Trade Expansion and Contract Enforcement

Abstract

Consider a world of traders separated in geographic, economic, or social space. Honest trade offers larger gains for more distant traders, but frequencies of meetings, and information flows about cheating, have local bias. Honesty is self‐enforcing only between pairs of sufficiently close neighbors. Global honesty prevails only in a sufficiently small world. The extent of self‐enforcing honesty is likely to decrease when the world expands beyond this size. Costly external enforcement is useful only if the world is sufficiently large, and its net payoff need not be larger than that of a self‐governing small community. Intermediate‐size worlds fare worst.