WHY THE WORK OF THE NEW NOBEL PRIZE WINNERS FOR ECONOMICS MAY SPELL THE DEMISE OF THE LAW AND ECONOMICS MOVEMENT:
The Problem With Posner, And With Assuming Rationality

By EDWARD LAZARUS

Thursday, Oct. 17, 2002

The legal world generally doesn't pay much attention to who wins the Nobel Prize for Economics, and this year is proving no exception. But I wonder if ten or fifteen years from now, we will look back at the moment of this year's prize announcement as the high water mark of the "Law and Economics" movement.

In the last decade, the Law and Economics movement has come to dominate legal scholarship and deeply influence legal and regulatory thinking. But its influence may soon be on the wane - as the Nobel Committee's choice shows.

This year, the Prize went to Daniel Kahneman and Vernon Smith. Notably, Kahneman is not an economist at all, but rather a psychologist. And even more notably, both recipients were selected for their pioneering work in demonstrating, through experimentation, that human beings frequently do not act as the kind of supremely rational actors ordinarily posited in economic theory.

The Law and Economics Movement and Its Deep Reliance on Rationality

At the risk of gross oversimplification, the most ardent devotees of the Law and Economics school tell us that scientific order both can and should be brought to the jumble of rules that we call law. If we think of humans as rational actors efficiently seeking to maximize their interests, according to the movement, then we can fashion legal rules that will best help them do so.

Much of this analysis takes place on a highly theoretical level. But the practical applications have expanded in recent years as leading Law and Economics theorists - most notably Richard Posner of the U.S. Court of Appeals for the Seventh Circuit - have been appointed to the bench.

Of course, you won't see any fancy econometric formulas showing up in their opinions. But these judges, self-consciously, are far more willing than most of their colleagues to choose between competing legal doctrines based on what they foresee as the likely practical consequences of each doctrinal choice.

Put another way, these judges are willing, even eager, to shape the law based on their assumptions about the likely effects of a legal regime. And, in turn, those assumptions about future effects are based on their judgments as to what a "rational" person would do under a given set of circumstances.

The Weaknesses of Law and Economics, Even Apart From the Nobelists' Work

Even before Smith and Kahneman told us that this premise of rationality is dramatically overblown, this kind of law-making was a dangerous business. Posner and other leaders in the field declare economics to be the most promising of the social sciences (notwithstanding its moniker as the "dismal" science), at least where the law is concerned. Yet in practice, its application is less than scientific.

Economics often involves not controlled and verifiable experimentation, but instead the positing of any number of unverifiable (and, as it turns out, dubious) assumptions. When these assumptions are thrown into doubt, the usefulness of the conclusions they lead to is also undermined.

Remember when all those economists were touting the virtues of stock options as a principal component of executive pay? What could be more "rational" than rewarding a top executive based on the performance of his or her company, as judged by the market value of the company's stock? "Pay for performance "became a virtual mantra.

Some people might say it isn't rational for very rich people to put themselves at risk of both going to prison and suffering economic ruin just to make themselves a whole lot richer. But that's what happened (as Sam Waksal just admitted with his recent guilty plea in the ImClone scandal). Thus, the Law and Economics folks' "scientific" crystal balls demonstrated themselves to be more than a little cloudy.

Examples like these show that the economic analysis of law seems wholly dependent on the perspicacity of its practitioner about the realities (not the rationality) of human and institutional behavior. And even the best of Law and Economics thinkers can stumble badly in practice - often because they are describing people as rational when their actions, in practice, are anything but.

The Problem with Posner's Law and Economics in Particular

Posner, who has emerged as one of the nation's leading public intellectuals, is a case in point. A decade ago, for example, in one of his leading opinions - Schurz Communications v. FCC - Posner struck down new regulations promulgated by the FCC, based largely on a Law and Economics analysis. But that turned out to be a serious mistake

The regulations had limited the right of television networks to engage in television production (as opposed to distribution). In the FCC's view, these regulations were necessary to protect independent television producers from being shut out by the networks - who dominated television distribution channels. The FCC also worried that, absent the regulations, television would (even despite cable) become increasingly homogeneous.

But Posner was not convinced. He freely expressed his own views on the most likely result of the proposed regulations, rather than deferring to the FCC's as administrative law required. And as a result of those views, he voided the FCC's limitations on networks as "arbitrary and capricious."

Of course, what the FCC had done wasn't arbitrary and capricious at all - it made perfect sense from the FCC's point of view. But in order to replace the FCC's point of view with his own, something judges are never supposed to do, Posner had to describe the FCC's decisionmaking as if it had barely been decisionmaking at all. (Ironically, Posner thus had to paint the FCC as being far from a rational actor.)

In hindsight, it's hard not to conclude that the FCC was mostly right. Independent television producers are an endangered species in Hollywood. Meanwhile, the networks (and their cable-heavy parent companies) now control a huge proportion of what's seen on TV. What the FCC predicted, actually came to pass, since the regulations that would have prevented it were struck down.

Posner Is Also Wrong on the Law and Economics of Campaign Finance Reform

Take Posner's assessment of campaign finance reform. In putting current proposals on his scale of good policy, Posner tells us that the harms caused by the current system are minor. Unlimited soft money contributions, he tells us, "buy access and modest influence, at best, and often just offset the contributions to competing candidates rather than causing substantial distortions in the markets in which the contributors operate."

Tell that to the California officials who tried to convince the Bush Administration to put temporary price caps on energy. They argued to a brick wall, given that the energy was being produced by the very market-manipulating companies that provided the financial spine for George W.'s presidential campaign.

Certainly, a growing number of politicians admit candidly that money buys a lot more than "modest influence" (and they should know, shouldn't they?). Moreover, if modest influence was indeed all that big contributions achieved, you'd think wealthy donors would have started putting their money to better uses; instead, they've pulled out all the stops, showering candidates with donations. (I guess Denise Rich hasn't read Posner.)

Naturally, if one undervalues the potential benefits of campaign finance reforms it's easier for a supposedly "scientific" economic approach to tip against reform. And Posner also puts his finger on the other side of the scale - by overstating the potential costs of reform, as well as understating its benefits.

For example, one creative notion for solving the campaign finance dilemma would be to turn current contribution disclosure laws on their head, and require that all campaign donations be anonymous. This way individuals and companies could still freely exercise their First Amendment right to give money to candidates of their choice. Yet the mandatory anonymity of the contributions would prevent the access and influence-buying that corrupts the present system: Candidates would not know who had filled their campaign coffers and without a "quid" to identify, would not be tempted to provide a "quo."

In Posner's view, however, this "donation booth" idea would impose an excessive "information cost" on voters, who would no longer be able to judge a candidate by his donors. According to Posner, "the identity of a donor is a clue to the likely policies of the donee should he be elected - a valuable clue if the donor has better information about the candidate than the average voter has."

Indeed, Posner finds this cost so significant he suggests it might be better to forbid anonymous contributions. Yet will it really benefit voters to be clued in as to which candidates are beholden to which donors? That will only help them to choose between different varieties of corruption; whereas anonymous donations might obviate corruption itself.

In any event, very few people, I would venture, assess the relative merits of candidates by looking at their donor lists - especially these days when interest groups routinely hide their true identities and agendas behind truth-bending names. Voters look at what voters have traditionally looked at - public positions, endorsements, and so on. I'd trade in a heartbeat the loss of information about donor identity in exchange for an end to the current practice of quasi-bribery, and I suspect most voters would feel the same.

Time for a New Psychology and Law Movement?

If these suggestions are true - and they certainly seem to be, then isn't the law making a terrible mistake by tying itself so closely to a science that is no science at all? Pretending to offer precise answers to legal questions by relying on false assumptions only gives a false sense of security and certainty.

Or, put differently, now that economics is a field shown to be powerfully dependent on psychology, shouldn't the legal academy think twice about putting so many of its eggs in the basket of economics? Shouldn't the Law and Psychology movement perhaps enjoy a second wind instead? But, hey, I was a history major - so what do I know.


Edward Lazarus writes about, practices, and teaches law in Los Angeles. A former federal prosecutor, he is the author of two books - most recently, Closed Chambers: The Rise, Fall, and Future of the Modern Supreme Court.

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