The argument of the volume
Begin with the problem the contract exists to solve. Exchange on the spot is easy: I trade you an apple for a coin, hand to hand, and neither of us need trust the other. But most valuable exchange cannot be simultaneous — the builder builds before he is paid, the lender lends before he is repaid, the worker labors before the wage arrives — and in every such exchange one party must perform first, and so puts himself at the other's mercy. This first performer's exposure is the fundamental obstacle to exchange across time: if it cannot be overcome, no one lends, no one builds on credit, no one works before payday, and the economy shrinks to the simultaneous swap among those who already trust each other. The contract is the institution that overcomes it, by turning the promise to perform later into a binding one — and so it is the contract, more than the price, that makes the across-time economy possible at all.
What makes a promise binding? Not the saying of it, for a promise is only words, and words are cheap. What binds a promise is enforcement — some power that makes the keeping of it cheaper than the breaking, so that the first performer may trust the second to follow. That power may be the law, the state's courts ordering the breacher to pay; or reputation, the good name forfeited by the cheat; or the hostage, the stake posted and lost on breach; or the norm, the sanction of conscience and community. A contract is a promise plus its enforcement, and is only as binding as the enforcement behind it. Yet the law's enforcement binds in a stranger way than it first appears, for the courts that stand behind a contract do not, as a rule, compel the breaker to perform; they compel him only to pay — so that to be bound by a contract is to face a choice, to keep the promise or to compensate the other for breaking it, and a breach that gains the breaker more than it costs the other may leave no one wronged. But here the volume's central difficulty enters: enforcement can bind only the terms the contract actually states, and no contract can state everything. The future is too vast to foresee and too costly to write down, and so every contract is incomplete — silent on the countless contingencies the parties did not address. The sword enforces the letter; but the letter always runs out, and then the sword has nothing to swing at.
What governs the parties, then, when the world springs a surprise the contract never named? The volume finds three answers, and a fourth beneath them. The law supplies default rules, the terms it reads into a contract for the cases the parties left open. The parties design incentives, tying an agent's pay to what can be seen when his effort cannot, to shape the conduct no clause can compel. And where they deal again and again, they rely on the relationship itself, the self-enforcing bond in which neither cheats because the future is worth more than the gain from cheating. But all three, the flagship will argue, rest on a fourth thing they cannot do without: the unwritten understanding — the trust, the reputation, the discretion — that fills the gaps no clause could close. And this overturns what we took a contract to be. We imagine the contract as the alternative to trust, the device that lets us deal with those we cannot trust by writing everything down; but no contract writes everything down, and the gaps can be filled only by the trust the contract was supposed to make unnecessary. The contract does not replace trust; it rests on it. The explicit floats on the implicit; the market built out of contracts rests on enforcement and trust together; and the wholly specified, trust-free economy is a thing that cannot be built.
The argument remains open. What follows is an attempt to fix its exact edges.
The twelve plates of this volume
- i The Swordin print Hobbes; the enforcement that turns a promise into a binding one, and lets exchange reach across time. Read the plate →
- ii The Hostagein print the bond, the collateral, the hostage staked and forfeited on breach; how a promisor binds himself by what he puts at risk. Read the plate →
- iii The Gapin print Ayres and Gertner; the incomplete contract, and the default rules by which the law fills the silence the parties left. Read the plate →
- iv The Tenantin print Holmström; the incentive contract, and the spur of reward bought always at the cost of risk, when effort cannot be watched. Read the plate →
- v The Handshakein print Macaulay; the promise kept for the relationship, not the court — the self-enforcing bond in the shadow of the future. Read the plate →
- vi The Breachin print Holmes; efficient breach, and the contract as an option to perform or to pay, the duty to keep it only a duty to compensate. Read the plate →
- vii The Statusin print Maine; the movement from the status one is born to, to the contract one chooses — the rise of the contract as the rise of the chooser. Read the plate →
- viii The Promisein print the deepest turn: what fills the gaps no clause can close — trust, reputation, discretion — and the discovery that the contract, emblem of the explicit, rests on the implicit it seemed to replace. Read the plate →
- ix The Boilerplatein print the standard form, the contract of adhesion, the fine print no one reads and no one can bargain; consent in the age of the mass contract. Read the plate →
- x The Limitin print the limits of freedom of contract; unconscionability, duress, and the bargains the law will not enforce though both parties freely struck them. Read the plate →
- xi The Contingencyin print the contract as a state-contingent claim, and the dream of complete markets in which every future could be insured against, were it only nameable. Read the plate →
- xii The Codein print the smart contract; the self-executing agreement enforced by the machine, not the court, and what is gained and lost when the sword becomes software. Read the plate →
In closing
This volume took up the second of the institutions: the contract, the promise made binding, the device that turns the bare word into an obligation and so lets exchange reach across time, with strangers, at scale. The firm replaces the market where the price is too costly; the contract constitutes the market, making the priced exchange possible at all — for almost everything that distinguishes a modern economy from a village market is an exchange across time, and every such exchange rests on a promise the contract has made binding.
The volume traced the contract from its enforcement to its foundation. Hobbes saw that a promise unbacked by a power to compel it is only words, and that what binds a promise is enforcement — the law's sword, or reputation, or the hostage, or the norm. Oliver Wendell Holmes pressed deeper into what that enforcement compels, and found it stranger than it seems: the courts, faced with a broken contract, do not as a rule force the breaker to perform, but only to pay, so that a contractual duty is at bottom a duty to keep one's word or else to compensate the other for not keeping it — and a breach that earns the breaker more than it costs the promisee may wrong no one and leave the world the richer. But enforcement, however it is understood, can bind only what the contract states, and no contract can state everything: the future is too vast, and every contract is incomplete, silent on most of what will come to pass. So the volume turned to what fills the silence. Ayres and Gertner showed the law's answer, the default rule it reads into the gaps, set sometimes to force the informed to speak. Holmström showed the designed incentive, the contract that makes a hidden agent exert himself by tying his pay to what can be seen, trading always the spur of reward against the burden of risk. And Macaulay found, in the field, that most contracting needs no court at all: the relational bond, self-enforcing in the shadow of the future, where neither party cheats because the relationship is worth more than the gain from cheating.
And then the volume found, beneath all three gap-fillers, the one they cannot do without. The default rule, the designed incentive, the self-enforcing relationship — each leaves gaps of its own, and the gaps are filled, in the end, by the unwritten: the trust, the reputation, the discretion that no clause can capture. This overturns what we took a contract to be. We imagine it as the alternative to trust, the device for dealing with those we cannot trust; but no contract writes everything down, and the gaps can be filled only by the trust the contract was supposed to make unnecessary. The contract does not replace trust — it rests on it; the explicit floats on the implicit; and the market, built out of incomplete contracts, rests not on enforcement alone but on enforcement and trust together, reaching only as far as both will stretch. Where the gaps grow too wide for trust to span, the parties stop contracting and integrate, filling them instead with the authority of the firm — so that the firm and the contract are twin answers to the one problem of incompleteness, the one filling its gaps with command, the other with good faith. With the contract the family's second member stands in print, and the institutions still to come are named by it: the money that must reckon the promise, the rule that stands behind its enforcement, and the tax that pays for the enforcing — for a promise must be counted, enforced, and the enforcing funded.
If every contract is incomplete, and what fills the gaps it leaves is the trust no clause can capture, then the question is no longer whether the promise is written, but what holds it where the writing runs out. Beneath every contract lies a promise, and beneath every promise, a trust the contract cannot replace. What fills the gaps?