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Are We Witnessing the Receding Tide of Law and Economics? (The Evolving Views of Judge Posner)

By Jack M. Balkin

The economic analysis of law has been the most influential theoretical approach to law of the last three decades. It has influenced several areas of law, and has been reflected in legislation, regulation, and judicial decisions. It is a major subject of legal scholarship, and professors with Ph.D?s in economics have obtained positions on a number of top law faculties. br /br /Put in the simplest terms: economic analysis proposes that law should be (and often is) oriented to maximizing social wealth. Law and economics assumes that individuals are rational actors who seek to maximize their interests. With this assumption in mind, it advocates that legal rules and institutions be designed and evaluated in terms of whether they are efficient. br /br /The leading developer and promoter of the economic analysis of law has been the peerless Judge Richard Posner. A student who attended a recent speech by Judge Posner at Columbia Law School enthused that ?He invented the law-economics field. He?s a rock star among lawyers.? Posner didn?t ?invent? the field?credit for its early development goes to Ronald Coase, Guido Calabresi, and Gary Becker?but he certainly deserves substantial credit for its current prominence. (And he emis/em a ?rock star? among legal theorists.)br /br /Judge Posner described the impressive success of the field:br /br /blockquoteIt is not merely an ivory-tower enterprise, at least in the United States, where the law and economics movement is understood to have influenced legal reform in a number of important areas. These areas include antitrust, the regulation of public utilities and common carriers, environmental regulation, the computation of damages in personal injury suits, the regulation of the securities markets, the federal sentencing guidelines, the division of property and the calculation of alimony in divorce cases, and the law governing investment by pension funds and other trustees, and to have been ema significant factor in the deregulation movement and in free-market ideology generally/em./blockquotebr /Posner made these observations in his 1998 Coase Lecture at Chicago. br /br /Today he sounds notably less enthusiastic. In his a href="http://www.law.columbia.edu/media_inquiries/news_events/2008/november2008/posner"speech/a three weeks ago at Columbia, Posner placed some blame for the current economic crisis on excessive deregulation. ?This was a big embarrassment to the economics profession,? Posner said. ?Mortgage brokers, local banks and homeowners knew what was going on, but banking and securities regulators did not.?br /br /Recent events appear to have genuinely shaken Posner?s faith in the self-correcting power of the market. He lamented that ?This is troublesome for economics. You can have rationality and you can have competition, and you can still have disasters.?br /br /span class="fullpost"br /On the Becker-Posner a href="http://www.becker-posner-blog.com/"Blog/a, Judge Posner has recently taken a series of surprising positions. For one, he supports the bailout of American auto companies, contrary to the standard economic position that inefficient firms should be allowed to fail, or at least to reorganize in bankruptcy (as Becker advocates). Posner also supports major public works projects as the solution to the current economic crisis (Obama?s proposed approach), contrary to the preference of free-market faithful for tax cuts, and contrary to their resistance to expansions of government programs and spending. br /br /Advocating a ?non-ideological,? ?pragmatic? approach, Posner is explicitly critical of doctrinaire conservative ?ideology? (although he also dislikes liberal ideology as well), which he blames for recent events:br /br /blockquoteConcretely, there is a range of perfectly respectable economic theorizing, at one end (the interventionist) typified by Paul Samuelson and at the other end (the libertarian) by Milton Friedman, but it would be a mistake to commit to one or the other end since neither can be proved to be correct. The libertarian end of the range failed to grasp the danger of deregulation of financial markets and underestimated the risk and depth of the current economic crisis--an economic shock that appears to be severe enough to trigger a genuine depression./blockquotebr /Gary Becker?s comments on the blog reflect a similar shift in views:br /blockquoteNevertheless, in light of the severity of the financial crisis, greater regulation of financial institutions is merited. The challenge is to find regulations that would significantly reduce the probability of future financial crises without discouraging the valuable contributions commercial banks, investment banks, and other financial institutions make to risk management and the financing of home ownership and business investments. br /br /Several changes do seem likely to be beneficial. Greater capital requirements (relative to assets) for all financial institutions, including investment banks and hedge funds, would help banks better weather runs on their assets. Greater transparency in the information financial institutions provide about their assets would also be useful, although modern assets are often so complicated that transparency will not always be easy to achieve. Fully privatizing Fannie Mae and Freddie Mac would help reduce the flow of mortgages to unqualified homeowners. Incomes of many fund managers and private equity leaders rose enormously, but it is difficult to prevent that from happening again without introducing controls over their salaries, stock options, and bonuses. The greatest challenge is to find ways to reduce the type of private risk-taking in which the taxpayer bails out failure, although greater capital requirements would help./blockquoteThese are remarkable assertions coming from Becker?advocating greater regulation, and even suggesting controls on compensation packages.br /br /Just decade ago, remember, Posner was touting the success of law and economics as a ?significant factor in the deregulation movement and in free-market ideology generally.?br /br /The economic analysis of law consists of a core of important insights and has real achievements to its credit. But it has also contained ?ideological? components: part dogma, part scientism, value-laden, overly broad claims, and often reliant upon speculative reasoning about what rational actors would do. br /br /Posner is not repudiating economic analysis?far from it. And the comments above are not specifically aimed at law and economics. Judging from these comments, however, his views on the subject appear to be undergoing a shift, although it is too early to know the extent or final destination of this shift. (In the past decade, Posner has focused more on pragmatism than on economic analysis, so his ideas have been evolving all along.) He shows no sign of embracing the opposite set of positions, but a moderation of his faith in what economic analysis of law can deliver seems likely.br /br /The fact that leading thinkers like Posner and Becker are modifying their positions need not portend the general direction of law and economics. Indeed, the field has already moved in recent years, with increasing momentum in the direction of behavioral economics, which incorporates the insight that people are often irrational (in predictable ways). And in certain respects economic analysis has been ?domesticated? within law, absorbing its useful insights shorn of its excesses. But it seems likely that the field generally will be shaken by the same events that have prompted Posner and Becker to rethink their positions. br /br /Judge Posner is one of the most influential legal thinkers of this generation. His willingness to critically re-examine ideas that he has championed for decades is uncommon among theorists of his stature. No doubt many jurists would be very interested in, and would learn from, a full elaboration by Judge Posner of his current views of the economic analysis of law. br /br /br //span

Full post as published by Balkinization on December 17, 2008 (boomark / email).