Methodology in LAW & ECONOMICS

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Methodology inLAW ECONOMICS

• Antonio Nicita
• UNIVERSITY OF SIENA
• Faculty of Economics R.M. Goodwin

ESNIE 2004
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Plural, please!

• Law Economics is not only Chicago LE
• Several schools of thought, several recent
  developments which link the study of law, of
  economic institutions and of organizations
• Some common features
• a) economic analysis of emergence, evolution
  and change in private and public orderings, norms
  and customs
• b) study of the effects of law on the economy
  and study of the effects of the economy on legal
  change
• c) application of economic methodology on the
  analysis of law
• d) acknowledgment of complexity and
  interdependence between legal rules, social
  norms and economic institutions

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Alchian Becker Buchanan Calabresi Coase Coleman Co
mmons Demsetz Director Dworkin Ely Llewellyn North
Posner Rose-Ackerman Simon Stigler Sunstein Tullo
ck Veblen Williamson

• Methodology and Content
• Chicago Law and Economics
• New Haven School
• New Institutional Economics
• Institutional Economics
• Public Choice Theorists
• Critical Legal Studies
• Post-Chicago Law and Economics
• Behavioral Law and Economics
• (Pragmatism)

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Aims Approaches(Sunstein et al. 1998)

• Positive Law and Economics
• How agents behave in response to legal rules
  and how rules are shaped?
• Prescriptive Law and Economics
• What rules should be adopted to advance
  specific ends?
• Normative Law and Economics
• How to select specific ends of the legal
  system?

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Chicago Mainstream/1

• Pre-conditions (Ruthenford, 2003)
• Methodological individualism and Mainstream
  Economics
• The impulse of Antitrust law and economics
• Critical analysis of Sherman Act, the efficiency
  of vertical restraints, pro-competitive intra
  brand restrictions, efficiency of leveraging,
  tie-in, bundling
• The efficiency of Common Law
• Common Law, as a Judge-made Law, is best
  understood not merely as a pricing mechanism but
  as pricing system designed to bring about an
  efficient allocation of resources in the
  Kaldor-Hicks sense (Posner, 1987)
• Development of the Common Law could be
  explained as if its goal was to maximize
  allocative efficiency (MercuroMedema, 1997)

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Chicago Mainstream/2

• What a wonderful world!
• Individuals are informed rational maximizers and
  their behavior is easy to formalize and predict
• Individual (always) respond to price incentives
• Microeconomics works (always) well
• Legal rules are (and should be) efficient (ex.
  efficient breach and remedies design in
  contracts)
• Wealth maximization has guided (and should guide)
  law, statutes and State intervention

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Chicago Mainstream/3

• Efficiency, values and consequences
• Externalities are reciprocal in nature (Coase,
  1960)
• Legal rules (law and private arrangements) may
  perform better than State intervention
• Absent transaction costs economic resources will
  be pushed in the ends of those agents who value
  them the most
• With positive transaction costs inertia (Posner,
  Coase), State intervention (Coase)

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Coase vs Posner

• COASE Im certainly not an expert in law and
  economics
• POSNER(...) NIE, save in Coases version, is
  just economics () and the LE movement is
  economics too
• COASE After having read Posners paper I felt I
  could not remain silent () on Posners highly
  inaccurate account on my views
• COASE The trouble with Posner () is not with
  what he doesnt know but with what he knows that
  aint so
• Comparing wealth maximization and Coase theorem

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The peculiarity of Coase

• Reciprocal externalities imply incomplete
  definition of property rights and rivalry in uses
• Pareto-relevant externalities could not always be
  absorbed by market mechanism economic exchange
  is not automatic
• Compared analysis of institutional performance
  based on transaction costs
• No preference towards one form of governance or
  another
• Rights definition and market as a public good
• Market as Equilibrium
• Case Study (pragmatism) methodology against
  formalism

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Property vs Liability rules

• Calabresi (1961, 1970, 1972)
• 2 ways of protecting entitlements against
  externalities injuction (property rule) and
  compensatory damages (liability rule), the choice
  depends on transaction costs
• liability rules may reduce the ex-ante and
  ex-post costs of accidents
• Specific remedies require empirical assessment
  of economic consequences (economics and fairness)
• New Haven School emphasis on the study of all
  aspects of government policy (the role of
  statutes vs common law)

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Public Choice and the role of the State

• Economic analysis is extended to nonmarket
  decisionmaking (theory of the State, voting
  rules, bureaucratic choice, regulation,
  corruption, etc.)
• Chicago assumption on homo economicus
• The motivation for political exchange is mutual
  advantage
• Rent seeking behavior may reduce the efficiency
  of public coordination

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New Institutionalism and TCE

• New with respect to...
• Unit of analysis is Transaction
• The paradigmatic problem is to minimize
  transaction costs
• Transaction (bounded rationality, incomplete
  contracts, opportunism, asset specificity)
• Emphasis on private orderings (organizations as
  tribunals, authority and hierarchy)
• Efficiency of vertical restraints and mergers
• Compared second best efficiency of alternative
  institutions in performing transaction costs

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Posner vs Williamson

• POSNER (...) in the process of moderating
  Coase, Williamson has gone toward collapsing the
  NIE back into mainstream economics which is
  fine with me
• POSNER the LE movement differs from the new
  institutional economics in that it has no, or at
  least very few, aspiration to change economic
  theory or economists empirical methodology
• WILLIAMSON() Posner has not understood the
  Coasian message (or does not like what he hears)
  misconstrues game theory has a truncated
  understanding of bounded rationality, the
  economics of information, and maximising
  mischaracterizes empirical research in
  transaction costs economics
• How to consider the distance among Posner, Coase
  and Williamson?

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Common features

• Maximizing (even bounded rational) agents
• Static environment (no ex-post competition
  skills and knowledge are given)
• Equilibrium (and competitive) markets
• Efficiency of market allocation (with negligible
  transaction costs)
• A paradox non market institutions emerge as
  response to market transaction costs but market
  is employed to allocate control (property rights)
• Zero transaction costs for the set up of existing
  legal system
• Efficiency defense of vertical restraints
• Conservative attitude towards private economic
  power

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Old institutionalism/1

• Institutionalism and Complexity (Veblen, Commons,
  Mitchell, Llewellyn)
• Evolution and growth of institutions, habits and
  norms
• Complex interaction among rights, duties,
  liberties and exposures
• Rejection of methodological individualism
• Transaction as a complex unit of analysis in
  which conflicts abound
• Efficiency in transactions depends on the
  definition of rights
• Complexity of enforcement devices

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Old institutionalism/2What is a transaction?

• J.R. Commons (1924, 1934, 1950) economic
  exchanges which take place in the real world
  economy are characterised by positive transaction
  costs. In order to properly assess the nature and
  the extent of transaction costs it is necessary
  to investigate in more detail the notion of
  transaction.
• when we reduce all prospective buyers and
  sellers upon a given market to those who
  participate in one bargaining transaction as our
  smallest unit of investigation, then they are the
  best two buyers and the best two sellers,
  meaning the two buyers who offer the highest
  prices and the two sellers who offer to accept
  the lowest prices, in consideration of transfers
  of ownership. ... The best two sellers are
  those able to sell at the lowest price. They
  compete for choice of alternatives offered by the
  best two buyers, those able to buy at the highest
  prices, while, in turn, the best two buyers are
  competing for choice of alternatives offered by
  the best two sellers.
• instead of the exchange of physical things
  between two parties, as contemplated in the
  former physical economics, there are five
  parties, all of whom are potential and then
  they are successively actual participants in
  the lawful alienation and acquisition of
  ownership. These five parties are four
  competitors (two buyers and two sellers) and the
  enforcer or judge who is ready to issue
  commands to any of the buyers and sellers in the
  name of sovereignty, if any dispute arises.

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Commons vs Williamson

• Transaction vs economic exchange
• From 5 agents to bilateral monopoly
• Williamson develops the efficiency branch but
  neglects the monopoly branch in a theory of the
  firm (market-contract interaction)
• Williamson under-estimates the role of market
  competition as a discipline market device
  (fundamental transformation and equilibrium
  market)
• Specificity is not a merely a technological
  rather a transactional matter
• Private orderings or public/private
  complementarity?
• History matters
• Power vs efficiency

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Power and Critical Legal Studies

• Law as a social institution
• The idea of efficient norms (wealth maximizing)
  embodies a liberist masking aimed at preserving
  existing social order
• The evolution of law and rights depends on the
  allocation of power
• From individualism to collectivism (law and ends)
• Formalism and Chicago methodology is ideology

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Methodological issues

• Predictions and the realism of assumption
• Posner logical truth explains causality
  direction (we should be pragmatic about theory.
  It is a tool, rather than a glipse of ultimate
  truth, and the criterion of a tool is utility)
• Coase even if predictions on the basis of
  unrealistic assumptions are correct, a theory
  based upon them may fail in providing insight in
  the working of the economic (or legal) system
• Posnernot only is it wrong to be against formal
  theory, but it is wrong to suppose that formal
  economic theory is inherently interventionist.
  Beckers example on the impact of theory on
  empirical research.
• Posner against pragmatismpragmatism gave legal
  realism intellectual shape .... Then prgmatism
  died and realism died

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Post-Chicago developments/1History and
Complementarity

• Comparing Chicago and CLS approaches
• Norms are efficient
• Norms are the result of discretionary power
  (incentives to subvert rules)
• Is there a possible self-enforcing institutional
  equilibrium? (Pagano and Rowthorn, 1996 Aoki,
  2001)
• History matters (legal origins) process of
  selection of alternative evolutionary paths
  against possible multiple equilibria (rise of
  regulatory state)
• Emergence of path-dependency in the evolution of
  norms according to institutional complementarity

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Post-Chicago developments/2Behavioral Law and
Economics

• How will law affect human behavior?
• What will individuals likely response to changes
  in the rules be?
• Why does law take the form that it does?
• BLE suggests that a superior understanding of
  actual human behavior will improve answers and
  predictions to such questions (Sunstein et al
  1998)
• Bounded rationality (rules of thumb are
  predictable)
• Bounded willpower (consistency)
• Bounded self-interest (fairness and acrimony)

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Behavioral LEexamples and methods

• Predicting inertia in Coase Theorem and choices
  in UG (fairness, endowment effect)
• Analysis of sunk costs (experiments with UG)
• Analysis of post-trials negotiations
• Self-serving (assessment of fairness is distorted
  by self-interest)
• Endogenous preferences
• Law and legal change is affected (and affects)
  agents perception of what is fair
• BLE may help in predicting not only the impact
  but also the dimension of the effects of legal
  change

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Post-Chicago developments/3Leveraging in
Antitrust

• Recent works in antitrust law and economics
  trespass the Chicago approach to leveraging,
  vertical restraints and bundling practices
  (Hovenkamp, 2000 Rey and Tirole, 2004 Nalebuff,
  2000)
• Leveraging should not be applied comparing two
  monopolists (upstream and downstream) against an
  integrated monopolist with downstream competitive
  markets, but an integrated monopolist against
  vertical network competition
• Defensive leveraging has recently been applied
  against Microsoft (US, Europe and Korea) and for
  the assessment of vertical mergers with network
  effects and bundled goods
• The example of Bork as a man at war with
  himself

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Post-Chicago developments/4The question of
access to bottleneck

• When a monopolist possesses an intermediate asset
  which is indivisible, unique (not substitutable),
  and for which technical and economic sharing is
  possible, the asset is an essential facility and
  competition and regulatory authority should grant
  access to downstream competitors (essential
  facility doctrine)
• In IPRs this idea has conducted to introduction
  of alternative instruments for providing
  incentives to innovate other than patents
• In liberalized market the Williamsonian attitude
  towards vertical integration has been replaced by
  vertical separation with the idea of sustaining
  short term increased transaction costs against
  long-term more competitive markets

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Research AgendaMethodology, Content, Aims

• In LE, methodology is influenced by the object
  of the study and the ends to be reached
• Post-Chicago developments show heterogeneity in
  object but a common feature in assumptions
  (bounded rationality but predictable maximizing
  behavior explicit consideration of agents
  hidden purposes)
• Norms are not simple solutions in a game but the
  result of institutional complementarity among
  several domains of choices
• The enforcement of legal rules is the complex
  result of complementary devices (such as the
  State and the Market)
• The impact of legal change is to be assessed and
  predicted according to actual behavior of real
  agents.