Riassunto esame Legal argumentation and economic analysis of law, Prof. Tuzet Giovanni, libro consigliato The Economic Approach to Law, T.J. Miceli

Economic analysis of law

Law and economics is the study of law from an economic point of view, focusing on how the law functions from an economist's perspective. Law is conceived as a system of incentives for citizens, through which it is possible to induce certain behaviours. It is based on the assumption that law’s addresses respond rationally (as economic agents do). If people are rational, they will surely take into consideration sanctions and behave accordingly, even though in reality, it’s different. Still, to examine the effect of incentives and sanctions, we must focus on those to whom it is a binding constraint and not on those for which they are only a consequence, but follow the law for a sense of rightness.

Sanctions

• Negative: e.g., jail time
• Positive: award of money, fiscal detractions

Law operates both by sanctioning and by awarding benefits.

Approach to analysis

There are two different approaches to the economic analysis of law: positive and negative.

Positive economic analysis

• It responds to the question “how the law is”; it doesn’t consider the purpose or how to make the people happier.
• It analyses:
  • How people actually respond to legal incentives and to the threat of legal sanctions
  • More ambitiously, it also claims that legal rules tend to reflect economic reasoning

Efficiency is seen as actually reflected in the law: it is based on the idea that law has an economic logic. Judge-made law tends to reflect economic efficiency as an important social value. Efficiency theory of common law (by Posner): common law sets of rules have existed for centuries; therefore, only those which are good and efficient have survived for this long. They are still here because they are actually efficient.

Normative economic analysis

• Responds to the question “how the law should be”; how can the law be improved to better achieve the goal of efficiency?

Possibly problematic: some people argue that efficiency is the only goal of a legal system (monistic view). However, law can’t be reduced to efficiency: there are also equal rights, liberty, dignity, etc. (pluralism of values). It sees efficiency as a social value that the law should promote; law becomes a tool to reach efficiency. This doesn’t mean it should be used in every context (e.g., criminal law).

Types of efficiency

There are three main types of efficiency:

1. Productive efficiency
2. Pareto efficiency
3. Kaldor-Hicks efficiency

Productive efficiency

It’s based on an economic definition. A productive process is efficient if and only if it obtains one of the following conditions:

1. It is impossible to produce the same amount of output using a lower-cost combination of inputs.
2. It is impossible to produce more output using the same combination of inputs.

There are different possible (and disputable) applications of productive efficiency to law:

• Legislation: A legislative body is inefficient if it could produce more outputs (laws) at the same cost or the same amount at a lower cost. But we need quality too!
• Administration of justice: A court is inefficient if it could produce more outputs (decisions) at the same cost or the same amount at a lower cost. Still, we also need quality: decisions must be impartial, fair, etc. N.B. This doesn't mean that a court can’t be inefficient, but that the due process can’t be sacrificed for the sake of efficiency.
• Costs and benefits of substantive rules: A rule is inefficient if it achieves a goal at a cost greater than the cost of a possible alternative rule.

Pareto efficiency

Proposed by Vilfredo Pareto, it starts from the fallacy of utilitarianism (supported by Beccaria, Bentham, and J.S. Mill) that it's based on the idea that by measuring the utility of states of affairs, it is also possible to classify them in cardinal rankings. Problem: interpersonal comparisons of utility are impossible because we can’t assign a value of utility to people's preferences. However, people have preferences that can be listed in ordinal rankings.

The Pareto efficiency is based on the ordinal rankings of preferences: an allocation of resources is efficient if it makes someone better off and no one worse off, according to their preferences (Pareto superiority), or when it is impossible to make someone better off and no one worse off, according to their preferences (Pareto optimality, or Pareto efficiency).

Pareto superiority

A state of affairs is Pareto-superior to another state of affairs if and only if:

• No one is worse off
• At least someone is better off

Any changes consistent with Pareto superiority should be consensual (or at least no one should seek to block them). E.g., I like to eat pizza more than pasta, whereas you are indifferent to both of them: if we go eat pizza, the situation is Pareto superior; I am better off, and you aren’t worse off.

Pareto optimality

A state of affairs is Pareto-optimal if and only if no one is worse or better off. E.g., there is a situation (S0) that everybody wants to change but there is no agreement on how to do it: the Pareto-optimal solution is to change nothing. It can be counterintuitive. There is a bias for the status quo: the status quo will remain because it’s more efficient but there also will be no changes.

Application to the law

Extending a legal right to a larger group of people (e.g., voting rights)

• Between those who get it: they are better off
• Between those who already have it: no one is worse off

Problem: some of them may feel like they are worse off, but for a Pareto-superior situation, there is the need for unanimity (necessary condition). However, it is also important to evaluate:

• Self-regarding preferences
• Other-regarding preferences: what other people should prefer

Kaldor-Hicks efficiency

The problem with Pareto efficiency is that it doesn’t apply to situations in which someone is worse off. Kaldor-Hicks efficiency is used in situations in which there are both winners and losers. An allocation of resources is efficient compared to the precedent if those who benefit from it:

• Can compensate those who incur costs
• Can still have a net benefit

It is also called the Kaldor-Hicks test or test of potential compensation. It doesn’t require actual compensation: it is sufficient that the gainers gained more than what the losers lost. It is also used to assess changes in social welfare. There is both continuity with the Pareto efficiency theory and also an important difference: the K-H efficiency is based on numbers (cardinal utility).

E.g., A1 A2 Total

• S1: 50 50 = 100
• S2: 70 40 = 110
• Variation: +20 -10
• S3: 60 50 = 110
• Variation to S1: +10 0

In this case, A1 could compensate A2 and still have a benefit. The state of affairs would be both Pareto efficient and K-H efficient. The Kaldor-Hicks test is also called the test of potential Pareto superiority.

It is a form of cost-benefit analysis: a project is undertaken when its benefits exceed its costs, which implies that the gainers could compensate the losers. Problem: it’s easy for monetary values but not for theoretical problems, as not everything can be translated into quantitative values. It is also consistent with the goal of wealth maximization: aggregate wealth must increase by the difference between benefits and costs. If all changes were dictated by Kaldor-Hicks, aggregate wealth would be maximized.

Giulio Calabresi suggests that we should enforce K-H efficient choices if they also have a fair distributional consequence. For example, the difference between S2 and S3 is how the “pie” is divided. This is okay for economists; however, this difference is important for jurists because the S2 situation is unfair, even if there could be a compensation (not always acceptable).

Consensual vs. non-consensual exchange

In KH changes, changes are not consensual because there are losers. There is a trade-off, which is based on the hope that those who lose from one policy will benefit from others. Plus, everyone will gain as aggregate wealth is increased. If the overall size of the pie expands, the average slice increases.

Coase theorem

Based on the concept of externalities: it’s the consequence of a certain activity on a third party, which can be both positive or negative. The Coase theorem deals with the problem of negative externalities. Pigou’s approach was to tax those who generate negative externalities, which needs government intervention. Coase’s approach is that of analyzing the reciprocal nature of the problem and from that to emphasize the role of bargaining and transaction costs.

E.g., Bill is causing negative externalities, BUT the victims of those externalities also cause a problem to Bill (e.g., by residing near Bill’s fabric that is polluting the air). It’s a reciprocal problem. The Coase theorem is based on the evaluation of the social cost as the difference between the value of two economic activities when:

1. They do not interfere with one another
2. They do interfere with one another

Sturges v. Bridgman: there is no interference.

• S1: Actual world, in which the Doctor has to stop seeing some patients because of the noise.
• S3: Rule for the Doctor: the Doctor returns to working, and the Confectioner has to use one out of two mortars.
• S4: Compensation of the Doctor: the Confectioner offers compensation to the doctor.
• Doctor Confectioner Total Wealth Social Cost:
• S: 100 100 200 0
• So: 80 100 180 -20
• S1: 100 50 150 -50 (Not economically efficient because it has a higher social cost + lower total wealth)
• S3: 100 80 180 -20 (Economically better than S2: D is indifferent and C is better off by giving a compensation)

Regardless of what the law established, if economic agents are rational and transaction costs are zero or very low, they will bargain for the optimal allocation of resources. This does not mean that the law is completely irrelevant because transaction costs are never zero. Problems:

1. Economic agents are not always rational.
2. Transaction costs are not zero. When transaction costs are high enough to prevent bargaining, the efficient use of resources will depend on how liability is assigned (by the law).

This shows how, when bargaining costs are high, the law matters for efficiency. This brings the question of how to structure the law: inflexible rules or to leave discretion to the judges.

• Normative idea by Cooter & Ulen: allocate property rights to the party who values them the most (but we don’t know the values!).
• Normative idea 2: allocate property rights in a clear and simple way.

This will affect and reduce the possible cost of transactions because there won’t be conflicts. The advantage of rules is that they are predictable and individuals can plan for the consequences of their actions. Miceli suggests giving the judge guidelines and standards to decide disputes like this in order to be efficient (≠ Cooter & Ulen).

Tort law

Tort law has two functions:

1. Compensate the victims for their injuries.
2. Deter “unreasonably” risky behaviours.

Economic analysis is more interested in the latter (which operates “in the shadows of the former, since you can deter with the duty to compensate): the goal is of establishing the optimal deterrence.

Liability schemes

They are basic schemes of liability:

• No liability: the injurer bears none of the victim’s damages.
• Strict liability: imposes all damages on the injurer. It requires:
  • Compensable harm (aka, the Italian “danno ingiusto”)
  • Causation between behaviour of the defendant and harm
• Negligence: the injurer can avoid liability by meeting the due standard of care; the plaintiff is required to demonstrate:
  • Compensable harm (aka, the Italian “danno ingiusto”)
  • Causation between behaviour of the defendant and harm
  • Negligence of the defendant

Proceedings

In order to recover damages, a victim (plaintiff) must file a lawsuit against the injurer (defendant). The plaintiff has the burden of proving that the defendant is legally responsible and therefore must pay for compensation. The plaintiff has to establish:

1. They sustained some damages.
2. The defendant was the cause of those damages.

Causation

Proving causation requires establishing two things:

1. Defendant’s action was the cause-in-fact of the damages: but-for the defendant’s action, the plaintiff would not have sustained harm.
   • It can be difficult in some situations to establish causation:
     • More causes that simultaneously produce a harm that either would have caused acting separately
     • More injurers act to produce a harm that would not have occurred if each acted separately
     • Extremely remote case
2. Prove proximate cause, aka the connection between the injurer’s action and the harm can’t be too remote.
   • Based on foreseeability: it tests whether a reasonable person would have foreseen that his failure to meet the due standard would cause the victim’s injuries.

Res ipsa loquitur

The plaintiff may be unable to prove that the defendant’s negligence was the cause of the harm, even though the circumstance makes it exceedingly likely that it was. In these cases, the court may allow invoking the doctrine of res ipsa loquitur: the occurrence of an accident is necessarily evidence of negligence and also cause-in-fact. N.B. there can be problems in the determination of causation, especially in those cases in which the causal chain is bizarre and there isn’t foreseeability.

Hand Formula

It sees negligence as a non-compliance with the standard of care. Based on an economic understanding of the situation, it considers three variables:

1. Precaution costs (B as in burden): are the money invested for preventing a certain event from happening
2. Probability of event (P)
3. Gravity of resulting loss (L)

There is negligence if the expected loss (L*P) is greater than the costs of precaution. When B<PL, the optimal level of precaution is at B = PL. If B<<, the agent has been legally negligent. If B>>, the behaviour of the agent has been economically inefficient. Problem: you can evaluate B and L, but it is difficult to calculate P; the assignment of a value can be tricky and never certain in life events. Advantages: it helps establish if a party has been negligent and it is able to induce efficient behaviours in two ways:

1. Setting a threshold that allows the injurer to avoid liability; incentive for the injurer
2. Imposing actual liability on the victim; incentive for the victim

Negligence and liability

The connection between negligence and liability isn’t actually immediate:

• Simple negligence rule: if the injurer is negligent, they have to compensate the victim; straightforward connection between negligence and liability.
• Contributory negligence defence: if the victim too is negligent, they have no right to compensation; not a straightforward connection.
  • It’s a defence for injurers: if an injurer admits to being negligent, he can still avoid liability by proving that the victim failed to meet the due standard.
  • Problem: it can be unfair, since a victim is slightly negligent loses completely their right. Can be more costly (proceeding, testimony, evidence, etc.) but gives more incentive to take some care.