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Journal of Economic Literature

Vol. XLIV (June 2006), pp. 405–414

A Review of Steven Shavell’s

Foundations of Economic Analysis
of Law
RICHARD A. POSNER∗

Steven Shavell’s Foundations of Economic Analysis of Law (Harvard University

Press, 2004) is a major theoretical contribution to “law and economics,” the applied
field of economics that studies the economic properties and consequences of legal doc-
trines and institutions. It is a field of immense practical importance, but unfamiliar to
many economists—a situation that Shavell’s book bids fair to rectify. This review
essay situates Shavell’s book in the history of economic scholarship about law and uses
the book as a springboard for speculation about new directions in that scholarship.

A fter receiving his doctorate in economics

from MIT in 1973, Steven Shavell began
teaching economics at Harvard. He moved
to the law school in 1980. Beginning that
year, and without abatement since, he has
published several books and more than one
hundred articles, all on economic analysis of
law, all theoretical, and all or virtually all on
the basic or, as he terms them, central fields
of law as a lawyer would recognize them—
torts, contracts, property, criminal law, pro-
cedure, and remedies—with some attention
as well to jurisprudence, including the nor-
mative adequacy of the economic approach
to law. He has done no empirical work, and
∗
Posner: Judge, U.S. Court of Appeals for the Seventh
Circuit; Senior Lecturer, University of Chicago Law
School. I thank William Landes and Andrei Shleifer for
helpful comments on a previous draft of this review, and
Meghan Maloney for helpful research assistance and cite
checking.
has done little in what in law would be con-
sidered the “advanced” subjects, such as
constitutional law, environmental law,
antitrust law, labor law (including pension
law and the law of employment discrimina-
tion), corporate and securities law, interna-
tional law, regulated industries, and
bankruptcy. A surprising omission, because
of its similarity to contract law, is family law.
In noting that Shavell has not covered the
entire vast field (as it has become) of eco-
nomic analysis of law (or “law and econom-
ics” as it is often called), I do not intend
belittlement. The scope and quality of his
work are remarkable. He is a superb theo-
retician, and the major theoretical contribu-
tor to most of the areas of economic analysis
of law in which he has written. He is the
leading figure in the “third generation” of
law and economics scholars and, before
turning to his latest and most important

405
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406 Journal of Economic Literature, Vol. XLIV (June 2006)
book, Foundations of Economic Analysis of
Law, I need to say a few words about the his-
tory of economic analysis of law—a field
that, despite its theoretical interest and prac-
tical importance, remains unfamiliar to
many economists.1
Traditionally, economics was thought to be
defined by its subject rather than by its
method. Its subject was the economy; and
the legal system, though understood to
affect the economy, was not thought to be
itself an economic system in the sense of a
social activity that could profitably be stud-
ied in economic terms. (Climate affects the
economy but the climate is not an economic
system.) With the startling exception of
Jeremy Bentham’s utilitarian analysis of
criminal punishment, which anticipated by
more than 150 years Gary Becker’s econom-
ic theory of criminal punishment, there was
very little economic writing on law outside
those areas, mainly antitrust and public util-
ity/common carrier regulation, where the
law seemed to have explicitly incorporated
economic concepts, such as, in the case of
antitrust, monopoly and competition.
A more sustained, extensive engagement
of economics with law had to await recogni-
tion (which again had been anticipated by
Bentham) that economics is a theory as well
as an “area study”—specifically the theory
of rational choice, a theory that can in prin-
ciple be applied to any social activity (even
nonhuman), thus including law, even when
law regulates nonmarket activities, such as
crime, adjudication, or marriage. The lead-
ing economist in refashioning economic
theory as the theory of rational choice and
enormously extending the application of
economics to nonmarket activity has been
Becker, who began publishing in the 1950s.
His book on the economics of racial dis-
crimination (Becker 1957), and his article
on the economics of crime and its punish-
ment (Becker 1968; see Posner 1993), were
landmarks in the emergence of economic
1
For a fuller discussion, see Posner (2001, ch. 1).
analysis of (all) law, though an even greater
landmark was Ronald Coase’s article on
social cost (Coase 1960). Coase himself, par-
adoxically, has rejected the concept of eco-
nomics as the theory of rational choice and
has indeed disclaimed any interest in law
except insofar as it affects the economy
(Coase 1988, 1984; Posner 1995, ch. 20).
Nevertheless, and of signal importance to
economic analysis of law, Coase’s article con-
tains an insightful analysis of the economiz-
ing properties of tort law; more important, it
focused attention on transaction costs, which
are central to the understanding of the law as
an economic system.
Coase, Becker, Guido Calabresi (then a
law professor, now a judge), and a few others
comprise what I am calling (with apologies to
Bentham) the “first generation” of economic
analysts of law. Their major contributions to
the field were complete by about 1970, the
year that Calabresi published his influential
book The Costs of Accidents.2 The second
generation, of younger scholars such as
myself and Becker’s students William Landes
and Isaac Ehrlich, began publishing in the
late 1960s (see, for example, Posner 1972b;
Becker and Landes 1974). They used the
theoretical approaches of the first generation
to extend economic analysis into a variety
of—eventually into almost all—fields of law,
with particular emphasis on exploring the
degree to which the law, especially the com-
mon law, might actually be a system for pro-
moting the efficient allocation of resources.3
Despite the archaic, moralistic vocabulary of
the law, the second generation of economic
analysts of law took seriously the possibility
that the (implicit, intuitive) logic of the law
2
The subject of a recent retrospective symposium
(“Symposium: Calabresi’s The Costs of Accidents: A
Generation of Impact on Law and Scholarship” 2005). But
of equal importance was Calabresi’s article with A.
Douglas Melamed (1972), which first analyzed the eco-
nomic difference between property rights and liability as
means by which the legal system directs the allocation of
resources.
3
This is a particular theme in Posner (1972b) and in
subsequent editions of that work.
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Posner: A Review of Foundations of Economic Analysis of Law
might indeed be economics. Their work,
much of it by law professors rather than by
professional economists, was characterized
by close attention to legal doctrines, proce-
dures, and institutions. Formal modeling was
not emphasized and theoretical rigor was
often absent in the work of the law profes-
sors. But as a result of the close attention to
the law itself, the work of the second genera-
tion had and continues to exert an immense
influence on legal education (both teaching
and scholarship) and a growing influence on
legal doctrine and on the practice and admin-
istration of law. By the time Steven Shavell
began publishing, economic analysis of law
was already recognized to be the foremost
interdisciplinary field of legal scholarship.
This was the legacy of the first and second
generations of economic analysts of law.
That economic analysis of law continues to
grow in scope, insight, and influence is, how-
ever, due in considerable measure to the
work of the third generation, Shavell’s gen-
eration. This generation is dominated by
technically sophisticated economists, such as
Oliver Hart (1995), A. Mitchell Polinsky, and
of course Shavell himself, and by law profes-
sors who have a doctorate (or, in a minority
of cases, an ABD) in economics, such as
Lucian Bebchuk, Louis Kaplow, and Alan
Sykes. (This is a very incomplete list.)
Whereas the second generation tended to
work the extensive margin, bringing more
and more doctrines, procedures, and institu-
tions under the lens of economics, the third
generation has tended to cultivate the inten-
sive margin, bringing new insights into fields
such as torts and contracts that had already
received considerable attention from the
second generation.
Shavell is the leading figure of the third
generation—and only in part because of his
seniority (at 59, he is one of the oldest of the
leading figures of the generation, and so he
has had more time to publish and become well
known and influential than the others). He is
not only a gifted theoretician but also a
dogged, careful, thorough worker, who, his
407
attention never flagging, has produced a
steady stream of pathbreaking work for a
quarter of a century, sharply focused on a con-
vergent body of issues and yielding the unified
theory of law set forth in Foundations—to
which at last I turn.
This massive tome of more than 700 pages
is best described as an economic treatise on
the basic fields of law that I listed at the out-
set—torts, contracts, remedies, etc. These are
fields to which Shavell has made important
contributions, which naturally are empha-
sized though not to the exclusion of other
major contributions—the hundreds of refer-
ences listed in the forty–four–page bibliogra-
phy make the book among other things an
immensely valuable guide to the scholarly lit-
erature of economic analysis of law. There is
only one field covered in the book to which
Shavell (2004) has not made major contribu-
tions, and that is intellectual property—and it
is the book’s thinnest, least interesting section
(pp. 137–74).
Although many of the most interesting
ideas presented in the book date from work
by Shavell and others in the early 1980s and
even earlier, there is much that is recent
(see, for example, references to Shavell’s own
recent work in Shavell 2004, pp. 711–13);
the book is up to date. And Shavell has done
something fresh and interesting that signifi-
cantly enhances its value as a reference work
and teaching supplement—which is to
exclude math from the text but place mathe-
matical versions of a number of the analytic
points made in the text in footnotes. The
mathless text makes the book intelligible to
the mathless reader, which is to say to the
average law professor, law student, lawyer,
and judge, all of whom can benefit immense-
ly from the book. The mathematical foot-
notes will enable the economist reader who
may not have encountered economic analysis
of law before to see it expressed in the formal
models with which he is familiar.
There are now a number of book-length
treatments of economic analysis of law, but
there is no book quite like Foundations.
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408 Journal of Economic Literature, Vol. XLIV (June 2006)
There are quite a few textbooks, most of
which proceed by first introducing the read-
er to the basic economic principles that are
relevant and then applying them to a hand-
ful of legal rules (see, for example, Polinsky
2003; Cooter and Ulen 2000; Friedman
2000; Miceli 2004; Spurr 2005). Shavell
skips that stage, presupposing the reader’s
knowledge of the most elementary princi-
ples of economics, and this enables him to
discuss more legal rules and in greater
depth. The same approach is taken in my
own textbook treatise.4 It is somewhat
longer than Shavell’s and covers a much
larger area of the law and in greater detail,
but my economic treatment of issues on
which our two books overlap lacks the depth
and rigor of Shavell’s treatment. There are
also encyclopedic works on economic analy-
sis of law (Newman 1998; Bouckaert and De
Geest 2000), necessarily unwieldy and het-
erogeneous; a number of anthologies of arti-
cles on law and economics (see, for
example, Oppenheimer and Mercuro 2005;
Wittman 2003; Posner 2000; Backhaus
1999; Katz 1998; Dau-Schmidt and Ulen
1998; Posner and Parisi 1997; Coleman and
Lange 1992); and some general introducto-
ry works that are not quite textbooks (for
example, Harrison 2003; Mercuro and
Medema 1997).5 Shavell’s book, in short,
fills a significant gap.
The word “foundations” in Shavell’s title is
a double entendre. In one sense it refers to
the legal subject matter analyzed in the
book, which consists, as I said, of the basic,
or foundational, fields of law and aspects of
the legal system. In another sense, the word
refers to the analytic foundations of econom-
ic analysis of law, which are the principles of
economics. Those foundations are vital, but
the foundations of an edifice are not the
entire edifice. In so saying, I do not mean to
4
The current edition is Posner (2003).
5
There are a number of books dealing with economic
analysis of particular fields of law, such as accident law, but
of course they are not comparable to Shavell’s in scope.
criticize Shavell for stopping after 737 pages.
The book does exactly what he set out to do,
and what he set out to do is immensely
important. But I want to dispel any impres-
sion that economists might take away from
reading the book that economic analysis of
law is exhausted in Shavell’s treatment.
To begin with, what Shavell means by eco-
nomic analysis of “law” is not what a lawyer
would understand by the term. The lawyer
would expect the book to be about the law as
it exists in statutes and cases and in the cus-
toms and practices of lawyers and judges and
prosecutors and the rest of the law’s drama-
tis personae—which is to say, the law as it is
stated in legal treatises and judicial decisions
plus the law in action, that is, the law as it is
actually practiced and enforced. The lawyer
would be wrong in that understanding of
Shavell’s book. The “law” that Shavell ana-
lyzes is an abstract or stylized—a simpli-
fied—version of actual law; it is law minus
detail and texture, law trimmed to fit the
economic model. Often this works fine in
capturing the essential features of the sub-
ject; indeed, it is hard to imagine how man-
ageable economic models of law, as of other
institutions or activities, could be developed
without considerable simplification of the
phenomenon being modeled. So “negli-
gence” to Shavell means failure to use due
care, as a result of which an injury occurs;
and he explains what this might mean in eco-
nomics, namely (an insight surprisingly
anticipated by a judge, Learned Hand, in a
1945 case) that the expected cost of the
injury (the cost of the injury if it occurs dis-
counted by the probability that it will occur)
exceeded the cost of a precaution that would
have prevented the injury from occurring.
Although judges rarely speak in cost–benefit
terms, cost–benefit analysis is a close
approximation to the negligence inquiry.
There are various buttressing rules of negli-
gence (assumption of risk, contributory and
comparative negligence, last clear chance,
etc.), some of which are discussed by Shavell
but many not; and there are fascinating cases
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Posner: A Review of Foundations of Economic Analysis of Law
that test and probe the rules, and these are
also not discussed. So there is considerable
simplification in his treatment of the con-
cept of negligence but there is no significant
distortion.
His treatment of tort law, however, is
incomplete. Shavell rightly emphasizes the
role of tort law in deterring inefficient
behavior, a role that follows directly from
rational-choice theory (the threat of liabili-
ty operating as a price for engaging in risky
behavior), but barely mentions the growing
literature in cognitive psychology (a litera-
ture sometimes referred to as “behavioral
economics” when used by economists),
which bears on the ability and inclination of
people to respond to risk and to the finan-
cial incentives and disincentives created by
tort liability (see, for example, Parisi and
Smith 2005; Sunstein 2000). To what
extent, for example, do people actually
understand and act upon the various risks
that law deals with and sometimes creates,
such as the risk of punishment for commit-
ting a crime? Do financial consequences of
tort liability actually add anything to the
deterrent effect that is exerted by fear of
being killed or injured in an accident,6 or of
being fined for dangerous behavior? Do
consumers actually read the fine print of
installment contracts? If they don’t, does it
matter? Shavell remarks that “a person
might pay his neighbor to plant a screen of
bushes around an unsightly garbage area so
that the person can enjoy a better view” (p.
86), but what is interesting is how rare such
transactions are, that is, value-maximizing
transactions in noncommercial settings.
Their rarity seems to reflect a peculiar shy-
ness about “commodifying” certain rela-
tionships. One might offer a neighbor’s
teenage son money to mow one’s lawn; but
6
Shavell (pp. 284, 395) suggests not, though without
discussion. He may be correct, but he is incorrect to sug-
gest that, if so, tort liability will have little effect on the
incidence of automobile accidents; for by increasing the
cost of driving (via the effect on liability insurance rates), it
will reduce the accident rate (Grayston 1973).
409
imagine making the same offer to the
neighbor himself!
The book has other limitations stemming
from its stylized treatment of law. There is,
unsurprisingly, a certain insensitivity to the
practical dimensions of law, as in the sugges-
tion that a higher-level court “could readily
accomplish harmonization [of the law—that
is, ‘reconciliation of conflicting interpretation
by different trial courts’] on its own initia-
tive,” without need to allow appeals (p. 463).
That would not be a court at all, in any rec-
ognizable sense. Or consider his advocacy of
substituting for the patent system a govern-
mental reward for valuable inventions (pp.
161–65), an approach that would generate
rent-seeking on a colossal scale. Or his (relat-
ed) advocacy of entitling a finder of lost prop-
erty to a mandatory reward from the owner
based on “the optimal recovery effort” (p. 43,
n. 21)—a determination that a court would
find extremely difficult to make and that
would not even be worth making. Most lost
property is of little value; when it is of sub-
stantial value, the owner can post a reward,
which is legally enforceable; there is little
reason for (further) public intervention.
And it seems odd to wonder as Shavell (p.
205) does why there should be strict liability
for allowing a wild animal to escape and
injure someone but not for an automobile
driver’s running down a pedestrian. The only
way to prevent the wild animal from escaping
may be not to have a wild animal on one’s
property in the first place, an activity-level
change (the not having) that strict liability
would induce but negligence liability would
not. Besides, a pedestrian can usually avoid
injury by being careful even if drivers are
negligent, but it is very difficult to protect
oneself against a rampaging wild animal.
Strangest of all is Shavell’s (pp. 58–59)
proposal that gifts (not just charitable gifts
but all gifts) should be subsidized on the
ground that very often a sum of money pos-
sessed by one person would confer a greater
total utility if it were transferred to another
person. That is true but the proposal would
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410 Journal of Economic Literature, Vol. XLIV (June 2006)
entail a massive administrative structure for
redistributing wealth. It is an example of
how a commitment to utilitarianism can lead
one astray. Utility is a useful concept in eco-
nomics but the idea that a society should
strive to maximize utility (and whose utili-
ty?—just members of the society, or foreign-
ers too, or maybe, as the classical utilitarians
thought, animals too?—and what about
unborn generations?) cannot be taken seri-
ously once one actually starts to think about
it. In part 7 of Foundations—“Welfare
Economics, Morality, and the Law,” consist-
ing of three short chapters—Shavell advo-
cates utilitarianism as the proper framework
for evaluating social welfare. He does so
without discussing the many disabling objec-
tions to utilitarianism as a normative system.
He is not a philosopher. He misunderstands
“wealth maximization,” which is simply the
Kaldor–Hicks criterion (potential Pareto
superiority) and he misunderstands “classic
corrective justice” to be the principle that
“the wrongdoer must make his victim whole”
(p. 635).7
Occasionally, Shavell’s refusal to engage
with the actual rules of the legal system leads
to error. These errors are frequent rather
than occasional in the chapter on property,
which is one of the weaker chapters in the
book—and not only because it is the chapter
in which he discusses intellectual property.
Not that there aren’t many fine insights even
in this chapter. I was particularly struck by a
novel, counterintuitive but sound argument
for the power of eminent domain: that even
if the utility of a person’s property to the per-
son is less than the utility that the property
would confer on society at large if the prop-
erty were put to some public use, there may
be no price that the owner would accept to
part with the property voluntarily because of
diminishing marginal utility of money (p.
125, n. 24). But in further discussion of emi-
nent domain, Shavell (pp. 127–28) stumbles,
7
On these issues, see Posner (2001, ch. 3; 1990, chs.
11–12).
claiming that compensation for taking prop-
erty by eminent domain is not required even
if property owners are risk averse because
they should be able to purchase insurance
against the taking of their property. This is
doubtful on two grounds. First, the risk may
not be susceptible of quantification, in
which event there is no basis for setting an
insurance premium.8 Second, moral hazard
would deter an insurance company from
insuring a property for more than its market
value. But it is precisely the “more” that the
property owner fearful of eminent domain
would want to insure because, in an eminent
domain proceeding, he would be entitled to
(and thus “insured” for) the market value of
his property.
Shavell (pp. 72–76) criticizes the rule of
adverse possession (which in some circum-
stances allows a person who occupies anoth-
er person’s land to obtain title to it without
the owner’s consent) seemingly without real-
izing that adverse possession requires not
only open (visible) occupancy visibly
adverse,9 but also that the occupant have a
good faith belief that he is the true owner of
the property. Shavell (p. 53) discusses the
bona fide purchaser rule (the rule that some-
one who buys in good faith can obtain good
title even if the seller was not authorized to
sell) on the assumption that it enables a thief
to pass good title. This is incorrect; the rule
allows a purchaser, again if he is acting in
good faith, to obtain ownership of property if
for example the seller was an agent of the
original owner and in selling rather than
renting the good exceeded his instructions;
but not if the property was stolen.
8
Insurance presupposes risk. Uncertain events (in
Frank Knight’s distinction between risk and uncertainty—
the first calculable, the second not) cannot be insured
against. The Lloyd’s syndicate in London traditionally
would insure anything—but that is just an example of the
fact that some people will gamble without knowing the
odds.
9
That is, the owner must be on notice that the posses-
sor’s claim is inconsistent with his (the original owner’s)
title. A tenant has possession of his landlord’s property, but
his possession is not inconsistent with the landlord’s con-
tinued ownership.
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Posner: A Review of Foundations of Economic Analysis of Law
I do not wish to exaggerate; Shavell’s legal
mistakes are few, given the length and scope
of the book. It is curious but true that,
although economics is intellectually more
sophisticated than law and though there is—
recognition of this point is close to the heart
of economic analysis of law10—a considerable
isomorphism between law and economics, no
one, however bright, who is not a lawyer can
get the law quite right. Law is like a language
that you have to be a native speaker of to
speak correctly. Shavell is not a lawyer, and a
strength of his work is his determination to
stick to his last, as an economic theorist
(which he fails to do only when he discusses
philosophy); and that is fine.
Another thing that Shavell is not is an
empiricist (if he were, he would have to con-
front the challenges that behavioral econom-
ics mount to the traditional rational-choice
model that Shavell employs), although he
cites many empirical studies in the econom-
ics of law and by doing so usefully reminds
the reader that there is by now a very exten-
sive body of such studies. Econometric
analysis of law is enabled by the prominence
of quantitative measures of legal activity—
such as number of cases of various kinds,11
number of reversals and affirmances, num-
ber of accidents and crimes of various
kinds—even the number of abortions (John
J. Donohue and Steven D. Levitt 2001)—
and the size of fines and length of prison
sentences. Explaining changes in these
measures over time and across different
legal jurisdictions is a challenging but feasi-
ble undertaking. We need to have a better
10
For an early example, see Posner (1972a).
11
The book contains a curious error concerning num-
ber of cases, however. It states that 2.3 million civil cases
were filed in federal courts in 2000. Id. at 390. This is
almost ten times the actual number, which was 259,517 in
fiscal 2000 (Administrative Office of the United States
Courts 2000, table C). An even odder mistake, because it
is purely arithmetic, is the statement that the number of
Americans in prison or jail, 1.9 million, is 3 percent of the
nation’s adult population (p. 534). The total adult popula-
tion of the United States is 300 million, which means that
the percentage imprisoned is less than 1 percent.
411
idea of when law conforms to the dictates of
economic efficiency and when it does not—
and why not, a question of political economy
that Shavell does not discuss. The lack of an
empirical dimension to the book under-
mines Shavell’s (p. 670) conclusion that eco-
nomic efficiency “sometimes is consistent
with our legal system and other times con-
flicts with it.” What he has analyzed is a
stripped-down model of our legal system,
not the system itself. No actual system cor-
responds exactly to an economic model of it.
The question that must be answered to
determine how efficient an actual legal sys-
tem is, is in what specific respects a change
in the system would increase efficiency. That
is an empirical question.
These critical comments must be placed
in perspective. Consdering the length of
Shavell’s book, I find remarkably little in it to
criticize or disagree with. Just as Thomas
Aquinas’s Summa Theologica is the defini-
tive summation of medieval scholasticism, so
with a little extravagance can Foundations of
Economic Analysis of Law be described as
the summa of the third generation of eco-
nomic analysis of law. So it is timely to con-
sider whether a fourth generation has
appeared on the scene. It has. It differs from
the preceding generations in part in its inter-
national, comparative, and historical focus
(see, for example, Shleifer 2005; Glaeser and
Shleifer 2002; La Porta, Lopez-de-Silanes,
and Shleifer 2006), whereas the previous
focus had been on modern Anglo–American
law, though with exceptions. The variety of
legal systems, across nations and through
time, is marked and calls for explanation.
(Shavell notes from time to time salient dif-
ferences between Anglo–American and
European law, but does not try to explain
them.) The consequences of that variety for
economic development are potentially very
great (a point grasped long ago by Max
Weber) and provide a rich field for empirical
study. The rising generation also displays a
greater interest in the effect of human cog-
nitive limitations on the law (the domain of
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412 Journal of Economic Literature, Vol. XLIV (June 2006)
behavioral economics) in normative systems
that are distinct from but intersect with law,
such as custom and social norms, and—
though this is just beginning—in the appli-
cation to law of the new (new to economic
analysts of law at any rate, and unmentioned
in Shavell’s book) field of organizational eco-
nomics (on which see, for example, Roberts
2004).
There is a degree of artificiality in my gen-
erational divisions. The generations overlap
both in time and in methods and subject
matter. Members of the second generation
are continuing to do second, third, and even
fourth generation work; third generation
work will undoubtedly continue for many
years. Shavell’s Foundations is not the com-
pletion of that work, but it does so well what
it does that it allows us to see more clearly
what remains to be done—the agenda for
what I am calling the fourth generation.
I said that Shavell is not an empiricist, a
psychologist, or a lawyer. The new agenda
will draw heavily on the skills denoted by
these vocations. Let me amplify the main
items on the agenda sketched very briefly
above. One is the comparative study of legal
institutions. To study the effects of a social
institution empirically using econometric
methods such as multiple regression, it is
helpful to have a lot of variation; and there is
much more variation in legal institutions
when one is comparing nations than when
one is comparing states within the United
States. The legal systems of our states, with
the principal (though not only, Berkowitz and
Clay 2005) exception of Louisiana, are based
on the English (common law) system; the
legal systems of most other nations are based
on the Continental (civil law) model. The two
models differ in doctrines, procedures, legal
professions, and judicial careers and struc-
tures. There is even more variation across
systems when the nations compared include
the nations of the developing world, most of
which have very inadequate legal institutions.
The second and third items on the agenda
are related in drawing on cognitive psychology
as well as on rational-choice theory. They are,
first, situating law in the total system of social
control, which includes custom (much
emphasized by Friedrich Hayek and, earlier,
by theorists of the common law), morality,
reputation, and emotion; and second, explain-
ing the behavior of judges. These central
actors in the legal systems especially of com-
mon law jurisdictions are surrounded by con-
straints that seem designed to strip them of all
the incentives on which the model of rational
choice is based. The judicial career is careful-
ly constructed to deny the judge any benefit
(or cost) from deciding a case one way or the
other or, indeed, from exerting himself. Not
only are judicial salaries fixed, with no bonus-
es or reductions based on performance, but,
in many judicial systems, including the U.S.
federal judiciary, judges have lifetime tenure
and can be removed only for the grossest mis-
conduct. Yet judicial decisions, including
those of federal judges, do not appear to be
random or judges strikingly lazy. So what is
their motivational structure?
These first three agenda items are all
empirical in emphasis. And rightly so, not
only because economic analysis of law has
been tilted too far toward theory but also
because with the growth of the Web and of
digitized data generally, far more data for the
quantitative study of law and legal institu-
tions are readily and cheaply available,
searchable, and, in short, eminently usable
than was true only a few years ago. The
recent founding of the Journal of Empirical
Legal Studies is a portent of new empirical
opportunities in law that economic analysts
of law are in the best position to exploit.
Fourth—and this relates to the economic
analysis of law in developing countries—is
the use of economic analysis to generate fea-
sible, concrete, needed legal reforms.
Economic analysis of law does not have such
intrinsic fascination that it can flourish in an
academic hothouse, with no real-world
applications. It is not like archeology, which
flourishes as a field because of a disinterest-
ed fascination with ancient civilization. The
jun06_Article4 5/15/06 4:16 PM Page 413
Posner: A Review of Foundations of Economic Analysis of Law
continued vitality of economic analysis of law
depends on its being able to contribute to
the improvement of law. The opportunities
are notable in developing countries because
their economic problems are bound up with
the inefficiency of their legal institutions; the
challenge is to reform those institutions
piecemeal in the absence of the kind of
political and economic infrastructure that
supports the legal institutions of the wealthy
countries. There are numerous opportuni-
ties for economics-guided reform of our own
laws and legal institutions as well. But to be
feasible, proposals for reform have to be
anchored in exact knowledge of the charac-
ter, structure, and consequences of the exist-
ing laws and institutions. A knowledge of the
economics of stylized legal rules is not good
enough.
Fifth, and closely related: in this task of
feasible reform, the literature in organiza-
tional economics, as yet neglected by eco-
nomic analysts of law, has an important role
to play. What distinguishes that field is that
its practitioners are not content to study styl-
ized models of organization (for example,
the “M-form” versus the “U-form”). They
study, often in the course of consulting for,
actual organizations. So far, it is mainly con-
ventional business firms that are being stud-
ied, but the principles of organizational
economics are equally applicable to nonmar-
ket organizations (see, for example,
Garicano and Posner 2005). Judiciaries and
law firms illustrate the centrality of organiza-
tion to the legal system. Such striking devel-
opments as the sudden, enormous surge in
litigation that began (in the United States) at
the end of the 1950s, the essentially effort-
less way in which that expansion was accom-
modated by a judicial system already
described as overburdened, and the vast
recent increase in the size and geographical
scope of law firms, are puzzling phenomena
that organizational economics may illumi-
nate. It may also help to explain the causes
and consequences of the striking organiza-
tional differences between the Continental
413
judiciaries, strongly centralized and hierar-
chic (“U-form”), and the U.S. judiciaries,
which are much more loosely coordinated
(“M-form”).
Organizational economics also has much to
contribute to unraveling the mystery of judicial
motivation. For organizational economists are
mindful of the limited feasibility of perform-
ance measures even in business firms and the
resulting need to establish incentive systems
that are not based on efforts to determine a
worker’s marginal product—systems that may
not rely on direct economic incentives at all
(Roberts 2004, pp. 173–76).
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