Endogenous institutional selection, building trust, and economic growth

Private-order market institutions founded on trust-based relational contracts suffer adverse selection and moral hazard problems, while public-order market institutions have a limited capacity to enforce contracts. I model agent selection between contract enforcement institutions and demonstrate that the state's contract enforcement capacity is complementary to private-order contract enforcement institutions for low to moderate levels of public-order enforcement capacity. This suggests that initial improvements to public order institutions cause the accumulation of trust and result in economic growth in both institutions. However, I show that the private-order institution must collapse once the public-order contract enforcement capacity is too great. (C) 2019 Elsevier Inc. All rights reserved.