Economic Analysis of Law

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Economic Analysis of Law

• http//www.daviddfriedman.com/Academic/Course_Page
  s/
• L_and_E_LS_09/Law_and_Econ_09.html

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Mechanics

• Midterm
• Final
• One Case, past or present
• That wasnt argued on economic terms
• And isnt in my book or Posners
• Brief oral or written presentation
• Supporting one side using economic arguments
• Due in or after the week in which the relevant
  part of the law is discussed.
• Readings
• My book
• At least one article, perhaps a few

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What is Economics

• Not a particular set of boring but important
  issues
• Inflation
• Unemployment
• Things having to do with money
• But
• A way of understanding behavior
• Based on the assumption of rationality
• Meaning that individuals have objectives
• And tend to choose the best way of achieving
  them.
• Not that they are perfect cold blooded
  calculators.
• Examples
• Rational baby
• Rational cat
• Rational genes

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Lessons

• Rationality doesnt have to come from calculation
• It might be produced by evolution (babies and
  cats)
• Or selection (CEOs).
• Or trial and error (my route home).
• The assumption doesnt have to be entirely true
  to be useful
• People make mistakes, but
• Unless you have a theory of mistakes
• It may make sense to assume rationality and allow
  for sometimes being wrong.
• You might know yourself well enough to do better
  than that.
• But it is still the best theory for
  understanding other people.
• For one theory of mistakes, see the article on
  economics and evolutionary biology on my web
  page.
• For an account of some predictable mistakes, see
  Nudges

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Layers of Rationality

• Physics problems often assume a vacuum
• Because the analysis is much easier and
• Often the result is almost right
• Although firing canon in a vacuum has some
  practical problems
• Suppose you wanted to include air resistance
• It's still the same theory, just more complicated
• The air resistance is due to interaction with
• Small canon balls called air molecules
• Moving in a vacuum!
• Similarly for rationality
• Simplest version People make the right decision
• If information costs are central to the problem,
  however
• People are assumed to make the right decision
• About how to decide
• Which includes being ignorant if the information
  isn't valuable to them
• For instance voting your shares of stock
• Or for President of the U.S.
• In either case, with near zero chance that you
  will affect the outcome.
• If commitment strategies are central to the
  problem

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What does it have to do with law?

• Law as incentive
• If we have this law
• And rational individuals take it into account in
  deciding how to act
• What will the consequences be?
• Which is relevant to
• Explaining why the law is what it is
• Recommending what the law should be

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Law as Incentive

• If we have this legal rule, how will people
  behave?
• Consider expanded discovery in civil litigation
• An incentive not to keep some kinds of records
• Maybe not to ask some questions
• Also a way of raising costs to your opponent
• Consider making homeowners civilly liable for
  injuring robbers
• It might make them less likely to use deadly
  force, or
• More likely
• Consider civil forfeiture
• Might make innocents more careful about how their
  property is used, but
• Might also give law enforcement agents an
  incentive to target valuable property.
• Bensons result on the effect of legal changes.

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• So economics provides a way of predicting the
  consequences of law
• Assuming rationality of potential criminals, but
  also of
• Litigators
• Cops,
• Forward not backward looking
• The central question is not how ought the mess
  to be settled but
• How will the way we settle this mess affect the
  behavior of people in the future
• Clean up your own mess as an economically
  efficient rule.
• Its less work for me to clean up my small
  childs mess
• Than to make him clean it up
• But
• I cooked, Im tired, shouldnt my roommate clean
  up?

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Predicting what the law will beExplaining what
it is

• Posner conjecture
• Common law legal rules are designed to maximize
  the size of the pie
• Wealth maximization aka economic efficiency.
• Which will be explained and discussed in more
  detail later.
• Why would it be true?
• It is one of the few good things judges can do,
  so they do it?
• Because of some invisible hand mechanism?
  Inefficient rules lead to litigation which leads
  to a change in the law?
• Neither is very convincingwill come back to them
  at the end. But
• Has created a project that has played a central
  role in law and econ
• Figure out, in each case, what legal rules would
  maximize efficiency
• Compare it with the legal rules that exist
• In the final chapter I try to sum up the evidence
  on whether the conjecture is true, but
• True or false, it has led to a lot of interesting
  work.

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Recommending what the law should be

• If you think economic efficiency is a reasonable
  thing for the law to aim it
• Then you can reverse the argument above
• Figure out what the law should be and if it isnt
  try to change it.
• If you have some other objective
• Figure out the consequences of legal rules
• So as to find the ones that best achieve it

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I Predicting ConsequencesII Predicting
LawIII Recommending Law
The Three Projects

• The first is the least disputablefigure out
  consequences
• The second is an empirical conjecture
• The third is a normative project, ought not is,
  but easily confused with the second.
• One could believe that the law is efficient but
  shouldnt be, or isnt but should be.

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One Interesting Feature

• This approach tends to unify law
• We see the same economic analysis appearing
• Across all the standard categories
• When you understand contract you understand tort
• And property
• And
• To what extent was that true of your first year
  classes?

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Law, economics and justice

• Many people think law can best be explained and
  judged in terms of justice
• The approach in this book almost entirely ignores
  such considerations
• Most strikingly, in maximizing the size of the
  pie, we
• give the same weight to costs and benefits to
  criminals as to costs and benefits to victims
• In part because deciding who is a criminal
  requires a theory of what the law should be
• Which is one of the things we are trying to
  produce
• In part because one interesting result of the
  project is seeing how much of what we think we
  favor because it is just in fact is efficient.
• And in part because I dont think we have an
  adequate theory of justice.

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What Economists Can Learn From Law

• Abstract theory can make quite serious mistakes
• PropertyI own the land or I dont own the land
• ContractI agree to do X
• Looking at the real world application of the
  theory may highlight those mistakes
• Just what rights do I own with regard to the
  land?
• What is a contract, what counts as a violation,
  what are the penalties?
• And sometimes the result is better theory
• Coases The Problem of Social Cost
• Came in part out of Coase looking at law cases
  and
• Demonstrated that the approach to externalities
  accepted by economists was fundamentally wrong
• Making it one of the most cited articles in
  modern economics
• Stiglers story about Coase at Chicago.

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Road Map to the Course

• Two approachesorganized by economics or by law.
  Do both.
• First half by economics
• Midterm
• Second half by law
• Extra stuff
• Some Very Different Systems of Legal Rules
• The Tort/Crime puzzle
• Is the Common Law Efficient?

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Organized by Economics

• Efficiency How do you define the size of the
  pie?
• Externalities
• Two approaches to understanding the problem
• Using the theory to design legal rules
• In particular, to decide who has what rights how
  protected
• For instance Property rules vs liability rules.
• Economics of risk
• Ex Post/Ex Ante enforcement
• Speed limits, or
• If you are in an accident you pay for it
• Game Theory
• Value of life

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Organized by Law

• Property
• Intellectual Property
• Contract
• Family Law
• Tort
• Crime
• Antitrust

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Extra Stuff at the End

• Some Very Different Systems of Legal Rules
• Saga period Icelandpure tort on steroids
• Kill someone, his relatives sue you
• Dont pay, you are now an outlaw
• It is legal to kill outlaws
• 18th c. England Criminal Law Without Cops
• Shasta Countynorms as a substitute for law
• The Tort/Crime puzzle
• O.J. Simpson was acquitted of the crime of
  killing his wife
• Then convicted of the tort of killing his wife
• Why do we have two systems of law to do the same
  thing?
• And why do they do them in different ways?
• Is the Common Law Efficient?

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What Is Economic Efficiency?

• We would like some way of evaluating legal rules
• Does this change help more than it hurts
• In terms of letting people achieve their
  objective
• Does it increase the size of the pie?
• The problem
• Any change in legal rules (or anything else)
• Affects lots of people in different ways
• Making some better off and some worse off
• Is there any way of summing?

• Marshalls answer
• Determine, for each person
• How much he would pay to get the change () or
  prevent (-)
• Sum those numbers
• If positive, an improvement

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Problems with Marshalls Solution

• We are judging value by actions but people may
  not know what is good for them
• Insulin to a diabetic is valuable
• And heroin to an addict
• And potato chips and spare ribs to me
• As shown by their actions
• We are only allowing for values to humans
• Perhaps there are things that matter whether or
  not they matter to people
• Redwood trees. Live oak in my back yard.
• Cant cut it down, but
• Would be happy if a lightning bolt did the job
  for me
• Mona Lisa?
• We are ignoring the different amounts of
  happiness measured by a dollar.
• Most obviously, rich vs poor
• Less obviously, ascetic vs materialist.

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Answers to Problems

• People may not always know, but what alternative
  is there on which to base legal rules?
• Someone else not only may not know what is good
  for me, he may not care. I care.
• Expertise I can always borrow.
• Other values
• Might be real, but
• Except as they are valued by people
• How are they going to affect human action?
• The tree cant sue.
• Rich/poor etc. Arguably the strongest.
• One answer is that courts dont have much power
  to redistribute.
• Consider a court that routinely favors poor
  tenants
• The result is to raise the costs of landlords who
  rent to them
• And ultimately to make housing less available or
  more expensive to poor people
• Consider Chapter 1 discussion of nonwaivable
  warranty of habitability
• Another version is that redistribution through
  the tax system makes more sense.
• Marshalls argument was that for most issues it
  averages out.
• Final answer is that it is much easier to see how
  to create institutions to maximize value than to
  maximize happiness
• Value to me is demonstrated, in comparable form,
  by market acts
• Every time I buy an apple

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Conclusion

• Considered as a normative criterion, efficiency
  is a proxy for utility/happiness
• Used because it is much easier to implement
• Both because dollar value is easier to measure
  than utility
• And because it is easier to see how to create
  rules to maximize it
• As we will see
• And the legal rules that maximize it are usually
  close to those that would maximize happiness.
• Considered as a predictive criterion, efficiency
  is probably better than happiness
• What affects legislatures is how much money they
  are offered to vote for a bill
• What affects litigation is how much people are
  willing to spend
• Only if judges are deliberately trying to do good
  might happiness make more sense, assuming they
  could separately maximize it.

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Note for Econ Students

• Two other concepts of efficiency are in the
  textbooks
• Pareto efficiency
• Hicks/Kaldor efficiency
• For the reasons I dont use either, see my webbed
  price theory chapter on efficiency. The link is
  on the class web page.

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Alternative Criteria?

• Can you offer a better general criterion of
  goodness?
• How would you operationalise it?
• Note that economic analysis of law doesnt
  require efficiency
• It is an interesting conjecture
• Perhaps an attractive normative criterion
• But the same tools could be used for other
  purposes
• Can you think of an alternative conjecture about
  what the law maximizes?

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How to Maximize Efficiency

• Not the court should decide who should win each
  case according to which outcome maximizes the
  efficiency for those people
• Most of the time, the court is just shuffling
  money
• Or imposing punishments, which are costly.
• But
• The court should establish those rules that
  result in people acting in the way that maximizes
  efficiency.
• Punish me for pushing my uncle off the cliff
• Not because that makes me or my uncle better off
• But because it saves future uncles from their
  nephews
• And murder is usually inefficient
• My uncle loses money, I get it

• He Loses a life, I dont get it

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Starting point Property, trade, laissez-faire

• Every object moves to the person who values it
  mostlike apples.
• Objects get produced if and only if the summed
  value to those who most want them is greater than
  the summed value of the inputs.
• Lots of complications in working out this
  argument to show that the result is efficient
• Which some of you have seen before. If not
• You can read my price theory book, or someone
  elses
• But we will let the short argument stand for why
  it is true
• And worry instead about why it isnt.

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Implicit Assumptions

• Only voluntary transactions.
• Exceptions include not only crime but also
• Torts and even
• Perfectly legal acts.
• Transaction costs
• We are assuming that if a transaction would
  benefit both parties, it happens
• Suppose we decide, because of worries about
  global warming, that one can only produce CO2
  with permission from everyone affected.
• Letting me (and you) exhale is surely efficient
• But consider the transactions needed to get
  permission

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Next Week Externalities

• Suppose my action imposes costs on you
• I do it if benefits to me are larger than costs
  to me
• But if benefits to me are less than costs to both
  of us
• Doing it is inefficient
• Suppose my action provides benefits to you
• I might not do it if benefits to me are less than
  costs to me
• Even if benefits to both of us are larger than
  costs.
• How can we set up legal rules that make it in my
  interest to do it only if there are net benefits?