Law and economics

Law and economics,” also known as the economic analysis of law, differs from other forms of legal analysis in two main ways. First, the theoretical analysis focuses on EFFICIENCY. In simple terms, a legal situation is said to be efficient if a right is given to the party who would be willing to pay the most for it. There are two distinct theories of legal efficiency, and law and economics scholars support arguments based on both. The positive theory of legal efficiency states that the common law (judge-made law, the main body of law in England and its former colonies, including the United States) is efficient, while the normative theory is that the law should be efficient. It is important that the two theories remain separate. Most economists accept both

The second characteristic of law and economics is its emphasis on incentives and people’s responses to these incentives. For example, the purpose of damage payments in accident (tort) law is not to compensate injured parties, but rather to provide an incentive for potential injurers to take efficient (cost-justified) precautions to avoid causing the accident. Law and economics shares with other branches of economics the assumption that individuals are rational and respond to incentives. When penalties for an action increase, people will undertake less of that action. Law and economics is more likely than other branches of legal analysis to use empirical or statistical methods to measure these responses to incentives

Modern law and economics dates from about 1960, when RONALD COASE (who later received a Nobel Prize) published “The Problem of Social Cost.” Gordon Tullock and FRIEDRICH HAYEK also wrote in the area, but the expansion of the field began with GARY BECKER’s 1968 paper on crime (Becker also received a Nobel Prize). In 1972, Richard Posner, a law and economics scholar and the major advocate of the positive theory of efficiency, published the first edition of Economic Analysis of Law and founded the Journal of Legal Studies, both important events in the creation of the field as a thriving scholarly discipline. Posner went on to become a federal judge while remaining a prolific scholar. An important factor leading to the spread of law and economics in the 1970s was a series of seminars and law courses for economists and economics courses for lawyers, organized by Henry Manne and funded, in part, by the Liberty Fund.

'Coase Theorem '

The Coase theorem states that where there is a conflict of property rights, the involved parties can bargain or negotiate terms that are more beneficial to both parties than the outcome of any assigned property rights. The theorem also asserts that in order for this to occur, bargaining must be costless; if there are costs associated with bargaining (such as meetings or enforcement), it will affect the outcome. The Coase theorem shows that where property rights are concerned, involved parties do not necessarily consider how the property rights are granted if they can trade to produce a mutually advantageous outcome. If transaction costs are zero—if, in other words, any agreement that is in the mutual benefit of the parties concerned gets made—then any initial definition of property rights leads to an efficient outcome.•

This theorem was developed by Ronald Coase when considering the regulation of radio frequencies. He posited that regulating frequencies was not required because stations with the most to gain by broadcasting on a particular frequency would have an incentive to pay other broadcasters not to interfere.

'Coase Theorem '

Concept that economic efficiency is achieved best by full allocation of, and completely free trade in, property rights. It states that what really matters is that everything is owned by someone and that, initially, who owns what doesn't matter. Based on two main ideas freedom of individual choice, and zero transaction costs (expenses associated with the process of buying and selling) it helps explain the unprecedented cost advantage online firms will have in the digital marketplace (where transaction costs are approaching zero) over the traditional firms. It has several other applications, such as in who pays for the pollution costs.

The Rise of the Chicago School of EconomicsUniversity of Chicago 1958 set up there a new center for scholars in law and economics. In 1958, Director founded the Journal of Law & Economics, which he co-edited with Nobel laureate Ronald Coase, and which helped to unite the fields of law and economics with far-reaching influence.[6] In 1962, he helped to found the Committee on a Free Society. Director's appointment to the faculty of the University of Chicago Law School in 1946 began a half-century of intellectual productivity, although his reluctance about publishing left few writings behind. In the early 1970s, Hennry Manne (a former student of Coase) set out to build a center for law and economics The latter soon became a center for the education of judges—many long out of law school and never exposed to numbers and economics

Positive law and economics

Positive law and economics uses economic analysis to predict the effects of various legal rules. So, for example, a positive economic analysis of tort law would predict the effects of a strict liability rule as opposed to the effects of a negligence rule. Positive law and economics has also at times purported to explain the development of legal rules, for example the common law of torts, in terms of their economic efficiency. Analysis of implementation (Regulatory guillotine)

Normative law and economics

Normative law and economics goes one step further and makes policy recommendations based on the economic consequences of various policies. The key concept for normative economic analysis is efficiency.A common concept of efficiency used by law and economics scholars is Pareto efficiency. A legal rule is Pareto efficient if it could not be changed so as to make one person better off without making another person worse off. A weaker conception of efficiency is Kaldor-Hicks efficiency. A legal rule is Kaldor-Hicks efficient if it could be made Pareto efficient by some parties compensating others as to offset their loss.

Judge Posner has written a number of books, including Economic Analysis of Law (8th ed., 2011); The Economics of Justice (1981); Law and Literature (3rd ed. 2009); The Problems of Jurisprudence (1990); Cardozo: A Study in Reputation (1990); The Essential Holmes (1992); Sex and Reason (1992); Overcoming Law (1995); The Federal Courts: Challenge and Reform (1996); Law and Legal Theory in England and America (1996); The Problematics of Moral and Legal Theory (1999); Antitrust Law (2d ed. 2001); Law, Pragmatism, and Democracy (2003); Catastrophe: Risk and Response (2004); Preventing Surprise Attacks: Intelligence Reform in the Wake of 9/11 (2005); How Judges Think (2008); A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009); and The Crisis of Capitalist Democracy (2010).

Should Marijuana Be Decriminalized Nationwide?—PosnerWith 20 states having now legalized medical marijuana use, and two (Washington and Colorado) having legalized recreational use of marijuana, the days of legal prohibition of use of marijuana for recreational as well as for medical purposes seem numbered. The case for prohibiting marijuana was never strong. It is a mind-altering drug, but no more so than alcohol, and it is considered less likely to induce violent behavior, and in general to have less destructive effects on the heavy user, the “addict.” Although some 58 percent of Americans believe that recreational use of marijuana should be made legal, law enforcement activity aimed at discouraging marijuana use continues at a high level, with some 750,000 persons being arrested every year on marijuana charges, almost 90 percent for possession rather than for production or distribution. Despite the threat of criminal punishment (though punishment for mere possession, other than possession with intent to distribute, is largely nominal Furthermore, legalization would undoubtedly be accompanied by the imposition of sales taxes comparable to those for cigarettes and alcohol (indeed the desire for tax revenue was apparently a major factor in Colorado’s decision to decriminalize marijuana), which would both generate needed tax revenues and limit the increase in use. Neither deterrence nor incapacitation seems to have much effect on the supply of illegal drugs, since the elasticity of supply of drug dealers is very high. Dealers make good incomes relative to alternative employment opportunities and expected punishment costs are low.

Has the United States, by Virtue of Its Size and Complexity, Become Ungovernable?—PosnerThere are, especially in Europe and East Asia, and to a limited extent in the Western Hemisphere, small countries that are well governed. But among large, populous countries, there appears to be only one well-governed country: Germany. The United States is the third largest country by land mass (after Russia and Canada) and population (after India and China), the wealthiest, the militarily most powerful, and generally regarded as the leading nation in the world—its geopolitical center. But all these are negatives from the standpoint of governance, as are the nation’s ethnic and cultural diversity, political divisiveness, high crime rates, and highly unequal distribution of income. Another major negative is the difficulty of changing the U.S. Constitution. Although there have been a number of amendments, the basic structure, set by the original Constitution of 1789, has not been changed significantly.

A serious problem of governance, or management, that all but the smallest organizations, whether private or governmental, encounter is the tension between the goals of the organization and the personal goals, which typically differ, of the individuals who comprise the organization. Stated differently, the individuals have personal utility functions that differ from the organization’s utility function. The larger the organization, the greater the divergence is likely to be and the more difficult to minimize. The organization that is the federal government of the United States has more than 4 million employees.

Competition between organizations is an important control on the divergence (which economists refer to as “agency costs”—the costs created by the fact that the employees of an organization have their own goals that often conflict with those of their employer). But nations do not feel the same competitive pressures as corporations. Even a small, miserable, effectively bankrupt nation like Greece does not disappear, as large corporations not infrequently do, because of its inefficiency. Because corporations are simpler and smaller and also more constrained by competition than nations, we can expect them to be managed more efficiently, and specifically to adopt an organizational structure that minimizes agency costs.

In an interesting and ominous book by Joseph A. Tainter called The Collapse of Complex Societies (1988), the author points to historical episodes of collapse of societies that had become too complex to manage effectively, such as the Mayan civilization of Central American and the Western Roman Empire. Successful societies, such as Britain, the United States, and Germany, in the nineteenth century, and Japan and the Soviet Union in roughly the first half of the twentieth century, tend, like successful companies, to expand. Expansion makes governance more complex, which can lead to ungovernability and eventual collapse. Companies that become ungovernable can shrink to a manageable size by selling off parts of themselves; or they can simply liquidate, in which event their assets are sold to other companies.

How Gay Marriage Became Legitimate A revisionist history of a social revolution After Lawrence, homosexuals could live together openly as couples anywhere in the United States without fear of prosecution. And if they had a right to cohabit, why not to marry? It began to seem arbitrary to deny them such a right, especially as some states—Vermont was the first, in 2000—were allowing homosexuals to form “civil unions” with all the rights of married couples except the right to call their relationship “marriage.” The denial of that right was equivalent to a state telling blacks that they could cohabit with whites and enjoy all the same rights as racially unmixed couples except the right to call their relationship “marriage.” That would be the purest, though not the most harmful, form of bigotry.

Let’s Be Honest: We’re in a Depression, Not a Recession, And There’s No End In SightThe American economy currently has both a short-term problem and a long-term problem. The short-term problem is that the economy is depressed; it is growing more slowly than the population, with the result that per capita income is declining. The high rate of un- and underemployment is a factor, but is itself the product of other factors, having mainly to do with the reluctance of over-indebted consumers (over-indebted in major part because of loss of equity in their houses, the major source of household wealth) to spend, the reluctance of the impaired banking industry to make risky loans, and the reluctance of businesses to invest and to hire, which is due in part to weak consumer spending and in part to profound uncertainty about the nation’s economic future.The roots of this catastrophic situations lie primarily, I think, in the incompetent economic management of the Bush administration and the Federal Reserve. The persistence of the depression, however, is due in part at least to surprising failures of the Obama administration—poor leadership, poor management, the sponsorship of incomprehensibly complex health care and financial regulation laws that have created widespread uncertainty that has discouraged consumption and investment, and the inability to explain the nature of the economy’s problems to the general public. These failures caused the stimulus enacted in February 2009 to be botched in both in its design and its administration, resulting in the discrediting of deficit spending as a response to depression.

Our Incompetent Government

Not anticipated--this brings us closer to the fundamental problem. A democratic government (perhaps any government) is incapable of anticipating and taking effective measures against novel threats. The threats do not have to be really novel; the fact that there was no recent example of a major American city being inundated was enough to put such a threat below the bureaucratic radar. The human mind finds it difficult to think in terms of probabilities, as distinct from frequencies, and often solves its difficulty by writing them down to zero. If an event is frequent, people expect it to recur. But if you tell them that something that has not occurred might occur and if it does occur it will cause great loss, they are unlikely to be impressed. Hurricanes are frequent, but Category Five hurricanes are rare. So it is the former for which the government prepares.

Property

In many circumstances, however, who owns the right will matter. Transactions costs are never zero, and so if rights are incorrectly allocated, a costly transaction will be needed to correct this misallocation. If transactions costs are greater than the increase in value from moving the resource to the efficient owner, there may be no corrective mechanism. This can happen in any sort of economy. An extreme example is Russia, where the courts have not been able to provide clear definitions of property rights, and those persons with control of firms are not necessarily the owners. That is, those with control over a firm cannot sell it and keep the proceeds. This creates incentives for inefficient use of the assets, such as sale of valuable raw materials for below-market prices, with the proceeds deposited outside the country. In such circumstances, the Coase theorem will not operate, and correctly defining property rights becomes important. More generally, experience in Russia and its former satellites has emphasized the importance of the legal system for development of a market economy and, thus, has shown the importance of law and economics in influencing policy.

Contract Law

The law governing exchange is crucial for a market economy. Most of the doctrines of contract law seem consistent with economic efficiency. Law and economics study of contract law has shown that, in general, it is efficient for parties to be allowed to write their own contracts, and under normal circumstances, for courts to enforce the agreed-on terms, including the agreed-on price. The courts will generally not enforce contracts if performance would be inefficient, but, rather, will allow payment of damages. If, for example, I agree to build something for you in return for $50,000, but meanwhile costs increase so that the thing would cost me $150,000 to build, it is inefficient for me to build it. Courts, recognizing this, allow me to compensate you with a monetary payment instead. This is efficient.ontracts and contract law are also designed to minimize problems of opportunism. The danger of opportunism arises when two parties agree to something, and one makes irreversible investments to carry out his side of the bargain. So, for example, a company invests in a railroad spur to a coal mine, making a contract in advance to ship the coal at a specific price

Tort Law

Tort law and criminal law protect property rights from intentional or unintentional harm. The primary purpose of these laws is to induce potential tortfeasors (those who cause torts, or accidents) or criminals to internalize—that is, take account of—the external costs of their actions, although criminal law has other functions as well.Tort law is part of the system of private law and is enforced through private actions. The economic analysis of tort law has stressed issues such as the distinction between negligence and strict liability. Because most accidents are caused by a joint action of injurer and victim (a driver goes too fast, and the pedestrian he hits does not look carefully), efficient rules create incentives for both parties to take care; most negligence rules create exactly these incentives. Strict liability is important when the issue is not only the care used in undertaking the activity, but also whether the activity is done at all and the extent to which it is done (the level of the activity); highly dangerous activities (e.g., blasting with explosives or keeping wild animals as pets) are generally governed by strict liability.

Criminal Law

Criminal law is enforced by the state rather than by victims. This is because efficient enforcement requires that only a fraction of criminals be caught (in order to conserve on enforcement resources) and the punishment of this fraction be multiplied to reflect the low probability of detection and conviction. If, for example, only one out of four criminals is caught and punished, then the punishment must be four times the cost of the crime in order to provide adequate deterrence.However, most criminals do not have sufficient wealth to pay such multiplied fines, and so incarceration or other forms of nonpecuniary punishment must be used. One implication of law and economics is that a fine should be used as punishment whenever the miscreant can pay. The reason is that fines are transfers and do not create deadweight losses (i.e., losses to some that are not gains to others); imprisonment, on the other hand, transfers virtually no wealth from the criminal but causes two forms of deadweight loss: the loss of the criminal’s earning power in a legitimate job in the outside world and the cost to taxpayers of providing a prison and guards. But because so few criminals have enough wealth to pay multiplied fines, private enforcement would not be profitable for private enforcers, and so the state provides enforcement. In some circumstances, incarceration serves the additional function of incapacitation of potential wrongdoers.

Criminal Law

Economic theory predicts that criminals, like others, respond to incentives, and there is unambiguous evidence that increases in the probability and severity of punishment in a jurisdiction lead to reduced levels of crime in that jurisdiction. The issue of the deterrent effect of capital punishment has been more controversial, but several recent papers using advanced econometric techniques and comprehensive data have found a significant deterrent effect; each execution deters between eight and twenty-eight murders, with eighteen being the best single estimate. No refereed empirical criticism of these papers has been published. Research on procedural rules has shown that increased rights for accused persons can lead to increases in crime. One controversial paper by John Donohue and Steven Levitt argues empirically that the easing of abortion restrictions led to a reduction in crime because unwanted children would have been more likely to become criminals. There are also major debates in the literature on the effect on crime of laws allowing easier carrying of concealed weapons. Some, such as John Lott, find significant decreases in crime from these laws, while others find much smaller effects, although there is little evidence of any increase in crime.

Criticism

• Homo oeconomicus• Rationality vs irrational• Predictability of behaviour• No social costs

Intelectual property

The economic analysis of law interprets legal rules and institutions with the methodology of economics, and so transforms them into unrecognisable artefacts. This is particularly so with regard to intellectual property law: while in the case of trademarks law-and-economics analysis is merely too simplistic and often superfluous, in the cases of patents and particularly copyright it is positively harmful to these legal institutions. Economic methodology has not been developed for the analysis of law, and the purpose of legal methodology is not the scientific exploration of economic efficiency. But it is a rejection of the remodelling of legal institutions and decisions in intellectual property law in accordance with certain scientific methods and paradigms developed in (and for) economics, and of the claim that a corresponding analysis could yield any epistemic value for the law and a normative standard of efficiency for future legal policy.