Spontaneous Market Emergence

Drawing insights from the literature on credit and labor markets and from the author’s own survey work on contractual practices among manufacturers and traders in Africa, this paper investigates the spontaneous emergence of markets in the presence of heterogeneous agents. Using a dynamic game setting, we derive precise conditions under which relational contracting spontaneously emerges and deters opportunistic breach of contract even in the absence of formal market institutions. Exclusion of cheaters from future trade is not required for exchange to begin. Markets at early stages of development are characterized by trade based on mutual trust and on the sharing of information among acquaintances. As markets develop, newcomers may be excluded from trade when screening costs are high and agents long lived. Reputational equilibria in which cheaters are permanently excluded from trade are not decentralizable unless markets are already developed and breach of contract is interpreted as a sign of impending bankruptcy. Market emergence is a path dependent process. JEL classification: O1; K0; P5