Contracts often require signatories to submit to binding arbitration. If a dispute arises, the parties don't go to court; they go to a private arbitrator. This arbitrator, in turn, makes a definitive ruling neither party can refuse. The whole point of binding arbitration is to bar parties from playing, "Heads I win, tails I break even": If the arbitrator rules against you, you can't appeal the decision to a conventional government court.
But the fundamental reason why this hasn't happened is that governments refuse to recognize fully binding arbitration.
Binding arbitration has thrived in recent decades. But on reflection, fully binding arbitration would nullify a vast swath of regulation. Every government effort to shift the terms of trade would be in grave danger. Imagine, for example, an employment contract specifying that alleged minimum wage violations will be resolved via binding arbitration. Any employer who wanted to offer less than the minimum wage could contractually specify an arbitrator who invariably rules in his favor. And any worker ready to work for less than the minimum wage would willingly sign. After all, what's the difference between the absence of a minimum wage and a minimum wage that's never enforced?
The same principle applies to all regulation of capitalist acts between consenting adults: safety regulations, discrimination laws, product liability, and so on. Want to work for me? Fine, as long as my brother adjudicates all our disputes. Parties who can contractually outsource enforcement to anyone they like can informally gut the law.
So why hasn't this already happened? Transactions costs are part of the reason; getting every trading partner to sign a contract is a pain in the neck. But the fundamental reason is that governments refuse to recognize fully binding arbitration - probably because its officials recognize, at least subconsciously, that fully binding arbitration would strip them of much of their power. The Legal Dictionary explains:
The FAA gives only four grounds on which a court may vacate, or overturn, an award: (1) where the award is the result of corruption, Fraud, or undue means; (2) where the arbitrators were evidently partial or corrupt; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing or hear pertinent evidence, or where their misbehavior prejudiced the rights of any party; and (4) where the arbitrators exceeded their powers or imperfectly executed them so that a mutual, final, and definite award was not made. In the 1953 case Wilkov. Swan... the U.S. Supreme Court suggested, in passing, that an award may be set aside if it is in "manifest disregard of the law," and federal courts have sometimes followed this principle. Public policy can also be grounds for vacating, but this recourse is severely limited to well-defined policy based on legal precedent, a rule emphasized by the Supreme Court in the 1987 case United Paperworkers International Union v. Misco...
The Legal Dictionary's tone suggests that these are but mild impediments. But they're huge. If the government can overrule binding arbitration because the arbitrators are "partial" or "manifestly disregard the law," arbitration's radical potential stays hidden.
Long ago, I interviewed the CEO of an arbitration firm. When I asked him about the radical implications of binding arbitration, he got nervous. His words were libertarian: "If you don't like the arbitration contract, don't sign." But he clearly wanted to change the subject. One of his key services was helping clients skirt the law - and the best way to continue providing such services was to pretend they didn't exist. I suppose I could have thanked him for mitigating the harm of a multitude of unjust and inefficient laws, but I think that just would have spooked him further.
Republished from EconLog.