Complementarities between Long-Term Relationships and Short-Term Contracts: Case of Early Modern Japan

Abstract

This paper examines the interaction between formal and relational enforcement in early modern Japan, focusing on financial relationships between *Daimyo* (regional lords) and merchants. Due to class distinctions, loans from merchants to *Daimyo* lacked legal enforceability, while contracts among merchants were court-enforceable. Some merchants built long-term self-enforcing relationships with *Daimyo* (becoming *Tachiiri*), whereas others provided short-term formal loans to underfunded *Tachiiri*. We develop a model with two markets---one that matches *Daimyo* with merchants, and the other that matches underfunded *Tachiiri* with lending merchants---and identify conditions for their co-existence in equilibrium. The analysis shows that merchants value becoming *Tachiiri* for long-term gains, and that the opportunities for short-term formal lending enhance the sustainability of relational contracts between *Daimyo* and *Tachiiri*.