Law and economics, or economic analysis of law, is the application of microeconomic theory to the analysis of

law Law is a set of rules that are created and are enforceable by social or governmental institutions to regulate behavior, with its precise definition a matter of longstanding debate. It has been variously described as a science and as the ar ...

. The field emerged in the United States during the early 1960s, primarily from the work of scholars from the

Chicago school of economics The Chicago school of economics is a Neoclassical economics, neoclassical Schools of economic thought, school of economic thought associated with the work of the faculty at the University of Chicago, some of whom have constructed and populari ...

such as Aaron Director,

George Stigler George Joseph Stigler (; January 17, 1911 – December 1, 1991) was an American economist. He was the 1982 laureate in Nobel Memorial Prize in Economic Sciences and is considered a key leader of the Chicago school of economics. Early life and e ...

, and

Ronald Coase Ronald Harry Coase (; 29 December 1910 – 2 September 2013) was a British economist and author. Coase was educated at the London School of Economics, where he was a member of the faculty until 1951. He was the Clifton R. Musser Professor of Eco ...

. The field uses

economics Economics () is a behavioral science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and interac ...

concepts to explain the effects of laws, assess which legal rules are economically efficient, and predict which legal rules will be promulgated. There are two major branches of law and economics; one based on the application of the methods and theories of

neoclassical economics Neoclassical economics is an approach to economics in which the production, consumption, and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a go ...

to the positive and normative analysis of the law, and a second branch which focuses on an institutional analysis of law and legal institutions, with a broader focus on economic, political, and social outcomes, and overlapping with analyses of the institutions of politics and governance.

History

Origin

The historical antecedents of law and economics can be traced back to the classical economists, who are credited with the foundations of modern economic thought. As early as the 18th century,

Adam Smith Adam Smith (baptised 1723 – 17 July 1790) was a Scottish economist and philosopher who was a pioneer in the field of political economy and key figure during the Scottish Enlightenment. Seen by some as the "father of economics"——— or ...

discussed the economic effects of mercantilist legislation; later,

David Ricardo David Ricardo (18 April 1772 – 11 September 1823) was a British political economist, politician, and member of Parliament. He is recognized as one of the most influential classical economists, alongside figures such as Thomas Malthus, Ada ...

opposed the British Corn Laws on the grounds that they hindered agricultural productivity; and Frédéric Bastiat, in his influential book '' The Law'', examined the unintended consequences of legislation. However, to apply economics to analyze the law regulating nonmarket activities is relatively new. A European law & economics movement around 1900 did not have any lasting influence. In a 1917 article analyzing the study of law and economics in American universities, Eugene Allen Gilmore concluded, "the relation between law and economics seems either not to be perceived, or, if perceived, not to be regarded as a relationship desirable or feasible of very much cultivation." Harold Luhnow, the head of the Volker Fund, not only financed F. A. Hayek in the U.S. starting in 1946, but he shortly thereafter financed Aaron Director's coming to the University of Chicago in order to set up there a new center for scholars in law and economics. The University was headed by Robert Maynard Hutchins, a close collaborator of Luhnow's in setting up the Chicago School, as it became commonly known. The university faculty then included a strong base of libertarian scholars, including Frank Knight,

, Henry Simons,

and Jacob Viner. Soon, it would also have not just Hayek himself, but Director's brother-in-law and Stigler's friend

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and ...

, and also Robert Fogel, Robert Lucas, Eugene Fama, Richard Posner, and Gary Becker. Historians Robert van Horn and Philip Mirowski described the development of modern economic concepts in "The Rise of the Chicago School of Economics", a chapter of ''The Road from Mont Pelerin ''(2009); and historian Bruce Caldwell (a great admirer of von Hayek) filled in more details of the account in his chapter, "The Chicago School, Hayek, and Neoliberalism", in ''Building Chicago Economics'' (2011). The field began with Gary Becker's 1968 paper on crime (Becker also received a Nobel Prize). In 1972, Richard Posner, a law and economics scholar and the major advocate of the positive theory of efficiency, published the first edition of Economic Analysis of Law and founded '' The Journal of Legal Studies'', both are regarded as important events. Gordon Tullock and Friedrich Hayek also wrote intensively in the area and influenced to spread of law and economics.

Founding

In 1958, Director founded '' The Journal of Law & Economics'', which he co-edited with Nobel laureate

, and which helped to unite the fields of law and economics with far-reaching influence. In 1960 and 1961, Ronald Coase and Guido Calabresi independently published two groundbreaking articles, " The Problem of Social Cost" and "Some Thoughts on Risk Distribution and the Law of Torts". This can be seen as the starting point for the modern school of law and economics. In 1962, Aaron Director helped to found the Committee on a Free Society. Director's appointment to the faculty of the University of Chicago Law School in 1946 began a half-century of intellectual productivity, although his reluctance about publishing left few writings behind. He taught antitrust courses at the law school with Edward Levi, who eventually would serve as Dean of Chicago's Law School, President of the University of Chicago, and as U.S. Attorney General in the Ford administration. After retiring from the

University of Chicago Law School The University of Chicago Law School is the Law school in the United States, law school of the University of Chicago, a Private university, private research university in Chicago, Illinois. It employs more than 180 full-time and part-time facul ...

in 1965, Director relocated to California and took a position at Stanford University's Hoover Institution. He died September 11, 2004, at his home in Los Altos Hills, California, ten days before his 103rd birthday.

Later development

In the early 1970s, Henry Manne (a former student of Coase) set out to build a center for law and economics at a major

law school A law school (also known as a law centre/center, college of law, or faculty of law) is an institution, professional school, or department of a college or university specializing in legal education, usually involved as part of a process for b ...

. Ultimately, Manne established a center at George Mason, which became a center for the education of judges — many never previously exposed to the concepts of law and economics. Manne also attracted the support of the John M. Olin Foundation; Olin centers (or programs) for Law and Economics now exist at many universities.

Positive and normative law and economics

Economic analysis of law is usually divided into two subfields: positive and normative.

Positive law and economics

'Positive law and economics' uses economic analysis to predict the effects of various legal rules. So, for example, a positive economic analysis of

tort law A tort is a civil wrong, other than breach of contract, that causes a claimant to suffer loss or harm, resulting in legal liability for the person who commits the tortious act. Tort law can be contrasted with criminal law, which deals with crime ...

would predict the effects of a

strict liability In criminal and civil law, strict liability is a standard of liability under which a person is legally responsible for the consequences flowing from an activity even in the absence of fault or criminal intent on the part of the defendant. Und ...

rule as opposed to the effects of a

negligence Negligence ( Lat. ''negligentia'') is a failure to exercise appropriate care expected to be exercised in similar circumstances. Within the scope of tort law, negligence pertains to harm caused by the violation of a duty of care through a neg ...

rule. Positive law and economics has also at times purported to explain the development of legal rules, for example the

common law Common law (also known as judicial precedent, judge-made law, or case law) is the body of law primarily developed through judicial decisions rather than statutes. Although common law may incorporate certain statutes, it is largely based on prece ...

of torts, in terms of their economic efficiency.

Normative law and economics

''Normative law and economics'' goes one step further and makes policy recommendations based on the economic consequences of various policies. The key concept for normative economic analysis is

efficiency Efficiency is the often measurable ability to avoid making mistakes or wasting materials, energy, efforts, money, and time while performing a task. In a more general sense, it is the ability to do things well, successfully, and without waste. ...

, in particular,

allocative efficiency Allocative efficiency is a state of the economy in which production is aligned with the preferences of consumers and producers; in particular, the set of outputs is chosen so as to maximize the Economic surplus, social welfare of society. This is a ...

. A common concept of efficiency used by law and economics scholars is

Pareto efficiency In welfare economics, a Pareto improvement formalizes the idea of an outcome being "better in every possible way". A change is called a Pareto improvement if it leaves at least one person in society better off without leaving anyone else worse ...

. A legal rule is Pareto efficient if it could not be changed so as to make one person better off without making another person worse off. A weaker conception of efficiency is Kaldor–Hicks efficiency. A legal rule is Kaldor–Hicks efficient if it could be made Pareto efficient by some parties compensating others as to offset their loss. Nonetheless, the possibility of a clear distinction between positive and normative analysis has been questioned by Guido Calabresi who, in his book on "The future of Law and Economics" (2016: 21-22), believes that there is an "actual - and unavoidable - existence of value judgments underlying much economic analysis" Uri Weiss proposed this alternative: "It is common in law and economics to search for the law that will lead to the optimal outcome, providing the maximum size 'pie,' and to think about maximizing happiness instead of minimizing pain. We prefer another approach: We do not try to identify games that will lead to the optimal result but to prevent games in which it is in the best interests of the players to come to an unjust result".

Criminal law

In 1968, Gary Becker, who would later win the Nobel prize for economics, published ''Crime and Punishment: An Economic Approach''. This work relied on the economic concept of utility as the basic unit of analysis. In 1985, in ''An Economic Theory of the Criminal Law'', Posner set out an alternative approach that relied instead on wealth as the basic unit of analysis.

Relationship to other disciplines and approaches

As used by

lawyer A lawyer is a person who is qualified to offer advice about the law, draft legal documents, or represent individuals in legal matters. The exact nature of a lawyer's work varies depending on the legal jurisdiction and the legal system, as w ...

s and legal scholars, the phrase "law and economics" refers to the application of microeconomic analysis to legal problems. Because of the overlap between legal systems and political systems, some of the issues in law and economics are also raised in

political economy Political or comparative economy is a branch of political science and economics studying economic systems (e.g. Marketplace, markets and national economies) and their governance by political systems (e.g. law, institutions, and government). Wi ...

constitutional economics Constitutional economics is a research program in economics and constitutionalism that has been described as explaining the choice "of alternative sets of legal-institutional-constitutional rules that constrain the choices and activities of econom ...

and

political science Political science is the scientific study of politics. It is a social science dealing with systems of governance and Power (social and political), power, and the analysis of political activities, political philosophy, political thought, polit ...

. Approaches to the same issues from

Marxist Marxism is a political philosophy and method of socioeconomic analysis. It uses a dialectical and materialist interpretation of historical development, better known as historical materialism, to analyse class relations, social conflic ...

and critical theory/

Frankfurt School The Frankfurt School is a school of thought in sociology and critical theory. It is associated with the University of Frankfurt Institute for Social Research, Institute for Social Research founded in 1923 at the University of Frankfurt am Main ...

perspectives usually do not identify themselves as "law and economics". For example, research by members of the critical legal studies movement and the

sociology of law The sociology of law, legal sociology, or law and society, is often described as a sub-discipline of sociology or an interdisciplinary approach within legal studies. Some see sociology of law as belonging "necessarily" to the field of sociolo ...

considers many of the same fundamental issues as does work labeled "law and economics", though from a vastly different perspective. The law and political economy movement also analyzes similar concepts using an entirely different approach. The one wing that represents a non-neoclassical approach to "law and economics" is the Continental (mainly German) tradition that sees the concept starting out of the governance and public policy (''Staatswissenschaften'') approach and the German Historical school of economics; this view is represented in the ''Elgar Companion to Law and Economics'' (2nd ed. 2005) and—though not exclusively—in the ''European Journal of Law and Economics''. Here, consciously non-neoclassical approaches to economics are used for the analysis of legal (and administrative/governance) problems. Law and economics is closely related to jurimetrics, the application of

probability Probability is a branch of mathematics and statistics concerning events and numerical descriptions of how likely they are to occur. The probability of an event is a number between 0 and 1; the larger the probability, the more likely an e ...

and

statistics Statistics (from German language, German: ', "description of a State (polity), state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of data. In applying statistics to a s ...

to legal questions.

Applications

Affirmative action Affirmative action (also sometimes called reservations, alternative access, positive discrimination or positive action in various countries' laws and policies) refers to a set of policies and practices within a government or organization seeking ...

( Coate-Loury model) *

Antitrust law Competition law is the field of law that promotes or seeks to maintain market competition by regulating anti-competitive conduct by companies. Competition law is implemented through public and private enforcement. It is also known as antitrust ...

( Herfindahl–Hirschman Index) * Calculus of negligence * Congestion pricing *

Corporate governance Corporate governance refers to the mechanisms, processes, practices, and relations by which corporations are controlled and operated by their boards of directors, managers, shareholders, and stakeholders. Definitions "Corporate governance" may ...

* Cost–benefit analysis **

Criminal law Criminal law is the body of law that relates to crime. It proscribes conduct perceived as threatening, harmful, or otherwise endangering to the property, health, safety, and Well-being, welfare of people inclusive of one's self. Most criminal l ...

** Mass surveillance in the United States **

Surveillance Surveillance is the monitoring of behavior, many activities, or information for the purpose of information gathering, influencing, managing, or directing. This can include observation from a distance by means of electronic equipment, such as ...

*Crime enforcement * Deregulation ( Airlines,

communications Communication is commonly defined as the transmission of information. Its precise definition is disputed and there are disagreements about whether Intention, unintentional or failed transmissions are included and whether communication not onl ...

energy Energy () is the physical quantity, quantitative physical property, property that is transferred to a physical body, body or to a physical system, recognizable in the performance of Work (thermodynamics), work and in the form of heat and l ...

, surface freight) *Design of contracts (

Contract theory From a legal point of view, a contract is an institutional arrangement for the way in which resources flow, which defines the various relationships between the parties to a transaction or limits the rights and obligations of the parties. From an ...

) ** Efficient breach *

Discrimination Discrimination is the process of making unfair or prejudicial distinctions between people based on the groups, classes, or other categories to which they belong or are perceived to belong, such as race, gender, age, class, religion, or sex ...

** Statistical discrimination (economics) * Drug policy ( Iron law of prohibition) *

Evidence Evidence for a proposition is what supports the proposition. It is usually understood as an indication that the proposition is truth, true. The exact definition and role of evidence vary across different fields. In epistemology, evidence is what J ...

Evolution Evolution is the change in the heritable Phenotypic trait, characteristics of biological populations over successive generations. It occurs when evolutionary processes such as natural selection and genetic drift act on genetic variation, re ...

of the

( Evolutionary game theory) *

Financial regulation Financial regulation is a broad set of policies that apply to the financial sector in most jurisdictions, justified by two main features of finance: systemic risk, which implies that the failure of financial firms involves public interest consi ...

( Efficient market hypothesis) ** Fraud-on-the-market theory *Governance of the

commons The commons is the cultural and natural resources accessible to all members of a society, including natural materials such as air, water, and a habitable Earth. These resources are held in common even when owned privately or publicly. Commons ...

** Tragedy of the commons * Institutional origins ** ''The Colonial Origins of Comparative Development: An Empirical Investigation'' **

Constitutional economics Constitutional economics is a research program in economics and constitutionalism that has been described as explaining the choice "of alternative sets of legal-institutional-constitutional rules that constrain the choices and activities of econom ...

Legal origins theory The legal origins theory claims that the two main legal traditions or origins, civil law and common law, crucially shape lawmaking and dispute adjudication and have not been reformed after the initial exogenous transplantation by Europeans. Theref ...

Property rights The right to property, or the right to own property (cf. ownership), is often classified as a human right for natural persons regarding their Possession (law), possessions. A general recognition of a right to private property is found more rarely ...

Intellectual property Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more than others. The best-known types are patents, co ...

( Economics and patents) *

Natural monopoly A natural monopoly is a monopoly in an industry in which high infrastructural costs and other barriers to entry relative to the size of the market give the largest supplier in an industry, often the first supplier in a market, an overwhelming adv ...

regulation ( Averch–Johnson effect) * Peltzman effect * Principal–agent problem **

Adverse selection In economics, insurance, and risk management, adverse selection is a market situation where Information asymmetry, asymmetric information results in a party taking advantage of undisclosed information to benefit more from a contract or trade. In ...

Moral hazard In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs associated with that risk, should things go wrong. For example, when a corporation i ...

Quarantine A quarantine is a restriction on the movement of people, animals, and goods which is intended to prevent the spread of disease or pests. It is often used in connection to disease and illness, preventing the movement of those who may have bee ...

measures for

public health Public health is "the science and art of preventing disease, prolonging life and promoting health through the organized efforts and informed choices of society, organizations, public and private, communities and individuals". Analyzing the de ...

* Prudent investor rule (

Modern portfolio theory Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of Diversificatio ...

) *

Rent control Rent regulation is a system of laws for the rental market of dwellings, with controversial effects on affordability of housing and tenancies. Generally, a system of rent regulation involves: *Price controls, limits on the rent that a landlord ...

Rent-seeking Rent-seeking is the act of growing one's existing wealth by manipulating the social or political environment without creating new wealth. Rent-seeking activities have negative effects on the rest of society. They result in reduced economic effi ...

Transaction costs In economics, a transaction cost is a cost incurred when making an economic trade when participating in a market. The idea that transactions form the basis of economic thinking was introduced by the institutional economist John R. Commons in 1 ...

( Coase theorem) * Value of a statistical life *

Voting systems An electoral or voting system is a set of rules used to determine the results of an election. Electoral systems are used in politics to elect governments, while non-political elections may take place in business, nonprofit organizations and inf ...

(

Social choice theory Social choice theory is a branch of welfare economics that extends the Decision theory, theory of rational choice to collective decision-making. Social choice studies the behavior of different mathematical procedures (social welfare function, soc ...

) *

Water law Water is an inorganic compound with the chemical formula . It is a transparent, tasteless, odorless, and nearly colorless chemical substance. It is the main constituent of Earth's hydrosphere and the fluids of all known living organisms ( ...

Influence

The economic analysis of law has been influential in the United States as well as elsewhere. Judicial opinions use economic analysis and the theories of law and economics with some regularity, in the US but also, increasingly, in Commonwealth countries and in Europe. The influence of law and economics has also been felt in legal education, with graduate programs in the subject being offered in a number of countries. The influence of law and economics in civil law countries may be gauged from the availability of textbooks of law and economics, in English as well as in other European languages (Schäfer and Ott 2004; Mackaay 2013). Many law schools in North America, Europe, and Asia have faculty members with a graduate degree in economics. In addition, many professional economists now study and write on the relationship between economics and legal doctrines. Anthony Kronman, former dean of Yale Law School, has written that "the intellectual movement that has had the greatest influence on American academic law in the past quarter-century f the 20th Century is law and economics.

Criticisms

Despite its influence, the law and economics movement has been criticized from a number of directions. This is especially true of normative law and economics. Because most law and economics scholarship operates within a neoclassical framework, fundamental criticisms of neoclassical economics have been drawn from other, competing frameworks, though there are numerous internal critiques as well. Yet other schools of economic thought have emerged and have been applied to the work of law and economics in, for example, the work of Edgardo Buscaglia and Robert Cooter in the book "Law and Economics of Development".

Rational choice theory

Critics of the economic analysis of legal questions have argued that normative economic analysis does not capture the importance of

human rights Human rights are universally recognized Morality, moral principles or Social norm, norms that establish standards of human behavior and are often protected by both Municipal law, national and international laws. These rights are considered ...

and concerns for

distributive justice Distributive justice concerns the Social justice, socially just Resource allocation, allocation of resources, goods, opportunity in a society. It is concerned with how to allocate resources fairly among members of a society, taking into account fa ...

. Some of the heaviest criticisms of law and economics come from the critical legal studies movement, in particular Duncan Kennedy and Mark Kelman. Jon D. Hanson, of

Harvard Law School Harvard Law School (HLS) is the law school of Harvard University, a Private university, private research university in Cambridge, Massachusetts. Founded in 1817, Harvard Law School is the oldest law school in continuous operation in the United ...

, argues that our legal, economic, political, and social systems are unduly influenced by an individualistic model of behavior based on preferences, instead of a model that incorporates

cognitive bias A cognitive bias is a systematic pattern of deviation from norm (philosophy), norm or rationality in judgment. Individuals create their own "subjective reality" from their perception of the input. An individual's construction of reality, not the ...

es and

social norm A social norm is a shared standard of acceptance, acceptable behavior by a group. Social norms can both be informal understandings that govern the behavior of members of a society, as well as be codified into wikt:rule, rules and laws. Social norma ...

Pareto efficiency

Additional criticism has been directed toward the assumed benefits of law and policy designed to increase

when such assumptions are modeled on "first-best" ( Pareto optimal) general-equilibrium conditions. Under the theory of the second best, for example, if the fulfillment of a subset of optimal conditions cannot be met under any circumstances, it is incorrect to conclude that the fulfillment of ''any'' subset of optimal conditions will necessarily result in an increase in allocative efficiency. Consequently, any expression of public policy whose purported purpose is an unambiguous increase in allocative efficiency (for example, consolidation of

research and development Research and development (R&D or R+D), known in some countries as OKB, experiment and design, is the set of innovative activities undertaken by corporations or governments in developing new services or products. R&D constitutes the first stage ...

costs through increased

mergers and acquisitions Mergers and acquisitions (M&A) are business transactions in which the ownership of a company, business organization, or one of their operating units is transferred to or consolidated with another entity. They may happen through direct absorpt ...

resulting from a systematic relaxation of antitrust laws) is, according to critics, fundamentally incorrect, as there is no general reason to conclude that an increase in allocative efficiency is more likely than a decrease. Essentially, the "first-best" neoclassical analysis fails to properly account for various kinds of general-equilibrium feedback relationships that result from intrinsic Pareto imperfections. Another critique comes from the fact that there is no unique optimal result. Warren Samuels in his 2007 book, ''The Legal-Economic Nexus'', argues, "efficiency in the Pareto sense cannot dispositively be applied to the definition and assignment of rights themselves, because efficiency requires an antecedent determination of the rights (23–4)".

"Internal" analytical criticisms

Relatedly, legal scholarship also has criticized the movement for allowing its framing of models to dictate its results, for over-emphasizing or under-emphasizing specific incentives and costs, and for building models that do not degrade "gracefully" (and therefore have difficulty modeling reality). In other words, the law and economics movement may not achieve "efficiency", even to the extent

is the goal of the law.

Criminal methodology

Cullerne Bown has criticised Posner's approach on methodological grounds. He concludes that Posner's approach to evaluating policies in the criminal process is methodologically invalid and that "these failings in turn make the entirety of his conclusions on the criminal process unreliable".

Responses to criticism

Law and economics has adapted to some of these criticisms and been developed in a variety of directions. One important trend has been the application of

game theory Game theory is the study of mathematical models of strategic interactions. It has applications in many fields of social science, and is used extensively in economics, logic, systems science and computer science. Initially, game theory addressed ...

to legal problems. Other developments have been the incorporation of

behavioral economics Behavioral economics is the study of the psychological (e.g. cognitive, behavioral, affective, social) factors involved in the decisions of individuals or institutions, and how these decisions deviate from those implied by traditional economi ...

into economic analysis of law, and the increasing use of

statistical Statistics (from German language, German: ', "description of a State (polity), state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of data. In applying statistics to a s ...

and

econometrics Econometrics is an application of statistical methods to economic data in order to give empirical content to economic relationships. M. Hashem Pesaran (1987). "Econometrics", '' The New Palgrave: A Dictionary of Economics'', v. 2, p. 8 p. 8 ...

techniques. Within the legal academy, the term socio-economics has been applied to economic approaches that are self-consciously broader than the neoclassical tradition. Property rights, which are analyzed using economic analysis, are seen as fundamental human rights by defenders of law and economics.

References

External links

"Law and Economics"
article in the ''

Internet Encyclopedia of Philosophy The ''Internet Encyclopedia of Philosophy'' (''IEP'') is a scholarly online encyclopedia with around 900 articles about philosophy, philosophers, and related topics. The IEP publishes only peer review, peer-reviewed and blind-refereed original p ...

''
Law & Economics LAB

Paper describing the effects of law and economics on inequality
{{Authority control Philosophy of law