Econ 522 Economics of Law Dan Quint Spring 2011 Lecture 24.

Econ 522Economics of Law

Dan Quint

Spring 2011

Lecture 24

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Fran’s review in section Friday Extra office hours (Fran and me) TBA

Final: Thursday May 12 12:25-2:25, 6210 Social Science Cumulative, more weight on second half of semester

Logistics

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Efficiencyrevisited

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Efficiency Property law: efficient allocation of rights/resources

Coase Theorem says this is easy… Contract law: efficient breach, efficient reliance, efficient disclosure of

information, etc. Tort law: efficient precaution to avoid accidents, efficient levels of

risky activities Civil and criminal law: minimize combined cost of administering

system and living with its errors

With each branch of law, we asked: What would efficient system look like? How do the rules in place measure up?

What have we done this semester?

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We could focus on final outcomes only No worries about process, procedural fairness, etc.

We could ignore transfers when considering efficiency Paying damages has no effect on efficiency ex-post So we can ignore the “direct” effect of most remedies, consider only

the impact on incentives

Goal was always to maximize total social surplus (or total wealth)

The focus on efficiency has made our lives much easier

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Is efficiency the right goal for the law?

Is there any reason to expect the law to be efficient?

This leads us back to two questions

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Simple example of bilateral precaution and car accidents If nobody takes precaution, $160 in expected harm Injurer precaution costs $20, cuts expected harm in half Victim precaution costs $20, cuts expected harm in half Strict liability precaution by injurers but not victims Simple negligence precaution by both


-60-20Negligence rule

0-100Strict liability rule

Expected payoff, victims

Expected payoff, injurers

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Posner Once you’ve already been hit by a car, you’d prefer a strict liability

rule to a negligence rule But if a negligence rule is more efficient… …then we’d all have agreed to it ex-ante (before the accident) “Ex-ante consent” / “ex-ante compensation”


-40-60-20Negligence rule

-500-100Strict liability rule

Expected payoff if you don’t know which one

you’ll be

Expected payoff, victims

Expected payoff, injurers

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Even if people are asymmetric… Consider a law: landlords must pay for heat Tenants get $1000 value from apartment, minus rent Landlords pay $100 for heat, $600 in other costs Without this law, tenants would pay their own heat Would heat apartment less, get $980 value and pay $60 for heat Might think tenants would prefer inefficient tenant-friendly law… But rents are set competitively, would go up to compensate…

Posner: “everyone would prefer the efficient law”


760 – 600= 160

980 – 60 – 760= 160

rent – 600980 – 60 – rentTenant pays for heat

850 – 600 – 100= 150

1000 – 850= 150

rent – 600 – 1001000 – rentLandlord pays for heat

LandlordsTenantsLandlords’

payoffsTenants’ payoffs

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Cooter and Ulen Society may have goals other than efficiency… …but it’s cheaper to design law to be efficient, and address the

distribution of wealth through the tax system

Why is tax system better way to control distribution of wealth? More directly targets high/low incomes, rather than rough proxies

(“consumers” vs “investors”, “doctors” vs “patients”) Effects of changes in legal system harder to predict Lawyers more expensive than accountants Redistributive laws would be like taxes on particular activities; narrow

taxes have greater deadweight loss


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Should the legal system aim to be efficient? Posner: it’s what we’d all have agreed to ex-ante Cooter/Ulen: if we want to adjust distribution of wealth, better to do

it through taxes

Second question: should we expect the law be efficient? Civil law: written at one point in time (late 1700s), meant to be static Common law: rooted in existing norms/practices, changed by

legislation and new precedents – meant to evolve over time Some believe this evolutionary process will naturally bring common

law toward greater efficiency

That answers the first question

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Posner

Some believe government, and courts, respond to politically powerful interest groups

Landlords might be more politically connected than tenants, so might influence laws…

…but like we just saw, even landlords probably don’t want inefficient pro-landlord laws, since they’d just lead to lower rents

So well-connected groups generally won’t resist efficient rules

Should we expect common law to naturally evolve toward efficiency?

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Cooter/Ulen: three ways the common law may naturally tend toward efficiency

By implementing social norms/existing industry practices Whaling example: industry norms were well-suited to each environment Common law judges enforced industry norms, making law efficient

Judges may deliberately try to make law more efficient Hand Rule: incorporated efficiency into legal standard for negligence Judges may be more willing to reverse inefficient precedents, as in

Boomer v Atlantic Cement


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Cooter/Ulen: three ways the common law may naturally tend toward efficiency

By implementing social norms/existing industry practices Whaling example: industry norms were well-suited to each environment Common law judges enforced industry norms, making law efficient

Judges may deliberately try to make law more efficient Hand Rule: incorporated efficiency into legal standard for negligence Judges may be more willing to reverse inefficient precedents, as in Boomer v

Atlantic Cement

Inefficient laws may lead to more litigation More opportunities to get them overturned


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So that’s two yeses: Posner: even politically influential will want efficient laws Cooter/Ulen: three ways common law evolves toward efficiency

But an opposing view: Gillian Hadfield, “Bias in the Evolution of Legal Rules” Cases are different, but law must be consistent So at best, courts can try to be “right on average” But courts will see a biased sample of all possible cases

Situations that lead to litigation are different from those that don’t So court will have biased view of what rules are efficient


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Hadfield, “Bias in the Evolution of Legal Rules” A given rule will have different effects on different individuals/firms Some will find it easy to follow rule: compliers Some will find it very costly to follow rule: violators (Others may drop out of market entirely) Being “right on average” means doing what’s efficient given the

true mix of compliers and violators in market But court will mostly see cases involving violators So it might choose rule that’s efficient for market containing only

violators… …which is different than the efficient rule


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Should we expect common law to naturally evolve toward efficiency? EXAMPLE

$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

$200$200$200$0$020%None

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm

Total Social Cost(Accidents + Precaution)

Cost of PrecautionProbabilityof Accident

Level of Precaution

Four levels of precaution: none, low, medium, high Accidents do $1,000 of harm Market has equal number of high- and low-cost firms

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$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

$200$200$200$0$020%None

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

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$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

$200$200$200$0$020%None

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

Efficient levels of precaution High-cost firms: low precaution is efficient Low-cost firms: high precaution is efficient One rule for all firms: medium precaution is most efficient

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$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

$200$200$200$0$020%None

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

If we must have one rule that applies to all firms… efficient rule requires is medium precaution level to avoid liability

If court only sees cases involving high-cost firms… it will think it’s to only require a low precaution level

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Hadfield: this bias will occur in any situation where courts adjust legal rule based on what appears efficient Whatever the existing rule, there will be some “compliers” and

some “violators” Courts will mostly see cases involving violators Law will evolve toward rule that would be efficient if only

violators existed But if compliers and violators are different enough, this won’t be

the efficient rule All this requires is enough heterogeneity in cases… …and courts that can only learn from the cases that go to trial


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Posner: yes Everyone, including the politically connected, wants efficient laws

Cooter/Ulen: yes Common law courts enforce existing norms/practices Courts may be more likely to overturn inefficient precedents Inefficient laws may lead to more litigation, and have more chances to

be overturned

Hadfield: no Courts see biased sample of cases If they adjust the law based on the cases they see, this will not lead to

efficient laws

So… should we expect common law to naturally tend toward efficiency?

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Unenforcedlaws

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Optimal criminal system will not detect/punish every crime, for two reasons Some crimes may be efficient (rare) When cost of deterrence is positive, it’s not worth paying enough to

deter every crime

But we still assumed most crimes are inefficient, and main reason not to punish them all is cost

We saw last week…

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There are a lot of old laws in many states that seem inefficient Massachusetts: can’t buy alcohol on Sundays Many states still have laws passed a long time ago

In some cases, law is enforced

Tim Wu, “American Lawbreaking” – many laws that we, as a society, have basically decided not to enforce at all

However…

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(Example I found online this weekend)

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Begins with New York prosecutors sitting around office, choosing celebrities (John Lennon, Mother Theresa) and coming up with obscure crimes they could be charged with “obstructing the mails,” “false pretenses on the high seas”

“Full enforcement of every last law on the books would put all of us in prison for crimes such as “injuring a mail bag.” No enforcement of our laws, on the other hand, would mean anarchy. Somehow, officials must choose what laws really matter.”

“Tolerated lawbreaking is almost always a response to a political failure – the inability of our political institutions to adapt to social change or reach a rational compromise that reflects the interests of the nation and all concerned parties. That’s why the American statutes are full of laws that no one wants to see fully enforced – or even enforced at all.”

Tim Wu, “American Lawbreaking” (Slate)http://www.slate.com/id/2175730/entry/2175733/

http://www.slate.com/id/2175730/entry/2175733/

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“Over the last two decades, the pharmaceutical industry has developed a full set of substitutes for just about every illegal narcotic we have.” Rather than legalizing street drugs… …society has developed Ritalin, vicodin, oxycontin, clonazepam, etc… …which may serve legitimate medical purposes in some instances, but

also mimic highs of cocaine and other drugs

Marijuana: several cities where police chiefs or DAs have announced they won’t prosecute possession Philadelphia law will treat possession as a ticketable offense Medical marijuana in California and elsewhere

First example doesn’t perfectly fit premise, but interesting

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Apparently, there’s porn on the internet

And it’s basically all illegal

Federal law prohibits using a “computer service” to transport over state lines “any obscene, lewd, lascivious, or filthy book, pamphlet, picture, motion-picture film, paper, letter, writing, print, or other matter or indecent character.”

Wu’s second example: pornography

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In 1968, Congress set up a commission to investigate Commission recommended we repeal all obscenity laws, replace them

with laws to protect children and control public display Nixon and other politicians condemned report as “morally bankrupt”,

insisted they would continue war on pornography

A few well-publicized prosecutions in 70s and 80s, halted in 90s

2005: Attorney General Alberto Gonzalez tried to pressure local prosecutors to crack down, but nothing happened One Miami attorney: “compared to terrorism, public corruption, and

narcotics, [pornography] is no worse than dropping gum on the sidewalk.”


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So pornography is technically illegal, rarely prosecuted

What’s developed is unofficial zoning system – rather than prohibiting behavior, it’s regulated Prosecuted when it crosses certain lines Ignored otherwise Super Bowl wardrobe malfunction – when something gets on prime-time

network TV, people freak out Child pornography still prosecuted But “mainstream” porn left alone, so functionally legal

So as a society, we’ve functionally legalized porn… Not through legislation or courts… …but through general concensus among prosecutors, FCC, FBI, local

police, etc., to do nothing about it


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Amish refuse to pay Social Security taxes, do not accept benefits, do not educate children past eighth grade

Mormons to some degree still practice polygamy

Wu discusses history of legal treatment

Again, what’s emerged is de facto zoning Mormon polygamist went on Sally Jessy and Springer to discuss his

lifestyle, he was tried and convicted But when it’s done quietly, in scattered communities outside of big

cities, polygamy still goes on and is basically tolerated Amish are open about how they live, but keep to themselves, and

nobody worries about it

Wu’s other examples: copyright law, illegal immigration, Amish and Mormons

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You’d think crimes are crimes because society wants them to be crimes

But in some cases, society doesn’t care whether something is a crime, but doesn’t care enough to make it legal either

Or, political system is “broken” enough that some things can’t be fixed, we adapt by ignoring certain laws

More obvious example: speeding

This may support Hadfield’s view that the law won’t automatically evolve to be efficient!

This all doesn’t really fit into our framework of criminal law

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The semesterin review

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Should the law aim to be efficient? Posner: yes, ex-ante consent Cooter and Ulen: yes, better to handle distribution through taxes

Will common law naturally tend toward efficiency? Posner: yes, even the politically influential want efficient laws Cooter and Ulen: yes

Common law enforces norms and industry practices, which are likely efficient

Judges may be more likely to overturn inefficient precedents Inefficient laws may lead to more litigation

Hadfield: no Court gets biased sample of cases, leading to “biased” laws

We began and ended with efficiency

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Coase: when there are no transaction costs: Just define property rights and make them tradable… …then sit back and let people trade till we get efficient allocation

But with transaction costs, this won’t work; we can either: try to reduce transaction costs, or… …try to get the allocation right to begin with

Some sources of transaction costs Search costs Private information Large numbers of parties Hostility Enforcement costs

Following efficiency, we got Coase

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Property/nuisance law Largely deals with situations where transaction costs are low

(especially private nuisances/property disputes) Clarify peoples’ rights/entitlements so they can enter into voluntary

exchange Initial allocation matters when transaction costs are high enough that

efficiency isn’t reached “automatically”

Contract law Costs of ex-ante negotiations not too high… …but renegotiation costs enough that we want to avoid it Aim to reduce transaction costs with efficient default rules, incentives

to share information

Branches of the law and transaction costs

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Tort law Accidental situations, strangers costs of ex-ante negotiations

prohibitively high All we can do is generate incentives to avoid harm when possible

Criminal law Ex-ante negotiations impossible for many reasons “Public bad” – many parties harmed, so transaction costs are high

Next, a few recurring themes from the semester…

Branches of the law and transaction costs

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Determining efficient action/outcome requires comparing social cost and social benefit of each activity Activity should occur when social benefit > social cost

We expect self-interested decision-makers to consider private cost and private benefit

If private cost < social cost, activity imposes a negative externality, and will naturally occur too much Tragedy of the commons Breach of contract in a world without remedies Reckless driving in a world without liability

If we can set private cost = social cost, people will naturally take efficient actions

1. To get efficient outcomes, design the law to make people internalize externalities

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If we set private cost = social cost and private benefit = social benefit, people naturally choose efficient action Contract law

Breach of contract imposes externality on promisee Expectation damages = anticipated benefit = harm done by breach So then we get efficient breach

Tort law Liability causes injurer to internalize harm his actions lead to Leads to efficient precaution, efficient activity level

Nuisance law Suppose I have a legal right to quiet enjoyment of my apartment You value making noise at $100, I value quiet at $50 If rights are tradable, silence costs me $100 in opportunity cost Tradable entitlements also lead to internalization, therefore efficient allocation

1. To get efficient outcomes, design the law to make people internalize externalities

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A right is protected if nobody can violate it without my permission Really, if violation is punished severely Injunctive relief protects rights

An interest is protect if violation must be compensated Interests are protected by damages

2. Choosing between protecting a right and protecting an interest

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Property law generally protects rights Trespassing on my land is punished severely, as a crime Theft: if you steal my iPhone, you don’t owe me $300, you go to jail But there are exceptions

Private necessity Eminent domain

Contract law generally protects interests Expectation damages protect promisee’s interest in performance of a

promise, not their right to performance But again, there are exceptions

Remedy of specific performance protects promisee’s right to a promise, is often used for contracts to sell unique good


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Tort law generally protects interests Nobody asks permission to break your arm in a car accident Instead, they hit you, then have to compensate you

Key difference between criminal law and civil (tort) law Crimes are intentional, so we may want to deter them Give you a right not to get stabbed, protect that right with severe

punishment for assault Torts are accidental, impossible to eliminate them Just want to reduce them to efficient level So we price them, to get injurer to internalize externality This is same as protecting an interest


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Designing efficient legal system means maximizing social surplus

Which is same as minimizing social costs Think about starting at most efficient outcome Costs are any deviations away from that

Costs typically take two forms: Direct costs of implementing some part of legal system Indirect costs: any flaws in system lead to imperfect incentives, and

therefore inefficient outcomes (“Administrative costs” and “error costs”)

Often tradeoff between cheaper/simpler system, and more costly/extensive system giving better incentives

3. Tradeoff between cheaper/simpler rule and better incentives

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Demsetz: private land ownership among native Americans Private ownership has higher direct costs: boundary maintenance Public ownership has high indirect costs: inefficient use of land

(overhunting)

Whaling “Fast fish/loose fish” – simpler rule, fewer disputes

Lower direct costs “Iron holds the whale” – creates more efficient incentives for

faster/more violent whales Lower indirect costs

Which is more efficient depends on situation


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Injunctions versus damages Damages more costly for court to calculate – higher direct costs Injunctions rely on bargaining – inefficient outcomes (high indirect costs)

if transaction costs are high

Filing fees to initiate a lawsuit Higher filing fees fewer lawsuits lower direct costs But more harms “unpunished” weaker incentives to avoid higher

indirect costs

Crime Catching more criminals is more costly (higher direct costs) But deterrence leads to fewer crimes (lower indirect costs)


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But recently, a few counterexamples

Trial by ordeal Seemingly irrational institution for dealing with information problem

Behavioral economics Ways that peoples’ behavior may differ from perfect rationality

Unenforced laws How we deal with imperfect political system which leads to laws we don’t

want but can’t overturn

Most of the semester, we’ve assumed rational individuals, rational institutions

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To wrap up…

And that’s basically the class

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Economics is a set of tools, not a set of answers Friedman: “Economics is neither a set of questions nor a set of answers;

it is an approach to understanding behavior”

Point of class Not to memorize which liability rules leads to efficient injurer activity …but to understand why To understand how people respond to incentives, and be able to predict

how a law or policy will affect peoples’ behavior

Santa Monica, CA City Council banned ATM fees in 1999 They were shocked the next day, when ATMs stopped giving money to

other banks’ customers I’d like to think you all would have been smarter than that

What do I want you to remember after May 12?

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Thank you allfor being here

Econ 522 Economics of Law Dan Quint Spring 2011 Lecture 24.

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