Sunday, July 26, 2009

from equity to will - update

See the first post, where the original question is asked, here

What is the primary motivation for equity in contracts in the first place? A contract specifies an exchange of property rights, so unequal exchange is simply not under this criterion. If unequal exchange does take place, it is probably because one party was forced, or deceived, or in some other way coerced into making the decision to trade. Thus it is assumed that to uphold individual freedom, one must prescribe to equality in exchange.

Notice that in theory, this fits perfectly well with the neoclassical model of market exchange. According to that model, individuals trade commodities/property rights until they reach a point where their marginal rates of substitution among the different commodities/property rights equalize. In labor markets, the worker gets paid for precisely how much they contribute to production -- wage equals marginal revenue product.

The reason I make this connection is because it is a central part of the story of the change in conception in contracts from equity to will in the beginning of the 19th century. My friend who is currently a law student at Wayne State University in Michigan offers a practical perspective: discussions in her classes on contracts and employment law observed that it would be too difficult for the courts to determine the just price, since there are so many variables influencing the value of a good. The answer is to leave it up to the free bargaining of the individuals involved in the exchange. In other words, the law assumes the employee and employer have freely bargained over the wage paid. She goes on to mention that a few times during the discussions in her courses the point was raised that in situations where jobs are abundant workers may have less bargaining power relative to situations where jobs are scarce, but no conclusion was reached regarding this issue.

This calls to mind the neoclassical concept of full employment. It seems that the law is assuming the same thing that Keynes attacked the classicals for assuming in their analyses of the Great Depression. If everyone who wants a job currently has one, and everyone who is out of a job is looking so that unemployment is only a temporary, disequilibrium phenomenon, then we can see how the above point concerning job scarcity and bargaining power has no relevance. Why? because job scarcity is defined as "exceeding full employment" so obviously some contract bargains will not be fulfilled, and job abundance is defined as "under full employment" so it's a simple search - and - match problem, not one of fundamental inequality in bargaining. Thus, my friend's class' "problem" is not an issue in the classical/neoclassical view of contract.

It is really interesting how many nuances exist in this theory of historical development. Another related point is the subjective vs. objective notions of value in neoclassical economics. It is contradictory to assert two notions at the same time, but that is exactly what the neoclassicals who work on law and economics do. Let me explain: neoclassical economic theory tells us that with the behavioral assumptions of self-interest and utility maximization brings marginal rates of substitution into equality, giving us the "just price" (justice here in the sense of equal, voluntary exchange). Thus, the just price is derived from objective principles and with the formalization of those principles, we can even come up with a "number" that it will equal. But the courts justify a will theory of contract partly based on the idea that value is subjective so that only individuals can arrive at the just price. What allows them to make this seemingly paradoxical argument, asserting two different conceptions of value at the same time? The answer lies in the space in which individuals interact, the market:

"In a market, goods came to be thought of as fungible; the function of contracts correspondingly shifted from that of simply transferring title to a specific item to that of ensuring an expected return." (161)

Now that we have resolved this paradox between neoclassical economic thoery and the liberal view of law, and realize the fundamental basis upon which the solution to that paradox rests (markets in all commodities guaranteed by their fungibility), we move toward establishing a basis for the equity to will transition. First, can we find conceptions of equity in early contract law? Horwitz' aim in The Transformation of American Law, 1780-1860 is to identify several strands of this view which extend into the 19th century. A South Carolina Chancellor in 1817 argued "it would be a great mishief to the community, and a reproach to the justice of the country" if unequal contracts could not be analyzed by the courts for the source of that inequality. Simialr sentiments were expressed in New York.

Another example is in how the courts dealt with the question of equity in terms of judicial process -- they left it up to the community to decide. Horwitz cites several cases in the late 18th century where the value of damage claims brought forward were decided by the jury who were assumed to arrive at an amount which preserved equity. This example is in the same vein as the customary price doctrine. One interesting quote comes from John Adams and Samuel Quincy (1765): "the Price for Boarding and Schooling is as much settled in the Country, as it is in the Town for a Yard of Cloth, or a Day's Work by a Carpenter" (172). And in addition to these legal formulations of equity conceptions, social historians of early American history have found ideologies of Americans from rural regions and artisans from cities such as New York and Philadelphia who share a similar view.

It suffices to say that the shift toward a will conception of contract was accompanied by the rise of the market economy, and this relationship assumed a variety of forms. In commodity markets, councils of merchants were increasingly aalled upon to decide on matters of future payment in contracts. In a landmark case from 1790, a stock owned by person A was borrowed by person B at a specific time and price. When it came time for person A to recover the value of the borrowed stock, the stock's value had risen substantially. The issue was whether person B should have to pay person A the market amount, or the amount the original transaction was for (the original amount agreed to). The court ruled for person A of the stock, which is a textbook example of the new market conception of the legal system and specifically, contract law.

(A similar example can be found in Hamilton's financial proposal, shortly after the Revolution. People who had bought bonds to fund the war with Britain found their notes substantially depreciated by the 1780s and sold them off, some of them to wealthy speculators. Hamilton's plan was to pay off the debt at substantially higher value than the one which the original purchasers of the debt (mostly soldiers) had sold them for. While Hamilton's plan passed eventually, it did not pass without several classes of protestors speaking against the plan including William Manning in his Key of Liberty.)

So, the central story is one of markets, and the importance of markets was emphasized in terms of 1. commodification (fungibility) of the property right and 2. market values.

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