Wealth, utility and revealed preferences: the choice of maximand
There is an important methodological question that has openly engaged the attention of prominent law and economics scholars: what should the legal system try to maximize? In this debate, even strict adherents to the instrumentalist view of the law may question whether the objective of the law should be the maximization of aggregate wealth, aggregate utility, or merely provide the conditions for free individual choice.
If the scholars involved in these debates could look at the issue as neutral spectators, consensus could be reached on the idea that the ultimate policy goal is the maximization of human happiness and well-being. But regardless of such an observation, economic analysis of law rarely uses utility-based methods of evaluation. The reason for this is, once again, mostly pragmatic. Unlike wealth (or quantities of physical resources), utility cannot be objectively measured. Furthermore, interpersonal comparisons of utility are impossible, rendering any balancing across groups or individuals largely arbitrary. These limitations make utility maximization unviable for practical policy purposes.
Given the above limitations, following Posner, several practitioners of economic analysis of law have departed from the nineteenth-century utilitarian ideal of utility maximization.10 Rather, they have increasingly used a paradigm of wealth maximization. Several scholars in law and economics remain uneasy in accepting the notion of wealth maximization as an ancillary paradigm of justice. Although several of the differences prove to be largely verbal, two objections continue to affect the lines of the debate.
The first objection relates to the need for specifying an initial set of individual entitlements or rights as a necessary prerequisite for operationalizing wealth maximization. In this context, one can think of the various criticisms of wealth maximization by property rights advocates who perceive the social cost of adopting such criterion of adjudication as very high, given wealth maximization’s instrumentalist view of individual rights and entitlements.
These critics argue that rights have value that must be accounted for outside of how useful they might be to the accumulation of wealth (Buchanan, 1974; Rowley, 1989).The second objection springs from the theoretical difficulty of defining the proper role of efficiency as an ingredient of justice, vis-a-vis other social goals. Legal scholars within the law and economics tradition (see, for example, Calabresi, 1980) have claimed that an increase in wealth cannot constitute social improvement unless it furthers some other social goal, such as utility or equality. Denying that one can trade off efficiency against justice, these scholars argue instead that efficiency and distribution are equally essential elements of justice, which is seen as a goal of a different order than either of its constitutive elements.
The functional school of law and economics provides a third alternative by identifying individual choice and revealed preferences as the fundamental criterion for evaluation. The design of metarules that are aimed at fostering free individual choice by eliminating strategic and transactional impediments to the revelation of true preferences becomes an explicit objective of the functional school. As discussed above, the evaluation of alternative sources of law requires an appropriate analysis of the incentive structure in the originating environment and is aimed at introducing market-like mechanisms in the creation and selection of legal rules, with an emphasis on institutional mechanism design and individual choice. The recent literature on reciprocity (Smith et al., 1998; Fon and Parisi, 2003), social norms and customary law (Parisi, 1998; Cooter, 2000), choice of law (Parisi and Ribstein, 1998; Romano, 1999; Ribstein and O’Hara, 2000), federalism (Ribstein and Kobayashi, 2001) and freedom of contract (Trebilcock, 1994; Buckley, 1999) are examples of the growth and value of functional approaches in law and economics.
Future generations of law and economics scholars should be cognizant of the important methodological debates that have engaged their precursors, taking full advantage of the insights developed by the different methodological traditions when appraising legal rules and institutions.
Notes
1. Ehrich and Posner (1974) offers crime as an example. Positive law and economics can help explain and predict how various punishments will affect the behaviour of criminals. It might determine that a certain sanction is more likely to deter a certain crime. While this analysis does not by itself mean that the law should be adopted, it can be used to influence normative analysis on whether the law would be beneficial to society.
2. MacKaay (2000) observes that the Yale school considers market failures to be more pervasive than Chicago scholars are willing to admit. Legal intervention is believed to be the appropriate way of correcting such failures, although it may not succeed in all circumstances.
3. For a brief intellectual history of the three approaches to law and economics, see Posner and Parisi (1998).
4. On this point, see Cooter (1994) introducing the similar idea of structural adjudication of norms.
5. As a corollary, a change to a Pareto superior alternative makes someone better off without making anyone worse off.
6. See Posner (1998) for an interesting discussion on Bentham and his influence on the law and economics movement.
7. One should note that, if actual compensation was carried out, any test satisfying the Kaldor-Hicks criterion of efficiency would also satisfy the Pareto criterion.
8. Notable scholars have considered the conditions under which principles of justice can emerge spontaneously through the voluntary interaction and exchange of individual members of a group. As in a contractarian setting, the reality of customary law formation relies on a voluntary process through which members of a community develop rules that govern their social interaction by voluntarily adhering to emerging behavioural standards. In this setting, Harsanyi (1955) suggests that optimal social norms are those that would emerge through the interaction of individual actors in a social setting with impersonal preferences. The impersonality requirement for individual preferences is satisfied if the decision makers have an equal chance of finding themselves in any one of the initial social positions and they rationally choose a set of rules to maximize their expected welfare.
Rawls (1971) employs Harsanyi’s model of stochastic ignorance in his theory of justice. However, the Rawlsian ‘veil of ignorance’ introduces an element of risk aversion in the choice between alternative states of the world, thus altering the outcome achievable under Harsanyi’s original model, with a bias toward equal distribution (that is, with results that approximate the Nash criterion of social welfare). Further analysis of the spontaneous formation of norms and principles of morality can be found in Ullmann-Margalit (1977); Sen (1979); and Gauthier (1986).9. According to the Nash criterion, social welfare is given by the product of the utility of the members of society (Nash, 1950). See Mueller (1989: 379-82), attributing the multiplicative form of the social welfare function to Nash.
10. Posner is the most notable exponent of the wealth-maximization paradigm. Under wealthmaximization principles, a transaction is desirable if it increases the sum of wealth for the relevant parties (where wealth is meant to include all tangible and intangible goods and services). Bentham (1839) had already challenged the use of objective factors, such as wealth or physical resources, as a proxy for human happiness. Despite the difficulties in quantification of values such as utility or happiness, the pursuit of pleasure and happiness and the avoidance of and pain are the motivating forces of human behaviour. Wealth, food and shelter are mere instruments to achieve such human goals.
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