The Online Library of Liberty

A project of Liberty Fund, Inc.

• Introduction
• Part 1: Economics and Ethics
• Chapter 1: Are Economists Basically Immoral? *
• Chapter 2: Economics and Ethics: the Problem of Dialogue *
• Chapter 3: Income and Ethics In the Market System *
• Part 2: Economics and Theology
• Chapter 4: Can Homo Economicus Be Christian? *
• Chapter 5: Economic Scientists and Skeptical Theologians *
• Chapter 6: Christian Theological Perspectives On the Economy *
• Chapter 7: Controlling Stories: On the Mutual Influence of Religious Narratives and Economic Explanations *
• Part 3: Economics, Theology, and Justice
• Chapter 8: Justice, Natural Law, and Reformation Theology *
• Chapter 9: The Concept of Economic Justice In Religious Discussion *
• Chapter 10: The U.s. Catholic Bishops and the Pursuit of Justice *
• Part 4: Economics and History
• Chapter 12: Christian Social Thought and the Origination of the Economic Order *
• Chapter 13: Clerical Laissez-faire: a Case Study In Theological Ethics *
• Part 5: On Teaching and Learning
• Chapter 14: “the Nature of Man”: What Are We After? *
• Chapter 15: Researchers and Degree Purchasers *
• Part 6: Teaching Economics
• Chapter 16: Economics Is a Way of Thinking *
• Chapter 17: Teaching Introductory Economics *
• Chapter 18: Teaching Economics By Telling Stories *
• Chapter 19: Between Sterility and Dogmatism *
• Part 7: Economic Method
• Chapter 20: Ethics On the Road to Serfdom and Beyond *
• Chapter 21: Measures of Wealth and Assumptions of Right: an Inquiry *
• Chapter 22: The Foundations of Law and Economics: Can the Blind Lead the Blind? *
• Part 8: Policy Commentary
• Chapter 23: What Is the Responsibility of Business Under Democratic Capitalism? *
• Chapter 25: An Economic Perspective On Illegal Drugs *
• Chapter 26: Economics, Ethics, and Ecology *

PART 7

Economic Method

CHAPTER 20

Ethics on The Road to Serfdom and Beyond*

Friedrich Hayek began The Road to Serfdom with a confession and a promise.

The original preface opens with the following admission:

That is the confession. The promise follows immediately:

I have deliberately chosen the word confession to describe Hayek’s discharge of his “first duty.” His language strongly suggests that, in his own judgment, a “professional student of social affairs” violates a rule of the guild when he writes a “political book.” That is because political books, unlike scientific books dealing with social affairs, depend upon the author’s values. When Hayek informs the reader that “all I shall have to say” is derived from “certain ultimate values,” he is confessing to a lapse: he has left the realm of science. He has also, in part, abandoned the realm of reasoned argument. As the word “ultimate” indicates, his values, indispensable though they are for such a book, cannot and therefore will not be defended or argued for. Because they are ultimate, there is nothing beyond or beneath to which one might point to make a rational or empirical case for them.

That explains the author’s duty to make clear to the reader “beyond doubt” what the ultimate values are on which the entire argument depends. Clarity and candor are all that can be demanded from the social scientist who introduces value judgments into his work. Hayek intends to satisfy that demand by making his value judgments unmistakably clear.

As it turns out, he does not fulfill his promise. Two readings of the book in its 50th anniversary year, including one reading with just this question in mind, have not enabled me to discover “the ultimate values . . . on which the whole argument depends.” Readers will gain frequent insight into Hayek’s values and ideals while reading The Road to Serfdom, but Hayek has certainly not made it “clear beyond doubt” what the ultimate values are.

He passes up a chance to do so in the first paragraph of Chapter I when he refers to “some of our most cherished ideals” without indicating what they are, and he passes up another chance in the next paragraph when he mentions “the values for which we are now fighting [World War II]” without stating them. He seems to place a high value on that “individualism” which grew out of Christianity and ancient classical philosophy, was first fully developed during the Renaissance, and subsequently grew into what we call “Western civilization” but he does not identify this individualism as one of his ultimate values. He complains that “ ‘[f]reedom’ and ‘liberty’ are now words so worn with use and abuse that one must hesitate to employ them to express the ideals for which they stood” during the post-Renaissance development of Western civilization. He suggests that the word “tolerance” might still preserve the full meaning of the principle which was in the ascendant during this period, but he does not pause to clarify or elaborate the concept, and he does not say that it is one of his ultimate values.

Hayek speculates that the “marvelous growth of science” might be “the greatest result of the unchaining of individual energies . . . which followed the march of individual liberty from Italy to England and beyond.” But the growth of knowledge is also not identified as an ultimate value. One could make a good case that the rule of law, discussed especially in Chapter VI, is the central concept around which the entire argument of The Road to Serfdom revolves. But Hayek does not put the rule of law forward as an ultimate value, and for excellent reasons. Its value for him derives from its consequences which must therefore be more ultimate than the rule of law itself.

Every student of Hayek knows how much he valued freedom from the arbitrary power of others, “release from the ties which left the individual no choice but obedience to the orders of a superior to whom he was attached.” This, he tells us, was what the word had meant “to the great apostles of freedom.” The connotations of the word “apostles” suggest the high value Hayek assigned to emancipation of individuals from the arbitrary power of others. But if this is the ultimate value upon which everything else depends, why did he not say so at this point? An extended discussion of freedom or liberty, defined as emancipation from the will of others, does not appear until Chapter IX. At the end of this chapter Hayek asserts that freedom or liberty can only be had at a price and that “we must be prepared to make severe material sacrifices to preserve our liberty.” But if this is one of the ultimate values on which the entire argument depends, it certainly has not been identified as such “beyond doubt.”

Hayek comes closest to so identifying it when he quotes Lord Acton, who “truly said of liberty” (emphasis added) that it “is not a means to a higher political end. It is itself the highest political end.” But the quotation continues:

The last part of the quotation seems to make liberty, which is the highest political end, a means to the achievement of yet higher ends that are not political. Had Hayek identified this liberty as one of his ultimate values, he would not have been vulnerable to George Stigler’s argument2 that wealth does more than the absence of coercion to advance the values that Hayek cherishes.

We know that democracy is not an ultimate value for Hayek. He states clearly that it is a mere means, and he warns against what he calls “[t]he fashionable concentration on democracy as the main value.”

What about respect for truth? Is this one of Hayek’s ultimate values? He states that “the sense of and respect for truth” is “one of the foundations of all morals,” and he warns against the corruption of science that occurs when “science has to serve, not truth, but the interests of a class, a community, or a state.” A plausible case can be made from arguments in his later books that respect for truth was indeed one of the deeper values informing Hayek’s thought. In Chapter III of The Constitution of Liberty Hayek seems to suggest that we fulfill ourselves in the process of learning something new, and that we desire to accumulate additional knowledge because it makes us wiser, even if it also makes us sadder or worse off in all other ways. But that respect for truth is an ultimate value is not “clear beyond doubt” even in later works, much less in The Road to Serfdom.

*

Why does Hayek tell the reader that he will state clearly the ultimate values on which his argument depends and then fail to do so? The contradiction points to what I believe is a significant characteristic of Hayek’s thought. He was always troubled by the suspicion that he had no adequate grounds for his own most important convictions. Hayek craved foundations for his legal, political, and economic philosophy, but he was never able to find any that were capable, in his own judgment, of bearing the weight he wanted to put on them.

In The Road to Serfdom, Hayek is a good positivist, as we would expect of one who had reached intellectual maturity in the 1920s and 1930s. He knows that he is making policy recommendations; he believes that policy recommendations must rest in part upon value judgments; he knows that he must therefore introduce his value judgments into the argument. But value judgments, he also believes, have no rational foundation. “Surely we have learned,” he writes,

In the course of discussing the moral consequences of totalitarian propaganda, he distinguishes between questions about values, which are “questions of opinion,” and “questions of fact where human intelligence is involved in a different way.” What exactly is that difference? He does not say. Is there some other way to exercise human intelligence than the way in which we exercise it to arrive at conclusions about “questions of fact”? Can intelligence be employed to arrive at opinions about “questions of value”? Or are we using some less respectable or less reliable faculty? How can we argue on behalf of our values if neither reason nor facts are relevant to their acceptance? Our ultimate values would appear to be especially immune to any kind of rational or empirical test; precisely because they are ultimate, they rest on nothing beyond themselves.

This is not a satisfactory position for someone who wants to persuade. And why else write a book, especially a political book? So Hayek simply ignores his positivist principles and argues on behalf of his values and against antithetical values, employing both reason and facts.

Democracy, for example, is not an ultimate value, he insists, despite what many people think. They are thinking wrongly. They have failed to see what democracy can and cannot accomplish and how ineffective it is as a means to other goods that they value more highly.

People have placed excessively high value on equality, security, and the “rational” organization of production. Their valuations are misplaced, Hayek tries to show, because they lead to consequences whose negative value exceeds whatever positive value they might have.

The single-minded idealists who have united under the banner of planning will alter their ideals when they come to see that they have adopted a very limited view of society. The socialists who so value “the deliberate organization of the labors of society for a definite social goal” will cease to do so once they have discovered that this presupposes something not available to them, namely, a comprehensive scale of values or a complete ethical code. Those whose moral ideals have led them to support collectivism will adjust their ideals when they learn that the implementation of these ideals will eventually undermine them. Values can be criticized and defended, as Hayek shows by doing it.

Consider also some of his remarks about morality in The Road to Serfdom. A genuine morality, he maintains, must leave the conscience free and must acknowledge some general rules that the individual is always required to observe. The sense of and the respect for truth is one of the foundations of all morals. Moral principles must be seriously upheld against the expediencies and exigencies of social machinery. Responsibility not to a superior but to one’s own conscience is “the very essence of any morals which deserve the name.” We must have “moral courage” to defend stoutly the traditional ideals that our enemies attack. These are not the sort of comments one would expect from a thinker who deemed morality entirely a matter of values that have no rational foundation.

Milton Friedman claimed in his well-known essay on “The Methodology of Positive Economics” that most differences about economic policy among disinterested citizens derived from different readings of the facts rather than “from fundamental differences in basic values,” and that this was a good thing because the former can, in principle at least, be eliminated by the growth of knowledge, whereas the latter are “differences about which men can ultimately only fight.”3 But that is surely not the case. Even if it is true that men can ultimately only fight about fundamental differences in basic values, value disagreements almost never produce violence among disinterested citizens. They do not reach that ultimate recourse because discussion provides so many better options along the way. If citizens cannot resolve fundamental differences in basic values, they also have a hard time discovering truly fundamental differences in truly basic values. It is not inability so much as impatience that prevents us from engaging in productive dialogue about conflicting values.

The insistence that there is no “truth” about values usually reflects a realization that we cannot find an ultimate proof for any value judgment, along with a failure to recognize that we also cannot find an ultimate proof for any other kind of judgment, including the conclusions of science. We do not so much prove as persuade, as Donald McCloskey has been arguing (persuasively) for the last decade or so. Fundamentalists (or foundationalists) lust for sure and certain foundations upon which they can construct knockdown arguments—arguments so powerful, as Robert Nozick once put it, that “they set up reverberations in the brain: if the person refuses to accept the conclusion, he dies. How’s that for a powerful argument?”4 Fortunately or unfortunately, we do not command any arguments with that kind of persuasive power.

It is ironic that Hayek, whose writings over the years demonstrated so effectively that rational arguments and the careful use of evidence can persuade people to alter their ethical positions, apparently never fully persuaded himself that this was the case. In Rules and Order, the first volume of his Law, Legislation and Liberty trilogy, Hayek repeatedly shows that the fact-value dichotomy is not fatal to rational discussion of ethical questions. He weaves together facts and norms in highly instructive ways, and shows in the course of doing so that David Hume, usually cited by those who claim there is an unbridgeable gulf between “is” and “ought,” actually offers valuable instruction on how to go back and forth across that alleged chasm.

The rule of law, arguably the pivotal concept in Hayek’s entire legal philosophy, has often been criticized on the grounds that it cannot be stated in an unambiguous way. That did not stop Hayek from employing the concept to formulate highly instructive criticisms of various tendencies in political theory and practice. What economists like to call rigorous arguments, arguments proceeding from clearly-defined postulates through formal logic to precise conclusions, are by no means the only kind of persuasive argument. Most of the published work by Hayek that eventually flowed from The Road to Serfdom reveals the power of arguments that persuade not by means of rigorous demonstration, but by highlighting the inadequacy of widely-held opinions and revealing the explanatory potential of novel organizing conceptions.

That is how he proceeded in The Road to Serfdom. His practice was superior to his profession. He never managed to make his ultimate values clear beyond doubt because he in fact had no ultimate values, which is to say, no values from which all other values were derived and which could themselves not be strengthened or weakened by arguments and evidence. His formal position, taken over uncritically from the intellectual milieu, might even be described as “constructivist rationalism,” the term he himself liked to use to describe those who exaggerated the power of the human mind to grasp the world whole and control it. His actual practice rejected the dogmas of constructivist rationalism in favor of a procedure much closer to what his friend Karl Popper called critical rationalism.

It is odd that a thinker who had so often demonstrated the folly of trying to construct completely comprehensive systems, capable of answering all questions in advance, nonetheless spent the final years of his career trying to construct an argument that would once and for all compel all socialist thinkers to forswear forever their attachment to central planning, social justice, and all the related mirages of constructivist rationalism. His last book, The Fatal Conceit, expresses this—may we say it?—fatal conceit. To make matters worse, Hayek ended up constructing the knockdown argument in a form that undermined his own repeated demonstrations in the course of a long career that ethics was a rational enterprise.

The argument first appeared in “The Three Sources of Human Values,” the Epilogue appended to The Political Order of a Free People, the third volume of Law, Legislation and Liberty. Here Hayek argued that there are not two but three kinds of human values: those that are “genetically ordered and therefore innate”; those that are “products of rational thought”; and values that had triumphed in the course of cultural evolution by demonstrating their suitability to the successful organization of social life. Values of this third sort are the values that have made possible the finest achievements of Western civilization, including science, the rule of law, and commercial society with all its miraculous creative and productive powers. While these values are not the product of rational thought, they are not for that reason arbitrary. They are a cultural inheritance, survivors of a competitive struggle, and essential conditions for the successful evolution of our society.

The discovery of this third source of values seemed to provide the foundations for which Hayek had so long been searching. These were the ultimate values upon which all his political arguments might be made to depend. There was indeed no way to establish them rationally. But they reigned nonetheless. Those who chose to reject them committed cultural suicide by sawing off the very branch on which they were sitting in order to saw. The knockdown argument lay at hand.

Hayek grew so fond of this argument, unfortunately, that at the end he came to revel in the nonrational and even irrational character of the ethical beliefs that have created Western civilization. In the last chapter of The Fatal Conceit, for example, he almost gleefully gives substantial credit to the mystical and religious beliefs of the principal monotheistic religions that he himself does not accept and cannot even understand. And the final appendix to the book—the last word of the last word—announces with great excitement and intense satisfaction Hayek’s discovery of a 1909 study by Sir James Frazer arguing that superstitions have often been of immense value. The last paragraph is worth quoting in its entirety.

This is surely a strange epitaph to the career of a thinker who did so much to show the enormous damage that mistaken opinions had done in the century spanned by his life.

CHAPTER 21

Measures of Wealth and Assumptions of Right: An Inquiry*

Introduction

There is no more important function of a first course in economics than to make the student see that the whole problem of social management is a value problem; that mechanical or technical efficiency is a meaningless combination of words.1

It is now almost sixty years since Frank Knight urged this perspective upon teachers of introductory economics, but his advice has not been heeded. To cite just one example: The glossary of a current Casebook edited by one of the profession’s most experienced and respected specialists in economic education includes the item “technical efficiency” and does not define it as “a meaningless combination of words.”2

The first section of this paper will attempt to demonstrate that Knight was correct, that “technical efficiency” cannot be defined except in a way that completely strips it of significance. Section two will argue that because, as Knight maintained, “the whole problem of social management is a value problem,” many other familiar concepts of economic theory cannot have the meaning commonly attributed to them. Section three will try to show that economists can coherently formulate and apply a wide range of concepts relating to efficiency and wealth only because they are implicitly using judgments about the rights people ought to have. The fourth and final section of the paper will consider and finally reject the conclusion that might seem to follow from the first three sections, the conclusion that economics is not and cannot be a science. Economics can be scientific, in a very defensible sense of that word, if economists simply recognize what they are doing and give up their claim to possess some wholly impartial perspective.

I

Efficiency refers to the ability to achieve a given objective with a minimum expenditure of resources or, alternatively, the ability to obtain from a given amount of resources a maximum amount of one’s objective. Efficiency is thus a ratio of output to input.

The crucial question, however, is how we measure output and input. Economists know that a ratio of mere physical quantities is not sufficient to determine the relative profitability of alternative processes. Decision makers who want to maximize net revenue must pay attention to the ratio between dollar values of outputs and inputs. Quite often, however, this concept of efficiency is called economic efficiency and is then contrasted with a purely physical efficiency, usually called technical efficiency. The significance of economic efficiency will often be argued for by showing the irrelevance of mere technical efficiency to any kind of goal-directed behavior.

The fatal slip occurs at this point, for efficiency has no meaning except with reference to goal-directed behavior. From a purely physical or technical point of view, the output of any process will always be equal to the inputs into that process. Technical efficiency is invariably one, at least if we can rely on the laws of the conservation of matter and energy. It follows that there is always a unique, invariant output from “given inputs,” so that the notion of “most output” simply makes no sense. It seems to make sense to economists who use the concept of technical efficiency because they have smuggled in an evaluation: Only selected outputs will be recognized as outputs; the rest will be called “waste.” The familiar term “engineering efficiency” acquires its meaning in precisely this way. A machine’s efficiency, supposedly measured by the work done or the energy developed relative to the energy supplied, is in fact measured by the useful work done or useful energy developed relative to the energy supplied. The work or energy is evaluated before it is admitted to the category of output.

The concept of technical efficiency is misleading because it distorts the problem that economists are trying to study. For example, a popular introductory text asserts:

The technocratic error looms close behind those sentences: the belief that “experts” are in command of costless procedures for achieving optimal arrangements. In reality, managers and engineers search for optimal input combinations until the expected benefits of further search no longer exceed the expected costs.

The same text, one page earlier, had defined “maximum technical efficiency” as a situation in which “resources are not being wasted,” and offered this illustration:

The author implicitly asserts in this passage that people producing tomatoes never want to use time on the job for conversation rather than single-minded tomato production, and that people who use tomato-picking machines in ways that don’t maximize the tomato output have no valued reason for doing so. This is obviously false. There is nothing inherently wasteful, inappropriate, or incorrect about any use of labor or capital.

The notion that there is an efficiency which exists independently of any valuations lends support to other misleading ideas. Consider the common belief that society (government officials? voters?) is faced with a tradeoff between efficiency and equity. If equity is valued, however, it will affect either the numerator or the denominator as people estimate the efficiency ratios of alternative processes. If the owner of a firm maintains certain wage differentials on the grounds of equity, despite his belief that net revenue could be increased by reducing those differentials, he is saying that the value imparted to the total outcome by equity exceeds, at the relevant margin, the value imparted by increased monetary income. From whose perspective is it “inefficient” for someone to prefer more equity to a larger money income?

The claim that “society” must choose between efficiency and equity obscures the actual situation, which is that people assign value to processes and their outcomes and that these valuations are often mutually incompatible.

II

The concept of technical efficiency will not be put to rest as long as the concept of objective costs continues to survive. The reformulation of economic theory that occurred in the last quarter of the nineteenth century produced the conclusion that all costs relevant to economizing decisions were the expected value of opportunities that would have to be forgone. Almost a century later, however, many economists continue to employ arguments that implicitly assume the existence of objective costs, costs that can be measured independently of anyone’s evaluations of alternatives.

A good example is the concept of “absolute advantage” which most textbooks use to explain comparative advantage. In the typical exposition, “absolute advantage” is rejected as an adequate reason for a nation to produce a good; a nation should import those goods in which it has a comparative disadvantage, even if its “real costs” of production are below those of any other country. This is usually taught with an air of presenting a paradox. There is no paradox, however, because there are no costs that are not the value of foregone opportunities and hence no advantages except comparative advantages. The “real costs” whose ultimate irrelevance to trade we triumphantly demonstrate to our students are not costs at all. They are merely physical units of inputs, usually “man-hours” in our examples, which we surreptitiously assume to be all of equal value. The existence of a comparative advantage, however, implies that the value of inputs varies as they are used to produce alternative outputs. To assume them equal in value is to assume away the possibility of comparative advantage.

Royall Brandis demonstrated the mythical character of absolute advantage in 1967,5 but his demonstration seems to have been largely ignored. Perhaps that’s just as well. The logic of the opportunity cost perspective, which demonstrates the chimerical character of absolute advantage, will do the same damage, if consistently applied, to much more fundamental concepts in the economist’s everyday kit of working tools. The casualties include a disturbing percentage of the supposedly empirical, objective concepts that we regularly use in discussing the performance of economic systems.

“Output restriction” provides a particularly instructive example. Suppose that widget producers establish a cartel and agree to reduce their rate of widget production in order to raise the market price above marginal cost. We commonly refer to this as “output-restriction,” and go on to show the “deadweight loss” that the cartel policy generates: the area above the marginal cost curve and below the demand curve between the “competitive” output and the cartel output.6

It is true that fewer widgets are produced as a result of the cartel’s operation. But is this an “output-restriction”? Outputs are ultimately valued opportunities, not things. The sum of the values produced under the “competitive” and under the cartel arrangement cannot be empirically compared, because the two arrangements produce different distributions of different goods among participants in the economic system. There is consequently no way to show empirically that the cartel arrangement results in less value than “competition” produces. The cartel arrangement produces fewer widgets, but that is because those who have the de facto right to determine widget output and prices believe that the lost widgets will be of less value than whatever it is they expect to gain by their decision.

There is one way in which we might succeed in demonstrating that the competitive situation generates a greater sum of values than the cartel arrangement. This might be done by showing that every interested person prefers the competitive situation. But if that were the case, the cartel would not exist. Faced with this fact, we may fall back on the argument that those who prefer the competitive situation could gain enough from its restoration to pay the cartel members a sum sufficient to persuade them to abandon the cartel. The continued existence of the cartel, however, is evidence that consent to its abandonment cannot actually be secured, which means that the prospective gain to any person or group from abandonment of the cartel is in reality less than the prospective cost to that person or group of securing its abandonment.

Some economists would reply: “The cartel situation nevertheless entails less total output because it is not Pareto-optimal.” And how do they know that? “Because an alternative arrangement exists under which no one would be worse off and some would be better off.” Then why isn’t the situation changed? “Because positive transaction costs prevent negotiation of the superior arrangement.”

That rejoinder amounts to the assertion that people would be better off under different circumstances that no one is able to create. We can all imagine a more satisfactory world, of course. We can imagine a low-cost procedure for creating energy by a fusion process and thereby imagine the OPEC cartel out of existence. But we have no more warrant for assuming away transaction costs than we have for assuming away the research costs of discovering an economical fusion process.7

Economic theory assumes that what people don’t do they don’t want to do, given their estimates of the prospective costs and benefits. These estimates presuppose a given state of knowledge. More knowledge of the right kind reduces costs, of course; that’s why people try to acquire additional knowledge. But until they have acquired it, production possibilities are limited by the knowledge people currently possess. Exchange is production, too, and the possibilities for increasing wealth through exchange are likewise limited by the knowledge people actually do possess. The knowledge they would have if they were, for example, completely familiar with everyone else’s true preferences has no significance for any empirical question.

Economic growth is another of the major concepts that economists talk about and even measure with little apparent recognition of their fundamentally subjective nature. The Nobel lecture of W. Arthur Lewis, for example, titled “The Slowing Down of the Engine of Growth,”8 speaks of various percentage growth rates in “more developed countries” and in “less developed countries” almost as if they were data quite as objective as average temperature reports.

Lewis betrays (without admitting) the dubious nature of what he’s doing right at the outset, in discussing reasons for the skepticism of many people in 1950 about “the capacity of LDCs to grow rapidly.”

This skepticism turned out to be mistaken, but that’s not the point. The point is that what the skeptics were really doubting was the willingness of people in the LDCs to change their preferences and values in ways that would yield a higher annual rate of increase in the monetary value of marketed goods.10 Empirical measures of economic growth are not, as is so often assumed, measures of increasing wealth.

The much-discussed “decline in productivity” in the United States economy in recent years is another “fact” that presupposes a variety of value judgments. A decline in the ratio of gross national product to compensated working hours is not necessarily a “problem.” It might mean, and apparently does in part, that many people are becoming less interested in purchasing money (and the goods that money can buy) with their labor and more interested in making work itself a satisfying experience. If that constitutes a decline in productivity, then productivity is being measured without reference to the human purposes that give to the concept of productivity whatever significance it has.

III

The concept of “voluntary exchange” plays a crucial role in the descriptions, predictions, and explanations of economists. We “know” that specialization and trade increases wealth because people would not voluntarily take actions unless they expected those actions to better their condition. The economist’s preferred way of speaking about efficiency, Pareto optimality, also relies upon the distinction between voluntary and coerced transactions. Despite all this, there seem to be no clear and agreed-upon criteria among economists for distinguishing a voluntary exchange from one that is involuntary. When we think carefully about what we mean in saying that a transaction was voluntary, rather than coerced, we discover how extensively economists’ descriptions, predictions, or explanations derive their content from assumptions about the rights that people ought to have.11

Suppose an armed robber confronts you with the choice, “Your money or your life.” We would say that you are not engaging in a voluntary exchange when you hand him the money in your wallet. We call that coercion, I suggest, because the robber induces you to do what he wants by threatening to reduce your options.

Contrast this situation with the one created by a cab driver who won’t give you a ride unless you give him your money. If you choose in this case to turn over the contents of your wallet, we would all agree that you are engaging in a voluntary transaction. The difference between the robber and the cab driver is that the cab driver induced you to do what he wanted by offering to extend your options.

It follows that we must know who has what options to begin with if we are to be able to distinguish a voluntary from an involuntary transaction. Is someone who induces you to do what he wants by threatening not to give you something you would like to have coercing you? He is not coercing you if what is in his power to bestow or withhold is in fact his and not yours. If the good is by right yours already, then he is coercing you.

We can illustrate by taking the case of an employer who tells an employee who wants to work the eight-to-five shift that he will have to work the graveyard shift instead. If the employee reluctantly agrees, has he been coerced or has he engaged in a voluntary exchange? Someone who maintains that the “job” is the property of the employer will deny that the employee was coerced. But someone who believes that the employee had earlier acquired a right in the job would quite properly deny that the transaction was a voluntary one. We cannot distinguish between voluntary and involuntary exchanges without a prior decision about the initial rights of the parties involved.12

Moreover, the rights in question are moral rights, not de facto rights. The armed robber has the de facto right to obtain your money by threatening to take your life. But he has no moral right to do so, and that’s what makes his behavior coercion. Or is it coercion because he has no legal right to obtain your cooperation by threatening to take your life? Many economists would be extremely unhappy to learn that voluntary exchange can’t be recognized except by those who are willing to decide what rights people ought to have (moral rights). They might be far more comfortable if the concept of voluntary exchange depended merely upon what rights prevailing law assigned to people (legal rights). In most cases a decision regarding legal rights will in fact be adequate to distinguish voluntary from involuntary transactions. But it will fail in precisely those cases where legal and moral rights diverge. In all such cases the person who wants to know whether an action was voluntary or coerced will be forced to decide whether people ought to have the rights that the law assigns them. The alternative is to adopt the position that people ought to have all those rights and only those rights that current law happens to assign them. However, this is itself a judgment about moral rights, and one that few people would be willing to uphold.

Very little of what currently passes as economic description, prediction, or explanation would survive in the absence of shared presuppositions regarding the rights that people ought to have. Economists are able to agree on whether particular actions increase or decrease efficiency, productivity, output, or wealth only insofar as they work within a particular moral consensus.

This conclusion should not be surprising. Efficiency, productivity, output, and wealth all refer to the values and interests of human beings. These values and interests do not form a completely harmonious whole. An action that increases the wealth of some will inevitably increase the wealth of certain others by less than an alternative action would have done, and in most cases it will actually reduce at least a few people’s wealth. Those who build better mousetraps diminish the wealth of competitors and increase by less than they might have the wealth of those who were hoping for an improved cockroach trap. It follows that economists must have some way to weigh values and interests before they can assess the relative contribution of alternative arrangements to overall efficiency, productivity, output, or wealth.

Does monetary or pecuniary wealth provide a common denominator that will enable us to weigh and thus to compare the otherwise incommensurable values and interests of different people? Wealth measured in monetary terms is the common denominator used, for example, in the extensive “economic analysis of law” literature associated with the work of Richard Posner and others.13 Unfortunately, most of those who advocate monetary wealth maximization as a norm for assessing alternative social arrangements omit the qualifying adjective and speak only of wealth maximization. George Stigler, in a provocative essay entitled “Wealth, and Possibly Liberty,” equates efficiency with wealth maximization and identifies changes in wealth with changes in utility. As the rest of the article makes clear, however, it is monetary wealth and not wealth in the utility sense that he is talking about. But monetary wealth maximization does not provide a policy norm that is superior, on all counts, to the advancement of liberty, as Stigler maintains. The cogency of Stigler’s essay depends largely upon the success with which he shifts back and forth between wealth and monetary wealth as his argument requires, in turn, a criterion relevant to human purposes or a common denominator in terms of which values can be compared by an observer.14

Marxists have long complained that conventional economic analysis takes for granted the existing system of property rights. The charge is fundamentally correct. Offers to supply goods and efforts to purchase goods always depend upon people’s expectations of what they can and may do under specific contemplated circumstances. What a person may do expresses, in the broadest sense, that person’s property rights. In order to predict, explain, or even talk intelligibly about those patterns and instances of social interaction that we call “the economy,” we must begin with people’s expectations, that is, their property rights.15

It is their de facto property rights, of course, or people’s actual expectations, that generate demand curves and supply curves. Legal rights that exist only as statutory or judicial declarations do not influence action. Similarly, the rights that people believe they ought to have will affect supply and demand schedules only insofar as these people also believe that others will in fact accept the obligations that their claims of right entail. In short, supply curves and demand curves plus the predictions and explanations that they produce can be obtained without any decision regarding the rights people ought to have. Economists only have to decide what rights people do have in the society being studied.

The contention in this section of the paper is that economists in their professional work have typically gone well beyond what mere agreement on de facto rights will allow. They have measured changes in productivity growth rates; they have assessed the relative efficiency of alternative government policies; they have contrasted positive-sum games with zero-sum and negative-sum games; they have articulated such concepts as “deadweight losses,” allocations “off the contract curve,” and output combinations “inside the production possibility frontier” and have attempted to illustrate such concepts in experience. It is these extensions of economic analysis that presuppose a moral consensus by assuming what property rights people ought to have. Economists who believe that economics should be value-free must therefore give such concepts up.16

What would be left? Would an economics deprived of all these concepts still be a science relevant to policy formation?

IV

Anxiety about value judgments in economic science has produced two opposite responses. One is a quest for purity; it aims at eliminating all value judgments from economics in order to create a purely positive science. The other might be called a quest for impurity; it aims at exposing the value judgments that remain even after the purifiers have done their best, in the hope of demolishing the claim that economics can be or is a purely positive science.17 The anxiety may be a larger problem than the value judgments. A more constructive approach, I shall argue in this final section, is closer attention to what we can and cannot infer from observed behavior, and what we must postulate if we want to offer particular judgments about alternative social institutions.

The best way of making the argument is through examples. I’ve chosen the issue of rent controls.

The political popularity of legislated controls on residential rents has surged in the United States in recent years, largely as a consequence of actions and misconceptions related to an accelerated rate of decline in the general purchasing power of money. What can economists as economists say about rent controls?

One common contribution of economists is the prediction that rent controls will prevent residential space from moving to its most highly valued use. This prediction changes no one’s mind, because most advocates of rent control want to prevent residential space from always moving to its most highly valued use. They believe that elderly people on low, fixed incomes should not have to give up their apartments simply because someone else is willing to pay a higher rent. The advocates of rent control believe that the monetary bids of current tenants should, at least in certain cases, have more weight in social allocation processes than the identical money bids of prospective tenants. “Most highly valued use” as defined by the typical economist does not correspond to “most highly valued use” as defined by the typical advocate of rent controls.

What else might economists contribute to the discussion? They could predict the evolution of key fees; the harassment of tenants by owners who want to terminate tenancies; the disappearance of housing stock from the rental market as owners sell or shift it into other uses; and cases where wealth will be transferred from low-income to high-income people. None of these predictions is a conclusive argument against legislated rent controls, however. Proponents can (and do) respond with proposals to tighten the law and prevent such “abuses.”

Still the discussion does not have to end. Economists can ask exactly how the law could be tightened to prevent, for example, a withdrawal of housing stock from the rental market, and then offer predictions about the consequences of such additional legal provisions. None of these predictions will be a conclusive argument, either, because a determined advocate of rent controls will be able to point to additional possibilities or neglected considerations that may overcome the force of the economist’s predictions.

Is this not why economists make such extensive use of pseudo-empirical aggregative concepts? Predicting the various consequences of a proposed policy will not be sufficient, in many cases, to establish the consequences relevant to a decision. Economists have long admitted their inability to evaluate consequences; but they have insisted upon their ability as “scientists” to predict consequences. The difficulty in practice is that the set of predictable consequences potentially relevant to a decision is indefinitely large. As a result, economists frequently cannot even establish “what is” in an adequate way (quite apart from any inability to achieve consensus on their specific predictions, often a considerable difficulty in itself). The appeal of pseudo-empirical concepts like efficiency or economic growth lies in their supposed summation of the “net effects,” a summation that enables economists to “stick to their last” (description and prediction) and still contribute to the discussion and formation of public policy. Few economists seem to be aware of the value judgments that give these concepts their content and significance.18

Can economists get safely back inside the circle of a purely “positive economics” by abandoning pseudo-empirical aggregates and confining themselves to concrete, well-specified descriptions and predictions? As the opening paragraph of this section suggested, the best answer may be a rejection of the question.

Economists cannot describe all the features or predict all the consequences of any situation. They therefore focus on significant facts. Since most economists are opposed to legislated rent controls, the consequences they predict are usually the undesirable ones. Economists are not likely to predict that properly written rent controls will reduce tenant mobility, thereby enabling urban neighbors to become better acquainted and to create safer neighborhoods. Nor are they likely to point out that rent controls can reduce congestion in already densely populated cities by restricting in-migration, or that they may contribute to the preservation of older buildings with historic architectural significance. The typical economist will instead predict a decline in the rate of new apartment construction, and will often not even notice that this presumably undesirable effect is the corollary of effects that are desired, at least by some people.

Advocates of a value-free economics seem to suppose that “positive economics” can and should describe all the consequences of a given policy proposal plus all the consequences of alternative policies, and only then allow value judgments to enter into the decision process. This is an impossible agenda. It is not made any less absurd by invoking the phrase “in principle,” the phrase we use so often when we want to argue for the desirability of doing something no one currently knows how to do. Economists will not (this is a prediction) be able to spell out all the facts, current and predicted, relevant to a policy decision in any case where there is substantial public disagreement on the policy. Of course, they can always present more of the consequences, working in the dialectical manner illustrated earlier. How long they will continue depends upon the estimated marginal benefits and costs of continuing.

Is there any good reason for refusing to appeal, in this kind of dialogue, to considerations of justice or fairness? That is surely the implicit argument in many predictions, such as the prediction that rent controls will increase the wealth of some tenants at the expense of owners who are less wealthy than themselves. Why not make it explicit? The reluctance or outright refusal of so many economists to appeal explicitly to moral considerations frequently makes their arguments less clear. Does it also make them more purely “economic” or “scientific”?

The belief that it does seems to be rooted in two widespread misconceptions. One is the general failure of economists to recognize the extent to which their analyses already make use implicitly of presuppositions regarding justice or fairness. The property rights or expectations that generate supply curves and demand curves are usually assumed by economists to be rights in whose exercise people ought to be secure. This is a controversial (and perhaps mistaken) claim which will not be defended here. A defense would run, however, along two lines. One line of defense would point out that prediction and even description becomes impossible in the absence of reasonably stable property rights. The other line of argument would attempt to show how frequently economists use measures of change (in wealth, output, efficiency, etc.) on the assumption that certain people—and not others—have a moral right to control the allocation of particular resources.

The other misconception is the belief that moral argument cannot be rational argument. As Sidney Alexander once observed, “the economist’s calendar of philosophy lies open to the year 1936.”19 Economists usually do not question Milton Friedman’s assertion that, when a policy disagreement is rooted in ethical rather than factual disagreement, the only resolution possible is through fighting,20 as they did not generally question Lionel Robbins’ claim twenty years earlier that in all such cases it was a matter of “thy blood or mine.”21 On this issue Robbins, Friedman, and the economists who join them are demonstrably wrong. People do not always resort to force when they find the path to policy agreement blocked by disagreement regarding what is just or fair. Instead they frequently turn to moral argument.

“Do you think it’s fair to change the rules of the game suddenly, thereby confiscating the property of apartment owners?”

“Do you think it’s fair for landlords to raise their rents even though most of their costs aren’t going up at all?”

Answers can be given to these questions. They aren’t likely to be definitive answers; but as we saw earlier, definitive assertions are equally hard to produce when we confine ourselves to empirical description and prediction. Moreover, just as the significance of empirical claims often depends upon underlying assumptions about fairness or justice, so people’s disagreements regarding fairness or justice often rest upon conflicting empirical claims. An empirical analysis can sometimes resolve an apparent disagreement about justice. It is no less true that attention to moral arguments can sometimes clarify and thereby resolve what seem at first to be empirical disagreements. In fact, it does not even seem possible to separate in any wholly satisfactory way the moral and the empirical aspects of any dialogue concerning public policy.

Economists persist in trying and continue to suppose they can succeed (at least “in principle”) because they want to be scientists. Interestingly, many people who take stands on policy issues that economists tend to condemn—in favor of rent controls, increases in the minimum wage, usury laws, etc.—are delighted to find themselves the only ones making moral claims on behalf of the policies they support. They know that, in the political arena, the unanswered claim that a particular policy is unjust will almost always defeat a similarly unanswered argument that the alternative is inefficient.

Surely we would not want it to be otherwise. If the argument of this paper is correct, it cannot be otherwise. A defense of efficiency is, in any particular case, a defense of some particular distribution of rights. If we want to argue for efficiency, we have two choices. We can examine the justice of the particular distribution of property rights we are defending. Or we can defend without examination the rights we are presupposing. Either choice is legitimate. Unexamined presuppositions are finally unavoidable at some level, and the search for hidden value judgments can too easily, as Lionel Robbins once suggested, take on the features of a witch hunt.22

But there is surely no reason for the economics profession to excommunicate those colleagues who choose to ask about the ethical norms that inform their own analysis or to call explicit attention to the ethical implications of the situations they describe and the consequences they predict.

CHAPTER 22

The Foundations of Law and Economics: Can the Blind Lead the Blind?*

I.

Introduction

When it comes to theorizing, most economists would rather follow David Ricardo than Adam Smith. They crave rigor. A plausible story, consistent with basic theory and supported by substantial evidence, is not as satisfactory as are conclusions established with the binding force of logic.3 That is why plausible explanations are so often “modeled” before they are presented in the journals. Even when the model is not used and so adds nothing but length to the presentation, a theory is not altogether respectable in economics until it has been presented in rigorous dress.4

This predilection toward rigor has some desirable consequences. For one thing, it discourages ad hoc theorizing. A well-modeled argument will more readily reveal the degree of its conformity to the organizing premise of economic theory: that social phenomena are the consequence of self-interested interactions pushing toward equilibrium positions.5 An explanation that cannot be reconciled with this Grand Model will “make no sense” to economists, and will be sent back to the manufacturer for fundamental repair—or sale in some other territory, such as sociology.

This tyranny of theory often irritates outsiders, and it positively infuriates such dissenting insiders as the American Institutionalists.6 It also draws an unusual amount of critical attention to the foundations of economic theory. The conclusions of a rigorous argument are no more persuasive, after all, than the premises from which they follow. And so the periodic anxieties of orthodox economists and the ongoing subversive interests of their critics have combined to produce a great deal of foundation-probing in the history of economic theory.7

Legal scholars form another group that has been unusually preoccupied with foundation questions.8 What is the law? Is it merely the enforceable dictates of whoever happens to be in power, as positivist theories of law seem to assert? Does it follow then that there is no “right” except might? If we reject this conclusion and maintain that there is reason in the law, what is the reason of the law? How do judges decide?

Constitutions, statutes, and precedents can never be sufficient to determine uniquely a particular judicial decision. Every decision is to some degree a new decision, an extension of established law to cover a novel case, since in the absence of novelty there would be nothing to litigate. Judges are therefore continually creating the law as well as applying it. How can they do this without becoming arbitrary? How can they decide in a way consistent with the “rule of law”?

The difficulties of formulating an adequate answer to that question regularly give rise to the suspicion that no adequate answer exists. Sometimes the suspicion grows into a conviction, as occurred at the height of the American Realist movement in the 1920s and 1930s. But the suspicion is always lurking, constantly nourished by unexpected or sharply divided decisions from high courts and complaints about “judicial legislation” from those who are aggrieved by these decisions. Are judges really deciding on the basis of principles, as they claim? Or are they only expressing, as some critics insist, the particular values to which they happen to subscribe?

One influential attempt to answer the lawyers’ question has come in recent years from economics. The so-called economic theory of law has proposed and extensively tested the hypothesis that the evolution of legal rules in common-law countries has been guided by the criterion of efficiency. The logic of the law, even when unrecognized by the judges, is wealth-maximization.9

During this same period, however, the concept of efficiency has itself been subjected to searching criticism by scholars working along the borders of law and economics.10 Many of these critics, among whom the Critical Legal Studies group is most prominent, have concluded that the efficiency concept used in economic theory is “incoherent.” As a result, they maintain, much of the work that has been done toward developing an economic theory of law is either tautological or ideological.

Can the blind lead the blind? If economic theory is incoherent, how can it provide foundations for law? This paper accepts the major arguments of the efficiency critics, but concludes nonetheless that economics can provide foundations of a sort for law. The allegedly vacuous efficiency concept actually has some foundations, located largely, as it turns out, in law. So the blind do lead the blind, perhaps enabled by this mutual assistance to avoid the ditches into which each would fall without the other’s assistance.

II

The most vigorous research programs in recent years within the field of law and economics have been the efficiency approach, identified principally with the name of Richard Posner, and the Critical Legal Studies attack, most ably represented by Duncan Kennedy. The efficiency school has produced a large number of studies assessing the wealth-enhancing effects of legal rules and institutions; the Critical Legal Studies group has concentrated on arguing the “incoherence” of the efficiency concept and hence of much of the law-and-economics output.11

The feature of the efficiency concept on which critics fasten is its dependence upon an initial assignment of property rights. The argument can be briefly stated. Every defensible measure of efficiency assesses the value of benefits obtained in relation to the value of benefits forgone. Concepts of technical or objective efficiency simply have no meaning; any meaning they might seem to have will be seen, upon a more careful analysis, to presuppose an evaluation of results obtained and alternative results forgone. What counts is the evaluations.

But once this is seen, the question arises, “Whose evaluations count?” Every answer to that question implicitly assigns property rights to some persons and denies them to others. It follows that we cannot use the concept of efficiency without endorsing some set of property rights, from which it then follows that the concept of efficiency cannot be used to resolve disputes over property rights without begging the question. A claim that voluntary exchange within a free market promotes efficiency or maximizes value has no persuasive force for anyone who denies the legitimacy of the property rights from which that exchange proceeds.12

This criticism calls into question considerably more than economists’ theory of law. It raises doubts about the objectivity of all economic analysis. Suppose, for example, that economists want to predict or explain the consequences of government price supports in agriculture. How can they even begin without assuming the existing system of property rights? Rational pursuit of self-interest is the fundamental postulate of standard economic analysis; but the postulate cannot generate implications until it is supplemented with specific assumptions about the “rules of the game.” Economists who want to predict the effects of agricultural price supports must assume, inter alia, that the existing property rights of farmers will be respected, that public servants will carry out the provisions of the law, and that taxpayers will provide the amounts which they are assessed to subsidize the program.

Any or all of these specific assumptions could be substantially false. As a matter of fact, economists also explore the ways in which legislation produces changes in property rights (as parties strive, for example, to capitalize and appropriate the promise of price supports); in the behavior of government agents (legislated programs create client groups among the dispensing officials as well as among the program targets); and in practices of tax avoidance. But the analyses in these cases must again presuppose the rest of the social system and the prevailing rules of the game.

Economic theory takes for granted, far more extensively than economists seem generally to recognize, the normative force of established rights and obligations.13 Does this undermine the objectivity of the theory? Does it make economic analysis an ideological prop of the established system and a servant of vested interests, rather than an impartial tool for the assessment of conflicting claims? Radical critics have long voiced this complaint, and it would seem that they have a case.

On the other hand, might we not ask whether any of this provides legitimate grounds for complaint? It is quite true that economists take the existing system for granted in their work; it would make no sense to do anything else. Karl Marx also assumed the existing nineteenth-century European system of property rights in his efforts to elucidate the laws of motion of the capitalist system.

Marx, however, had no apologetic intent; his goal was to show how capitalism would destroy itself. The thrust of most contemporary economic analysis, on the other hand, is to demonstrate the cooperative features of market interaction: to show how the processes of supply and demand continually move resources toward more highly valued uses, producing economic growth and larger real incomes. And that is precisely the conclusion which the radical critics insist cannot be drawn. The only demonstrable growth that such a system produces is growth in the value of entitlements of those whose initial entitlements enable them to play the game. Economists may be able to predict what will occur; but nothing that occurs can be shown to be more valuable than anything else unless the legitimacy of the controlling valuations is presupposed, which is to say, unless a particular system of property rights is implicitly endorsed.

There are a number of responses that economists can make to this criticism. One is to ignore it completely. For reasons that will gradually become clear, and that are implicit in the quotation from Hart at the beginning of the paper, I consider this a thoroughly legitimate response. That is fortunate, because it is obviously the response most economists have chosen.

Another approach is to go the critics one better and argue that economic theory provides a foundation for the property rights which economic theory necessarily presupposes.14 Who ought to have which rights depends, in this version of the economic theory of law, upon who values the rights more highly. The law does and should assign property rights in disputed cases to the party who would be willing to pay the most to obtain them. That is where they will end up anyway, or, more accurately, where they would end up if property rights could be exchanged without significant cost. Since in reality there are costs associated with exchange, and these costs will sometimes prevent the transfer of rights to those who value them most highly, it makes sense for courts, in disputed cases, to place the rights where they ought to be. The “ought” presupposes, of course, that the courts do and should use wealth-maximization as their criterion in rule making.15

This line of argument does not have to be as subversive of established rights as it might at first seem. Two qualifying phrases are crucial: in disputed cases and their criterion in rule making.16

No proponent of the economic theory of law contends that all property rights should now be brought before the courts for them to undertake a vast redistribution. If A goes to court and asks for the title to B’s house, on the grounds that the house offers a magnificent view which B, a blind bachelor, cannot appreciate at all, while A and his large family collectively value the view at $100,000, A will lose and B will retain his property right. Why? Because A has no basis for his suit! Assuming that B bought the property in a legitimate way (i.e., according to the established legal rules), he has a clear and undisputed title. The fact that A says he values the property more than B carries no weight at all. Well-established legal rules specify what A must do to establish a right to B’s property: most simply, he must persuade B to transfer the title by offering a price that B will accept. That is how A “proves” his claim that he places a greater value on the house than does B.

It is the rules which common-law judges apply that allegedly do and should maximize social or aggregate wealth. A case that falls clearly under the rules is not a disputed case. It will not be litigated because no one wants to bear the costs of litigation knowing that he will lose, and by our assumption that the rules governing the case are clear, he does know that he will lose. If he is someone who values litigation for its own sake, and who consequently files a case he has no chance to win, the courts will not search for a wealth-maximizing rule with which to settle the case. They will apply the (by assumption) clear and well-settled rules that govern such circumstances to dispose of the case quickly.17

To understand what the economic theory of law is claiming, you must imagine a disputed case in which the facts are not at issue. Everything therefore depends upon the legal rule that the court applies, but the court does not know what rule it ought to apply. The case must raise questions not previously dealt with, or at least not dealt with in any way that managed to generate a decisive rule. The court is consequently caught between the inconsistent legal claims of plaintiff and defendant, and forced to decide without any rule to determine its decision. In such a situation the court must create a new rule. It is at this point that the criterion of efficiency or aggregate wealth-maximization enters to make its impact.

Notice that the new rule, under the ideal circumstances we have described, will violate no one’s property rights. If the property right in dispute is assigned to A rather than B, B loses the case but does not lose a property right. He never had it—it was in dispute—and so he cannot “lose” it. All others who might be in B’s circumstances likewise do not have anything taken away by the new rule, at least nothing to which they previously had legal title. By our assumptions, there were no legal titles prior to the enunciating of the new legal rule growing out of the case.

What is wrong with the economic theory of law as just stated? For one thing, it completely fails to answer the complaint of those who claim that the concept of efficiency is “incoherent.” Assigning property rights on the basis of willingness to pay for them, which is what the wealth-maximization criterion calls for, obviously assigns property rights at least in part on the basis of existing property rights. Willingness-to-pay depends partly upon wealth, and one’s wealth depends largely upon one’s property rights. The argument assumes property rights while claiming to justify or settle property rights.18

The claim of the critics seems to me logically sound and almost wholly irrelevant. Courts do indeed assume established, well-settled rules or property rights in order to conduct their analyses and decide what the rights ought to be in disputed cases. Who would want them to do anything else? The most “radical” court decision, one that stirs widespread cries of outrage (or satisfaction) by upsetting long and firmly established expectations, will depend for its reasoning, impact, and significance upon the vastly greater body of well-settled rules and property rights which it does not touch but wholly assumes.19 How could it be otherwise?

The Critical Legal Studies group likes to extol “imagination.” Legal or economic analyses that presuppose the existing social order are faulted not merely for their “incoherence” (something that turns out, in their analysis, to be unavoidable), but also for their failure to work at the task of imagining an alternative order.20 It might be that the critics have overestimated the relative difficulty of the two tasks: understanding the existing order and imagining an alternative one. Imagining a new social order is quite easy when one does not have to supply the innumerable details that any actual order would have to display and reconcile. Understanding the existing order, by contrast, can be quite difficult, because innumerable actual details are available to contradict any erroneous explanation.

It is decidedly not the case that everyone who assumes the existing order, or who even explicates the cooperative features of the existing order, is necessarily committed to all the features of that order, or opposed to radical change. He is likely to be opposed to unrealistic proposals for change, but primarily because he has taken the problem of social order seriously enough to study it and to learn something about what works and what is likely not to work.

In the case of a judge, someone whose decisions determine the rights of actual people and not just imagined ones, the argument for assuming existing rules or property rights becomes overwhelming. The mental experiments of an academic writer inflict their costs primarily on uncoerced readers; the experiments of a sitting judge would be coercive and unjust. This can only be denied by someone who has abstracted from the society in which he lives.

Just as the courts, in creating new legal rules, take for granted the existing body of established rules, so economic analysis, in attempting to predict, explain, or prescribe, must take for granted the existing body of established rules. Economic theory merely looks at them from a different perspective and calls them all “property rights.” The courts see property rights as something to be clarified and secured; economists view property rights as something to be used. Economists are interested in the supply curves and demand curves that are generated by self-interested action in a particular property-rights setting, and in the consequences to which the interactions of these supply and demand curves will lead.

The foundations of economics are thus in the law, at least insofar as it is the law that clarifies property rights and secures their acceptance. The major qualification is that custom and morality assist the law in its task. The foundations of economics, then, are in the established laws, customs, and morality of the society which the economist is studying.

III

Can economics return the favor and provide foundations for law? In particular, can it help legal scholars dispel what H. L. A. Hart has called:

Many legal scholars would prefer to resolve this problem without any help from economics. The logic of economics seems utilitarian, and a good deal of contemporary legal and political philosophy is openly hostile to utilitarianism. The moral concept with which the law has traditionally been most concerned is justice; and that is the moral concept with which utilitarianism experiences the most difficulty.

Economists have not waited for an invitation or a welcome. They have “advanced the hypothesis that the rules, procedures, and institutions of the common or judge-made law . . . promoted efficiency.”22 This is called the positive economic theory of law. A few economists, notably Richard Posner, have gone on to argue a normative theory that wealth-maximization is a commendable moral criterion and an appropriate one for judges to use in formulating legal rules.23

It is difficult to test the positive economic theory of law without sliding into an evaluation of the normative theory. Moreover, for reasons which will emerge, it seems to me that they largely stand or fall together. So I shall “test” them simultaneously, or perhaps dialectically, if that term has not become too fashionable to retain a meaning.

The “test” will entail a comparison with an alternative positive and normative theory, which I shall call the fairness theory. To focus the discussion, keep it within bounds, and not wander too far beyond the limits of my competence, the “test” will be confined to one small but important area of the law, the common law of contracts. Obviously, the word “test” belongs within quotation marks; it would not satisfy George Stigler. On the other hand, it might have some appeal to Ronald Coase.24 In any event, the results interest me and serve the purpose of this paper.

We begin with a very general question. Why do/should the courts employ the rule of enforcing contracts as they were written by the contracting parties?

One good answer is, “Why not?” It is not obvious that the rule of enforcing contracts as written must bear the burden of proof. But we want to set this answer aside in order to examine two others.

One intuitively plausible reason for the courts to enforce contracts as written is that contracts are promises and it is only fair that promises be honored. This is the fairness argument.

The economic argument asserts that contracts ought to be enforced as written because the enforcement of contracts maximizes social wealth, measured by aggregate willingness to pay.

It follows that, under the fairness argument, contracts should be enforced insofar as they express genuine promises. Under the economic argument, contracts should be enforced insofar as doing so will increase social wealth.

Keep in mind that the discussion is about rules. The economic argument does not say that judges do or should scrutinize each contract to determine its wealth-enhancing effects, and then enforce only as much of it as will increase aggregate wealth. We are asking about the rules the courts follow in contract litigation. The question is whether economics or fairness considerations provide a better explanation or reason for these rules.

Let us consider the rule which says that contracts signed under duress shall not be enforced. If Canterbury contracts to pay York $1,000 in return for York’s promise not to burn down Canterbury’s house, the courts will not hold Canterbury to the contract. Why do/should the courts make this exception to the rule of enforcing contracts?

The economic argument supports contracts and hence contract-enforcement because it supports voluntary exchange as a wealth-maximizing process.25 A coerced exchange is not a voluntary exchange; therefore it should not be encouraged. People should be discouraged from attempts to substitute involuntary for voluntary exchange. A rule against enforcing contracts signed under duress has this effect.

The fairness argument simply points out that a promise extracted under threat is not a genuine promise and so carries no obligation to perform.

But let us make the case more difficult to see what guidance the two arguments can give. Suppose Canterbury contracts to pay York $1,000 in return for York’s promise to repair a puncture in an automobile tire. (Canterbury punctured the tire through his own carelessness.) Should Canterbury be required to pay after York has performed as promised?

Why not? “Because York coerced me,” says Canterbury. “I only signed the contract because I was in the desert, had no spare, and would have missed a speaking engagement and a $2,000 fee if York—the only person around—had not repaired the tire.”

Is this coercion? Interestingly, some proponents of the economic analysis of law deny that “coercion” is a concept appropriate to economic analysis.26 Even “your money or your life,” uttered behind a gun, is an invitation to a voluntary exchange, according to this view of the matter. The “victim” is free to choose: to give up the money in exchange for his life, or to reject the exchange and be shot. The “victim” increases his wealth by surrendering his money, if that is what he chooses to do. If he rejects the exchange, that also must be wealth-increasing, at least ex ante, which is the only relevant perspective.

The economic argument against encouraging exchange-offers of that sort, and in favor of strongly discouraging them, is that this kind of transfer, while it increases wealth for the two parties involved, is not in the long run wealth-creating for the society as a whole. Deterring such exchanges gives people incentives to seek wealth in ways that contribute more effectively to aggregate social wealth.

Let us carry this analysis back to the case of Canterbury, York, and the $1,000 tire repair. The exchange was voluntary. The only question is whether social wealth is likely to be greater or less under a rule that calls for enforcement of such contracts. To answer that, we must ask what incentives such a rule would create. On the positive (wealth-enhancing) side, a rule of enforcement would encourage motorists to take a low-cost precaution (carrying a spare) that could prevent large potential costs. Also on the positive side, it would encourage motorists to carry tire-repair equipment, not only to avoid the risk of paying a $1,000 fee, but also to increase their chances of obtaining such a fee. In fact, tire-repair kits might multiply enormously in response to such an incentive, creating a vastly greater supply of emergency service and eventually competing the fee down to a much lower level. On the other hand, might this not attract too many resources into tire repair? Punctures are infrequent; punctures in cases where no spare tire is available to transport the motorist to a repair station are even less frequent. Would not the total cost of acquiring all those additional repair kits tend to exceed the marginal value to motorists of the extra repair services made available?

Remember, too, that we’re talking about legal rules. A legal rule governing this case is going to be a more general rule, covering something like promises made in emergencies to pay monopoly prices that are significantly higher than prices customarily charged. If people expect to be forced to pay such high prices when they find themselves, through some misfortune, in a temporarily “desperate” strait, they may begin taking a wide array of precautions whose aggregate marginal cost will exceed their aggregate marginal value. So the wealth-maximizing rule is likely to be something like: no enforcement of such contracts; or, breach allowed, with “damages” equal to the customary price in the area; or, damages equal to the court-estimated cost of supplying the good. Those are legal rules we actually see applied in cases of this sort. The economic argument “explains” the outcome.

How would the fairness argument handle York’s complaints that Canterbury has breached his contract? Contracts signed under coercion are not genuine promises. But did York coerce Canterbury?

It is not coercion and hence not unfair to induce another person to cooperate by threatening to withhold a benefit if one has a right to withhold the benefit.27 This is standard and accepted practice: buyers induce sellers to lower their prices by threatening to withhold their patronage. We do not call that coercion because we assume that buyers have a right to distribute their patronage as they please.

Sometimes, however, this right will be a limited right because of prior commitments. If Canterbury had chosen York’s service out of several in the Yellow Pages, phoned to ask York’s price, and then requested York to make a road-service call, he would not in fairness have a right, after York arrived, to demand a lower price by threatening to withhold his patronage. Nor would York, in these circumstances, have a right in fairness to insist upon a price higher than the one quoted, after arriving on the scene and discovering that Canterbury would lose $2,000 if the puncture was not repaired at once. The common law rules are clear in such cases: failure to perform as promised, when the promise induced detrimental reliance (York drove all the way out on the basis of Canterbury’s promise; Canterbury waited for York on the basis of York’s promise, rather than phoning someone else), entitles the promisees to performance or to damages. (Efficiency considerations would yield the same rule.)

We want a case, however, that is not settled so readily by a clear and well-established legal rule. Suppose that there was no prior contract between York and Canterbury. York just happened to be passing by, out on a sightseeing trip, and also just happened to have with him all the equipment required to repair Canterbury’s punctured tire. He stopped, discovered Canterbury’s plight, and offered to repair the puncture for $1,000. Since Canterbury was carrying no cash, York accepted a written promise to pay within seven days. Once safely back in the city, Canterbury refused to perform (pay the promised $1,000). York sued, alleging breach of contract. What guidance does the fairness criterion provide in this case?

It seems considerably less difficult to recognize unfairness than it is to define fairness.28 So let us ask if there was anything recognizably unfair about the contract York induced Canterbury to sign.

The price is certainly extraordinary. What did York do to earn such a huge return for his services? Was it not sheer luck that put him in a position to demand a price so advantageous to the unfortunate Canterbury? It was not sheer luck; York had prepared himself for such situations, and that seems to entitle him to some advantage. But $1,000 certainly looks excessive. It seems . . . unconscionable.

Unconscionable contracts are not enforceable at common law. But how do we distinguish unconscionable contracts? To claim that a contract is unconscionable if its terms are unfair leaves us with the problem of defining an unfair bargain. The courts are reluctant to rewrite the terms of a contract freely entered into by the parties. But was Canterbury free? Or did he sign under duress? Was he coerced into an involuntary exchange?

The answer is negative if we judge by legal entitlements. York had full legal ownership of his repair services, and an unquestioned right to leave Canterbury in the lurch if his asking price was not met. The common law courts generally do not enforce a Good Samaritan rule, which would confer upon victims of misfortune a legal right to assistance from passersby. Excellent reasons can be given in support of this reluctance to impose duties to assist, reasons grounded both in efficiency considerations and notions of fairness.29 But reluctance is not the same as blanket refusal. Once York had stopped, discovered Canterbury’s desperate situation, and revealed his own ability to help, did he not have some obligation to assist? Would not York himself expect assistance, even from a complete stranger, if he were in a situation where the stranger could provide extremely valuable assistance at low cost to himself? Is not such an expectation especially justified when the assistance does not so much convey an additional benefit as prevent a large loss? Don’t we owe something to others simply on the grounds that we are all human beings, members of the same society, fellow motorists, or capable ourselves of being in the same sort of fix? Are we not all much better off, won’t we all have greater wealth, if we live in a society where people have an obligation to help each other whenever the help offers an enormous benefit at a trivial cost? Have we not in some sense contracted together, just by living in the same society, to practice elementary decency?30

Common law courts would almost certainly refuse to enforce the contract we are discussing. They would invoke the unconscionability rule. This is admittedly a vague rule, which leaves judges with a great deal of discretion. Perhaps it leaves them with too much discretion, so that we would be better off if unconscionability were more precisely defined.31 But no rule can ever be defined so completely as to obviate any future need for interpretation.

It is a commonplace of conversation that fairness or justice is impossible to define. We make too much of this commonplace, since, as suggested earlier, injustice is regularly and often rather easily recognized. We know more than we fully understand, and far more than we can articulate clearly.32 It probably is well-nigh impossible to secure agreement among any substantial number of citizens (or judges) on an acceptable definition of fairness. It does not follow from this, however, that we ought to exclude the concept from legal thinking. It certainly does not follow that we should substitute efficiency for fairness as the dominant criterion of legal rule making.33

Efficiency and fairness have this in common, that neither one can be unambiguously defined in a completely defensible way. That is what these shifting and inconclusive arguments about Canterbury and York were designed to suggest. Efficiency presupposes property rights. An efficient outcome based on an unfair endowment of rights is not necessarily better than an inefficient outcome derived from a fair assignment of property rights. But the fundamental rules by means of which the members of a society assess the fairness of property rights arrangements are not independent of the effects those rules have on the creation of social wealth, defined as aggregate willingness to pay. In fact, we can and do assess the relative efficiency of alternative arrangements in order to determine, in hard cases, what is fair.34 The plausible assumption that people prefer more wealth to less will sometimes help us decide what people were intending to do, and knowledge of intentions is often crucial to determinations of fairness.

This is the important truth that is expressed in both the positive and normative economic theories of law. Those who reject the economic theory of law on the grounds that justice rather than efficiency is and should be the criterion of judicial decisions overlook the important assistance that efficiency considerations can provide in the quest for justice.35 But advocates of the economic theory of law have invited this response by arguing that efficiency should take the place of fairness in legal rule making. Efficiency and fairness are complements, not substitutes. Each helps to repair the ultimate indeterminacy of the other. We do not have to repudiate fairness to obtain help from efficiency; nor must we forgo the assistance that efficiency considerations provide in our groping for fairness.

A continuing problem for those who maintain that common law rules are in effect rules for maximizing social wealth is to explain how such rules could have developed.36 The reasoning that judges employ reveals no special concern for efficiency. On the contrary, judges seem more interested in devising rules that will yield justice in the case at hand than they are in the incentives these rules will provide in the future.37 To settle a case by reference to future effects on social wealth rather than to the past actions of the litigants would strike most students of the law as a perversion of justice. How, then, could common law rules have evolved over the years in the direction of efficiency?

Many of the attempts at explanation dismiss as irrelevant the arguments of the judges and the concerns expressed in their decisions. This dubious procedure may be altogether unnecessary. The courts could have developed efficient rules as an unintended by-product of their conscious efforts to develop fair rules. Suppose, for example, that the defendant in the breach of contract case pleads an unforeseen change in circumstances—which is the usual pleading. This amounts to a claim that, had the parties considered the possibility of what actually occurred and written a clause to cover it, the clause would have called for breach. The defendant, in short, claims to have behaved fairly, because in breaching the written contract he was only conforming to the larger, implicit contract in which the written contract is imbedded. The task of the courts in such cases, if they are concerned with fairness between the parties, is to determine the relevant provisions of the unwritten contract. What arrangements would the parties have agreed upon had they considered the possibility of the unforeseen event?

It makes a great deal of sense to assume that the parties would have designed the clause they did not write so as to maximize the positive impact on the sum of the two parties’ wealth. They would thus have assigned liabilities in the event of these contingencies on the basis of their estimated respective abilities to manage them in wealth-enhancing ways.38 Legal rules promoting wealth maximization might thus have developed out of judicial efforts to decide, in various classes of cases, what fairness would require. The argument sketched here would apply to the evolution of tort liability rules and rules settling disputed property rights boundaries,39 as well as to rules for resolving contract disputes.

This explanation for the evolution of efficient common law rules does not have to assume that judges are either dupes or liars. Judges claim to be aiming at fairness, and in fact they are. But through the use of efficiency criteria to decide in uncertain cases what fairness would require, the judges may have been led by an invisible hand to promote a desirable social end that was not part of their conscious intention.

IV

In economics and in law, we always know more than we realize, and far more than we can fully articulate or rigorously prove. Whatever the virtues of rigorous reasoning in these disciplines, it must be used judiciously. Or would it be better to say economically? When we give up our obsession with incontestable arguments, we begin to learn more about what we actually know and about the limitations of that knowledge. And sometimes it even happens that others then begin to listen to us more attentively.

References

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• Buchanan, James. (1974) “Good Economics—Bad Law,” Virginia Law Review, vol. 60, pp. 483-92.
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• ——. (1982) How Should Economists Choose? Washington, D.C.: American Enterprise Institute.
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• ——. (1966) “Some Aspects of Property Rights,” Journal of Law and Economics, vol. 9, pp. 61-70.
• ——. (1967) “Toward a Theory of Property Rights,” American Economic Review, vol. 57, pp. 347-59.
• ——. (1972a) “When Does the Rule of Liability Matter?” Journal of Legal Studies, vol. 1, no. 1, pp. 13-28.
• ——. (1972b) “Wealth Distribution and the Ownership of Rights,” Journal of Legal Studies, vol. 1, no. 2, pp. 223-32.
• ——. (1979) “Ethics and Efficiency in Property Rights Systems,” pp. 97-116 in M. J. Rizzo (ed.), Time, Uncertainty, and Disequilibrium, Lexington, Mass.: D. C. Heath and Company.
• ——. (1982) “Professor Michelman’s Unnecessary and Futile Search for the Philosopher’s Touchstone,” pp. 41-47 in J. Roland Pennock and John W. Chapman (eds.), Ethics, Economics, and the Law, Nomos XXIV, New York: New York University Press.
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• ——. (1979) “Nuisance Law: Corrective Justice and Its Utilitarian Constraints,” Journal of Legal Studies, vol. 8, pp. 49-102.
• Freeman, Alan D. (1981) “Truth and Mystification in Legal Scholarship,” Yale Law Journal, vol. 90, pp. 1229-37.
• Fried, Charles. (1980) “The Laws of Change: The Cunning of Reason in Moral and Legal History,” Journal of Legal Studies, vol. 9, pp. 335-53.
• Frug, Gerald E. (1982) “Cities and Homeowners Associations: A Reply,” University of Pennsylvania Law Review, vol. 130, pp. 1589-1601.
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• Gordon, Robert W. (1981) “Historicism in Legal Scholarship,” Yale Law Journal, vol. 90, pp. 1017-56.
• Hart, H. L. A. (1983) Essays in Jurisprudence and Philosophy, New York: Oxford University Press.
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• ——. (1976) Law, Legislation and Liberty: vol. 2, The Mirage of Social Justice, Chicago, Ill.: University of Chicago Press.
• Heyne, Paul. (1987) The Economic Way of Thinking, 5th ed., Chicago, IL: Science Research Associates.
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• Javins v. First National Realty Corporation, 428 F.2d 1071 (1970).
• Kelman, Mark. (1979) “Choice and Utility,” Wisconsin Law Review, pp. 769-97.
• Kennedy, Duncan. (1976) “Form and Substance in Private Law Adjudication,” Harvard Law Review, vol. 89, pp. 1685-1778.
• ——. (1981a) “Cost-Benefit Analysis of Entitlement Problems: A Critique,” Stanford Law Review, vol. 33, pp. 387-445.
• ——. (1981b) “Cost-Reduction Theory as Legitimation,” Yale Law Journal, vol. 90, pp. 1275-83.
• Klein, Benjamin (1980). “Transaction Cost Determinants of ‘Unfair’ Contractual Arrangements,” American Economic Review, vol. 70, no. 2, pp. 356-62.
• Klein, Benjamin, Robert G. Crawford, and Armen A. Alchian. (1978) “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process,” Journal of Law and Economics, vol. 21, no. 2, pp. 297-326.
• Landes, William M., and Richard A. Posner. (1978) “Salvors, Finders, Good Samaritans, and Other Rescuers: An Economic Study of Law and Altruism,” Journal of Legal Studies, vol. 7, pp. 83-128.
• Liebhafsky, H. H. (1976) “Price Theory as Jurisprudence,” Journal of Economic Issues, vol. 10, no. 1, pp. 23-43.
• Michelman, Frank I. (1978) “Norms and Normativity in the Economic Theory of Law,” Minnesota Law Review, vol. 62, pp. 1015-48.
• ——. (1982) “Ethics, Economics, and the Law of Property,” pp. 3-40 in J. Roland Pennock and John W. Chapman (eds.), Ethics, Economics, and the Law, Nomos XXIV, New York: New York University Press.
• Nelson, Richard R. (1970) Discussion, American Economic Review, vol. 60, no. 2, pp. 127-28.
• Nelson, Richard, and Sidney G. Winter. (1982) An Evolutionary Theory of Economic Change, Cambridge, Mass.: Harvard University Press.
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• ——. (1986) Economic Analysis of Law, 3d ed., Boston: Little, Brown and Company.
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• ——. (1980a) “Law Amid Flux: The Economics of Negligence and Strict Liability in Tort,” Journal of Legal Studies, vol. 9, pp. 291-318.
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• Samuels, Warren J. (1981) “Maximization of Wealth as Justice: An Essay on Posnerian Law and Economics as Policy Analysis,” Texas Law Review, vol. 60, pp. 147-72.
• Samuels, Warren J., and A. Allan Schmid, eds. (1981) Law and Economics: An Institutional Perspective, Boston, MA: Martinus Nijhoff.
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[* ] Unpublished typescript, provenance unknown, reprinted by permission of Mrs. Juliana Heyne.

[1. ] Friedrich Hayek, The Road to Serfdom (Chicago: University of Chicago Press, 1972), xvii. Citations are to the edition with a new, 1976 preface by the author.

[2. ] George J. Stigler, “Wealth, and Possibly Liberty,” Journal of Legal Studies, Volume VII, no. 2 (June 1978): 213-17.

[3. ] Milton Friedman, Essays in Positive Economics (Chicago: University of Chicago Press, 1953), 5.

[4. ] Robert Nozick, Philosophical Explanations (Cambridge, Mass.: Harvard University Press, 1981), 4.

[* ] Unpublished typescript of discussion paper prepared for a Liberty Fund conference, “Science, Markets, and Liberty,” San Antonio, Texas, 5-8 March 1981. Reprinted by permission of Mrs. Juliana Heyne.

[1. ] Frank H. Knight, “The Ethics of Competition,” published originally in 1923 in the Quarterly Journal of Economics, reprinted in Knight, The Ethics of Competition and Other Essays (Chicago: University of Chicago Press, 1976 Midway Reprint), p. 43.

[2. ] Rendigs Fels, Stephen Buckles, and Walter L. Johnson, Casebook of Economic Problems and Policies: Practice in Thinking, 4th ed. (St. Paul: West Publishing Company, 1979), p. 161. The definition offered is: “production by a firm of the most output with given inputs of labor, capital, and natural resources; producing a given amount of output using the least inputs.”

[3. ] Willis L. Peterson, Principles of Economics: Micro, 4th ed. (Homewood, Ill.: Richard D. Irwin, 1980), p. 230.

[4. ] Ibid., p. 229 A similar argument is presented on p. 8.

[5. ] Royall Brandis, “The Myth of Absolute Advantage,” American Economic Review, March 1967, pp. 169-75.

[6. ] For proof that those who throw stones sometimes live in glass houses, see Paul Heyne, The Economic Way of Thinking, 2nd edition (Palo Alto: Science Research Associates, 1976), pp. 106-7, 142-44. The 3rd edition (1980) is more circumspect but still in error. The evidence may be found on pp. 144-47.

[7. ] The argument of this paragraph is a minor variation on the theme developed by Carl Dahlman in “The Problem of Externality,” Journal of Law and Economics, April 1979, pp. 141-62.

[8. ] A revised version of the lecture is printed as an article in the American Economic Review, September 1980, pp. 555-64.

[9. ] Ibid., p. 555.

[10. ] Ibid.

[11. ] The central idea in this section of the paper turned out to be much less “original” than I had initially supposed, when I began thinking about it in the course of reflecting on a manuscript by Terry L. Anderson and Peter J. Hill, published as The Birth of a Transfer Society (Stanford: Hoover Institution Press, 1980). The concept that informs the argument was clearly stated by John Egger in his comment on a paper by Harold Demsetz, both reprinted in Mario Rizzo, ed., Time, Uncertainty, and Disequilibrium (Lexington, Mass.: Lexington Books, 1979). See Demsetz, “Ethics and Efficiency in Property Rights Systems,” pp. 97-116, and Egger, “Comment: Efficiency Is Not a Substitute for Ethics,” pp. 117-25. A similar analysis is presented by Mario Rizzo,” Uncertainty, Subjectivity, and the Economic Analysis of Law,” ibid., pp. 71-89, and by Murray Rothbard in his “Comment: The Myth of Efficiency,” ibid., pp. 90-95. An entire issue of the Journal of Legal Studies, March 1980, titled “Change in the Common Law: Legal and Economic Perspectives,” revolves around the issues discussed here, and several of the authors make the point, from different perspectives, that I am arguing for here. I now suspect that the entire paper may be implicit in the writings of James Buchanan over the years. See especially his unjustly neglected article, “Positive Economics, Welfare Economics, and Political Economy,” Journal of Law and Economics, October 1959, pp. 124-38, and his presidential address to the Southern Economic Association, “What Should Economists Do?” Southern Economic Journal, January 1964, reprinted in the collection of his essays assembled by H. Geoffrey Brennan and Robert D. Tollison, What Should Economists Do? (Indianapolis: Liberty Fund, 1979). Many of us cannot recognize a conclusion until we work it through for ourselves.

[12. ] “Other people’s actions place limits on one’s available opportunities. Whether this makes one’s resulting action non-voluntary depends upon whether those others had the right to act as they did.” Robert Nozick, Anarchy, State, and Utopia (New York: Basic Books, 1974), p. 262. Consider the opening sentence of a paper by Benjamin Klein, “Transaction Cost Determinants of ‘Unfair’ Contractual Arrangements,” American EconomicReview, May 1980, p. 356: “Terms such as ‘unfair’ are foreign to the economic model of voluntary exchange which implies anticipated gains to all transactors.” The term “unfair” is implicit, I am arguing, in the concept of “voluntary exchange.” The contention of Harold Demsetz that “extortion” is not an economic concept seems to me to require that we simultaneously banish the concept of voluntary as against coerced transactions. See Demsetz, “When Does the Rule of Liability Matter?” Journal of Legal Studies, January 1972, especially p. 24, and, by the same author, “Wealth Distribution and the Ownership of Rights,” ibid., June 1972, especially pp. 231-32. The question of “extortion” has been usefully examined by, among others, Donald C. Shoup, “Theoretical Efficiency in Pollution Control: Comment,” Western Economic Journal, September 1971, pp. 310-13; Richard O. Zerbe, “Theoretical Efficiency in Pollution Control: Reply,” ibid., pp. 314-17; Harold Demsetz, “Theoretical Efficiency in Pollution Control: Comment on Comments,” ibid., December 1971, pp. 444-46; G. A. Mumey, “The Coase Theorem: A Reexamination,” Quarterly Journal of Economics, November 1971, pp. 718-23; Donald H. Regan, “The Problem of Social Cost Revisited,” Journal of Law and Economics, October 1972, pp. 427-37; George Daly and J. Fred Giertz, “Externalities, Extortion, and Efficiency,” American Economic Review, December 1975, pp. 997-1001; David Bromley, “Externalities, Extortion, and Efficiency: Comment,” ibid., September 1978, pp. 730-35; and Daly and Giertz, “Externalities, Extortion, and Efficiency: Reply,” ibid., pp. 736-38.

[13. ] Richard Posner, Economic Analysis of Law, 2nd edition (Boston: Little, Brown and Company, 1977). See also, by the same author, “Utilitarianism, Economics, and Legal Theory,” Journal of Legal Studies, January 1979, pp. 103-40, and “The Value of Wealth: A Comment on Dworkin and Kronman,” ibid., March 1980, pp. 243-52.

[14. ] George J. Stigler, “Wealth, and Possibly Liberty,” Journal of Legal Studies, June 1978, pp. 213-17.

[15. ] The Coase Theorem is frequently summarized as the assertion that the allocation of resources will not be affected by the assignment of property rights in a world of zero transaction costs. This is an odd way to state it. A rich literature dealing with property rights has grown up over the past twenty years on the soil Coase cultivated, because economists have recognized that transaction costs are important. Why do so many persist in stating the theorem in a way that suggests property rights don’t matter, when the obvious contribution of the theorem was in inducing economists to see all the ways in which property rights do matter?

[16. ] Here is as good a place as any to acknowledge a book that I discovered too late for it to influence this paper: A. Allan Schmid, Property, Power, and Public Choice: An Inquiry into Law and Economics (New York: Praeger Publishers, 1978). This is a careful, well-informed, and comprehensive examination of most of the issues raised in the present paper. Its “institutionalist” orientation may keep it from having as much impact on “mainstream” theorizing as I think it ought to have.

[17. ] For an excellent historical survey, see T. W. Hutchison, “Positive” Economics and Policy Objectives (Cambridge, Mass.: Harvard University Press, 1964).

[18. ] A. Allan Schmid, op. cit., especially pp. 24-34, 201-50. I would disagree only with Schmid’s conclusion that, when values conflict, we have no rational procedure for resolving the disagreements. See pp. 248-49.

[19. ] For a lucid and cogent refutation (by an economist) of the prejudice that we cannot rationally discuss and resolve normative disagreements, see Sidney S. Alexander, “Human Values and Economists’ Values,” in Sidney Hook, ed., Human Values and Economic Policy (New York: New York University Press, 1967), pp. 101-16. The quotation is from p. 102.

[20. ] Milton Friedman, “The Methodology of Positive Economics,” in Essays in Positive Economics (Chicago: University of Chicago Press, 1953), p. 5.

[21. ] Lionel Robbins, An Essay on the Nature and Significance of Economic Science, 2nd ed. (London: Macmillan, 1935), p. 50.

[22. ] Lionel Robbins, Politics and Economics (New York: St. Martin’s Press, 1963), p. 6.

[* ] First published in Research in Law and Economics 11 (1988): 53-71. Reprinted by permission of Mrs. Juliana Heyne.

[1. ] Hayek (1973, pp. 4-5).

[2. ] Hart (1983, p. 21). The quotation is the opening sentence of Hart’s 1953 inaugural lecture as Professor of Jurisprudence at Oxford.

[3. ] Ricardo had a motive as well as the method and an occasion. He and his friend James Mill wanted the free-trade doctrine to be recognized as a conclusion of science, not seen as a disputable opinion. See the instructive essay by T. W. Hutchison on James Mill and Ricardo in Hutchison (1978, pp. 26-57).

[4. ] Richard R. Nelson (1970, p. 127), in commenting on a paper presented to the American Economic Association, once raised in public the question that non-mathematical economists often entertain but fear to ask: “But before proceeding let me remark that while I found the verbal theorizing clear and provocative I did not find that the mathematical treatment added anything at all, either in terms of sharpening and clarifying concepts or in terms of permitting one to see interesting implications that were not apparent from the verbal discussion. I wonder, therefore, what R. . . .’s purpose was in presenting the mathematics.”

[5. ] “The combined assumptions of maximizing behavior, market equilibrium, and stable preferences, used relentlessly and unflinchingly, form the heart of the economic approach,” according to the profession’s most relentless and unflinching practitioner of that approach, Gary Becker (1976, p. 5). Becker argues that stable preferences must be assumed to keep the approach from degenerating into tautologies.

[6. ] The Journal of Economic Issues regularly records their fury. For an example related to the theme of this paper, see Liebhafsky (1976).

[7. ] The achievements and the limitations of such foundation probing, as well as the motivating forces behind it, are probably still best illustrated by Robbins (1935).

[8. ] H. L. A. Hart and Ronald Dworkin have been the most influential foundation-probers in Anglo-American law since World War II. See Hart (1983) and Dworkin (1986).

[9. ] The leading name is that of Richard A. Posner, and the definitive explication and application of the theory is in Posner (1986). Much of the supporting work has appeared in the Journal of Legal Studies, founded by Posner in 1972 and edited by him until his resignation in 1981 to accept appointment as a Federal Appeals Court judge.

[10. ] For an unusually high-quality selection of articles by legal scholars criticizing the concept of efficiency, along with some defenses of the concept (principally by Posner), see Journal of Legal Studies (1980), reprinting a symposium on “Change in the Common Law: Legal and Economic Perspectives”; two issues of the Hofstra Law Review (1980), devoted almost entirely to the topic; and Posner’s reply to the Hofstra symposium (Posner, 1981b).

[11. ] The seminal study is Kennedy (1976). For further development of the argument, see Kennedy (1981a). The latter paper is directed at the Paretian tradition in economic analysis of law, which, as Kennedy notes, Posner repudiates. A less subtle but considerably briefer analysis widely cited by Critical Legal Studies scholars is Kelman (1979).

[12. ] This argument is by no means the exclusive property of market-system critics. See Rizzo (1979, 1980a, 1980b) and Rothbard (1979). The question-begging properties of the efficiency concept also form the central theme in Samuels and Schmid (1981) and Samuels (1981).

[13. ] An instructive illustration is provided by the work of Benjamin Klein and his colleagues on the use of contracts to control opportunistic behavior. One study (Klein, 1980) begins with the statement: “Terms such as ‘unfair’ are foreign to the economic model of voluntary exchange which implies anticipated gains to all transactors.” Can this be correct? The concept of an unfair transaction is implicit in the concept of fair transactions, and some baseline of fairness is inevitably assumed in any empirical economic analysis. Can we even recognize a voluntary exchange without implicitly using some notion of fairness? How can the concept of “opportunistic behavior” have any meaning for someone who does not recognize a distinction between fair and unfair? The contracts that Klein discusses as devices for controlling opportunistic behavior will only work as long as opportunistic behavior is constrained by fairness! If, for example, the party whose opportunism is to be controlled by the contract subsequently persuades a court to discharge the contract on grounds of unconscionability, opportunism has occurred at a deeper level, and a new kind of contract will have to be devised if further cooperation of the sort in question is to be mutually advantageous ex ante. See also Klein, Crawford, and Alchian (1978).

[14. ] Posner (1979a, pp. 125-27). For a revised and more complete statement of his views on the economics and ethics of wealth-maximization, see Posner (1981a, especially pp. 48-115).

[15. ] The roots of this argument are in Coase (1960). It has been further developed in a number of articles by Demsetz (1964, 1966, 1967, 1972a, 1972b, 1979, 1982).

[16. ] This is not to say that exponents have always stated these qualifications adequately. The language used by Posner, for example, would seem to justify the criticism that he is urging judges to behave as legislators. If we adopt the interpretation of his argument presented here, the force of these criticisms is greatly diminished. See, for example, Buchanan (1974), reviewing the first edition of Economic Analysis of Law.

[17. ] What if the rule is clear but the litigant wants to see it changed? Do not lawyers occasionally go to court hoping for a reversal of some long-standing rule? They do, of course, but their arguments in such cases will present grounds for reversal. These grounds will be other and more fundamental rules that allegedly conflict with the challenged rule.

[18. ] For a careful statement of the problem, see Michelman (1982).

[19. ] U.S. Appellate Court Judge J. Skelly Wright, praised by Critical Legal Studies scholars for his decision to incorporate municipal housing codes into all landlord-tenant contracts, is much more radical in his obiter dicta than in anything else. The judgment and supporting legal reasoning are quite conservative in Wright’s celebrated decision Javins v. First National Realty Corporation, 428 F.2d 1071 (1970).

[20. ] Kennedy (1976, pp. 1777-78, 1981b, p. 1283), Freeman (1981, pp. 1230-31), Gordon (1981, p. 1056), Frug (1982, pp. 1600-1601).

[21. ] Hart (1983, p. 127).

[22. ] Posner (1979b, p. 289).

[23. ] See especially Posner (1981a, pp. 88-115).

[24. ] Coase (1982).

[25. ] The economic arguments or rationales presented in this section draw heavily upon the writings of Posner. See especially Posner (1986).

[26. ] Demsetz (1972a, p. 24, 1972b, pp. 231-33).

[27. ] Nozick (1974, p. 262); Heyne (1987, p. 323).

[28. ] This is an ancient but still much neglected insight. See especially Hayek (1976, pp. 35-48, 162-64).

[29. ] Landes and Posner (1978, pp. 93-100, 119-27).

[30. ] If it seems to the reader that the efficiency and fairness criteria are getting all mixed up, that is intended.

[31. ] Epstein (1975).

[32. ] Readers who know the work of Michael Polanyi will have noticed that this paper is in part an attempt to apply Polanyi’s theory of knowledge. See especially Polanyi (1958). The paper has also been influenced by reflection on many of the arguments advanced in Nelson and Winter (1982).

[33. ] Compare Stigler (1978).

[34. ] The claim here is a bit stronger, I believe, than Michelman’s conception of efficiency as a “tie breaker.” Michelman (1978, p. 1047).

[35. ] The change in Richard Epstein’s position from the early to the late 1970s reflects, I believe, a growing recognition of this fact. Compare Epstein (1973) with Epstein (1979).

[36. ] Posner has himself regularly called attention to this weakness in the positive economic theory of law. See, for example, Posner (1981b, pp. 776-77).

[37. ] Fried (1980).

[38. ] Goetz and Scott (1977).

[39. ] The cases discussed by Ronald Coase in “The Problem of Social Cost” read somewhat differently from this perspective. See Coase (1960, pp. 8-15, 19-28).