Economic Analysis Of Law Research Paper

1. Economic Analysis

Economics first developed as a discipline in the seventeenth century, in close association with the accompanying social sciences of political science and sociology. During this early period of development, the social sciences enjoyed considerable overlap in examined problems and methodology. Although some works from this time can be identified as being distinctly ‘economic,’ early social scientists such as Adam Smith, Karl Marx, and John Stuart Mill hypothesized about economic, social, and political institutions with equal skill and aplomb. This close association between the social sciences continued into the beginning of the twentieth century with the work of institutional economists such as John R. Commons, and economically oriented sociologists such as Emile Durkheim and Max Weber. Indeed, Weber, one of the most distinguished sociologists of his time, held several academic positions as an economist.

However, early in the twentieth century, economics began to separate from the other social sciences in two important ways. First, economics began to diverge in terms of its examined subject matter. Economists began to focus more on studying the machinations of the market, leaving subjects such as social relationships and political economy to the other disciplines. Since the work of Gary Becker (1968, 1976), however, this trend has been reversed, so that now economists study a wide variety of social and political phenomena, including the law. Second, economics began to diverge in terms of its adopted methodology. Although all of the social sciences adopted modern statistical methods for analyzing data as the primary focus of empirical work, economists also undertook to develop a ‘positive science’ of economics under the neoclassical model.

1.1 Positive Economics

Since early in the twentieth century, most economists have endeavored to develop economics as a positive science analogous to the physical sciences. As the name suggests, the ultimate goal of a ‘positive science’ is to produce theories that describe observed phenomena accurately, rather than offer a normative evaluation of the desirability of the phenomena. Such theories are devised by making assumptions about the world that abstract the essential features of the examined problem, and then using logic to deduce predictions about the as yet unobserved events. The validity of the theory is then confirmed through empirical work, which examines the predicted events and tests the statistical significance of results consistent with the theoretical model. This deductive process, working from theory to data, can be distinguished from the inductive process used by many other social scientists, who tend to analyze the data before inductively deriving their theories. Accordingly, for the majority of the twentieth century, most economists aspired to conduct economics as a positive science that deduces empirical predictions from theory and then tests those predictions against data.

1.2 The Neoclassical Model

In the development of economics as a positive science, the dominant paradigm has been the ‘neoclassical model.’ The neoclassical model consists of a set of assumptions that economists make in analyzing problems. This set of assumptions achieved paradigmatic dominance in economics because they proved useful in analyzing market behavior, and because they were tractable mathematically. Under the neoclassical model, economists assume generally that: the appropriate unit for analysis is the individual consumer or firm, individuals and firms rationally choose among available alternatives according to their preferences to select the option that maximizes utility or profits, people’s preferences are exogenous to the model, and transaction and information costs are zero. Economists have a well-defined notion of ‘rationality’; they assume that people have preferences with respect to all possible states of the world, that these preferences are reflexive and transitive, and that the people will select the option they most prefer. The assumption of free information is usually referred to as the assumption of ‘perfect information.’ It has deceptively broad-ranging implications in that it implies that each person knows the quality of each good and the price of all alternatives, and indeed has the knowledge necessary to enter the market and produce the good if the market for the good enjoys supercompetitive profits. The assumption of zero transaction costs also has potentially far-reaching implications since, as Ronald Coase (1960) has pointed out, in a world of zero transaction costs, everything happens at once.

The conduct of economics as a positive science using the neoclassical model tends to separate the work of economists from that of other disciplines. The adoption of the perspective of the individual as the unit of analysis, and the assumption that preferences are exogenous, preclude consideration of the effect of social norms and the process of socialization that are so important to many sociological analyses. The construction of the concept of individual utility based merely on an ordinal preference ranking was undertaken with the purpose of avoiding some of the stickier problems in psychology, thus making the concept ‘psychology-free.’ The economists’ well-defined concept of rationality is much narrower than that used in any other discipline. Moreover, since the other social sciences rely more on inductive logic, working from data to theories, they generally do not make any a priori assumptions about what constitutes rational choice. Accordingly, some sociologists have argued that they study rather than assume human rationality.

1.3 The Importance Of Empirical Work

The assumptions of the neoclassical model are clearly unrealistic, and this fact raises the importance of empirical work in economics. Every analysis of a problem is necessarily an abstraction from reality, ignoring some of the complexities of the real word to focus on others. The art of modeling is to know which simplifying assumptions one can make and still capture the essence of the problem. Of course, an important test of how well a theory captures the essence of a problem is how well it fits the available data. Milton Friedman (1953) has argued that the realism of a model’s underlying assumptions is of little importance as long as the model yields good predictive results. Indeed, Friedman has gone so far as to argue that, paradoxically, the most important hypotheses have the most unrealistic assumptions, because a hypothesis is important if it abstracts the crucial elements of a phenomenon in such a way as to explain much of the phenomenon by assuming little. Other economists have argued that there are purposes to modeling beyond mere prediction, such as explaining the phenomenon or providing a catalog of knowledge for future work. As a result, they have argued that there are reasons for considering the realism of economic assumptions that go beyond the simple predictive value of the model.

2. The Economic Analysis Of Law

Beginning with the pioneering work of Gary Becker (1968, 1973), economists have sought to broaden the scope of their inquiry to all aspects of society. This movement to broaden the scope of economic analysis has brought economics into a variety of subject matters previously studied by other disciplines, including the family, education, discrimination, politics, and even the law.

2.1 The Modern Law And Economics Movement

The modern law and economics movement had its origin in the work of Gary Becker, Ronald Coase and Guido Calabresi. Becker (1968) used simple principles of labor economics to analyze the criminal’s decision of whether to engage in crime, and derived implications for optimal penalties and optimal enforcement of the law. Coase’s (1960) work established the proposition known as the ‘Coase Theorem’, showing that, in a world of zero transaction costs, the distribution of resources is invariant to the rule of law. However, Coase later made clear that he considers his work concerning how to minimize the effects of transaction costs in assigning the rule of law under the more realistic assumption of positive transaction costs to be more important. Calabresi (1970) wrote a classical study analyzing the costs of accidents and suggesting ways in which tort law might be formulated to minimize those costs. After these initial contributions, a notable and extensive body of work in the economic analysis of law was, and continues to be, authored by Richard Posner, who has applied the principle of wealth maximization to a plethora of legal problems, explaining either how the law can be understood as promoting wealth maximization, or how it might be amended to better achieve that objective (see, for example, Posner 1998). As will be discussed in detail below, in more recent years, work in the economic analysis of law has taken a variety of forms, from the traditional neoclassical analyses to socioeconomic and behavioral economic analyses.

2.2 Empirical Work In Law And Economics

Empirical work in the economic analysis of law has been slow to follow these theoretical advances. The reasons for the relative paucity of empirical work are several and varied, including a lack of training in empirical methods among legal academics, a lack of resources dedicated to such work, a lack of prestige and incentives attached to such work, and perhaps even some fear of exposure to falsification through replication on the part of law and economics scholars.

Despite these impediments to empirical work in law and economics, a number of notable studies have been done directly on issues important to the economic analysis of law. One of the earliest significant empirical works in law and economics was Isaac Ehrlich’s (1975) work showing a deterrent effect from capital punishment. Ehrlich’s work prompted enormous academic and public debate on the subject, and his results were later disputed by other scholars. A number of scholars have done empirical work in an attempt to verify or disprove the fundamental implication of Coase’s work that, when transaction costs are negligible, the distribution of resources is invariant with respect to the rule of law. Among these works, perhaps the most notable for the purposes of this essay is Robert Ellickson’s (1986) on the distribution of cattle in Shasta County, California, under alternative rules of free range and non-free range. Ellickson found that Coase was correct that changes in the rule of law did not affect the distribution of cattle; however, Ellickson attributed this finding more to the sociological reason that neighbors had informal means of dealing with animal trespasses that were not influenced by changes in the law, than Coase’s reasoning that neighbors would just bargain around inefficient assignments of entitlements. Kip Viscusi (1983, 1992) has also made important empirical contributions in the economic analysis of legal issues through his analysis of the valuation of life and limb and the relative magnitude of various risks. Viscusi’s work is important in evaluating the efficiency of tort law, workers’ compensation laws, and government regulation of various workplace and environmental risks.

3. Empirical Work In Law And Economics As A Touchstone For A Multidisciplinary Discourse On Law

It has become apparent that empirical work in law and economics often serves as a touchstone for interdisciplinary discourse on law. This is true for several reasons. First, economics shares the same accepted statistical methods for analyzing data with most other disciplines. As a result, as economists have expanded the scope of their research to areas (such as law) that traditionally have been studied by other disciplines, they have found that their empirical work is relevant to, and can be usefully informed by, empirical work already done in the subject area by other disciplines. Second, as economists have done empirical work in the economic analysis of law, or as they have borrowed from the empirical work of other disciplines, many have found reasons to relax some of the assumptions of the neoclassical model in their analysis of the law. The traditional economic model of individual rational choice does not always capture adequately the essence of legal problems in the way that it did in the study of atomistic markets, and as a result economists have sought to relax some of the assumptions of the neoclassical model in order to produce theoretical models with greater predictive or explanatory power.

By relaxing some of the assumptions of the neoclassical model, economists have found that their work becomes less distinct from that of theoretical work in other disciplines. This is true not only for the reason that such economic work is inductive rather than deductive in nature, working from the data to theory, but also because relaxation of some of the assumptions of the neoclassical model allows for the consideration of work from other disciplines. In particular, some law and economics scholars have found connections between their work and the work of sociologists who study law, while other law and economics scholars have made use of empirical work out of the behavioral sciences for their work in the economic analysis of law.

3.1 Sociological Influences In The Economic Analysis Of Law

Some economists have drawn on the work of sociologists in their economic analysis of law. Indeed, in recent years there has been a growing interest among law and economics scholars in the influence of social norms and status production on people’s behavior, and the role of law in the socialization process. In order to examine these phenomena, the economist usually has to relax one or more of the traditional assumptions of the neoclassical model. For example, to examine the influence of social norms or status production on people’s behavior, the economist might adopt a perspective of analysis that takes into account group or community interests, rather than just individual interests. Similarly, in examining the role of law in the socialization process, some economists have found it useful to relax the assumption that people’s preferences are determined exogenously. With the relaxation of these assumptions, it is also necessary generally to adopt an objective function other than individual utility, wealth or profit for maximization in the economic model—for example, net social benefits or social welfare.

The intensity of economists’ interest in social norms in the 1990s has been rather remarkable. No less than four symposia on the subject have been published in major US law reviews since 1996 (Ellickson 1998). Although some very interesting work in the study of norms from the economic perspective has been done by Richard McAdams (1997) and Eric Posner (1996), perhaps the seminal work on the subject was the work previously alluded to by Robert Ellickson (1986). As previously mentioned, Ellickson undertook an empirical study of the effect of changes in the legal rule from open range to closed range on the allocation of cattle and fencing resources to test Coase’s famous hypothesis that, in low transaction cost cases, the allocation of resources would be invariant to the rule of law because the affected parties would just bargain around any inefficient allocation of entitlements. To study this problem, Ellickson surveyed land owners in Shasta County, California, as to the number of animal trespass cases they had experienced under different legal regimes, and how those incidents were resolved. Ellickson found that the allocation of resources was indeed invariant to the legal rule, as predicted by Coase.

However, Ellickson found that this result, obtained not because transaction costs were low and the parties had bargained around the law to reach an efficient allocation of resources, but instead because resort to the law was costly, and as an alternative the affected parties were committed to a norm of cooperation with their neighbors, regardless of the rule of law. As a result, Ellickson concluded that work in law and economics would benefit from consideration of previous work on such questions in sociology, and the law and society movement. Taking his own suggestion to heart, Ellickson has used empirical work from other disciplines on norms of ‘fairness’ and ‘civic responsibility’ to analyze a variety of legal problems including rent control, the doctrine of unconscionability, the implied covenant of good faith and fair dealing, the duty to rescue, political and judicial processes, and the First Amendment.

Law and economics scholars have also demonstrated an interest in using models of individual and group status production to analyze the efficacy of antidiscrimination laws. The seminal work in this regard is that of Richard McAdams (1995). Although Gary Becker’s (1957) neoclassical analysis of discrimination based on a distaste for association has also been used to analyze antidiscrimination laws, this model has never been empirically satisfying, since it predicts that firms that discriminate will be put at a competitive disadvantage and driven from the marketplace, even in the absence of antidiscrimination laws. Drawing on work in sociology, McAdams developed a model of discrimination based on people’s desire to produce inter and intragroup status. According to McAdams, whites discriminate against lower black group status and raise white group status relative to blacks. Intragroup status is used by whites to compensate individuals for costs they incur in raising whites’ group status relative to blacks, for example by forgoing profits they would make in nondiscriminatory associations with blacks. McAdams’ model is empirically more satisfying than Becker’s, because it explains how discrimination can persist in the marketplace despite individual costs associated with discrimination. McAdams’ model also explains nicely the existence and function of Jim Crow laws in the old South to reinforce group status production and prevent individual defection from this strategy. The status production model also yields very different policy prescriptions from those associated with Becker’s neoclassical model since, under the status production model, antidiscrimination laws are no longer a superfluous addition to market pressures, but instead can be a useful tool to discourage wasteful competition in group status production.

A final area in which the economic analysis of law has shown connections to work in sociology is the analysis of the role of law in the process of socialization. In this area, the present author has written an economic analysis of the criminal law as a preference-shaping policy (Dau-Schmidt 1992). If one relaxes the neoclassical assumption that preferences are exogenous to the model, and instead assumes that the criminal law is intended to discourage preferences for criminal behavior, as well as to raise the costs of engaging in such behavior, then one can explain many of the fundamental doctrines of the criminal law. Under this analysis, the requirement of intent in the criminal law can be understood as part of the attempt to identify deviant preferences that should be punished to be discouraged. After all, it is only when someone intends the harm that they cause that we know that they desired to bring it about. Similarly, we criminalize attempts (in the absence of actual harm) to ideality and punish deviant preferences in need of modification. Indeed, the preference-shaping model of criminal law allows one to distinguish criminal liability from ordinary tort liability, on the basis that criminal liability is intended to modify both preferences and rewards, whereas ordinary tort liability is intended merely to modify rewards. The preference-shaping model lends itself naturally to integration with work from sociology, criminology, and psychology, because it raises questions concerning how we determine which preferences are socially deviant, and how best to discourage such preferences in people.

3.2 Behavioral Law And Economics

Other economists have drawn on the empirical work of behavioral psychologists in their analysis of law. In ‘laboratory’ experiments, behavioral psychologists such as Amos Tversky and Daniel Kahneman (Tversky and Kahneman 1982) have established that the human decision-making process typically varies in predictable ways from the simple model of rational choice assumed in the neoclassical economic model. In particular, they have established that people commonly exhibit ‘bounded rationality’ in that they can only process a finite amount of information and thus must rely on rules of thumb to help them make decisions, ‘bounded willpower’ in that they sometimes do things that are clearly not in their long-term interests, and ‘bounded self-interest’ in that they care about other people and whether the treatment in their relationship is reciprocally ‘fair.’ Tversky and Kahneman have also established that people evaluate outcomes based on the change they represent from an initial ‘reference point,’ weighting potential losses from the reference point more heavily than potential gains. This finding is referred to as ‘prospect theory’ in the literature, and it can be exploited to manipulate people’s decision-making process by suggesting the initial reference point to ‘frame’ possible choices as gains or losses.

As with the influence of sociology on the economic analysis of the law, there has been a boom in the number of scholars who seek to use ‘behavioral economics’ in their analyses of the law. Early proponents of such work include Thomas Ulen (1989) and Robert Ellickson (1989), but they have since been joined by others including Russell Korobkin (see Korobkin and Ulen 2000), and Christine Jolls, Cass Sunstein, and Richard Thaler. These scholars argue that amendment of the assumptions of the neoclassical model concerning individual rational choice according to the empirical findings of behavioral economics is necessary to improve the predictive power of the economic model. Their critique is fundamental, in that it goes back to basic assumptions about the purposes of law, and how people will react to and enforce the law. For example, Jolls et al. (1998) have argued that the Coase theorem is often empirically false, because empirical work in behavioral economics suggests that people sometimes develop attachments to objects they possess, and this ‘endowment effect’ may mean that people must sometimes be paid more to part with an entitlement than they would pay to possess the entitlement. Accordingly, people will not bargain around the assignment of entitlements in the way described by Coase. Similarly, Korobkin has argued that information heuristics will affect the efficacy of tort damages in providing efficient incentives to take care. Because work in behavioral economics shows that people are often overly optimistic in that they undervalue the chances of something bad happening, and overvalue the chances of something good happening, this suggests that, even if tort damages are set at efficient levels, people will not account adequately for the chance of accident and so will not take efficient care. Paradoxically, Jolls et al. (1998) have argued that, although potential tort feasors may be overly optimistic, the juries that later try them will suffer from ‘hindsight bias’ and overestimate the probability of accident, merely because an accident has in fact happened, thus too readily finding tort defendants liable. Of course, whether potential tort feasors anticipate hindsight bias on the part of later jury members, and which effect dominates in their decision-making process, are questions for future empirical work.

Bibliography:

1. Becker G 1957 The Economics of Discrimination. University of Chicago Press, Chicago
2. Becker G 1968 Crime and punishment: An economic approach. Journal of Political Economy 76: 169–217
3. Becker G 1976 The Economic Approach to Human Behavior. University of Chicago Press, Chicago
4. Calabresi G 1970 The Costs of Accidents: A Legal and Economic Analysis. Yale University Press, New Haven, CT
5. Coase R 1960 The problem of social cost. The Journal of Law and Economics 3: 1–44
6. Cotterell R 1995 Sociological interpretations of legal development. European Journal of Law and Economics 2: 347–59
7. Dau-Schmidt K G 1991 Relaxing traditional assumptions and values: Toward a new multidisciplinary discourse on law. Syracuse Law Review 42: 181–95
8. Dau-Schmidt K G 1992 An economic analysis of the criminal law as a preference shaping policy. Duke Law Journal 1990: 1–38
9. Dau-Schmidt K G 1997 Economics and sociology: the prospects for an interdisciplinary discourse on law. Wisconsin Law Review 1997: 389–419
10. De Geest G 1995 Toward an integration of economic and sociological approaches. European Journal of Law and Economics 2: 301–8
11. Ehrlich I 1975 The deterrent effect of capital punishment: A question of life and death. American Economic Review 81: 397–417
12. Ellickson R C 1986 Of Coase and cattle: Dispute resolution among neighbors in Shasta County. Stanford Law Review 38: 623–87
13. Ellickson R C 1989 Bringing culture and human frailty to rational actors: A critique of classical law and economics. Chicago-Kent Law Review 65: 23–55
14. Ellickson R C 1998 Law and economics discovers social norms. The Journal of Legal Studies 27: 537–52
15. Friedman M 1953 The methodology of positive economics. In: Friedman M (ed.) Essays in Positive Economics. University of Chicago Press, Chicago pp. 1–38
16. Heise M 1999 The importance of being empirical. Pepperdine Law Review 26: 807–34
17. Jolls C, Sunstein C R, Thaler R 1998 A behavioral approach to law and economics. Stanford Law Review 50: 1471–550
18. Kahneman D, Tversky A 1979 Prospect theory: An analysis of decision under risk. Econometrica 47: 263–92
19. Korobkin R, Ulen T 2000 Law and behavioral science: Removing the rationality assumption from law and economics. California Law Review 88: 1051
20. Macneil I R 2000 Other sociological approaches. In: Bouckaert B, De Geest G (eds.) Encyclopedia of Law and Economics. Edward Elgar, Cheltenham, UK
21. McAdams R 1995 Cooperation and conflict: The economics of group status production and race discrimination. Har ard Law Review 108: 1005–89
22. McAdams R 1997 The origins, development and regulation of norms. Michigan Law Review 96: 338–433
23. Posner E 1996 The regulation of groups: The influence of legal and nonlegal sanctions on collective action. University of Chicago Law Review 63: 133–97
24. Posner R 1998 Economic Analysis of Law, 5th edn. Aspen Law and Business, New York
25. Tversky A, Kahneman D 1982 Judgment under uncertainty: Heuristics and biases. In: Tversky A, Slovic P, Kahneman D (eds.) Judgment Under Uncertainty. Cambridge University Press, Cambridge, UK
26. Ulen T 1989 Cognitive imperfections and the economic analysis of law. Hamline Law Review 12: 385–410
27. Viscusi W K 1983 Risk by Choice: Regulating Health and Safety in the Workplace. Harvard University Press, Cambridge, MA
28. Viscusi W K 1992 Fatal Tradeoffs: Public and Private Responsibilities for Risk. Oxford University Press, New York