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Taking the costs of consent seriously: an alternative understanding of efficiency as a legal concern.

3.5. The Supply of and Demand for Law

The final step in the process efficiency analysis is to identify those variables that are predicted to be most important in affecting the structure of the law-making costs (and, thereby, of determining the relative efficiency of alternative sources of law). In this respect, it is useful to organize the inquiry along the lines of a supply of and demand for law. As has been repeatedly emphasized, the central hypothesis is that the efficiency of law depends upon the interplay between the demand for and supply of law--that is, the interaction between institutional and structural variables that is at work within the formation process of law determines the efficiency properties of the outcome. Figure 3 illustrates the analytical framework of the process-outcome relationship.

Let me succinctly provide some explanatory examples of variables affecting lawmaking costs. It is convenient to proceed at two levels of abstraction. At the highest level of abstraction, it is possible to identify four variables (two institutional and two structural) that most affect law-making costs. on the supply side, the ex ante versus ex post dimensions and the degree of centralization of lawmaking significantly affect the three components of process efficiency. (46) On the demand side, the degrees of frequency and homogeneity of the behaviors subjected to regulation largely determine the optimal mix of ex ante and ex post regulation and of centralized versus decentralized law-making. (47)

This four-dimensional framework of law-making allows for the formulation of three general hypotheses, to be tested against the results of the comparative institutional analysis on a case-by-case basis. First, under conditions of high homogeneity and frequency of the demand for law, the ex ante centralization of law-making allows for significant economies of scale, which significantly reduce the average (production and compliance) information costs. Second, ex ante centralization entails a significant increase in the agency costs of law-making. Third, ex ante centralization reduces the magnitude of the adaptation transaction costs associated with legal change. it increases the magnitude of resistance and maladaptation costs when the legal demand is heterogeneous and when both the aggregate frequency and the frequency per actor increase.

At the lower level of abstraction, additional institutional and environmental features, which vary across institutions, might exacerbate or counterbalance the effects of ex ante versus ex post and of centralized versus decentralized dimensions. Let me provide some examples.

Information Costs. in politics and bureaucracy, the information advantages of ex ante centralization must be weighed against the disadvantages associated with the high irrationality and limited information capabilities of the political law-maker and the tendency toward overregulation and output ineffectiveness of the bureaucratic processes. Adjudication enjoys comparative advantages in that it allows for greater responsiveness of the production of law to local preferences in a context characterized by high heterogeneity. private law-making produces efficient legal rules only under the very restrictive conditions of close-knittedness (Ellickson, 1991; Bernstein, 1992; Cooter, 1992).

Agency Costs. In politics, three institutional features exacerbate the agency costs associated with ex ante law-making: the rational ignorance of the electorate as a whole, the majoritarian character of political decision-making, and the collectivized nature of the legislative outcome. Administrative law-making entails bureaucratic drift costs, as well as costs related to the strategic use of delegation by politicians, which exacerbate the agency problem associated with ex ante centralization. In adjudication, the doctrine of stare decisis accentuates the ex ante dimension of judicial law-making, thereby further increasing the rent-seeking pressures aimed at influencing the evolution of precedents. private law-making significantly decreases agency costs (although it is not immune from the agency problem). However, even in the context of private legal orderings, as the degree of centralization increases and the law-making adopts an ex ante perspective (e.g., industry "self-regulation"), agency costs increase significantly.

Adaptation Costs. The political representative mechanism exacerbates the tendency of ex ante centralization to increase resistance and maladaptation costs. This is due to many factors, including: the increasing number of veto players that, in the political process, might block efficient transitions; the increasing number of rent-seeking groups that have incentives to promote inefficient transitions; and the transitional gain trap that prevents efficient legal change (Tullock, 1975). At the same time, however, it must be recognized that the offsetting capabilities of legislators can reduce resistance costs. The adjudication process has relative advantages over politics for three reasons: the leveling-of-the-playing-field effect associated with the judicial process; the incremental nature of judicial legal change; and the lower access costs than in the political process. private legal orderings enjoy comparative advantages in these environments, in which group members are receptive to new technical information and are able to cheaply communicate with one another and coordinate a collective move toward efficient legal regimes. When these conditions are absent, pure, decentralized law-making is subject to the risk of being impeded by evolutionary traps and manipulated by interest groups; hence, it evolves toward or may stabilize the emergence of inefficient legal rules.


This section discusses the issue of product safety. The aim is not to provide a comprehensive discussion, but to provide some examples of how the process efficiency analysis helps to provide a different understanding of legal-economic issues that complements the traditional output-oriented perspective.

4.1. Output-Oriented Analysis

Most law and economics scholarship on product safety focuses on the following three issues. First, much discussion focuses on the choice between alternative liability rules (e.g., strict liability versus the negligence rule ("issue 1") (Shavell, 1980; Miceli, 1997; Shavell, 2004; Cooter & Ulen, 2008). (48) Second, divergent views have emerged over the issue of whether allowing manufacturers and consumers to design their own liability schemes, through contract, will allow them to shift product-related risks to those who can bear them at a lower cost, thereby enhancing social welfare ("issue 2"). (49) Third, a stream of scholarship inquires into the choice between tort liability and safety regulation ("issue 3"). In this latter respect, there has been a tendency to agree on the complementariness of ex post liability and ex ante regulation, as well as on the social-welfare enhancing effect of the joint use of the two instruments (Shavell, 1984; Kolstad, Ulen, & Johnson, 1990; Schmitz, 2000). (50)

Conventional law and economics approaches each of these issues from an output-oriented, single-institutional perspective. The analysis of issue 1 focuses on the impact of differing liability rules on the incentives to adopt efficient levels of precaution and engage in the optimal level of risky activities (Shavell, 1980). (51) The source of transaction costs is exogenous to the model, and variations of these costs are independent of the choice between alternative institutional processes and environmental variables. The debate regarding issue 2 focuses on measuring the imperfections of private markets against an idealized, but unattainable, adjudication process (Bertrand, 2014), thereby exposing the analysis to a Nirvana fallacy. Similarly, the debate on issue 3 assumes alternative classes of rules (e.g., strict liability, uniform safety standards) to be exogenously given. It investigates the impacts of these outcomes on the incentives structure confronted by potential injurers and injured parties. There is no inquiry into how differentially alternative sources of law affect the content of the outcome. (52) I do not want to be interpreted as claiming that these analyses are incorrect. However, I suggest that the output-oriented approach needs to be integrated with a complementary analysis of the process-outcome relationship.

4.2. Process Efficiency Analysis

In the following pages, I analyze each of the three components of process efficiency analysis: information, agency, and adaptive efficiency. From this perspective, I show that: issue 1 is better understood in light of the impact on the law-making costs and in relationship with the overall organization of the sources of law; issue 2 is misplaced; issue 3 gains central importance, but from the contrasting perspective of the impact of the ex ante--ex post perspective on the structure of the law-making costs.

Each of the following subsections is organized into two steps. First, it discusses the choice between strict liability and negligence in the area of product safety (issue 1). Second, it emphasizes the relative advantages and disadvantages of politics, bureaucracy, judge-made law, and private legal orderings (thereby illuminating issues 2 and 3).

4.2.1. Information Efficiency

Strict Liability versus Negligence. One theory that explains the regime of strict liability in the area of product safety is the structure of production information costs. Strict liability increases the degree of centralization in the law-making process and implants an ex ante perspective into the context of adjudication (hereinafter, "ex ante centralization"). Liability is established prospectively for an entire "class" of cases, regardless of the level of precaution adopted by the injurer. As Epstein (1988) observes, strict liability "reserve[s] to the courts a legal monopoly to fashion the relevant terms and conditions on which all products should be sold in all relevant markets."

Process efficiency analysis suggests that, when the demand for safety products is characterized by a high degree of frequency and homogeneity, ex ante centralization allows for significant economies of scale with respect to production information costs. From this perspective, the adoption of a regime of strict liability is justified in cases in which the demand for product safety is highly homogeneous and frequent. The traditional class of widely sold products with manufacturing defects (e.g., exploding Coke bottles) provides a good example of homogeneity and frequency that justifies (from an information efficiency standpoint) a strict liability regime. Far less homogeneous is the stream of designing and warning cases, which is characterized by a higher heterogeneity that causes the marginal informational costs to vary from case to case (i.e., are not diminishing), thereby preventing scale effects via the impact on the lawmaking average cost function.

A second reason that explains the regime of strict liability is related to the structure of compliance information costs. Assuming high frequency and homogeneity, if the application of the law is concentrated on a relatively limited number of people--such that the frequency per actor is high (53)--strict liability will be combined with a high level of ex ante specificity of the content of legal rules. The reason for this is that higher frequencies per actor entail higher expected benefits from compliance--and, thus, higher demand for ex ante law-making, and higher legal specificity on the part of those most frequently subject to the rules. Differently stated, the higher the expected net benefit value from compliance, the greater the amount of resources that the individual is willing to use to increase his or her knowledge of the law. In this respect, observe that the demand for product safety often emerges from economic sectors with sharp polarizations between consumers and producers. That is, a relatively small number of potential injurers (cheaper precaution-takers) are exposed to high frequencies per actor so that the application of the law concentrates upon a relatively limited number of economic actors. In such cases, the regime of strict liability has an advantage in terms of information efficiency, as it enhances the deterrence effect of total liability while reducing the average costs of defining the terms of liability.

The two preceding arguments are consistent with the actual trend among several jurisdictions to adopt strict liability regimes in the area of product safety. The European Union Directive on product safety (54) offers a good example of centralized regulation of product safety. Furthermore, empirical observation shows that many strict liability regimes are statutory in nature, which confirms the argument that strict liability is efficient under the same efficiency conditions as ex ante centralized law-making.

Sources of Law. The last consideration raises the issue of the impact of alternative sources on the definition of the optimal standard of care. This problem is acute when it comes to risky products. In fact, this area is often characterized by pervasive outcome uncertainty and requires both specialized competence and technical information on the part of the law-maker (Fraiberg & Trebilock, 1997)'

The judicial law-making process proves highly inefficient in defining the content of a tort liability regime in the area of risky products. The ex post perspective exposes judicial law-making to cognitive biases in the measurement and assessment of risk. Loss aversion, hindsight bias, anchoring, framing effects, and other cognitive distortions prevent judicial decision-making from identifying efficient safety incentives in the area of risky products. (Rachlinski, 1998) (Guthrie, Rachlinski, & Wistrich, 2001). These inefficiencies are exacerbated by juries' aversion toward corporate risk analysis. Empirical studies have shown that jurors tend to punish those corporations that carry out a cost-benefit analysis, interpreting the higher level of information about risk as an indicator of the intention to inflict the risk (rather than as a sign of corporate responsibility or an effort to achieve risk-cost balancing) (Moore & Viscusi, 1991; Viscusi, 2000).

Economic theory suggests that, because agencies and bureaucracies possess greater cognitive resources (and gather technical information at lower costs) than legislatures, the expected benefit of delegating law-making power to them increases with the complexity and uncertainty of the decision-making (Mitnick, 1980; Aranson et al., 1982). Despite this advantage, the structural features of the bureaucratic process are often at odds with information efficiency (and the efficient allocation of risks). First, when uncertainties emerge from regulatory processes, agencies' regulatory responses to the demand for risk regulation are plagued by the "vicious circle" including public risk perception and congressional action and reaction. (Breyer, 2009). Namely, the bias in the public's perception of risk is magnified by uncertainties regarding the regulatory process, and the increased pressure on agencies is likely to be reflected in a decision-making process that is in various way biased. (55)

Second, because excessive risk-taking, in the context of bureaucratic decisions, is more easily detectable than insufficient risk-taking, bureaucrats tend to over estimate the risk of imposing, through regulation, an "excess risk" on society--in comparison to that of allocating "insufficient risk." Said differently, administrative regulation is systematically biased in favor of avoiding Type II errors (i.e., excessive risk), rather than Type I errors (i.e., sub-optimal risk) (Stearns & Todd, 2009), despite the fact that the costs of the latter might be equal to or even greater than those of the former. (56) Third, the institutional insulation from people subject to the law deprives bureaucratic law-making of feedback signals concerning the relative benefits and costs of regulation. (57) In conclusion, during assessments of the information efficiency of law-making through agencies, the advantages of specialized knowledge should be weighed against the costs of bureaucratic insulation.

Private legal orderings enjoy relative advantages in environments characterized by technical complexity, in which the identification of standards of conduct requires specialized knowledge on the part of the same economic actors involved in the risky activity. In general, private legal orderings are characterized by the fact that norm producers coincide with both targeted actors and normbeneficiaries. This increases information efficiency because, unlike centralized law-making bodies, norm producers have a direct perception of their costs and benefits. Second, the fact that norm producers and norm beneficiaries are two identical sets of individuals raises the cost of irrational behavior in the process of norm creation--and, thereby, creates incentives to adopt rational beliefs and behave accordingly. This is a significant difference from the incentive structure confronted by norm producers in political and administrative processes. The comparative informational advantage of private ordering over other sources of law is consistent with the fact that, in the U.S., the vast majority of the technical standards necessary to protect public safety are developed by private, non-profit organizations. Namely, in crafting public rules, agencies rely on privately created standards by using the practice of "incorporation by reference (Bremer, 2013).

As will be clear shortly, the information advantages of private orderings must be weighed against their disadvantages in terms of adaptive efficiency. However, it is generally recognized in the law and economic literature that the seller-customer relationship between firms and consumers provides firms with incentives to regulate risk and to subject themselves to liability rules as a signal to consumers of the quality of their products (Daughety & Reinganum, 1995).

4.2.2. Agency Efficiency

This subsection is organized around two steps. First, it explains that the liability regime affects the degree of centralization of the law-making process. Centralization, in turn, increases the expected return from rent-seeking--thereby increasing the external pressures on the law-making body (Patchel, 1993; Ribstein & Kobayashi, 1996). Second, I briefly emphasize the relative advantages and disadvantages of politics, bureaucracy, judge-made law and private legal orderings.

Strict Liability versus Negligence. Compared to negligence, strict liability accentuates the centralization of the supply of law, (58) thereby reducing the costs of coordinating interest group pressures. Consider two opposing scenarios. under a negligence rule in a decentralized adjudication system, interest groups must engage in rent-seeking activities in each local jurisdiction to obtain favorable decisions. Taken to the extreme, in an ideal, polycentric, decentralized system (with a competitive pluralism of adjudicating bodies), the favorable decision produces effects among the parties to the dispute. only the parties to a dispute have an incentive to invest in influence activities. Conversely, under a regime of strict liability, in the context of centralized adjudication, the greater uniformity of the law will ensure the uniform application and enforcement of the law across all local jurisdictions. This has three consequences. First, centralization allows rent-seekers to exert pressure at lower cost and greater effectiveness, thus allowing them to exploit economies of scale in rent-seeking (Redoano, 2010). Second, as the degree of centralization increases, it becomes more costly for individuals to opt out of inefficient laws; (59) those individuals who suffer from higher costs from inefficient laws are forced to engage in a relatively more costly "voice" strategy. (60) Third, as a consequence of this effect, centralization involves "outcome" agency costs. Interest group theory has long demonstrated that large, broadly based interests suffer from the problem of collective action, whereas concentrated special interests tend to be advanced more effectively by smaller and more organized interest groups that will manipulate legal outcomes to their advantage (often at the costs of larger, more disorganized interests) (Olson, 1965; Becker, 1983; Tollison, 1988).

From the agency efficiency perspective, although relevant, the choice between strict liability and the negligence rule loses centrality in favor of a more comprehensive analysis of the institutional law-making design. Consider two situations in which the degree of centralization and the liability rule counterbalance each other. A regime of strict liability enforced in the context of a highly decentralized system would likely generate lower agency costs than a negligence rule applied through a highly centralized adjudication system. For example, in a federal system, one state's enactment of legislation imposing a strict liability rule for injuries caused by a specific type of product would not ensure uniformity across jurisdictions, which would depend on the adoption of the proposal either by each state legislature or by the federal legislature. This is because the effects of decentralization (i.e., decreased returns from rent-seeking and decreased exit option costs) dominate the effects of a move from negligence to strict liability (i.e., reduced uniformity and scope of the law). Conversely, a rule of negligence applied by a centralized adjudicative system would increase the magnitude of influence agency costs more so than a decentralized application of a regime of strict liability would. This is because the effects of centralization (i.e., increased returns from rent-seeking and increased exit option costs) would dominate the effects of a move from strict liability to negligence (i.e., reduced uniformity and scope of the law).

The discussion so far suggests the existence of a trade-off between informational efficiency (which is favored by strict liability) and agency efficiency (which is favored by the negligence rule) in the choice of the liability rule. A process efficiency analysis aims at identifying the institutional variables for choice that optimize this agency/information trade-off. For example, the strictness of the application of the stare decisis principle affects the expected duration of the period in which the precedent is likely to remain in force; this increases the expected value of the rents extracted from a favorable legal precedent (Zywicki, 2003). Hence, the sum invested in rent-seeking will increase with increasingly strict applications of the doctrine of precedent. This suggests that, in designing a liability regime in the area of product safety, one might consider exploiting the information cost advantages of strict liability, on th one hand, and mitigating the rent-seeking pressure through a more flexible application of the doctrine precedent, on the other hand.

Sources of Law. I now turn to alternative sources of law in the context of risk regulation. First, the politicization of law-making is likely to increase the magnitude of outcome agency costs (61) The cognitive biases that affect the public perception of risk create opportunities for politicians to extract private benefits from the manipulation of political processes. For example, through the effect of the "availability bias", a highly-publicized, disastrous event may cause an overestimation of the probability of such an event. (Aviram, 2006, 2007). The poorly intentioned politician could reap the benefits of a public over-estimation of the risk by persuasively overstating the effects of his proposed law and convincing people that the law reduces the likelihood of the disastrous event. In this respect, the adoption of a statutory regime of strict liability would exacerbate the magnitude of outcome agency costs (i.e., costs associated with the manipulation of the outcome). By contrast, a negligence rule, by allocating a portion of lawmaking power to courts, would counterbalance the distortive effect of politicization.

Second, technocratic law-making entails significant agency costs. As already noted, increased outcome uncertainty leads legislators to enlarge the scope of delegation to agencies, thereby expanding the set of feasible alternatives for agency consideration. This increases outcome agency costs, since the expansion of the regulatory scope of agencies leads to an increasing risk of bureaucratic drift. Delegation in environments characterized by high monitoring costs (often due to information asymmetry, as in the case of risk regulation) increases the costs of reducing agency costs. In response, legislators will set up more constraining regulatory procedures to minimize the risk of bureaucratic drift (McCubbins, 1987; McCubbins et al. 1987).

Courts enjoy comparative advantages in terms of agency efficiency over politics (and bureaucracy). However, such advantages depend on the elasticity of the respective supply curves with respect to external rent-seeking pressures. In fact, while both politics and adjudication supply functions reach a point of inelastidty with respect to influence expenditures, (62) "judicial supply curves become inelastic at much lower prices than legislative supply curves do." (Merrill, 1997)' The differences in the shapes of the political and judicial supply curves reflect the greater "rent-selling" power of politicians. (63) Namely, the adjudication process reaches a limit with regard to the capacity of supplying legal change and accommodates rent-seeking pressures at lower levels of influencing expenditures. (64)

In environmental settings, in which there appear to be unusually high incentives for pressure groups to engage in rent-seeking activities, two instruments are available to mitigate agency costs. one instrument involves moving to a negligence rule, thereby allocating greater law-making activity powers to judges and exploiting the advantages associated with the elasticity differential between the political and judicial supply curves. (65) The negligence rule has the potential to reduce deadweight losses by diminishing the magnitude of influence expenditures sustained under by stakeholders as effect of rent extorsion by politicians. The second agency-cost-reducing strategy could involve lessening the strictness in the application of the principle of stare decisis. This suggests that, in contexts with high rent-seeking pressures, if the conditions associated with the informational advantage of strict liability are lacking (e.g., homogeneity of legal demand), the negligence rule is likely to be the "process efficient" rule. By comparison, if the demand is homogeneous and frequent and the incentives to engage in rent-seeking activities are high, the decision between the negligence rule and strict liability will depend on the relative intensities of the two counterbalancing effects (i.e., the information cost reducing effect of strict liability vs. the agency information cost reducing effect of negligence).

Generally, private legal ordering suffers from rent-seeking pressures and related risks of norm manipulation. However, in the area of product safety, the agency costs associated with private law-making are mitigated. First, the reputational element is intensified by the seller-customer relationship between consumers and firms that underlies the demand for product safety. Litigation cases involving product liability receive significant attention in the media, especially when they concern widely sold products (Klein & Leffer, 1981). Moreover, informational and reputational cascades may quickly induce changes in the public's perception of risk. Second, monitoring costs are lower because of the large number of consumers involved; thus, wrongful conduct is more likely to be detected. Third, the presence of common regulatory interests among consumers facilitates their coalescence and coordination. This is confirmed by the increasing role played by consumer associations in the policy-making process. All of these environmental conditions facilitate the functioning of private regulatory systems aimed at mitigating the opportunistic behaviors of manufacturing industries.

4.2.3. Adaptive Efficiency

To provide the right signals to firms, the expected costs of legal liability must be predictable. Predictable product liability rules increase deterrence by lowering the costs of appreciating the legal consequences of behaviors. At the same time, product liability rules must adapt to changes in the demand for product safety associated with technological innovation. The process efficiency analysis poses the question of which institutional law-making mechanism is best able to deal with the trade-off between predictability and adaptivity.

Predictability: Strict Liability versus Negligence. First, from a predictability standpoint, strict liability appears suited to providing a more stable legal regime. By simplifying the grounds on which cases are decided, strict liability provides a clearer definition and a strict enforcement of property rights, thereby generating a certainty-enhancing effect. (66) Observe, however, that it can be said that strict liability strictly enforces property rights only if factual causation is the criterion for the imputation of legal liability (Rizzo, 1980). If factual causation (ie., the question of who has caused the damage) is regarded irrelevant, as in the conventional perspective, (67) than the judge is entitled to allocate liability on the basis of output-oriented efficiency criteria, which depend on several difficult-tomeasure (and, therefore, hard to predict) quantitative relationships.

Predictability: Sources of Law. The choice of the source of law also has implications in terms of legal certainty. Some scholars have maintained that scheduled damages and capped damages could increase stability and enhance legal certainty in the application of product liability rules (Danzon, 1992). However, the process efficiency analysis suggests that legal predictability is a function of the quality of the law-making process, rather than of the formal characteristics of the legal outcome. Capped or scheduled damages improve the precision of the written rule. However, legal certainty remains impossible to achieve through the legislative process because legislators' incentives to change or maintain existing laws are highly volatile and dependent on the balance of power among competing contingent interest groups.

Adaptivity: Strict Liability versus Negligence. The promulgation of legal rules by a centralized lawmaker provides a focal point around which people can coordinate their compliance decisions (Ribstein, 1992; Gillette, 1998). The enactment of standards of behavior that are binding on the whole of the community can support a mass migration to a new Pareto-superior legal equilibrium by reducing the fear of a solitary transition, thus allowing for a "simultaneous movement" to a superior legal regime. (68) In this respect, a regime of strict liability, combined with the centralization of the law-making process (either judicial, administrative, or political) might favor legal change when high information adaption costs impair collective migration of manufacturers to more efficient standards of behavior.

On the other hand, due to high levels of information and agency costs, centralized responses to the demand for legal change are often slow to emerge (whether in courts, legislatures, or administrative agencies). (69) Further, centralized law-makers do not internalize the benefits or (most of the) costs of enacted legislation--a reality that contradicts an essential condition of efficient legal change. Epstein (1998) vividly summarizes this point: "The centralization of power has the same consequences here [i.e., in a strict product liability regime] that it has in other area of government regulation. It leads to a legal regime that is unresponsive to changes in demand and technology."

Adaptivity: Sources of Law. The analysis of the sources of law provides further insights. Political law-making faces high resistance costs. In fact, the prospective nature of enacted rules imposes a non-incremental direction on legal changes and a consequent larger resistance on the part of losers. Resistance arises, in particular, as an effect of the impact of a new product liability regime on products previously placed in the stream of commerce (e.g., many durable or capital goods have long-term risky effects).

Courts enjoy strategic political advantages in terms of adaptive efficiency. First, as already noted, the judicial supply of law becomes inelastic at lower levels of influence expenditures, thereby causing a leveling of the playing field. This proves crucial in the area of product safety, which is usually characterized by strong asymmetries in influencing power between consumers and producers. Second, the fact-specific and retrospective nature of judicial decisions enables judges to lower the political visibility of legal changes, thereby lowering the level of resistance costs. Furthermore, the incremental nature of judicial legal change enables individuals to make more accurate estimations of the expected costs of future courses of action. it also reduces the prohibitively high marginal information costs that the synoptic approach postulated by rational choice theory would entail. (70) Furthermore, proceeding through marginal adjustments reduces the risk of errors generated by outcome uncertainty (Sweet, 2002). The preceding considerations might explain why the evolution of the regime of product liability in the u.S. has been, foremost, a creature of judicial action and has moved in the direction of shifting the burden of loss from producers to consumers (Epstein, 1988; Priest, 1991).

However, it must be recognized that judicial decision-making is affected by cognitive biases that affect its ability to properly assess the risk associated with products. (71) Therefore, the improved ability of courts to promote legal change, if combined with environmental settings (as outcome uncertainties) that emphasize these cognitive limitations, might ultimately exacerbate outcome inefficiency. Discussing the prominent role of judicial action in the area of product liability, Epstein (1988) observed: "[...] all doctrinal innovation has come from the courts, where the technical lags and information deficits are at their highest."

Most law and economics literature justifies judicial or regulatory intervention in the area of product safety based on the failure of voluntary transactions (Spence, 1977; Epple & Raviv, 1978; Polinsky & Rogerson, 1983; Geistfield, 1995). However, the environmental setting generating the demand for safety provides incentives for the emergence of private legal orderings aimed at mitigating the opportunistic behaviors of manufacturing industries. (72) Furthermore, as has been already noted, private legal orderings enjoy relative advantages in environments characterized by technical complexity and outcome uncertainty, in which the identification of efficient standards of conduct requires the specialized knowledge possessed by economic actors. Interestingly, greater technical complexity (and, thus, greater need for de-centralized sources of information) emerges in more concentrated markets--that is, those markets in which the potential for the self-correction of private markets through self-regulation is stronger (Ramseyer, 1996).

4.3. Summary

The discussion of product safety has exemplified how process efficiency analysis can complement the conventional output-oriented economic approach to legal issues. First, conventional law and economics explains the choice between strict liability and negligence based on the costs and incentives faced by potential injurers and the potential injured. By contrast, process efficiency analysis suggests that this choice is better explained in terms of the impact on law-making costs. In fact, strict liability increases the uniformity and scope of the application of the law, thereby accentuating the ex-ante centralized dimension of law making. In terms of information efficiency, strict liability proves efficient when the demand for law is highly homogeneous and frequent. In addition, when both aggregate frequency and frequency per actor are relatively high, the relative advantages of strict liability in terms of lower information cost are magnified. In short, a move from negligence to strict liability intensifies the economizing effect associated with ex-ante centralization by increasing the uniformity of the supply and breadth of the scope of the law.

Second, with respect to agency efficiency, a regime of strict liability is likely to increase agency costs both in terms of rent-seeking costs and outcome agency costs; conversely, a regime of negligence allows for decreased agency costs due to the advantages of adjudication in terms lessened rent-selling power. Process efficiency analysis illuminates a trade-off between information costs and agency costs, which is generally overlooked by conventional output oriented analysis. Finally, with regard to adaptive efficiency, a regime of strict liability is likely to slow the responsiveness of the law to changes in legal environments.

Third, and perhaps more importantly, process efficiency analysis identifies a number of institutional variables whose impact in terms of efficiency is far more profound than the move from negligence to strict liability. The effect of changes in the degree of centralization in law-making institutional design is likely to dominate the effects of changes in the regime of liability. A move from a negligence rule to a strict liability regime exerts different impacts on the lawmaking cost structure (at both the process and the output level) depending on the overall organization of the sources of law. For example, a regime of strict liability enforced in the context of a highly decentralized system would likely generate lower agency costs than a negligence rule applied through a highly centralized adjudication system. This is because the effects of decentralization (a decreased return from rent seeking and decreased exit option costs) would dominate the effects of a move from negligence to strict liability (reduced uniformity and width of the scope of the law).

Fourth, conventional law and economics tends to overlook the choice of the institutional mechanisms that are adopted to define the legal standard of care. For example, the traditional debate on ex-post tort liability versus ex-ante safety standards is output-oriented in that it focuses on the incentive structure faced by potential injurers and injured. This perspective tends to miss the important understanding that the ex-ante and ex-post dimension of law making affects both the structure of law-making costs and the content of alternative classes of rules due to the differences in alternative sources of law in terms of information, agency, and adaptive efficiency. On the contrary, as repeatedly emphasized, process efficiency analysis illuminates the relative advantages and disadvantages in terms of the efficiency of courts, legislatures, administrative agencies, and private organizations.

Process efficiency illuminates the importance of institutional choice in those areas where riskiness and outcome uncertainty are relatively high. In these cases, the choice of the institutional decision-making mechanism has a dramatic impact on the liability regime. The choice of the law maker is probably more salient in determining the efficiency of the law than the choice between strict liability and the negligence rule. Process efficiency analysis suggests that under certain conditions, shifting portions of law-making powers to private legal orderings might generate significant efficiency advantages in tailoring the regulatory intervention to redress the informational failures of the unregulated market.

The Japanese product liability system, which was in force until 1995, represents a significant historical example of a nongovernmental product liability system. until 1995, product liability in Japan was formally subject to a general negligence regime. Despite this form of legal regime, many Japanese firms had incentives to offer insurance coverage as a signal to buyers of the quality and safety of their products and agreed to be subject to a regime of strict liability. The enforcement mechanism was based on a centralized public authority, but the creation of the liability regime was activated by the spontaneous choices of manufacturing industries (Ramseyer, 1996).

In conclusion, process efficiency analysis provides a different perspective on the three issues mentioned above and also reconsiders their actual relevance relative to the more general organizational framework of the sources of law. As to issue 1, the move from negligence to strict liability is viewed as one that increases the uniformity and scope of the application of the law, thereby affecting the structure and magnitude of law-making costs. Issue 2 is misplaced; the question is not whether the market could efficiently regulate the area of product safety but rather which of the available institutional law-making alternatives enhances efficiency in the area of product safety depending on the specific characteristics of the demand for safety. As to issue 3, the choice between ex-post tort liability or ex-ante safety standards depends on the structure of law-making costs (with regard to specific objects of regulation) rather than on the incentives of relevant actors at the margin.


I have investigated several issues in this paper. First, i have argued that an output bias underlies conventional law and economics methodology. The structural features of the legal environment contradict, in many important respects, the assumptions underlying conventional models. To overcome these shortcomings, this paper has argued that the efficiency of the law is better explained as a function of the institutional and structural variables that affect the law formation mechanisms (rather than the allocation of legal entitlements insulated from the law-making process). Efficiency is not an objective property of the outcome independent of the process; rather, it depends on the ability of the law-making process to embody, in a cost-effective manner, the general consensus of all the people concerned. Individuals consent to the "process-outcome relationship" rather than to an idealized output insulated from the law-making process. They choose the best possible process-outcome ratio: the one that enhances their own welfare while minimizing the costs of reaching consensus, under the constraint of the preferences of others and the conditions of the status quo. The outcome attained is not "optimal" in the standard Paretian sense but is "optimally" produced.

Second, to enable the assessment of alternative law-making mechanisms, I have introduced the notion of process efficiency. The law-making process is efficient if there is no alternative institution that does better across the circumstances in which it actually operates in producing legal rules such that each member of society is enabled to enhance his or her own welfare. The comparative assessment of alternative sources of law is based on the structure of the transaction costs associated with each law-making mechanism under changing environmental settings. For this purpose, I have proposed a unified taxonomy of law-making costs based on the three components of process efficiency: information efficiency, agency efficiency, and adaptive efficiency. The analysis of the variables affecting law-making costs is organized for each category of costs along the lines of a supply and demand model. The supply side summarizes the features of the law-making process that are predicted to mostly affect the structure of law-making costs The demand side summarizes the exogenous conditions of the regulated environments. Each category of cost includes demand side costs, supply side costs, and an "outcome" dimension (see supra figure 2). Thus, the outcome is not eschewed by the efficiency analysis; rather, it is conceptualized as a function of the incentive structure underlying the lawmaking process.

Third, the discussion on product safety has illustrated more concretely how process efficiency analysis can complement the conventional output oriented economic approach to legal issues. The move from negligence to strict liability is viewed as one that increases the uniformity and scope of the supply of law, thereby affecting the structure and magnitude of law-making costs. Generally, strict liability is justified when the demand for safety exhibits high levels of both homogeneity and frequency of the legal demand. There is a trade-off between information and agency costs. The optimization of this trade-off is related to the degree of centralization in the overall organization of the sources of law and with the degree of strictness of the doctrine of precedent. The choice between ex-post tort liability and ex-ante safety standards also affects the structure of law-making costs. In this respect, process efficiency analysis illuminates the relative advantages and disadvantages of ex-ante centralized processes versus ex-post decentralized processes in the definition of the optimal standards of care. It also emphasizes the relative advantages of private legal orderings in the creation of legal rules in areas characterized by technical complexity, outcome uncertainty, and relatively high rates of change.


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This paper was prepared for presentation at The 52nd Annual Meetings of the Public Choice Society, San Antonio, Texas, March 12-15, 2015.

I am grateful to Nuno Garoupa, Giorgio Rampa and Michael Trebilcock for comments on earlier drafts.

(1) Holding constant existing technology, available resources, and individual preferences and setting aside (temporarily) the transaction cost issue.

(2) This is congenial to economists' prevailing attitude regarding the prediction of efficient equilibria resulting from competitive market interactions.

(3) Ostrom (2005) provides a useful distinction between "framework" and "theory". "Frameworks (...) attempt to identify the universal elements that any relevant theory would need to include. (...) The elements contained in a framework help the analyst generate the questions that need to be addressed when first conducting an analysis. (...) Theories enable the analyst to specify which components of a framework are relevant for certain kinds of questions and to make broad working assumptions about these elements. Thus, theories focus on parts of a framework and make specific assumptions that are necessary for the analyst to diagnose a phenomenon, explain its process and predict outcomes."

(4) Komesar (1994) has proposed a comparative analysis of alternative institutions (i.e., politics, courts and markets) that illuminates the limitations of the prevailing scholarship based on single institutional analysis. Komesar's general analytical framework constitutes an important reference point for all those who engage in a comparative institutional of the sources of law. Parisi & Fon (2009) examine "the relative advantages and the respective limits of alternative sources of law." one important set of tools they use to investigate the structure of law-making costs is modern investment theory. From this methodological perspective, they conceptualize the production of legal rules as an economic investment in which the lawmaker sustains present costs in view of future uncertain benefits.

(5) It is the law-making process that confers a legal nature to legal rights. A chief concern regarding the diverse set of disciplines related to legal theory, to which law and economics belong, is the relationship between the structure of the legal process and the content of legal rules.

(6) I borrow this expression from Trebilcock (2014)

(7) One task involves understanding the initial distribution of normative resources; another task entials showing how to maximize the value of said resources. While the former is a task for philosophers, historians, or legal theorists, the latter is a proper object of the efficiency analysis of law, which ought to be concerned only with marginal improvements with respect to presumptive wealth distributions.

(8) Calabresi (1991) maintains that all legal changes must, ex ante, entail some losers and that it is necessary to deal with the presence of losers to formulate normative judgments on the efficiency of a legal change.

(9) Mishan (1967) has demonstrated that since the law influences the distribution of wealth, the optimal allocation of resources ultimately depends on the structure of the legal order.

(10) Mishan (1967) makes the following three points: "(1) [...] the characteristics of an optimal solution are not uniquely specified but depend, in general, on the existing law; (2) [.] the costs incurred in realizing an optimal outcome, and the question therefore of its "feasibility", also depend upon the existing law, and finally; (3) [.] an optimal solution emerging from conflicts of interest is optimal only with respect to an implicit constraint requiring the area in question to be used in common by the groups or persons having conflicting interests.

Once separate areas, or separate facilities, are introduced solutions appear that are Pareto superior to the familiar constrained optimal outcomes".

(11) As will become clearer later, the reference to the welfare of the people can be interpreted in two different ways, depending on whether is measured by intrapersonal or interpersonal comparison of utilities.

(12) Coleman (1985) demonstrates that "in order to overcome market failure it is necessary to integrate considerations of efficiency and wealth distribution" and that "the problem of inefficiency (...) requires attending both efficiency and distributive aspects of the problem".

(13) For an excellent discussion of the role played by consent in the normative justification of efficiency, see Coleman (1987).

(14) Cardinal individual utility is abandoned in favor of the use of ordinal individual preferences, which facilitates a comparison of individuals' ordering of alternative social states that does not require the assignment of cardinal values to individual preferences. Cirillo (1979) provides a useful reconstruction of Pareto's economic thought, in which he clarifies the importance of the principle of ethical neutrality in the thought of the Italian economist.

(15) It is as if individuals are assumed to have lexicographic preferences with respect to their own personal utilities. That is, individuals are assumed not to compare their own personal utilities with social utility or with other individuals' utilities; rather, if offered several social states, they invariably choose the social state that offers the highest personal utility, regardless of how much social utility (or others' utility) is derived from it.

(16) However--as I explain below in the text--Pareto optimality does not assure social-welfare maximization. The notion of "social welfare" rests on the assumption of interpersonal comparision of individual utility functions, while Pareto efficiency is based on the idea of intrapersonal comparision of utilities. Pareto himself did not interpret his proposed efficiency criterion as one that identifies a unique social optimum. In this respect, Cirillo, (1979) explains that Pareto in developing his notion of efficiency Pareto did not presuppose the existence of a social welfare function. The utilitarian jusitifcation of Pareto efficiency, according to which the Pareto test allows to maximize the sum of individuals' utilities, is therefore highly objectable. On the utilitarian justification of the Pareto principle and a comparison with alternative normative foundations of Pareto efficiency, see Coleman (1980).

(17) In g, person c is better off while p is indifferent; by comparison, in f person b is better off and c is indifferent; but, absent any cardinal measure of preference intensity, we cannot say whether c or p values the right the most. Again, c prefers g to a (and d to g); similarly, p prefers b to a and f to b, but this does not allow a "social" valuation for which a social welfare function is needed.

(18) Coleman (1980) shows that a "Pareto optimal distribution can be reached either by Pareto superior steps or 'moves,' by Pareto inferior moves, or by a combination of the two."

(19) Sen (1970) explains that, depending on the characteristics of the relations between individual preferences, the Pareto notion of efficiency might fail to fulfill the important property of completeness. More precisely, the Pareto test fails to provide guidance when individuals have strictly opposite preferences.

(20) This concept of efficiency traces back to the contributions of Kaldor (1939) and Hicks (1941).

(21) Bodway & Bruce (1984) provides a useful explanation of the principle of compensation as a theoretical device for separating efficiency and equity.

(22) Hypothetical compensation requires some measurement of gains and losses. As I will explain below in the text, the monetization of individuals' utility functions is the source of major criticism of KH efficiency test as a legal efficiency criterion.

(23) Champman (2005) demonstrates that "(...) in a Kaldor-Hicks superior re-allocation (...) it is possible that all we have accomplished is the transfer of a good from someone who values it more highly to someone who values it less highly and, therefore, a loss of total welfare overall." Le Grand (1991) also clarifes this point.

(24) observe that losers would not agree to compensation that does not effectively offset their suffered losses.

(25) The reasons can be different. First, the marginal utility of money differs across people depending on their income levels. Second, external factors might determine a utility differential between gainers and losers with respect to the same sum of money. For example, the availability of goods that can effectively replace, in terms of utility, the lost resource might not be sufficient to compensate losers. Third, individuals have different levels of "productivity" in terms of converting the monetary compensation received into actual utility.

(26) Champman (2005) clarifies that despite the gainers' gains are larger than the losers' losses in monetary terms, still the monetary value received by gainers might not enable them to generate a utility large enough to offset the losers' losses. Adler (2000) and Mathis (2009) provide a similar critique to KH efficiency.

(27) The KH test assumes implicitly a constant and equal marginal utility for all individuals. As Le Grand (1991) demonstrates, rather than achieving neutrality, KH efficiency conceals a peculiar social welfare function that systematically values rich people more than poor people. Similarly, Markovits (1993) emphasizes that the standard, monetized KH test does not consider that the monetary evaluation of gains and losses is positively wealth elastic.

(28) Mathis (2009) observes that, as a consequence of a rigorous application of the KH test, "the rich would get even richer and their ability and willingness to pay would rise continually".

(29) The Numeraire fallacy is associated with the use of the same numeraire (i.e., money) to measure both efficiency and distribution. Ellerman (2009) observes that, while according to its proponents KH efficiency is based on the separation of efficiency and distribution, efficiency is assessed through the same numeraire by which distribution is measured. However, if the transfer of resources undertaken to compensate losers is measured with the same numeraire used to measure the "size of the pie," there will never appear to be any increase or decrease in the size of the pie, and any KH move will appear to be a mere re-distribution of resources.

(30) In addition to the Numeraire fallacy that I have emphasized in the text, KH efficiency is subject to a further problem of logical consistency. Scitovsky (1941) demonstrated that in some cases two different states of affairs might be Kaldhor-Hicks efficient to one another. This is generally known as the Scitovsky Paradox. However, it should be noticed that the Scitovsky paradox does not have significant relevance in limiting in practice the use of the KH test in law and economics. In practical terms it occurs when, in the transition from one state to another, a change in income distribution occurs so that the preferences of the winners and the losers differ substantiallyThis occurs for those projects that are of such a scale in relation to the total economy as to bring about strong income effects with consequent relevant changes in prices. Conversely, when the dimension of a project is small relative to the total economy, so that the influence on prices is not significant, it is unlikely that a problem of inconsistency in the result of cost-benefit analysis rises.

(31) That is, it is assumed that consensus follows preferences.

(32) In practice, Posner turns the idea of wealth maximization (hereinafter, "WM") into an "auction rule:" legal entitlements should be conferred on the party who is willing to pay the highest price.

(33) Notice that intrapersonal comparison of utility is abandoned. Individual preferences are cardinalized through market prices so to allows for interpersonal comparison of relative gain and losses.

(34) Strcitly speaking, WM is not an efficiency criterion. See, on this point, supra note 16, Coleman, "Efficiency," 521.

(35) Komesar (1994) elucidates the single-institutional nature of conventional law and economics. In paticular, Komesar emphasizes that Posner's economic analysis of law fails to investigate the relative advantages and disadvantages of common law over alternative law-making institutions. Thus, Posner's positive claim falls into the Nirvana fallacy.

(36) Coleman (1980) emphasizes that wealth maximization is incapable of generating an initial assignment of rights.

(37) While there is no denying that part of the normative attractiveness of unanimity is independent of its impact in terms of efficiency, it is also true that unanimity is attractive for reasons related to efficiency. As Buchanan contends, unanimity is the only test that can ensure that a change is beneficial to all the parties affected by a re-distribution. Coleman (1987) proposes a different understanding of Buchanan's idea of efficiency; namely, he maintains that, by adopting unanimity as the only test for efficiency Buchanan reduces entirely efficiency to unanimity.

(38) Harsanyi (1978) develops the idea of a setting in which each actor has the same probability of finding himself or herself in different alternative situations. More recently, Parisi (1995) emphasizes the role of structural, stochastic and induced symmetry in ensuring impersonality of preferences. For a critique of contractarian methodology see Muller, 2002).

(39) In practice, the efficient lawmaking process stays with an optimal mix of alternative sources of law. The ultimate goal of the process efficiency analysis is to identify the optimal division of labor among different lawmaking mechanisms in order to maximize institutional complementarities and comparative advantages.

(40) As the discussion proceeds, it will become clear that I categorize outcome inefficiency costs as "law-making" costs because they are a function of the incentives embedded in the institutional structure of the law-making process. That is, they are causally related to the structure of the lawmaking process.

(41) For example, in the political process, voters bear significant information costs in order to participate in the election of their representatives; in the judicial process, litigants spend a significant amount of resources in collecting and elaborating on the information essential to the adversarial process; and, finally, individuals in the market process bear information costs related to acquiring the information necessary to engage in market transactions (i.e., information on the quality of economic goods, the reliability of the counterpart to the transaction, and so forth).

(42) Influence agency costs and internal pressure costs differ with respect to the source of the rent-seeking activity. While internal pressures derive from rent-seeking efforts on the part of officials operating within the law-making arena, external pressures derive from various stakeholders' efforts to extract rents from the law-making process.

(43) Influence agency costs and internal pressure costs are independent of whether the rent-seeking efforts of agents and principals succeed.

(44) Both losers and individuals who do not appreciate the efficiency advantages of legal change tend to stick to "old" norms, thereby incurring resistance costs.

(45) In the event of a change in the regulatory environment, legal rules that were previously efficient may become inefficient. The mismatch between the supervening inefficient rule and the changing context determines the magnitude of the maladaptation costs.

(46) Ex ante law-making produces legal principles that are applicable to classes of cases included within the scope of the law. This entails that, from an economic perspective, the fixed costs of creating legal principles are borne only once.

(47) On one hand, the frequency of the regulated behavior affects the variable component of the cost function, and the high level of frequency enables the lawmaker to distribute the high fixed costs of ex ante law-making over a high number of legal cases. On the other hand, the homogeneity of legal demand (i.e., when the elements that determine the need for legal intervention occur in similar fashions) enables the lawmaker to organize the application of a single legal response to an indefinite number of facts of law. Namely, if a sequence of potential cases that gives rise to a specific economic need are similar with regard to how they can be addressed by the law, then the lawmaker can shape the same institutional legal response to all cases. From this perspective, the homogeneity increases the marginal productivity of the ex ante law-making. Furthermore, the homogeneity of the legal demand allows for the regulation of prospective legal cases with a high level of ex ante legal precision.

(48) According to traditional law and economics prescription, when the technology of precaution is bilateral, then the negligence standard provides efficient incentives; conversely, when the technology of precaution is unilateral, strict liability is considered to be more efficient.

(49) Cfr., for example, in favor of a contractual liability regime, Priest (1982, 1991) Schwartz (1992) Ausness (2000). Contra, Arlen (2010) Goldberg & Zipursky (2010) Choi & Spier (2013).

(50) For a more elaborated position see the recent contribution by Miceli, Rabon, & Segerson, (2013).

(51) This approach is dominant in most used law and economics text-books (Miceli, 1997; Shavell, 2004; Cooter & Ulen, 2008).

(52) Generally, it is implicitly assumed that the source of "legal liability" is judicial in nature. Little attention is devoted to other institutional sources of legal liability (e.g., statutory or administrative liability). In addition, law-making costs are usually lumped into the sweeping concept of administrative costs, summarized into constant variables used in formal models. Finally, the errors of judges are considered in a number of models, (52) as is the uncertainty in the definition of legal standards. However, again, these important variables are not treated as functions of the institutional law-making framework.

(53) Frequency per actor affects the intensity of the behavioural effect by influencing individual incentives to comply with the law. Thus, holding the aggregate frequency constant, when the regulated behaviour is concentrated on a few actors, the high frequency per actor reinforces the behavioural effect. On the contrary, when regulated behaviours are widely distributed among the individuals subject to the law, the frequency per actor is low, thereby weakening the incentive to comply.

(54) Directive 2001/95/EC of 3 December 2001 on General Product Safety

(55) Breyer suggests that regulatory inefficiency--manifests in three serious biases. First, agencies exhibit a tendency to focus narrowly on their regulatory mission at the expense of other policy goals (i.e., "tunnel vision"). Second, agencies do not prioritize the most significant problems; rather their regulatory priorities are influenced by public misperceptions of risks. (i.e., "random agenda selection"). Third, agencies may possess overlapping jurisdictions for the same regulatory issue, which creates the risk of inconsistent regulation when bureaucratic objectives and preferences are not aligned.

(56) The effect of bureaucrats' risk aversion on the level of regulation can be usefully explained through the concepts of Type I and Type II errors. Type I errors occur when bureaucrats reach the conclusion that a safe activity is risky; conversely, Type II errors occur when bureaucrats reach the conclusion that a risky activity is safe. In many cases, Type II errors involve more easily detectable societal costs because they manifest in tangible harm to people; on the contrary, Type I errors engender social costs detectable only through a counterfactual assessment of foregone benefits that could have been derived from the safe activity that was not pursued.

(57) Unlike legislators, bureaucrats do not face direct electoral constraints, and, unlike judges, they are not involved in the litigation process between interested parties.

(58) However, also negligence standards can be centralized. For this reason, as emphasized shortly, the characterisitcs of instituional sources of liability rules needs to be anlyzed in relationship with substantive legal rules determining the liability regime.

(59) For an excellent discussion of the relationship between exit options and the efficiency of the law, see O'Hara & Ribstein (2000).

(60) In contrast, decentralization and inter-jurisdictional competition facilitate the exercise of the exit option, reduce the monopolistic power of the centralized lawmaker, and ultimately limit the returns expected from rent-seeking behaviour.

(61) A vast body of economic literature analyzes the agency problems that plague the political process. Here, I briefly mention only those that are specifically related to the area of product safety.

(62) Epstein (1982) that emphasizes the presence of "institutional barriers to effective wealth redistribution through the manipulation of common law rules".

(63) Rent-offering power is the lawmaker's ability to satisfy rent-seekers' demands by influencing the quality of the legal outcome to swing in a preferred direction. An approximate measure of rent-offering power might be the monetary amount of rent that the lawmaker can offer to rentseekers.

(64) Epstein (1982) emphasizes, with respect to the common law system, the presence of "institutional barriers to effective wealth redistribution through the manipulation of common law rules"].

(65) The elasticity differential between political and judicial supply curves has two important implications in terms of agency costs. First, when the supply curves reach the point of inelasticity, the influence curves of opposing interest groups become identical. At that point, adjudication becomes unresponsive to any increase in the level of influence expenditures; that is, no group is capable of enhancing its influence power (I assume here that all groups have reached the level of influence expenditures at which the supply curve becomes inelastic). Second, from the aggregate standpoint, when the relative influence powers of pressure groups are neutralized, the amount of resources invested in influence expenditures constitutes a deadweight loss for society.

(66) Countearguments can be found in Trebilcock (1989).

(67) From a conventional law and economics standpoint, in case of negative externality, the identification of the efficient allocation of property rights is indipendent of the issue of material causation ("who causes the damage"). It rather depends on the identification of the most valued use of the property right ("who values the property right the most").

(68) Due to network externalities, individuals' expected benefit from transiting to a new legal regime depends on the number of people who will adopt it. Efficiency requires that the number of people who adopt the new rule positively affect the benefit of belonging to the new legal network, to the point that the benefits exceed the transition costs.

(69) Uniform top-down legal supply systems suffer from informational disadvantages, especially when the supply of law 1) depends on widely dispersed factual knowledge or 2) requires an exploration of innovative legal solutions. By comparison, diversified bottom-up law-making processes ensure a more efficient use of the dispersed information and generate innovative legal solutions as a result of parallel experimentation processes.

(70) In synoptic decision-making, all the information relevant to the decision is gathered and evaluated in light of all of the relevant goals. These goals are clearly identified ex ante and weighed according to the decision-maker's values and preferences, which are also clearly identified and prioritized. Every available, rationally conceivable, alternative policy is considered, and the consequences of each possible alternative are weighed according to the identified values, preferences, and goals. By contrast, incremental decision-making begins with a consideration of the status quo, rather than an assessment of every policy alternative. Importantly, the status quo is generally maintained until an existing policy fails, which triggers the need for change and a search for alternatives. Only a restricted number of alternatives is examined, and only a limited range of consequences is weighed. Finally, decisions are continuously adjusted to the feedback generated by the regulatory environment resulting from previous marginal changes.

(71) A number of experimental studies have documented those shortcomings in jury behaviour that discourage the introduction of new products (and novel risks). For example, Moore & Viscusi (1991) provide empirical findings supporting the hypothesis that novel hazards are hit harder than more familiar risks because courts and jurors tend to award larger damages in cases of novel risk-related injuries..

(72) The insistence by the majority of law and economics scholarship on the centralized form of intervention is a form of Nirvana fallacy: The imperfection of the market is per se sufficient to justify a call for other idealized sources of law. By contrast, a careful process efficiency analysis requires a comparative investigation of the relative abilities of alternative law-making mechanisms to improve efficiency.

Daniele Bertolini

Assistant Professor

Ted Rogers School of Management--Ryerson University

Figure 2 Unified Taxonomy of Law-making Costs

              Supply Side

Information   (1) Information Gathering
              (e.g., costs associated with
              appreciating people's
              preferences and estimating the
              distribution of prospective
              cases with respect to the
              variables relevant for

Agency        (1) Internal Pressure Costs

Costs         (e.g., rent-extortion costs,
              augmented transaction costs)

              (2) Costs of Reducing the
              Agency Costs

              (e.g., costs associated with
              checks and balances in the
              political process, ex ante and ex
              post control costs in the
              bureaucratic process, and so on)

Adaptive      (1) Dynamic Implications of
Costs         Information and Agency

              Demand Side

Information   (2) Compliance Information
              (e.g., costs associated with
              appreciating the content of
              legal rules)

              (3) Participation-
              Information Costs

              (e.g., costs associated with
              litigation, with participation in
              the electoral process, and so

Agency        (3) External Pressure Costs

Costs         (e.g., rent-seeking costs)

Adaptive      (2) Adaptation Transaction
Costs         Costs (e.g., the cost of
              appreciating the advantages of
              legal change)

              (3) Adjustment Costs (e.g.,
              costs of adopting new
              behavioral standards)

              (4) Resistance Costs (e.g.,
              costs of maintaining old


Information   (4) Maladaptation Costs

Costs         (e.g., costs associated with
              the inability of the
              lawmaker to meet the
              heterogeneity of local

Agency        (4) Outcome Agency

Costs         (e.g., monopolistic rent
              costs in the political
              process or bureaucratic
              and legislative drift in the
              bureaucratic process)

Adaptive      (5) Maladaptation
Costs         Costs (e.g., costs of legal
              obsolescence, or
              retardations in
              adaptations to changes in
              the regulated
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Title Annotation:p. 402-430
Author:Bertolini, Daniele
Publication:The Journal Jurisprudence
Date:Dec 1, 2015
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