econ 522 economics of law dan quint spring 2013 lecture 27

Econ 522Economics of Law

Dan Quint

Spring 2013

Lecture 27

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Final exam: Sunday (May 12) 5:05-7:05 p.m., 6210 Social Science Cumulative, more weight on second half of semester

Extra office hours this week

Logistics

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Efficiencyrevisited

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Efficiency Property law: efficient allocation of rights/resources

Coase Theorem says this is easy… Contract law: efficient breach, efficient reliance, efficient disclosure of

information, etc. Tort law: efficient precaution to avoid accidents, efficient levels of

risky activities Civil and criminal law: minimize combined cost of administering

system and living with its errors

With each branch of law, we asked: What would efficient system look like? How do the rules in place measure up?

We’ve focused on efficiency throughout the semester

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We could focus on final outcomes only No worries about process, procedural fairness, etc.

We could ignore transfers when considering efficiency Paying damages has no effect on efficiency ex-post So we can ignore the “direct” effect of most remedies, consider only

the impact on incentives

Goal was always to maximize total social surplus (or total wealth)

The focus on efficiency has made our lives much easier

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Is efficiency the right goal for the law?

Is there any reason to expect the law to be efficient?

This leads us back to two questions

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Simple example of bilateral precaution and car accidents If nobody takes precaution, $160 in expected harm Injurer precaution costs $20, cuts expected harm in half Victim precaution costs $20, cuts expected harm in half Strict liability precaution by injurers but not victims Simple negligence precaution by both


-60-20Negligence rule

0-100Strict liability rule

Expected payoff, victims

Expected payoff, injurers

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Posner Once you’ve already been hit by a car, you’d prefer a strict liability

rule to a negligence rule But if a negligence rule is more efficient… …then we’d all have agreed to it ex-ante (before the accident) “Ex-ante consent” / “ex-ante compensation”


-40-60-20Negligence rule

-500-100Strict liability rule

Expected payoff if you don’t know which one

you’ll be

Expected payoff, victims

Expected payoff, injurers

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Even if people are asymmetric… Consider a law: landlords must pay for heat Tenants get $1000 value from apartment, minus rent Landlords pay $100 for heat, $600 in other costs Without this law, tenants would pay their own heat Would heat apartment less, get $980 value and pay $60 for heat Might think tenants would prefer inefficient tenant-friendly law… But rents are set competitively, would go up to compensate…

Posner: “everyone would prefer the efficient law”


760 – 600= 160

980 – 60 – 760= 160

rent – 600980 – 60 – rentTenant pays for heat

850 – 600 – 100= 150

1000 – 850= 150

rent – 600 – 1001000 – rentLandlord pays for heat

LandlordsTenantsLandlords’

payoffsTenants’ payoffs

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Cooter and Ulen Society may have goals other than efficiency… …but it’s cheaper to design law to be efficient, and address the

distribution of wealth through the tax system

Why is tax system better way to control distribution of wealth? More directly targets high/low incomes, rather than rough proxies

(“consumers” vs “investors”, “doctors” vs “patients”) Effects of changes in legal system harder to predict Lawyers more expensive than accountants Redistributive laws would be like taxes on particular activities; narrow

taxes have greater deadweight loss


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Should the legal system aim to be efficient? Posner: it’s what we’d all have agreed to ex-ante Cooter/Ulen: if we want to adjust distribution of wealth, better to do

it through taxes

Second question: should we expect the law be efficient? Civil law: written at one point in time (late 1700s), meant to be static Common law: rooted in existing norms/practices, changed by

legislation and new precedents – meant to evolve over time Some believe this evolutionary process will naturally bring common

law toward greater efficiency

That answers the first question

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Posner

Some believe government, and courts, respond to politically powerful interest groups

Landlords might be more politically connected than tenants, so might influence laws…

…but like we just saw, even landlords probably don’t want inefficient pro-landlord laws, since they’d just lead to lower rents

So well-connected groups generally won’t resist efficient rules

Should we expect common law to naturally evolve toward efficiency?

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Cooter/Ulen: three ways the common law may naturally tend toward efficiency

By implementing social norms/existing industry practices Whaling example: industry norms were well-suited to each environment Common law judges enforced industry norms, making law efficient

Judges may deliberately try to make law more efficient Hand Rule: incorporated efficiency into legal standard for negligence Judges may be more willing to reverse inefficient precedents, as in

Boomer v Atlantic Cement


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Cooter/Ulen: three ways the common law may naturally tend toward efficiency

By implementing social norms/existing industry practices Whaling example: industry norms were well-suited to each environment Common law judges enforced industry norms, making law efficient

Judges may deliberately try to make law more efficient Hand Rule: incorporated efficiency into legal standard for negligence Judges may be more willing to reverse inefficient precedents, as in Boomer v

Atlantic Cement

Inefficient laws may lead to more litigation More opportunities to get them overturned


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So that’s two yeses: Posner: even politically influential will want efficient laws Cooter/Ulen: three ways common law evolves toward efficiency

But an opposing view: Gillian Hadfield, “Bias in the Evolution of Legal Rules” Cases are different, but law must be consistent So at best, courts can try to be “right on average” But courts will see a biased sample of all possible cases

Situations that lead to litigation are different from those that don’t So court will have biased view of what rules are efficient


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Hadfield, “Bias in the Evolution of Legal Rules” A given rule will have different effects on different individuals/firms Some will find it easy to follow rule: compliers Some will find it very costly to follow rule: violators (Others may drop out of market entirely) Being “right on average” means doing what’s efficient given the

true mix of compliers and violators in market But court will mostly see cases involving violators So it might choose rule that’s efficient for market containing only

violators… …which is different than the efficient rule


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Should we expect common law to naturally evolve toward efficiency? EXAMPLE

$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm

Total Social Cost(Accidents + Precaution)

Cost of PrecautionProbabilityof Accident

Level of Precaution

Three levels of precaution: low, medium, high Accidents do $1,000 of harm Two types of firms, high- and low-cost Equal number of high- and low-cost firms in market

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$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

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Efficient levels of precaution High-cost firms: low precaution is efficient Low-cost firms: high precaution is efficient One rule for all firms: medium precaution is most efficient

$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

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If we must have one rule that applies to all firms… efficient rule requires medium precaution level to avoid liability

If mostly high-cost firms get sued… court will think it’s efficient to only require low precaution level

$145$100$190$90$1801%High

$140$110$170$60$1205%Medium

$145$130$160$30$6010%Low

“Average” Firm

Low-cost Firm

High-cost Firm

Low-cost Firm

High-cost Firm



Level of Precaution

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Hadfield: this bias will occur in any situation where courts adjust legal rule based on what appears efficient Whatever the existing rule, there will be some “compliers” and

some “violators” Courts will mostly see cases involving violators Law will evolve toward rule that would be efficient if only

violators existed But if compliers and violators are different enough, this won’t be

the efficient rule All this requires is enough heterogeneity in cases… …and courts that can only learn from the cases that go to trial


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Posner: yes Everyone, including the politically connected, wants efficient laws

Cooter/Ulen: yes Common law courts enforce existing norms/practices Courts may be more likely to overturn inefficient precedents Inefficient laws may lead to more litigation, and have more chances to

be overturned

Hadfield: no Courts see biased sample of cases If they adjust the law based on the cases they see, this will not lead to

efficient laws

So… should we expect common law to naturally tend toward efficiency?

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Unenforcedlaws

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Optimal criminal system will not detect/punish every crime, for two reasons Some crimes may be efficient (rare) When cost of deterrence is positive, it’s not worth paying enough to

deter every crime

But we still assumed most crimes are inefficient, and main reason not to punish them all is cost

We saw last week…

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There are a lot of old laws in many states that seem inefficient Massachusetts: can’t buy alcohol on Sundays Many states still have laws passed a long time ago

In some cases, law is enforced

Tim Wu, “American Lawbreaking” – many laws that we, as a society, have basically decided not to enforce at all

However…

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(Example I found online a year ago)

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Begins with New York prosecutors sitting around office, choosing celebrities (John Lennon, Mother Theresa) and coming up with obscure crimes they could be charged with “obstructing the mails,” “false pretenses on the high seas”

“Full enforcement of every last law on the books would put all of us in prison for crimes such as “injuring a mail bag.” No enforcement of our laws, on the other hand, would mean anarchy. Somehow, officials must choose what laws really matter.”

“Tolerated lawbreaking is almost always a response to a political failure – the inability of our political institutions to adapt to social change or reach a rational compromise that reflects the interests of the nation and all concerned parties. That’s why the American statutes are full of laws that no one wants to see fully enforced – or even enforced at all.”

Tim Wu, “American Lawbreaking” (Slate)http://www.slate.com/id/2175730/entry/2175733/

http://www.slate.com/id/2175730/entry/2175733/

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“Over the last two decades, the pharmaceutical industry has developed a full set of substitutes for just about every illegal narcotic we have.” Rather than legalizing street drugs… …society has developed Ritalin, vicodin, oxycontin, clonazepam, etc… …which may serve legitimate medical purposes in some instances, but

also mimic highs of cocaine and other drugs

Marijuana: several cities where police chiefs or DAs have announced they won’t prosecute possession Philadelphia law to treat possession as a ticketable offense Medical marijuana in California and elsewhere

First example doesn’t perfectly fit premise, but interesting

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Apparently, there’s porn on the internet

And it’s basically all illegal

Federal law prohibits using a “computer service” to transport over state lines “any obscene, lewd, lascivious, or filthy book, pamphlet, picture, motion-picture film, paper, letter, writing, print, or other matter or indecent character.”

Wu’s second example: pornography

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In 1968, Congress set up a commission to investigate Commission recommended we repeal all obscenity laws, replace them

with laws to protect children and control public display Nixon and other politicians condemned report as “morally bankrupt”,

insisted they would continue war on pornography

A few well-publicized prosecutions in 70s and 80s, halted in 90s

2005: Attorney General Alberto Gonzalez tried to pressure local prosecutors to crack down, but nothing happened One Miami attorney: “compared to terrorism, public corruption, and

narcotics, [pornography] is no worse than dropping gum on the sidewalk.”


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So pornography is technically illegal, rarely prosecuted

What’s developed is unofficial zoning system – rather than prohibiting behavior, it’s implicitly regulated Prosecuted when it crosses certain lines Ignored otherwise Super Bowl wardrobe malfunction – when something gets on prime-time

network TV, people freak out Child pornography still prosecuted But “mainstream” porn left alone, so functionally legal

So as a society, we’ve functionally legalized porn… Not through legislation or courts… …but through general consensus among prosecutors, FCC, FBI, local

police, etc., to do nothing about it


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Amish refuse to pay Social Security taxes, do not accept benefits, do not educate children past eighth grade

Mormons to some degree still practice polygamy

Wu discusses history of legal treatment

Again, what’s emerged is de facto zoning Mormon polygamist went on Sally Jessy and Springer to discuss his

lifestyle, he was tried and convicted But when it’s done quietly, in scattered communities outside big

cities, polygamy still goes on and is basically tolerated Amish are open about how they live, but keep to themselves, and

nobody worries about it

Wu’s other examples: copyright law, illegal immigration, Amish and Mormons

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You’d think crimes are crimes because society wants them to be crimes

But in some cases, society doesn’t care whether something is a crime, but doesn’t care enough to make it legal either

Or, political system is “broken” enough that some things can’t be fixed, we adapt by ignoring certain laws

More obvious example: speeding

This may support Hadfield’s view that the law won’t automatically evolve to be efficient!

This all doesn’t really fit into our framework of criminal law

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Recap of a few ofthe semester’s big ideas

or,

“What do I hope you’ll remember after May 12?”

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Friedman: “Economics is neither a set of questions nor a set of answers; it is an approach to understanding behavior” Keynes’ imaginary “dentist” does not exist

Point of class Not to memorize facts like which liability rules leads to efficient

injurer activity… …but to understand why To understand how people respond to incentives, and be able to

predict how a law or policy will affect peoples’ behavior

What other big-picture ideas do I hope you’ll remember?

Economics is tools, not answers

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1. Incentives matter…

Six big ideas to remember in law and econ

Effects aren’t always easy to measure, but… Evidence greater tort liability

does reduce accidents Evidence greater expected

punishment does deter crime

Laws (and norms) create incentives Define payoffs of the “game”

people play… …and people respond

strategically (in own interest)

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not always in the obvious way


Unintended consequences Make cars safer

maybe people drive more recklessly

Punish robbery severely maybe more murders

Prevent accidents at nuclear plants with strict liability, harsh punishments maybe managers cover up small leaks

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2. Efficiency: a good starting point


Not the only thing we should care about as a society…

But maximizing total resources/wealth generally a good thing Can always redistribute later

Studying efficiency is something economists do well When you have a hammer…

Starting with efficiency forces honesty about other goals If you’re defending an inefficient

policy, need to explain why – and whether that goal is worth the social “cost” it would take

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3. Can we depend on people to bargain to efficient outcomes?


Coase Theorem But transaction costs matter

Normative Hobbes Farnsworth paper: no

bargaining after judgment Self-serving bias: settlements

may be hard to reach

When failure to agree would be disastrous, may want to design law to not depend on bargaining Private necessity Necessity/duress Eminent domain

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4. Efficiency requires incentives for socially valuable activities


Nuisance law, contract law, tort law – largely about getting people to internalize externalities they cause

Intellectual property

Letting people profit from private information leads to incentives to acquire it Unilateral mistake

But, better not to reward purely redistributive actions Problem with first possession

rules

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5. A perfect rule may not exist even in theory…


Paradox of compensation Single rule, multiple incentives

can’t always get all right Damages for breach of contract

with reliance investments – can’t get efficient reliance and breach

(Friedman tugboat example) Liability in tort cases – can’t get

efficient activity level by both injurers and victims

Focus on the incentives which matter most Which actions/decisions are most

sensitive to incentives? Which have largest effect on

efficiency?

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…and when it does, still may not be the rule we actually want


Direct costs vs error costs Whaling: fast fish/loose fish versus

iron-holds-the-whale Demsetz: boundary maint-enance

costs vs overhunting Nuisance remedies: injuncations

vs damages Filing fees: fewer lawsuits vs less

precaution Criminal law: deterrence is costly,

reduces crimes

Right answer depends on circumstances How sensitive are peoples’ actions

to incentives? How much does an action affect

efficiency?

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6. Need to know how conclusions depend on assumptions


Example: rationality Throughout semester, we’ve

assumed rationality Recent exceptions: behavioral

econ; ordeals; unenforced laws Can we hope to design laws

that still work well when people are not perfectly rational?

More generally… World is a complicated place –

can’t model it without simplifying assumptions

Need to think what happens when these are violated

And design rules that are “robust”

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6. Need to know how conclusions depend on assumptions


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I hope you’ll remember how to think about laws or policies through the lens of incentives…

…that is, to think about the effects of a law or policy based on peoples’ likely responses to the change in incentives

In 1999, city council of Santa Monica CA banned banks from charging a fee to non-customers withdrawing money Next morning, ATMs stopped serving other banks’ customers City Council was shocked I’d like to think you all would have seen it coming

But mostly…

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Thank you allfor being here

econ 522 economics of law dan quint spring 2013 lecture 27

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