21 Economic Analysis of Law
1. INTRODUCTION
The study of law, its efficiency and efficacy, is not the exclusive province of lawyers , academicians and practitioners alone. It was explored by other disciplines as well and from different perspectives. Experts in the field of political science, sociology, psychology, theology and economics have analysed the merits and demerits, durability and desirability and tenacity and enforceability of legal principles being followed as well as proposed. Law, far from being a unidisciplinary study has transformed into an interdisciplinary study. One such interdisciplinary study is the Economic Analysis of Law.
2. ECONOMICS AND JURISPRUDENCE
Economics, in the most simple terms, is the science of wealth. Broadly, it deals with the production of wealth and promoting maximisation of wealth. Economics identifies the important factors of production as the source of wealth creation. It explains the necessity and hurdles faced in the society in the proper distribution of wealth on the parameters of utility, optimality and efficiency. Its ultimate end is promoting maximisation of satisfaction. The study of the dichotomy between the unending human wants and limited resources is the province of the discipline of economics. Its ultimate aim, as is the case of all disciplines , is the welfare of the society.
Jurisprudence, on the other hand, in the simplest language, is the science of law. In general, it deals with making of the law, mechanisms for its enforcement and maximisation of justice. Jurisprudence identifies the important sources of law, and examines their relative merits and demerits, the role played and being played by the different sources of law and compares with the reality in the contemporary society. It explores the processes for the enforcement of legal principles and the stumbling blocks on the parameters of cost, time and justice. Its ultimate objective is ensuring justice in the society , its realisation and maximisation. Jurisprudence is the study of conceptualisation, categorisation and correlation of the legal principles, both ‘is’ as well as ‘ought’ with the ultimate aim of conceiving a legal system that makes justice prevalent in the society. Its aim, ultimately, is the welfare of the society.
Law and Economics are thus interlinked with the end of both the disciplines being “welfare” of the mankind. It is not uncommon not to link the economic principles and theories to legal postulates and problems. This phenomena is prevalent not only among the non-lawyers but also among the lawyers. Many deal with legal questions with exclusivity without taking cognizance of the ideas from the other disciplines. Many lawyers are under the impression that economics is the study of inflation, unemployment etc and totally unconnected with the concerns of the legal system. Economists point out that , for example, if price of corn falls , it impacts not only the price of wheat; but it may also impact crime. The study of the interplay between the price theory in economics and crime as a legal problem is undertaken using the tools peculiar to the discipline of economics leading to the adventurous field of Economic Analysis of Law. “Economics” is used as a powerful tool for analysing variety of legal issues and preferences and gave rise to the interdisciplinary analytical method titled , “ Economic Analysis of Law”.
3. BASIS OF ECONOMIC ANALYSIS OF LAW
Economic Analysis of law is laid on the foundation that a human being is a rational maximizer of his ends or his satisfactions in life. The human being is driven by his self-interest. Self-interest is different from selfishness. Self interest normally denotes one’s own happiness ; whereas, selfishness embraces the misery of other people too. The expression self-interest is sometimes used to include both one’s own happiness and the other’s misery. In order to avoid this confusion, economists use the word utility instead of self-interest. Economic Analysis of Law is grounded on the philosophy of “utilitarianism”.
Utilitarianism was propounded by Jeremy Bentham. His general view on utilitarianism is aptly expressed in this classic passage :
“Nature has placed mankind under the governance of two sovereign masters, pain and pleasure. It is for them alone to point out what we ought to do, as well as to determine what we shall do. On the other hand the standard of right and wrong , on the other the chain of causes and effects, are fastened to their throne. The principle of utility recognises this subjection and assumes it for the foundation of that system, the object of which is to rear the fabric of felicity by the hands of reason and law. Systems which attempt to question it, deal in sounds instead of sense, in caprice instead of reason , in darkness instead of light”.1
Utilitarianism thus looks to the future. Its concern is maximisation of happiness or welfare or something that is good. Two forms of utilitarianism ; ‘act utilitarianism’ and ‘rule utilitarianism’ were advocated. “Act utilitarianism” takes the stand that the rightness or wrongness of an action is to be judged by the consequences, good or bad, of the action itself. “Rule utilitarianism” adopts the position that the rightness or wrongness of an action is to be judged by the consequences, good or bad of the rule itself; when the action is performed by everyone in like circumstances. Utilitarianism thus focuses on the consequences of either a rule or an action.
1 Jeremy Bentham, AN INTRODUCTION TO THE PRINCIPLES OF MORALS AND LEGISLATION, ed. J.H.Burns and H.L.A. Hart Ch 1 Para 1.( London, Athlone Press, 1970)
Prof. H.L.A. Hart criticised utilitarianism. 2 According to him, utilitarianism treats individual persons equally, but only by effectively treating them as having no worth, for their value is not as persons but as experiences of pleasure or happiness. Separate individuals are important to utilitarians only in so far as they are ‘ the channels where what is of value is to be found’. The analogy used by utilitarians, of a rational single individual prudently sacrificing present happiness for later satisfaction is not beyond questioning for it treats my pleasures as replaceable by the greater pleasure of others. He questions, why should we regard as valuable moral goal the mere increase in totals of pleasure or happiness abstraced from all questions of distribution of happiness, welfare etc. ?
Despite the severe criticism, it had its own influence. Many of the important law reforms of the 19th century are attributable to its influence as a political theory. It appears in the nether garments of the ‘economic analysis of law’. It is the modern form of utilitarianism. It has as its launching pad the proposition that the rational man or woman always chooses to do what will maximise his or her satisfactions. If they want something badly enough they will be prepared to pay for it. The parameters for analysis of law from an economic standpoint with maximisation of satisfaction as the end are utility, optimality and efficiency of either a rule or an act.
4. GENESIS AND GROWTH OF ECONOMIC ANALYSIS OF LAW
The economic analysis of law can be said to have begun with GUIDO CALABRESI’s first article on torts3 and RONALD COASE’s article on social costs4 in the 1960’s. Till 1960’s economists were occupied with studies relating to antitrust and monopolistic business practices. They studied the economic rationale behind such practices and their consequences and impact on the society. Their findings had considerable influence in determining the legal policy on those matters. Yet what they did was to explain the behaviour of participants in any economic market scenario, no different from the approach of the traditional economists. However, it proved to be a prosperous field of exploration.
2 H.L.A.Hart , ESSAYS IN JURISPRUDENCE AND PHILOSOPHY, PP 200-2. ( Oxford, Clarendon Press, 1982)
3 GUIDO CALABRESI, “ Some thoughts on Risk Distribution and the Law of Torts”, 70 Yale L.J 499(1961).
4 RONALD H. COASE , “The Problem of Social cost”, 3 J.Law & Econ. 1(1960).
The exploration commenced since 1960s. The economic analysis of law provided a new framework for analysing the assignment of property rights and liabilities in economic terms. It opened a vast field of legal doctrine to fruitful economic analysis. The common law principles of torts, contracts, restitution and property were subjected to this new approach to study the efficacy of law. The areas covered by legislation such as environmental law, intellectual property were also taken into its fold. Civil law, criminal law, constitutional law, any law for that matter, was explored and exposed through the lens of economic analysis. Theory of legislation and regulation , besides law enforcement and judicial administration , were subjected to the triple test of utility, optimality and efficiency leading to the message that many doctrines and institutions of any legal system are better understood as efforts to promote efficient allocation of resources. The credit of bringing a formal shape and structure to sporadic endeavours by a few economists under the rubric of economic analysis of law is given to RICHARD A. POSNER.5
Posner posits that much of the common law can be explained by the fact that judges frequently decide hard cases by choosing an outcome which will maximize the wealth of society. He attempted to demonstrate how common law judges have, mostly unconsciously, been guided by these economic considerations. The economic analysis of law thus found its place in the gamut of jurisprudence.
5 RICHARD A. POSNER, THE ECONOMIC ANALYSIS OF LAW, 2nd ed. ( Boston, Mass: Little, Brown & Co. 1977).
5. SALIENT FEATURES OF ECONOMIC ANALYSIS OF LAW
Economic analysis of law can be better understood and appreciated by considering its salient features. One significant feature is it possesses exploratory power. It explores the cost-effect impact. For example, an accused is being prosecuted for theft of an article worth Rs. 50,000/-. What is the cost of the trial, what is the expense of keeping the accused in jail. If the cost and expense of prosecution and implementation of sentence is more than the value of the article stolen, is it worth pursuing the prosecution ? is a pertinent question. Such approach is never undertaken in studies on punishment of criminals. Such an approach is what is propagated by the economic analysis of law.
Efficiency as value outcome is an important feature of the economic analysis of law. It may better be explained by taking an environment pollution example. Suppose a factory emits smoke which causes damage to clothes hung outdoors by residents in five houses near to the factory. In the absence of any corrective measure, each resident would suffer Rs. 750/-in damages ; a total of Rs. 3750/-. The damage due to smoke may be prevented, let us assume, in one of the two ways : either a smoke-screen could be installed on the factory chimney at a cost of Rs. 1500/- , or each resident could be provided with an electric drier at a cost of Rs. 500/- per resident. The efficient solution is obviously to install the smoke-screen since it eliminates total damage of Rs. 3750/- by spending only Rs.1500/- , and it is cheaper than purchasing five electric driers for Rs. 2500/-. This is pure and simple economics.
Such simplicity is not possible in the realm of law. It is to be ascertained in the light of the legal principle involved. Let us assume that the right to clear air is conferred upon the residents. Then the factory has three choices : pollute and pay Rs. 3750/- in damages, install a smoke-screen for Rs. 1500/- or buy five electric driers for the residents at a total cost of Rs. 2500/-. The factory would, naturally install the smoke-screen, the efficient solution. On the other hand, if there is a right to pollute, the residents have three choices : suffer their collective damages of Rs.3750/- , buy five electric driers for Rs. 2500/- or buy a smoke-screen for the factory for Rs. 1500/-. They, too, would choose to buy the smoke-screen. The efficient outcome would therefore be achieved regardless of the assignment of the legal right.
In the economic analysis of law thus, there is much to stimulate the lawyers and judges besides the legislators into thinking about just solutions, at least where it is possible to place an economic value on costs and benefits. It has therefore been applied, with success upto some extent at least, to the problem of measuring the efficiency of systems of accident compensation and theory and practice of law enforcement.
The economic analysis of law is a useful tool for the policy maker and legislator as it enables him to assess whether the means for achieving legislative goals are efficient or inefficient. At the macro level ; it enables state to decide whether special tribunals are to be established for dealing with specific disputes in preference to the ordinary courts by making an economic analysis of cost so as to find out which is efficient. At micro level it points out to an individual the economic implications of pursuing litigation vis-a-vis selection of other modes of settlement. Moreover, empirical support can be provided by this approach to any proposed measure. It emerged as a useful analytical tool in policy formulation, formalisation and forecasting.
The economic analysis of law positively helps in explaining the implications of legal rules as they are rather than to change them. It also performs a normative function in that it can be used for establishing that it would be inefficient to apply a legal principle. It can be efficiently and successfully used for suggesting value preference in case of value conflict. For example, in case of value conflict between morality and materiality involved in the value preference of the proposal to legalise prostitution or permitting human organ sale , the economic analysis of law provides the necessary empirical data and support for value preference and consequent policy formulation etc.
From the economic analysis of law point of view, “the common law method is to allocate responsibilities between people engaged in interacting activities in such a way as to maximise the joint value ,or , what amounts to the same thing , minimize the joint cost of activities. It is effected either by redefining a property right or by devising a new rule of liability or by recognising a contractual right,” according to Richard A. Posner.6 In view of its all encompassing nature , its application to specific fields of law augments its overall amplitude.
6. ECONOMIC ANALYSIS OF TORT
Economic analysis is widely applied to torts, especially to cases of negligence. If accident happens due to negligence and someone is injured, compensation has to be paid. Compensation paid vis-a-vis the cost of prevention is analysed. If cost of prevention is more than the compensation payable, the wrongdoer will prefer to pay the compensation. On the other hand if the cost of prevention is lesser than the compensation to be paid in the event of an accident, the wrongdoer would adopt the preventive measures. Suppose the person taking precautions to prevent accidents and the person who may be injured if they are not taken are the same, the optimal precautions will be taken without legal intervention.
On the same lines is the liability of the manufacturer of goods for personal injury caused to the consumer, popularly known as products liability. If the cost of making the product more safer is less than the products liability that in all probabilities is likely to be incurred by the manufacturer ; the manufacturer suo moto would not make the product more safer unless there is a legal provision mandating it. Many other torts can be analysed similarly and law of torts is a rich arena for economic analysis.
6 Ibid at P 179.
7. ECONOMIC ANALYSIS OF CONTRACT
Contract necessarily involves economic activity and economic analysis of contract is a natural concomitant. Contract law aims at deterring parties from being opportunistic. It is but natural for a party to calculate the cost of performance vis-a-vis the cost of breach of contract and the consequential liability to pay damages to the other party to the contract. Cost of performance being lesser than the damages is the incentive for performance. If more, breach is preferred, generally, to performance.
The inclusion of escalation clause in a contract is the result of economic orientations in thinking by contracting parties. As the possibility of the rates prevailing on the day of entering into agreement being not the same and likely to increase on the day of performance, the interest of a party is protected by the escalation clause. Contract being self regulatory within the province of contract law, which only lays down the over-riding principles, the parties in the process of bargain naturally are lead by the factum of which is better for him. A rich field for economic analysis of law is Contract Rights and Remedies.
8. ECONOMIC ANALYSIS OF CRIME
State determines what conduct constitutes a crime and lays down the punishment for their commission. It may be imprisonment for a term or payment of fine by the accused to the state or both. It is generally believed that a person commits a crime because the expected benefits exceed the costs of commission. The benefit may be a pecuniary gain or even psychological satisfaction sometimes. The costs include the expenses for procuring the material objects for crime commission and expected costs of possible punishment. A person accused of a crime is prosecuted by the state.
The cost of prosecution and trial ; the cost of keeping the accused in jail until the end of trial and the cost of keeping the convicted in jail after conviction vis-a-vis the cost of dropping the trial and its impact on the values and implications on society measured in monetary value to the extent possible is the subject of economic analysis. On the same lines the impact of severe punishment by law on crime reduction or prevention is analysed with the economic approach.
Futher, plea-bargaining is a fertile area for economic analysis. The cost of litigation , the length of time taken , the work load on judges and the cost of holding the accused in jail till the completion of the trial is weighed against the advantages of permitting plea-bargaining.
Basing on such data, policy of plea bargaining is formulated and structured. The economics of criminal law has been analysed not only by the criminologists but also equally by the economists in this materialistic world.
9. ECONOMIC ANALYSIS OF LITIGATION
Crucial decisions relating to litigation are taken at individual level by a litigant. Before proceeding with litigation, even before deciding to go ahead with litigation, the individual litigant takes into account the cost of litigation versus the cost of non-litigation. If the expected outcome of litigation falls below the cost of litigation, a prudent litigant would rather prefer to forego his right than to pursue the same in a court of law.
A litigant may weigh in balance the adjudicatory outcome versus negotiated outcome. If the negotiatory outcome is more lucrative than the adjudicatory outcome, the decision , of course, would be to opt for negotiation. The cost of pursuit of litigation , the time expected to take and the likely result of the pursuit of litigation are the factors considered for reaching a conclusion on the question is it worthwhile to pursue any dispute in a court of law.
10. EXPANSION OF ITS APPLICATION
The device, economic analysis of law, is based on the utilisation philosophy : “ Law that ensures greatest good to greatest number of people commands respect.” Making this philosophy as its corner stone, the analysts made a foray into the very theory of legislation. The science of economics was applied with enthusiasm to analyse whether the legal system is providing cheap, hassle free, participative mechanism and to find out the efficacy and optimality of judicial administration.
The entire process is based on the fact that the legal status of a matter may be different according to the point of view of the legal system from which it is considered. But such differences will generally not have any relevant economic consequences. Any legal guarantee is directly at the service of economic interests to a very large extent and economic interests are among the strongest factors influencing the creation of law and under certain conditions a legal order can remain unchanged while economic relations are undergoing a radical transformation. Changes in one social activity in the society can not happen without changes in another social activity. Change in economic outlook necessarily brings about a change in the legal outlook. The latter cannot be understood without appreciating the former and relative connection. It is that connection that is explored by the economists through the process—economic analysis of law. Such process cannot be expected to obtain universal acceptance and is not above criticism.
11. CRITICISMOF ECONOMIC ANALYSIS OF LAW.
Antagonists to economic analysis of law are many and the weaknesses pointed out are varied.
The following are the most pronounced :
A) Ignores ‘Justice’
B) Manifests a conservative political bias
C) Repulsive of fundamental social norms
D) Logic of law is not Economics.
E) Wealth is not a ‘value’.
11.1 . IGNORES JUSTICE
Economic Analysis of Law ignores the primary objective of law, ‘justice’ is the first criticism levelled. Justice as a value cannot be diluted to economic efficiency. It is much more than that. The protagonists of this criticism argue that it is not inefficient to allow private discrimination on racial, religious or sexual grounds; yet it offends the sense of justice. They further point out that efficiency, the crux of economic analysis of law, becomes a means of rationalising and sustaining economic inequality. The antagonists of this criticism argue that one must keep in mind the different meanings of the word justice and that it includes distributive justice ensuring economic equality to some extent and thereby increasing efficiency , the other facet of justice.
11.2. MANIFESTS A CONSERVATIVE POLITICAL BIAS
Efficiency, the hallmark of economic analysis of law, manifests a conservative political bias as it promotes policies that are geared for free-market economy and a ‘laissez-faire state’ in preference to ‘welfare state’. Ideological bias is the crux of this criticism. As a matter of fact many promoters of this approach to analyse law are ideologically neutral. Therefore, the criticism is not properly founded is the opinion in some quarters.
11.3. REPULSIVE OF FUNDAMENTAL SOCIAL NORMS
The normative nature of the economic analysis of law is repulsive of fundamental social norms that it is impossible to conceive a legal system that adopts it, say the critics of this approach. Law ought to reflect and enforce fundamental social norms that are in consonance with ‘values’ and not those not in tune with such norms. The supporters plead that efficiency is certainly a fundamental social norm in a market oriented system and there is nothing in it that is unethical. When courts are unable to promote social goals effectively, efficiency ought to influence law and administration of justice.
11.4 LOGIC OF LAW IS NOT ECONOMICS.
‘The life of law is not logic but experience’ was a time tested classic declaration. The economic analysis of law replaces experience with economics. It is excessively interventionist in the process of law enforcement. In the modern materialistic world the greatest experience is ‘efficiency and maximisation’ , the twin focal points of economic analysis of law. It does not replace experience but only strengthens experience is the reply. The opponents of economic analysis of law argue that why efficiency and why not effectiveness ? Society and law ought to aim for effectiveness vis-a-vis efficiency. Efficiency as a goal would follow effectiveness and not precede it , they comment.
11.5. WEALTH IS NOT A ‘VALUE’
Increasing social wealth does not in itself make the society better. Wealth is not a value to be cherished in a society riddled with inequalities in many areas of social life. A legal system that does not promote proper values in the society and reflect them in law would crumble in no time, say the non-supporters. Without social wealth, society can never become better was the reply given by the promoters. Society becomes better when all institutions in the society, including law, contribute for improved standard of living of people in any given society. Better standard of living is possible only when social wealth is increased and better distributed; which is the essence of the economic approach to analyse law. Therefore, this criticism does not hold water , the proponents argue.
12. CONTRIBUTION TO JURISPRUDENCE
Claims are counter-claims relating to any concept, its efficiency and efficacy, are common. Subjecting the concept to refinement in the light of them is the way forward from jurisprudence point of view. Such openness contributes for strengthening the legal order in a social polity. The economic analysis of law opens up one’s mind to treat the subject of making and administering law as heterogeneous and not homogenous. It impresses that law should embrace the concepts of other disciplines and shape itself, as all are part of the society. Instead of having a narrow approach, a broad based approach is advocated by the economic analysis of law.
Jurisprudence, knowledge of law, is not a unifocal , but a multifocal science. Its paradigms are changing, ever expanding , with the new thinking. Traditionally ‘justice’ is the paradigm of law. Efficiency, optimality and utility are the new paradigms for law or ought to be its values postulates the economic analysis of law approach.
It places before a student of jurisprudence that, “ legal education primarily consists of teaching students to dig beneath the rhetorical surface to find the true grounds of legal decisions , many of which turn out to have an economic character.” Exploration of such economic character as an essential component of decisions of law making and law administration is the contribution of economic analysis of law to the ever expanding contours of jurisprudence.
LEARN MORE:
1) Richard A. Posner, Economic Analysis of Law (Aspen Casebooks, 8th)
2) Richard A. Posner, Values and Consequences: As an Introduction to Economic Analysis of Law (Coase-Sandor Institute for Law & Economics Working Paper No. 53, 1998).
3) Steven Shavell, Foundations of Economic Analysis of Law (Harvard University Press, March 2004)