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The Substituting and Complementing of Formal and Informal Enforcement Mechanisms

This paper argues that formal and informal enforcement mechanisms not only substitute but also complement each other in fostering cooperation. Our central tenet is that whether protection or punishment is the more effective formal mechanism to promote cooperation hinges on the configuration of the informal enforcement mechanisms of trust and time horizon. We argue that trust and time horizon have conjoint influence on one's fear of being a sucker and one's greed for gains from free-riding. As such, different configurations of trust and time horizon lead to different relative intensities of greed and fear. How the strength of one compares to that of the other therefore determines whether the need for punishment or protection prevails. We conduct a public goods experiment to test these propositions. We contribute to the literature by pointing out that there might be a unique optimal match between formal and informal enforcement mechanisms. Specifically, one set of formal institutions may be more effective in a particular economic situation than in another.