account. Today all banks and payment processors use similar technology. Almost everyone agrees the fraudster is not acting morally and that a legal system should not condone such behavior. But such a question becomes irrelevant in practice when the problem can be solved using the private mechanisms payment processors have introduced.

Or consider a problem banks and other financial institutions face. Imagine a circular chain of five financial institutions where each pays the next one $100 million and receives from another one $100 million so that the net change in balance is $0 for each. But if some transactions take longer to settle than others, one bank could find itself waiting for its $100 million from one counterparty and unable to pay its other counterparty $100 million. Such a problem can be avoided if settlement is delayed and netted a few days from now, but the longer the time to settlement the greater the odds such problem could arise for other transactions. To both the legal centralist and the libertarian theorizer, if one bank takes longer to get its $100 million and delays sending its $100 million the other banks can take that bank to court and recover damages. In reality, banks cannot have their assets and balance sheets tied up in court proceedings that can take ages. That would likewise be the case for courts run by even the best libertarian protection agencies. Like the payment processors, banks do not treat such a problem as a legalistic one. Instead they look to ways to make the settlement process more seamless. At present the above problem does not debilitate financial institutions, but it can expose certain counterparties to risk they don’t want to assume. As a potential solution, many mainstream financial institutions are experimenting with blockchain technology (independent of Bitcoin) to find ways to pre-reconcile and more quickly settle trades. Here too we see an example of a private solution to what otherwise could have been considered a legal problem. Statements reminiscent of science fiction, such as that delayed settlement would be illegal in an ideal libertarian world, become irrelevant in practice.

Kuznicki writes, “We already have all kinds of different moral arguments for capitalism and voluntarism.… But we have lacked even a vague idea of how crucial types of voluntary social interaction might be carried out in the absence of a state, or with little to nothing in the way of state participation.” Although I agree the area is understudied, many good examples have already been found that researchers should document further. For example, my research looks at how in the world’s first stock markets, government refused to enforce advanced contracts such as forward contracts and how providers of private governance such as the London Stock Exchange or the New York Stock Exchange emerged to create and enforce rules. Both started out as coffeehouses, and the first rulebook of the London Stock Exchange stated that its rules arose because the laws of the land were not sufficient to deal with the problems in the market. Although they had not read my book Private Governance, they are still, in my opinion, heroes of markets.

It theoretically could be the case that the lessons from the London or New York Stock Exchanges in no way apply to other markets, implying that because one studies certain examples does not mean all possible related questions or problems have been addressed. But many similarities between markets exist, and I would venture to say that the London Stock Exchange of two hundred years ago and eBay of today have a lot more in common than dreamt-up theories by legal centralists or libertarian theorizers. Instead of saying, “Here is how I believe the law could solve this,” we can say, “Here is how forward contracts were enforced independently of government law for hundreds of years.” It avoids the pitfalls of utopian thinking that Kuznicki rightly criticizes. Studying existing examples of private governance and observing newly emerging forms of private governance means that libertarians don’t need to come up with a blueprint of all possible solutions. It also sheds light on how many problems a libertarian theorizer might speculate about have already been solved.

Before I conclude, let me highlight one quibble with Kuznicki’s post: I think his term “libertarian social engineering” is suboptimal. He means, “It’s libertarian because it operates in the private sphere and no one is ever required to use it. If you don’t like what’s being done, you are free to ignore it.” But the term “social engineering” connotes much more than attempting to get people to go along with your new way of doing things. Instead, engineering is what I would call the actions of the founders of the London Stock Exchange in 1800, PayPal in 2000, or developers of blockchain technology today—pioneers of private governance.  


Also from this issue

Lead Essay

  • Jason Kuznicki recommends what he calls “libertarian social engineering,” which builds institutions and practices for a freer society. Libertarians are well versed in moral arguments, he says, but moral arguments alone tend to generate only a short burst of enthusiasm before fading. Much better would be to get to work on building the practical - and voluntary - future that we all profess to desire.

Response Essays

  • Some institutions aren’t necessary to a free market as a matter of principle, but they make life in market-oriented society much better. Those of us who believe that markets are a key part of a well-ordered society should take the lead in developing these institutions. Not only might they bring about a more voluntary society, they will also improve the quality of our lives. Tabarrok cites several some surprising examples of institutional innovations to justify these claims.

  • Edward Stringham argues that there’s been a lot more real-world private governance than one might imagine at first. Historically, banks, payment processors, and financial markets have commonly created their own, self-enforcing rules, which were often highly effective. A persistent habit among statist thinkers is to assume the necessity of the state; libertarians will often counter a persistent tendency to speculate. Neither is quite warranted, says Stringham.

  • Tom W. Bell suggests three ideas that might help achieve a freer society. Together they form a general approach to privatizing state-supplied goods. He cautions that libertarian engineering will have limited capabilities under existing governments; to significantly change how law functions, and to move it in a libertarian direction, may require new systems entirely. Bell concludes with a sketch of three possible features they may contain: shared ownership, jointly held democracy between citizens and private owners, and open-source law.

  • Vitalik Buterin argues that the way to build a more decentralized world is to make that world rewarding. Most people aren’t libertarians, and few will change their minds about politics simply because libertarians urge them to. But when specific social systems make it relatively advantageous to engage in market behavior, and when people can trust one another in a context that does need the state, their actions will take on a libertarian character anyway, and the world itself will improve, both by our standards and by those of others.