Economic Theory in the 1L Curriculum (First Draft)

-- By DanielMargolskee - 27 Feb 2009

Writing about the study of law, Justice Holmes predicted that while “the blackletter man may be the man of the present, the man of the future is the man of statistics and the master of economics.” In many 1L classrooms, Holmes’s prediction has come half true--but only half.

In standard Contracts or Torts classes, students are expected to be able to analyze what consequences a proposed rule of law would have in society, under the stylized assumptions of economic theory--that people and firms are utility maximizers, that some amount of money damages is enough to make a person indifferent to suffering a given injury, and that markets are perfectly efficient. The results of these economic thought experiments, however, are incomplete substitutes for the study, using statistics and other disciplines, of what the actual empirical effect a given rule of law would be on society in practice. Still less can economic models substitute for frankly confronting whether the changes produced by a given rule will, in their actual empirical operation, help to bring about a society we actually prefer to live in.

In studying whether a particular rule of law is a desirable one (or, indeed, whether a particular rule of law is ever actually applied as conceived), the empirical dimension is often missing from the 1L classroom: predictions about the social consequences of a rule are extrapolated from standard economic axioms, instead of examining what the consequences of changed rules actually are in society through empirical study. Then, as a normative matter, the proposed rule is judged according to the efficiency of the outcomes that are predicted in theory, rather than the actual social interactions that are produced by the rule in fact.

The result is that while moral language is largely displaced from the study of Contract and Tort law for 1Ls (as Holmes indeed did advocate), the notion that ideal rules of law can “be worked out like mathematics from some general axioms of conduct” has not been completely expelled.

The Efficient Breach Hypothesis and the Assumption of “Full” Compensation

Contrast, for example, the efficient breach hypothesis as taught in a 1L Contracts class with the account of contract breach Holmes sets out in The Path of the Law.

Our Contracts textbook suggests that, in understanding how the law operates, we might fruitfully think of a promisor as having the equivalent of an “‘option’ to breach and pay expectation damages instead of performing, when it is in her economic interest to do so.” Farnsworth et al., Contracts, 20 (7th ed. 2008). This is quite in line with Holmes’ observation that, from the perspective of the bad man, the “duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it--and nothing else.” So long as (and only so long as) the resulting consequences are the same, it does not matter to the bad man whether the law gives different names to a “cancellation option” and to a “breach.”

In contrast to Holmes, however, the Contracts text suggests that, as long as the promisee is in some ill-defined sense fully compensated for his expected benefit under the contract, a breach by the promisor will “leave the promisee just as well off as he would have been had the promisor performed. In principle, then, breaches of this sort make promisors better off without making promisees worse off.” Id.

Moral considerations are eliminated not only from the analysis of how the party in breach is likely to perceive the consequences of breach, but also from the question of what the consequences of breach should actually be in our society. Instead, it is hypothesized that there exists a sufficient level of compensation which will be enough to make the aggrieved party indifferent to the breach, and that when damages are fixed at that point, society as a whole is made “better off” through the breaches that result, because the inefficient performance of contracts is discouraged.

Contract Breach in the Absence of “Full” Compensation

In principle, it is trivially true that if an aggrieved party’s expectations are “fully” compensated, then he would be as well off as if the promise had been performed––if the aggrieved promisee isn’t indifferent in some sense, then hasn’t been “fully” compensated for that expectation. In practice, though, when courts award “expectation damages,” they typically don’t fully compensate the aggrieved party’s expectations. The damages for breach compensate only the consequences which are “reasonably foreseeable”; attorneys fees are typically not compensable; and no accommodation is made for the non-economic value the aggrieved party places on the performance of the contract.

The efficient breach hypothesis, then, describes the situations under which a breach would make all parties better off, only because of the implicit assumption that every injury is in compensable with some amount of money, and because of the definitional relationship between “full” compensation and the aggrieved party’s indifference. But a definition and an assumption, under Holmes’ framework, is not the equivalent of an argument which would “justify” the “social advantage” of a given rule of law. It is rather more the equivalent of the “blind guess” that punishment actually deters crime--or, to put it a different way, that a sufficient level of punishment for crime would produce only the “efficient” level of criminal activity.

• Two different arguments are made here, and they are somewhat in conflict despite their compatibility's being taken for granted and going undiscussed. In the first place, you argue (correctly) that "law and economics" has become a form of transcendental nonsense done by theory, rather than in relation to facts discovered about the way things actually work. (The first critic to observe this, as it happens, was Art Leff, who reviewed Posner's Economic Analysis of Law in 1974 and presciently there discovered the onset of what he called "American Legal Nominalism.") In the second place, you argue that the doctrine of efficient breach is based on a biased definition of full compensation, because it ignores both specific idiosyncratic value in performance and the general moral value of promise-keeping. This argument is made solely on the basis of theoretical constructs, without any showing of the extent of actual insufficient compensation in the world of real-life transactions.

• Both of these arguments can be made. Maybe even in the same essay. But their conflicting methodologies would have to be acknowledged and dealt with somehow. And one must say that the first seems stronger without the second. It sounds as though there might be an alternative before you throw in the towel and start steering by speculation, just like everyone else.

New Revision:

Economic Theory and the Rational Study of Law (Revised Draft)

Writing about the study of law, Justice Holmes predicted that, while “the blackletter man may be the man of the present, the man of the future is the man of statistics and the master of economics.” In the 1L curriculum, that prediction has proven only half-true. Formal economic analysis has come to dominate the teaching of Torts, Contracts, and Property, and yet, the curriculum falls short of Holmes’s aspirations for a “rational study of law.”

Insights from economics are part of the “rational study of law” Holmes yearned for--but only a part. In privileging the methods of axiomatic economic analysis over the methods in other disciplines, the 1L curriculum fails to confront those unanswerable questions which, despite (or because of) their indeterminacy, were of paramount concern for Holmes: How does the law actually operate? What kind of society do we want to have? How can we change the law to bring about the society we would rather live in? How can a

Economics as Part of a Rational Study of Law

Holmes thought that the tools of economics and statistics would be useful in steering lawyers and judges away from three habitual mistakes: (1) “confusion” of legal terms with moral terms; (2) uncritical mimicry of the past (“the pitfalls of antiquarianism”); and (3) the belief that legal doctrine is logically deducible from self-evident axioms (“the fallacy of logical form”). In Holmes’s framework, these three habits of thought conspire to prevent lawyers from accurately predicting the “incidence of the public force,” and prevent judges and legislators from consciously and intelligently confronting “their duty of weighing considerations of social advantage.” These conceptual mistakes lead lawyers to give wrong answers, because they lead lawyers habitually to ask the wrong questions.

Statistics and economics were to complement history and jurisprudence as part of a “rational study of law.” That study would be characterized by an “enlightened skepticism” of received wisdom and a “deliberate reconsideration of the worth of [legal] rules” from the perspective of present needs. It would be simultaneously theoretical and empirical: it would “get to the bottom of the subject itself.”

Now, Holmes simultaneously maintains that, in weighing considerations of social advantage, no resolution will be accepted always, everywhere, and by everyone. The “longing for certainty and for repose” that inheres “every human mind” is destined to go unfulfilled.

And yet, in the enigmatic closing passage to the Path of the Law, Holmes invokes the universalistic aspirations of Hegel, Kant, and Descartes to express his own longing to “catch an echo of the infinite, a glimpse of its unfathomable process, a hint of the universal law.” Further, he suggests that the “command of ideas” and the exploration of the “remoter and more general aspects of law” (and presumably of social life in general) are a mechanism for actually achieving moments of transcendence. Though there is no certainty in Holmes’ framework, there are gestures toward what Eben sometimes calls “salvation,” and that salvation is found in the rational study of social questions.

Read in light of this passage, it is possible that for Holmes, the perpetually-unsettled questions at the heart of legal decisionmaking (questions of “social advantage”) are also something inexpressibly more than, say, questions of how to minimize the “aggregate social cost” of accidents, or of how to guide society ever closer to one or another Pareto-efficient equilibrium, or, in short, of how to “satisfy[]” the “appetite.” Instead, it is a question of . . . well, of what, exactly?

Economics in the 1L Curriculum

The lawyer of the present is the master of economics, at least in the 1L classroom. Tort class is an extended meditation on Calabresi’s The Cost of Accidents (1970); Contract law is reconceived as a quest for transaction-cost minimizing default rules in the footsteps of Coase’s The Problem of Social Cost (1960); Property law is taught and learned in the shadow of Calabresi and Melamed’s Property Rules, Liability Rules and Inalienability (1970).

To be sure, there are moments of great resonance between Holmes’s Path of the Law and the law-and-economics essays on which so much of the curriculum is now based. Implicit in Holmes’s observation that “the duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it” is a distinction between rights enforced by liability rules and those enforced by property rules. Holmes is keenly aware that some number of accidents are too costly to avoid in modern life; that compensating injured workers can be recast as “the public … insur[ing] the safety of one whose work it uses”; even that the value, in economic terms, “of a life to the community can be estimated.”

Saying Something More

In the first incarnation of this paper, I tried to argue that the formal economic thought experiments taught in the 1L curriculum are yet more transcendental nonsense. As Eben pointed out, this is a point Arthur Leff made more than thirty years ago. And indeed, it’s a point implicit in other works we’ve read this semester: Theory of the Leisure Class posits a small set of human motivations and then tries to explain the human experience solely in terms of those motivations, in what could be read as parodying the economists mistaking, in Leff’s terms, “the light” for “the thing illuminated.”

Not only did Leff make that point, but he also showed that it’s source is in the “terrifying” message of the Realists, their “simultaneously horrifying and banal” recognition, in Holmes’s words, that“[n]o concrete proposition is self-evident, no matter how ready we may be to accept it,” that “certainty generally is an illusion and repose is not the destiny of man.”

But I find myself leaving class wanting to say something more about the world than can be said with the aid of simplifying assumptions or the inhibition that comes from radical uncertainty; what more, it’s hard to say.