Two Normative Approaches to Law & Economics
Design the law to:
1) Minimize the cost of bargaining
- Normative Coase: “Structure the law so as to remove the impediments to private bargaining”
2) Minimize the need for bargaining
- Normative Hobbes: “Structure the law so as to minimize the harm caused by failures in private agreements”
Two Normative Approaches to Law & Economics
- Compare the costs of each approach
- Normative Coase: cost of bargaining, lubricate private exchange
- Normative Hobbes: information costs of determining how to efficiently allocate property rights
When transaction costs are low and information costs are high, structure the law so as to minimize transaction costs
When transaction costs are high and information costs are low, structure the law so as to allocate property rights to whomever values them the most
What Would an Efficient Property Law Look Like?
- Recall the 4 questions any property system must answer:
What can be privately owned?
What can (and can't) an owner do with her property?
How are property rights established?
What remedies are available when property rights are violated?
What Would an Efficient Property Law Look Like?
- Recall the 4 questions any property system must answer:
What can be privately owned?
What can (and can't) an owner do with her property?
How are property rights established?
What remedies are available when property rights are violated?
Some Common Law Terms & History
Legal remedy: focuses on relief via payment of money compensation for damages to “make the Plaintiff whole”
- grew out of Courts of Law
Equitable remedy: an order by the court to provide relief requiring the Defendant perform (or refrain from) some action
- grew out of the Court of Chancery, originally made to streamline
- most typically, an injunction which enjoins party to (not) perform a specific action
A court ruling on a case may provide both types of relief
- Note legal remedies are “backward-looking” vs. equitable remedies are “forward-looking”
Some Common Law Terms & History
We often summarize by referring to the difference between:
“Property rule”: equitable relief for appropriation, trespass, interfering with another's property
- More common in law of property
“Liability rule”: damages awarded for broken promises and accidents
- More common in law of contracts & torts
Applied to Our Farmer-Rancher Example
With Rancher's cattle straying onto Farmer's crops
Liability rule: Court may require Rancher to compensate Farmer for damages
Property rule: Court may enjoin Rancher from letting cattle trespass onto Farm (if Farmer found to have property right to be free of cattle's interference)
Calabresi & Melamed on Efficient Remedies
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
Guido Calabresi: Major figure in Law & Economics field
- 1994—2009 Judge of U.S Court of Appeals for the 2nd Circuit
- Yale Law Professor
A. Douglas Melamed: Stanford Law professor specializing in antitrust law; general counsel of Intel; antitrust lawyer
Along with Coase (1960), one of the first applications of a consistent framework to unify property, contract, and (esp.) tort law
Calabresi & Melamed on Efficient Remedies
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
How are property rights enforced? What remedies are used when rights are violated?
C&M: Treat property and liability law (different areas) under common framework
Both are cases of entitlements
- is the Farmer entitled to land free from trespassing animals?
- is the Rancher entitled to the natural actions of her cattle?
Three Ways to Protect Entitlements
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
Property rule/injunctive relief
- violation of entitlement punished as a crime (not mere restitution owed)
- but entitlement is negotiable (owner can choose to sell or not exercise the right)
Liability rule/damages
- violations of entitlement require compensation
- Defendant pays damages to make the Plaintiff whole
Inalienability rule
- violations are punished as a crime
- but entitlement cannot be sold or waived
Calabresi & Melamed on Efficient Remedies
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
What rule is more efficient?
- Again: with low transaction costs, Coase reminds is it would not matter!
But the different rules will still lead to different distributions, and there are transaction costs to worry about
Calabresi & Melamed on Efficient Remedies
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
Liability (damages) rule is more favorable to the Defendant (injurer)
- injurer has higher BATNA — has option to just violate and compensate
Property rule is more favorable to the Plaintiff (injuree)
- punishment is severe
- if two sides need to negotiate, injurer's BATNA is lower
Comparing Injunctive Relief to Damages: Example
Example: An electric company (E) emits smoke, which dirties the laundry at a nearby laundromat (L). Suppose:
- E earns profits of 1,000
- Without smoke, L would earn profits of 300
- Smoke reduces L's profits from 300 to 100
- E could install scrubbers to cease pollution at cost -500
- L could prevent smoke damage by installing a filter at cost -100
Comparing Injunctive Relief to Damages: Example
Example: An electric company (E) emits smoke, which dirties the laundry at a nearby laundromat (L). Suppose:
- E earns profits of 1,000
- Without smoke, L would earn profits of 300
- Smoke reduces L's profits from 300 to 100
- E could install scrubbers to cease pollution at cost -500
- L could prevent smoke damage by installing a filter at cost -100
Comparing Injunctive Relief to Damages: Example
- Consider the non-cooperative outcomes
- Polluter's rights (no remedy)
- E earns 1,000
- L installs filters, earns 300-100=200
Comparing Injunctive Relief to Damages: Example
- Consider the non-cooperative outcomes
Polluter's rights (no remedy)
- E earns 1,000
- L installs filters, earns 300-100=200
Laundromat has right to damages
- E earns 1,000-200=800
- L earns 300-200+200=300
Comparing Injunctive Relief to Damages: Example
- Consider the non-cooperative outcomes
Polluter's rights (no remedy)
- E earns 1,000
- L installs filters, earns 300-100=200
Laundromat has right to damages
- E earns 1,000-200=800
- L earns 300-200+200=300
Laundromat has right to injunction
- E installs scrubbers, earns 1,000-500=500
- L earns 300
Comparing Damages and Injunctions
Injunctions are generally cheaper for court to administer
- no need to estimate value of harm done
But damages are generally more efficient when bargaining is unlikely
| Damages | Injunction | |
|---|---|---|
| E payoff (non-coop) | 800 | 500 |
| L payoff (non-coop) | 300 | 300 |
| Joint payoff (non-coop) | 1,100 | 800 |
Comparing Damages and Injunctions
- In general, three possible outcomes: injurer prevents harm, injuree prevents harm, or nobody prevents harm (injurer pays damages for it instead)
- Efficient outcome is the cheapest of the three
- Damages: injurer can prevent harm or compensate for it, injurer chooses whatever is cheapest
- Injunction: injurer can only prevent harm
Summing Up Damages and Injunctions
So per Coase (1960), any rule leads to efficiency under no transaction costs
Injunctions are cheaper to implement
Damages lead to more efficient outcomes when transaction costs are high
Calabresi & Melamed on Efficient Remedies
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
When transaction costs are low, a property rule (injunctive relief) is more efficient
When transaction costs are high, a liability rule (damages) is more efficient
This is Consistent With Before
When transaction costs are low and information costs are high, structure the law so as to minimize transaction costs
- Property rule does this: clarify right and allow trade
When transaction costs are high and information costs are low, structure the law so as to allocate property rights to whomever values them the most
- Liability rule does this: give injurer right to violate entitlement when efficient, even without prior consent
Injunctive Relief for When Transaction Costs are Low
Cheaper for court to administer
With low transaction costs, we expect parties to bargain when right is inefficiently allocated
Injunctive Relief for When Transaction Costs are Low
Cheaper for court to administer
With low transaction costs, we expect parties to bargain when right is inefficiently allocated
But do they?
Injunctive Relief for When Transaction Costs are Low
“When transaction costs preclude bargaining, the court should protect a right by an injunctive remedy if it knows which party values the right relatively more and it does not know how much either party values it absolutely.”
“Conversely, the court should protect a right by a damages remedy if it knows how much one of the parties values the right absolutely and it does not know which party values it relatively more.”
Cooter and Ulen
Damages for When Transaction Costs are High
- Examine 20 nuisance cases; found no bargaining made after court judgment
“In almost every case the lawyers said that acrimony between the parties was an important obstacle to bargaining...Frequently the parties were not on speaking terms...The second recurring obstacle involves the parties’ disinclination to think of the rights at stake… as readily commensurable with cash.”
Farnsworth, Ward, 1999, “Do Parties to Nuisance Cases Bargain After Judgment? A Glimpse Inside The Cathedral”
Third Way to Protect Entitlements: Unalienability Rule
Guido Calabresi
1932—
Fmr. U.S. 2nd Circuit Judge
Inalienability: when an entitlement is not transferable or sellable (regardless of consent)
- Entitlement not see as “property”
Examples: sex, kidneys, cocaine, babies, nuclear weapons, votes
Often the result of statutes governing “health, safety, and morals” for the public good, paternalism
Unalienability
From a Coasian perspective, this does not appear to make sense
- Let people trade their entitlements as they please to achieve efficient allocation!
Does makes more sense in certain scenarios (when allocating rights imposes an externality)
Unalienability
- Example 1: enriched uranium
Unalienability
- Example 2: human organs like kidneys, lungs
Unalienability
- Example 2: human organs like kidneys, lungs
Unalienability
Thomas Jefferson
1743—1826
“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness”
1776, United States Declaration of Independence
Alternative Interpretation of Unalienability
Alvin Roth
1951—
2012 Economics Nobel
- “Repugnant markets”: exchanges made illegal because people find them morally or aesthetically objectionable
“Many Californians not only don’t wish to eat horses or dogs themselves, but find it repugnant that anyone else should do so, and they enacted this repugnance into California law… in 1998”
Roth, Alvin E, 2007, “Repugnance as a Constraint on Markets,” Journal of Economic Perspectives 21(3)
Alternative Interpretation of Unalienability
“Repugnant markets”: exchanges made illegal because people find them morally or aesthetically objectionable
Examples: Ticket scalping, price gouging, gambling, drugs, prostitution, dwarf tossing, paying for kidneys, babies, etc
Note what people find repugnant changes over time! (charging interest)
Summing Up Remedies
When transaction costs are low, use injunctive relief
- either rule will lead to efficiency (Coase)
- but injunctions are easier to implement
- Normative Coase: design law to facilitate exchange
When transaction costs are high, use damages
- if bargaining unlikely, damages lead to more efficient outcomes
- Normative Hobbes: design law to not rely on bargaining