1. Econ 522 Economics of Law Dan Quint Fall 2011 Lecture 24

2. 1  Next Monday: Fran review session  Next Wednesday: I’ll do practice exam problems  Extra office hours (Fran and me) TBA  Final exam: Thursday Dec 22  12:25-2:25, 6210 Social Science  Cumulative, more weight on second half of semester Logistics

3. 2 Efficiency revisited

4. 3  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

5. 4  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

6. 5  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

7. 6  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 Is efficiency the right goal for the law? -60-20Negligence rule 0-100Strict liability rule Expected payoff, victims Expected payoff, injurers

8. 7  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” Is efficiency the right goal for the law? -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

9. 8  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” Is efficiency the right goal for the law? 760 – 600 = 160 980 – 60 – 760 = 160 rent – 600980 – 60 – rent Tenant pays for heat 850 – 600 – 100 = 150 1000 – 850 = 150 rent – 600 – 1001000 – rent Landlord pays for heat LandlordsTenants Landlords’ payoffs Tenants’ payoffs

10. 9  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 Is efficiency the right goal for the law?

11. 10  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

12. 11  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?

13. 12  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 Should we expect common law to naturally evolve toward efficiency?

14. 13  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 Should we expect common law to naturally evolve toward efficiency?

15. 14  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 Should we expect common law to naturally evolve toward efficiency?

16. 15  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 Should we expect common law to naturally evolve toward efficiency?

17. 16 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 Precaution Probability of 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

18. 17 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 Precaution Probability of Accident Level of Precaution

19. 18 Should we expect common law to naturally evolve toward efficiency? EXAMPLE  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 Total Social Cost (Accidents + Precaution) Cost of Precaution Probability of Accident Level of Precaution

20. 19 Should we expect common law to naturally evolve toward efficiency? EXAMPLE  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 Total Social Cost (Accidents + Precaution) Cost of Precaution Probability of Accident Level of Precaution

21. 20  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 Should we expect common law to naturally evolve toward efficiency?

22. 21  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?

23. 22 Unenforced laws

24. 23  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…

25. 24  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…

26. 25 (Example I found online last semester)

27. 26  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/

28. 27  “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

29. 28  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

30. 29  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.” Wu’s second example: pornography

31. 30  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 Wu’s second example: pornography

32. 31  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

33. 32  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

34. 33 Recap of a few of the semester’s big ideas or, “What do I hope you’ll remember after December 22?”

35. 34  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

36. 35 but not always in the most obvious way  Effects are hard to measure, but still…  Evidence stricter tort liability reduces accidents  Evidence greater expected punishment deters crime  Laws (and other things like social norms) create incentives  Define payoffs of the “game” people play…  …and people respond strategically (in own interest)  Unintended consequences  Make cars safer  maybe people drive more recklessly  Punish robbery more severely  maybe more murders 1. Incentives matter…

37. 36  Not the only thing we should care about as a society…  But maximizing total resources/wealth is generally a good thing  We can always redistribute later through tax system  And studying efficiency is something economists are good at  When you have a hammer, all problems look like nails  And starting with efficiency forces honesty about other goals  If you’re arguing for an inefficient policy, need to explain why – and whether that other goal is worth the social “cost” it would require 2. Efficiency is a good starting point for what we want out of a legal system

38. 37  Nuisance law, contract law, tort law – largely about getting people to internalize externalities they impose  Letting people profit from private information leads to incentives to acquire it  Enforcing contracts under unilateral mistake  But, better not to give incentives for purely redistributive actions  Problem with first possession rules 3. Achieving efficiency requires providing incentives for socially valuable activities

39. 38  Coase Theorem  But transaction costs matter  Normative Hobbes view  Farnsworth paper: no bargaining after judgment  Self-serving bias: out-of-court settlements may be difficult to reach  When failure to agree would be particularly disastrous, may want to design law to not depend on bargaining  Private necessity as exception to trespassing  Necessity/duress as a way out of a contract  Eminent domain 4. Should we expect people to bargain to efficient outcomes on their own?

40. 39  A right is protected if violations are punished as crimes  injunctive relief protects rights  An interest is protected if violations must be compensated  damages rules protect interests  Property law generally protects rights, but some exceptions  eminent domain, private necessity  Contract law generally protects interests, but some exceptions  specific performance as remedy for breach of sale contract  Tort law generally protects interests  that’s the main difference between tort and criminal law 5. Law can protect either rights or interests

41. 40  Paradox of compensation  When one rule determines multiple incentives, may not be able to get efficient behavior in all of them  Damages for breach of contract under reliance investments – can’t get both efficient reliance and efficient breach  Liability in tort cases – can’t get efficient activity levels by both injurers and victims  (Friedman example of tugboats and sailboats)  Solution: figure out which incentives matter most  Which actions/decisions are most sensitive to incentives…  …and which have largest effects on efficiency 6. Even in theory, there may be no such thing as the “perfect” rule

42. 41  Direct costs versus error costs  Whaling: fast fish/loose fish simpler, leads to fewer disputes; iron-holds-the-whale gives better incentives in some settings  Demsetz: boundary maintenance costs vs. overhunting  Nuisance remedies: injunctive relief cheaper to implement, damages lead to better outcomes if parties can’t bargain  Filing fees: fewer lawsuits vs less precaution  Criminal law: deterrence is costly but reduces crimes  Right answer depends on circumstances  How sensitive are peoples’ actions to a particular incentive…  …and how much does that action effect efficiency? 7. Even when perfect rule exists in theory, tradeoff between direct costs and error costs

43. 42  Example: assumption of 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  But, want to think about what happens when these are violated  And design rules that are “robust” 8. Always be aware of how our conclusions depend on our assumptions

44. 43 1.Incentives matter (but not always in the obvious way) 2.Efficiency is a good starting point 3.Achieving it requires providing incentives for socially valuable activities 4.Can we depend on people to bargain to efficient outcomes? 5.Law can protect either rights or interests 6.Perfect rule may not exist even in theory 7.Even when it does, tradeoff between direct costs and error costs 8.Need to know how conclusions depend on assumptions Big ideas to remember in law and econ

45. 44  I hope you’ll remember how to logically anticipate the consequences of a law or policy…  …given peoples’ likely responses to the corresponding changes to their private costs and benefits  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…

46. 45 Thank you all for being here