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Law and economics (also known as the economic analysis of law) is an approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.[1]
As used by lawyers and legal scholars, the phrase "law and economics" refers to the application of the methods of economics to legal problems. Because of the overlap between legal systems and political systems, some of the issues in law and economics are also raised in political economy, constitutional economics and political science. Most formal academic work done in law and economics is broadly within the Neoclassical tradition.[citation needed]
Approaches to the same issues from Marxist and critical theory/Frankfurt School perspectives usually do not identify themselves as "law and economics". For example, research by members of the critical legal studies movement and the sociology of law considers many of the same fundamental issues as does work labeled "law and economics".
The one wing that represents a non-neoclassical approach to "law and economics" is the Continental (mainly German) tradition that sees the concept starting out of the Staatswissenschaften approach and the German Historical School of Economics; this view is represented in the Elgar Companion to Law and Economics (2nd ed. 2005) and—though not exclusively—in the European Journal of Law and Economics. Here, consciously non-neoclassical approaches to economics are used for the analysis of legal (and administrative/governance) problems.
As early as in the 18th century, Adam Smith discussed the economic effect of mercantilist legislation. However, to apply economics to analyze the law regulating nonmarket activities is relatively new. In 1961, Ronald Coase and Guido Calabresi independently from each other published two groundbreaking articles: "The Problem of Social Cost" [2] and "Some Thoughts on Risk Distribution and the Law of Torts".[3] This can been seen as the starting point for the modern school of law and economics.[4]
In the early 1970s, Henry Manne (a former student of Coase) set out to build a Center for Law and Economics at a major law school. He began at Rochester, worked at Miami, but was soon made unwelcome, moved to Emory, and ended at George Mason. The latter soon became a center for the education of judges—many long out of law school and never exposed to numbers and economics. Manne also attracted the support of the John M. Olin Foundation, whose support accelerated the movement. Today, Olin centers (or programs) for Law and Economics exist at many universities.
Economic analysis of law is usually divided into two subfields, positive and normative.
Positive law and economics uses economic analysis to predict the effects of various legal rules. So, for example, a positive economic analysis of tort law would predict the effects of a strict liability rule as opposed to the effects of a negligence rule. Positive law and economics has also at times purported to explain the development of legal rules, for example the common law of torts, in terms of their economic efficiency.
Normative law and economics goes one step further and makes policy recommendations based on the economic consequences of various policies. The key concept for normative economic analysis is efficiency, in particular, allocative efficiency.
A common concept of efficiency used by law and economics scholars is Pareto efficiency. A legal rule is Pareto efficient if it could not be changed so as to make one person better off without making another person worse off. A weaker conception of efficiency is Kaldor-Hicks efficiency. A legal rule is Kaldor-Hicks efficient if it could be made Pareto efficient by some parties compensating others as to offset their loss.
Important figures include the Nobel Prize winning economists Ronald Coase and Gary Becker, U.S. Court of Appeals for the Seventh Circuit judges Frank Easterbrook and Richard Posner, Andrei Shleifer and other distinguished scholars such as Robert Cooter, Henry Manne, William Landes, A. Mitchell Polinsky, and Ugyen Rangdol from Rangsit University. Guido Calabresi, judge for the U.S. Court of Appeals for the Second Circuit, author of the 1970 book, The Costs of Accidents: A Legal and Economic Analysis, wrote in depth on this subject, with Costs of Accidents being cited as influential in its extensive treatment of the proper incentives and compensation required in accident situations.[5] Calabresi took a different approach in his 1985 book, Ideals, Beliefs, Attitudes, and the Law, where he argued , "who is the cheapest avoider of a cost, depends on the valuations put on acts, activities and beliefs by the whole of our law and not on some objective or scientific notion (69)."
In the United States, economic analysis of law has been extremely influential. Judicial opinions utilize economic analysis and the theories of law and economics with some regularity. The influence of law and economics has also been felt in legal education. Many law schools in North America, Europe, and Asia have faculty members with a graduate degree in economics. In addition, many professional economists now study and write on the relationship between economics and legal doctrines. Anthony Kronman, former dean of Yale Law School, has written that "the intellectual movement that has had the greatest influence on American academic law in the past quarter-century [of the 20th Century]" is law-and-economics.[6]
Despite its influence, the law and economics movement has been criticized from a number of directions. This is especially true of normative law and economics. Because most law and economics scholarship operates within a neoclassical framework, fundamental criticisms of neoclassical economics have been applied to work in law and economics.
Within the legal academy, law and economics has been criticized on the ground that rational choice theory in economics makes unrealistic simplifying assumptions about human nature (see rational choice theory (criminology)); Posner's application of law and economic reasoning to rape and sex [7] may be an example of this. Critics of the law and economics movements have argued that normative economic analysis does not capture the importance of human rights and concerns for distributive justice. Some of the heaviest criticisms of the "classical" law and economics come from the critical legal studies movement, in particular Duncan Kennedy[1] and Mark Kelman. A classic criticism of Posner's Economic Analysis of the Law, and more generally of similar approaches, was written by Arthur Allen Leff, who criticized Posner on formal grounds, namely that Posner's reasoning depends upon the arbitrary assumption that economically rational behavior is desirable.
Relatedly, additional critique has been directed toward the assumed benefits of law and policy designed to increase allocative efficiency when such assumptions are modeled on "first-best" (Pareto optimal) general-equilibrium conditions. Under the theory of the second best, for example, if the fulfillment of a subset of optimal conditions cannot be met under any circumstances, it is incorrect to conclude that the fulfillment of any subset of optimal conditions will necessarily result in an increase in allocative efficiency.[8]
Consequently, any expression of public policy whose purported purpose is an unambiguous increase in allocative efficiency (for example, consolidation of research and development costs through increased mergers and acquisitions resulting from a systematic relaxation of anti-trust laws) is, according to critics, fundamentally incorrect, as there is no general reason to conclude that an increase in allocative efficiency is more likely than a decrease.
Essentially, the "first-best" neoclassical analysis fails to properly account for various kinds of general-equilibrium feedback relationships that result from intrinsic Pareto imperfections.[8]
Another critique comes from the fact that there is no unique optimal result. Warren Samuels in his 2007 book, The Legal-Economic Nexus, argues, "efficiency in the Pareto sense cannot dispositively be applied to the definition and assignment of rights themselves, because efficiency requires an antecedent determination of the rights (23-4)."
Law and economics has adapted to some of these criticisms (see "contemporary developments," below). One critic, Jon D. Hanson of Harvard Law School, argues that our legal, economic, political, and social systems are unduly influenced by an individualistic model that assumes "dispositionism" -- the idea that outcomes are the result of our "dispositions" (economists would say "preferences"). Instead, Hanson argues, we should look to the "situation", both inside of us (including cognitive biases) and outside of us (family, community, social norms, and other environmental factors) that have a much larger impact on our actions than mere "choice." Hanson has written many law review articles on the subject and has books forthcoming.
Law and economics has developed in a variety of directions. One important trend has been the application of game theory to legal problems. Other developments have been the incorporation of behavioral economics into economic analysis of law, and the increasing use of statistical and econometrics techniques. Within the legal academy, the term socio-economics has been applied to economic approaches that are self-consciously broader than the neoclassical tradition.
Almost every major American law school, and most leading economics departments, offer courses in law and economics and has faculty working in the field.
Two of the leading law schools focusing on Law and Economics are the University of Chicago Law School, whose faculty includes Judge Richard A. Posner, Ronald Coase and Gary Becker, and the George Mason University School of Law, whose faculty used to include Nobel laureate Vernon Smith (though Smith and his team have since moved to Chapman University), and perennial Nobel finalist Gordon Tullock. In the spring of 2006, Vanderbilt University Law School announced the creation of a new program to award a Ph.D. in Law & Economics. A ranking of law and economics Ph.D. programs was published in the Southern Economics Journal in 2008, and also includes among the top 10 programs (based on publications in the field) the economics departments at UC Berkeley, Harvard University, University of Connecticut, UC San Diego, Princeton University, MIT, University of Wisconsin - Madison, Florida State University, Central Michigan University, and the University of Michigan.
The University of Toronto's Faculty of Law offers a combined J.D. / M.A. Economics, as well as a J.D. / Ph.D. Economics.
In Europe, a consortium of universities from ten different countries is running the European Master Program in Law and Economics, also known as EMLE which is the leading European program in the field since 1990. A newer European Doctorate in Law and Economics program is operated by three leading European centers in Law and Economics.
Since 2009 there has been created a new PhD program in Law and Economics of Finance and Money from Goethe University in Frankfurt am Main/Germany. The program is entirely created for the purpose of research in fields such as regulation of Financial Institutions and Market Regulation. The program is thought to be finished within four years and is entirely taught in English.
The Collegio Carlo Alberto in Turin, Italy hosts an International Ph.D. Program in Institutions, Economics and Law within the CLEI Centre. Members of the teaching staff come from various academic institutes in Europe and the United States. A separate Doctoral Program in Law and Economics is currently run by the School of Economics at the University of Siena. Also in Italy, the International University College of Turin [2], with students and faculty from worldwide, runs a biennial Master of Sciences in Comparative Law, Economics and Finance which challenges mainstream views on the subject.
Switzerland's University of St. Gallen has a Law and Economics Program on both the undergraduate (Bachelor of Arts in Law and Economics) and graduate levels (Master of Arts in Law and Economics). The graduate program was initiated in October 2005 at the first international scientific conference on Law and Economics by the President of the University, Ernst Mohr and the St. Gallen Professor and leading business lawyer Peter Nobel. The Law and Economics Program is supported by an International Academic Council lead by leading experts in the field of law and economics, such as Richard A. Posner, Ronald J. Gilson, Victor Goldberg or Geoffrey P. Miller.
Operating outside this particular framework, the Utrecht University offers students the possibility to major in law and economics as part of their undergraduate studies, or to specialize in law and economics in a one-year post-graduate programme.
University of Economics, Prague, namely Department of Institutional Economics at the Faculty of Economics and Public Administration, offers Law and Economics as a possible specialization for graduate students, while complete graduate program is being prepared.
The University of Cambridge also has a specific course called 'Land Economy', who combines law, economy and the environment into one discipline.[3] The University of Manchester Law School, Nottingham University Business School and City University Law School, London have undergraduate courses in Law and Economics. University College London offers undergraduate courses in Law and Economics in its Economics Faculty and post-graduate courses in its Law Faculty. In India, the National University of Juridical Sciences (NUJS) offers two courses in Law and Economics to its undergraduate students. [4]
In the National University of Singapore, a highly selective Double Honours Programme in Law and Economics was launched in 2005, whereby students complete two Bachelors' degrees in five years.
The University of Bonn has recently founded a Center for the Advanced Studies of Law and Economics (CASTLE).
