International Institutions
Modelling arbitration

Recent expansion in international arbitration may be viewed as a move towards the creation of a transnational law by private traders, independently of national parliaments and courts. They develop common forms of communication: a language, a currency, standards and conventions, and a body of laws. New institutions formed to supply these public goods allow further expansion of trade and sow the seeds for future political transformations, as illustrated by the current debate within the European Community in which economic questions are strictly tied to the design of new `rules of the game'.

In Discussion Paper No. 721, Research Fellow Alessandra Casella identifies four essential features of international commercial arbitration: it relies on enforcement by the courts, but arbitrators have remarkable latitude in their decisions; it is particularly important in international transactions; it is essentially linked with heterogeneity of economic agents; and it is costly. She develops a theoretical model to show that highly productive traders' option to go to arbitration increases the size of the international market while increases in their productivity also increase the level of arbitration and hence its cost. Arbitration also permits restricting the courts to smaller, domestic disputes, while arbitration attracts the more important cases. It thereby denies courts access to those disputes necessary to develop a detailed and up-to-date law of commerce.

Finally, as international trade expands, the share of international traders preferring arbitration to the courts also rises. Arbitration becomes more costly, but the gap between the services provided by arbitrators and by the courts also increases, and the larger market and higher productivity more than justify the additional expenditure. Casella concludes that her model can explain current developments in international arbitration and can be extended to more abstract descriptions of the supply of public goods and changes in trade flows, which may be important to further research on international integration.

Arbitration in International Trade
Alessandra Casella

Discussion Paper No. 721, September 1992 (IT)