Question # The economic interpretation of law advances a bold thesis: this is that many areas of the law can be understood to be concerned with the promotion of efficiency. – Explain & Illustrate.
From its inauguration, a first claim of law and economics is that law tends to the promotion of economic efficiency. The efficiency-enhancing characteristics of the law have weakened over time and that during the 20th century law has progressively produced more rules that promote wealth redistribution instead of efficiency. Nevertheless, the application of economics to determine the efficiency-promoting tendencies of various legal rules remains a defining research topic for law and economics. The focus of this essay is not on the postulated efficiency-enhancing properties of particular legal rules, but rather this corollary question of the common law process itself and whether that process tends to the promotion of efficiency enhancing rules. The economic interpretation of law advances a bold thesis: this is that many, if not all; areas of the law can be understood to be concerned with the promotion of efficiency. The thesis has both a descriptive and a normative aspect. According to the former, analysis reveals that many legal rules in areas such as tort and contract in fact promote efficiency; while according to the latter, the theory forms a basis for the critique and evaluation of new legal rules and legislation. The arguments turn on concepts like efficiency, superiority, optimality, allocation and distribution.
This conception of efficiency suffers from serious problems, however. First, recall the formula just given, that a transaction is Kaldor-Hicks efficient if the gains to those who win from it are larger than the losses to the losers. Consider how those losses are to be reckoned. The only coherent measure available is the consent of each of the losers. So a transaction would be efficient only if the party losing out could have been fully compensated to its own satisfaction, while still leaving a surplus for the party benefiting from the transaction. It follows, however, that if any person affected by a transaction objects very strongly to being deprived against his will of an asset or entitlement, so that a very high level of ex post compensation would have to be offered to redress his grievance at being treated thus, then the efficiency of the transaction becomes doubtful.
Contrarian theorists have provided several theoretical arguments as to why the mechanisms of common law adjudication should not lead to the production of efficient rules. On the other hand, these articles do not seem to rebut the central empirical phenomenon to be explained: the apparent tendency of the common law to produce efficient rules over time, even if that tendency is weaker than in prior eras. While some of these authors provide some isolated examples where the phenomena they describe arguably explains inefficient rules, they do not seem to rebut the central claim of common law efficiency that the original generation of scholars sought to explain. Thus, it is not always clear whether they reject the premise that the common law tends toward efficiency or whether they accept the proposition but not the models that had been offered to explain it.
Richard Allen Posner (born January 11, 1939) is currently a judge on the United States Court of Appeals for the Seventh Circuit in Chicago and a Senior Lecturer at the University of Chicago Law School. He is an influential figure in the law and economics movement. Posner’s initial foray into a positive explanation for the tendency of law to promote efficient rules postulated that this tendency arose from the preferences of common law judges for efficient rules. These preferences may arise either because judges affirmatively choose to prefer efficiency as a normative value over alternative values (such as wealth redistribution or some measure of social egalitarianism) or alternatively because even if judges theoretically prefer the pursuit of other normative values they nonetheless pursue wealth maximization as the most practical to accomplish, as if by an implicit process of elimination where judges find other goals to be unattainable in light of the constraints of the judicial process.
Second, Pareto efficiency provides the usual starting point for discussion of this subject. A distribution of resources (or opportunities or entitlements) is Pareto optimal (or efficient) if any further change would not make even one person better off and would make at least one person worse off, judged both times by the person’s own standards. To understand what this means, suppose there are only two people (A and B) affected by a transaction which consists of taking an asset away from A and giving it to B. The change is Pareto superior if B compensates A fully for that loss, and is still better off him. Likewise, a change which affects numerous people is Pareto superior if all potential losers from the change have been fully compensated, and the gainers are still better off because of it. A distribution is Pareto optimal (or efficient) when all such mutually beneficial exchanges have been fully exhausted.
However appealing the notion of Pareto efficiency might seem, it is not very useful. Hardly any transaction in the world – perhaps none –satisfies the criterion of Pareto superiority. Almost every transaction affects countless parties, at least some of whom are made worse off because of it. At the very least, almost any transaction changes the pattern of demand for the resource exchanged (by satisfying someone’s demand for it). It thus affects the market price of that resource, thereby reducing the prices of identical or substitutory goods and adversely affecting the suppliers of those goods. Further, given that few Pareto superior transactions can be made, it follows that almost any state of affairs is Pareto optimal: ‘What is, is Pareto optimal’! Not much guidance can be gained about the real world from a set of criteria which outlaws virtually every transaction, and which validates almost any distribution of resources.
And finally, the wealth maximization framework relies on Kaldor-Hicks efficiency which relies on hypothetical compensation rather than actual agreed-upon compensation as the yardstick for efficiency. If subjective value is important, however, then judges may have no idea how much people value outcomes, so this conceptual move from Pareto optimality to Kaldor-Hicks efficiency is not defensible. Indeed, attempting to measure net willingness to pay at most only makes sense with a given legal system and allocation of rights, and that if one changes a legal system one changes net willingness to pay associated with different outcomes. One changes the distribution of property rights the economically “efficient” outcome can change leading to a non-commensurability of different regimes, even within the same system under two hypothetically different property right allocations. In addition, the assumption that one can assume away the relevance of wealth effects is untenable to the extent that wealth distributions change individual budget constraints and because of the diminishing marginal utility of wealth.
Instead, in order to promote economic efficiency it arguably follows that the role of the judges and the law should be to establish a clear, predictable legal framework that encourages consensual exchanges with a minimum of judicial intervention beyond enforcing consensual contracts. (Aranson 1990). Acknowledging the presence of subjective value suggests that where possible the law should seek to promote voluntary market-based exchanges, such as by the use of property rules versus liability rules in many situations or a broader use of injunctive remedies that promote subsequent bargaining rather than damages as remedies.
Significantly, a difference was drawn between the critical ends of the law, and the methods it adopts in attempting to achieve those ends. It was pointed out that the three benchmarks so far considered are about means not ends, and therefore, that their invocation is entirely question begging unless it can be connected to a clear statement of the ultimate aims the law is attempting to attain. Only in that case would we be able to evaluate the productivity of Finch’s analysis in helping us understand the law’s efficiency in attaining those ends. Her fairness level provides a suitable candidate – as noted, fairness can undoubtedly serve as a substantive goal of the law. In view of this, her discussion of fairness bears a heavy analytic burden. So finally in this review, that is what we must consider. There are two proposals about how to bring about these goals. Now it is obvious that no proposal can be operationalised and implemented costlessly. Some resources will inevitably be consumed simply in putting in place any such proposal, and in maintaining it in operation. Remember also that most resources are scarce. So the more resources that are consumed in implementing a particular scheme, the fewer that will be available for other
Worthwhile objectives. It follows that if there are two methods of bringing about a certain goal in these circumstances, we must choose the method which is less costly to implement, other things being equal. Any other decision would amount to wasting resources, since the same objective could have been attained and in addition, a surplus would be available for application towards other valued goals. This waste is morally objectionable, then, to the extent that the
Attainment of those others goals is morally desirable. This provides an understanding of transaction cost efficiency. A method of implementing a set of substantive goals is efficient in this way when the resources it consumes in the process of implementation are lower than would be consumed by adopting any other feasible method of implementation. Put differently, a method is efficient, given a particular amount of resources dedicated towards implementation; when it can be operationalize the set of Substantive goals to a greater degree than would be possible for any other feasible method.
We must conclude that efficiency in itself does not provide a goal that any area of the law should aim at. It creates no sufficient reason for the law to be one way rather than another. This shows why efficiency concerns law to be one way rather than another. But note the emphasized qualification that efficiency does cannot be on par with fairness concerns, which do create good reasons goals for the law. Here is how this is to be understood for the not ‘in itself’ provide any goals for the law. Here is how this is to be understood.
To sum up, efficiency in itself does not provide a goal that any area of the law should aim at. It creates no sufficient reason for the law to be one way rather than another. This shows why efficiency concerns cannot be on par with fairness concerns, which do create good reasons for the law to be one way rather than another. But note the emphasized qualification, that efficiency does not ‘in itself’ provide any goals for the law. Here is how this is to be understood.
Bailey, Martin J. and Paul H. Rubin. 1994. A Positive Theory of Legal Change. International Review of Law and Economics 14: 467-477.
Claeys, Eric R. 2010. Jefferson Meets Coase: Land-Use Torts, Law and Economics, and Natural Property Rights. Notre Dame Law Review 85(4): 101-164.
Fon, Vincy and Francesco Parisi. 2006. Judicial Precedents in Civil Law Systems: A Dynamic Analysis. International Review of Law and Economics 26: 519-535.