Schools and intellectual perspectives in law and economics

Most practitioners of law and economics believe that there is an important common ground that unifies all scholars in the discipline, regardless of their ideological creed: a search for new insights in the law by applying economic concepts and theories (MacKaay, 2000).

The Chicago and Yale schools: positive versus normative approaches to law and economics

During the early period of the discipline, law and economics scholarship was labelled ‘Chicago’ or ‘Yale’ style. These labels made reference to the respec­tive positive or normative approach utilized by each school. The origins of the Chicago and Yale schools of law and economics are attributable to the early work of a handful of scholars, including the pioneering work of Coase and Calabresi in the early 1960s.

At this point, methodological differences came to the surface with substan­tive practical differences. The Chicago school laid most of its foundations on the work carried out by Posner in the 1970s. An important premise of the Chicago approach to law and economics is the idea that the common law is the result of an effort - conscious or not - to induce efficient outcomes. This premise is known as the efficiency of the common law hypothesis. According to this hypothesis, first intimated by Coase (I960), and later systematized and greatly extended by Ehrlich and Posner (1974), Rubin (1977) and Priest (1977), common law rules attempt to allocate resources in either a Pareto or Kaldor-Hicks efficient manner. Further, according to the positive school, common law rules are said to enjoy a comparative advantage over legislation in fulfilling this task because of the evolutionary selection of common law rules through adjudication.

The primary hypothesis advanced by positive economic analysis of law is thus the notion that efficiency is the predominant factor shaping the rules, procedures and institutions of the common law. Posner contends that effi­ciency is a defensible criterion in the context of judicial decision making because ‘justice’ considerations - on the content of which there is no aca­demic or political consensus - introduce unacceptable ambiguity into the judicial process.

In arguing for positive use of economics, Ehrich and Posner (1974) is not denying the existence of valuable normative law and economics applications. In fact, law and economics often has many objective things to say that will affect one’s normative analysis of a policy.¹

Despite the powerful analytical reach of economic analysis, Chicago schol­ars acknowledged from the outset that the economist’s competence in the evaluation of legal issues was limited. While the economist’s perspective could prove crucial for the positive analysis of the efficiency of alternative legal rules and the study of the effects of alternative rules on the distribution of wealth and income, Chicago-style economists generally recognized the limits of their role in providing normative prescriptions for social change or legal reform.

On the contrary, the Yale school of law and economics, often described as the ‘normative’ school, believes that there is a greater need for legal interven­tion in order to correct for pervasive forms of market failure.² Distributional concerns are central to the Yale-style literature. The overall philosophy of this group is often presented as more value tainted and more prone to policy intervention than the Chicago law and economics school.

Unlike its Chicago counterpart, the Yale school has attracted liberal prac­titioners who employ the methodology of the Chicago school but push it to formulate normative propositions on what the law ought to be like (MacKaay, 2000).

The Virginia school: the functional approach and the return to normative individualism

In recent years, a new generation of literature - developed at the interface of law, economics and public choice theory - pushes the methodological bound­aries of economic analysis of law. The resulting approach is in many respects functional in its ultimate mission, cutting across the positive and normative distinction and unveiling the promises and pitfalls of both the normative and the positive alternatives. This approach to legal analysis has the potential of shedding light on the traditional conception of lawmaking, suggesting that the comparative evaluation of alternative sources of law requires an appropri­ate analysis of the incentive structure in the originating environment. This line of research is attentive to the identification of political failures in the formation of law, stressing the importance of market-like mechanisms in the creation and selection of legal rules.

The functional approach to law and economics is still in its initial phase of development and far from a point of theoretical maturity, but this approach is unquestionably successful in raising some crucial questions regarding the difficult link between individual preferences and social outcomes, with an emphasis on institutional mechanism design and individual choice. The re­sulting approach is quite sceptical of both the normative and the positive alternatives.³ Public choice theory provides strong methodological founda­tions for the functional school of law and economics: the systematic incorporation of the findings of public choice theory into the economic analy­sis of law may serve to bridge the conflicting normative perspectives in law and economics, at least by bringing the debate onto the more solid ground of collective choice theory.

The functional approach is wary of the generalized efficiency hypotheses espoused by the positive school. In this respect, the functionalists share some of this scepticism of the normative school. Nothing supports a generalized trust in the efficiency of the law in all areas of the law. Even more vocally, the functional school of law and economics is sceptical of a general efficiency hypothesis when applied to sources of the law other than common law (for example, legislation or administrative regulations).

The functional approach is also critical of the normative extensions and ad hoc corrective policies, which are often advocated by the normative schools. Economic models are a simplified depiction of reality. Thus, functionalists think it is often dangerous to utilize such tools to design corrective or inter­ventionist policies. In this respect, the functionalists are aligned with the positive school in their criticism of the normative approach. According to both the positivists and the functionalists, normative economic analysis often risks overlooking the many unintended consequences of legal intervention.

An important premise of the functional approach to law and economics is its reliance on methodological individualism. According to this paradigm of analysis, only individuals choose and act (see, for example, Buchanan, 1990 and the various contributions of the Virginia school of political economy). The functional approach to law and economics is informed by an explicit recognition that whatever social reality we seek to explain at the aggregate level, ought to be understood as the result of the choices and actions of individual human beings who pursue their goals with an independently formed understanding of the reality that surrounds them (Vanberg, 1994: 1). Norma­tive individualism further postulates that only the judgment of single individuals can provide a relevant benchmark against which the merits of alternative rules can be evaluated.

The findings of public choice theory, while supporting much of the tradi­tional wisdom, pose several challenges to neoclassical law and economics.