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CHAPTER 22: The Foundations of Law and Economics: Can the Blind Lead the Blind? * - Paul Heyne, “Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion 
“Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion, edited and with an Introduction by Geoffrey Brennan and A.M.C. Waterman (Indianapolis: Liberty Fund, 2008).
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The Foundations of Law and Economics: Can the Blind Lead the Blind?*
[T]he rules of just conduct which the lawyer studies serve a kind of order of the character of which the lawyer is largely ignorant; . . . this order is studied chiefly by the economist who in turn is similarly ignorant of the character of the rules of conduct on which the order that he studies rests.
—Friedrich A. Hayek1
In law as elsewhere, we can know and yet not understand.
—H. L. A. Hart2
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.
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.
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:
the Nightmare view that, in spite of pretensions to the contrary, judges make the law which they apply to litigants and are not impartial, objective declarers of existing law[?]21
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.
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.
[* ] 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).