Shruti Rajagopalan and Mario J. Rizzo
This article describes and analyzes the Austrian approach to law and economics within the context of the law and economics discipline. The important and distinctive feature of the Austrian approach is the emphasis on economic and legal processes. The article focuses on four themes within the Austrian approach to law and economics: the spontaneous origin of legal institutions; the analysis of implications of ignorance, decentralization of knowledge, and static and dynamic uncertainty; the interaction between the changes in legal institutions and the market process and coordination; and entrepreneurship in market and non-market settings.
Behavioural economics has become a leading force in applied economics, including in economic analysis of law. At the heart of behavioural economics is the concept of bounded rationality. Bounded rationality suggests that humans face important limitations in knowledge and decision-making capability. Such limitations have clear importance to both the understanding and the improvement of the legal system. Knowledge limitations present a particularly compelling area for legal analysis. Two case studies of debiasing through law in response to knowledge limitations reveal the potential mechanisms by which law may ease such limitations among boundedly rational actors. In such cases of debiasing through law, empirical evidence plays a pivotal role, as this evidence both identifies the existence of knowledge limitations in the first instance and provides a means by which to assess whether a given legal rule allays such limitations.
Giuseppe Dari-Mattiacci and Gerrit DeGeest
This article draws a general picture of the differences between the metaphors of carrots and sticks. It discusses incentive effects (in principle, a $100 carrot creates the same incentives as a $100 stick, but there are exceptions); transaction costs (carrots are paid upon compliance, sticks upon violation, therefore sticks have lower transaction costs if the majority complies); risks (probabilistic carrots create risks for compliers, probabilistic sticks for violators); wealth and budget constraints (the maximum carrot depends on the principal's wealth, the maximum stick on the agent's wealth, but sticks can have a multiplication effect); distributive effects (carrots may overcompensate, sticks may undercompensate; individualizing sanctions changes the distributive effect of carrots but not of sticks); activity level effects caused by these distributive effects; the principal's incentives to behave opportunistically; and the agent's incentives to self-report. The article also discusses special types (precompensated, annullable, combined, intra-group financed, reversible, strict liability carrots and sticks) and two extensions (political risks, behavioural effects).
Shmuel Nitzan and Jacob Paroush
Issues related to collective decision making and to Condorcet jury theorems have been studied and publicly discussed for over two hundred years. Recently, there is a burgeoning interest in the topic by academicians as well as practitioners in the fields of Law, Economics, Political Science, and Psychology. Typical questions are: What is the optimal size of a panel of decision makers such as a jury, a political committee, or a board of directors? Which decision rule to utilize? Who should be the members of the team, representatives or professionals? What is the effect of strategic behaviour, group dynamics, conflict of interests, free riding, social interactions, and personal interdependencies on the final collective decision? This article presents current thinking in the field, offers suggestions for further research, and alludes to possible future developments regarding public choice and collective decision making.
Harold Alderman, Jishnu Das, and Vijayendra Rao
This chapter discusses practical issues confronted when conducting surveys as well as designing appropriate field trials. First, we look at the challenge of ensuring transparency while maintaining confidentiality. Second, we explore the role of trust in light of asymmetric information held by the surveyor and by the respondents as well as the latter’s expectations as to what their participation will set in motion. We present case studies relevant to both of these issues. Finally, we discuss the role of ethical review from the perspective of research conducted through the World Bank.
The economic analysis of constitutions, also known as ‘constitutional economics’ or ‘constitutional political economy’ is a young research program. Standard economics used to focus on the analysis of choices within rules, thus assuming rules to be exogenously given and fixed. Constitutional economics broadens this research program by analyzing the choice of rules, using the established method of economics, i.e. rational choice. This article discusses the two broad research avenues in constitutional economics: the normative branch, which is interested in legitimizing the state and its most basic rules by drawing solely on the self-interest of rational individuals; and the positive branch, which is interested in explaining, firstly, the (economic) effects of alternative constitutional rules and, secondly, the emergence and modification of constitutional rules.
Georg Vanberg and Viktor Vanberg
This article sketches the distinct perspective that a contractarian approach can bring to law and economics. It focuses on a particularly important strand of the contractarian tradition: the constitutional political economy (CPE) research program (also known as constitutional economics), developed most fully in the work of Nobel laureate James Buchanan. Like law and economics, the CPE paradigm is primarily concerned with the comparative analysis of social, economic, and political institutions. But its foundational assumptions offer a distinct contrast to the mainstream neoclassical paradigm that has dominated law and economics as a field. The article first provides a brief overview of contractarian approaches. It then describes the central features of the CPE paradigm. It contrasts the foundations of the CPE approach with those of neo-classical economics; explores the implications of these differences for the research foci at the heart of these two traditions; and discusses how mainstream and constitutional economics approaches may be reconciled.
Richard O. Zerbe Jr.
Benefit-cost analysis (BCA), or cost-benefit analysis, is important in policy and law. This article introduces the nature and history of BCA to provide an understanding of the development of the benefit-cost concepts, objections to the concepts, and their actual use in legal and economic practice. The term ‘benefit-cost’ is used to differentiate from the term ‘cost-benefit’ used by engineers whose approach is more mechanical than terms of efficiency used in law and economics. BCA is seen as a useful tool with some positive predictive ability in determining judge's decisions. It also appears to contribute to greater efficiency in government investment spending.
David Driesen and Robin Paul Malloy
This article summarizes leading critiques of law and economics. These critiques are grouped into three categories. The article first addresses concerns about the normative value of economic efficiency as a leading goal for law. It then addresses methodological criticisms, which often call into question the coherence of the allocative efficiency concept. Finally, it discusses the interpretive criticisms of law and microeconomics, which view law and economics as a rhetorical form and raises questions based on that view. Scholars have questioned the normative value of economic efficiency as a central goal of law. They have also challenged the coherence and objectivity of the methods used to assess economic efficiency. They have questioned the claim of economics as somehow providing a scientific justification for law, arguing instead that it constitutes a rhetorical form shifting the terms of legal argument and changing its outcomes.
Thomas J. Miceli
This article discusses the use of economic models for understanding law. It begins by describing the nature of economic models in general, and then turns to the specific application of economic models to law. It distinguishes between ‘economic analysis of law’, which concerns the use of economic theory for describing the incentive effects of legal rules (positive analysis) and for prescribing better rules (normative analysis); and ‘law and economics’, which concerns the relationship between law and markets as alternative institutions for organizing economic activity. The article concludes with some comments on the actual process of building economic models of law.
Jonah B. Gelbach and Jonathan Klick
This article begins with a stylized history of empirical work in law and economics. It links the success of the empirical movement in law and economics with the so-called ‘credibility revolution’. The hallmark of this revolution has been a focus on research designs that helped overcome some of the impediments to empirical work in law schools. It then provides some methodological observations about a number of commonly used approaches to estimating policy effects. Next, it uses the literature on the economics of crime and criminal procedure to illustrate the ways in which many of these techniques have been used. It provides examples of fields — corporate law and economics and civil procedure — that would benefit from increased attention to modern empirical analysis and methods.
Georg von Wangenheim
This article examines the use of evolutionary theories in law and economics. It begins with a discussion of the concept of evolution. It then explains the central ideas of three central evolutionary approaches in law and economics: the neo-institutional approach, microeconomic models, and the idea of competing jurisdictions. Neo-institutionalist approaches provide a bouquet of arguments which may be used to explain the evolution of law. Microeconomic approaches driven by demand for, and supply of legal rules as well as their interactions with social norms and technological evolution may provide such models, but, since these models are based on Markov processes and thus on stochasticity, they may only describe and predict expected values of legal change. As a consequence, explanations of specific legal variations cannot be traced back to specific elements of these evolutionary theories in law and economics. This caveat persists even if one would extend the models to allow for co-evolution of jurisdictions partly driven by comparative lawyers' research. Nevertheless, the said microeconomic approaches may still be useful for normative evaluations of differences in the law: If the frameworks of legal evolution in jurisdictions differ, the theory may offer arguments for why the evolution in one or the other will tend towards a more desirable outcome (for example efficiency). One should however always be aware that these theories can only make statements on tendencies of evolution, not on specific legal changes. The same caveats apply in an even stronger way to the use of (evolutionary) theories of inter-jurisdictional competition.
Donald A. Wittman
Sometimes the sequence of events is important for establishing rights and obligations, and sometimes it is not. For example, if a nuisance was there before the neighbouring residences arrived, the nuisance is sometimes allowed to continue in the same location under the doctrine of coming to the nuisance. When and why should the doctrine be (or not be) upheld? While many concepts in law and economics do not explicitly have a time dimension, once we start thinking about ex ante versus ex post, a large number of seemingly unrelated areas of the law involve similar issues of sequence. When new regulations are imposed, sometimes pre-existing businesses are exempt and sometimes not. In accident law, negligent behaviour by the first actor may require the second actor to take action beyond the ordinarily efficient actions as can be seen in the doctrine of last clear chance. What is the underlying rational for the application of this rule? Rights typically go to the highest bidder, but at 4-way stop signs, rights are granted according to who was there first. In other areas involving traffic, being first accedes to other criteria such as majority rule. As a final example, priority in bankruptcy gives the right to the first creditor of the same secured debt, but not to the first creditor of unsecured debt. Why? This article presents an efficiency-based framework for answering these questions.
Charles Holt and Sean P. Sullivan
Experimental economics finds an analytical foothold in at least three archetypal areas of legal scholarship and practice. First, it can be used to explore the functioning of legal institutions, such as settlement bargaining, jury deliberation, and alternative dispute resolution. Second, it can be directed to the study of legal doctrines, such as those relating to proper-ty-rule liability, damages doctrines, and the negligence standard. Third, it can contribute to the practice of law, for example, by informing how the presentation of probabilities is handled at trial, or how damages claims or other complicated legal theories are demonstrated to the trier of fact. This article illustrates the current achievements and future role of experimental economics in shaping law and legal analysis in each of these three broad subject areas. Starting with a brief primer on the theory and methodology of experimental economics, the article goes on to discuss some important topics within each broad area of application. It focuses on general findings, areas for development, and opportunities for innovation and growth. The unifying theme of this discussion is a versatile relationship between experimental economics and legal analysis broadly construed.
Experimental psychology has become an increasingly reliable and available tool for legal scholars the research of which implicates human behaviour and cognition. This article considers areas of legal scholarship that have used experimental psychology in different ways. These areas include tort law and settlement (e.g. assessing fairness, punishment, and compensation); contracts (e.g. assessing the social, moral, and practical meanings of promissory obligations for ordinary people); dispute resolution, intellectual property, and studies on the differential effects of certain manipulations on different cultural sub-groups. Using these areas as case studies, it is possible to unpack the resonances, implications, and limitations of an experimental psychology approach to legal questions. The article concludes with an example of how experimental psychology has been used to uncover and explain a real-world effect, in this case in the bankruptcy context.
Gary S. Becker and Richard A. Posner
This exchange between Judge Posner and Professor Becker — two founding fathers of our discipline — was composed almost three years ago, but the perspective and wisdom of this exchange remains most relevant to this day. Since then, Professor Becker has died; Judge Posner has added a brief remembrance of Becker at the end of this exchange.
Legal norms are often seen as a means to regulate behaviour when neither self-interest nor social norms produce the desired behaviour in individuals. This suggests, on the one hand, that the law should regulate those areas in which social norms do not exist and provide support and extra enforcement in those areas where social norms exist. It also suggests on the other hand that there seems to be no questioning of the intrinsic efficiency and fairness of existing social norms. This article first looks at the genesis of social norms and the mechanism of their enforcement. This allows a closer inspection of the efficiency and fairness concepts. It then considers the impact that introducing legal norms has in contexts in which social norms already exist and in those that social interaction left unregulated. The main issue here is that the social norms prevailing at some historical moment may be just an equilibrium among multiple equilibriums. Given many possible equilibriums, we need to explain why and how one equilibrium is selected and others are rejected. The scholarship on social norms emphasizes that expressive acts in law can select the equilibrium. Legal norms seemingly reinforce existing social norms, bending them towards the law when discrepancy exists and favouring their creation where social norms do not exist. However, legal regulation can also destroy existing social norms (crowding out) or it can be defeated by them (legal backlash and countervailing effects).
Mechanism design is the game theoretic jargon for institutional design and the even older tradition (in German) of ‘Ordnungspolitik’ (institutional design policy). When implementing institutions or mechanisms (or simply rules of conduct) such regulation should usually be codified by complementing the law appropriately. This article first derives and discusses legal rules as traditionally justified and implemented legally. This is then confronted with game theoretic mechanism design, relying on Dominance Solvability or the Revelation Principle. It is argued that the Revelation Principle is very useful for welfaristic or, more generally, consequentialistic explorations of what is attainable but offers no practical basis for legal mechanism design due to its unrealistic common knowledge restrictions.
Brian H. Bix
This article explores how law and economics is viewed from the perspective of moral philosophy. Given that ‘law and economics’ is a category that covers a large and diverse set of theories and theorists, and that ‘moral philosophy’ as a category is even larger and more diverse, there are a vast number of potential topics and perspectives. The article offers a sample of the many intersections of those two categories. Part I offers a brief introduction to some central ideas of economics and to the different schools of moral philosophy. Part II summarizes some defences of law and economics from the perspective of moral philosophy, while Part III summarizes criticisms from the same source.
Chris William Sanchirico
This article discusses three strands of the literature on optimal redistributional instruments. The first strand concerns what is sometimes referred to as the ‘tax substitution argument’, which supports the proposition that distributional goals should generally be pursued exclusively through taxes (and subsidies) on labour earnings. The argument rests the controversial assumption that, controlling for labour earnings, all individuals are identical. The second strand, a response to the first, attempts to counter the view that labour earnings exclusivity for redistributional policy is the natural lesson of the economic literature on ‘optimal taxation’. This second subliterature examines the consequences of removing the tax substitution assumption while retaining, arguendo, the optimal tax and policy framework. The third strand of the literature, concerning ‘policy uncertainty’, steps outside the bounds of the conventional model of optimal tax and policy. It first arises as a kind of alternative defence of labour earnings exclusivity in light of the challenge posed by policy eclecticism. Even if the conventional optimal tax and policy model sans tax substitution assumption points toward eclecticism, the defence proceeds, policymakers lack adequate information about the proper direction and scale of distributionally motivated adjustments to other policy instruments. Given the risk of perverse unintended consequences, policymakers should refrain from distributionally motivated tinkering.