Review of the Book:

From Posner to Post-Modernism
by Nicolaus Mercero and Steven C. Medema

Clifford Cobb

[January 1999]

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 thought.

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.