Efficiency and equity: What can be gained by combining Coase and Rawls?

Washington Law Review

Volumn 73, Issue 2, 1998, Pages 329-346

  Korobkin, Russell B ^a   Ulen, Thomas S ^a  

^a UNIVERSITY OF ILLINOIS AT URBANA CHAMPAIGN   (United States)

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EID: 0347669707     PISSN: 00430617     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (57)

1. See, e.g., Richard A. Posner, Economic Analysis of Law 27-29, 271-75 (5th ed. 1998).
2. The suggestion that the common law process gives rise to efficient legal rules was developed in John C. Goodman, An Economic Theory of the Evolution of Common Law, 7 J. Legal Stud. 393 (1978),
3. George L. Priest, The Common Law Process and the Selection of Efficient Rules, 6 J. Legal Stud. 65 (1977),
4. and Paul H. Rubin, Why Is the Common Law Efficient?, 6 J. Legal Stud. 51 (1977).
5. That suggestion is criticized in Robert D. Cooter & Lewis Kornhauser, Can Litigation Improve the Law Without the Help of Judges?, 8 J. Legal Stud. 139 (1980),
6. and Gillian K. Hadfield, Bias in the Evolution of Legal Rules, 80 Geo. L.J. 583 (1992).
7. See Frank H. Easterbrook, The Supreme Court, 1983 Term: The Court and the Economic System, 98 Harv. L. Rev. 4 (1984).
8. That article was criticized in Laurence Tribe, Constitutional Calculus: Equal Justice or Economic Efficiency?, 98 Harv. L. Rev. 592 (1985).
9. Easterbrook replied in Frank H. Easterbrook, Method, Result, and Authority: A Reply, 98 Harv. L. Rev. 622 (1985).
10. See Robert D. Cooter & Thomas S. Ulen, Law and Economics 104-06 (2d ed. 1997).
11. This is the thrust of much of the conventional law and economics of property, contract, and tort law. For example, one might well argue that it is efficient to compensate property owners when the government physically takes their property because that rule generally induces both private parties and the government to make efficient land-use decisions. But one could just as easily argue that the compensation requirement does justice to the private property owner. On the economic analysis of taking and regulatory taking, see Cooter & Ulen, supra note 3, at 149-55. On the general comparison between efficiency and fairness analyses of law, see Posner, supra note 1, at 30-31. See also Symposium, Efficiency as a Legal Concern, 8 Hofstra L. Rev. 485 (1980);
12. Debate: Is Law and Economics Moral?, 24 Valparaiso L. Rev. 147 (1990).
13. There are, of course, instances in which efficiency and traditional analyses of legal rules reach different conclusions. For instance, one of us has argued that the efficiency of contracting and of the resolution of contractual disputes would be more efficient if specific performance were the routine remedy for breach of contract. Thomas S. Ulen, The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies, 83 Mich. L. Rev. 341 (1984). Neither all or even most law and economics scholars agree with that position. The traditional view is, of course, that money damages should be the routine remedy for contract breach. Importantly, where this and other differences between efficiency and equity exist, very few followers of law and economics categorically assert that the efficiency analysis should prevail.
14. Michael I. Swygert & Katherine Earle Yanes, A Unified Theory of Justice: The Integration of Fairness into Efficiency, 73 Wash. L. Rev. 249 (1998).
15. See, e.g., Louis Kaplow & Steven Shavell, Why the Legal System Is Less Efficient than the Income Tax in Redistributing Income, 23 J. Legal Stud. 667 (1994);
16. Steven Shavell, A Note on Efficiency vs. Distributional Equity in Legal Rulemaking: Should Distributional Equity Matter Given Optimal Income Taxation?, 71 Am. Econ. Rev. 414 (1981).
17. The Second Theorem - or the Second Fundamental Theorem - of Welfare Economics, which we discuss more fully below in Part III.A, holds that, in competitive markets, efficiency and equity are separable. The implication is that society need not use a single policy instrument to achieve its efficiency and distributive goals. Rather, separate policy instruments can independently seek to achieve societal goals with respect to the efficient allocation of resources and the equitable distribution of income and wealth.
18. R.H. Coase, The Problem of Social Cost, 3 J.L. & Econ. 1, 6 (1960).
19. See Cooter & Ulen, supra note 3, at 79-93 (discussing Coase Theorem).
20. Professor Coase contends that the initial assignment does not affect income and wealth positions when transaction costs are zero because each party will have discounted the value of holding the entitlement to reflect the likelihood of exchanges and other future changes. See Ronald Coase, The Firm, the Market, and the Law 170-74 (1988).
21. The offending inattention to equity arises only in bargains having to do with fundamental legal rights and obligations. By this friendly amendment to Professors Swygert and Yanes' proposal, we mean to suggest that no one cares deeply about the division of a cooperative surplus between a green-grocer and a purchaser of onions, but they do care about the meta-rules of surplus division in contractual relations, real property transactions, bargains for the potential waiver of fundamental constitutional rights, employer-employee relationships, and similar situations.
22. We assume that there is no dispute between Professors Swygert and Yanes and law and economics scholars about the appropriate circumstances in which to apply the Coase Theorem. That is, we all seem to agree that the Coase Theorem is to be used, if at all, in settings of zero transaction costs.
23. Swygert & Yanes, supra note 5, at 314-16.
24. Id. at 14.
25. 350 F.2d 445 (D.C. Cir. 1965); see Cooter & Ulen, supra note 3, at 253-55 (discussing Williams).
26. Williams, 350 F.2d at 447.
27. Id. at 450.
28. Swygert & Yanes, supra note 5, at 317-19.
29. Id. at 319.
30. Id.
31. That is, most individuals are risk averse. For a discussion of the connection between one's marginal utility of income or wealth and one's attitudes toward risk, see Cooter & Ulen, supra note 3, at 44-48. See also Russell Korobkin, Determining Health Care Rights from Behind a Veil of Ignorance, 1998 U. Ill. L. Rev. (forthcoming).
32. An exchange or reallocation is "Pareto efficient" if it makes no party worse off and at least one of the parties better off. See Cooter & Ulen, supra note 3, at 12.
33. See extended discussion infra Part III.B. 1.
34. See Swygert & Yanes, supra note 5, at 317-23. Actually, their analysis concentrates on how their approach would be operationalized in regard to a certain type of contract law rules: "immutable" rules. The problems with applying the authors' approach to "default" contract law rules is considered infra in Part III.B.3.
35. Swygert & Yanes, supra note 5, at 324-25.
36. Coase, supra note 8, at 41-42.
37. Swygert & Yanes, supra note 5, at 324-25.
38. For the seminal discussion that divides remedies into classes of "property rules" and "liability rules," see Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 Harv. L. Rev. 1089 (1972).
39. The problem is cleverly revisited in James E. Krier & Stewart J. Schwab, Property Rules and Liability Rules: The Cathedral in Another Light, 70 N.Y.U. L. Rev. 440 (1995).
40. See also Symposium, Properly Rules, Liability Rules, and Inalienability: A Twenty-Five Year Retrospective, 106 Yale L.J. 2081 (1997).
41. See Spur Indus., Inc. v. Del E. Webb Dev. Co., 494 P.2d 700 (Ariz. 1972) (requiring polluter to shut down its operation near residential neighborhood, but also requiring neighborhood's developer to pay polluter's costs of relocation).
42. Mark Kelman, A Guide to Critical Legal Studies 123-24 (1987); see also Coase, supra note 8, at 17-18.
43. Cf. Krier & Schwab, supra note 28, at 449 (noting that when it is unclear which party values entitlement most and transaction costs are asymmetric, efficiency is best served by allocating entitlement to party that will be able to trade it at lowest cost). A "hold-out problem" exists when a purchaser must get the consent of a large number of people in order to conclude a transaction. Each of those who must consent has an incentive to withhold that consent in order to get as large a fraction of the cooperative surplus from the transaction as possible. A "free-rider problem" exists when it is costly to a seller to make each of the beneficiaries from a transaction pay a proportionate share of the benefit.
44. Actually, the situation is even worse from a distributive perspective. The factory owner gains the $1000 surplus plus an additional $2000 that, figuratively, comes out of the pocket of the neighbors. Thus, the factory owner ends the day at +$3000, while the neighbors end the day at -$2000.
45. Another way to achieve a division of the cooperative surplus is to divide the entitlement between the claimants. Ayres and Talley have suggested such a division, although for efficiency rather than equity reasons. They believe that divided entitlements can reduce strategic behavior in bargaining that would otherwise preclude efficient transactions. See Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 Yale L.J. 235 (1995);
46. Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 Yale L.J. 1027 (1995).
47. But see Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 Yale L.J. 221 (1995) (criticizing Ayres and Talley approach);
48. Louis Kaplow & Steven Shavell, Property Rules Versus Liability Rules: An Economic Analysis, 109 Harv. L. Rev. 713 (1996) [hereinafter Kaplow & Shavell, Property Rules].
49. This approach seems to us to be a property-law equivalent of the argument in favor of penalty default rules in contract law. See Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L.J. 87 (1989). A need for a special default rule arises in the contractual situation in which one of the parties has special losses from the other party's non-performance. Penalty default rules call for assigning the liability for failing to divulge those special losses to the party who would suffer them as an inducement for that party to reveal special information to the other party in the contract formation phase.
50. Swygert & Yanes, supra note 5, at 255-56 ("[L]aw and economics proponents argue that legal rules should be applied to produce the most efficient, wealth-maximizing consequences, wholly apart from empathic considerations about the parties and their relative situations.").
51. We recognize that the criticisms we are about to make might also apply to our market-contrarian approach.
52. The theorem states that each Pareto-efficient allocation is a market equilibrium. There are some important technical requirements for the theorem to hold - namely, that consumer preferences are convex and that production technologies are also convex. See Hal R. Varian, Intermediate Microeconomics: A Modern Approach 515 (4th ed. 1996). On the separation aspect of the Second Theorem, see id. at 517-18.
53. As explained above, assumption two probably is not realistic.
54. See Kaplow & Shavell, Property Rules, supra note 33, at 713 (claiming that it is inefficient to set condemnation payments above point at which payment would make "seller" indifferent).
55. Cf. A. Mitchell Polinsky, Resolving Nuisance Disputes: The Simple Economics of Injunctive and Damage Remedies, 32 Stan. L. Rev. 1075, 1079 (1980) (pointing out that assessment costs might prevent judges from making efficient damages calculations under liability rules); Krier & Schwab, supra note 28, at 453-54 (reinforcing Polinsky's point).
56. Ayres & Gertner, supra note 34, at 87; see also Symposium, Default Rules and Contractual Consent, 3 S. Cal. J. Interdisc. L. 1 (1993).
57. See Restatement (Second) of Contracts § 261 (1979).