Sunday, October 24, 2010

econ 703 topics, 10-25

The early 1960s saw the birth of the law and economics movement, the tenets of which are most famously represented by Ronald Coase's 1960 article on "The Problem of Social Cost" in the Journal of Law and Economics (that journal began in 1958 and is published by University of Chicago Press). From that article many have extracted the famous “Coase theorem” regarding the efficiency of private bargaining solutions to externality problems, in the absence of transactions costs and regardless of the initial distribution of property rights. Ronald Coase moved to the University of Chicago in 1964 and became editor of the Journal of Law and Economics there. In the 1970s the discipline generated more steam as Richard Posner published his Economic Analysis of the Law in 1973. (Posner moved to University of Chicago in 1969.) Law and economics was heavily influenced by libertarianism and many of its proponents argued for strict private property rights and enforceable contracts, as well as an overall market-oriented view of society.

One can see how this field made a strong impact in economics as well as law departments. The institutional world view encapsulated in law and economics perfectly captures the Walrasian model of microeconomic theory: general equilibrium, arising from enforceable and complete contracts, clear property rights, and perfectly competitive markets. One might say it was a match made in heaven.

Interestingly, just as discontents with the neoclassical model of economics led to certain contradictions in the field in the late 1960s and 1970s (look no further than our own department's radical history for evidence of that), a similar dialectics occurred in law, beginning in the late 1970s with the Critical Legal Studies movement (CLS). And on another point of similarity, CLS also began at Harvard. Influenced by post-structuralism, Frankfurt school critical theory, as well as social problems such as with race, CLS had its reactions against the law and economics school. (In fact, in the late 1980s when Obama was a law student at Harvard, the CLS scholars were constantly in heated debates with the law and economics group, all the while Elena Kagan, Supreme Court Justice, was dean of the school: source.)

In particular, CLS was fueled by some of law and economics' assertions. For example, CLS had an issue with the idea that that law must leave (or, in general, does leave) matters of distribution to the legislative branch. I.e., they contested the claim that property law was not distributional. Also, CLS took law and economics to task for its assertion that that law, in a liberal democracy, fosters Pareto efficiency through enforcing contracts, protecting property rights, thereby promoting private bargaining solutions to problems of externalities. On the first point, CLS (recall their Marxist influences) argued that law shows clear evidence of class bias and is therefore not distributionally neutral. They also showed that a social definition of property completely excludes the possibility of neutrality. On the second point, CLS argued that there are a multitude of real blockades to the efficient bargaining model that are more than simple perturbations from the standard Coasean or Walrasian bargaining model. Economic agents play by a fundamentally different kind of game than the one asserted by the law and economics school.

The CLS critique, like their brother radicals in economics, was both contemporary- and historically-oriented. Horwitz’ book, whether consciously or not (asked years later whether he thought Transformation was Marxist, he replied that he didn't think so), illustrates the relative autonomy thesis of Marxism in historical context. This thesis, advanced by Althusser and later expounded upon by Poulantzas, holds that in a base-superstructure framework, law is relatively autonomous from the economy to the extent that law serves no particular class, though does, in its reproducing of the existing order of social relations, promote the political position of capitalists. In other words, after the American Revolution, the courts began to make reasoned decisions that just so happened to aid the propertied class.

This is supported by the three-stage transition outlined in Transformation. We are familiar with the first two stages: the shift from law as custom to law as an instrument. Beginning in the early nineteenth century, judges consciously changed their views on the nature of the law: when defending their position in the cordwainers’ case of 1806 (denying workers the right to strike) they appealed to the law as “the will of the majority. It is law because it is their will – if it is law, there may be good reasons for it though we cannot find them out” (22). “Judges began to conceive of themselves as legislators,” Horwitz writes, in a thesis that highlights the judges’ reasons behind their decisions to consciously favor one economic group over another.

In other words, law has its own political mechanisms, but courts in this period became more conscious of their role as promoter of economic performance. They saw law as an instrument for economic growth, but they themselves were not instruments of a social class. They were the ones that changed their views and took on a more powerful role in American political economy – it was not a direct propertied influence from a new class of merchants and entrepreneurs in the sense of, say, Ralph Miliband’s view of British politics in modern capitalist society.

If it seems like we have strayed a bit too far from law and economics at this point, that is because we have! The CLS arguments are so radically different from the view of the law as a distributionally neutral institution which promotes efficient bargaining. In the language of political economy, Horwitz is an institutionalist because he refuses to see the law as epiphenomenal to market activity. He believes, to the contrary, that our "present conceptions of the rule of law" rest on a "Hobbesian vision of the state and human nature," so that the law essentially vindicates the "adversarial, competitive, atomistic conception of human relations" (565).

Why should economists care? How can we operationalize, or make use of, Horwitz’ insights concerning the law? Consider this quote, again from 1977: "a recent interpretation of Marx's political theory [by Avineri] ... has demonstrated that Marx himself consistently asserted a regular interaction between 'substructure' and 'superstructure' through which thought, values, and social arrangements actually do affect consciousness and, ultimately, history" (563). In other words, while it is true that economy constitutes law, law also constitutes economy.

This is the central point of Friedman’s view of law and society – society makes property, and the types of property regimes in law serve to promote certain types of accumulation over others. Any regime of intensive property rights is going to have these effects. Under the Walrasian model, enforceable and complete contracts are assumed with absolute property rights to lead to an efficient allocation of goods and services. This is in a market of price takers. But as Friedman points out, absolute property rights are intensive property rights which confer a monopoly to a certain group. Thus, the competitive model needs to assume, in addition to absolute property rights, constant returns to scale. Otherwise, in the face of increasing returns and market power, average costs fall and so prices have a distributional effect in the market. Horwitz too highlights this on pg. 43, in the debate between priority and reasonable use, the latter of which operates under a doctrine of proportionality. Priority implies monopoly, "depriv[ing society] of the 'benefit which always attends competition and rivalry'" (43).

Furthermore, this is not a story of absolute property rights or of promoting the Walrasian model of competition -- in fact, that would be the case if priority were upheld. The point is that by operating under an instrumental criterion the courts simply moved property rights in a new dimension. That is, while priority was not upheld, later reconstructions of sic utere gave substantial intensive property rights to proponents of property development such as mill owners and builders, who would not bear many of the costs of compensation to the people whose property (say, downstream or from a canal product) was damaged.

At this point it also is important to remember the role Coase plays in this story. Coase found that if a railroad, in its operation, was giving off sparks to the surrounding village, a private bargaining solution (in the absence of transactions costs) is feasible. In particular, the initial distribution of property rights did not matter to the ability to find a solution. Consider a related example: the land of a farmer is occupied by himself and a cattle raiser. The cattle raiser's herd comes over and eats the crop of the farmer. The data look like this:

Number in herd (steers) | Annual crop loss (tons) | Marginal crop loss (tons)
1 1 1
2 3 2
3 6 3
4 10 4

Given that the crop price is $1 per ton and the cost to the farmer of fencing the property is $9. The cattle raiser must pay the farmer for the lost crops given that the farmer owns the land, and given the total crop loss of 4 steers, then it is clear that if the cattle raiser wants 4 steers, he will pay the farmer to erect the fence.

But all that is important here is that, for any desired herd less than 4, the cattle raiser must factor into his decision to raise more cattle the marginal costs of $1 per ton of crop lost. Coase brings up a very curious problem, however. Given that the farmer is being paid for any lost crop, shouldn't he simply produce more crops, in fact produce more crops to the point that an inefficient allocation of (crop, herd) will arise? No, Coase says -- "If the crop was previously sold in conditions of perfect competition, marginal cost was equal to price for the amount of planting undertaken and any expansion of output would have reduced the profits of the farmer."

Notice the issue here -- in perfect competition. The marginal cost of the crop is $1, so that the price paid for any lost crop offsets the value of the crop and no difference in production decisions arises. And in particular, the pricing mechanism in the theory of perfect competition does not permit market power from increasing returns, which we noted is quite possible in any intensive property rights regime. In this case, price might be greater than marginal costs, leading to a misallocation in the system: the price of the lost crop paid by the cattle raiser may distort incentives and thereby lead to increased production, hindering the herder's decision to reach a an efficient point for his own decisions.

Translating to U.S. economic history: Horwitz and Friedman both make clear the fact that different property regimes promote different distributions of income, violating the predictions of the Walrasian model in the process. In canals and mills, where substantial damages to property occurred due to the decisions of entrepreneurs, monopoly power was distributed to a particular group, violating the assumptions of the Coasean model in the process.

Is it efficient? At this point, the question may seem absurd. It is, however important and in fact, Horwitz does briefly bring up the point of whether legal subsidization of economic growth was efficient. I personally think we would need to focus on technical efficiency, which is useful for understanding economic growth but not for understanding policy or, more broadly, questions of social welfare. In particular, pushing against the incentives argument by North and others, I would argue that the law does much more than passively create the appropriate incentives. Through the conscious choices law, it actively takes a part in redistribution of income, thereby promoting growth.

In fact, more recent, more explicit, and even somewhat more mainstream examples of this train of thought can be found in the literature on the late developers. Through directly subsidizing and promoting some industries over others, and coercively protect some industries from outside competition and eliminate others the government was able to promote growth.
At any rate, we see that the project of the early nineteenth century courts was to argue, through the rhetoric of classical economic thought (pg. 3), that competition were to be promoted by destroying certain obvious forms of monopoly but really they were just allocating intensive property rights to different actors in society in that process. This is the lesson learned from the Charles River Bridge case, when intensive rights were distributed from the traditional owners of a bridge to the new property developers. This is a direct subsidization of growth.

It is also the case in labor contract disputes, though we will talk more about those on Wednesday. But briefly, because it relates to the point raised here concerning the law favoring the entrepreneur, we find that in building contracts if the entrepreneur had partially fulfilled his contract (maybe by not doing a "sufficiently good" job in constructing the house) he would still be given compensation for the work performed. Horwitz has found that in a similar type of case involving the laborer, he or she was not given partial compensation.

More to come on labor on Wednesday, but for now, wrapping up, I think we can gain a better appreciation of why law should matter to political economy. And in the early nineteenth century, as law changed its views concerning economic development, the entire playing field was shaken up.

What did it all mean for labor?

1 comment:

  1. Hey Dan, great lecture in today's class and thanks for posting these notes.

    Is it possible to generalize that explicit private property rights generally discredit Coase's model do to the distributional effects? Isn't that sort of contradictory that the same neoliberal or libertarian thought-path would lead to a legal structure that hinders its own model to efficiently operate? Is this an example of the inefficiency of the legal system itself, as you explained, especially in that it is a "passive" institution in this case. Maybe I read into this wrong? It was a lot to take in being relatively unfamiliar with the Horwitz book. I may be a bit confused.

    Looking forward to hearing more on labor law.