economics movement are arguably the dominant current challenge to more
traditional jurisprudential theories. Like other contemporary
philosophical theories of law, the law and economics movement purports
to offer a general theory of the nature of law as well as conceptual
tools for the clarification and improvement of its practices. As a
theory that claims descriptive accuracy, the theory of law and
economics is offered as the best explanation of how law actually
functions. As a normative stance it is argued that the tools of
economic reasoning offer the best possibility for consistent and
justified legal practices. In addition, as a research agenda the
combination of legal theory and economic reasoning tools has created
new and active research agendas such as public choice theory and the
application of game theory to legal issues.
1. Law as an Autonomous Practice
Most traditional theories of jurisprudence set out on a search for the
"essential" or definitive aspects of the institution of law. Two of
the most influential of answers to this question, answers that can
properly serve as representative, are legal positivism and Dworkin's
"law as integrity." While both of these philosophical answers differ
as to their definition of law and legal reasoning, they more
importantly agree upon some basic central assumptions. This agreement
in assumptions largely determines the answers that philosophical
investigations of the same kind, with largely the same aims, can
offer. Because of this it is important to acknowledge some of the
assumptions that are held in common by these jurisprudential stances.
First, both theories agree upon the conceptual nature of
jurisprudential enterprise. That is, both agree that it is important
for a philosophical theory of law to define the core or defining
aspects of proper legal practice in order to fulfill the function of
philosophical jurisprudence. In fact, much philosophical discussion of
law assumes that such a characterization is the essential aim of
jurisprudence. Second, it is believed that in order to arrive at a
properly analyzed concept of law the theories of both legal positivism
and law as integrity are best constructed from specific techniques
accepted within the traditions of analytic and linguistic philosophy.
These techniques include the investigation and clarification of the
way people commonly speak about law and careful parsing of aspects of
social practices that separate areas assumed to be clearly legal from
others thought non-legal. One important assumption held in common is
that the best way to understand legal practice is to understand the
necessary and sufficient qualities that make some rule or statement
into a law. Once such a set of necessary and sufficient conditions is
identified (or approximated) it is thought that the essential aspects
of particularly legal practices have been understood.
What the project of conceptual definition of law has tended to
conclude, though this is in no way necessarily implied by the above
philosophical tools and aims, is that law has features that make it
essentially different and unique. In other words, law is investigated
as an autonomous discipline with its own unique aims and
characteristics. The unique aim identified might be to protect rights,
to ensure justice or one of many other options. The unique
characteristics, in addition to possibly unique types of aims, might
be a distinct manner of reasoning or a different source of authority.
This theoretical agenda therefore results quite often in a picture of
law as an autonomous practice with aims, rules and logic unique to its
distinctive place in human relations. Instead of following this path,
theorists within the law and economics movement have attacked the
study of law from another angle. Rather than trying to identify unique
conceptual aspects of law, what is advocated is an investigation of
legal practices through the means of economic analysis. The conclusion
offered is that legal practice is best described by its purported
function as a social tool aiming at the promotion of economic
efficiency – something it has in common with other social practices.
2. Law as a Tool to Encourage Economic Efficiency
So, instead of looking for the unique and defining features of law,
the practitioner of law and economics looks at law as a social tool
and tries to evaluate it functionally. What is emphasized is not its
uniqueness as an institution, but its place within the general and
common economic structure of society. The descriptive claim most often
associated with law and economics is that legal practices are best
characterized as tools for encouraging economically efficient social
relations. To understand this claim it is important to examine some of
the basic concepts used in models of economic reasoning.
a. Basic Concepts in Economic Reasoning
Essential to an understanding of the law and economics movement is a
set of fundamental concepts. The most central assumption in economics
is that human beings are rational maximizers of their individual
satisfactions. This, in turn, implies that human beings respond to
incentives. A rational maximizer of personal satisfaction adjusts
means to ends in the most efficient way possible. It is important to
realize that economics, as understood here, is not restricted to
analysis of monetary issues; there are nonmonetary as well as monetary
satisfactions. Every potential satisfaction is implicated in the
calculus of economic satisfactions and therefore can be investigated
according to economic or means-end rationality and the trade-off of
costs and benefits. Normally what is aimed at through economic
reasoning is the improvement of efficiency.
A more efficient allocation is one that increases the net value of
resources. Efficiency in the allocation of resources is distinguished
from equity, which is concerned with justice in the distribution of
wealth. Because some people value specific goods higher or lower than
others, economic efficiency can often be raised through voluntary
transfers of goods. The most obvious example of an efficiency
promoting transfer is that of a freely entered into contractual
relationship. Because one party to the transaction values money more
than the item owned, and the other values the item owned more than the
asking price, the exchange produces a net gain in economic goods. Each
person ends up better off than before. Some economists have gone so
far as to argue that such a contractual exchange is often morally
optimal because it works both with Kantian and utilitarian theories of
morality. They argue that it works with Kantian theories because a
contract is thought to represent a good example of interaction between
free and rational agents. It works with utilitarianism because the
idea of wealth maximization intuitively seems to translate into more
utility. In any case economists have a variety of terms to describe
possible outcomes of economic exchanges. For instance "Pareto
optimality" is defined as a point where resources are allocated such
that no one is willing to trade further. As such Pareto optimality is
the eventual endpoint of a series of "Pareto superior" moves. A Pareto
superior change makes at least one person better of without making
anyone worse off. Because no one is worse off after the trade there
are no losers in Pareto improvements. Somewhat counterintuitively,
there may be many different Pareto optimal endpoints. Further, because
there are many obstacles to freely contracted exchanges (some will be
discussed below) economists have developed the concept of
"Kaldor-Hicks efficiency." Kaldor-Hicks efficiency, or "potential
Pareto superiority," results when the overall economic gains outweigh
the losses. In other words, the gains in economic efficiency are large
enough that the winners could, if they had to, compensate the losers
in the new allocation of goods and still remain better off.
b. How Law Can Encourage Economic Efficiency
As stated above, the descriptive claim made by proponents of the law
and economics movement is that law is best understood as a tool to
promote economic efficiency. But how can the institution of law help
encourage efficient transactions? One way is to help avoid situations
that lead to market failure. An obvious example of market failure is
the existence of monopolies. A functional monopoly enables one party
to extract more profit from a good than a healthy market would allow.
Law can be used as a tool to ensure that monopoly situations are hard
to bring about and maintain. Another way legal systems can be used to
ensure economically efficient transactions is through the enforcement
of valid contracts. By ensuring compliance with contractual terms
courts can give parties to a contract the expectation that the other
party will have good reason to fulfill the agreed-to obligations. This
becomes especially important in situations where the parties must
complete their obligations at different times.
But some types of market failure are less obvious, and the legal means
toward remedying them subtler. One problem in market transactions is
that of externalities. An externality is a cost not reflected in the
market price of a good. For instance, a factory may not have to
internalize the costs it imposes upon the environment into the selling
price of its goods. In this case the market price of the good will not
reflect its real cost – and therefore some of the costs are imposed
upon parties in an involuntary manner. In light of this possibility
Pigou argued that to internalize the externalities legal means should
be used to impose a marginal tax upon the offending party. The
economist Coase argued that this conclusion, while warranted in
specific cases, was too global. In fact, Coase argued that in a market
where transactions are costless and people do not act strategically
rights assignments are irrelevant because from any starting point the
results will be economically efficient. In other words, the Coase
Theorem states that if there are no transaction costs the assignment
of entitlements will be irrelevant to the goal of allocative
efficiency. In such a situation there will be no need for law to
internalize costs because people will bargain to the most efficient
possible allocation of goods. But outside of conceptually ideal
markets there are always transaction costs such as information costs,
opportunity costs and administrative costs. And if transaction costs
are somewhat high, then it does matter how property rights are
assigned. Therefore the enforcement and allocation of legal
entitlements will be an important factor in ensuring economically
efficient exchanges. So law can be used to encourage economic
efficiency. But is all law best described in economic terms?
c. Can All Law be Explained as Economic in Nature?
It may be no real surprise that law often is used to encourage
efficient exchanges. But it seems a stretch to claim that law as an
institution is best completely described in economic terms. It seems
counterintuitive to view all law as based upon market principles. One
of the virtues of the economic analysis of law is that, contrary to
our unschooled intuitions, it can see such disparate areas as
contract, tort and criminal law as all based upon economic aims,
therefore giving law a more coherent basis than other theories can
offer. For instance Richard Posner argues that tort cases (or cases
involving "private" harm) can be seen as contractual by looking for
the hypothetical terms that the parties to the accident would have
agreed to in advance in order to bring about the "accident"
voluntarily. A more obvious example is the assumption that criminals
are deterred by the threat of punishment only if the likelihood of
punishment multiplied by the quantity of punishment exceeds the gain
offered by the specific criminal act. Scholars have been quite
effective in extending the tools of economic analysis into areas that
seem upon first inspection to be anything but economic in nature. Even
rules of evidence and legal ethics have proved amenable to economic
analysis. But it may be argued that an economic explanation of law
fails as either a descriptive analysis of law (for example because it
doesn't do justice to everyday conceptions used within law) or as an
analytical analysis of the necessary conditions for the practice of
law to exist (for example economic analysis may not be able to account
for the "internal point of view" which Hart thought so central to a
proper understanding of law). More "analytical" approaches to economic
analysis of law have considered this a fatal flaw in the project (see
Coleman 2001). This may be mistakenly importing traditional
philosophical aims into a drastically different project, but the truth
is that it is often hard to tell what types of theoretical claims are
being made within law and economics. If the claims are of exhaustive
descriptive accuracy or of the necessary and sufficient conceptual
foundations of law then it is more than likely a failure. But whether
or not law and economics analysis should be taken as offering an
accurate or even conceptually necessary description of law as a social
institution, and whether or not is suffices as a complete analysis of
law, it could be argued that law should in any case adopt economic
efficiency as the central aim animating judicial decision-making.
3. Economics and Normative Jurisprudence
It may be the case that though analytically incomplete economic
analysis models the actual results of legal institutions better than
any other theory. Even so, this would not entail that law ought to be
consciously used for such an aim. Might not law be better used to aim
at issues related to "Justice," "Duty" or the like? Advocates of a
normative jurisprudence of law and economics have argued against such
a conclusion. The arguments usually are of two types. First, it is
claimed that meanings of words such as "justice" or "duty" are so
vague and in dispute that the use of such concepts for a basis of
judicial decisions offers no guidance whatsoever. Further, it is
argued that while such concepts are unhelpfully complex, the tools of
economic analysis and the concept of economic efficiency are
sufficiently clear to provide the judge a solid and predictable basis
of decision. One further point often made here is that law is better
able to allocate according to efficiency rather than justice or duty
due to limitations of institutional competence. This might be so if
issues of justice are so complex as to necessitate the ability to
cognize information that courts are structurally incapable to
recognize. Second, it has been argued that because the paradigm case
of justice is the freely entered in to contract, law is best seen as a
tool to optimize contractual arrangements. If this is so, then where
law can help is in situations where transaction costs are so high as
to prohibit efficient contractual relationships. Here Posner argues
that law can encourage economic efficiency by assigning property
rights to those parties who would have secured them through market
exchange if transaction costs were lower. In other words law should
bring about allocations that mimic the results of a properly
functioning market. In addition, advocates of the application of
economic analysis of law claim that other jurisprudential traditions
seem to be unable to make: that the analytic tools offered by law and
economics has encouraged the further creation of other productive
areas for analyzing law (see Posner 1998).
4. Later Developments
Another argument for the fertility of the economic analysis of law is
that it has spawned a number of further tools that seem analytically
helpful for understanding legal institutions. Three of the most
important of these are the results of behavioral economics, game
theory and public choice theory.
a. Behavioral Economics and Law
Practitioners of behavioral law and economics examine human limits to
means-end rationality. One of the many results of behavioral economics
is the concept of "bounded rationality." Bounded rationality means
that information is not processed according to a model of perfect
means-end rationality but, to the contrary, is distorted due to limits
of our cognitive abilities. For instance the "endowment effect" is
thought to be a behavioral limit that distorts the proper valuation of
property (which is an important aspect of bargaining to efficient
outcomes). According to such an effect, the actual ownership of
objects creates an irrational cognitive overvaluation of such objects.
Another claim is that our cognitive abilities are distorted by the
"availability heuristic." According to this the availability of strong
imagery may induce us to over or underestimate the actual probability
of events associated with the image. For instance, graphic
representations of highly improbable harms might be more influential
on behavior and demand unjustified use of resources if in opposition
to statistical analysis showing another equally undesirable harm to be
more common and easier to avoid. Jurisprudential practices could be
significantly influenced by such results. For instance, judges might
be as irrationally influenced by the availability heuristic as other
human beings. Therefore victim impact statements might be important
correctives to the court if a well-presented defendant's presence in
the court skews judicial or jury-based analysis. An awareness of such
a cognitive failure could help adjust legal reasoning and its
conclusions accordingly. Finally, an awareness and exploitation of
universal cognitive limits might help legislators to design more
effective laws (see Sunstein 2000).
b. Game Theory
Game theory adds to economic modeling the phenomenon of strategic
action. Strategic actions are actions adopted because of the
competitive nature of many social transactions. Strategic action is
action that is adopted due to how the individual expects others to act
in response. So, for example, a person who wishes to buy an item cheap
would act disinterested so as not to signal his or her actual desires
to the seller. Addition of analytic tools dealing with strategic
action greatly strengthens the economic analysis of law. For instance,
the Coase theorem, to function properly, necessarily excludes
strategic action; cooperation is just assumed. But it seems apparent
that legal actions often are deeply implicated in and animated by
strategic motives. Common sense tells us that full open cooperation is
not always the best path to bringing about one's desired results. In
fact much of the bargaining invested in designing an effective
contract seems to be done in the shadow of potential strategic action
on the part of the contracting parties. Designing legal rules with an
eye to the possibility of strategic action helps ensure that the rules
will not create perverse outcomes. For instance, if the defendant's
privilege against self-incrimination were attached to a prosecutorial
right to encourage an inference of guilt from the silence the
privilege would be all but useless. Therefore, courts have not only
barred comment on the refusal to testify but also have required that
juries, on defendant's request, be instructed that no inference should
be made from such a choice (see Baird et al 1994). Further, the
understanding that legislators might have adopted specific wording for
a law based upon strategic motives may help direct the proper aims of
judicial interpretation. This type of claim, though, is often better
analyzed by the tools offered in public choice theory.
c. Public Choice Theory
The agenda set by those involved in public choice theory is centered
upon how the nature of the legislative process and collective decision
processes influence the nature of law. It is often described as the
application of economic models of decision-making and their results
(such as Arrow's Theorem) to the issues that traditionally occupy
political science. One claim made within public choice theory is that
a proper understanding of collective decision processes will help
judges understand their position within the system. For instance it
might be argued that if all collective decisions are unavoidably
influenced by those who get to frame the questions debated and the
order of voting (in other words that all collective decisions are
influenced by the agenda-setter) public legislation will need to be
interpreted differently than if it were a more neutral recording of
collective wishes. For example, such a theoretical result makes
problematic a court's reference to the intent of the legislature.
5. References and Further Readings
Ackerman, Bruce, The Economic Foundations of Property Law (Boston:
Little, Brown & Co., 1975)
Baird, Douglas, Robert Gertner and Randal Picker, Game Theory and the
Law (Cambridge: Harvard University Press, 1994)
Becker, Gary S., "Nobel Lecture: The Economic Way of Looking at
Behavior," 101 Journal of Political Economy 385 (1993)
Calabresi, Guido, The Costs of Accidents (1970)
——, and Douglas Melamed, "Property Rules, Liability Rules and
Inalienability: One View of the Cathedral," 85 Harvard Law Review 1089
(1972)
——, "Some Thoughts on Risk Distribution and the Law of Torts," 70 Yale
Law Journal 499 (1961)
Coase, Ronald, "The Problem of Social Cost," 3 Journal of Law and
Economics 1 (1960)
Coleman, Jules, "Efficiency, Auction and Exchange: Philosophic Aspects
of the Economic Approach to Law," 68 California Law Review 221 (1980)
——, Market, Morals and the Law (Cambridge: Cambridge University Press, 1988)
—–, The Practice of Principle: In Defense of a Pragmatist Approach to
Legal Theory (Oxford: Oxford University Press, 2001)
Cotter, Thomas F., "Legal Pragmatism and the Law and Economics
Movement," 84 Georgetown Law Journal 2071 (1996)
Farber, Daniel, and Philip Frickey, Law and Public Choice (Chicago:
University of Chicago Press, 1991)
Harrison, Jeffrey L., Law and Economics (St. Paul: West Group, 1995)
Horwitz, Morton, "Law and Economics: Science or Politics?," 8 Hofstra
Law Review 905 (1981)
Katz, Avery Weiner, Foundations of the Economic Approach to Law
(Oxford: Oxford University Press, 1998)
Landes, William and Richard Posner, The Economic Structure of Tort Law
(Cambridge: Harvard University Press, 1987)
Leff, Arthur, "Economic Analysis of Law: Some Realism About
Nominalism," 60 Virginia Law Review 451 (1974)
Miceli, Thomas J., Economics of the Law: Torts, Contracts, Property,
Litigation (1997)
Murphy, Jeffrie G. and Jules L. Coleman, Philosophy of Law (Boulder:
Westview Press, 1990)
Polinsky, A. Mitchell, An Introduction to Law and Economics (Boston:
Little, Brown & Company, 1989)
Posner, Richard A., Economic Analysis of Law (New York: Aspen, 5th ed., 1998)
——, The Economics of Justice (Cambridge: Harvard University Press, 1983)
——, Frontiers of Legal Theory (Cambridge: Harvard University Press, 2001)
——, "Gary Becker's Contributions to Law and Economics," 22 Journal of
Legal Studies 211 (1993)
"Symposium on Post-Chicago Law and Economics," 65 Chicago-Kent Law
Review 1 (1989)
Sunstein, Cass R., Behavioral Law and Economics (Cambridge:
CambridgeUniversity Press, 2000)
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