The Effect of State-endorsed Arbitration Institutions on International Trade

Abstract

Click to increase image sizeClick to decrease image size Notes The current study examines the disputes between two private parties. Thus, the dispute between a private party and a state, as well as the dispute between two states, are not concerns of this study. Julian Lew's study, for example, reports that around 80 per cent of international trade contracts had arbitration clauses, which expressively empowered commercial arbitration as the exclusive means of dispute resolution for contracting parties. Julian Lew, Applicable Law in International Commercial Arbitration: A Study in Commercial Arbitration Awards (Oceana Publications, 1978). More recently, Berger noted that more and more international contracts had turned to arbitration over time – about 90 percent of all international trade contracts contained arbitration clauses in the early 1990s. Klaus P. Berger, ‘Aufgaben und Grensen de Parteiautonomie in der Inernationalen Wirtschaftsschiedsgerichtsbarkeit’, Recht der internationalen Wirtschaft, Vol. 40 (1994), pp. 12–18. William Landes & Richard Posner, ‘Adjudication as a Private Good’, Journal of Legal Studies, Vol. 8, No. 2 (1979), pp. 235–84; Steven Shavell, ‘Alternative Dispute Resolution: An Economic Analysis’, Journal of Legal Studies, Vol. 24, No. 1 (1995), pp. 1–28. David Charny, ‘Nonlegal Sanctions in Commercial Relationships’, Harvard Law Review, Vol. 104, No. 2 (1990), pp. 373–467; Bruce Benson, ‘To Arbitrate or to Litigate: That is the Question’, European Journal of Law and Economics, Vol. 8, No. 2 (1999), pp. 91–151; Bruce Benson, ‘Contractual Nullification of Economically-detrimental State-made Laws’, Review of Austrian Economics, Vol. 19, No. 2 (2006), pp. 149–87. Janet Landa, ‘A Theory of the Ethnically Homogenous Middle Group: An Institutional Alternative to Contract Law’, Journal of Legal Studies, Vol. 10, No. 2 (1981), pp. 349–62; Robert Cooter & Janet Landa, ‘Personal versus Impersonal Trade: The Size of Trading Groups and Contract Law’, International Review of Law and Economics, Vol. 4, No. 1 (1984), pp. 15–22; James Rauch & Vitor Trindade, ‘Ethnic Chinese Networks in International Trade’, Review of Economics and Statistics, Vol. 84, No. 1, pp. 116–30; Lisa Bernstein, ‘Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry’, Journal of Legal Studies, Vol. 21, No. 1 (1992), pp. 115–57; Avner Greif, ‘Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Traders’ Coalition', American Economic Review, Vol. 83, No. 3 (1993), pp. 525–48; Avner Greif, Paul Milgrom & Barry Weingast, ‘Coordination, Commitment, and Enforcement: The Case of the Merchant Guild’, Journal of Political Economy, Vol. 102, No. 4 (1994), pp. 745–76. Contracting parties in this case may try to nullify the ill-designed state-endorsed arbitration institutions. However, such nullification (either contractually or legally) incurs costs on the contracting parties, which ultimately hurt the efficiency of the economy and the volume of trade. Mediation and reconciliation are the primary alternative methods of dispute resolution to third-party tribunals. The innocent parties will be rewarded by either a fine imposed on the perpetrating parties or the performance of contract obligations by the perpetrators. Walter Mattli, ‘Private Justice in a Global Economy: From Litigation to Arbitration’, International Organization, Vol. 55, No. 4 (2001), pp. 919–47; Julian Lew, Loukas Mistelis & Stefan Kroll, Comparative International Commercial Arbitration (Kluwer Law International, 2003); Alan Redfern, Martin Hunter, Nigel Blackaby & Constantine Partasides, Law and Practice of International Commercial Arbitration (Sweet & Maxwell Ltd. 2004). Benson, ‘To Arbitrate or to Litigate’, p. 109; Benson, ‘Contractual Nullification of Economically-detrimental State-made Laws’, p. 157; Redfern et al., Law and Practice of International Commercial Arbitration, p. 184; Bernstein, ‘Opting out of the Legal System’, p. 137. John Umbeck, ‘A Theory of Contract Choice and the California Gold Rush’, Journal of Law and Economics, Vol. 2, No. 2 (1977), pp. 421–37; Ethan Bueno de Mesquite & Matthew Stephenson, ‘Legal Institutions and Informal Networks’, Journal of Theoretical Politics, Vol. 18, No. 1 (2006), pp. 40–67; Paul Rubin, ‘Growing a Legal System in the Post-Communist Economics’, Cornell International Law Journal, Vol. 27, No. 1 (1994), pp. 1–47. Previous studies about the effectiveness of traditional (state-fee) arbitration institutions confirm this reasoning. Travelling groups of traders in medieval Europe, ethnic and geographic groups and homogenous business groups are all cases where the communal population has been highly limited to supporting cooperative behaviours in contract enforcement. In some cases, this trade-off between enforceability and scale inherited in community enforcement could be lessened by advancements in information technology and the so-called polycentric governance. However, none of these can really solve the dilemma. Developments in information technology can decrease the costs of contract enforcement associated with geographical distance among traders. However, they do not decrease the distance in terms of people's behavioural norms. The polycentric governance theory argues that a business entity could simultaneously belong to different groups that have their own customs and that being in one group does not preclude dealing with people in other groups. Thus, without increasing the size of each business group and without resorting to the help of legal authorities such as international treaties or state laws, contract cooperation among potentially profitable but starkly different people could be sustained by linking large numbers of parallel communities with overlapping memberships. This argument, however, is flawed for the following reasons. First, it is an unwarranted statement that for most transactions there always exist different groups equipped with well-established norms that can both cover the entire chain of exchanges and be independent of state power. Second, given the complexity of international contract cooperation, this mechanism of polycentric governance requires (as many supporters of this theory recognise) a long chain of exchanges and hence a large number of linkages for finishing each transaction. It is quite unlikely, however, that each linkage within the suggested web of interactions is so effective that it incurs no significant transaction cost. Thus, as the number of involved intermediate connections increases, the overall transaction cost associated with this mechanism could be large enough to negate its usefulness in supporting contract cooperation. Therefore, this suggested mechanism of polycentric governance could not be as effective as legal authorities such as treaties and domestic laws in supporting cooperation within a large contractable population. Grief et al., ‘Coordination, Commitment, and Enforcement’, p. 773. Bueno de Mesquita & Stephenson, ‘Legal Institutions and Informal Networks’, p. 40. The five situations are (a) the arbitration agreement was not valid, (b) proper notice was not given to the party against whom a negative arbitral decision was made, (c) arbitral awards went beyond the issue scope defined in the arbitration agreement, (d) the composition of arbitral authority or the use of arbitral procedure was not in accordance with agreement of the parties, and (e) the award was not binding or had been set aside or suspended by a competent authority of the country where the award was made. Jian Han, Theory and Practice of Modern International Commercial Arbitration (Law Press of China, 2000). Bruce Bueno de Mesquita & Hilton Root, ‘When Bad Economics Is Good Politics’, in Bruce Bueno de Mesquita & Hilton Root (eds), Governing for Prosperity (Yale University Press, 2000), pp. 1–16; Bruce Bueno de Mesquita, Alastair Smith, Randolph Siverson & James Morrow, The Logic of Political Survival (MIT Press, 2006). Andrew Rose, ‘Do We Really Know that the WTO Increases Trade?’, American Economic Review, Vol. 94, No. 1 (2004), pp. 98–114. During the past three decades, various theoretical justifications for this model have been offered. See James Anderson, ‘A Theoretical Foundation for the Gravity Equation’, American Economic Review, Vol. 69, No. 1 (1979), pp. 106–16; Alan V. Deardorff, ‘Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?’, in Jeffrey A. Frankel (ed.), Regionalization of the World Economy (University of Chicago Press 1998), pp. 7–28; Elhanan Helpman & Paul Krugman, Market Structure and Foreign Trade (MIT Press, 1985). Population is included in the gravity model as a proxy for a country's market size. GDP here is the measurement of a state's capability to support exports and to demand imports. Distance is included as a proxy for transportation cost. http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/NYConvention_status.html (accessed July 2007). http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/NYConvention_status.html (accessed July 2007). Hans Smit and Vratislav Pechota, National Arbitration Laws (Juris Publishing, 1999); http://www.kluwerarbitration.com/ (accessed July 2007). They measure the directed bilateral trade volume during the previous year, whether the two sides within a directed trading dyad shared a land border, whether they ever were under the same colonial rule in history, whether they were under the same colonial rule after the Second World War, whether they shared a common language, whether they had a common currency and whether they had a generalised system of preferences and a regional trade agreement (RTA). Rose, ‘Do We Really Know that the WTO Increases Trade?’, p. 100. Daniel Berkowitz, Johannes Moenius & Katharina Pistor, ‘Trade, Law, and Product Complexity’, Review of Economics and Statistics, Vol. 88, No. 2 (2006), pp. 363–73. Rose, ‘Do We Really Know that the WTO Increases Trade?’, p. 98. The difference between civil law and socialist law is more about ideology than practice. Thus, for the purpose of this study, I treat socialist law as a subset of the civil-law tradition. John Merryman, The Civil Law Tradition: An Introduction to the Legal System of Western Europe and Latin America (Stanford University Press, 1985); John Merryman, ‘French Deviation’, American Journal of Comparative Law, Vol. 44, No. 1 (1996), pp. 109–19. For more details about why legal traditions constitute an exogenous momentum of domestic legislation on economic issues, see Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer & Robert Vishny, ‘Law and Finance’, Journal of Political Economy, Vol. 106, No. 6 (1998), pp. 1113–55; Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer & Robert Vishny, ‘The Investor Protection and Corporate Governance’, Journal of Financial Economics, Vol. 58, No. 1 (2000), pp. 3–27; Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer & Christian Pop-Eleches, ‘Judicial Checks and Balances’, Journal of Political Economy, Vol. 112, No. 2 (2004), pp. 445–70. Bruce Benson, ‘An Exploration of the Impact of Modern Arbitration Statutes on the Development of Arbitration in the United States’, Journal of Law, Economics, & Organization, Vol. 11, No. 2 (1995), pp. 479–501. Benson's study did establish the connection between the increment in domestic commercial activities and the ultimate legislation on arbitration in the USA. However, the increment in international trade rather than domestic trade is the concern of the current study. James Morrow, Randolph Siverson & Tressa Tabares, ‘The Political Determinants of International Trade’, American Political Science Review, Vol. 92, No. 3 (1998), pp. 649–61. Peter Leeson, ‘How Important is State Enforcement for Trade?’, American Law and Economics Review, Vol. 10, No. 1 (2008), pp. 61–89. Stephen Knack, ‘Governance and Growth: Measurement and Evidence’, Forum Series on the Role of Institutions in Promoting Economic Growth, Washington DC, 25 February 2002, pp. 1–36. For comprehensive criticisms of ‘first generation measurement of institutions’, see Edward Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, ‘Do Institutions Causes Growth?’, Journal of Economic Growth, Vol. 9, No. 3 (2004), pp. 271–303; and Adam Przeworski, ‘Some Historical, Theoretical and Methodological Issues of Identifying Effect of Political Institutions’, unpublished manuscript, Department of Politics, New York University, 2004. La Porta et al., ‘Judicial Checks and Balances’. Stare Decisis is a common-law doctrine under which judges are obligated to follow the precedents established in previous cases. International Chamber of Commerce, Rules of Arbitration, Article 35. Redfern et al., Law and Practice of International Commercial Arbitration, p. 483. Also see Mahmood Bagheri, International Contracts and National Economic Regulation (Kluwer Law International, 2000), ch. V, pp. 95–121. Karl Heinz Bockstiegel, Arbitration and State Enterprise: A Survey of National and International State of Law and Practice (Kluwer Law and Taxation Publishers, 1984). Bueno de Mesquita & Stephenson, ‘Legal Institutions and Informal Networks’, p. 40. The prosperity of commercial arbitration in the post-war era seems to prove the validity of Bueno de Mesquita and Stephenson's theory, because the development of commercial arbitration in this period is characterised by the rise of state-endorsed arbitration institutions at the cost of both court adjudication and traditional arbitration institutions. Following the same logic, the clause of public interest in the main body of the NYC could be the next point at which a reform effort may be initiated. Unlike the proposed reform of the commercial clause of the NYC, which could be realised by a unilateral effort by individual country parties, reform of the clause of public interest requires the collective efforts of the entire community of NYC country parties.