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

❖ It’s the study of law from an economic point of view, aka how the law functions from the point of

view of economists

➢ Law is conceived as a system of incentives to 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 (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 consequence, but follow the

law for sense of rightness)

SANCTIONS

Can be:

❖ 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 approach to the economic analysis of law: positive and negative

POSITIVE ECONOMIC ANALYSIS

❖ It responds to the question “how the law is” → no consideration of purpose or on 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 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 has 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 obtains one at least of the following conditions:

1. No same quantity at lower cost: it is impossible to produce the same amount of

output using a lower-cost combination of inputs

No more quantity at the same cost: it is impossible to produce more output using

2. the same combination of inputs

❖ There are different possible (and disputable) applications of the 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 the quality: decisions must be impartial, fair, etc.

N.B. this doesn't mean that 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

which is 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 is 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 in 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, 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 (S ) that everybody wants to change but there is no agreement on how to do it: the

0

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 of the Pareto efficiency is that it doesn’t apply to situation 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 but also an important difference: the K-H

efficiency is based on numbers (→ cardinal utility)

E.g. A A Total

1 2

S 50 50 100

1

S 70 40 110

2

Variation +20 -10

S 60 50

3

Variation to S +10 0

1

● In this case, A could compensate A and still have a benefit → the state of affairs would be both

1 2

Pareto efficient and K-H efficient → the Kaldor-Hicks test is also called test of potential Pareto

superiority

❖ It is a form of cost-benefit analysis: a project is undertaken when its benefits exceeds its costs, which

implies that the gainers could compensate the losers

➢ Problem: it’s easy for monetary values but not for theoretical problems: not everything can

be translated in quantitative values

❖ It is also consistent with the goal of wealth maximisation → aggregate wealth must increase by the

difference between benefits and costs: if all changes were dictated by Kaldor-Hicks, aggregate wealth

would be maximised

❖ Giulio Calabresi: we should enforce K-H efficient choices if they also have a fair distributional

consequence

E.g. S S S

1 2 3

A 50 150 (+100) 100 (+50)

1

A 50 0 (-50) 50 (-0)

2

Total 100 150 150

Kaldor-Hicks Efficient Pareto Efficient + K-H

Efficient

● The difference between S and S is how the “pie” is divided and this is ok for economists; however,

2 3

this difference is important for jurists because the S situation is unfair, even if there could be a

2

compensation (not always acceptable)

CONSENSUAL VS. NONCONSENSUAL 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; it 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 → needs government

intervention

➢ Coase’s approach is that of analysing the reciprocal nature of the problem and from that to

emphasize the role of bargaining and transaction costs

E.g. Bill is causing a negative externalities BUT the victims of that 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

❖ Coase theoremis based on the evaluation of the social cost as the difference between the value of

two economic activities when:

a. They do not interfere with one another

b. When they do interfere with one another

STURGES V. BRIDGMAN

S : there is no interference

o

S : actual world, in which the Doctor has to stop seeing some patients because of the noise

1

S : rule for the Doctor → the Doctor return to working and the Confectioner has to use one out of two mortars

3

S : compensation of the Doctor → the Confectioners offers a compensation to the doctor

4 Doctor Confectioner Total Wealth Social Cost

S 100 100 200 0

o

S 80 100 180 -20

1

S 100 50 150 -50 Not economically efficient because has higher

2 social cost + lower total wealth

S 100 80 180 -20 Economically better than S : D is indifferent and C is

3 2

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. Transactions costs are not zero → when transactions cost are high enough to prevent bargaining, the

efficient use of resources will depend on how liability is assigned (by the law)

➢ This show how, when bargaining costs are high, the law matters for efficiency → this brings

the question on 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

● It 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 individual can plan

for the consequence of their actions

❖ Miceli: give the judge guidelines and standards to decide disputes like this in order to be efficient (≠

Cooter & Ulen)

TORT LAW

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 if the victim’s damages

❖ Strict liability: imposes all damages on the injurer. It requires:

i. Compensable harm (aka, the Italian “danno ingiusto”)

ii. Causation between behaviour of the defendant and harm

❖ Negligence: the injurer can avoid liability by meeting the due standar of care; the plaintiff is required

to demonstrate:

i. Compensable harm (aka, the Italian “danno ingiusto”)

ii. Causation between behaviour of the defendant and harm

iii. 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 that damages

CAUSATION

❖ Proving causation requires to establish two things:

1. Defendant’s action was 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 situation to establish causation:

1. More causes that simultaneously produce a harm that either would have

caused acting separately

2. More injurers act to produce a harm that would not have occurred if each

acted separately

3. 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 make it exceedingly likely that it was

➢ In this cases, the court may allow to invoke 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 problem in the determination of causation, especially in those cases in which the causal

chain is bizarre and there isn’t foreseeability

ADMINISTRATIVE COSTS

STRICT LIABILITY CASES NEGLIGENCE CASES

Cost per case Cost per case: higher

Plaintiffs only need to prove causation, not fault Plaintiffs are required to prove causation and fault

Less costly More costrly

Number of lawsuit Number of lawsuit

Victim will file lawsuit only if: The injurer has a powerful incentive to meet the due

standards, so victims will ofter be deterred from

1. She can prove the causation filing suit under negligence

2. Her losses exceed the cost of bringing suit Fewer lawsuit

More lawsuit

Less costly but more lawsuit More costly but less lawsuit

HAND FORMULA

❖ It sees negligence as a non-compliance with the standard of care

❖ Based on an economic understanding of the situation

❖ Based on three variables:

i. Precaution costs (B as in burden): are the money invested for preventing a certain event from

happening

ii. Probability of event (P)

iii. 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 establishing if a party has been negligent + it is able to induce efficient

behaviours in two ways:

a. Setting a threshold that hallows the injurer to avoid liability → incentive for the injurer

b. 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 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 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

NEGLIGENCE UNDER CONTRIBUTORY NEGLIGENCE STRICT LIABILITY UNDER CONTRIBUTORY

NEGLIGENCE

Due standard for both the injurer and the victim

● If victim reach the due standard, the injurer Only