Fragile markets: An experiment on judicial independence

• Consider a credit transaction under different systems of judicial enforcement.
• Judges can be independent, or either controlled by borrowers or lenders.
• Enforcement has both immediate and systemic consequences on transactions.
• Participants would benefit from markets but they sometimes destroy them.
• Borrowers struggle the most to grasp the systemic consequences of their choices.

Contract enforcement does not only affect single transactions but the market as a whole. We compare alternative institutions that allocate enforcement rights to the different parties to a credit transaction: either lenders, borrowers, or judges. Despite all parties having incentives to enforce and transact, the market flourishes or disappears depending on the treatment: paying judges according to lenders’ votes maximizes total surplus and equity; and a similar result appears when judges are paid according to average earnings in society. In contrast, paying judges according to borrowers’ votes generates the poorest and most unequal society. These results suggest that parties playing the role of borrowers understand poorly the systemic consequences of their decisions, triggering under-enforcement, and hence wasting profitable trade opportunities.