This section centres on normative law and economics. It explains what economists mean when they recommend a particular law on the ground that it is “effi cient”, and explores the extent to which economic analysis of law escapes the problems that affl ict classical utilitarianism. The discussion will enable readers to decide for themselves how to weigh the values underlying the effi ciency metric.
10 Ibid . 11 Ibid.
NEOCLASSICAL WELFARE ECONOMICS AS APPLIED TO LAW | 51
Law and economics does not simply apply utilitarian moral theory to legal problems.
Economists understand the defi ciencies underlying this branch of philosophy, and have devised their own approach to resolving confl icting claims of right. First, they do not try to estimate people’s utility. By jettisoning cardinal measures of utility, economists avoid calculating which policy would maximise the amount of pleasure in the world. Instead, law and economics focuses on hypothetical consent, and on satisfying individual preferences, which approach refl ects personal autonomy. Thus, when studying law, economists typically use the term “utility” in the sense of
“ordinal utility”. In other words, they embrace the notion that a person has a stable and consistent preference for one item over another, as measured by that individual’s paying more for one product than for the other. Economists will not attempt to specify cardinal values.
A recurring feature of law- and-economics theory is that rules can induce people to behave effi ciently (i.e. in a manner consistent with what all stakeholders would have collectively agreed to ex ante in a hypothetical setting of no transaction cost). Yet, the economic analysis of law can do more than induce effi cient behaviour. Consistent with that hypothetical bargain, the economic approach can achieve equity by remedying dissatisfi ed preferences through compensation. Law and economics thus attempts to achieve Pareto improvements, where possible.
What happens when people’s preferences confl ict, as they often do? The most extreme case is where one person wants another to suffer. In the vocabulary of economics, one person’s disutility constitutes a positive element of another person’s utility function. More generally, individual pref-erences confl ict when a policy or action negatively affl icts some people, whilst benefi ting others.
The harm in this second case is an incident, rather than an object, of the relevant policy. Law and economics solves incompatible preferences as follows: it makes consent the measure and requisite of effi ciency.
Consider the case where harm is the ancillary side effect of an action. Countless public-policy questions implicate the well- being of stakeholders in variously negative and positive fashions.
When confl icting preferences accompany a policy decision, what should be the pertinent rule of decision? The answer, from the perspective of law and economics, is to appeal to the Coase Theorem and to ask how the parties, in a world without transaction costs, would have agreed to resolve the issue. A foundational premise underlying law and economics is that such stakeholders would have agreed on the path that maximises their collective well being, even if that outcome would appear to render some of them potentially worse off ex post . They would so agree because the benefi tted parties could compensate the people whom the policy decision negatively affl icted and yet still be better off than they were ex ante . Such compensation would effect a Pareto improvement, such that adopting the more effi cient course increases the total welfare of society without leaving anyone worse off.
The reader may question the assumption that those bargaining over the resolution of a policy issue would agree, ex ante , to maximise their combined welfare. Some people, after all, concern themselves only with their own utility, as opposed to that of other stakeholders. Why would non- altruistic types make collective well-being, rather than their own, the object of their desire, when their and society’s interests may be in confl ict?
John Rawls famously argued that, negotiating behind a “veil of ignorance”, people would maximise equality. According to Rawls, each person would reason that he could not know where he will lie on the social ladder in the future state of the world. If he agreed to an unequal society, he might end up on the bottom. For that reason, he and other members of society would seek ex ante to minimise the impact of their potential misfortune ex post . Morality justifi es departures from equality, Rawls argued, only insofar as they satisfy “the difference principle” – specifi cally, such departures must benefi t those who are least well off.
If Rawls is right, might economists be wrong to think that parties would negotiate ex ante to the wealth- maximising outcome? Of course, that is a matter of debate. Still, Rawls’s thesis is not iron clad. The members of his hypothetical collective are highly risk averse. In fact, each of them is
infi nitely risk averse, maximising not expected value, but the minimum value that each could obtain in the world. This can lead to absurdities. John Harsanyi observed, for example, that Rawls’s
“maximin” principle would cause people always to avoid the worst possible outcome, even if the probability of that event were almost vanishingly small. 12 Thus, a person would not accept a dream job in a desirable city because fl ying there would entail a non- zero chance of dying in a plane crash.
No one would cross a street; no one would get married; and so on.
Further, the assumptions underlying Coasean hypothetical bargaining and the Rawlsian veil of ignorance are different. In the latter setting, probabilities are unknown, while they are under the Coase Theorem. Under the assumption of zero- transaction-cost bargaining where probabilities can be assigned to possible outcomes, expected-utility theory has force. This makes the effi ciency metric a legitimate basis for policy recommendations about tortious conduct, breach of contract, property rights, and more besides.
Now consider the problem of the so- called “utility monster”. Economic analysis of law would reject the following argument: effi ciency justifi ed a person in hurting another because the pleasure that the actor derived from injuring his victim exceeded the latter’s trauma. In any such case, be it murder, rape, battery, burglary, robbery, larceny, or any other serious crime, transaction costs would not be so high as to foreclose ex ante agreement between the criminal and the victim. In the case of any of the crimes just mentioned, the guilty party could have sought permission from the victim ex ante , but did not. Where bargaining costs are low, economics will not entertain claims of effi ciency when the wrongdoing party bypassed the market (i.e. where he did not seek the injured party’s consent). For instance, it would not credit an argument that a stolen car is worth more to the robber than to the owner.
This discussion might strike the reader as an odd way to address the wrongfulness of crime. Is something of moral signifi cance lacking if one analyses serious offences by reference to foregone market transactions and without regard to the innate wrongness of the conduct? In fact, law and economics captures this quality of wrongness – it merely expresses it in a different way. The reality of serious crime is that there is no amount of money that a criminal would pay and that a potential victim would accept to undergo the relevant experience. The price that a person would demand in exchange for permitting another to kill him would be, absent euthanasia concerns or some outlandish scenario, infi nite. This approach to crime recognises the right of the individual to consent to a chosen course. If a person would not agree to it, the criminal who nevertheless takes what he wants should be subject to the full condemnation of the law.
Notice that, even if transaction costs were high such that bargain was not feasible, one could safely condemn the criminal act were it clear that the victim would not have consented to the relevant behaviour even if negotiations had been possible. This insight distinguishes two sorts of potentially criminal behaviour: that which society should, and should not, abolish entirely. An illu-minative way to apply the defence of necessity, for instance, is to ask whether the parties would have agreed to the conduct ex ante had transaction costs not been prohibitive. As explored in Part 3, however, if one excludes cases of necessity and the costs of employing the criminal-law system, the optimal level of much criminal activity (i.e. the effi cient output in the market for crime) is zero.
The preceding account defi nes welfare through the satisfaction of preferences, which econo-mists assume to be fi xed and exogenous. By adopting neoclassical theory, normative law and economics provides policy prescriptions aimed at promoting this vision of welfare. This perspective celebrates individual autonomy, thus respecting the ends that different people choose for them-selves. In this sense, law and economics theory displays a libertarian quality.
12 John C. Harsanyi, ‘Can the maximin principle serve as a basis for morality? A critique of John Rawls’s theory’ (1975) 69 Am Pol’y Sci Rev 594.
THE ETHICS OF MARKETS | 53
As with any normative theory, however, economic analysis of law has limitations. These occur when paternalistic considerations come to the fore, most obviously when people make decisions that hurt their interests. Imagine a person whose preferences are antithetical to her well being. Law and economics would applaud an arrangement that satisfi es those preferences, even though they inure to her ruin. An extreme, though illuminative, example involves a bizarre case of consensual cannibalism in Germany. An individual by the name of Armin Meiwes sought online a volunteer for the once- in-a- lifetime experience of being killed and eaten. As unlikely as it was, someone actually agreed to the offer. Meiwes was ultimately convicted of murder – in many ways, an unremarkable result. If the individuals involved, however, were both informed and competent (a fantastical assumption, perhaps) then an arrangement that satisfi ed the preferences of all contracting parties is effi cient and therefore desirable within the confi nes of neoclassical welfare economics.
Yet, outlier cases may not be the best metric by which to judge theories. In many, if not most, circumstances, people can determine their welfare better than third parties can. For those who believe that a person should decide his wants for himself, normative law and economics may be attractive.
This section closes with a word of caution. In analysing public-policy questions, economists can often identify effi cient solutions. That function is valuable because effi ciency is important. Yet, that goal is but a component of justice. Although the two concepts may sometimes be coterminous, resolving some policy questions may involve goals that confl ict with effi ciency. Law and economics still plays an important role in these situations, however, in quantifying the cost of policy decisions that depart from effi ciency. Legislatures, in making diffi cult determinations, should have all avail-able information in front of them, so that they may make informed conclusions.
For example, consider whether a state should implement a “three- strikes law”. California is a jurisdiction that imposes mandatory life sentences on criminals whom it convicts of a third felony.
Such laws can involve grave disparities between the wrong (it may be non- violent) and the severity of the ensuing punishment. This gulf between crime and punishment offends many people’s sense of justice, which requires proportionality between the offending act and corresponding penalty. Yet, a prediction that the “three- strikes” law would reduce crime surely weighs on whether to enact such legislation. It remains true, of course, that a legislature may properly refuse to pass draconian laws, but its decision is more informed if it has all relevant information, including that supplied by economic analysis.
The point, in short, is that effi ciency need not be controversial, especially when one realises that effi ciency is but a component of the larger concept of justice. Law and economics is a powerful tool of policy analysis, but it is by no means the exclusive means by which to understand legal problems.