Law, Morality, Trust, and their Limits

-- By EdiRumano - 16 Feb 2012

This paper is an exploration of the idea that “if you want to know the law and nothing else, you must look at it as a bad man.” By examining a little more thoroughly the distinction between law and morality, and how this distinction plays out in certain types of economic arrangements, I hope to better understand the limits of the law as a force of social control and in fact the weakest form of social control. These ideas come from our class readings as well as David Rose’s “The Moral Foundation of Economic Behavior” (2011).

Economic production requires cooperative behavior among individuals. The fundamental problem with cooperation is the ability of people to behave opportunistically, which is to say that they behave contrary to an agreement that is supposed to maximize group benefit by engaging in behavior that maximizes their own welfare at others expense. The classic problem is the prisoners’ dilemma, but this happens in all contexts. The clerk at the cash register could take the cash, or the business partner could engage in deceptive practices and leave you holding the bag.

In small group scenarios, this kind of opportunism can be controlled by reputational effects so that it’s not individuals’ interests to behave opportunistically because then other actors will refuse to cooperate with them in the future. As the social group grows from a family to a tribe to a nation, these repeat-play effects diminish so other forms of control are necessary. The state, through its courts, officers, legislature, and all the different institutions we call the “law,” can diminish this kind of opportunism by threatening punishment.

Of course, if we believed people were trustworthy, there would be no need for most of those institutions or even of most of contract law. If we could trust the clerk to not take money from the cash register because the guilt of doing so would be too much, there would be no need for security cameras or the criminal law. Instead, the law provides a way to exchange trust for assurance, so that we are assured it is in the clerk’s self-interest not to steal. This is what I believe Holmes meant by thinking of the law as a bad man. For good men, or people who internalize the cost of breaking an agreement, there is no need for law.

Under this analysis, the limits of the law become immediately apparent. To combat certain types of opportunism, the law can be effective if the person can be caught. Large business transactions can then be made possible if both sides specify as much as possible the details of the deal so the force of law can be introduced if they are not attained.

But there are types of transactions where the law cannot reach. In classic principal-agent problems, the agent has agreed to maximize the interest of the principal but finds that he can maximize his own welfare at the expense of the principal. If this effect can be documented, then the law can provide a sanction. But in large economies with fine divisions of labor, the principal often does not know that the agreement was even broken. The law is useless in this type of opportunism because it can’t be detected.

The only way to solve that problem is by changing people’s moral preferences so that they internalize the cost of breaking an agreement by feeling guilty. Without those preferences, individuals will not engage in certain types of transactions because they know in the absence of external incentives, other people will behave opportunistically, e.g. untrustworthy.

This highlights why law is such a weak social force. It operates on large time scales and is only used to solve problems that other forces such as social ostracizing cannot solve themselves.

I think the real work to be done in generating a well-off and happy society is the work in instructing its members to behave morally in the absence of external incentives. Only if we can believe rationally that other people are trustworthy will we be able to fully utilize the division of labor that is the hallmark of contemporary economies. Until then, the law is just a transaction cost to make possible these arrangements in the absence of trust. Perhaps by believing that all people are self-interested we make it true and decrease our collective welfare in the process.

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