Examen Final - Law and Economics
I. Fundamentals of Law and Economics (L&E)
Core Purpose of L&E: The economy offers analytical tools to understand and improve the law.
The efficiency of a legal rule is a useful measure for institutional analysis, though not the only one.
The fundamental question in L&E is: "What incentives does this rule create?".
Economic Efficiency Concepts:
Pareto Efficiency: A state where it is impossible to make any person better off without making someone else worse off.
This standard is difficult to apply in practice because identifying if "no one loses" is highly subjective, even if losses are non-monetary (e.g., envy).
Marshall Efficiency (Kaldor-Hicks): Achieved when the total benefits exceed the total costs of a rule or action.
This is the preferred and more functional standard used for practical institutional analysis.
Economics in Legal Analysis:
Positive Economics: Description and explanation of how legal rules and economic systems actually function.
Normative Economics: Policy recommendations on how legal rules and economic systems should be, based on efficiency criteria.
II. Ethical Systems
Ethics and Morality Distinction:
Ethics: A system of established norms used to resolve conflicts in a society, encompassing what is just or legal.
Moral: Actions pursued individually in the search for virtue or perceived right action.
Utilitarianism (Consequentialism): Evaluates actions or rules based on their consequences for maximizing societal well-being or utility.
Act Utilitarianism (Small Unit Perspective): Focuses on evaluating the consequence of a single, isolated action to maximize utility in that specific case.
Critique: Leads to exceptions that undermine established rules; utility is subjective and cannot be summed (cardinal valuation is impossible); may justify violating individual rights (e.g., killing one person for organ harvesting to save many).
Rule Utilitarianism (Bundling Perspective): Evaluates the utility of following a general rule; the correct action aligns with rules whose indirect, long-term consequences maximize general welfare.
Bundling: Treating a collective package of choices or actions (like a rule) as the unit of evaluation.
Benefits: Provides a more consistent basis for strict moralities and policy prescriptions by arguing that the rule, as a whole, makes sense. Essential when expectations and incentives matter.
Natural Law:
Adherents believe in certain higher, immutable, and universal principles that govern man-made law.
These principles are discoverable by human reason and observation of man's nature.
Man's natural ends, such as self-preservation, protecting family, and living in society, dictate these principles.
If human law conflicts with natural law, it is deemed inferior and may lack validity or be a corruption of law.
III. The Coase Theorem and Externalities
Externalities: Occur when an activity imposes costs (negative) or benefits (positive) on a third party who is neither compensated nor charged.
Reciprocity of Externalities: Externalities have two sides; preventing harm to one party imposes a cost (negative externality) on the party whose action is restricted. They are fundamentally conflicts over the allocation of property rights.
Pigouvian Solution: Government intervention via taxes or subsidies to internalize externalities and reach the efficient quantity.
Pigouvian Taxes: Tax on activities generating external costs (e.g., pollution) to raise the private cost and reduce production.
Austrian Critique: Pigouvian solutions suffer from information problems (governments cannot know the exact optimal tax/subsidy needed for efficiency) and incentive problems.
Coase Theorem (Zero Transaction Costs): If transaction costs (costs of negotiating, measuring, and enforcing agreements) are zero and property rights are clearly defined, private parties will negotiate to achieve an efficient resource allocation, regardless of who was originally assigned the rights.
Coase Theorem (Reality): In the real world, transaction costs are often high, and property rights are frequently ambiguous.
When transaction costs are high, the initial allocation of property rights does matter for both efficiency and distribution.
In high-cost scenarios, Coase suggested that courts or judges may be the best avenue for determining who has the superior right, thus determining resource allocation.
Alternatives to Command and Control/Pigouvian Taxes:
Negotiable Permits (Cap and Trade): A market solution where the government sets an upper limit (cap) on external costs (e.g., emissions), and companies trade the right to pollute up to that limit.
While an application of Coasean principles (creating a market for rights), it still suffers from the information problem of knowing the efficient optimal limit (X).
Class Action (Collective Demand): A solution to high transaction costs that arise when many individuals are harmed by the same external cost (e.g., pollution), allowing for efficient litigation by pooling resources.
IV. Comparative Legal Systems
Two Dominant Traditions: Derecho Continental (Civil Law) and Derecho Anglosajón (Common Law).
The fundamental distinction is between found law (discovered) and created law (planned).
Analysis involves comparing institutions to discern the effects of different rules.
Derecho Continental (Civil Law):
Source of Law: Principal source is legislation (written law and codes).
Role of Judge: Judges primarily apply the existing law, having a limited role in creating norms. Decisions of higher courts (Tribunal Supremo) can form doctrina, which is a secondary source of law.
Certainty and Stability: Appears stable because everything is codified. However, the law can change frequently and radically by legislative decree, leading to actual instability (e.g., education or abortion laws changing with each new government).
Information and Incentives: Legislators suffer from the centralization of information problem (Hayek's knowledge problem), having to plan everything centrally. Legislators are incentivized to increase the number of laws constantly and favor interest groups through lobbying (capture of the regulator).
System Characteristics: Inquisitivo (judges can initiate proceedings); broad regulation and imperative norms limiting contractual freedom.
Derecho Anglosajón (Common Law):
Source of Law: Principal source is jurisprudence and precedents (decisions of judges).
Role of Judge: Has a central role in creating and discovering the law through an evolutionary process where efficient norms are retained. Judges' decisions are analogous to islands of central planning (socialism) in a sea of capitalism, where the competing decisions of different judges yield information, and the most efficient decisions survive.
Certainty and Stability: Generates higher certainty because it relies on known, long-maintained principles of law, reducing uncertainty and fostering a lower temporal preference (planning long-term). Changes are marginal, not radical.
System Characteristics: Adversarial (parties initiate proceedings); greater flexibility allowing adaptation to specific circumstances (e.g., percentage of fault) and more contractual freedom.
Cost of Litigation: Empirically more costly, partly because the losing party often has to pay the opponent's legal fees and court costs, incentivizing parties to settle when the outcome is predictable.
V. Institutional Emergence and Spontaneous Order
Institutions: A set of established norms (including rules and laws) that organize and coordinate human interaction.
Function: Solve problems of information (e.g., knowing which side of the road to drive on) and incentives (e.g., sanctions/rewards for following rules).
Order Creation (Hayek's Distinction):
Taxis (Planned Order): Order arising from the deliberate, rational organization by a central entity (e.g., legislation).
Cosmos (Spontaneous Order): Order arising from the interaction of complex phenomena, developing without central design.
Spontaneous orders possess emergent qualities.
Complexity: Can exceed the comprehension capacity of any single human mind.
Function: Provides reliable predictability, helping actors fulfill their separate goals.
Focal Points (Schelling Points): Forms of action that generate a convergence of mutual expectations, enabling coordination without explicit communication (e.g., meeting in a central, obvious place at a central time).
The emergence of norms like the respect for private property can be seen as a result of focal points, where individuals generate a mutual expectation of defense against aggression.
Fatal Arrogance: The belief that one can reorganize or reprogram society successfully while ignoring the dispersed knowledge embedded in existing customs and institutions.
VI. Property Rights and Contracts
Property Rights Foundation: Property rights are necessary because resources are scarce, leading to potential conflict over their use.
Natural Property: Rights over one's own body (self-ownership).
Economically efficient because individuals face the lowest transaction costs to control and use their own body.
Acquisition of External Property: Rights to external resources are established by:
Homesteading: Mixing one's labor (body) with previously unowned resources; the first to arrive, transform, and protect the resource gains the best claim.
Exchange or Payment: Property acquired through mutually agreed trade or compensation.
Contracts: Legally enforceable agreements designed to coordinate expectations and allocate risk.
Enforceability Requirement: Requires the mutual intention to create legal relations, differentiating serious agreements from informal promises or jokes.
Gaps in Contracts: Contracts are necessarily incomplete; no amount of detail can cover every possible contingency, requiring courts or contractual law to fill in the gaps.
Freedom of Contract: The general ability of parties to agree to terms, including clauses defining compensation upon breach (punitive clauses or liquidated damages).
Limits: Coercion (duress) or material lack of information can invalidate a contract.
Efficient Breach: Under the rule of expectation damages (damages sufficient to make the victim whole), a party will breach if their cost of fulfilling the contract is greater than the victim's cost of the breach. This leads to an efficient allocation of resources.
VII. Intellectual Property (IP)
Definition: IP grants property rights in ideal objects (ideas, patterns, inventions, expressions).
Types of IP:
Copyright: Exclusive right to reproduce or display original works (e.g., books, movies); protects the expression, not the underlying idea.
Patent: Grants a limited monopoly (right to exclude) over a useful invention or process.
Trade Secret: Confidential information that provides a competitive edge, enforceable only if kept secret.
IP Critique (Anti-IP Position):
Ideas are Non-Rival Goods: Ideas are not scarce resources; their use by one person does not prevent others from using them (Jefferson's "He who receives an idea from me... receives instruction himself without lessening mine").
Creation of Artificial Scarcity: IP attempts to impose artificial scarcity on non-scarce goods, leading to inefficiencies.
Violation of Tangible Property Rights: IP dictates how owners of tangible property (e.g., paper, printing press) can use their own physical resources, violating self-ownership principles.
Tragedy of the Anticommons: Excessive patenting (especially in complex products like smartphones) creates a scenario where too many property rights exist over components, leading to a "hold-up problem" and high licensing fees that hinder innovation.
Barriers to Entry: Complex legal language (legalese) in patents and massive portfolios held by large firms create high transaction costs and entry barriers for smaller competitors.
Incentives vs. Evidence: Empirical studies show weak or no link between strengthening patents and increasing innovation; some evidence suggests negative overall welfare effects. Alternative incentives like first-mover advantage (reputation) and trade secrecy often suffice.
VIII. Crime, Punishment, and Torts (Damages Law)
Deterrence vs. Compensation:
Criminal Law (Crime): Primary objective is deterrence of future offenses. Requires dolo (intent/willful attempt).
Damages Law (Torts): Primary objective is compensation of the victim for losses incurred. Typically deals with lack of intent (e.g., negligence).
Standard of Proof (Standard Procesal): The minimum amount of evidence required to establish guilt or liability.
Torts (Civil Law): Balance of Probabilities (Preponderance of the Evidence): Requires that the accused is more likely than not the source of the damage.
Crime (Penal Law): Beyond a Reasonable Doubt (Más allá de toda duda razonable): A much stricter standard reflecting the higher stakes (loss of liberty).
Punishment and Efficiency:
Probability Multiplier: In criminal law, if the probability of catching and convicting an offender is low, the punishment imposed must be proportionally increased to maintain deterrence.
Becker’s Puzzle: While theoretically efficient to impose high fines with low probability of detection, this is limited by the offender's ability to pay (wealth). Once punishment exceeds wealth, costly measures like imprisonment or execution must be used, increasing the social cost of punishment per offense.
Liability Standards (Torts):
Strict Liability: The injurer pays for damages regardless of fault. It is more efficient when external costs are unobservable (like the activity level), as it forces the injurer to internalize the full costs of their activity.
Negligence: Liability is determined by fault or failure to take sufficient care.
Coming to the Nuisance (Acercarse a la molestia): A doctrine arguing that a party who knowingly moves near an existing nuisance (e.g., an airport or factory) should bear the costs, as they are the party generating the cost after the fact and should initiate negotiation.
IX. Monetary Policy and Central Banking
Central Bank (CB): A privileged institution holding the monopoly on the emission of the national currency (Fiat Money).
Seigniorage: The profit government derives from issuing new base money.
Government Objective: By monetizing debt (purchasing federal debt), the government can finance spending without increasing debt or explicit taxes.
Bureaucratic Objective: CB officials maximize their own budget and discretionary profits (bureaucratic seigniorage), leading to inefficient growth (e.g., lavish amenities, high salaries).
Incentives for Instability:
Inflation: The monopolistic issuance of money provides a systematic incentive for the CB to increase the money supply, causing inflation.
Moral Hazard in Commercial Banks: Commercial banks are incentivized to engage in risky financial behavior, specifically mismatched maturities (borrowing short-term while investing long-term and high-risk).
Government Protection and Bailouts: Government mechanisms (like deposit insurance and CB liquidity provision, e.g., the discount window or open market operations) shield banks from the consequences of their risks (liquidity and solvency risk). This protection increases moral hazard, as creditors lack the incentive to monitor or audit banks.
X. Experimental Economics and the Law
Role: Experimental economics uses controlled laboratory settings to test economic theories and evaluate legal institutions and doctrines, often under less restrictive assumptions than theoretical models.
Methodology:
Uses induced-value theory to assign specific values and costs to subjects, ensuring control over their preferences and allowing measurement of efficiency.
Allows scaled observation to study concepts difficult to observe in the field (e.g., economic efficiency).
The hallmark is causal inference, achieved through repetition and replication.
Applications in L&E:
Legal Institutions: Exploring functions like settlement bargaining (e.g., finding that self-serving bias causes systematic divergence of expectations, leading disputes to trial) and jury deliberation.
Legal Doctrines: Studying the incentive effects of liability regimes (e.g., negligence vs. strict liability).
Legal Practice: Experiments can be used as admissible evidence at trial to demonstrate general rules or scientific principles.
XI. Anarchy Cases and Decentralized Law
A. Core Principles of Anarcho-Capitalism (Anarchy Theory)
Order, Not Chaos: Anarcho-capitalism is hypothesized to be an orderly system where property rights are protected and civil order prevails, contradicting the belief that anarchy necessarily results in confusion or chaos.
Private Provision of Order: Orderly society is achieved through private agencies providing necessary functions like protection and adjudication, rather than relying on a governmental monopoly on coercion.
These agencies operate under the profit motive, incentivizing them to be efficient and high-quality providers of justice.
Warfare Avoidance: Private agencies quickly discover that violence and warfare are costly ways of resolving disputes, leading to the use of lower-cost methods like arbitration and courts.
Competition and Checks: Competition among protection and adjudication bodies serves as a check against undesirable or unjust behavior. Consumers retain information and incentives to judge these agencies.
Justice as Non-Immutable: The concept of justice is not absolute or immutable; under anarchy, various rules can exist across societies, reflecting varying individual preferences for rules and the price they are willing to pay for them.
Lack of Economies of Scale in Crime: Major organized crime (like large "mafia" organizations) does not evolve and dominate society because the costs of operating large bands are high and inefficient, limiting the ability to exploit illegal markets.
Arbitration Incentives: In a world without a state, individuals are incentivized to use and obey private arbitration decisions due to the high costs of conflict and the importance of reputation.
Failure to accept arbitration makes an individual appear culpable, severely reducing the willingness of others (including private security agencies) to interact with them.
B. Case Studies of Decentralized Order
The Not So Wild, Wild West (1830-1900): This period approximated anarcho-capitalism, providing insights into voluntary rights definition and enforcement.
Land Clubs/Claims Associations: Settlers in public lands formed extralegal organizations to adopt constitutions, bylaws, and rules for protecting property rights, especially against "claim jumpers and speculators".
Mining Camps: Groups organized autonomously, often drafting rules and constitutions before setting out. They elected judges and allowed any law-abiding citizen to serve as prosecutor or defender.
Multiple jurisdictions coexisted, respected each other's judgments, and citizens favored the most just systems.
Historically, these autonomous camps had less crime than the period following the establishment of regular territorial government.
Wagon Trains: Companies established their own constitutions and rules that members voluntarily accepted for the duration of the risky journey. Disputes were frequently settled by three arbitrators, ensuring impartial justice.
Medieval Iceland (c. 930–1262 AD): This system lacked a formal executive or government employees, relying instead on private enforcement.
Chieftains (Goði): Held rights (goðorð) which were private property (transferable, sellable, inheritable) and served as the link between individuals (thingmen) and the legal system.
Damages/Tort Law Focus: The entire body of law was essentially damages law (tort law), focusing on compensating victims rather than penal punishment.
Transferability of Claims: To solve the problem of powerful individuals ignoring verdicts against weaker opponents, the right to claim damages was a transferable property item. A weaker victim could sell the claim to a stronger individual who had the resources and reputation incentive to enforce the verdict.
Sunset Law: There was an early form of sunset legislation where the lawspeaker recited one-third of the law annually, and if an omission was made and no one objected, that part of the law was removed.
Pirate Law: A decentralized legal system (articles) emerged among criminal crews living in confined, high-conflict environments to ensure internal order.
Rules and Insurance: Each crew swore to its articles, which regulated violence, prohibited theft, and even included an employment insurance policy for injuries.
Checks and Balances: The system employed a division of labor, with a captain for combat and a quartermaster for civil control.
Judicial Mechanism: When the articles did not cover a dispute, an ad hoc jury would be appointed to interpret the rules or decide the case by vote.
The Amish: A contemporary example of effective, voluntary self-governance.
Regulation and Custom: The Amish deliberately choose which technologies to use based on a practical, social engineering assessment to maintain their social structure, rather than adhering to simple asceticism.
Excommunication (Meidung): Disagreements are settled by the community, and refusal to accept a settlement or persistent violation results in a sanction imposed by the bishop, potentially leading to Meidung (shunning or excommunication) as a last resort.
Voluntary Consent/The Rumspringa: To counter the argument that their laws are coercively imposed on children, the Amish have a system where members between 16 and 20 years old are encouraged to experience the outside world before voluntarily choosing whether to join the community and commit to the rules (Ordnung).