Course:Law3020/2014WT1/Group P/Law As Efficiency

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Lady Justice

Efficiency and Law

When assessing the validity of the law, it has not been a common approach to understand legal mechanisms from a position grounded in economic theory. The economics theory to understanding law arose predominantly due to the United States, and has been greatly influenced by Richard A. Posner. The over-arching premise of this theory is that there must be efficiency in the law for the law to be valid. Efficiency is embodied through the Wealth Maximizing Principle. The application of economics to law requires us to view law through the concept of efficiencies, where efficiency is understood as a way to maximize the wealth of society. Wealth maximizing in the sense of law and economics is not to be equated necessarily with wealth in the monetary sense, but as “social wealth”. Social wealth includes monetary gains and losses, but also the ‘wealth’ generated by the satisfaction gained from goods being in the hands of those who value them most. In other words, social wealth accounts for the desires of the purchaser and the seller being fulfilled through an exchange or transaction. It is the accumulation of many exchanges and transactions – each increasing social wealth – that an efficient organization of society is achieved. The law becomes a mechanism for aiding the efficient exchanges that organize society.

As a result, it makes sense that Dimock presents the following claim in relation to law and economic theory: “Efficient rules are good rules, and efficiency is a normative value that ought to be promoted” (Susan Dimock, Classic Readings and Canadian Cases in the Philosophy of Law, 2001, Pg.117).

Pareto-Superior Exchanges and Maximizing Social Wealth

When efficient exchanges are made, both parties in the exchange experience a ‘win-win’ situation, meaning that net utility increases for both parties involved. This type of exchange is obviously preferred by law and economic theorists because of its efficiency, and is referred to as a Pareto-superior exchange. In a perfect world by law and economic standards, when as many Pareto-superior exchanges as possible have been made, society reaches a state where no further Pareto-exchanges are possible. This state is referred to as Pareto-optimal, meaning that to complete any further exchanges would result in a ‘winner’ and a ‘loser’, which would decrease social wealth. There are some problems with the theory regarding what distribution of monetary wealth is considered Pareto-optimal, but these are largely side-stepped by law and economic theorists recognizing that it is the job of others (such as philosophers) to define what exactly is or is not a Pareto-optimal state. By having non-law and economic theorists define the parameters of a Pareto-optimal state, a society divided by gross monetary inequality is avoided.

A Kaldur-Hicks exchange is the real world workaround adopted by law and economics theorists. In this scenario, so long as the gain experienced by the ‘winner’ of a transaction could theoretically compensate the ‘loser’, the gain is considered to maximize overall social wealth. This workaround was created to consider scenarios where one party imposes a loss on many others, but cannot realistically provide compensation. For example, factories may generate environmental pollution and spread the loss (living next to a polluted river) minimally across many individuals, who have not offered to participate in an exchange with the factory. The factory likely gains a great deal of monetary rewards for the loss it inflicts on those living next to the polluted river, but faces no obligation to compensate the ‘losers’ for the loss they suffer.

It is important to note that in a Kaldur-Hicks exchange, the compensation from the winner to the loser is never given. If compensation were given, the exchange would cease to be Kaldur-Hicks, and instead be a second type of Pareto-superior exchange. Kaldur-Hicks exchanges are a symptom of a messy reality imposing itself on the immaculate world of theory.

Four Angles of Law and Economic Theory

Dimock presents four different angles of law and economic theory, considering tort law, contract law, property law and criminal law individually. Some of these angles align better with the judgment from Egan v Canada than others. For instance, no property damage took place in the case, and no criminal conduct was involved, which relegates two of the angles of law and economics theory to a backseat role in this analysis.

In tort law, law and economic theory would have the court order the defendant to pay damages only if the cost to prevent the harm done is less than that of the probability and cost of the accident. This is because by the time a tort claim reaches the courts, the costs associated with the accident are sunk, and no longer recoverable. An efficient court then takes the most efficient action left available to it; it aims to decrease the occurrence of similar accidents in the future by altering the behavior of future citizens. The court alters the behavior of future citizens by imposing the cost of damages on the present defendant, future citizens are deterred from actions that could create a similar accident because they are aware of the monetary damages they may face.

In contract law, law and economics theory would encourage parties to facilitate efficient exchange. Under the economics framework, there is a greater amount of trust in the other party and this greatly encourages trade among members of society. Where more transactions are able to take place, there is a greater opportunity for the generation of social wealth.

The property law angle focuses on the societal value of protecting private property and the systems used to transfer title of the property. This angle is not focused on producing a society of equal property distribution or ownership. For law and economic theorists the barrier to efficiency and greater social wealth in society is not that citizens own unequal amounts or types of property, but that they face barriers to the exchange of property, such as transaction costs.

Criminal law demonstrates the net utility of a transaction of the Pareto-Superior quite effectively. When there is an infringement on a right or a law restricting a certain behavior, we are often told it is for the greater good of society, a phrase reminiscent of Natural Law. Yet, what is often implied in this phrase is that there has been a balancing of the infringement against the action and, if more people will benefit from the restriction than from the action, there is a demonstrated net utility.

Application to the Case

These examples give deterrents and incentives if it is efficient to do so, assuming that all people are rational. Discriminating against same-sex marriage does not seem efficient by these standards. By limiting spousal benefits to only heterosexual couples the legislation deprives one group without giving the ability to compensate to the other. This would fail both the Pareto-superior and Hicks exchange tests. Without even the opportunity to compensate same-sex couples in this scenario, the exclusion does not provide a true net utility and creates a highly one-sided transaction.

$5000 American Currency

The Majority in Egan did not see a need to compensate the gay community in reinforcing the heterosexual standard, even in the face of a section 15 Charter challenge. Arguably, legal economists would point out that the majority of the population is heterosexual. Therefore, if we are to apply the math formula presented by Posner in a free-market, the value of the definition, say $50, was expanded by the courts to $150, there would be a cost to the majority, who held $200, of $100. This would create a net gain for the minority gay community and a loss to the majority. This would not be a wealth maximization transaction for the majority.

Yet, if we are to apply the Coase Theorem, economists would find that the transaction of recognizing same sex relationships would not have been costless. This means that individuals would not have “internalize[d] externalities in a way that achieves optimality (ibid, p.20). This is where the majority of the Supreme Court stepped in to assign rights in a way that reflected the societal market of the time.

The fact that the majority gave same-sex couples recognition of being an analogous group under section 15 could be related to the economics of property law where the enjoyment of the right would be most efficient when in the hands of those who enjoy it most and by allocating this group those rights the wealth is most efficient in their hands. The economists would find a way to justify the ruling in Egan and would most likely point to the low cost to society in changing the definition of spouse under the legislation. At the time of the ruling, the state of affairs in which marriage is understood as a man and woman was valued more highly than the state in which the definition of spouse allowed for same sex couples.