legal system chicago school common law efficiency


Schools of Law and Economics

by Fred E. Foldvary, Senior Editor, 13 May 2013

“Law and economics” applies economic theory and history to laws in order to explain the legal system and its effect on the economy and social well-being. One of its topics is the various forms of legal remedies for acts that negatively effect others, including criminal law, law suits (torts), negotiations, regulations, and “civil” action by government. Law and economics also examines laws that prohibit bad action (ex ante) versus laws that punish bad acts after they occur (ex post liability). Law and economics examines both the efficiency and the equity of laws.

Just as there are several schools of thought in economic theory, there are schools of thought in theory applied to law. The predominant school in law and economics is that which has been centered in the University of Chicago. That school applies cost-benefit microeconomic theory to law, using the concepts of marginal (extra) cost and marginal benefit. In the Chicago approach, legal rules establish costs such as fines, legal expenses, prison time, and community service. People rationally weight the costs of violating laws with the benefits from the violation, such as loot or saving time by speeding. The costs are weighed by the probability of detection and conviction.

Major theorists of Chicago law and economics have been Ronald Coase and Richard Posner. Coase is known for the proposition that when a party suffers some damage, it may negotiate an efficient solution with the party that caused it, either to eliminate the damage or compensate for the damage, whichever costs less. Coase argues further that the costs are reciprocal, because the party that receives a damage award can be regarded as imposing a cost on the party that pays it. Chicago-school economists believe that English common law is efficient as judges and juries seek efficient solutions to conflicts as the law evolves via judge-made modifications to law.

The Virginia school of public choice applies economics to the production of law. Its main theorist was James Buchanan. There is a supply and demand for law as with anything else. The public-choice school of thought makes a distinction between constitutional and institutional decision making. Action is voluntary at the constitutional level of entering into a contract or joining a club. After that, there are institutional decisions that a member may not like, but he agreed to the package of costs and benefits. A premise of public choice theory is that politicians act to promote their self-interest, just like private-sector actors. There is therefore a market for legislation, in which special interest transfer-seekers provide campaign finance and lobby for subsidies, at the expense of the public, due to the concentrated benefits to the officials and the spreading out of costs to taxpayers and consumers. Hence the common law too may be lacking in efficiency and equity.

The Institutional school of thought believes that abstract economic theory is not sufficient to explain the economy and law. Its main theorists were Thornstein Veblen and John R. Commons. This school says that to explain law, we need to include institutions such as labor unions, corporations, banking, and governments. In contrast to the deductive approach of the Chicago school, this school generalizes from actual practice, examining cultural influences and coercive power relationships. Institutionalists believe that there are no correct or optimal efficiencies or rights, as these are based on the prevailing powers and the institutional environment that evolves. They also argue that efficiency needs to include the distribution of income and wealth. Institutionalists deny the abstract efficiency of common law.

The main economists of the Austrian school are Carl Menger, Ludwig von Mises, and Friedrich Hayek. They regard the market as well as the evolution of law as a spontaneous order. The school emphasizes entrepreneurship, and treats lawyers and judges as entrepreneurs in law. In Austrian theory, costs are subjective, therefore efficiency is not a single objective standard. The Austrian benchmark is the market process. The Austrian school rejects the efficiency of the common law, because due to uncertainty and dispersed knowledge, as well as bias, judges do not have sufficient information to consistently guide common law into greater efficiency. In Austrian law and economics, decentralized private communities provide greater efficiency and equity than the conceit of governmental central planning and intervention.

There has not been a Georgist school of thought for law and economics, but one can well apply geoclassical or Georgist economic concepts to law. The “geoist” approach combines economics, ethics, and political science. In Georgist theory, law imposes costs and provides privileges that are implicit taxes and subsidies. Georgists agree with Institutionalists that efficiency involves distribution as well as production. The optimal law provides equity as well as efficiency with laws that enable maximum individual choice, and also by an equal distribution of the benefits from natural resources. But the actual aim of governments has been redistribution to the ruling rentiers.

Georgist law and economics draws elements from Chicago-school microeconomic analysis, Virginia public choice theory, Institutional concepts, and the Austrian approach. The Georgist approach combines these concepts with the Georgist emphasis on land and rent to develop a comprehensive perspective that integrates ethics, entrepreneurship, market dynamics, and governmental constitutions and institutions that minimize special-interest rent seeking.

-- Fred Foldvary


Copyright 2010 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.

Also see:

Pros need to know that ethics matters ...

Henry George, The First Progressive

What a 19th-Century Economist Can Teach Us

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