Avner Greif	  	 Paul Milgrom	   Barry Weingast
Stanford University

	The process of European economic growth from the eleventh to the fourteenth centuries 
is best described using the words of the great economic historian Robert Lopen as "The 
Commercial Revolution of the Middle Ages."  Economic growth was based upon commercial 
expansion.  Many studies have outlined the nature of this commercial expansion and the 
associated development of trade practices.  For this commercial expansion to be possible, 
however, institutions capable of mitigating contractual problems associated with long-
distance trade were required.  The operation of these institutions was more important than 
might be inferred from a simple reading of the historical record.  The effectiveness of 
institutions for deterring breach of contract might best be judged like that of peacetime 
armies - by how little they are used.  In reading the historical record to determine whether 
institutions like the merchant gild were created largely to ensure contract compliance, the 
number of instances of enforcement is not a useful measure.  Instead, one has to ask:  What 
were the things that threatened, and on occasion thwarted, efficient trading?  Can details of 
these institutions be explained as a response to those threats?  What triggered major changes 
in these institutions?  Were changes in structure followed by important changes in trading 
relations, especially by improved contract compliance?
	A comprehensive analysis of an enforcement institution must consider why it was 
needed, what sanctions were to be used to deter undesirable behavior, who was to apply the 
sanctions, how the sanctioners learned or decided what sanctions to apply, why they did not 
shirk from their duty, and why the offender did not flee to avoid sanction.  Some full game-
theoretical analyses according to these criteria have been developed.  Greif (1989) has 
analyzed the institution that governed the relations between merchants and their overseas 
agents in the eleventh century Mediterranean trade.  To reap the benefit of employing 
overseas agents, a specific group of merchants, known as the Maghribi traders, organized 
agency relations with a "coalition" whose members ostracized and retaliated against agents 
who violated their commercial code.  Interrelated contractual arrangements assured proper 
incentives, while close community ties assured that each member had the necessary 
information to participate in sanctions when necessary.  Milgrom, North and Weingast 
(1990) have argued that the use of merchant courts in the Champagne fairs can be analyzed as 
an institution with proper incentives for gathering information, honoring agreements, 
reporting disputes, and adhering to the judgments of the merchant courts.  Moreover, by 
centralizing certain record keeping functions and effectively permitting only merchants in 
good standing to remain at the fairs, this institution also achieved significant transaction 
costs economies relative to other feasible enforcement institutions.
	The papers we have just cited provide consistent analyses of institutions used to 
overcome contractual problems between individual merchants active in long-distance trade.  
The merchants, however, were not the only important parties;  the trading centers where the 
merchants met and brought their goods were an important independent force.  This paper is 
concerned with the institutional arrangements that surmounted the commitment problem 
associated with the relations between a ruler and alien merchants.  It develops a theory to 
explain how the attributes of the institutions that mitigate the ruler's commitment problem 
affect the possibility of trade expansion.  This theory is applied in a preliminary historical 
study of the medieval Merchant Gild.
	In his own territory, the Medieval ruler had the ability to abuse the rights of alien 
merchants using his coercive power.  In the age before the emergence of the "state," alien 
merchants could expect little military or political aid from their countrymen.  Without any 
institutional arrangements enabling a ruler to commit himself ex-ante, not to abuse alien 
merchants' rights ex-post, after the merchants had come to trade, the merchants were not 
likely to frequent that ruler's territory.  Thus, trade could not expand, leading to the 
deprivation of rulers and traders alike.
	Intuitively, one can conjecture that the rulers' commitment problem can be surmounted 
by bilateral or multilateral reputation mechanisms in which the threat of the merchants to 
impose an embargo on a trade center that abused their rights in enough to deter abuse.  
However, when the ruler-merchants commitment problem is modeled, this intuition is found 
to be inaccurate.  Simple bilateral and multilateral reputation mechanisms, without 
supporting institutions, lack the attributes required to overcome the commitment problem at 
the efficient level of trade.  Accordingly, the model is used to study the attributes required 
from institutions to support an efficient level of trade by supplementing the operation of 
multilateral reputation mechanism.  The multilateral reputation mechanism in which the 
merchants are to collectively punish a ruler who abused the rights of some of them to 
surmount the ruler-merchant commitment problem must be a part of an institution that has 
the ability to coordinate merchants' responses and to force all (or most of) the merchants to 
follow its decisions after the rights of some merchants were abused.  An institution with 
these attributes may enable trade to expand to its efficient level by surmounting the 
commitment problems.
	Bilateral and multilateral reputation mechanisms fail to surmount the commitment 
problem without supporting institutions since in the efficient level of trade the "value" to 
the ruler of the "marginal traders' trade" is "very low."  Thus the threat of future boycott by 
these marginal traders would not prevent the ruler from abusing their rights.  In other words, 
when the ruler-merchants relations are governed by bilateral or multilateral reputation 
mechanisms there is no sub-game perfect equilibrium in which the ruler's :promise" to 
respect the rights of the merchants in the efficient level of trade is credible and hence trade 
can not expand to its efficient level.  On the other hand when a multilateral reputation 
mechanism is supplemented by a "coordinating" mechanism, that is, a mechanism that 
coordinates the responses of all the merchants to the abuse of the rights of some merchants, 
the commitment problem can be overcome.  There is a sub-game perfect equilibrium in which 
the ruler's "promise" to respect the rights of the merchants is credible in the efficient level of 
trade.
	When a coordinating mechanism exists there is an equilibrium in which the 
commitment problem is surmounted.  It is the efficient equilibrium but not the only 
equilibrium possible.  Accordingly, we use the notion of re-negotiation proof to evaluate the 
plausibility of this equilibrium and ascertain that it is not a plausible equilibrium.  
Intuitively, the coordinating institution's threat to punish a ruler by declaring an embargo if 
he ever abuses rights is not credible since some merchants will find it to their advantage not 
to respect the coordinating institution's embargo decision.  If the number of these merchants 
is large enough, the embargo threat is not credible and the commitment problem can not be 
surmounted through a coordinating institution.  Thus, to overcome the commitment problem 
there is a need for an institution that also possesses "internal enforcement" attributes.  That 
is, an institution that has the ability to force its decisions regarding their relations with 
rulers upon the merchants.
	The historical analysis of the commitment problem led us to advance the hypothesis 
that during the late Medieval period a specific institution, the Merchant Gild, functioned as a 
nexus of contracts that surmounted the ruler-merchants commitment problem by supplanting 
the operation of multilateral reputation mechanism with its ability to coordinate and enforce 
merchants' responses.  The core of a Merchant Gild was a society of merchants organized on 
territorial bases with some regulatory power over its members.  This regulatory power over 
its members.  This regulatory power could not be subdued by the ruler, usually because the 
Gild's territorial bases were out of his reach.  The Gild governed the relations between an 
individual merchant and rulers of regions outside the Gild's territorial bases, and the relations 
between the merchants themselves.  The Gild established procedures for information 
gathering and transmission that coordinated the responses of all the merchants in cases 
when the rights of some of them were abused abroad.  The gild used its power to regulate 
merchants' activities in its territorial bases to insure its members' obedience to the Gild's 
decisions.  In particular, it insured that all merchants observe trade embargoes declared by 
the Gild against foreign rulers who had abused members' rights.  The Merchant Gild appeared 
during the late Medieval period in various forms -- the German Hansa, the English Gilds and 
some Italian and Germanic towns -- were Merchant Gilds.  They were merchant gilds because 
they provided the merchants with the mechanism required for coordination and internal 
enforcement.
	By fulfilling these functions of coordination and internal enforcement, the Gild enabled 
the merchants to collectively commit themselves to retaliate by never trading again in a city 
whose ruler had abused the rights of any individual member.  This collective credible threat 
increased the long-run cost of abusing traders' rights above the short run gains from abusing.  
Thus, it became known ex-ante that the best a ruler can do ex-post, after the alien merchants 
had arrived in his city, was to respect the merchants' rights.  Thus, the merchants could 
"trust" the ruler ex-ante and trade could expand.  The Gild was an institution in the sense that 
its operation constrained the ruler and the merchants by altering the payoffs associated with 
specific actions.  By channeling their choice of behavior, the Gild enabled them to commit 
themselves.
	To support the above hypothesis about the role of the Merchant Gilds in overcoming 
the commitment problem this paper provides historical evidence.  Since , in other times and 
places, the details of Gilds' organizations differed, we distinguish between three groups of 
historical evidence in our presentation.
	The first group contains evidence on the importance of the commitment problem, the 
role of reputation mechanism in overcoming it, and the relations between overcoming the 
commitment problem and trade expansion.  The relation between the credibility of the 
commitment to respect alien merchants' rights and trade expansion seems to have been clear 
to Medieval rulers.  For example, Edward the Third, King of England, declared in 1283 that 
because alien merchants did not receive the protection they had expected, "many merchants 
are put off from coming to this land with their merchandise to the detriment of merchants and 
of the whole kingdom."  Edward's words should be understood against the background of 
events like the one that occurred in Boston, England.  According to an enquiry conducted in 
1241, after a Flemish merchant accused an English trader of not repaying a commercial loan 
"   there was an uproar on all sides and the English merchants assembled to attack the 
Flemings, who retired to their lodging in the churchyard,...The English threw down the 
pailings, broke the doors and windows and dragged out Peter Balg [the lender] and five 
others, whom they foully beat and wounded and set in the stocks.  All the other Flemings 
they beat, ill-treated and robbed, and pierced their cloths with swords and knives.   Their 
silver cups were carried off as they sat at table, their purses cut and the money in them stolen, 
their chests broken open and money and goods, to an unknown extent, taken away, and their 
cloths pierced with knives."
	The historical records suggest that the evolution of gilds facilitated the growth of trade.  
For example, it was noted that the Catalan merchants' trade expanded "within only a few 
months" after they received, in 1286, privileges and the right to have a consul in Sicily.  
The trade of the German merchants in Bruges expanded after they had received privileges and 
the right to have a gild, called a Kontor  (establishment or office).  The fact that the Italians 
were able to secure their trade in Flanders only after they established gilds, called 'nations,' 
indicated the importance of these organizations in increasing the ability of the merchants to 
retaliate.
	The importance of reputation in providing protection to alien merchants is reflected, for 
example, in the agreement made in 1261 between Flemish merchants from different towns 
who were "associated with the buying of wool from abbeys" in England. The agreement 
reflects their decision that "if it should happen that any cleric or any other merchant 
anywhere in England who deals with sales of wool deals falsely with any merchant in the 
alliance   , by giving false weight or false dressing of the wool or false produce,...and if they 
do not wish to make amends, we have decided that no present or future member of this 
alliance will be so bold as to trade with them..."  Note the implied inability to seek justice in 
the local court and the use of collective economic sanctions to increase the cost of cheating 
any individual merchants.
	The second group of evidence contains information about the internal structure of Gilds, 
the contractual arrangements between Gilds and their members, between Gilds and the rulers 
of the Gilds' territorial bases, and between Gilds and rulers who controlled trade centers 
outside the Gilds' territorial bases.  The evidence indicates that the attributes of the Gild and 
its contractual arrangements were parallel to those found in our theoretical analysis to be 
required to overcome the commitment problem.  For example, the Flemish merchants whose 
agreement was quoted above recognized that some coordination is required to make the 
boycott functional and hence they "have decided that there will be in each of these cities one 
man to view and judge the grievances, and to persuade the wrongdoers to make amends."
	Simple coordination, however, was not usually sufficient and internal enforcement was 
required.  Historical evidence indicates that ignoring a ban could be very profitable and that 
gilds faced difficulties in insuring that trade embargoes would be respected by their members.  
In 1284 a German trading ship was attached and pillaged by the Norwegians.  The German 
towns responded by imposing an embargo on Norway.  The export of grain, flour, 
vegetables and beer was prohibited.  According to the chronicler Detmar, "there broke out a 
famine so great that (the Norwegians) were forced to make atonement."  The temptation for 
an individual merchant to smuggle food to Norway in this situation is clear.  To prevent 
smuggling and sustain the embargo, the German towns had to post ships in the Danish 
Straits.  The fact that the success of a trade embargo depended crucially on obtaining the 
support of virtually all of the individual merchants involved was also clear to the cities on 
which embargo was inflicted.  When, in 1358, the German towns imposed an embargo on 
Bruges, the city attempted to defeat the embargo by offering Cologne extensive trade 
privileges.
	Similar attention to the need to guarantee solidarity of incentives among merchants is 
also reflected in Flemish regulations for trade at the English fairs written in 1240.  "If any 
man of Ypres or Daouai shall go against those decisions [made by the gild]....for the 
common good, regarding fines or anything else, that man shall be excluded from selling, 
lodging, eating, or depositing his wool or cloth in ships with the rest of the 
merchants...And if anyone violates this ostracism, he shall be fined 5s..."  Placing ships in 
a strait and imposing fines are specific ways to overcome the distinct incentives problem.  
The evidence, however, indicates a variety of means through which the credibility of the 
threat to carry out an embargo was sustained.
	In England, for example, a gild had exclusive trade privileges in its own town, usually 
including monopoly rights over retail trade within the town, exclusive exemption from tolls 
and so forth, as well as the right to exclude under certain circumstances members from the 
gild.  The English gilds were thus able to provide their members with streams of rents in 
their home towns.  Receiving these rents, however, was conditional to following the 
recommendations of the gild as the Flemish regulations of 1240 illustrate.  A merchant who 
ignored the ban imposed by the gild on another town was expelled, losing his rent stream.  
Hence, the Gilds' exclusive rights should be understood as an integral part of a system that 
facilitated trade expansion rather than being simply monopoly rights that hindered trade.
	Finally, the paper provides a description of the evolution of a specific Gild - the German 
Hansa - during the thirteenth and fourteenth centuries.  This description illustrates that the 
evolution of this Gild is consistent with our theoretical analysis -- to overcome the 
commitment problem, for the ruler to commit himself to respect the merchants' rights, there 
is a need for an institution with coordination and internal enforcement abilities that control 
a sufficiently large number of merchants.  For historical reasons, in the basic organizational 
unit that coordinated the activities of German merchants abroad -- the Kontor --membership 
was not conditional upon residency in one particular town.  Any German merchant who 
arrived in a non-German city could join the local Kontor.  While the Kontor had the same 
function as the gild in coordinating the responses of the German merchants in disputes with 
the town, it lacked the enforcement ability against its own members.  This weakness, and the 
way it was overcome, is the essence of the history of the contractual relations between the 
German Kontor of Bruges, and the German towns.
	In 1252, a Kontor of the German merchants obtained extensive trading privileges from 
Bruges, and a permanent settlement followed.  Before long, however, the trading privileges 
given to the alien merchants in Bruges were continually abused and eventually the German 
merchants under the leadership of Lubeck retaliated in 1280 by transferring their trade from 
Bruges to Aardenburg.  After two years of negotiation, a new agreement was reached and the 
alien merchants returned to Bruges.  Only seemingly successful, the embargo failed to 
guarantee the property rights of the German merchants in Bruges, as the city simply ignored 
its agreement with them.  It should be noted, however, that Bruges did respect the rights of 
other alien merchants who frequented the city.  Our analysis points to the reason for that 
uneven treatment.  The embargo was not imposed by the German merchants but by the alien 
merchants in Bruges in general.  In particular, the important and well organized Italian and 
Spanish "nations" took part in the boycott.  While the lesson for Bruges from that episode 
was to respect the rights of those well organized nations, it soon became clear to the city 
that the German merchants were the "marginal" traders.  The Kontor was not capable of 
increasing the cost of abusing German merchants since it did not have the ability to enforce 
its own decision upon its members.  A main source of this inability was that the KONTOR  
embodied only the German merchants actually present in Bruges rather than all the potential 
German traders.
	Another embargo, from 1307 to 1309, in which only the Germans participated was 
required to force Bruges to respect its contractual commitments with them.  Between 1280 
and 1307 the ability of the German traders to coordinate their responses on the level of 
towns was enhanced as a consequence of the embargo they imposed in 1284 on Norway.  The 
towns collectively achieved for the first time the coordination needed to expel one of their 
members.  Hence, by 1307, the ability of the German merchants to commit themselves, to 
coordinate their actions, and thus guarantee Bruges's adherence to its contractual 
obligations, was rather advanced although it was still the local Kontor that organized the 
embargo.  Bruges respected the charters agreed upon in 1307 and 1309 and, consequently, 
Flanders' trade flourished and expanded for the next 50 years.
	It was not until the middle of the century, when the cost of providing security around 
Bruges rose drastically that a new level of cooperation among the German towns was needed 
to force Bruges to provide the security required to support trade.  The Hansa relations with 
Bruges deteriorated around 1350, mainly because Bruges was not ready to compensate the 
Germans for their damages in Flanders from the war between England and France.  The Hansa 
responded by strengthening its internal organization and held, in 1356, its first Diet  in 
which it was agreed that the Kontor of Bruges should be operated according to the decisions 
of the Diet.  The institution of the German Hansa was not crystallized and an Hanseatic trade 
ban followed in 1358.  It was announced that any disobedience, whether by a town or an 
individual, was to be punished by perpetual exclusion from the Hansa.  This time, 
recognizing the ability of Hanseatic towns to coordinate and internally enforce their 
decisions, the privileges were written, "in much detail as to prevent any one-sided 
interpretations."  The trade of Northern Europe prospered under the supremacy of the Hansa, 
and although the trade embargo of 1307 was not the last, later trade disputes seem to have 
been centered around distributive issues - the provision of trade privileges.  Commitment for 
security was no longer an issue.
	It is illuminating to compare the development of the Hansa among German towns with 
the rather different organization among the Italian cities.  The solid internal, political and 
commercial organization of the Italian cities and their prominence in trade enabled them to 
overcome the coordination and distinct incentive problems.  None of the cities were 
"marginal players" in the ports where they traded.  In contrast, the German Kontor was a 
local organization in a trading center which lacked the ability to enforce its decisions upon 
its members who came from various German towns.  The German towns themselves were 
small and, before the establishment of the Hansa, each of them was relatively insignificant 
in its trading relations.  For these reasons, overcoming the commitment problem required a 
trans-town organization.  As described above, these towns eventually formed the Hansa in 
order to present a more unified front against the cities where they traded.  The resulting 
increased security afforded to the merchants and their property contributed to increasing 
levels of trade in the regions.
	The historical application of our theoretical model is to the historical issue that led to 
the construction of this model, namely the study of ruler-merchants relations.  We contend, 
however, that the insights of this model can be used to highlight the essence of other 
institutions that throughout history advanced efficiency by enabling rulers to commit 
themselves.