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Article Excerpt
Abstract
Migrant worker remittances often take place outside the scope of government enforcement. Through an examination of the informal remittance transfer system of hawala, this paper argues that self-enforcing exchange mechanisms can support high volume trade in the absence of formal contract enforcement. Hawala networks employ ex post reputation mechanisms between agents and ex ante signaling to uphold obligations under conditions of contract uncertainty.
JEL Codes: D85, F33, G29, N25, P48, Z13
Keywords: Hawala, Self-enforcement, Remittances, Networks
I. Introduction
Trade flourishes when individuals have confidence that other members of society will honor and enforce obligations and promises. In countries where the rule of law is the modus operandi, contract law serves to provide confidence by constraining traders, enforcing breaches, and lowering transaction costs. However, when the machinery of law is not formally present, private arrangements often emerge to mitigate conflict and support cooperation. One finds examples of efficient private enforcement institutions throughout history and within the context of international trade (Landa, 1981; Bernstein, 1992; Grief, 1993; Stringham, 2003, 2004; Leeson, 2006). In lieu of state enforcement, private arrangements rely on alternative mechanisms to sustain cooperation.
Remittance networks provide a window into functional operations of self-enforcement. When a migrant worker residing in Saudi Arabia remits a portion of his earnings to his family in a remote Indian village, commonly he chooses the informal, illegal hawala network to do so. From the migrant worker's perspective, hawala will transfer funds at much lower cost than formal mechanisms.
Hawala is a set of money transfer networks in operation since ancient times, having emerged in the context where formal enforcement of internal transactions by rulers and governments was non-existent. As international trade began to emerge in South Asia in the 11th century, hawala networks soon became important to facilitating exchange. Moreover, these networks continue to operate today, as they did in the past, relying on reputation mechanisms and signaling to sustain coordination despite their illegality in most countries.
The literature on self-enforcing exchange relationships focuses predominantly on sustainable transactions between a relatively small number of traders in periodic face-to-face exchange (Landa, 1981; North, 1990; Bernstein, 1992; Grief, 1993; Stringham, 2003, 2004). Among small groups of people, word travels fast. Reputations develop, and because of the low cost of communication among the group, all others in the group can use knowledge of past performance to punish a cheat. In this manner, ex post multilateral punishment mechanisms--such as ostracism--work well to ensure cooperation. As long as myopic individuals do not populate the group, defection is limited by the ability to detect and punish.
While Greif (1989, 1993) shows that reputation mechanisms functioned efficiently in earlier periods among similar peoples, the results of this line of research suggest that these mechanisms may only be effective in particular settings with particular groups (i.e., several dozen Maghribi traders). To reinforce this view, Milgrom, North and Wiengast (1990) attribute the transition from "simple" reputation mechanisms to third party enforcement to the increasing costs of keeping everyone informed: a requisite condition for reputation mechanisms to operate. It is possible that these costs may be systematically lower under particular conditions, under which the particulars of time and place would determine the extent to which reputation mechanisms could sustain trade. At some point, however, self-enforcing exchange among large groups breaks down as the costs of communication in large numbers become prohibitively high (Greif, 1989, 2002; Landa, 1994; Zerbe and Anderson, 2001).
North states that "realizing the economic potential of the gains from trade in a high technology world of enormous specialization and division of labor characterized by impersonal exchange is extremely rare, because one does not necessarily have repeated dealings, nor know the other party, nor deal with a small number of other people" (1990). Thus, while breakdown must occur at some level, it is premature to dismiss self-enforcing mechanisms as simple and operative only among small, localized groups. Notably, research by Ferson and Laitin (1996) and Leeson (2006) suggests that self-enforcing exchange can be effective across larger populations and greater distances, and Stringham (2005) considers environments as indeterminate as the Internet. The size and scope of self-enforcing networks of exchange merits further investigation.
Following Ferson and Laitin (1996), this paper considers ex ante and ex post mechanisms that create the foundations of extra-legal, yet peaceful, frequent exchange across great geographic distance. The compelling theory of ethnically homogeneous middleman groups put forth by Landa (1981, 1994) is shown herein to apply to exchange relations of spanning greater geographic distances and scope than previously considered. Hawala networks function as self-enforcing structures through ex post reputation mechanisms and ex ante signaling mechanisms. These serve as functional substitutes in niche markets for formal contract enforcement mechanisms.
Serving individuals as far flung as New York and rural South Asian villages, hawala transactions encompass a multitude of diverse traders and cross countless borders. This system of self-enforcement fills a very narrow but important gap in the formal market for remittance transfer services. While this does not necessarily mean that these self-enforcing exchange relationships and mechanisms can support all high volume trade, it does suggest that some types of trade are sustainable in this manner. Hence, hawala networks raise the question of the magnitude of trade, distance, and traders capable of exchanging through mechanisms of reputation and signaling. (1)
This paper extends the literature on private or informal contract enforcement (Milgrom, North, and Weingast, 1990; Greif, 1989, 1993, 2002; Landa, 1994; Leeson, 2006; Stringham, 2003) by examining the remarkable hawala money-transfer systems that operate today between South Asia and the rest of the world. Section II begins by giving an account of how hawala transfer networks work and the extent of their operations. The important points here are the market niche that these self-enforcing remittance networks serve, the amount of trade flowing through these networks, and the geopolitical borders these transactions cross. The third section analyzes the ex post reputation mechanisms that sustain cooperation within the core of the network. Section IV examines the ex ante signaling devices used in reassuring peripheral clients. The fifth section concludes.
II. The Hawala Networks
Hawala is a Middle Eastern and South Asian informal system of transferring money across long distances and borders. Similar networks have and do exist in many other parts of the world and throughout history (such as the fei-ch'ien in China and al barakat in Somalia). (2) These practices represent long-standing Islamic traditions developed in various forms across the regions of the Middle East and South Asia. Emerging in ancient times, hawala networks continued to operate throughout the medieval and colonial eras, and are still widely in use today (Ballard, 2005; Passas, 2006; Schramm and Taube, 2003; Wilson, 2002; Ismail, 2007).
Hawala first emerged to facilitate trade across geographical, political and cultural borders in a context of weak, absent or conflicting formal institutions. In many cases, individuals chose the informal services as a direct result of generally poor provision of additional banking services by the...
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