Remittances and Reputations in Hawala Money-Transfer Systems: Self-Enforcing Exchange on an International Scale

By Schaeffer, Emily C. | Journal of Private Enterprise, Fall 2008 | Go to article overview

Remittances and Reputations in Hawala Money-Transfer Systems: Self-Enforcing Exchange on an International Scale


Schaeffer, Emily C., Journal of Private Enterprise


Abstract

Migrant worker remittances often take place outside the scope of government enforcement. Through an examination of the informal remittance transfer system of hawala, this paper argues that self-enforcing exchange mechanisms can support high volume trade in the absence of formal contract enforcement. Hawala networks employ ex post reputation mechanisms between agents and ex ante signaling to uphold obligations under conditions of contract uncertainty.

JEL Codes: D85, F33, G29, N25, P48, Z13

Keywords: Hawala, Self-enforcement, Remittances, Networks

I. Introduction

Trade flourishes when individuals have confidence that other members of society will honor and enforce obligations and promises. In countries where the rule of law is the modus operandi, contract law serves to provide confidence by constraining traders, enforcing breaches, and lowering transaction costs. However, when the machinery of law is not formally present, private arrangements often emerge to mitigate conflict and support cooperation. One finds examples of efficient private enforcement institutions throughout history and within the context of international trade (Landa, 1981; Bernstein, 1992; Grief, 1993; Stringham, 2003, 2004; Leeson, 2006). In lieu of state enforcement, private arrangements rely on alternative mechanisms to sustain cooperation.

Remittance networks provide a window into functional operations of self-enforcement. When a migrant worker residing in Saudi Arabia remits a portion of his earnings to his family in a remote Indian village, commonly he chooses the informal, illegal hawala network to do so. From the migrant worker's perspective, hawala will transfer funds at much lower cost than formal mechanisms.

Hawala is a set of money transfer networks in operation since ancient times, having emerged in the context where formal enforcement of internal transactions by rulers and governments was non-existent. As international trade began to emerge in South Asia in the 11th century, hawala networks soon became important to facilitating exchange. Moreover, diese networks continue to operate today, as they did in the past, relying on reputation mechanisms and signaling to sustain coordination despite their illegality in most countries.

The literature on self-enforcing exchange relationships focuses predominantly on sustainable transactions between a relatively small number of traders in periodic face-to-face exchange (Landa, 1981; North, 1990; Bernstein, 1992; Grief, 1993; Stringham, 2003, 2004). Among small groups of people, word travels fast. Reputations develop, and because of the low cost of communication among the group, all others in the group can use knowledge of past performance to punish a cheat. In this manner, ex post multilateral punishment mechanisms - such as ostracism - work well to ensure cooperation. As long as myopic individuals do not populate the group, defection is limited by the ability to detect and punish.

While Greif (1989, 1993) shows that reputation mechanisms functioned efficiently in earlier periods among similar peoples, the results of this line of research suggest that these mechanisms may only be effective in particular settings with particular groups (i.e., several dozen Maghribi traders). To reinforce this view, Milgrom, North and Wiengast (1990) attribute the transition from "simple" reputation mechanisms to third party enforcement to the increasing costs of keeping everyone informed: a requisite condition for reputation mechanisms to operate. It is possible that these costs may be systematically lower under particular conditions, under which the particulars of time and place would determine the extent to which reputation mechanisms could sustain trade. At some point, however, self-enforcing exchange among large groups breaks down as the costs of communication in large numbers become prohibitively high (Greif, 1989, 2002; Landa, 1994; Zerbe and Anderson, 2001). …

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