1. 1 George Mason School of Law Contracts I B.Why Enforce Contracts F.H. Buckley fbuckley@gmu.edu

2. 2 Some housekeeping  Please send a one or two paragraph bio to Susan Birchler at sbirchle@gmu.edu sbirchle@gmu.edu  Helen Alvare Event Wednesday at 500 2

3. 3 Last day  We wouldn’t want all contracts to be enforced: Corrective justice and: Fraud and Duress Error Unconscionability?

4. 4 A presumption of enforceability  But let’s start with the presumption that contracts should otherwise be enforceable  And why this is so can be understood from the perspective of law-and- economics

5. 5 Law and Economics: Understand the world through numbers  Can we count up pleasures and pains?

6. 6 By numbers: Jeremy Bentham’s hedonic calculus  The principle of utility is the foundation of the present work: it will be proper therefore at the outset to give an explicit and determinate account of what is meant by it. By the principle of utility is meant that principle which approves or disapproves of every action whatsoever, according to the tendency which it appears to have to augment or diminish the happiness of the party whose interest is in question: or, what is the same thing in other words, to promote or to oppose that happiness. I say of every action whatsoever and therefore not only of every action of a private individual, but of every measure of government. Principles of Morals and Legislation (1789)

7. 7 By numbers: Jeremy Bentham’s hedonic calculus  The principle of utility: Utilitarianism

8. 8 Jeremy Bentham—really… The “auto-icon” Founder of University College, London

9. The Law and Economics movement 9 Henry ManneRichard Posner

10. Economic Analysis of Contract Law  Economics as an explanation for contract enforcement 10

11. Economic Analysis of Contract Law  Economics as an explanation for why we enforce contracts  Economics as an explanation for the contours of contract law Positive and normative 11

12. Economics as an explanation for contract enforcement  Printing & Numerical v. Sampson 12 Sir George Jessel, M.R

13. Printing & Numerical v. Sampson  What was the promise here and what was the argument that it was against public policy? 13

14. Printing & Numerical v. Sampson  What was the promise here and what was the argument that it was against public policy? Sale of future inventions Fetters on improvements? 14

15. Printing & Numerical v. Sampson  When, per Jessel, should public policy be invoked to bar enforceability? Public vs. Private Law 15

16. Printing & Numerical v. Sampson  If there is one thing which more than another public policy requires it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts when entered into freely and voluntarily shall be held sacred and shall be enforced by Courts of justice. 16

17. Printing & Numerical v. Sampson  Who benefits in a case such as this from contract enforcement? 17

18. Printing & Numerical v. Sampson  Who benefits? A man who is a needy and struggling inventor may well agree either for a present payment in money down, or for an annual payment, to put his intellectual gifts at the service of a purchaser. 18

19. Promising and Efficiency  The benefit afforded by promissory institutions is a greater assurance of performance  So why is that important? 19

20. Promising and Efficiency  Let’s assume (for the moment) that contract enforceability has something to do with societal wealth 20

21. Promising and Efficiency  Let’s also assume (with Bentham) that happiness is a desirable goal 21

22. Promising and Efficiency  So is societal wealth correlated with happiness? 22

23. The Happiness Literature  Survey reports of subjective well-being “Would you say that you are very happy, pretty happy, or not too happy?” 23

24. 24

25. The curve isn’t linear…  Diminishing marginal utility 25

26. The Happiness Literature: Frey & Stutzer  The Easterlin paradox: The Hedonic Treadmill  For countries and individuals, a regression to the mean over time  Adaption set-points?  Aspiration levels change? 26

27. The Happiness Literature  But the relationship holds for a snapshot at a single time, for nations and individuals both 27

28. 28

29. The Happiness Literature  The omitted variable problem: What about happiness and freedom? 29

30. 30

31. The Happy Zone (upper right)  What do the countries in the Happy Zone have in common? 31

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33. 33

34. What goes into the rule of law?  Corruption?  Stable property rights  Sanctity of contract 34

35. Heritage Economic Freedom 2014 1 Hong Kong90.1Free 2 Singapore89.4Free 3 Australia82.0Free 4 Switzerland81.6Free 5 New Zealand81.2Free 6 Canada80.2Free 7 Chile78.7Partly Free 8 Mauritius76.5Partly Free 9 Ireland76.2Partly Free 10 Denmark76.1Partly Free 11 Estonia75.9Partly Free 12 United States75.5Partly Free 35

36. The earth’s economic center of gravity 36 Weighing locations by GDP and projecting to the earth’s surface

37. Where does contract law come in?  Sanctity of Contract and the Rule of Law  Freedom makes people happy And contract enforcement promotes freedom per Jessel.  Wealth makes people happy And contract enforcement makes people wealthy per Jessel 37

38. Where does contract law come in?  Exploiting bargaining gains through contract enforcement  And how we leave money on the table without contract enforcement 38

39. 39 Contracting as a solution to the Prisoners’ Dilemma game  A simple game that has become the dominant paradigm for social scientists since it was invented about 1960.  How the game works – and why did not work for Dilbert

40. 40 The paradox of the PD game  While cooperation is collectively rational, defection is individually rational.

41. 41 Hollywood gets in the act Russell Crowe as John Nash in “A Beautiful Mind”

42. 42 The need for poetic license

43. 43 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both

44. 44 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both  Two possible strategies: A party cooperates when he performs value- increasing promises, and defects when he breaches

45. 45 Cooperate Player 1 Modeling Two-party choice

46. 46 Defect Player 1 Modeling Two-party choice

47. 47 Cooperate Player 2 Modeling Two-party choice: Player 2

48. 48 Defect Player 2 Modeling Two-party choice Player 2

49. 49 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

50. 50 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

51. 51 CooperateDefect Cooperate Player 1 cooperates, Player 2 defects Defect Player 2 Player 1 Modeling Two-party Choice Sucker’s payoff for Player 1

52. 52 CooperateDefect Cooperate Defect Player 1 defects, Player 2 cooperates Player 2 Player 1 Modeling Two-party Choice Player 1’s temptation to defect

53. 53 CooperateDefect Cooperate Joint cooperation Player 1: sucker’s payoff Defect Player 2: Sucker’s payoff Joint defection Player 2 Player 1 Bargains as a Prisoner Dilemma game Cooperation: Promise and Perform Defect: Promise and Breach

54. 54 CooperateDefect Cooperate3, 3-1, 4 Defect4, -10, 0 Player 2 Player 1 Plugging in payoffs First number is payoff for Player 1, Second number is payoff for Player 2

55. 55 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? Player 2

56. 56 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? Player 2 Player 1 gets 3 if he cooperates and 4 if he defects So he defects…

57. 57 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? 

58. 58 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect?

59. 59 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect? 

60. 60 CooperateDefect Cooperate3 Defect40 Player 1 Defection dominates for Player 1 

61. 61 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate?

62. 62 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate? 

63. 63 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect?

64. 64 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect? 

65. 65 CooperateDefect Cooperate34 Defect0 Player 2 Defection dominates for Player 2  

66. 66 CooperateDefect Cooperate Defect 0 Player 2 Defection dominates for both Players

67. 67 The paradox of the PD game  While cooperation is collectively rational, defection is individually rational.

68. 68 The paradox of the PD game  While cooperation is collectively rational, defection is individually rational.  The undersupply of cooperation is “the tragedy of the commons.” Garrett Hardin, The Tragedy of the Commons (1968).

69. 69 The Tragedy of the Commons and the Law of the Sea )

70. 70 The Tragedy of the Commons: Ranchers (open land) vs farmers (private property) ) The Man Who Shot Liberty Valance (1962)

71. 71 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 Two-party Choice in Contracting

72. 72 Joint Cooperation Everyone promises and performs I’m worried about Tessio… The food is better at the Tattaglias…

73. 73 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 Joint Defection

74. 74 Joint defection Can these gentlemen be acting efficiently? In what sense is this joint defection?

75. 75 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 The Sucker’s Payoff

76. 76 The Sucker’s payoff Sucker performs, other party defects GONERIL Hear me, my lord; What need you five and twenty, ten, or five, To follow in a house where twice so many Have a command to tend you? REGAN What need one? KING LEAR O, reason not the need…

77. 77 CooperateDefect Cooperate Joint cooperation: Both perform Player 1 performs, Player 2 breaches Defect Player 1 breaches, Player 2 performs Both defect: Neither performs Player 2 Player 1 The Defector’s Payoff

78. 78 The Defector’s Payoff Defector breaches, sucker performs Gov. Earl K. Long "Don't write anything you can phone. Don't phone anything you can talk. Don't talk anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink." "I can make them voting machines sing Home Sweet Home."

79. 79 PD games help to explain why we do dumb things  Over-fish lakes and oceans  Pollute  Arms race

80. 80 PD games help to explain why we do dumb things  Over-fish lakes and oceans  Pollute  Arms race  Fail to exploit bargaining gains

81. 81 The Tragedy of the Commons  What solutions does Hardin suggest?

82. 82 What if contracts are prohibited?

83. 83 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 Marriage is more than a contract; it’s a covenant…

84. 84 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 But it’s less than a contract if the parties have unilateral exit rights under no-fault divorce laws

85. 85 Marriage, Divorce, Natality  What did no-fault divorce do to the cost of matrimonial fault?

86. 86 Marriage, Divorce, Natality  What did no-fault divorce do to the cost of matrimonial fault? Under fault, the straying party pays if he wants a divorce—or if his spouse seeks one So fault is costly in a fault regime

87. 87 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce?

88. 88 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce? Fewer marriages

89. 89 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce? Fewer marriages Increased female participation in the labor force

90. 90 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce? Fewer marriages Increased female participation in the labor force And what about kids?

91. 91 Children as marriage-specific assets Divorce rate 1965-83 ——— Natality rate for married couples 1965-83 ———

92. 92 Marriage, Divorce, Natality  Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998) Subsidize something (or reduce costs) and you get more of it

93. 93 Contractarianism  Might other branches of the law, apart from contract, be amenable to bargaining?

94. 94 Contractarianism  Might other branches of the law, apart from contract, be amenable to bargaining? Family Law Corporate Law Bankruptcy International Law

95. 95 Contractarianism  Might other branches of the law, apart from contract, be amenable to hypothetical bargaining? Tort Law Environmental Law Constitutional Law

96. 96 Contractarianism  What might constrain the parties from entering into a bargain?

97. 97 Contractarianism  What might constrain the parties from entering into a bargain? Illegal Contracts  Article 9 barriers to security interests in consumer goods  Waivers of divorce rights

98. 98 Contractarianism  What might constrain the parties from entering into a bargain? Illegal Contracts  Article 9 barriers to security interests in consumer goods  No waivers of divorce rights

99. 99 Contractarianism  What might constrain the parties from entering into a bargain? Transaction Costs

100. 100 Contractarianism  The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs Ronald Coase

101. So what are transaction costs? 101  Give examples of things that get in the way of bargaining

102. So what are transaction costs? 102  Too many parties. Eg, pollution

103. So what are transaction costs? 103  Emergencies: No time to bargain

104. So what are transaction costs? 104  Information processing problems

105. 105 War as a Coasian Problem: Why no peace treaty? Uccello, Battle of San Romano

106. 106 War as a Bargaining Problem The Absence of a Bargaining Space President Bashar al-Assad (and family?) in Vogue

107. 107 War as a Bargaining Problem Too many parties?

108. 108 War as a Bargaining Problem Informational Problems So you’re telling me there’s something wrong with attacking uphill and across a river? Ambrose Burnside December 1862

109. 109 War as a Bargaining Problem Agent Misbehavior What was Sir Charles Napier’s explanation for his capture of Sindh in 1843?

110. 110 War as a Bargaining Problem Agent Misbehavior Peccavi.

111. 111 All we are saying is … Give Contracts a Chance Iranians employing the defect strategy

112. Is there no cooperation without binding contracts? 112

113. Cooperation without Law?  Voting as an economic puzzle 113

114. Cooperation without Law?  Voting  No littering 114

115. Cooperation without Law?  It’s 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free… 115

116. Wikiconomics  It’s 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free… 116

117. Crowdsourcing 117

118. Bloggers vs. Mainstream Media 118