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Law and Economics: Law as Efficiency

Richard Posner

The central claim of the approach of Law and Economics is that law serves the goal of economic efficiency, and so laws are mechanisms for maximizing wealth in society. There are three claims accepted by proponents of Law and Economics. The descriptive and explanatory claims see efficiency as describing how some legal rules operate and why laws develop towards efficiency as they do, even where the claim is that those laws were adopted for other reasons. The normative claim purports that good legal rules are efficient rules, and so when legal rules are put into place it is asked whether the law will promote efficiency. The Law and economics theory is contrary to Natural law theory and morality is not brought into discussion with law. Thus, just as Legal Positivists use morality to evaluate laws, here legal economists use efficiency to evaluate laws.

Wealth-maximization is concerned with social wealth and all measurable satisfactions. This includes all tangible and intangible goods and services, not just monetary gain alone. Economists assume that all people are rational, and so to be rational is to adopt efficient means to achieve ends. Thus when viewing branches of law through an economic lens, rational actors make choices based on what will maximize self-interest.

Law and Economics: measurements of efficiency

Pareto Standard

Pareto-superiority is where a move from one state of affairs to another state of affairs is superior when at least one party is better off and no one else is worse off. Pareto-superior transactions increase net utility for the parties to the transaction. These are situations of win-win, when all parties benefit from a transaction, or win-lose situations where winners fully compensate the losers and these winners still have a net gain after compensation.

Pareto-optimality is where there is no superior move possible from the current state of affairs because an optimal position has been reached. When Pareto-optimality is reached, all possible moves to make some people better off would result in making others worse off.

A problem arises with using the Pareto standard. All optimal states are such that there are no moves from them that would be Pareto-superior (no losers). To address this problem some theorists have suggested that the goal should be to reach Pareto-optimal outcomes through Pareto-superior moves. However, the problem with this remedy is that in reality there are not many moves that result in no-loser possibilities. In almost all distributional struggles, some will gain and some will lose.

Kaldor-Hicks

Recognizing this theoretical and practical problem of the Pareto Standard, economists have formulated a standard of efficiency called the Kaldor-Hicks test. When a move is potentially superior the move is justified. Thus a move is justified when the party (A) gaining from the move gains more than the other party (B) loses. Party A could compensate B for B’s losses and still have something left over. Thus, the move would actually be Pareto Superior if the compensation were paid. Though this compensation is only potential and does not have to be paid, the move is still justified because society benefits overall since social wealth has been increased.

The Coase Theorem

Under the Coase Theorem, when transaction costs are low and individuals act cooperatively, any assignment of rights initially would be efficient because each party will come to a distribution, which benefits both. When Coase Theorem conditions are met the law does not need to assign property rights in any particular way to regulate distribution of resources. When conditions are not met the law can step in and assign rights in a way to achieve efficiency as would be achieved under Coase conditions.

Legislatures and Judges

Law and economics theorists distinguish between what legislators and judges add to economic efficiency in law. Theorists suggest that what Legislators do almost never satisfy the Pareto principles, because government action taken through law will make some people better off at the expense of others.

The theorist, Richard Posner, purports that Legislators are rational actors like everyone else and as such they act to maximize their self-interest. This self-interest is to be re-elected and so in exchange for votes from certain organizations they will make deals that serve the interests of those groups. The benefits that these organized groups receive are paid for by the general population through taxation. This redistribution is not required to be efficient and so there is no guarantee that legislation aimed at redistribution will be efficient or utility increasing.

Judges on the other hand do not have redistributive power but can help achieve efficiency through the common law system. Judicial decisions can correct or maintain the market (i.e. property disputes). Further, any inefficient decisions can be appealed so that over time through precedents there will be an increase in efficient judgments.

Bedford: Law and economics

The law and economics approach extends to different branches of law such as tort, contract, property and criminal law. Bedford falls within the criminal law branch because the laws are within the criminal code, however the case also intersects with property law because at issue is the idea of regulating personal property rights (an individuals right to their body).

Law and economic theorists believe that laws protecting property through criminal sanctions are put in place to promote market transactions (Text pg. 132). It is believed that these laws provide holders of goods with assurances of their future enjoyment of their entitlements by ensuring that non-wealth maximizing transfers do not take place and making sure that people can enter into negotiations with others over their goods. Thus criminal law protects interest that we think of as inalienable or essential.

Looking at the courts analysis of the three provisions in Bedford through an economic lens shows that all three provisions are inefficient in promoting market transactions. They reduce the ability of prostitutes to enter into negotiations with others over their entitlement (bodies). S. 210 makes it an offence to keep a fixed location where prostitution can take place. The court found that the effect of this rule was to force prostitutes to work on the street, which makes them more vulnerable and creates danger to their person (Bedford para 62-63). S. 212(1)(j) criminalizes living on the avails of prostitution of another person and the courts found that the effect of this provision was to prevent prostitutes form hiring bodyguards and drivers, which would ensure safety for prostitutes (Bedford para 66). S. 213(1)(c) prohibits communication in regards to selling sex for money in public places, and the court found that the effect of this provision was to prevent prostitutes form screening their clients for personal safety (Bedford para 71).

Ultimately the Supreme Court found that the three provisions in addition to imposing conditions on how prostitutes operate also imposed dangerous conditions on prostitution because “they prevent people engaged in a risky – but legal – activity from taking steps to protect themselves from the risks” (Bedford para 60). This inability to protect their bodies, which is key to their productive labor, is inefficient because the social cost is unjustifiable. The cost-benefit analysis in this case would find that it is not efficient to diminish the ability of prostitutes to ensure their safety in a profession that is legal because the cost of violating their rights to life, liberty and security (s. 7 of the Charter) is too high for society to bear.

Thus, the provisions at issue fail to answer the three questions Economists ask in relation to criminal law. First when should criminal law be used? Economists believe that coercion should be used to support the operation of the market, which involves protecting rights to personal and private property and freedom of transactions. All three provisions are inefficient in this sense because they diminish the ability of prostitutes to secure their bodies or to get into transactions with their bodies. By having the provisions in place would be a Pareto-Optimal situation because legislators in enacting this legislation may have gained votes from the public or conservative organizations, but in doing the cost to prostitutes has been detrimental.

Second is the question of how much should be spent on crime control and what would be an efficient amount? Economists believe that only where the cost of preventing a crime is less than the cost of suffering it to happen should the criminal law apply. Prostitution itself is not illegal, so creating these provisions, which make engaging in a legal activity to be dangerous and strip freedoms essential to an individual, it is very inefficient to the cost that goes into to imprisoning women. On the other hand s.212 (1)(j) could be said to be efficient because it is meant to diminish the harm against women in relation to exploitation from pimps or johns. However an Economist could find that it is an overbroad law and the social cost of not allowing children, parents or employees of prostitutes to live off the avails of the primary breadwinner is a higher cost than women being exploited.

The third question is what level of enforcement and scheme of penalties will induce compliance with the law? If the goal of punishing crime is deterrence through the threat of penalties, those penalties must be set at an efficient rate if they are to fulfill this function. As mentioned above, prostitution is not a crime, and so setting provisions that ultimately criminalize a legal act is not an efficient use of penalties. The penalties range from summary conviction to imprisonment for a term not exceeding ten years. An economist would find these penalties to be disproportionate and thus inefficient to the crimes of keeping a common bawdy house, living off the avails of a prostitute and communicating in public for the purposes of prostitution.