Law and economics

The historical antecedents of law and economics can be traced back to the classical economists, who are credited with the foundations of modern economic thought. As early as the 18th century, Adam Smith discussed the economic effects of mercantilist legislation; later, David Ricardo opposed the British Corn Laws on the grounds that they hindered agricultural productivity; and Frédéric Bastiat, in his influential book The Law, examined the unintended consequences of legislation. However, to apply economics to analyze the law regulating nonmarket activities is relatively new. A European law & economics movement around 1900 did not have any lasting influence.[3]

Harold Luhnow, the head of the Volker Fund, not only financed F. A. Hayek in the U.S. starting in 1946, but he shortly thereafter financed Aaron Director's coming to the University of Chicago in order to set up there a new center for scholars in law and economics. The University was headed by Robert Maynard Hutchins, a close collaborator of Luhnow's in setting up the Chicago School, as it became commonly known. The university faculty then included a strong base of libertarian scholars, including Frank Knight, George Stigler, Henry Simons, Ronald Coase and Jacob Viner.[4] Soon, it would also have not just Hayek himself, but Director's brother-in-law and Stigler's friend Milton Friedman, and also Robert Fogel, Robert Lucas, Eugene Fama, Richard Posner, and Gary Becker.

Historians Robert van Horn and Philip Mirowski described the development of modern economic concepts in "The Rise of the Chicago School of Economics", a chapter of The Road from Mont Pelerin (2009); and historian Bruce Caldwell (a great admirer of von Hayek) filled in more details of the account in his chapter, "The Chicago School, Hayek, and Neoliberalism", in Building Chicago Economics (2011). 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 are regarded as important events. Gordon Tullock and Friedrich Hayek also wrote intensively in the area and influenced to spread of 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.[5] In 1960 and 1961, Ronald Coase and Guido Calabresi independently published two groundbreaking articles, "The Problem of Social Cost"[6] and "Some Thoughts on Risk Distribution and the Law of Torts".[7] This can be seen as the starting point for the modern school of law and economics.[8]

In 1962, Aaron Director 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.[9] He taught antitrust courses at the law school with Edward Levi, who eventually would serve as Dean of Chicago's Law School, President of the University of Chicago, and as U.S. Attorney General in the Ford administration. After retiring from the University of Chicago Law School in 1965, Director relocated to California and took a position at Stanford University's Hoover Institution. He died September 11, 2004, at his home in Los Altos Hills, California, ten days before his 103rd birthday.

In the early 1970s, Henry Manne (a former student of Coase) set out to build a center for law and economics at a major law school. He began at the University of Rochester, worked at the University of Miami, but was soon made unwelcome, moved to Emory University, and ended up at George Mason.[10] The last soon became a center for the education of judges—many long out of law school and never exposed to numbers and economics. Manne also attracted the support of the John M. Olin Foundation, whose support accelerated the movement. Today, Olin centers (or programs) for Law and Economics exist at many universities.

'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.

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, in particular, allocative 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.

Nonetheless, the possibility of a clear distinction between positive and normative analysis has been questioned by Guido Calabresi who, in his book on "The future of Law and Economics" (2016: 21-22), believes that there is an "actual - and unavoidable - existence of value judgments underlying much economic analysis"[19]

Uri Weiss proposed this alternative: "It is common in law and economics to search for the law that will lead to the optimal outcome, providing the maximum size 'pie,' and to think about maximizing happiness instead of minimizing pain. We prefer another approach: We do not try to identify games that will lead to the optimal result but to prevent games in which it is in the best interests of the players to come to an unjust result".[20]

Critics of the economic analysis of legal questions have argued that normative economic analysis does not capture the importance of human rights and concerns for distributive justice. Some of the heaviest criticisms of law and economics come from the critical legal studies movement, in particular Duncan Kennedy[52] and Mark Kelman. Jon D. Hanson, of Harvard Law School, argues that our legal, economic, political, and social systems are unduly influenced by an individualistic model of behavior based on preferences, instead of a model that incorporates cognitive biases and social norms.[53]

Additional criticism has been directed toward the assumed benefits of law and policy designed to increase allocative efficiency when such assumptions are modeled on "first-best" (Pareto optimal) general-equilibrium conditions. Under the theory of the second best, for example, if the fulfillment of a subset of optimal conditions cannot be met under any circumstances, it is incorrect to conclude that the fulfillment of any subset of optimal conditions will necessarily result in an increase in allocative efficiency.[54]

Consequently, any expression of public policy whose purported purpose is an unambiguous increase in allocative efficiency (for example, consolidation of research and development costs through increased mergers and acquisitions resulting from a systematic relaxation of antitrust laws) is, according to critics, fundamentally incorrect, as there is no general reason to conclude that an increase in allocative efficiency is more likely than a decrease.

Essentially, the "first-best" neoclassical analysis fails to properly account for various kinds of general-equilibrium feedback relationships that result from intrinsic Pareto imperfections.[54]

Another critique comes from the fact that there is no unique optimal result. Warren Samuels in his 2007 book, The Legal-Economic Nexus, argues, "efficiency in the Pareto sense cannot dispositively be applied to the definition and assignment of rights themselves, because efficiency requires an antecedent determination of the rights (23–4)".

Relatedly, legal scholarship also has criticized the movement for allowing its framing of models to dictate its results, for over-emphasizing or under-emphasizing specific incentives and costs, and for building models that do not degrade "gracefully" (and therefore have difficulty modeling reality).[55] In other words, the law and economics movement may not achieve "efficiency", even to the extent allocative efficiency is the goal of the law.[56]

Cullerne Bown has criticised Posner's approach on methodological grounds. He concludes that Posner's approach to evaluating policies in the criminal process is methodologically invalid and that "these failings in turn make the entirety of his conclusions on the criminal process unreliable".[57]

Law and economics has adapted to some of these criticisms and been developed in a variety of directions. One important trend has been the application of game theory to legal problems.[58] Other developments have been the incorporation of behavioral economics into economic analysis of law,[59] and the increasing use of statistical and econometrics techniques.[60] Within the legal academy, the term socio-economics has been applied to economic approaches that are self-consciously broader than the neoclassical tradition.

Property rights, which are analyzed using economic analysis, are seen as fundamental human rights by defenders of law and economics.[61]