Substantive Fairness

1
Substantive Fairness

• F.H. Buckley
• Sciences Po
• Buckley 136-56

2
The agenda

• The overlap between fairness and efficiency
• How economics provides the analytical tools to
  explain fundamental instincts about the law

3
Rational Choice Five assumptions

• 1. Perfect rationality
• 2. Full Information
• 3. Non-satiation
• 4. Completeness or comparability
• 5. No third party effects (externalities)

4
1. Perfect Rationality

• Lets leave this one till we get to Paternalism

5
2. Full Information

• This would assume full information about product
  quality, and also about the other partys
  preferences.
• Obviously, this assumption is never satisfied.
• Yet this does not impeach the contract.

6
Full InformationMisrepresentation and
Nondisclosure

• A simple informational asymmetry does not
  constitute fraud. In general, the informed party
  is not obliged to make an affirmative disclosure.
• Bargaining over antiques.
• Land assembly in Texas Gulf Sulfur.
• Insider trading in Texas Gulf Sulfur.

7
Full InformationWhy no liability for
nondisclosure?

• Because information is itself a commodity, with a
  cost of production, and disclosure duties would
  eliminate the incentive to produce the
  information.
• Some examples
• Trade secrets
• Patentable inventions
• Market information

8
Full InformationWhy no liability for
nondisclosure?

• In general, the misfeasance-nonfeasance
  distinction upheld at law
• A presumption that information is costly
• Some exceptions
• Half-truths
• Fiduciary relationships

9
3. Non-satiation B A




Time 1









More is always better














B











A












































Time 2
0














10
Non-satiation is not inconsistent with
diminishing marginal utility




Utility
















Utility increases at a declining rate






























































Good
0














11
Non-satiation not the same as Greed

• Does non-satiation commit us
• to a view of homo economicus
• as selfishly aquisitive?
• A positive, not a normative view.
• We do suggest that a persons
• preferences are wholly self-centered.

12
4. Comparability No incommensurabilities
No black holes
13
Incommensurability Tragic Choices

• Sophies Choice
• You are a member of a hospitals ethics
  committee. You have to choose between allocating
  a kidney to an alcoholic former sports idol or a
  mother of two.
• Can you think of other examples?

14
5. Third party effects Bargaining with a third
person
Mary
Ann
Representing Anns utility on a third dimension
Beth
15
What happens if third parties cant be joined?

• Paretian norms dont workif its an external
  cost
• Externalities and Tort Law

16
But nearly everything has third party effects

• Do we then abandon the concept of efficiency?
• A more relaxed standard Kaldor-Hicks efficiency
• A transformation is Kaldor-Hicks efficient when
  the winners could compensate the losers
  (Potential Pareto-Efficiency)

17
Examples of Kaldor-Hicks Efficiency

• It is proposed to abandon steel tariffs that
  impose costs of 10B on the economy but provide
  steel manufacturers with a gain of 1B.
• The bankruptcy of a failing business imposes a
  cost to shareholders of 1M, but provides a
  benefit of 5M to creditors.

18
C is Kaldor-Hicks Efficient to A At C Beth is
better off than she is at A She could also give
up CB roses to move to B and still be better off
than she was at A, while Mary would be no worse
off
Beth
A
?
B
?
C
?
Mary
19
Substantive Fairness Dividing the bargaining
surplus

• The Edgeworth Box Function teaches us that
  bargaining is a non-zero sum game
• But at the heart of the bargaining game is a
  zero-sum game

20
The Contract Curve Can we shift from commodity
to utility space?
Beth
E
?
A
?
C
?
F
?
?
G
?
B
D
?
Mary
21
Blowing up the bargaining lens
C
A


A is the endowment point
F


G

Were still in commodity space
B
22
Blowing up the bargaining lens
At C Mary is much better off than at A, and Beth
is neither better nor worse off
C
A


A is the endowment point
F


G

B
23
Blowing up the bargaining lens
C
A


A is the endowment point
F


G

B
At B Beth is much better off than at A, and Mary
is neither better nor worse off
24
Blowing up the bargaining lens
C
A


A is the endowment point
F


G
At G both parties are better off than at A

B
25
Blowing up the bargaining lens
At C Mary is much better off than at A, and Beth
is neither better nor worse off
C
A


A is the endowment point
F


G
At G both parties are better off than at A

B
At B Beth is much better off than at A, and Mary
is neither better nor worse off
26
Lets see that again
Beth
E
?
A
?
C
?
F
?
?
G
?
B
D
?
Mary
27
Blowing up the bargaining lens
At C Mary is much better off than at A, and Beth
is neither better nor worse off
C
A


A is the endowment point
F


G
At G both parties are better off than at A

B
At B Beth is much better off than at A, and Mary
is neither better nor worse off
28
Now lets suppose we can measure Marys utility
levels
The units of measurement are now in utilities,
not commodities
A
G
C
29
Now lets suppose we can measure Marys utility
levels
A
G
C
Cardinal, not ordinal utility
30
And suppose we can do the same for Beth
Beths utility
B
G'
Utility Space
Marys utility
A
G
C
31
We can then represent the contract curve in
utility space
BC represents the presolution to the game it
is feasible and efficient
B
Beth
A
C
Mary
32
We can then represent the contract curve in
utility space
BC is concave (bends outward) because we assume
that joint utility is maximized when gains are
shared
B
Beth
A
C
Mary
33
To simplify we normalize the utility functions of
both from 0 to 1.0
1.0
Beth
0
1.0
Mary
34
The solution to the two-person bargaining game
picks one point at which the parties agree
1.0
Beth
0
1.0
Mary
35
The Nash Solution is one such solution to the
two-person bargaining game
Russell Crowe as John Nash in A Beautiful Mind
Can you spot the bargaining lens?
36
The Worst Reason to turn down a job at the
University of Chicago is
Because I expect to be named the Emperor of
Antarctica!
37
The Nash Solution Nash maximizes the product of
the utility gains
1.0
Nash solution of (.75 .8 ) .6

Beth
0
1.0
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
38
The Nash solution rests on four simplifying
assumptions

• Efficiency Solution is
• on the contract curve

1.0

Beth
0
1.0
Mary
39
The Nash solution rests on four simplifying
assumptions

• Efficiency Solution is
• on the contract curve

1.0

• Symmetry doesnt matter who is Beth and who Mary

Beth
0
1.0
Mary
40
The Nash solution rests on four simplifying
assumptions

• Efficiency Solution is
• on the contract curve

1.0

• Symmetry doesnt matter who is Beth and who Mary

Beth
3. Independent of irrelevant alternatives
0
1.0
Mary
41
The Nash solution rests on four simplifying
assumptions

• Efficiency Solution is
• on the contract curve

1.0

• Symmetry doesnt matter who is Beth and who Mary

Beth
3. Independent of irrelevant alternatives

• Doesnt matter
• how utilities are scaled

0
1.0
Mary
42
The Nash solution does not depend on scaling
1.0
Nash solution of (75 .8 ) 60

Beth
0
100
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
43
The Equi-util Solution Equi-util equalizes
utility gains
1.0
Nash solution of (.75 .8 ) .6

Beth

Equi-util solution of (.77.77 ) .5929
0
1.0
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
44
The Equi-util Solution Equi-util equalizes
utility gains
1.0
Nash solution of (.75 .8) .6

Beth

Equi-util solution of (.77.77 ) .5929
Equi-util seems more egalitarian, Nash more
utilitarian
0
1.0
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
45
The Nash and Equi-util solutions may be quite
dissimilar
Nash (.50, 1.0)

1.0
Beth
Equi-util (.67,.67)

0
1.0
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
46
The equi-util solution depends on scaling
Equi-util solution of (.9 .9 ) .81

1.0
Nash solution of (75 .8 ) 60

Beth
0
100
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
47
The equi-util solution depends on scaling
Equi-util solution of (.9 .9 ) .81

1.0
Nash solution of (75 .8 ) .60

Beth
The utility monster?
0
100
Mary
Howard Raiffa, The Art and Science of Negotiation
(1982)
48
But do people bargain to the Nash solution?The
ultimatum game

• We have 1,000 to divide between us.
• I first decide how the money is to divided.
• In the second stage you decide whether or not to
  accept the split I propose.
• If you accept the split we both take our
  respective shares.
• If you reject the split neither of us get
  anything.

49
The ultimatum game

• In the first stage I propose the following split
  I get 990, you get 10.
• In the second stage, do you accept or reject
  this?
• What is the Nash solution?

50
The Tenth Man

• Ten hostages are held by terrorists. They are
  told that one will be executed tomorrow and are
  asked to pick straws. The lot falls to the
  richest man. He sells the short straw to the
  poorest man for 1,000,000, who is executed the
  next day, after arranging to give the money to
  his family.
• What is the Nash solution? Is this an efficient
  agreement?
• Is there nevertheless a problem here?

51
The Nash solution to the Tenth Man?
1.0

Beth
0
1.0
Mary
52
Should substantive fairness norms be enforced?

• Cooperation Theories
• Incentive Theories
• Screening Theories

53
1. Cooperation Theories
At the heart of each non zero-sum bargaining
game is a zero-sum game
1.0

Beth
0
1.0
Mary
54
1. Cooperation Theories
Efficiency gains are exploited when the parties
bargain to the contract curve (presolution).
But that doesnt tell us how they split the
bargaining surplus (solution)
1.0

Beth
0
1.0
Mary
55
The hard bargainer
Mary insists on a payoff of at least .95
1.0

Beth
0
.95
1.0
.95
Mary
56
The hard bargainer
1.0

Beth
Qu. How many such bargains will be lost
through bargaining breakdown?
0
.95
1.0
.95
Mary
57
The hard bargainer Is this a game of chance?
Not the way I play it..
58
The hard bargainerWanna shoot with Fast Eddie?
Its like a church
Yeah. The church of the good hustle
Jackie Gleason, Paul Newman in The
Hustler (LEscroc)
59
Getting to Yes Suppose we resist enforcing hard
bargains?
1.0
Assume that an arbitrator can measure utilities
and refuses to enforce bargains that allocate
.95 of the gains to one party
.95

Beth
Some contracts will not be enforced. But might
more be entered into because hard bargainers
have been chilled?
0
1.0
.95
Mary
60
Now back to the ultimatum game

• Suppose we refused to enforce bargains that
  appear wholly one-sided?

61
Now back to the ultimatum game

• Suppose we refused to enforce bargains that
  appear wholly one-sided?
• This would result in an efficiency loss. But
  would chilling the hard bargainers result in a
  greater number or bargains, and a net efficiency
  gain?

62
2. Incentive TheoriesWould enforcing a contract
lead the parties to overinvest in pre-contract
expenses?

• Blackmail
• Rescue contracts

63
Incentive TheoriesWhats wrong with blackmail?

• Suppose Blackmail were legalizedthe rise of
  Blackmail Inc.
• Blackmail enforces social norms--So whats wrong
  with that?

64
Incentive TheoriesWhats wrong with blackmail?

• The problem with blackmail is that the
  blackmailer invests in the production of
  information about deviance and then does not
  publish it. Comment on this.
• What happens to deviance when the cost goes up?

65
Ex ante, how would people react to the
legalization of blackmail?

• Blackmailers would invest in the production of
  information about deviance
• There would be less transgressive behavior by
  victims.
• Victims would also invest in techniques to hide
  their behavior.

66
Lets assume that all social norms are benign

• Can you come up with an argument against
  blackmail?
• There would be less transgressive behavior by
  victims.
• Even then, blackmail might be wasteful.

67
Lets assume that all social norms are benign

• Let B the benefit of reducing deviant behavior
• Where B wasteful, where
• IB investment by blackmailer
• IV investment by victim in hiding his activity

68
Lets assume that all social norms are benign

• Where B wasteful, where
• IB investment by blackmailer
• IV investment by victim in hiding his activity
• Some examples
• Nude beaches
• Dirty jokes

69
Lets assume that all social norms are benign

• Where B wasteful, where
• IB investment by blackmailer
• IV investment by victim in hiding his activity
• Would you like to lie your entire life as though
  you were on public display? Do rights of privacy
  have anything to do with this?

70
Should we assume that all social norms are
benign?

• We are at times prompted by envy or prejudice,
  and our emotions are fueled by hatred. Should we
  assume that our social norms are more moral than
  we are? Might they pander to base desires?
• Qu. blackmail of homosexuals (who might be
  outed by other gays).

71
Or course one can tough it out
Publish and be damned!
72
But that doesnt always work
No man shall have the right to fix the boundary
to the march of a Nation, right Kitty?
Charles Stewart Parnell
73
Suppose then that the victim should be permitted
to hide behind a veil of privacy

• All expenditures by Blackmail Inc. to produce
  information are wasteful
• Victims will adhere to norms of dull conformity

74
Incentive TheoriesRescue Contracts
The cutter Eastwind cruises around the still
floating stern section of the SS Fort Mercer.
75
Rescue ContractsThe Bargaining Surplus

• Lets say the rescuer and victim bargain over a
  rescue.
• The rescuer will undertake to attempt a rescue
  provided that L R, where
• L, the cost of the loss if no rescue
• R, the cost of the actual rescue
• The bargaining surplus to be divided between them
  is thus L R.

76
Rescue ContractsThe Social Costs of Rescues

• What are the costs associated with a rescue?
• L, the cost of the loss if no rescue
• R, the cost of the actual rescue
• x, the pre-rescue costs born by the victim in
  anticipation of the loss
• y, the pre-rescue costs born by the rescuer in
  anticipation of the reward from the rescue

77
Rescue ContractsThe Social Costs of Rescues

• The Social Costs of the rescue C are then a
  function of pre-rescue care x and y
• C(x,y) pV(1-pR)L pVpRR x y, where
• pV is the probability that the victim will need a
  rescue, and
• pR is the probability of a successful rescue

78
Rescue ContractsThe Social Costs of Rescues

• Assume that, by investing in pre-rescue care x
  the victim can reduce the probability that hell
  need to be rescued
• He might avoid dangerous places
• He might take extra precautions or extra care
• Assume that, by investing in pre-rescue care y
  the rescuer can increase the probability of a
  successful rescue.
• He might frequent dangerous places
• He might take extra precautions or extra care

79
Rescue ContractsThe Social Costs of Rescues

• Is it possible for the parties to take excessive
  care?

80
Rescue ContractsThe Starving Millionaire

• Livingston is an explorer who finds himself
  without food or water, alone in the desert. After
  a week he comes across an inn, owned by Conrad.
  Ill give you food and water, says Conrad, in
  exchange for all your money. Livingston is a
  millionaire. Think it over, says Conrad.
• This is a rescue contract where the rescuer
  bargains for L in exchange for the rescue.

81
Rescue ContractsThe Starving Millionaire

• This is a rescue contract where the rescuer
  bargains for L in exchange for the rescue.
• The optimal pre-rescue costs of the rescuer might
  however be 0. In that case, the rescuer is
  adequately compensated if he is given R for the
  rescue.
• Enforcing a rescue contract which gives him L
  gives him an excessive incentive to take
  pre-rescue care the victim will also take
  excessive care in this case.

82
Rescue and status obligations

• A rule of efficiency would minimize social costs,
  which include victims harm costs, rescuers
  rescue costs, and pre-accident care investments
  by both parties.
• Where rescue contracts are enforced in extreme
  cases, what does this do to pre-rescue investment
  costs?
• The law of rescue at sea.
• Status contracts Hotelkeepers

83
Incentive Theories3. Screening Theories

• Whats wrong with slavery?
• Could a contract of slavery (as opposed to forced
  servitude) ever be efficient? What does slavery
  do to the slaves incentives?
• Do you see a parallel to personal bankruptcy
  protection?

84
Incentive Theories3. Screening Theories

• Whats wrong with slavery?
• Lets assume, per impossibilia, that the master
  really does want to purchase a persons services
  as a slave. But would anyone every want to sell
  his services for life in this way?
• Lets assume that one person in a billion might
  wish to do so. Do we enforce the contract?

85
Incentive Theories3. Screening Theories

• As a judge, would we not want to take care to
  ensure that this really is that one in a billion
  case? Would we not want to review the evidence
  carefully as to the slaves consent to the
  contract?
• Given the extreme likelihood that consent was not
  freely given, as well as the presumed
  inefficiency where consent is not freely given,
  would the benefits of enforcement not be
  outweighed by judicial screening costs? If so,
  does that explain the rule of illegality?

86
Incentive Theories3. Screening Theories

• This suggests that, for contracts which seem
  egregiously unfair, refusal to enforce the
  agreement may economize on both
• (1) judicial screening costs, and
• (2) consumer screening costs.

87
Incentive Theories3. Screening Theories

• In Thornborow v. Whitacre, the defendant borrowed
  5 and in return promised plaintiff two grains of
  rye-corn the first week , four the second, eight
  the third, and so on for a year. (22223252)
• There was no enough grain in the world to satisfy
  the agreement.
• Held Contract was illegal.

88
Incentive Theories3. Screening Theories

• In James v. Morgan, defendant bought a horse in
  return for a barley-corn for the horses first
  shoe nail, two for the second nail, four for the
  third nail, and so on.
• The price came to six tons of barley
• Held Contract was illegal.

89
Incentive Theories3. Screening Theories

• But just how often does one want to have recourse
  to these theories?
• The case of penalty clauses.
• The example of exemption clauses.

90
Incentive Theories3. Screening Theories

• The special concern for standard form contracts
  or contrats dadhesion
• Friedrich Kessler on a new form of fascism
• Can you offer some economic explanations for the
  use of standard form contracts other than
  oppression?