Law's Order
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Law's Order

What Economics Has to Do with Law and Why It Matters

David D. Friedman

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Law's Order

What Economics Has to Do with Law and Why It Matters

David D. Friedman

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What does economics have to do with law? Suppose legislators propose that armed robbers receive life imprisonment. Editorial pages applaud them for getting tough on crime. Constitutional lawyers raise the issue of cruel and unusual punishment. Legal philosophers ponder questions of justness. An economist, on the other hand, observes that making the punishment for armed robbery the same as that for murder encourages muggers to kill their victims. This is the cut-to-the-chase quality that makes economics not only applicable to the interpretation of law, but beneficial to its crafting.
Drawing on numerous commonsense examples, in addition to his extensive knowledge of Chicago-school economics, David D. Friedman offers a spirited defense of the economic view of law. He clarifies the relationship between law and economics in clear prose that is friendly to students, lawyers, and lay readers without sacrificing the intellectual heft of the ideas presented. Friedman is the ideal spokesman for an approach to law that is controversial not because it overturns the conclusions of traditional legal scholars--it can be used to advocate a surprising variety of political positions, including both sides of such contentious issues as capital punishment--but rather because it alters the very nature of their arguments. For example, rather than viewing landlord-tenant law as a matter of favoring landlords over tenants or tenants over landlords, an economic analysis makes clear that a bad law injures both groups in the long run. And unlike traditional legal doctrines, economics offers a unified approach, one that applies the same fundamental ideas to understand and evaluate legal rules in contract, property, crime, tort, and every other category of law, whether in modern day America or other times and places--and systems of non-legal rules, such as social norms, as well.
This book will undoubtedly raise the discourse on the increasingly important topic of the economics of law, giving both supporters and critics of the economic perspective a place to organize their ideas.

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What Does Economics Have to Do with Law?

YOU LIVE IN A STATE where the most severe criminal punishment is life imprisonment. Someone proposes that since armed robbery is a very serious crime, armed robbers should get a life sentence. A constitutional lawyer asks whether that is consistent with the prohibition on cruel and unusual punishment. A legal philosopher asks whether it is just.
An economist points out that if the punishments for armed robbery and for armed robbery plus murder are the same, the additional punishment for the murder is zero—and asks whether you really want to make it in the interest of robbers to murder their victims.
That is what economics has to do with law. Economics, whose subject, at the most fundamental level, is not money or the economy but the implications of rational choice, is an essential tool for figuring out the effects of legal rules. Knowing what effects rules will have is central both to understanding the rules we have and to deciding what rules we should have.
The fundamental assumption of the economic approach, to law and everything else, is that people are rational. A mugger is a mugger for the same reason I am an economist: Given his tastes, opportunities, and abilities, it is the most attractive profession open to him. What laws are passed, how they are interpreted and enforced, ultimately depend on what behavior is in the rational interest of legislators, judges, and police.
Rationality does not mean that a burglar compiles an elaborate spreadsheet of costs and benefits before deciding whether to rob your house. An armed robber does not work out a precise analysis of how shooting his victim will affect the odds of being caught, whether it will reduce the chances by 10 percent or by 20. But if it is clear that it will reduce the risk of being caught without increasing the punishment, he is quite likely to pull the trigger.
Even in this weaker sense people are not always rational. I, for example, occasionally take a third helping of spaghetti when a careful calculation of my own long-run interests would lead me to abstain. I am well acquainted with my own irrationality and can take steps to deal with it. Having discovered that bowls of potato chips located within arm’s reach empty themselves mysteriously, I at least sometimes take the precaution of putting the bowl somewhere else.
But I do not know other people—the vast masses of other people to whom economic analysis of law is intended to apply—well enough to incorporate their irrationalities into my analysis of the effect of legal rules on their behavior. What I do know about them is that they, like me, have purposes they wish to achieve and tend, albeit imperfectly, to correctly choose how to achieve them. That is the predictable element in human behavior, and it is on that element that economics is built.
Whether armed robbers should get ten years or life is not a burning issue for most of us. A question of considerably more importance is the standard of proof. In order for you to be convicted of a crime or to lose a civil case and have to pay damages, just how strong must the evidence against you be?
It is tempting to reply that nobody should be punished unless we are certain he is guilty. But by that standard nobody would ever be punished; the strongest evidence establishes only a probability. Even a confession is not absolute proof: While our legal system no longer permits torture, it does permit plea bargaining, and an innocent defendant may prefer a guilty plea on a minor charge to risking a long prison term on a major one. Scientific evidence is no more conclusive; even if we somehow had a perfect match between the DNA of the suspect and the criminal, there would still be the possibility that someone at the lab made a mistake or that somewhere, perhaps unknown to him, the suspect has an identical twin. If we are to convict anyone at all, we must do it on evidence short of absolute proof.
How far short? Raising the standard of proof reduces the chance of convicting an innocent defendant but increases the chance of acquitting a guilty one. Whether that is on net worth doing depends on the relative costs of the two kinds of mistakes. If, as Blackstone wrote more than two hundred years ago, it is better that ten guilty men go free than that one innocent be convicted, we should keep raising our standard of proof as long as doing so saves one more innocent defendant at the cost of freeing no more than ten guilty ones. We would end up with a high standard.
In fact, law in the United States and similar systems requires a high standard of proof (“beyond a reasonable doubt”) in a criminal case but only a low standard (“preponderance of the evidence”) in a civil case. Why? The answer cannot simply be that we are more careful with criminal convictions because the penalties are bigger. A damage judgment of a million dollars, after all, is a considerably more severe punishment for most of us than a week in jail.
Economics suggests a simple explanation. The typical result of losing a lawsuit is a cash payment from the defendant to the plaintiff. The result of being convicted of a crime may well be imprisonment or execution. A high error rate in civil cases means that sometimes I lose a case I should have won and pay you some money and sometimes you lose a case you should have won and pay me some money. On average, the punishment itself imposes no net cost; it is simply a transfer. A high error rate in criminal cases means that sometimes I get hanged for a murder I didn’t commit and sometimes you get hanged for a murder you didn’t commit. In the criminal case, unlike the civil case, one man’s loss is not another man’s gain. Punishment is mostly net cost rather than transfer, so it makes sense to be a good deal more careful about imposing it.
For an application of economics to a different part of the law, consider the nonwaivable warranty of habitability, a legal doctrine under which some courts hold that apartments must meet court-defined standards with regard to features such as heating, hot water, sometimes even air conditioning, whether or not such terms are provided in the lease—indeed, even if the lease specifically denies that it includes them. The immediate effect is that certain tenants get services that their landlords might not otherwise have provided. Some landlords are worse off as a result; some tenants are better off. It seems as though supporting or opposing the rule should depend mainly on whose side you are on.
In the longer run the effect is quite different. Every lease now automatically includes a quality guarantee. This makes rentals more attractive to tenants and more costly to landlords. The supply curve, the demand curve, and the price, the rent on an apartment, all shift up. The question, from the standpoint of a tenant, is not whether the features mandated by the court are worth anything but whether they are worth what they will cost.
The answer may well be no. If those features were worth more to the tenants than they cost landlords to provide, landlords should already be including them in their leases—and charging for them. If they cost the landlord more than they are worth to the tenant, then requiring them and letting rents adjust accordingly is likely to make both landlord and tenant worse off. It is particularly likely to make poorer tenants worse off, since they are the ones least likely to value the additional features at more than their cost. A cynical observer might conclude that the real function of the doctrine is to squeeze poor people out of jurisdictions that adopt it by making it illegal, in those jurisdictions, to provide housing of the quality they can afford to rent.
If my analysis of the effect of this legal doctrine seems implausible, consider the analogous case of a law requiring that all cars be equipped with sunroofs and CD changers. Some customers—those who would have purchased those features anyway—are unaffected. Others find that they are getting features worth less to them than they cost and paying for them in the increased price of the car.
This is a very brief sketch of a moderately complicated economic problem, and the result is not quite so clear as the sketch suggests. With a little effort one can construct possible situations in which a restriction on the terms of leases benefits some tenants and landlords at the expense of others, or most tenants, or most landlords. With more effort one could construct a situation in which the restriction benefits both landlords and tenants. The important point is not that restrictions on the terms of contracts are a good or a bad thing but that one cannot evaluate their effects by looking only at the terms that are restricted. You also have to look at the effect of the restriction on the other terms of the contract, in my example the rent.
In any particular law case it looks as though what is at stake is how the legal system will deal with this particular set of events, all of which have already happened. From that backward-looking point of view it is often hard to make sense out of existing law. The reason is not that law does not make sense but that we are facing in the wrong direction.
Suppose, for example, that I take advantage of a particularly good opportunity to push my rich uncle off a cliff. By extraordinary bad fortune a birdwatcher happens to have his camera pointed in my direction at just the wrong time, with the result that I am caught, tried, and convicted. During the sentencing phase of the trial my attorney points out that my crime was due to the conjunction of extraordinary temptation (he was very rich, I was very poor) and an improbably good opportunity—and I had only one rich uncle. Besides, once I have been convicted of this crime, potential future victims are unlikely to go rock climbing with me. Hence, he argues, the court should convict me and then let me go. Whatever they do, I will never kill again, and hanging or imprisoning me will not, he points out, bring my uncle back to life.
The conclusion is bizarre, but the argument seems logical. The reply many legal scholars would probably offer is that the law is concerned not only with consequences but also with justice. Letting me go may do no damage, but it is still wrong.
The economist offers a different response. The mistake is not in looking at consequences but in looking at the wrong consequences, backward at a murder that has already happened instead of forward at murders that may happen in the future. By letting me off unpunished, the court is announcing a legal rule that lowers the risk of punishment confronting other nephews faced, in the future, by similar temptations. Executing this murderer will not bring his victim back to life, but the legal rule it establishes may deter future murderers and so save those who would have been their victims. Legal rules are to be judged by the structure of incentives they establish and the consequences of people altering their behavior in response to those incentives.
Crime and contract are not the only parts of law in which the economic approach proves useful. Speeding fines are intended, not as an odd sort of tax, but as a way of making it in the interest of drivers to drive more slowly. Tort law determines what happens to people who get in auto accidents and thus affects the incentive to do things that might lead to being in an auto accident, such as not having your brakes checked, driving drunk, driving at all. The rules of civil procedure determine what sorts of information litigants are entitled to demand from each other and thus affect the incentive of firms to keep (or not keep) records, to investigate (or not investigate) problems with their products that might become the subject of litigation, to sue or not to sue. Divorce law determines under what circumstances you can get out of a marriage, which is one of the things relevant to deciding whether to get into it. The subject of economic analysis of law is law. All of it.

The Proper Application of High Explosives to Legal Theory

A physics student who has learned classical mechanics and the theory of electricity and magnetism has the basic equipment to deal with practically any pre-twentieth-century physics problem. Just add facts and mathematics and turn the crank. Throw in relativity and quantum mechanics and you can drop the “pre-twentieth-century” restriction. An economics student who has thoroughly mastered price theory is equipped to deal with very nearly every problem to which economic theory gives a clear answer, with the result that many of the courses offered by an economics department are simply applications of price theory to such particular areas as transportation, agriculture, trade, or law. A law student who has learned to understand tort law has the basic equipment to understand tort law. If he wants to understand criminal law, he must start over again.
Economics changes that. In the next few chapters you will be acquiring a set of intellectual tools. The rest of the book consists of the application of those tools to different areas of law. As you will see, once you understand property, or contract, or tort from the point of view of economics, you have done most of the work toward understanding any of the others. While each raises a few special issues, the fundamental analysis is common to all.
This is one explanation for the controversial nature of economics within the legal academy. On the one hand, it offers the possibility of making sense out of what legal academics do. On the other hand, it asserts that in order for legal academics to fully understand what they are doing, they must first learn economics. In the world of ideas, as in the world of geopolitics, imperialism is often unpopular with its targets.
A second reason economic analysis is controversial is that it sometimes produces conclusions with which many legal academics disagree—for example, that laws “protecting” tenants are quite likely to make tenants worse off. Scholars who apply economic analysis to law are routinely charged with conservatism, not in the literal sense of wanting to keep things unchanged (in that sense the traditional scholars in any field are the conservatives and the challengers the radicals) but in the current political sense.
There is some truth to this claim—more if “conservative” is changed to “libertarian.” Part of the reason is the economist’s underlying assumption that individuals are rational. While that assumption does not, as we will see, eliminate all reasons for wanting to interfere with market outcomes, it does eliminate many. And while rationality is an optimistic assumption when applied to individuals who are supposed to be acting for their own interest—buying and selling, signing contracts, getting married or divorced—it can be a pessimistic assumption when applied to people who are supposed to be acting in someone else’s interests, such as judges or legislators. Their rationality may consist of rationally sacrificing the interests they are supposed to be serving, such as justice and the public good, to their own private interests.
But while economists are more likely to get some answers and less likely to get others than traditional ...

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