Market Emergence, Trust and Reputation

Marcel Fafchamps

Working Papers from Stanford University, Department of Economics

Abstract: First draft: February 1996. This draft: November 1996.

Drawing insights from survey work on enterprise finance and from the literature on credit and labor markets, this paper investigates the spontaneous emergence of markets in the presence of heterogeneous agents and commitment failure. We show that courts and other formal market institutions are not a prerequisite for market exchange to take place. Fully decentralized markets can spontaneously emerge and discipline themselves. Exchange is not anonymous but based on mutual trust and on the sharing of information among agents. Economic efficiency is not fully achieved. Screening costs lead to closed-shop markets and segmented equilibria. The permanent exclusion of cheaters from future trade can be self-enforcing and self-emerging if breach of contract is interpreted as a sign of impending bankruptcy.

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