Can markets work without state regulation? The conventional wisdom suggests that this is not possible, but it turns out that trade often thrives outside of the state. There is a growing literature that demonstrates this. One of my favorite studies is from Peter Leeson, who shows that 18th-century pirate ships were self-organizing based on constitutional, democratic principles. Other classic pieces show why Orthodox Jewish diamond dealers didn't use contracts, how rural neighbors resolve disputes through social norms instead of courts, and how long-distance commercial ventures in the 11th-century were self-regulating. My own research has also shown how an informal money transfer system, known as Hawala, allows high-volume, international financial transactions without any oversight or regulation by nation states, and that it has done so successfully for several centuries. These studies illustrate how markets and social cooperation can emerge without the state.
In a recent paper in the American Political Science Review, David Skarbek contributes to this literature by showing how prisoners create systems of self-regulation in the underground economies in prisons around the world. (Full disclosure: David is my partner.) The paper, "Covenants without the Sword? Comparing Prison Self-Governance Globally," shows that there is significant variation in the informal life of prisoners (ungated copy).
In Latin America, inmate groups of diverse variety wield authority, and they are sometimes the main or only source of governance. In Scandinavian countries, by contrast, informal institutions are relatively unimportant. Informal institutions also vary within developed western countries. Organized, ethnically segregated gangs govern Californian men's prisons, but similar groups do not operate in England.
Skarbek makes two arguments. First, when officials do not govern effectively, informal prisoner institutions play a more important role. Prisoners fill the gap in governance left by delinquent officials. When officials do their jobs well, such as in Norway, prisoners have little need to self-organize. Second, prison gangs do a good job of regulating the underground economy, but they are not always the most efficient source of governance. As earlier studies showed, ostracism is effective in small, tight-knit communities, but these decentralized punishments are ineffective in large populations of strangers. As a result, in large prison systems, prisoners turn to gangs to create rules, threaten more severe punishments, and to facilitate order (see this Econtalk). In small prison systems, prisoners do not need gangs to do so. They can easily do it on their own.
Studying prison social order shows how informal institutions work and how they evolve across time and space, given the constraints faced by a particular community. This account differs from much of criminology by providing a new theoretical framework for analyzing prison social order. It also builds on one of Elinor Ostrom's classic (1992) contributions, by showing that not only is self-governance possible, but it can even work among people most likely to misbehave. As Skarbek writes:
prison presents something closer to a "worst case" scenario. Prison populations are comprised of a biased agent type, forced to interact with each other, with no exit options, and sometimes living in desperate poverty. Nevertheless, this article shows that inmates can develop effective (albeit far from ideal) solutions to the problem of order, and these solutions take diverse forms depending on official's choices and the demographics of the community. Extralegal governance is not only possible, but is often robust to significant difficulties.