Today we continue our discussion of economists’ theories of law-making and ceiling building, which we kicked off by analyzing Adam Smith and Carl Menger. Suitably, we move to the neoclassical synthesis that took key concepts from both.
This may seem like an odd choice, since neoclassicals have fairly weak-to-nonexistent accounts of the emergence (and persistence) of institutions (Hodgson, 2009), so it is not surprising that they would have difficulty formulating a consistent theory on the role of judiciaries. Economist Kenneth Arrow, who generally thought that private adults consenting to exchange of commodities was preferable to other means of managing resources, and who had little confidence in the reliability of political solutions to problems (Arrow, 1950), nonetheless felt that law itself should be outside the domain of the market. (Arrow, 1972)
Much of the heavy lifting for the neoclassical account of the judiciary has fallen to one of the few actual judges in their ranks, University of Chicago law
professor Richard Posner. Since neoclassicals believe that their favored rational choice methodologies can help explain “everything” (Chang, 2013, Chapter 1), it is not surprising that Posner believes that these tools can also explain law and the behavior of judges. For instance, judges – just like anyone else – are self-interested individuals, and the domain of the law can be analyzed in terms of the market for legal services. (Posner, 1977, at 399 and 415) The same basic framework can explain the differing forms of justice and dispute settlement that take place in modern and in primitive societies, as Posner argues in a widely cited article with University of Chicago economist William Landes. (Landes and Posner, 1979, at 242)
This is a significant departure from Smith’s classical thought (and other neoclassicals like Arrow), which saw justice as “special,” not present in every moment of history, and saw human motivation as motivated by diverse factors like obeisance to authority. Indeed, Posner and Landes distinguish their own views from Smith’s by suggesting that he failed to understand how “the provision of judicial services precedes the formation of the state; that many formally public courts long had important characteristics of private institutions (for example, until 1825 English judges were paid out of litigants’ fees as well as general tax revenue), and that even today much adjudication is private (commercial arbitration being an important example).” They further note that many disputes are settled out of court, and are privately financed in any case, suggesting a strong if not dominant role of private actors. (Landes and Posner, 1979, at 235) Not only does law not need the state, but even apparently state-generated law may be driven by private actors.
Law plays a special role…
Posner has difficulty reconciling how justice is “not special” with its unique structural role in contemporary life. While it can be analyzed from a market lens, the legal system seems to also hover above or alongside the market. Posner writes that, “…economics is the deep structure of the common law, and the doctrines of that law are the surface structure. The doctrines, understood in economic terms, form a coherent system for inducing people to behave efficiently, not only in explicit markets but across the whole of social interactions.” (Posner, 2010) The common law is a system that helps maximize social wealth. In settings where transaction costs are low, law creates incentives for people to channel transactions through markets, by creating property rights and enforcing remedies. In high transaction costs settings, the law prices behavior so as to simulate the allocation of resources that would have held in a market.[i] While market allocation is still superior to legal allocation,[ii] the “aloof disinterest of judges” simulates the “invisible hand” of the market (Posner, 1977, at 401).
In general, the common law promotes efficiency by correctly assigning efficiency-maximizing theories of liability. Posner tangles with seeming exceptions, such as courts’ 19th century leniency with respect to the railroads, when they prioritize capital accumulation at the expense of textbook efficiency. However, even this scenario can be always accommodated back into a neoclassical framework by finding some uncompensated externality (railroads’ uncertainty over the property ownership of adjacent lands) that judges could actually be correcting through failing to enforce strict efficiency elsewhere. (Posner, 2010,at 323-326)
… But its Constituent Parts are not special
This unique oracular role would seem to make judges “special”, and something more than just ordinary market participants. But Posner goes to great lengths to analyze them too through a rational choice framework. Judges are utility maximizers, like everyone else. So why do they not simply seek payoffs from plaintiffs or other interest groups? Because institutional forms ensure that the expected costs to doing so exceed any benefit. These rules include lifetime tenure, salary guarantees, the forbidding of ex parte contracts (i.e. out of court agreements with judges), the plaintiff standing requirement of “actual injury,” and the exclusion of evidence in court unrelated to the claim. In other words, the judge will have little information before him other than the particulars of the case, and cases must be argued and judgments rendered pursuant only to this information. This supposedly minimizes the role for overt class or sectional bias from judges. (Posner, 1977, at 410)
Posner has difficulty explaining what “utility,” costs and benefits actually consist of for judges. They don’t maximize leisure, he says, because it is obvious from “casual observation” that judges work hard. They have set income, and apparently don’t try to get more because of the rules of the game noted above. Even though a judge might be tempted to rule in favor of his own economic class, the marginal income gain from doing so would pale in comparison to the professional penalties, which are said to include public “criticism” or reversal by a higher court. Posner does not explain how the utility of cash payments could be directly compared to the disutility of public disapproval, sense these presumably contain distinct denominators. Moreover, he appears to consider judges “special” when he says that they want to impose their tastes on society, which they can only do through the creation of precedent (in common law cases) and the upholding of congressional intent (in statutory interpretation cases). Judges accomplish this feat through maximizing the number of citations. (Posner, 1977, at 415-416, 420)
Posner does not explain why non-judges are less interested than judges in imposing their tastes on society. Setting aside for a moment the apparent mysticism of this posture, it is useful to ask how court decisions make the world a more efficient place. After all, how could a public sector institution outperform the private market when it came to efficiency?
In true neoclassical fashion, Posner’s answer is a market failure in law. The production of precedent can be seen as a function of litigation (which can be further decomposed into the inputs of legal and judicial services).
Precedents contain a positive externality in that their value is not only captured by the parties to a dispute, but also by others in society that will benefit from the legal certainty it creates. Landes and Posner also argue that judges might issue intentionally vague decisions in order to maximize repeat business in clarification services.[iii] They also note that there are “tremendous economies of standardization in the precedent market,” in that the social value of precedent is undermined by the types of inconsistent decisions one might expect to find in a private judicial market. This tends to promote the emergence of a monopoly in appellate adjudication (Landes and Posner, 1979, at 239, 241, 248)[iv]
If the market failure can be corrected (through the public intervention of courts), then precedent production follows normal microeconomic supply functions (i.e. it increases when social demand for precedent shifts outward, as during times of revolution or uncertainty).
The mechanisms whereby the incentives of suppliers of precedent (courts and lawyers) are set at socially optimal levels are mysterious.
For judges, the answer appears to be that they value, and wish to maximize citations. These yield non-pecuniary benefits, and cannot be monetized (such as through giving property rights in precedent) because of the measurement problems involved. (Landes and Posner, 1979, at 242) Citations are in turn provided through the citation market. Judges’ rulings can only be cited if their decisions are not overturned. Fellow judges will only supply citations in their rulings if they themselves are cited in the rulings of others. If judges supplied “wrong” precedent and were overturned by higher courts, their utility would be decreased – both through foregone citations, and losing leisure time through having to re-hear the case.[v]
For lawyers (and disputants), the answer seems to be that they are incentivized to help generate the socially optimal level of efficiency-enhancing precedent through more traditional utility functions. Litigants who see inefficient rules or outcomes will have personal incentives to invest in information collection and litigation with the hope of obtaining compensatory damages, and establishing more efficient rules for future transactions. (See discussion at Schwartzstein, 1994, at 1053)[vi]
[i] Posner writes, “The law of contracts… places liability on the party better able either to prevent the contingency from occurring or to minimize the disutility of its occurrence by buying insurance or self-insuring. The law of property does the same thing by limiting property rights in situations in which insistence on an absolute right would prevent a value-maximizing exchange. To reverse the previous order of discussion, the common law establishes property rights, regulates their exchange, and protects them from unreasonable interference – all to the end of facilitating the operation of the free market, and where the free market is unworkable of simulating its results.” (Posner, 2010, at 315-316)
[ii] Posner writes that, “willingness to pay imparts greater credibility to a claim of superior value than forensic energy” of a court. (Posner, 1977, at 402)
[iii] The authors note nonetheless that competitive private judges may begin to produce precedent in order to cement their reputations for impartiality. Doing so might be a form of advertising, although the authors suggest that there might be cheaper ways of doing so. (Landes and Posner, 1979, at 238-240)
[iv] The authors also acknowledge that arbitration in some sense “free rides” on the public production of law, since most arbitration apples court-made law or treaty-derived rules. They argue that this is not a major problem, since the parties to arbitration do not derive more benefits that court litigants do from this preexisting precedent stock, and that they may actually lose more money through arbitration. (Landes and Posner, 1979, at 249) This is not convincing in all cases, however, since the value of rules in ISDR, for instance, do not accrue but to a very specific subset of society. Moreover, without further empirical support, it is difficult to know whether the costs of arbitration or public litigation are actually higher.
Later, they argue that the case for monopoly might be weakened in instances where there is a perceived bias against defendant, as is allegedly the case in state courts. (Landes and Posner, 1979, at 255)
[v] Posner attempts to interpret even Supreme Court behavior through this lens, because, even though there is no appellate court keeping their interpretations in check, they want to maximize citations and not be overturned by future Supreme Courts. This is even less convincing, however, since (even assuming that judges are motivated by will imposition and citation rather than income) the private benefits to being upheld by future Supreme Courts would accrue almost entirely after a given justice’s death. This is because Supreme Court judges, because of lifetime tenure and political pressure to not resign except when one’s own party is in control of the presidency, tend to serve out almost the entirety of their natural lives. (McGuire, 2005)
[vi] There are other neoclassicals that have considered disputant motivation, and reached similar conclusions. For instance, Paul Rubin of Emory University created a model showing that the judge does not have to be interested in efficiency, provided that the disputants are and have an interest in future cases. (Rubin, 1977) In a series of papers, George Priest of Yale University built on Priest’s model to show that disputants’ interest in future cases is not important, since “inefficient” legal rules will always be more costly to comply with and therefore worth litigating over. As a consequence, disputants have an incentive to settle out of court if the legal rule is efficient, and the court system itself is filled mostly with litigation over inefficient rules. (Priest, 1977), (Priest, 1980), (Priest and Klein, 1984)
Todd N. Tucker, PhD 
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