Economism and the Law

By James Kwak

Economism—the simplistic, unreflecting application of Economics 101 models to complex, real-world issues—is particularly influential in the law, including both legal academia and actual court opinions that decide important questions.

Noah Smith, for example, points to a paper by a law professor arguing that forced prison labor deters crime because it effectively raises the price of crime in a supply-and-demand model. The problem with this model is that it doesn’t accurately describe criminal behavior. Smith quotes economist Alex Tabarrok on what happened when the United States dramatically increased the harshness of punishments:

In theory, this should have reduced crime, reduced the costs of crime control and led to fewer people in prison. In practice … the experiment with greater punishment led to more spending on crime control and many more people in prison.

I discuss economism and the law briefly in the historical chapter of my book, but the basic story is simple. Beginning in the 1960s, the law and economics movement, most closely associated with Richard Posner, re-conceptualized various areas of the law in economic terms. To simplify greatly, the central idea was that the law should be designed to promote economically efficient outcomes; for example, a product manufacturer should only be liable for failing to include some safety feature if the cost of that feature was exceeded by its expected benefits in the form of reduced injuries. Law and economics was and remains a valuable way to think about the law. At the time, however, few law professors knew very much about economics, and so there was an explosion of theoretical papers that assumed the accuracy of basic rational-actor models more or less swallowed whole from Economics 101. (The law and economics movement was also enthusiastically backed by conservative foundations, most notably the Olin Foundation, who saw in it a way to reorient the judiciary toward business-friendly, free-market principles.)

My go-to example of economism in the law is Frank Easterbrook’s opinion in Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008). One of the issues was whether it is possible for mutual fund fees to be excessive. Easterbrook thought not, because those fees are set by a competitive market. Among other things, he wrote:

It won’t do to reply that most investors are unsophisticated and don’t compare prices. The sophisticated investors who do shop create a competitive pressure that protects the rest. See Alan Schwartz [and] Louis Wilde, Imperfect Information in Markets for Contract Terms, 69 Va. L.Rev. 1387 (1983).

Now, I’ve looked at the article by Schwartz and Wilde: It’s about contract terms in general, its primary examples are warranties and security interests (not mutual funds), and it is entirely theoretical. By 2008, of course, the world had learned a lot more about how consumers make decisions—and it isn’t the way you would expect based on Economics 101. But Easterbrook had no need for reality, since the model sufficed to make his point.

I just read Richard Posner’s book Divergent Paths (the one in which he cites one of my anti- Bluebook rants), and he has another good example (beginning on page 192). It’s Edwards v. District of Columbia 755 F.3d 996 (D.C. Cir. 2014), a case in which a company that gives tours of Washington, DC challenged a city regulation requiring tour guides to pass a test of their knowledge of the city. The court overturned the regulation because the city did not provide evidence that “market forces are an inadequate defense to seedy, slothful tour guides”; in Posner’s words, “The opinion rejects the legitimacy of government regulation in any situation in which the market can in principle do an adequate job of regulation, whatever the reality” (emphasis added).

Posner fills in several reasons why markets will not protect tourists from being ripped off by tour guides, which really anyone could think of: tourists will not necessarily know they are being misled, Internet rating websites (on which the court relied) do not adequately police services aimed at tourists, and so on. And as an aside, can you guess what constitutional protection this regulation violated? That’s right: the First Amendment right to freedom of speech. As Posner points out, a person who fails the tour guide test is in the same situation as “an applicant for a teaching job who having flunked her licensing test cannot exercise her right of free speech at the front of a Washington schoolroom.”

In short, the D.C. Circuit invokes the magic tool of free markets without pausing to consider whether it can actually do the job it needs to do in this context. This is not economics; this is ideology. (Posner: “There is no plausible nonideological explanation for the decision.”) That’s what economism looks like in action.

2 thoughts on “Economism and the Law

  1. The question comes up at to whether we ought to be teaching Econ 101 as we do. Perhaps the whole rational-actor perfectly competitive market model (which, if I understand correctly is usually called rational choice theory) ought to be taught in Econ 201 as an interesting and important special case, but one largely limited to financial exchanges. Elementary teaching of the physical sciences has long used idealized models, and the situations they apply to are common enough that they are useful in common practice (one can, for instance, depend on Newtonian mechanics for the design of bridges, even very large bridges) but if one is running a small shop or hiring employees rational choice theory has little to offer.

    Perhaps we ought to be teaching consumer and business economics as the first thing, instead of rational choice theory.

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