Review of the Book:
From Posner to Post-Modernism
by Nicolaus Mercero and Steven C. Medema
This book that discusses different schools within the law and
economics movement. You may judge for yourselves its relevance to
Georgist thought. I am sure for many on this list, the following
material will be well known. For others, however, it may be new.
The current "law and economics" movement arose at the
University of Chicago law school in the 1940s under the leadership
of Henry Simon and Aaron Director. The Chicago law and economics
project is of more than passing significance because it is a core
application of the principles of a leading form of libertarian
The economists associated with the Chicago law and economics
movement were Frank Knight, Milton Friedman, George Stigler, Armen
Alchian, Harold Demsetz, and Ronald Coase. Robert Bork and Richard
Posner are the two most famous jurists.
The law and economics movement proposes to replace the "reasonable
person" test (based on prevailing social conventions) with the "rational
self-maximizing person" test. A rational person is presumed to
judge efficiency higher than social convention. Richard Posner has
put it this way: "The basic function of law in an economic or
wealth maximizing perspective is to alter incentives."
Elsewhere he says that the task of law "is to influence
[individuals] so as to maximize [their] output."
The general approach has been to argue that 1) clarification of
property rights is a necessary condition for economic efficiency and
wealth maximization, and 2) judges and legislators should weigh
costs and benefits in accordance with the Kaldor-Hicks efficiency
criterion rather than the Pareto efficiency criterion. The latter
distinction means that actions should be judged efficient if
everyone could be made better off from an action through
compensation, even if such compensation is unlikely to take place.
(Requiring compensation is effectively the same as applying the
Pareto criterion.) Another way of describing the Kaldor-Hicks
criterion is that decisions should increase the overall productivity
of the economy, without being concerned about the distribution of
costs and benefits. The assumption implicit in this criterion is
that everyone benefits from economic growth.
Coase, Posner, and others have not only argued that the law
*ought* to follow the Kaldor-Hicks criterion but that the common law
has in fact done so. On that basis, they have claimed that the
common law yields efficient results and that it should not be
overridden by statutes, even when there is evidence of market
failure. (Common law is considered efficient because, through an
evolutionary process similar to natural selection, inefficient
common law rules are presumably challenged frequently until they
become efficient. Inefficient rules are ones that fail to minimize
net costs to society, which means that there is a self-interest
motive to challengers and a social welfare interest to courts in
modifying them.) This is the idea made famous by Coase: unless
transaction costs are too high, it is best to leave remedies to
bargaining among private parties (via common law) rather than
imposing a statute which is bound to be inefficient.
An example of how that logic works in practice will explain why
the Kaldor-Hicks efficiency or "wealth maximizing"
criterion has been rather controversial (Mercero and Medema, 59):
Suppose a firm dumps chemicals into a stream, and thereby
reduces the property values of downstream landownwers by $1 million.
If those downstream can't prevent the damage, but the polluter could
eliminate it by spending $600,000 on equipment, the court should
find for the downstream owners, since society will be better off by
$400,000. If, however, those downstream can eliminate the damage for
$300,000, the court should find for the polluter (allow the
pollution to continue), since those downstream could solve the
problem more cheaply (more efficiently) and save society $100,000.
(This example ignores marginal costs. In fact, Calabresi and
Melamed, discussed below, have pointed out that a liability rule
should be substituted for a property rule to account for marginal
changes. A property rule yields an either-or decision, such as an
injunction. A liability rule can yield a more nuanced outcome such
as a balancing of marginal costs and benefits.)
Implicit in the example is the assumption that the definition of
initial rights or entitlements is considered purely arbitrary in the
law and economics approach. The court observes rights or
entitlements in conflict: the right of downstream users to pure
water and the right entitlement of the upstream users. It is
inappropriate, according to Posner, for the court to judge one right
as having priority. This, as I understand it, is central to Coase's
argument that appropriate decision rules are unaffected by the
initial allocation of entitlements.
The fundamental concepts of torts is overturned by this approach
and replaced by an extended law of contracts. The polluter is the
tort-feasor only if its abatement costs are lower than those of
downstream users. Otherwise (according to Landes & Posner, 1983,
p. 110), when making the polluter liable "would not promote
efficiency, . . . then the cause of the [damage] will be ascribed to
'an act of God' or some other force on which liability cannot rest."
The concept of causation thus depends on results, not actions.
By a similar process of reasoning, contract law is also turned on
its head. If society can be made better off by the breaking of a
contract, then it is incumbent upon the courts not to enforce "inefficient"
contracts. Mercuro and Medema (p. 68) give the following example: A
has a contract to sell a house to B. C comes along and offers a
higher price. A sells to C. It is inefficient, according to Posner
and other Chicagoans for the courts to enforce the contract between
A and B or to require A to compensate B. They deduce this conclusion
from the following logic: It is inefficient (due to transaction
costs) for two parties to consider all contingencies ex ante. The
role of the judge is to determine, on the basis of ex post
information, which party would have accepted liability for the
contingency in question. The judge should assume that the two
parties would have wanted to minimize total costs to society (i.e.,
would have sought the most efficient or least cost contractual
arrangement). In essence, the Chicago rule for contracts shifts from
Pareto efficiency (everyone better off) to Kaldor-Hicks efficiency
(everyone could be better off, but in practice, someone loses).
The Chicago school of law and economics made its most enduring
impact in antitrust law. It argues that the goal of this law is to
promote efficiency, not equitable distribution. It further claims
that monopolies are occasional, unstable, and transitory. As a
consequence, antitrust law is really unnecessary, since all
monopolies will eventually be broken by competitive pressures.
Guido Calabresi, Douglas Melamed, and Susan Rose-Ackerman
represent the New Haven (Yale) school of law and economics. It
differs from the Chicago school in that its adherents believe that
1) statutory law and regulations are often more efficient and
equitable than common law, 2) distributional considerations are as
important as allocative efficiency, 3) nonmonetary considerations
should enter the calculus of justice, and 4) certain rights are
nonalienable or nonfungible. In the case of tort law, Calabresi has
argued that liability should be placed on the least-cost avoider --
the person best able to act on rational cost-benefit analysis. Yet,
the identification of this person is not possible as a practical
matter. This exemplifies a general problem with the law and
economics approach: it often cannot be applied in practice according
to the norms laid down by its theorists.