on this year's Nobel and the future of the law and economics movement

["Ian Murray" <seamus2001@xxxxxxxxx>]

http://writ.findlaw.com/lazarus/20021017.html

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WHY THE WORK OF THE NEW NOBEL PRIZE WINNERS FOR ECONOMICS MAY SPELL THE
DEMISE OF THE LAW AND ECONOMICS MOVEMENT:
The Problem With Posner, And With Assuming Rationality
By EDWARD LAZARUS
elazarus@xxxxxxxxxxx
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Thursday, Oct. 17, 2002

The legal world generally doesn't pay much attention to who wins the Nobel
Prize for Economics, and this year is proving no exception. But I wonder if
ten or fifteen years from now, we will look back at the moment of this
year's prize announcement as the high water mark of the "Law and Economics"
movement.

In the last decade, the Law and Economics movement has come to dominate
legal scholarship and deeply influence legal and regulatory thinking. But
its influence may soon be on the wane - as the Nobel Committee's choice
shows.

This year, the Prize went to Daniel Kahneman and Vernon Smith. Notably,
Kahneman is not an economist at all, but rather a psychologist. And even
more notably, both recipients were selected for their pioneering work in
demonstrating, through experimentation, that human beings frequently do not
act as the kind of supremely rational actors ordinarily posited in economic
theory.

The "discovery" that people often make irrational choices - one more likely
to shock economists than ordinary folk - strikes at the heart of the Law and
Economics enterprise. For years, the denizens of this approach have been
preaching that the study of "economics" can provide a rigorous scientific
framework for nearly every field of law, based largely on the assumption
that human behavior is rational. If that assumption is wrong, the movement
suffers accordingly.

The Law and Economics Movement and Its Deep Reliance on Rationality

At the risk of gross oversimplification, the most ardent devotees of the Law
and Economics school tell us that scientific order both can and should be
brought to the jumble of rules that we call law. If we think of humans as
rational actors efficiently seeking to maximize their interests, according
to the movement, then we can fashion legal rules that will best help them do
so.

Much of this analysis takes place on a highly theoretical level. But the
practical applications have expanded in recent years as leading Law and
Economics theorists - most notably Richard Posner of the U.S. Court of
Appeals for the Seventh Circuit - have been appointed to the bench.

Of course, you won't see any fancy econometric formulas showing up in their
opinions. But these judges, self-consciously, are far more willing than most
of their colleagues to choose between competing legal doctrines based on
what they foresee as the likely practical consequences of each doctrinal
choice.

Put another way, these judges are willing, even eager, to shape the law
based on their assumptions about the likely effects of a legal regime. And,
in turn, those assumptions about future effects are based on their judgments
as to what a "rational" person would do under a given set of circumstances.

The Weaknesses of Law and Economics, Even Apart From the Nobelists' Work

Even before Smith and Kahneman told us that this premise of rationality is
dramatically overblown, this kind of law-making was a dangerous business.
Posner and other leaders in the field declare economics to be the most
promising of the social sciences (notwithstanding its moniker as the
"dismal" science), at least where the law is concerned. Yet in practice, its
application is less than scientific.

Economics often involves not controlled and verifiable experimentation, but
instead the positing of any number of unverifiable (and, as it turns out,
dubious) assumptions. When these assumptions are thrown into doubt, the
usefulness of the conclusions they lead to is also undermined.

Remember when all those economists were touting the virtues of stock options
as a principal component of executive pay? What could be more "rational"
than rewarding a top executive based on the performance of his or her
company, as judged by the market value of the company's stock? "Pay for
performance "became a virtual mantra.

But it turns out all those stock options had a major, unacknowledged down
side. They gave executives a giant incentive to artificially inflate their
companies' stock prices, by engaging in all kinds of illegal activity to
understate expenses and pump up revenues. The options also gave executives a
big incentive to engage in insider trading when they learned that the
proverbial mud was about to hit the fan.

Some people might say it isn't rational for very rich people to put
themselves at risk of both going to prison and suffering economic ruin just
to make themselves a whole lot richer. But that's what happened (as Sam
Waksal just admitted with his recent guilty plea in the ImClone scandal).
Thus, the Law and Economics folks' "scientific" crystal balls demonstrated
themselves to be more than a little cloudy.

Examples like these show that the economic analysis of law seems wholly
dependent on the perspicacity of its practitioner about the realities (not
the rationality) of human and institutional behavior. And even the best of
Law and Economics thinkers can stumble badly in practice - often because
they are describing people as rational when their actions, in practice, are
anything but.

The Problem with Posner's Law and Economics in Particular

Posner, who has emerged as one of the nation's leading public intellectuals,
is a case in point. A decade ago, for example, in one of his leading
opinions - Schurz Communications v. FCC - Posner struck down new regulations
promulgated by the FCC, based largely on a Law and Economics analysis. But
that turned out to be a serious mistake

The regulations had limited the right of television networks to engage in
television production (as opposed to distribution). In the FCC's view, these
regulations were necessary to protect independent television producers from
being shut out by the networks - who dominated television distribution
channels. The FCC also worried that, absent the regulations, television
would (even despite cable) become increasingly homogeneous.

But Posner was not convinced. He freely expressed his own views on the most
likely result of the proposed regulations, rather than deferring to the
FCC's as administrative law required. And as a result of those views, he
voided the FCC's limitations on networks as "arbitrary and capricious."

Of course, what the FCC had done wasn't arbitrary and capricious at all - it
made perfect sense from the FCC's point of view. But in order to replace the
FCC's point of view with his own, something judges are never supposed to do,
Posner had to describe the FCC's decisionmaking as if it had barely been
decisionmaking at all. (Ironically, Posner thus had to paint the FCC as
being far from a rational actor.)

In hindsight, it's hard not to conclude that the FCC was mostly right.
Independent television producers are an endangered species in Hollywood.
Meanwhile, the networks (and their cable-heavy parent companies) now control
a huge proportion of what's seen on TV. What the FCC predicted, actually
came to pass, since the regulations that would have prevented it were struck
down.

Posner Is Also Wrong on the Law and Economics of Campaign Finance Reform

Posner's views on important issues of policy fall victim to the same
problem - namely, that an approach dependent on the weighing of costs and
benefits is only as good as the judgment of the "weigher."

Take Posner's assessment of campaign finance reform. In putting current
proposals on his scale of good policy, Posner tells us that the harms caused
by the current system are minor. Unlimited soft money contributions, he
tells us, "buy access and modest influence, at best, and often just offset
the contributions to competing candidates rather than causing substantial
distortions in the markets in which the contributors operate."

Tell that to the California officials who tried to convince the Bush
Administration to put temporary price caps on energy. They argued to a brick
wall, given that the energy was being produced by the very
market-manipulating companies that provided the financial spine for George
W.'s presidential campaign.

Certainly, a growing number of politicians admit candidly that money buys a
lot more than "modest influence" (and they should know, shouldn't they?).
Moreover, if modest influence was indeed all that big contributions
achieved, you'd think wealthy donors would have started putting their money
to better uses; instead, they've pulled out all the stops, showering
candidates with donations. (I guess Denise Rich hasn't read Posner.)

Naturally, if one undervalues the potential benefits of campaign finance
reforms it's easier for a supposedly "scientific" economic approach to tip
against reform. And Posner also puts his finger on the other side of the
scale - by overstating the potential costs of reform, as well as
understating its benefits.

For example, one creative notion for solving the campaign finance dilemma
would be to turn current contribution disclosure laws on their head, and
require that all campaign donations be anonymous. This way individuals and
companies could still freely exercise their First Amendment right to give
money to candidates of their choice. Yet the mandatory anonymity of the
contributions would prevent the access and influence-buying that corrupts
the present system: Candidates would not know who had filled their campaign
coffers and without a "quid" to identify, would not be tempted to provide a
"quo."

In Posner's view, however, this "donation booth" idea would impose an
excessive "information cost" on voters, who would no longer be able to judge
a candidate by his donors. According to Posner, "the identity of a donor is
a clue to the likely policies of the donee should he be elected - a valuable
clue if the donor has better information about the candidate than the
average voter has."

Indeed, Posner finds this cost so significant he suggests it might be better
to forbid anonymous contributions. Yet will it really benefit voters to be
clued in as to which candidates are beholden to which donors? That will only
help them to choose between different varieties of corruption; whereas
anonymous donations might obviate corruption itself.

In any event, very few people, I would venture, assess the relative merits
of candidates by looking at their donor lists - especially these days when
interest groups routinely hide their true identities and agendas behind
truth-bending names. Voters look at what voters have traditionally looked
at - public positions, endorsements, and so on. I'd trade in a heartbeat the
loss of information about donor identity in exchange for an end to the
current practice of quasi-bribery, and I suspect most voters would feel the
same.

Time for a New Psychology and Law Movement?

All of which brings me back to Smith and Kahneman. They have suggested, and
it appears to be true, that human and institutional behavior is, at best, a
complicated mix of the rational and irrational. They have also suggested,
further, that even the definition of rational behavior is subject to
plausibly conflicting views and deep uncertainty.

If these suggestions are true - and they certainly seem to be, then isn't
the law making a terrible mistake by tying itself so closely to a science
that is no science at all? Pretending to offer precise answers to legal
questions by relying on false assumptions only gives a false sense of
security and certainty.

Or, put differently, now that economics is a field shown to be powerfully
dependent on psychology, shouldn't the legal academy think twice about
putting so many of its eggs in the basket of economics? Shouldn't the Law
and Psychology movement perhaps enjoy a second wind instead? But, hey, I was
a history major - so what do I know.


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Edward Lazarus writes about, practices, and teaches law in Los Angeles. A
former federal prosecutor, he is the author of two books - most recently,
Closed Chambers: The Rise, Fall, and Future of the Modern Supreme Court.