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Economics and the Law
From Posner to Postmodernism and Beyond
By Nicholas Mercuro Steven G. Medema Princeton University Press
Copyright © 2006 Princeton University Press
All right reserved. ISBN: 0-691-12572-4
Chapter One
CHICAGO LAW AND ECONOMICS
A second meaning of "justice," and the most common I would argue, is simply "efficiency." When we describe as "unjust" convicting a person without a trial, taking property without just compensation, or failing to require a negligent automobile driver to answer in damages to the victim of his carelessness, we can be interpreted as meaning simply that the conduct or practice in question wastes resources. (Posner 1975, p. 777)
INTRODUCTION
While the roots of Law and Economics go back at least to Adam Smith and Jeremy Bentham, it came of age as an intellectual discipline within economics and law in the 1960s and 1970s through the work of such notable figures as Ronald H. Coase, Guido Calabresi, Henry Manne, Gary Becker, and Richard A. Posner. The work of these scholars-of whom Posner as professor, scholar, and judge is perhaps the foremost exponent-forms the core of the Chicago approach to law and economics, an approach that has attracted a large following and has come to dominate scholarship within the economic analysis of law. For the purposes of thisdiscussion, the Chicago school is deemed to encompass most of the scholarship falling under the umbrella of "mainstream law and economics," as reflected in the pages of, for example, the Journal of Law and Economics, the Journal of Legal Studies, the American Law and Economics Review, Research in Law and Economics, and many of the major law reviews.
This having been said, the history of law and economics at the University of Chicago begins well before the birth in the 1960s of the "new law and economics" that is now synonymous with the Chicago school label. The distinction that is often made between the "old" and "new" Chicago law and economics within the Chicago oral tradition is part folklore and part fact,4 and, to appreciate the nature of this distinction, it is useful to mention a few of the highlights of this earlier era of economics and law. As will become evident, although some of the early history and subsequent success of Chicago law and economics is attributable to scholars in the Department of Economics at Chicago, much of the credit owes to the intellectual edifice provided by the faculty of the law school.
The Law School
As we noted in chapter 1, the Realist-Institutionalist interaction of the 1920s and 1930s did a great deal to bring law and economics together. A similar interaction, but with a distinctly different flavor, commenced at nearly the same time at the University of Chicago. Within the law school, the origins of Chicago law and economics can be traced back to the latter part of the 1930s, when the faculty, under the deanship of Wilber Katz, instituted a four-year interdisciplinary legal studies curriculum that included courses in economics and accounting (Katz 1937). In 1939, the law school appointed its first economist, Henry Simons, to the faculty. Simons had been a lecturer in the Department of Economics and was a former student of Professor Frank Knight, who was in many respects the father of the modern price-theoretic tradition of Chicago economics (Kitch 1983a, p. 167). Simons's appointment to the law school was the culmination of many episodes of political infighting between Frank Knight and Paul Douglas within the Department of Economics. Douglas-a strong proponent of Keynesian thinking and advocate of government intervention in the economy-and others within the economics department fought both Simons's promotion and tenure. As a result, Simons was ultimately appointed to the law faculty to teach a course titled "Economic Analysis of Public Policy" (essentially a course in applied microeconomics for lawyers), and, in 1945, he was promoted to full professor and became the first economist granted tenure by the law school. By the mid-1940s, Simons had established himself as a contributing, but by no means seminal, figure at the headwaters of the Chicago law and economics movement, and his view that law should be structured so as to promote competitive markets reflected the perspective that has come to be associated with Chicago law and economics. His tenure at the law school helped to lay a solid foundation and provide a receptive environment for the then-emerging field of law and economics.
Simons helped to ensure the continuity and growth of Chicago law and economics through his role (together with Friedrich A. Hayek and financial backing from the Volker Fund) in bringing to the law school the individual most responsible for firmly establishing the law and economics tradition at Chicago, Aaron Director. Director was a student of Frank Knight, had been a member of the economics faculty in the early 1930s, and had authored articles that had a distinct Chicago price-theoretic flavor. After being away for a short time, Director returned to the University of Chicago in 1946. Simons urged the law school to have Director assume the directorship of a university center (affiliated with the law school) dedicated to undertaking "a study of a suitable legal and institutional framework of an effective competitive system" (Coase 1993, p. 246), and he was appointed to that position in 1946. Director also took over responsibility for teaching the course on "Economic Analysis of Public Policy" from Simons, who died in the summer of 1946.
Subsequent to his law school appointment, Director was invited by Edward Levi to collaborate in the teaching of the antitrust course. Director continued teaching the course throughout his time at the law school, and it was during this period that the Chicago approach to antitrust law began to emerge as a distinct body of thought. Antitrust had long been an area of law particularly open to the influence of economic ideas, and it was through his teaching in this course that Director, armed with the tools of price theory, had an especially formidable impact on both Chicago law students and a number of his colleagues. Director's students included Robert H. Bork, John S. McGee, Henry Manne, Edmund Kitch, Bernard H. Seigan, and Wesley J. Liebeler; colleagues who were impacted included Ward Bowman and Lester G. Telser. Director's antitrust students, many of whom went on to very successful careers as economists in their own right, speak of the "conversion" that they experienced in this class. Levi would teach a traditional antitrust course for four days each week, and then Director would come in on the fifth day and, using the tools of price theory, show that the traditional legal approach could not stand up to rigors of microeconomic analysis. As Posner points out,
The "kinked demand curve," "workable competition," "cut-throat competition," "leverage," "administered prices," and the other characteristic concepts of the industrial organization of this period had this in common: they were not derived from and were often inconsistent with economic theory, and in particular with the premises of rational profit maximization. They were derived from observation, unsystematic and often superficial, of business behavior. Director's approach was the opposite. He explained tie-ins, resale price maintenance, and other business behavior described in antitrust cases not by studying the practices but by looking for an explanation for them that squared with basic economic theory. (Posner 1978, p. 931)
The result was, as Liebeler put it, "We learned that there was a system of analysis [price theory] that (1) was quite relevant to the stuff we talked about in law school and (2) was much more powerful than anything that the law professors, than anything Ed Levi had to tell us" (quoted in Kitch 1983a, p. 183).
Director taught his students that the appropriate goal for antitrust law was the promotion of efficiency. Reflecting the emphasis within the Chicago tradition on the efficacy of the competitive system, monopoly was viewed as occasional, unstable, and transitory-a potential outcome of the competitive process, but one that would soon be removed (in effect if not in existence) by competitive pressures. Given this, rigorous antitrust enforcement was thought to be unnecessary, and, even when monopolies were shown to generate long-term inefficiencies, the governmental cure was thought to be often worse than the disease, owing to the inefficiencies of government. The past several decades of legal-economic scholarship bear witness to Herbert Hovenkamp's (1986, p. 1020) comment that "the Chicago School has done more for antitrust policy than any other coherent economic theory since the New Deal. No one ... can escape [its] influence on antitrust analysis." Indeed, and as we will show later in this chapter, the Chicago school has become so firmly established within this area that it can claim a partial victory in what Eleanor Fox (1987a) has called the "battle for the soul of antitrust."
Director's impact at the law school, however, went far beyond antitrust: he was the prime mover in the early professionalization of Chicago law and The transcript of the conference indicates that, over the course of time, Professor Levi also became converted (Kitch 1983a). Indeed, in 1951 Director and Levi (1951, p. 282) wrote, "We believe the conclusions of economics do not justify the application of the antitrust laws in many situations in which the laws are now being applied." economics. Director formally established the nation's first law and economics program (derivative of the school's antitrust project), which maintained visiting fellowships for law and economics scholars, set in place the workshop in the law school (an arena of vigorous debate over issues of current research, already an established tradition within the economics department), and, in 1958, founded the Journal of Law and Economics. Throughout his tenure at Chicago, he imparted a persuasive message to the students-that regulation was the proper function of markets, not government. This message was one that often resulted in legal reasoning losing out to economic analysis and was, to the students of law, "a message which was at once both unfamiliar and yet quite understandable" (Duxbury 1995, p. 344).
Kitch, a Chicago-trained lawyer (1961-64) and later the director of the Law and Economics Program at Chicago, describes the thrust of law and economics at the Chicago law school during this era in terms that make it seem like a perfectly natural activity for law school professors to pursue-a view, in fact, very consistent with the rationale behind the Legal Realists' blending of economics and law:
The interest ... in economics did not come out of any anti-interventionist thinking. It essentially came out of the idea that the legal system is going to be doing this now [i.e., impacting the economic system] and that means we need to learn how to do it right and maybe economists know something about how to do it right.... There is a great legitimacy given to the idea that government is going to be doing these things and we in the law schools should try to help the government do it right. (Kitch 1983a, pp. 175-76)
Indeed, this was the very perspective motivating much of the work of one of the other major founders of Chicago law and economics in this early period, Ronald H. Coase.
Coase was educated at the London School of Economics and served on the faculty there from 1935-51, when he emigrated to the United States. He held appointments at the Universities of Buffalo and Virginia before moving on to the University of Chicago Law School in 1964. Although Coase is most closely associated with the Chicago school, his seminal article, "The Problem of Social Cost," which is the cornerstone of Chicago law and economics literature (see pp. 107-19), was actually written several years before he arrived at Chicago. One of Coase's major reasons for going to the law school was to assume the editorship (with Director) of the Journal of Law and Economics, and he describes his motivation in going to Chicago as follows: "I don't think that I would ever have come to the University of Chicago had it not been for the existence of the Journal of Law and Economics. That's what I wanted to do. I wanted to get what Aaron had started going for the whole profession-and when I say the profession, I mean the economics profession; I have no interest in lawyers or legal education" (Coase, quoted in Kitch 1983a, p. 192). That someone so avowedly indifferent to legal education became such a major figure in the evolution of the economic analysis of law is itself an interesting episode in the history of ideas (Medema 1994, 1998)-but then, Coase could not have anticipated that the influence of his insights in "The Problem of Social Cost" would be at least as great on legal scholarship as on economics.
The Economics Department
Although the events in the law school laid the foundation for the development of law and economics at Chicago, a full understanding of what transpired also necessitates an appreciation of the scholarship generated by the faculty of the Department of Economics, both before World War II and thereafter. Especially with respect to economic method, there were really two Chicago schools of thought, roughly divided in time by the war (Duxbury 1995, p. 367; Reder 1982; Emmett, forthcoming). The perspective of the prewar Chicago school is evidenced in the scholarship of Frank Knight, Jacob Viner, Paul Douglas, and Henry Schultz, who were themselves by no means of a homogeneous perspective. In simple terms, proponents of the early Chicago approach generally accepted the propositions that had been at the heart of economics since the publication of Adam Smith's Wealth of Nations (1776)-within a liberal democracy, the rational pursuit of economic self-interest by economic actors was taken as given, competition was seen as inherent within and intrinsic to economic life, and market-generated outcomes were said to be generally superior to those resulting from government interference with the market mechanism. Although these propositions (the latter two in particular) were being increasingly called into question within the profession at large during the 1930s, their continuity within the Chicago tradition served (and continues to serve) to set the Chicago perspective apart from much of the rest of the economics profession.
From this group, it was Knight who had the most impact on what has come to be known as Chicago law and economics. While his writings were a significant force, his greatest influence came through the perspective that he imparted to his students-most importantly, for present purposes, Milton Friedman, George Stigler, and Director. Knight's interest and strength did not lie in the use of formal mathematical and quantitative tools, but rather in the economic way of thinking and in applying this way of thinking to the development of economic ideas and to the tearing down of what he saw as false theories that were becoming increasingly fashionable within economics (Reder 1982, pp. 4, 6).
The next generation of Chicago economists kept one foot in this camp but also moved beyond it. As Duxbury (1995, p. 368) has pointed out, whereas the earlier generation of Chicago economists "had grasped and applied certain of the basic insights of Adam Smith ... [p]ost-war Chicagoans were more intent on elaborating and extending these insights." In line with this, the new generation undertook to demonstrate, in formal terms, the detailed nexus between competitive markets and efficient outcomes. The nature of these price-theoretic undertakings was necessarily abstract and typically ahistorical, largely relying on positive, empirical research and mathematical analysis, all very much in keeping with broader movements within neoclassical economics at the time, and toward which Knight, ironically, had been rather hostile. In this sense, then, as Reder (1982, p. 6) has noted, "Knight contributed to the formation of their minds but did not influence the direction of their research." Following the lead of Friedman and Stigler, postwar Chicago economists, buttressed by their empirical research, emphasized the efficacy of the competitive market system, arguing for less government intervention, fewer wealth redistribution policies, reliance on voluntary exchange with a concomitant reliance on the common law for mediating conflicts, and an across-the-board promotion of more private enterprise-which, based on the evidence provided by their empirical research, would facilitate a more efficient allocation of resources.
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