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date: 15 October 2018

Law, Economics, and Courts

Summary and Keywords

Law and economics is an important, growing field of specialization for both legal scholars and economists. It applies efficiency analysis to property, contracts, torts, procedure, and many other areas of the law. The use of economics as a methodology for understanding law is not immune to criticism. The rationality assumption and the efficiency principle have been intensively debated. Overall, the field has advanced in recent years by incorporating insights from psychology and other social sciences. In that respect, many questions concerning the efficiency of legal rules and norms are still open and respond to a multifaceted balance among diverse costs and benefits. The role of courts in explaining economic performance is a more specific area of analysis that emerged in the late 1990s. The relationship between law and economic growth is complex and debatable. An important literature has pointed to significant differences at the macro-level between the Anglo-American common law family and the civil law families. Although these initial results have been heavily scrutinized, other important subjects have surfaced such as convergence of legal systems, transplants, infrastructure of legal systems, rule of law and development, among others.

Keywords: law and economics, common law, business law, courts, legal families, rule of law, economic growth

What Is Law and Economics?

There has been long-standing discussion about the nature of law and economics, particularly the extent to which law and economics and economic analysis of law are the same thing. Those who argued for a distinction between law and economics (as a discipline of law) and economic analysis of law (as an applied field of economics) so many decades ago might be surprised about subsequent developments. The field has flourished consistently since the 1970s. It is now a fertile area of specialization for both legal scholars and economists.

Law and economics uses the methodology of microeconomic theory to investigate two fundamental questions: a positive question about the impact of laws and regulations on individuals’ decision-making and the consequent implications for social welfare (that is, law and economics is about predicting how individuals will react to legal norms and institutions), and a normative question concerning the relative advantages of laws in terms of efficiency and social welfare (that is, efficiency is a valid normative principle for evaluating law). To answer these two questions, law and economics makes use of standard principles of microeconomic analysis, namely demand theory. It is known that microeconomic analysis makes certain simplifying assumptions─namely, that individuals respond to incentives and make their decisions rationally, comparing costs and benefits, given all the available information. It does not mean that individuals are necessarily selfish, but that it is unlikely that they are consistently prone to misjudgments in a particular direction. More recent developments have relaxed the assumption of full rationality to adopt a more realistic, limited rationality assumption in the context of so-called behavioral law and economics. Another important feature of the economic model is that the welfare of society is measured by aggregating the individual welfares of its members (Shavell, 2004). This approach has been widely criticized and discussed in the literature (Kaplow & Shavell, 2002).

By the early 21st century, law and economics had become one of the most influential methodologies in American legal thinking. The origins of the field can be traced back to the 18th and 19th centuries─for example, in the writings of Bentham (1789)─but economic analysis of law gained notoriety with articles by Nobel laureates Ronald Coase (1960) and Gary Becker (1968), and the books of Guido Calabresi (1970) and Richard Posner (1972). Since the 1960s, law and economics has expanded to all areas of the law, starting with the areas of more obvious economic significance (antitrust and regulation, tax, corporate governance, bankruptcy, and employment) to the hard core of legal studies (contracts, tort, property, crime, and civil and criminal procedure) and new areas of the law (such as family law, environmental law, or constitutional structure). Comparative law is no exception (Garoupa & Ginsburg, 2012).

The starting point is the Coase Theorem, introduced by Ronald Coase (1960). Before his article, economists defended the position that externalities (external effects to particular market transactions), such as pollution, should be addressed by appropriate taxation (which requires government intervention). Coase changed the analysis by focusing on the role of bargaining and transaction costs in determining efficiency within a certain entitlement imposed by law (Miceli, 2017). In a world of zero transaction costs and well-defined legal rules (plus a few other less important technical assumptions), a Coasian bargaining guarantees efficiency. In such a world, law is about specifying initial entitlements, guaranteeing costless enforcement and possible redistribution (since initial entitlements do not affect efficient outcomes but do shape redistribution). However, in a world with transaction costs, different legal regimes may have varying consequences on efficiency (Calabresi & Melamed, 1972). Transaction costs are the costs of making and enforcing the transaction of initial entitlements (Wittman, 2006). Examples include negotiation costs and agency costs (monitoring, enforcement, and avoidance).

The next building block is Kaldor-Hicks efficiency. In a very general way, this principle suggests that changes in legal policy are efficient if gains exceed or compensate losses (Miceli, 2017). Thus, after exhausting all possible modifications that satisfy the Kaldor-Hicks principle, the emerging law should maximize social welfare (that is, aggregate wealth). However, unlike the Pareto principle, the Kaldor-Hicks approach does not claim consensual exchanges. The Pareto principle demands that no one can be made better off without making someone else worse off. Therefore, as long as there are Pareto improvements (making someone better without making someone else worse), social welfare has not been optimized. However, Kaldor-Hicks efficiency guarantees that social welfare is maximized, but not that everyone is in a better-off world. It shows that, under the most efficient law, the winners could potentially compensate the losers. It has been said that the Kaldor-Hicks principle is about implied consent, thus replacing actual consent under Pareto efficiency.

This article reviews the main literature in law and economics, with a focus on the core areas of common law. The priority at the micro-level is where contributions have been made to different areas of the law. The next part of the discussion looks at the macro-level, where economics has addressed the importance of legal families and courts in determining economic outputs. In that regard, the article follows closely Garoupa and Ginsburg (2012), but with a more general, rather than specifically comparative, view.

Economic Analysis of the Law

Contracts

Law and economics develops the perspective that contractual parties engage in mutually beneficial exchanges that are efficient in nature. Contracts are stipulated to enhance the occurrence of such transfers. However, since they take place in a context of imperfect or asymmetric information, it is possible that at some point the social benefits do not justify the social costs of performance, raising the possibility of optimal breach. Law and economics investigates the extent to which remedies for nonperformance induce optimal breach, in particular specific performance and damages (Shavell, 2004).

Courts should adopt contractual remedies that promote breach only when it is efficient to do so. Unlimited expectation damages are usually inefficient because they generate incentives for appropriate reliance but also inappropriate risk sharing. Therefore, limited expectation damages are usually better. By the same reasoning, mere reliance damages are generally insufficient. Specific performance emerges as an efficient remedy for specific assets (that is, unique goods and services) because it tends to lower transaction costs and to protect subjective value. Liquidated damages are an example of a remedy negotiated by the parties. Since court-designed remedies are costly to enforce and require information (that is, courts make mistakes), law and economics suggests that liquidated damages should be enforced, since they support credible commitment by the parties and reflect an effort to maximize the value of the contract (Miceli, 2017).

One important aspect of contractual law that has deserved attention by legal economists is disclosure rules. Since asymmetric information might chill efficient transactions or promote inefficient exchanges, disclosure of information is relevant. However, the nature of the information matters for assessing rules. For example, casually acquired information makes the disclosure rule irrelevant for efficiency. The opposite example is deliberately acquired information (which presupposes some cost). Purely distributive information should require disclosure (at the penalty of rescinding), while socially valuable information does not require disclosure (contract should be enforced). These rules enhance the production of socially useful information while discouraging a costly search for purely distributive information. In particular, mandatory rules of disclosure make information a public good, hence generating suboptimal contracts (Miceli, 2017).

The question of monetary damages versus specific performance has deserved attention from a comparative perspective, given the general sense that Anglo-American legal systems tend to prefer monetary damages, whereas civil law jurisdictions seem to favor specific performance, even under conditions that make it unlikely to be efficient. Other important issues in contract law that have deserved attention from legal economists include precontractual liability in the context of the efficient breach theory, disclosure of information prior to contract formation, and regulation of cooling-off periods.

Family law and economics sees marriage as a long-term contract and applies economic principles to understand optimal regulation of divorce (which can be viewed as a breach of the marriage contract). Property division, spousal support (alimony), prenuptial contracts, and fault regimes have been discussed from an efficiency perspective (Wittman, 2006).

Torts

The economic perspective on torts looks at the most efficient way of deterring accidents. Remedies and liability rules are assessed from the perspective of the benefit in avoiding accidents or tort wrongdoings (hence, deterring their occurrence) and the cost of prevention. Compensation of victims is discussed from the perspective of internalizing accident costs and providing the adequate incentives to potential tortfeasors (Shavell, 2004).

The literature uses the unilateral care model for pedagogical reasons. Suppose there is a dollar investment in precaution spent by the injurer, a probability of an accident that varies with precaution, and damage suffered by the victim. The social optimum would be a level of precaution that minimizes its cost plus the expected damage for the victim. Under a no-liability rule, the injurer would spend zero dollars, which is clearly inefficient. Therefore, strict liability emerges as an efficient solution, since it forces the injurer to internalize the costs of wrongdoing. What about negligence rules? They are optimal in the unilateral care model because there is only one source of causation—the injurer’s behavior. These results can be framed under the Hand Rule formulated by Judge Learned Hand in 1947 (Miceli, 2017). He argued that if the burden (of avoiding a wrongdoing) is less than the expected damage imposed on the victim, then the injurer should be liable.

Different negligence rules can be assessed in the bilateral care model. Strict liability is no longer efficient, since it creates a moral hazard problem (victim free rides on the injurer’s compensation). Contributory negligence is now economically more sensible since it balances the injurer’s costs of precaution against the victim’s cost of avoiding an accident. It turns out that the final result depends on the due care standard (that is, the switch point between strict liability and no liability for the injurer). If correctly specified, it can be proved that a contributory negligence rule is efficient.

Extensions of the basic accident model (activity levels, participation costs, learning, different forms of causation, scope of liability, and judgment-proof issues) complicate the analysis and highlight that both strict liability and different negligence rules (contributory negligence, strict liability with contributory negligence, comparative negligence, sharing negligence, and other variations) have efficiency shortcomings. For example, while strict liability does not require any particular knowledge about the appropriate due care standard, a negligence rule begs a court that is not prone to error. Without both correct estimation of the injurer’s actual precaution and due care standard, a negligence rule inevitably introduces legal error—false positives (wrong convictions) and false negatives (wrong acquittals). These additional costs of legal error have to been added to the costs of prevention.

Punitive damages have attracted attention by legal economists. As opposed to compensatory damages, punitive damages exceed the harm suffered by the victim. The economic rationale is that compensation to the victim is not certain. Therefore, in order to impose the correct cost-benefit analysis to the injurer, expected damages might have to equal the harm. Under such condition, actual damages should equal the harm divided by the probability of paying damages (the multiplier principle). Punitive damages, in this analysis, play the adequate role of capturing the less-than-one probability of paying damages faced by the injurer.

A related issue is the decoupling between damages paid by the injurer and award received by the victim. The economic reasoning is clear—there are two goals (setting the levels of precaution for injurer and victim) and one instrument (level of compensation). Therefore, the possibility of separating damages and awards emerges as a viable solution. The more controversial discussion is about an efficient policy concerning the difference between what the injurer pays and what the victim receives, being positive (damages are taxed and split between victim and government) or negative (requires a subsidy by the government to the victim).

In a more comparative law analysis, Anglo-American tort doctrines have been compared to the civil law of obligations, and the way incentives are shaped in that context has been debated. Among the relevant topics addressed in the literature are tort law, product liability, the different approaches to strict liability and negligence rules across jurisdictions (for example, the Good Samaritan rule, mitigation of damages, and last clear chance), quasi-contracts, gestion d’affaires (a particular form of quasi-contract under French law by which the actions of one individual benefit another individual), the principle of non-cumul in contractual and tort liability (Ogus, 2006; under French law, contractual and tort liability cannot be challenged at the same time), and pure economic losses (with traditional limited recovery).

Torts are negative externalities, hence the focus of an economic analysis is on liability rules that force injurers and victims to act efficiently. However, there are positive externalities. Yet negative liability rarely exists (as regulated by the law of restitution). The explanation is mainly administrative costs. Transaction costs and potential coordination issues may justify why restitution is limited (Wittman, 2006).

Property

From the viewpoint of law and economics, property law should be designed to ensure maximization of property value, both in terms of transactions and use as collateral for development of capital markets. Moreover, following the basic insight of Coase (1960), the establishment of adequate entitlements and the adoption of legal rules that reduce transaction costs will help in the necessary bargaining to internalize externalities.

Under consensual transfer of property, in a world of costless information, rules should favor the original owner (a property rule prevails—all transfers are voluntary and require some form of consent). However, since information is costly, legal protection of original ownership should be incomplete (a liability rule could be efficient—involuntary transfer is allowed occasionally, but the original owner is compensated). Therefore, when facing competing claims by the current possessor and a claimant (presumably the original owner), protection of property titling has to balance incentives (possible moral hazard concerns) and risk sharing. The result may require a combination of rules (a pliability rule—an entitlement protected by a property rule as long as some conditions apply turns into a liability rule when such conditions disappear). For example, the treatment of a bona fide purchase has to take into account the costs of prevention (by the original owner) against the costs of titling search (by the new buyer), thus resulting in complex arrangements (Ogus, 2006).

The law and economics of property emphasizes consensual exchange as the primary mechanism in achieving allocative efficiency. Nonconsensual transfers attract attention when there are high transaction costs or significant externalities. Adverse possession, for example, should be understood in this context. It is a form of coercive transfer of property between private individuals. However, it does provide for important incentives—it deters the owner from neglecting the property and it reduces uncertainty in time (by arranging for statutory limitations).

Government takings are also an interesting example. Law and economics introduces an economic meaning to just compensation. It cannot be too low, because it would foster too many takings (since the government would not bear the actual cost of a taking) and underinvestment in development by current landowners. It cannot be too high (full compensation), because there would be overinvestment in development (moral hazard). A possible rule would be: no compensation is paid if the taking is efficient and full compensation should be paid if the taking is inefficient (Miceli, 2017).

The fact that property law varies across jurisdictions has naturally attracted the attention of legal economists to assess the extent to which certain aspects of property law are more or less efficient. A fundamental issue is of course titling of property around the world─namely, recording versus registration (Arruñada & Garoupa, 2005). One other significant topic is the rise of anticommons (that is, a single resource with numerous rights holders who can prevent others from using it by opposition to commons, a single resource with too many users) and its consequences for property market and investment (Heller, 1998).

Litigation and Civil Procedure

There is a serious divergence between the private and the social motivation to litigate. Each party cares about the estimated benefit from litigation and the respective private costs. Society cares about the extent to which litigation incentivizes compliance with the law and helps the development of the legal system through articulating efficient rules. From this perspective, the rules of civil procedure and the institutional framework where litigation takes place should reduce transaction costs (thus favoring cheaper out-of-court settlements) and align the private interests of the litigants with the social-welfare-maximizing goals.

Litigation generates transaction costs. From an economic viewpoint, the puzzling question is why trials occur. Plaintiff and defendant save on trial costs if they reach a settlement out of court, but settlements do not always occur. There are two explanations for why (a small fraction of) cases end up in trial. Litigants may have different opinions about the outcome of trial (for example, optimism bias) or they may have private information about the case (a standard case of asymmetric information). Both models point to the same reasoning—a disagreement between plaintiff and defendant that undermines the possibility of a settlement (Miceli, 2017).

Procedural rules, such as pretrial discovery or standard of proof, can be assessed within the two models of litigation. In the context of differing perceptions, procedural rules should be used to promote convergence of beliefs and facilitate settlement. In the context of asymmetric information, procedural rules should be evaluated for the extent to which they approximate information sets. For example, disclosure of evidence promotes convergence of beliefs and reduces asymmetry of information. However, it could also dissuade production of evidence by plaintiff or defendant.

Rules for allocating legal expenses have been considered by legal economists. Under the American rule, each side pays their own legal costs. Under the English rule, the loser pays all. Under Rule 68 of the Federal Rules of Civil Procedure, a plaintiff who rejects a formal settlement offer by the defendant and later obtains a less favorable judgment pays the defendant’s legal costs (post offer). Which of these rules promotes settlements? Rule 68 is clearly designed to favor settlements by making trial more costly to the plaintiff. Still, it also shifts settlement amount in favor of defendants. The English versus American rule depends on the specifics of the analysis. If plaintiff and defendant are extremely optimistic, we should expect more trials under the English rule (because both sides think the legal costs will be borne by the other side). However, if both plaintiff and defendant exhibit significant aversion to risk, the American rule might induce more trials (since both sides are exposed to less risk). However, once legal costs are endogenous to the rules for allocating legal expenses, the analytics are complex and are driven by varying parameters (Miceli, 2017).

Another important topic in this context is the use of contingent fees for paying lawyers. More generally, the rules for allocating costs between the plaintiff and the plaintiff’s lawyers also affect the outcome of litigation. When a fixed fee regulates the relationship between plaintiff and lawyer, the lawyer is paid regardless of the outcome. Under a contingent fee, a percentage (usually one third) of the award goes to the lawyer. The lawyer gets zero if the plaintiff loses (no win, no fee). A conditional fee usually involves a flat payment plus a percentage of the recovery. Economists like contingent fee arrangements because of incentives to work (avoid shirking), risk sharing, and access to justice (they allow poor plaintiffs to pursue lawsuits by using the value of the potential award as a collateral). However, there are concerns—issues with settlement, since both sides share risk (mainly, allocation of settlement authority), possibility of frivolous suits (because plaintiffs ignore the full cost of trial), and bilateral moral hazard (plaintiff and defendant may have limited incentives to disclose appropriate information to each other).

We should point out that settlements have intrinsic costs that should not be ignored in a more comprehensive analysis. Disputes in trial are important for the development of common law, for example. They may also be relevant for a general perception of the law and codes of social conduct. Therefore, the elimination of trials is not an optimal policy. A similar reasoning applies to alternative dispute resolution mechanisms. They may save costs and enhance the quality of adjudication. However, they may have a negative impact on legal development (a problem enhanced if outcomes are subject to confidentiality).

The regulation of class actions is also relevant. In many situations, the individual expected benefit from filing a lawsuit is too low, which could be a concern (because it fails to discipline potential defendants). The possibility of class actions internalizes this collective action problem by lowering participation costs and reallocating authority to one individual (the lawyer forming the class). The disadvantages of class actions include potential misalignment between plaintiffs and lawyer, asymmetric information within the litigant group, and the possibility of frivolous lawsuits.

Appeals are justified from an economic perspective as a means of error correction (Shavell, 1995) as well as a mechanism for improving lawmaking (Miceli, 2017; Posner, 1972). When appeals are not allowed, possible errors committed at trial go uncorrected. However, if appeals are allowed with no restriction, litigants might use them as part of a strategy to postpone legal obligations. Therefore, an appeal system should be understood as a separating device. Litigation costs, procedure, and rules of evidence need to be adjusted in order to address correction of errors in a cost-effective way.

Criminal Law and Procedure

Law and economics has suggested that efficient punishment should be a combination of high (costless) sanctions and low (costly) probabilities (Becker, 1968). However, the optimal expected sanction does not equal the harm imposed on the victim because of enforcement costs. At the same time, harm-based fines are more appropriate than gain-based fines. When imprisonment is available, it should be used only after the deterrent effect of fines has been exhausted (because nonmonetary sanctions are costly, while monetary sanctions can be considered costless transfers).

The economic literature has developed several reasons to temper the use of maximal fines, including risk aversion, enforcement errors, avoidance activities, incentives for potential victims, displacement effects, the possibility of corruption, and other complex interactions. One immediate argument is marginal deterrence. If there are possible sequential decisions concerning compliance with the law, but the first offense gets the maximal fine, there is no additional cost for a second and subsequent offenses. Therefore, the optimal punishment must be such that one offense incurs a lower fine, while many offenses are punished with more severe fines (Stigler, 1970).

Criminal procedure establishes the rules under which criminal law is litigated. From the viewpoint of the economic theory of optimal law enforcement, criminal procedure should be designed to achieve efficient deterrence at minimal cost (Shavell, 2004). Topics include inquisitorial versus adversarial criminal procedure, the role of prosecutors, the principle of double jeopardy, mandatory disclosure rules, rules against self-incrimination, the bail system, and private enforcement (Miceli, 2017).

The introduction of plea bargaining has been the object of economic analysis. On the one hand, it reduces the costs to the criminal justice system (by replacing criminal trials with negotiated outcomes) and allows better allocation of judicial resources. It also reduces risk (both prosecutor and defendant bypass the jury). Under some circumstances, a plea-bargaining mechanism could also be used to induce a separating strategy between guilty and innocent defendants (hence, part of a signaling game). However, on the other hand, apart from other possible concerns, plea bargaining decreases deterrence (by reducing expected punishment).

Corporate Law and Governance

Corporate law and economics has probably attracted the most attention from legal economists. There is extensive literature on the economic reasoning and consequences of the different legal frameworks regulating how companies are formed, investors operate, and managers make decisions. The way legal systems have tackled the separation of control and ownership varies considerably, and it has been at the heart of the debate. In particular, the advantages and disadvantages of the Anglo-American market-based system (disseminated ownership) versus the long-term large investor model of Germany (concentrated ownership) have been widely debated (Hansmann et al., 2004). Economic reasoning for limited liability of stockholders, the different role of bondholders (debt versus equity), and the rules of corporate governance addressing agency costs are standard topics in this discussion. Another area that has been addressed is the significant differences in the legal treatment of trusts (Mattei, 1997).

Recent literature has developed a new field called law and finance that investigates the extent to which corporate performance, ownership, and organization are influenced by potential legal determinants (La Porta, Lopez de Silanes, & Shleifer, 1999; La Porta, Lopez de Silanes, Shleifer, & Vishny, 1998, 2000) or what particular forms of law enforcement provide a more successful regulation of the market for securities (La Porta, Lopez de Silanes, & Shleifer, 2006).

Other Areas of Business Law

The sharp contrast between corporate and personal bankruptcy law in the United States has raised questions concerning the economic adequacy of each model. Corporate reorganization, liquidation, and a fresh start in the American tradition and the extent to which employment goals should prevail in bankruptcy in the French tradition have been analyzed by legal economists (White, 1996). At the same time, the differential use of bankruptcy law and its effects on credit markets, contractual performance, and business environment have deserved attention (Ayotte & Yun, 2009). Finally, the identification of successful procedural and substantive rules of bankruptcy has been related to the broader issue of legal origin (Djankov, Hart, McLeish, & Shleifer, 2008).

Alongside corporate and bankruptcy law, antitrust law and economics is the field that more rapidly has been under the scrutiny of law and economics. It includes the neoclassical analysis of monopolies and oligopoly models as well as natural monopoly and price regulation. Specific substantive issues (concerning cartel behavior, unilateral conduct, and mergers and acquisitions) and procedural approaches (judicial versus administrative enforcement of competition law) have been at the heart of economic analysis. For example, optimal fines, per se rule versus the rule of reason, market contestability, and the treatment of intellectual property (patents create a monopoly) have generated an extensive economic literature (Miceli, 2017).

Courts and Economic Performance

Economic analysis has also been used to understand issues related to the structure of legal systems and the incentives of legal actors who work within the system (Garoupa & Ginsburg, 2012).

Efficiency of Common Law

The efficiency of common law generated discussion in law and economics early on (Posner, 1972). The main argument is that there is an implicit and consistent economic logic to common law. Under the theory proposed in the seminal book by Richard Posner (1972), the doctrines in common law provide a coherent system of incentives inducing efficient behavior, not merely in explicit markets, but in all social contexts (the so-called implicit markets). For example, common law reduces transaction costs to favor market transactions when that is appropriate. Quite naturally, not all doctrines in common law are economically justifiable or even easy to understand from an economic perspective. To be exact, law and economics does not offer a complete and exhausting theory of common law, but the original view is that it offers a balanced and significant explanation. A remarkable literature emerged as a consequence of this proposition. Legal economists proposed different and ingenious explanations (Garoupa, Gómez, & Melon, 2016).

One immediate explanation for the efficiency of common law hypothesis is that judges and courts have an inherent preference for efficiency. If judges pursue efficiency as the goal of law, it is no surprise that common law is efficient. However, this does not seem to be a convincing argument. Why would judges care about efficiency rather than equality or other possible goals? A second possible explanation is that efficiency is promoted by the prevalence of precedent; more efficient rules are more likely to survive through a mechanism of precedent (Rubin, 1977). Another explanation relies on the incentives to bring cases and the role of court litigation, since inefficient rules are not welfare maximizing (Priest, 1977). Nevertheless, the two explanations require a particular combination of case litigation in order to derive an efficient outcome (Miceli, 2017).

The efficiency of common law must be unequivocally related to the observation that litigation follows private interests. Presumably, it is true that bad rules are challenged more often than good rules, so naturally court intervention could improve the overall quality of the law. However, this line of reasoning is not without problematic shortcomings. It could be that the subset of cases that are actually litigated are not representative enough to trigger the necessary improvements, hence biasing evolution of legal rules against efficiency (Hadfield, 1992). Furthermore, the emergence of efficiency in common law necessarily depends on a number of factors in the evolutionary mechanism, namely initial conditions, path dependence, and possible random shocks (Roe, 1996).

More recent work has provided a more comprehensive analytical framework to show under which precise (mathematical) conditions the evolution of common law tends to efficiency. For example, even if judges are ultimately efficiency-seeking, precedent and overruling must be balanced in an appropriate way. Judicial bias could distort the law in the short run but at the same time could provide the mechanism to improve the law in the long run, depending on critical elements of the evolution of common law (Gennaioli & Shleifer, 2007). The possibility of selective litigation driven by private interests (likely to be misaligned with social interests) just makes the whole process more complex; convergence to efficiency is still possible as long as the biases are not overwhelming to the point of hurting the likelihood that inefficient laws will be more often litigated. Naturally strong precedent could be socially valuable if judges are significantly biased (Miceli, 2009).

The more technical explanations have been essentially evolutionary models that identify the forces that have shaped common law in order to generate efficient rules (Garoupa et al., 2016; Rubin, 2005). A different perspective on the efficiency of common law comes from the distinction between judge-made law and statutes. In particular, it has been suggested that statute law is intrinsically less efficient than judge-made law. One of the main arguments for the superiority of case law is that private interests are more likely to capture the legislature than the courts (Crew & Twight, 1990; Rubin, 1982). However, others have contested this argument (Tullock, 1997; Zywicki, 2008).

An appropriate combination of judicial precedent and statute rule is likely to be the efficient outcome (Parisi & Fon, 2009; Ponzetto & Fernandez, 2008). Nevertheless, while the literature tends to discuss efficiency of common law as demand-side-induced (i.e., through the incentives provided by litigation and procedure), there are concurring supply-side explanations. According to this version, the historical competition between common law and equity courts was the driving force; once these courts were merged and a jurisdictional monopoly was achieved, the efficiency forces lost stimulus (Klerman, 2007; Zywicki, 2003). This reasoning can equally be applied to the evolution of civil law (Garoupa et al., 2016).

Legal Families and Economic Growth

At the macro-level, the economic literature has investigated the hypothesis that the common law system is particularly conducive to economic growth in opposition to civil law. This is a vein of literature essentially empirically oriented (La Porta, Lopez de Silanes, & Shleifer, 2008; Mahoney, 2001). This new literature defends the notion that legal systems that originated in the English common law have institutions for sustainable economic growth and development superior to those of French civil law. According to the proponents of this view, there are essentially two reasons for the links between common law and economic growth. First, common law provides more adequate institutions for financial markets and business transactions generally, which in turn fuel more economic growth. These institutions may include more efficient substantive rules, as well as mechanisms by which common law tends to develop such rules. Second, civil law presupposes a greater role for state intervention that is detrimental to economic freedom and market efficiency, hence less conducive to economic growth. The relationship between growth or economic performance and the legal system carries an implicit assumption: law and legal institutions matter for economic growth. This has been a driving idea of institutional economics for decades (North, 1991), but it is nevertheless debatable (Acemoglu & Johnson, 2005; Acemoglu, Johnson, & Robinson, 2001). In particular, within a legal system, property-related laws seems more relevant than contract-related laws (the argument being that individual actors can negotiate around bad contract law).

The alleged bias of common law has been challenged. The thesis that civil law is less effective than common law in protecting property rights from state predation has been disputed (Arruñada, 2003; Arruñada & Garoupa, 2005). Even the empirical evidence has now been revised, and no significant bias favorable to economic growth is found (Oto-Perálias & Romero Ávila, 2014). Stability of the law is another possible argument favoring judge-made law with deference to precedent instead of systematic and chaotic legislative production. However, in this respect, when subject to empirical analysis, it is not clear that case law is more stable than legislation (Cross, 2007). In addition, the argument that common law is more stable undercuts other claims that the mechanism for its efficiency lies in the selection of disputes for litigation (Rubin, 2005).

Another possible channel by which common law might support growth is the enhanced willingness in common law jurisdictions to allow choice of law. But globalization of business transactions has exerted enormous pressure for change in civil law jurisdictions in this respect. Overall, it may well be that common law is more efficient and positively correlated with economic growth, but the causation remains undertheorized to a larger extent (Cross, 2002). The mechanism for the efficiency of common law versus civil law is intrinsically convoluted and debatable. Furthermore, the analysis is complicated by the fact that it is now largely the model for legal reform, as embodied by the Doing Business program promoted by the World Bank. There are good reasons to be careful about the implications of the Doing Business reforms in the economy (Garoupa et al., 2016).

Convergence of Legal Systems

Legal economists have entered the debate about the convergence of legal systems and the role of harmonization. When there is freedom of choice about the legal regime to be used, competition between legal systems will emerge (O’Hara & Ribstein, 2009). Consequently convergence is expected in facilitative areas of the law, whereas divergence due to different local preferences could be sustainable in interventionist areas of the law not subject to market pressure (Garoupa & Ogus, 2006; Ogus, 1999). This would be true so long as jurisdictions are unconstrained to adopt rules and have good information about the effects of alternative arrangements.

Divergences of legal systems are not necessarily a sign of inefficiency. There is no reason to think that there is only one single efficient rule for every legal problem (Ogus, 1999). Yet, there are obstacles to convergence that result from local rent-seeking (essentially by the legal professions), legal culture, and other forms of transaction costs (Garoupa & Ogus, 2006; Ogus, 2002).

Transplants

Legal transplants raise two significant economic questions. First, about the extent to which a given jurisdiction will prefer to merely adopt a solution already available in a different jurisdiction rather than develop their own rule (incurring the possibility of rediscovering the wheel). The development of internal rules or the adoption of transplants responds to a trade-off between benefits in terms of facilitating international interaction (economic or otherwise) and the internal costs of legal consistency and local preferences (Garoupa & Ogus, 2006). The existence of a strategic motivation that ignores externalities derived from the adoption of particular transplants may generate an inefficient level of transplant adoption (Garoupa & Ogus, 2006).

The second set of issues involves what legal systems or legal families are more prone to import or export legal rules successfully. It has been argued that the local conditions for transplanting and adopting a particular law are more important than the supply from a particular legal family. Predisposition and familiarity with the transplanted laws are more important than legal origin in ensuring effective transplants (Berkowitz, Pistor, & Richard, 2003).

Rule of Law and Development

Rule of law is expected to be associated with legal certainty, an independent judiciary, and serious limits to both private and state expropriation. A positive correlation is anticipated between a high adherence to rule of law, investment, and measures of economic development (Kaufmann, Kraay, & Mastruzzi, 2008). Although generally there is a strong relationship between rule of law and economic development, the reasons are debatable once we recognize that the fastest growing economies do not have an effective court system (Cooter & Schäfer, 2012; La Porta, Lopez de Silanes, Pop Eleches, & Shleifer, 2004). The interaction between rule of law and economic development may be more complex than initially anticipated. To a large extent, the direction of causation is still unclear (Glaeser, La Porta, Lopez de Silanes, & Shleifer, 2004). The economic approach to rule of law and development has been criticized for not taking into account specific institutional and legal arrangements (Cooter & Schäfer, 2012; Trebilcock & Mota Prado, 2014).

Infrastructure of the Legal System

Every legal system is based on an infrastructure of legal actors (Hadfield, 2016). As central actors in any legal system, judges are an understandable focus of economic analysis. One appropriate distinction is between “career” judiciaries, in which judges serve in a bureaucratic hierarchy for an entire career, and “recognition” judiciaries, in which judges are appointed to the bench relatively late in life (Garoupa & Ginsburg, 2012). These systems can be distinguished as emphasizing different forms of monitoring agents: the career system emphasizes ex post controls on judicial decision-making, while the recognition system involves ex ante screening of agents (Garoupa & Ginsburg, 2015; Posner, 2005).

The incentives provided by different institutional audiences and the way different legal systems tackled them have also been addressed from an economic perspective, particularly selection mechanisms (Garoupa & Ginsburg, 2015). Such work has suggested a more nuanced approach than relying on the traditional common law−civil law distinction, examining micro-incentives, and distinguishing judiciaries even within the same legal tradition (Posner, 1996).

An economic perspective on the legal profession and the structure of law firms has looked at entry regulation, legal fees (the existence of contingent and conditional fees, in particular), organization of law firms, the regulation of publicity and information disclosure about legal services, and rules of conduct (Garoupa, 2014).

Important differences in legal education and legal scholarship have been the object of economic analysis. Rather than relying exclusively on cultural preferences and path dependence, legal economists use incentives and a market approach to understand why legal education and the production of innovations in legal analysis have been persistently different across the world. A particular topic of interest is the asymmetric influence of law and economics in legal thinking in different jurisdictions (Grechenig & Gelter, 2008). Generally speaking, it is safe to say that law and economics has been more influential in North America than in other regions of the world, and this fact itself is an interesting question for analysis.

To date, there has date been relatively less work on prosecutors. In an underresourced environment, we should expect that prosecutors will bring only the cases they are likely to win. A high conviction rate thus may provide insight into prosecutor incentives as well as judicial propensities. Risk aversion and career goals also vary across legal systems (Garoupa, 2009, 2012).

Public Choice and the Courts

Constitutional law and economics overlaps significantly with public choice theory (Cooter, 2000). The two fields share a focus on the role of rules in structuring and constraining decision-making, shifting the debate from choice within rules to the choice of higher-order rules. Constitutions are generally viewed as devices for minimizing agency costs. By establishing structures that prevent capture by certain interest groups, constitutions can ensure superior governance. Another tradition emphasizes the role of constitutions in constraining intertemporal choice through some form of precommitment (Cooter & Gilbert, 2018).

As noted before, lawmaking varies across legal families. This raises a question about the efficiency of a particular mix of statute law or codification with judge-made law. In other words, it is debatable if there is a “one size fits all” lawmaking efficient arrangement. Depending on preferences, the role of precedent, and idiosyncrasies of a particular legal system, different mixes of case law and statute law can be efficient (Garoupa et al., 2016). Public choice considerations look at the specific structure of lawmaking, codification versus judge-made law, but also at customary law and international treaties. They focus on the role of rules (which are rigid and specific), standards (which are less rigid, with a wider range of discretion, but are subject to exhaustive considerations), and principles (which are subject to general and non-exhaustive considerations), timing, private interests, capture, and the political process (Parisi & Fon, 2009).

Game Theory and the Courts

Game theory has been a tool for explaining judicial independence. Two fundamental theories have emerged: delegation explanations (for unpopular policies, enhancing political payoffs, or helping the legislature to monitor the executive branch), and political insurance against future losses. Uncertainty concerning the outcome of policies plays a significant role in promoting judicial independence (Vanberg, 2015). However, the game theory approach requires certain conditions, including a competitive political process, a sufficiently long time horizon, and the responsiveness of judicial rulings to political competition. Judicial independence has also been the focus of some important empirical work (La Porta et al., 2004; Melton & Ginsburg, 2014; Ramseyer & Rasmusen, 2006).

Conclusion

Law and economics is a growing field that applies the economic method to legal analysis. It now has a consolidated body of legal theory that makes use of efficiency analysis to understand property, contracts, torts, litigation and civil procedure, criminal law and procedure, business law, and so on. At the same time, the role of courts and economic performance has emerged in the late 1990s as a fundamental area of study. The important empirical literature that points out significant macro-level differences between the Anglo-American common law family and the civil law families is still under scrutiny. The relationship between law and economic growth is complex and subject to debate.

The use of economics as a methodology for understanding law and legal institutions is not immune to criticism. Since the early work, in particular the comprehensive book by Posner (1972), the rationality assumption and the efficiency principle have been severely debated. The assessment of the rule of law and legal families in terms of economic performance has received a cold shoulder by comparativists and other legal scholars. The original economic methodology of law and economics has now evolved into a plurality of methodologies (Ulen, 2017). The narrower microeconomic theory that supported the early years of law and economics now coexists with new insights from psychology (e.g., behavioral law and economics; Jolls, Sunstein, & Thaler, 1998; Wilkinson-Ryan, 2017) and sociology (e.g., law and economics of social norms or expressive law and economics; Carbonara, 2017; Cooter, 1998; Posner, 2000). At the same time, public choice theory (Farber, 2017; Frickey & Farber, 1991) and game theory (Baird, Gertner, & Picker, 1998; Hanson, Hanson, & Hart, 2014) have made their way into law and economics. It seems the future of law and economics is not only promising but also challenging, as ongoing important legal questions beg for creative answers.

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