Empiricist Approach to Incomplete Contract Theory

Abstract

Maskin and Tirole (1999a) lamented research findings of incomplete contracts studies as “hopelessly unrealistic”. Reason is that economics didn’t make progress toward modeling bounded rationality. Economics of empiricism is built on Hume’s epistemology (Hume, 1739). Sympathy-consent process, such as trust, determines actions of exchange. Price becomes a part of sympathy-consent process. Market is what to build and what changes ceaselessly. Market is not what is given at the outset, unlike the premise of rational agent model (Arrow and Debreu, 1954; Arrow and Hahn, 1971). Rational agent model cannot avoid a dilemma when addressing real life problems like asset specificity, relational contracting, hold-up, indescribability of contingencies and incomplete contracts. Inductive reasoning of empiricist approach combines with deductive reasoning of value-cost rationalist approach to build the integrating analytical framework of economics. It opens gateway to the economics of bounded rationality and resolves the dilemma.