ECONOMICS AND THE LAW, SECOND EDITION FROM POSNER TO POSTMODERNISM AND BEYOND Nichelas Mercure and Sieven G. Medema PRINCETON UNIVERSITY PRESS PRINCETON AND OXFORDa Preftve Wax Peter DousueRry, our editor at Princeton University Press, asked us if we were willing to prepare a second edition of Economies and the Law, the first thing we did was to reexamine the reviews of the first edition that ap- peared in various economic and legal journals. Given the positive reception accorded to the first edition, the feeling that we could do some things a litle better than we had the first time around, and, some of the new and interesting developments taking place in Law and Economics, we agreed to go forward ‘with the writing of a second edition. Our intent was that the new edition would remain que to the seope and purposes ofthe first edition but also take account of the evolution of the field in the eight years since the book was originally published, As such, this second edition of Economics and the Low has main- tained both its basic siructure and its original purpose—to provide the reader with a concise overview of the dominant schools of thought that make up the field of Law and Economics. “Those familiar with the first edition will notice that we have made several ‘changes for this new edition, First, we have expanded the discussion of the New Haven and Modern Civic Republican approaches and combined them with a new discussion of the Austrian school of law and economics in a chap- ter entitled, “Branching Out.” Second, we have added a chapter exploring the law and economics literature on social norms, which has become an integral part ofall ofthe schools of thought in Law and Economics. The chapters on the ‘Chicago approach to law and economics, public choice theory, institntional law ‘and economics, and the new institutional economies have been expanded. and ‘cach includes a substantive “At Work” section that presents applications of that particular schoo! of thought. Finally, we have eliminated the postmodern ehap- 2, “Critical Legal Studies,” which appeared in the first edition. Our decision to Se Minow (1987-93) Ruin 1986, p39) woe ht the resis matin that ger gs pincipes do ot ‘xi ny i ays the cent of some speci lever, whether leila, ait, ot ne anit sly eft te piypedectins of tala16 cHAPTER 1 ‘Furthermore, the constant change of la, pethaps most strikingly in response “> 9 the industrial revolution, belied the claim that law was certain, fixed, and log- ‘The formalist approach used inductive reasoning with an exclusive focus On data from past common law cases to establish legal docwine, and then, ‘througl deduction and syllogistic reasoning, to apply the law. The Realist of the Redliss, asserting that, with their they sere-not tha differen} from the maditional.” 10 argued for law's s¢ charac “Along with:theidea that law cannot be a logical, selfcontained discipline eae th resolon ht stl cae ll renin it oa at ‘i shoald become more overtly tuned tothe Soial ends that it nesessaily~ serves. The Realiss field a strong instrumentalist conception of law; for them, Jay iis, and had fo be Seen a, “working toot" (Friedman 1973, p. 592) ‘This demanded an understanding of the relationship between law and society {nd of the way that results—economic, political, and social—followed upon legal decisions. Every legal decision was understood to have social, ethical, political, and economic implicstions, and the Realiss maintained that these should be recognized and explicitly dealt with by judges, not hidden behind a ‘yell of logical reasoning. The corllary was that 9 understand these implica “gs teri i meGessary 10 explore the interelitions einong ly and the ~ “ge Soil ienees; incliding sociology, psychslogy, politcal scence, and = eons = Ofpprticular impor for presem purposes is he Realist interest in using eco- ‘nomics to understand and to guide the development of law. The Realists ‘argued that the importance ofthe interelations between economics and the Jaw can be seen in the twin fats that legal éhange is often a function of exo- nomic ideas and conditions, which necessitate and/or generate demands for legal chinge, and that economic change is often governed by legal change. Llewellyn pointed to.a number of ways in which law influences economic coneitions, including its role in providing a foundation fr the economic order, its influence onthe operation and outcomes ofthe competitive market process (oaricularly through the sructre of law pening to propery, gntac, and ceil, and through restrictions placed by law onthe competitive process), and? te infvence of taxation, social welfre legislation, and public enterprise on production and distribution * E 8 The Realist quest fora "true" science of law is described in Duxbary (1995, pp. 78-82). For surveys of the inte between Realism and eco, See Sane (1983) and "3 Sax fer xangl,Liewelya (92), Ltchman (192, ad Holsworth (927-25). 3 > Sos Liweli 1925, pp, 678-1) an he dscasoa in Samuels (1093, p, 27-8. 3 ‘THE JORISPRUDENTIAL NICHE 17 Given the important interdependencies that they saw between law and econ- ‘omy, it is not suprising that Realists such as Llewellyn considered economic analysis useful fool for understanding law and legal change and for devising laws that would improve the social condition. Indeed, Samuel Herman went so {ar a5 to assert that [te law of a state never rises higher than ils economics” (Herman 1957, p. $31), and expressed the hope that "‘a disciplined judicial ‘econoitics’ might become ‘a realistic and tempered instrument for solving the {najr judicial questions of our time" (Samuels 1993, p, 263, quoting Herman 1), p821). Whereas the Realists found certain aspects of neoclassical eco- nes, suc as marginal analysis, bseful, it was with the Institutional ec0- "otics of Thorstein Veblen and Joba R, Commons rather than with neo! seal écoriomics, thatthe Realists found a close affinity. Tis affinity wed very | gquch on the pessimism reflected within both Realism and Insttuionalisn re- “garding Isissez faire legal-economic policy and the inequalities of power and ih that were masked under the laissez-fere emphasis on individual ib- ty From the Realist-Insttutonalist project came nimerous studies that at= {tampted to probe the linkages between law and economy, and, inthe process, Pine legal and economic thinking and decision-making. ‘The Need to Fillthe Void Although Legal Realism largely spelled the end of doctrinalist excesses, it “ never became established as the dominant view of law. Its sputtering exis- (ence, if notits demise, was followed, in the 1940s, by a renewed belief in the © autonomy of law, this time in the form of the legal-process movement—a movement that ran roughly from 1940 to 1960 and emphasized that certain principles of process were neutral, and hence immutable.” ‘The main exponedts of the legal-process approach were Lon L. Fuller (1940), Henry M. Hart and Albert M. Sacks (1958), and Herbert Wechsler 11959), Like the Realist, the legal-process school viewed law as dynamic and * policy-oriented. To this end, Hart and Sacks drew on the earlier works of Faller to establish the interconnectedness of human beings and the usefulness ‘of law in establishing a community. For them, law had a purpose: the state was there to advance society's collective goals. Hart and Sacks argued, “Law is 8 doing of something, a purposive activity, 2 continuous suiving 10 solve the basic problems of social living” (1958, p. 166). Fora dicusio of he inks benwoun Rests and Insane Duxbury (1995, pp. 7-111 Meco (1998), a Rhett (203,200). acon of the Isao pose on wich sass oot thease er found in cps 4 og oe Mob ead Wir (1985, 29, Wend (190, a Desig 1985 ch 4.18 cuarrery ‘lke the Realist, however, proponents of the legal-processapprosch gen- erily advocated a eur othe view of lw a8 an atonomous displ, with law's legitimacy and objectivity now preserved by focusing on be proces and & institutions by which the law evolved. This marked a major point of depar- {ure em preyions theories of lw that looked to thee foondations to justify © prgstration ofthe amtnom. morality, and eptimacy of law. The focus of : pgach was on axoredure—on What Hart and Sacks (1958, THE SURISPRUDENTIAL NICHE 19 “Firs, this period witnessed the end of the political consensus in the United “nts that was so prominent in the 1950s. As Owen Fss (1986, p. 2) has put “ity he potential “death of law’ is derivative of the turmoil of the 1960s, from ‘hich came a “rejection ofthe notion of law asa public ideal” and of “judi Zaton asthe process for interpreting and nartuing a public morality." Second, ihe “boom” in disciplines complementary to law, suchas economics and phi egal process appinach *|qcply, gave tise wo effort by practioner within these other disipin £5) fined the “Prpeiples of institutional settlement”; and on what West itr oat ‘into new areas, pels "Third, there was collapse of con £11958; Bel : eee me Oe ie ee E ‘inthe ability of lawyers to solve the major problems of the legal system pitas ate) eae aa eee oe ss by offering (2 past ova Fourth, tere was a etng tha there was lite new tobe sid in af govdinment possesses a distinctive aren of competence such tha tasks can be assed to that asitation withott ffertnes to tho subst re policies involved, Because it has no substantive implications, it does not connit th emo of the -ferjalists by placing lea principles above the political ‘process. As Buin (1996, p. 1396) describes ity “The legal prooess schoo! e- ‘constited the prior sepitation between law and polite, not by positing tan seendeit legal principles, but by identifying a separate and politically esab- lished legal realm in which reasoned argument prevails.” Thus, against debates = ‘over whether a particular decision conformed to principles of natural law or the Scientifically based principles of doctinalism, the legal-process approach as- _Bued that 1aw’s legitimacy was embedded in neutral, institutional structures : sd legal proceshitesinat is, within the very proces by which the society had ‘chose Yo dover iit. Ife decision is purposive andthe result of an estab- = “Ail dosepted, nuit Iegal process, the oitcome was sti to be legitimated.» ‘By the end of the 1950s, we witness a tensfon created by two divergent. ‘uends On the one hand, thet’ was a continuing focus on legal process, to- ‘gether with an ongoing doctrinlist legacy: legal education largely consisting ‘of studying, analyzing, and ertiguing authoritative texs—opinions, statutes, anid legal rules—with an eye on process. On the othiee hand, one cannot ignore, the impact the Legal Realists bad in cracking the edifice of dectrinaism:; and, with the edie cracked, avoid had been created for others to fill. As Edmund ‘Kitch (19834 b), among others, has noted, i was the Lepal Realists who ere: sated ai environtient that was more receptive tothe introduction of economics into law school curiculum. “This tension Ted to yet another breakdown in the belief in law's autonomy— ‘wether grounded in natural lw, doetrinalism, or legal process—beginning in the early 1960s, Posner (1987, pp. 765-73) suggests several reasons for this. ‘uly accorded Wo scientific modes of inquiry, and ths the relative the prestige and authority accorded to the ostensibly noascientifc of legal analysis, pushed legal scholars to adopt more “scientific” modes _ SFanasi.Fnaly statutes andthe Consation were becoming increasingly Jippocal relative to common la, and the legal profession quickly found out pa tie tools for interpreting statutory and Constitutional issues and docu- © ents were simply inadequate, That i, lawyers trained inthe traditional legal ptbod to analyze the underpinnings of case law hod fe, if ny, sil to exe EE ple the underpinnings of states or the Constutios, This caused legal echol - at look elsewhere—outward—fr interpretive principles. ‘his rebirth of the disilsionment with the ides of law os an autonomous ciple, and the search for other bases on whic io ground legal analysis — ‘We setng for which had infact been established by the Realsts—has resulted ‘phe growth of numerous “law and__" movements over the past thirty yes, These movements have sought o bring the insights of sociology, Con “nena philosophy, literary theory, anthropology, feminist studies, Marxism, ind of particular imporance hee, economics, into legal tues. Each of hese projects represents an attempt to turn law outward and bas, in its own way, - sought to answer te thes fundamental questions we laid out evlier—in pac tio in posting abess on which to found les legitimacy. In dong so, each ight, overly or not, 0 fill the void left by Legal Realism. The plethora of dees andthe zeal of their advocates has made legal analysis highly politicized and interwoven with the social sciences and humanities (Minow 1987, p. 79) "No longer is law seen a being able to, on its own, generate results that const tute objective tath—to state what the la isto discern its basis fr legitimacy, Gr to say what the law shouldbe, The earlier consenses regarding how to think bout and to resolve important legal questions has all but disappeared. ‘Fs cason ds oa Hui (96, gp. 1395-85). Thee ern coroogiigs betwen hs ett be eoeutonl apron o Law 1 ‘snd ono dono Ses M Buchanan and others, whic is dscassedin chapter 3 Shain weer ta is endeny iby no meas ingles ep slr. See Wei U9, “Sel Gado (1550, 43).2 cuarrens ‘THE “ECONOMICS” IN “LAW AND ECONOMICS” ‘Ags! the dea tht Ia canbe understood only trough the we of the td tional legal doctrinal concepts based on justice and fairness, economics coun- ‘ers tht cor understanding can be enhanced—even supplied, according to “Somes -econsine conckps, including the ctetia,of ezonomic efficiency. “ As’uch, the “Econo” in “Law and Ecoiioimics" consists primarily (but, as ‘Will become clear in subgequent chapters, by.no mieans exclusively) of neo. * clsical miproeconotics and Welfaré economics, Wwheté the operative orga: tiizhig cpngopt are Pareto efficiency in exchange, Pareto efficiency in produ tion, and Kaldor Hicks efficiency (ie, wealth maximization). We want to ‘uidetscorg ite point that ot ell the schools of thought’présénted here give ‘ual credeive to these various ciiteia of efficiency, and i erally is, without dispatescrbs schools of thought, or even within them, such emphasis one ought to give © dese concepts, Nonetheless, her impor- ‘tant place within the Law. and Economics literature necessitates an under- Standing of these concepts. Toward that end, we provide a brief overview of ‘neoclassical efciency analysis at this point, leaving a more extensive discus- sion ote two appendices to this chapter. Tn nore elementary terms, the market demand curve will reflect MSB and the ‘soppy curve will eflect MSC, and thas the market equilibum (e- ‘inand = supply) will he efficient (MSB = MSC). The significance of this con- dition, and its relation to Pareto optimality, is beat srted by examining the inion when it does nor old. * In figure 1-2, where the marginal social benefits and costs associated with food X are depicted, consider first an allocation of resources such tht the eet Notice that, et tis point and from it up 19 X*, mar- ‘Social benefit is grester than marginal social cost. Given this, the alloca- igh of additional resources to the production of good X will generate incre- ‘mental social benefit in excess ofthe incremental social costs, thus enhancing society's welfare. This increase in net social benefits is available up to X*, be- oli which the costs to society of additional units of good X exceed the gains, AUX, then, MSB=MSC and society is said to have achieved a Pareto- efficient allocation of those resources devoted o the production of good X. At any evel of output less that X*, where MSB > MSC, there will bea persistent lnderallecation of society's scarce resources to good X. ‘)Second, consider an allocation of resources to good X that generates an ~ “amnouint X; of the good. Here, and at all points between X* and XX, marginal social cost.exceeds marginal social benefit, By reducing the level of resources allocated to the production of good X, and thus the amount of good X pro- duced, the costs saved by society exceed the benefits lost, thereby incressing social welfare until we reach X*, where MSB = MSC. Ths, beyond X, such 28 at X,, MSB < MSC, and we now have a persistent over-allocation of soci- ‘ys scarce resources tothe production of good X. “Fors grpicl analysis ofthe implications of obing each ofthe four codon, si ‘esi.