Web Notes – Sixth Edition Cooter & Ulen
Web Notes
Sixth Edition
The following are the web notes for the sixth edition of Law and Economics by Robert D. Cooter and Thomas S. Ulen. Our intent in these notes is to extend the material in the text by describing some additional issues, articles, cases, and books. Because the fields of law, economics, and law and economics are not standing still – because, that is, scholars are adding interesting new material all the time, we may supplement, alter, and add to these notes from time to time.
Each note begins with a copy of the material from the text about the content of the web note and the page on which that web note can be found. We will from time to time insert new material, update some of the entries, and add some additional material. You should be able to download pdf versions of each chapter’s web notes and of the entire set of web notes for all 13 chapters.
We have found that the very best students and their instructors from all over the world pay close attention to these web notes. They often have good ideas about how to add to the entries already here and suggestions about articles, cases, books, and topics that would be instructive to add. We would be grateful for any comments or suggestions about any of the notes.
Chapter 1
Web Note 1.1 (p. 9)
Besides efficiency, what other policy values should matter to making law and applying it? In Fairness Versus Welfare (2002), Louis Kaplow and Steven Shavell of the Harvard Law School say “None.” Others disagree. See Chris Sanchirico, Deconstructing the New Efficiency Rationale, 86 Cornell L. Rev. 1005 (2001), and Daniel Farber, What (If Anything) Can Economics Say About Equity?, 101 Mich. L. Rev. 1791 (2003).
When law and economics first appeared in the late 1970s and early 1980s, there was a great deal of resistance from the legal academy to the notion that efficiency could contribute to an understanding of the law or could provide a normative standard to which law should aspire. In part (but only in part), this resistance arose from some overselling on the part of proponents of law and economics and misunderstanding on the part of traditional, doctrinal legal scholars. The heart of the contention had to do with whether efficiency and justice (or equity or fairness) were substitutes or complements, to use economic jargon.
Scholars devoted a great deal of energy to exploring the appropriate relationship between efficiency and justice in the early 1980s. It is probably fair to describe the result of all this exploration to be a standoff or agreement to disagree. No general consensus on the appropriate relationship seemed to have been reached. Instead, the issue simply receded in importance.
Then, in a series of papers and subsequently, a book entitled Fairness and Welfare (2002), Louis Kaplow and Steven Shavell of the Harvard Law School revived the issue by aggressively and forcefully arguing that efficiency (or welfare, as they call it) is a far more coherent concept than welfare and that, in fact, fairness considerations reduce to efficiency considerations. We think that this is an important enough topic that we ought to give you a sense of the debate.
So, this note first summarizes the central argument in Kaplow and Shavell’s book and summarize a discussion from an earlier article in the Journal of Legal Studies regarding the appropriate division of authority between the tax-and-transfer system and adjudication for achieving distributive social goals. (We made favorable use of this argument in the text of Chapter 1.) We then briefly summarize an important criticism of the Kaplow-Shavell argument by Professor Chris Sanchirico of the Wharton School and School of Law at the University of Pennsylvania. We conclude with a summary of two articles: a very favorable review of Fairness Versus Welfare by Professor Richard Craswell of Stanford and a somewhat critical review by Professor Daniel Farber of the University of California, Berkeley, School of Law (Boalt Hall).
A Summary of Louis Kaplow & Steven Shavell, Fairness Versus Welfare (2002).
The central claim of Kaplow and Shavell is that “the welfare-based normative approach should be exclusively employed in evaluating legal rules. That is, legal rules should be selected entirely with respect to their effects on the well-being of individuals in society.” They also argue that welfare economics evaluation reflects concerns about the distribution of income. Under their approach, notions of fairness such as corrective justice or retributive justice should receive no independent weight in the assessment of legal rules. Kaplow and Shavell argue that “these notions of fairness depend directly on characteristics of individuals’ acts (for example, whether injurers behave wrongfully) rather than on the effects of rules on individuals’ well-being (such as the extent to which penalizing injurers reduces the rate of injuries).”
Under welfare economics, policies are assessed exclusively in terms of their effects on the well-being of individuals. Accordingly, whatever is relevant to individuals’ well-being is relevant under welfare economics, and vice versa. The welfare economics conception of individuals’ well-being is all-encompassing. It recognizes not only individuals’ levels of material comfort, but also their degree of aesthetic fulfillment, their feelings for others, and anything else that they might value, however intangible.
In contrast to the common understanding of normative economic analysis under which legal rules are assessed by reference to wealth maximization or efficiency and which omits important aspects of individuals’ well-being, as well as distributive concerns, the welfare economics approach is similar to adopting the moral position that the design of the legal system should depend solely on concerns for human welfare.
The claim that the assessment of legal policy should rely only on welfare economics relies on two arguments. The first argument suggests that pursuing notions of fairness comes at the expense of individuals’ welfare. Whenever a notion of fairness led an analyst to choose a legal rule different from the one favored under welfare economics, every individuals’ well-being was reduced. Under the second argument, there are no rationales for notions of fairness that justify advancing them at the expense of the individuals’ welfare. Furthermore, in many instances, individuals who would seem to be the intended beneficiaries of a notion of fairness, such as the victims of accidents or of breaches of contracts, were worse off under rules that were supposed to be fair to them.
If the criticism of the notion of fairness has the force that is claimed, why does fairness possess so much appeal? The reason might be related to the fact that most notions of fairness seem to correspond to social norms that are principles that well-socialized members of society use to guide their behavior in everyday life and that because social norms have a powerful influence on our minds, it is not surprising that related ideas of fairness seem important. Nevertheless, notions of fairness should not be elevated to the status of independent evaluative principles when assessing legal policy. One of the reasons for this conclusion is that the formal legal system differs in a number of important ways from the operation of social norms in everyday life, and as a result, there is reason to expect that the best rule for everyday life may not be the optimal rule for the legal system. When decisions are based on the notion of fairness, they depend on instincts and intuitions. These instincts and intuitions have no place in the design of the research agenda of legal academics and other policy analysts who are engaged in the long-term enterprise of analyzing and empirically investigating the legal system in order to identify which legal rules are socially best.
Under welfare economics, the evaluation of a legal policy depends on how it influences individuals’ welfare and nothing else. It is easy to evaluate a policy when we deal with a case in which all the individuals are made better off or all are made worse off, but it is much more difficult when some individuals gain and some lose under a policy. In the latter case, the policy affects the distribution of income and well-being and therefore a distributive judgment must be the tool that should be used.
You should also read the chapters on “Welfare, Morality, and the Law” in Shavell’s Foundations of Economic Analysis of Law (2004). Professor Shavell there summarizes the argument on welfare (as defined by economists) as the only defensible measure of well-being.
Louis Kaplow & Steven Shavell, “Why the Legal System Is Less Efficient Than the Income Tax in Redistributing Income,” 23 J. Legal Stud. 667 (1994).
The argument in Fairness Versus Welfare extends a famous argument that Kaplow and Shavell made earlier in an article in the Journal of Legal Studies. In the text, we paraphrased the central argument of that article (namely, that common law or private adjudication should strive for efficiency, while matters of distributive equity should be handled by the tax-and-transfer system). Here is a brief summary of that article.
Under the formal model—which the authors call-the “new efficiency rationale”—only the income tax system should be employed to achieve distributional goals. The common law adjudication system should be used only for efficiency ends and not to seek to achieve distributional goals. In order to make their point, Kaplow and Shavell make a “tax-substitution” argument. The gist of this argument is that, for every redistributional legal rule (including those conditioned on parties’ incomes), we can find an alternative tax surcharge that accomplishes precisely the same redistribution but also raises tax revenue. This tax revenue can then be distributed to the population or used for public goods. The conclusion reached under this argument is that any redistribution accomplished by adjusting legal rules away from efficient standards can be more efficiently accomplished by leaving the efficient legal rule as it is and accomplishing the equitable goal with taxes.
Chris Sanchirico, “Deconstructing the New Efficiency Rationale,” 86 Cornell L. Rev. 1005 (2001).
Professor Chris Sanchirico of the Wharton School and the Law School at the University of Pennsylvania has produced some extremely interesting criticisms of the Kaplow-Shavell argument. Here is a summary of his article from the Cornell Law Review.
In the matter of evaluating legal rules, for as long as law and economics has played a formative role in legal scholarship, its principal mode of analysis has been to evaluate legal rules according to the sole criterion of “efficiency.” This has meant that we should evaluate rules by the sum of the costs and benefits that they impose on individuals without regard to how those costs and benefits are distributed among different individuals.
However, recently there was an emergence and rapid acceptance of a new justification for efficiency, a “new efficiency rationale.” The new rationale is shunting distributional concerns across disciplinary boundaries from private law to tax. Furthermore, while proponents of the new rational conditionally concede the importance of equity (which is, in this context, the equality of economic well-being) as a political-philosophical value, they insist that the legal sphere is not the proper place to pursue distributional objectives. These proponents argue that the efforts to decrease economic inequality should be corralled into the tax code, while legal rules should be left in a pristinely efficient state, unsullied by distributive justice.
The “double-distortion argument” is the backbone of the new rationale. This argument rests on the idea that conditioning the application of legal rules on parties’ incomes will affect their decisions in the labor market in much the same way as directly taxing their earnings. Increasing an individual’s expected damages bill when she earns more affects her incentive to earn in the same way as does increasing her tax bill. Thus, effecting redistribution by conditioning legal rules on income distorts not only the behavior that the legal rule is meant to regulate, but also labor-leisure choices. However, redistributing income by taxing the income directly will create only a single distortion to labor market decisions. Therefore, only the income tax should be employed in pursuit of redistributional goals and it is thus appropriate for the economic analysis of legal rules to focus on efficiency. However, the conclusion under which legal rules should always be set solely on the basis of efficiency is not correct.
Professor Sanchirico opposes the new rationale and holds that the legal rule has a redistributional impact whenever it affects different individuals differently and that this redistributional impact should figure centrally in our evaluation of legal rules. Income, wealth, consumption, contractual activity, property owned, harm caused, harm suffered, and the like, are all “imperfect signals” of the underlying immutable characteristics of individuals upon which the state would ideally base its redistributive policy if only it had such information. While the double-distortion argument suggests that legal rules should never be informed by redistributive objectives, the “imperfect-signals” framework implies the more-than-opposite proposition that legal rules should always be redistributionally informed.
Another claim in favor of the proposition that legal rules should always be redistributionally informed is that if we currently conduct no redistribution through the legal system, the legal system is initially available as a perfect means of transfer. If, in addition, we already have a substantial redistributional income tax in place, that tool’s redistributional efficacy is under strain, and every dollar transferred by that means exacts potentially significant efficiency costs. Consequently, it will always improve social welfare to enlist the legal system as a redistributional tool to relieve the income tax of some of its redistributional burden.