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Law, Economics and Liberty
What is Economics?
•A way of understanding behavior
•Based on one assumption
•Individuals have objectives
•And tend to take the actions that achieve them
•Rationality
•Not perfect, but the only predictable pattern
•For more details, see my
•Law’s Order, or Hidden Order, or Price Theory, or …
What does it have to do with law?
•Think of a legal system as a system of incentives
• If I do this, what will happen to me?
• How will rational individuals respond?
•Suppose we impose the death penalty for armed robbery?
• Constitutional scholar: Is this cruel and unusual?
• Legal philosopher: Is this just?
• Economist: Do we want armed robbers to kill their victims?
• Because if the penalty for armed robbery and armed robbery+murder
are the same
• The additional penalty for murder is zero
• And a dead victim can’t identify you in a police lineup.
Economic Efficiency
•Not central to the definition of economic analysis of law, but
has played an important role in how the theory developed
•Roughly speaking
• Maximizing the size of the pie
• The degree to which everyone gets what he wants
• For a more complicated explanation, see my Law’s Order or other
books.
•Not a complete description of everything people care about
• But perhaps the closest that everyone agrees on
• And that we have a hope of using economics to figure out how to
get
The Coordination Problem
•To get anything done, millions of people have to
cooperate
•A pencil requires wood
• Requires chain saws
• Require steel and oil and …
• Each of which requires …
•Two Solutions
• Centralized top down authority
• Decentralized coordination
• One of which doesn’t work
The Decentralized Solution
•Everything belongs to someone
•Each person decides what to do with himself and his
stuff
•People coordinate through the market, with prices
signaling whether more or less of something should
be produced
•Each of us maximizes his net benefit, so
•All of us maximize our net benefit
•But …
Market Failure
•Situations where individual rationality does not produce group
rationality
•If my action imposes costs on other people which I don’t have
to compensate them for
•Or provides benefits I don’t get paid for
•Those costs and benefits are left out of my calculation of what
to do, so …
•What is in my interest may not be in our interest
• I may do something which imposes costs >benefits, (air pollution,
…) or
• Fail to do something with benefits > costs (basic research, national
defense)
Law Solves Some of It
•Tort Law
• I do something that imposes costs on you.
• Should I? From the standpoint of efficiency
• Yes if my benefit > your cost
• No if my benefit < your cost
• If I have to compensate you, that is when I will do it.
•Property law
• What you own is a bundle of rights
• Define the bundle to include rights that go together
• Owning land includes the right to forbid trespassers but not
• Planes a mile above, radio waves passing through
• Owning a gun does not include the right to shoot at random
• But not all problems can be solved that way
The Usual Policy Conclusion
•Market failure results in inefficient outcomes
•The problem cannot be entirely solved
•By private transactions or
•By properly designed legal rules
•So government steps in to
•either regulate or …
•Tax negative externalities, subsidize positive externalities
•For economists, this is the main argument for
government intervention in the economy
Problem: The Political Market
•Government is not a wise and benevolent ruler
•It is a political market
• Just as in the private market
• Rational individuals spend resources trying to get what they want
• Under a different set of rules
•Private market, I need your consent to hire, buy, sell
•On the political market, if I have the votes, or guns, I don’t
•Public Choice Theory: Apply economic analysis to decide
• What will happen on the political market
• Will the result be efficient?
• Just like economics of private market
Market Failure on the Political Market
•Most political decisions are made by people who neither pay
the cost nor receive the benefit
• The voter who makes himself well informed provides benefits
mostly to others
• The legislator who passes a bill provides costs and benefits to others
• The lobbyist benefits his customers at the cost of others
• The judge makes decisions, set precedents, almost all of whose costs
and benefits will be born by others
•So there is no reason to expect political actors to take the
actions that maximize net benefit for all
•For example …
The Rationally Ignorant Voter
•For democracy to work, voters must be well informed
•But information is costly
•And if my vote has any effect at all
•most of the benefit goes to others
•So most voters are rationally ignorant
•If voters are rationally ignorant …
•They support the policies that sound good
•To someone who knows little about them
•And has no incentive to learn more
•Giving a politics of sound bites and demagoguery
Short Political Time Horizons
• The incentive to bear costs now for benefits in the future
• Depends on the person who bears costs now getting the benefits later.
• A politician who does politically costly things now
• Will provide a benefit to his successor 20 years later
• By which time he is out of office
• Politicians pretend to be interested in the future
• Because voters can’t see the future, so can be fooled
• Into accepting real costs now for imaginary benefits then
• But politicians decide what to do by what the effects will be on the
next election
Lethal Caution
• Drug Regulation
• A regulator who permits a drug that kills 20 people is out of a job
• A regulator who delays a drug, killing 100, pays no cost
• Because statistical deaths are invisible, and …
• Voters are rationally ignorant
• Covid vaccine
• Producing a successful vaccine took less than a week
• It could have been tested for safety in a month or two
• It took almost a year to get approved
• Because they used a slightly better approach: Controlled experiment
• At the cost of thousands of lives a day
• But not the lives of the regulators
Redistribution to Favor Concentrated Interest Groups
•An auto tariff benefits car makers and their workers
•At the cost of consumers and farmers
•The beneficiaries are a few firms and a union with a lot at
stake, the losers are hundreds of millions of people, each losing
a little
• The beneficiaries can organize to offer politicians support and
campaign contributions
• Much more easily than the losers can, so
• It is politically profitable to benefit concentrated groups at the cost
of dispersed groups, even if the cost is much larger than the benefit.
Conclusion
• On the private market
• Individuals must usually pay for what they use and get paid for what they
produce
But
• There are sometimes situations where they don’t
• So market failure sometimes occurs
• On the political market
• Individuals almost never bear the costs or receive the benefits of their
actions
• So have no incentive to make those choices
• That maximize the net benefit to all
• So market failure on the political market is common
• Market failure is the exception on the private market, the norm on
the political market
The Choice Between Private and Political Market
• Between individual liberty and government control
• Liberty is almost always better
• From the standpoint of economic efficiency
• Aside from moral arguments for it
• Are there exceptions?
• If market failure on the private market bad enough
• So the outcome is even worse than due to failure on the political market
• But … who decides? Market failure in that decision
• Conclusion
• Exceptions only if private failure is catastrophic
• National defense is probably the strongest case for government
• For Ukraine or Slovakia
• Possibly not for the U.S.
• Russia is a more dangerous neighbor than Canada or Mexico

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David Friedman: Law, Economics and Liberty

  • 2. What is Economics? •A way of understanding behavior •Based on one assumption •Individuals have objectives •And tend to take the actions that achieve them •Rationality •Not perfect, but the only predictable pattern •For more details, see my •Law’s Order, or Hidden Order, or Price Theory, or …
  • 3. What does it have to do with law? •Think of a legal system as a system of incentives • If I do this, what will happen to me? • How will rational individuals respond? •Suppose we impose the death penalty for armed robbery? • Constitutional scholar: Is this cruel and unusual? • Legal philosopher: Is this just? • Economist: Do we want armed robbers to kill their victims? • Because if the penalty for armed robbery and armed robbery+murder are the same • The additional penalty for murder is zero • And a dead victim can’t identify you in a police lineup.
  • 4. Economic Efficiency •Not central to the definition of economic analysis of law, but has played an important role in how the theory developed •Roughly speaking • Maximizing the size of the pie • The degree to which everyone gets what he wants • For a more complicated explanation, see my Law’s Order or other books. •Not a complete description of everything people care about • But perhaps the closest that everyone agrees on • And that we have a hope of using economics to figure out how to get
  • 5. The Coordination Problem •To get anything done, millions of people have to cooperate •A pencil requires wood • Requires chain saws • Require steel and oil and … • Each of which requires … •Two Solutions • Centralized top down authority • Decentralized coordination • One of which doesn’t work
  • 6. The Decentralized Solution •Everything belongs to someone •Each person decides what to do with himself and his stuff •People coordinate through the market, with prices signaling whether more or less of something should be produced •Each of us maximizes his net benefit, so •All of us maximize our net benefit •But …
  • 7. Market Failure •Situations where individual rationality does not produce group rationality •If my action imposes costs on other people which I don’t have to compensate them for •Or provides benefits I don’t get paid for •Those costs and benefits are left out of my calculation of what to do, so … •What is in my interest may not be in our interest • I may do something which imposes costs >benefits, (air pollution, …) or • Fail to do something with benefits > costs (basic research, national defense)
  • 8. Law Solves Some of It •Tort Law • I do something that imposes costs on you. • Should I? From the standpoint of efficiency • Yes if my benefit > your cost • No if my benefit < your cost • If I have to compensate you, that is when I will do it. •Property law • What you own is a bundle of rights • Define the bundle to include rights that go together • Owning land includes the right to forbid trespassers but not • Planes a mile above, radio waves passing through • Owning a gun does not include the right to shoot at random • But not all problems can be solved that way
  • 9. The Usual Policy Conclusion •Market failure results in inefficient outcomes •The problem cannot be entirely solved •By private transactions or •By properly designed legal rules •So government steps in to •either regulate or … •Tax negative externalities, subsidize positive externalities •For economists, this is the main argument for government intervention in the economy
  • 10. Problem: The Political Market •Government is not a wise and benevolent ruler •It is a political market • Just as in the private market • Rational individuals spend resources trying to get what they want • Under a different set of rules •Private market, I need your consent to hire, buy, sell •On the political market, if I have the votes, or guns, I don’t •Public Choice Theory: Apply economic analysis to decide • What will happen on the political market • Will the result be efficient? • Just like economics of private market
  • 11. Market Failure on the Political Market •Most political decisions are made by people who neither pay the cost nor receive the benefit • The voter who makes himself well informed provides benefits mostly to others • The legislator who passes a bill provides costs and benefits to others • The lobbyist benefits his customers at the cost of others • The judge makes decisions, set precedents, almost all of whose costs and benefits will be born by others •So there is no reason to expect political actors to take the actions that maximize net benefit for all •For example …
  • 12. The Rationally Ignorant Voter •For democracy to work, voters must be well informed •But information is costly •And if my vote has any effect at all •most of the benefit goes to others •So most voters are rationally ignorant •If voters are rationally ignorant … •They support the policies that sound good •To someone who knows little about them •And has no incentive to learn more •Giving a politics of sound bites and demagoguery
  • 13. Short Political Time Horizons • The incentive to bear costs now for benefits in the future • Depends on the person who bears costs now getting the benefits later. • A politician who does politically costly things now • Will provide a benefit to his successor 20 years later • By which time he is out of office • Politicians pretend to be interested in the future • Because voters can’t see the future, so can be fooled • Into accepting real costs now for imaginary benefits then • But politicians decide what to do by what the effects will be on the next election
  • 14. Lethal Caution • Drug Regulation • A regulator who permits a drug that kills 20 people is out of a job • A regulator who delays a drug, killing 100, pays no cost • Because statistical deaths are invisible, and … • Voters are rationally ignorant • Covid vaccine • Producing a successful vaccine took less than a week • It could have been tested for safety in a month or two • It took almost a year to get approved • Because they used a slightly better approach: Controlled experiment • At the cost of thousands of lives a day • But not the lives of the regulators
  • 15. Redistribution to Favor Concentrated Interest Groups •An auto tariff benefits car makers and their workers •At the cost of consumers and farmers •The beneficiaries are a few firms and a union with a lot at stake, the losers are hundreds of millions of people, each losing a little • The beneficiaries can organize to offer politicians support and campaign contributions • Much more easily than the losers can, so • It is politically profitable to benefit concentrated groups at the cost of dispersed groups, even if the cost is much larger than the benefit.
  • 16. Conclusion • On the private market • Individuals must usually pay for what they use and get paid for what they produce But • There are sometimes situations where they don’t • So market failure sometimes occurs • On the political market • Individuals almost never bear the costs or receive the benefits of their actions • So have no incentive to make those choices • That maximize the net benefit to all • So market failure on the political market is common • Market failure is the exception on the private market, the norm on the political market
  • 17. The Choice Between Private and Political Market • Between individual liberty and government control • Liberty is almost always better • From the standpoint of economic efficiency • Aside from moral arguments for it • Are there exceptions? • If market failure on the private market bad enough • So the outcome is even worse than due to failure on the political market • But … who decides? Market failure in that decision • Conclusion • Exceptions only if private failure is catastrophic • National defense is probably the strongest case for government • For Ukraine or Slovakia • Possibly not for the U.S. • Russia is a more dangerous neighbor than Canada or Mexico