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© The Authors and Contributors Severally 2015 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2015943164 This book is available electronically in the Law subject collection DOI 10.4337/9781783471676 ISBN 978 1 78347 166 9 (cased) ISBN 978 1 78347 167 6 (eBook) Typeset by Servis Filmsetting Ltd, Stockport, Cheshire 1 0 Contents List of contributors vi Preface vii 1. Economic methods and legal reasoning 1 Niels Petersen and Emanuel V. Towfigh 2. The economic paradigm 18 Emanuel V. Towfigh 3. Demand, supply, and markets 32 Alexander Morell 4. Game theory and collective goods 61 Stefan Magen 5. Contract theory and the economics of contract law 96 Klaus Ulrich Schmolke 6. Public and social choice theory 121 Emanuel V. Towfigh and Niels Petersen 7. Empirical research and statistics 146 Sebastian J. Goerg and Niels Petersen 8. Behavioral law and economics 177 Markus Englerth Index 205 v Contributors Markus Englerth, Attorney- at- law with Danckert Huber Bärlein, Berlin Sebastian J. Goerg, Assistant Professor of Economics, Florida State University Stefan Magen, Professor of Public Law, Legal Philosophy, and Law and Economics, University of Bochum Alexander Morell, Senior Research Fellow, Max Planck Institute for Research on Collective Goods Niels Petersen, Professor of Public Law, International Law, and EU Law, University of Münster Klaus Ulrich Schmolke, Professor of Private Law, Commercial, Company and Business Law, University of Erlangen- Nuremberg Emanuel V. Towfigh, Senior Research Fellow, Max Planck Institute for Research on Collective Goods vi Preface Economic methodology has been gaining increasing attention in legal studies over the last few decades – for a while now in the Anglo-A merican discourse, and more recently also in continental Europe. Arguments based on economic thinking were first advanced in private law and then in other areas of law as well. Nowadays, nobody is surprised anymore to read of ‘incentives’ or ‘actors’ in a legal text, or – more recently – of ‘nudges’. There is hardly a treatise on torts which does not contain reflections on the best insurability; in the field of emissions trading law, EU law specialists discuss the first allocation of certificates; and criminal law experts debate whether increasing the chances of detecting crimes would have a stronger deterrent effect than the mere increasing of sentences. Further prominent examples could be named for a whole string of legal areas, ranging from medical liability and intellectual property rights to tax and environmental law as well as antitrust and consumer protection law. In comparative law, economic theory is frequently used as a tertium comparationis, a standard of comparison. While law and economics in the initial stages primarily dealt with theoretical models, in recent times empirical findings have also increasingly been making their way into legal studies. There is also a growing demand for legal scholars to justify legislation (already in force or about to be implemented) on the basis of evidence on human behavior – for example, from politics or neighboring disciplines. Is an intended legal measure really suited to fulfill its goal? Legal practition- ers are thus increasingly compelled to assure themselves of the fundamentals of their own discipline. In order not to lose their clout to have a strong impact on society, they must become experts for behavioral interventions through law. Law and economics provides a suitable framework for this, in particular, if evidence from the behavioral sciences is taken into account. These developments also mean there is an increasing demand for knowledge of social science methodology in general and of economics in particular to be passed on. How does one find access to this mode of thinking? What limitations have to be taken into account when introducing an economic argument into the legal discourse? How do we recognize a good, economically sound argument, and how can we debunk a poor one? And vii viii Economic methods for lawyers finally, how can we learn to make a valid economic argument ourselves? This textbook is an attempt to answer these questions. It addresses readers who are familiar with legal studies, yet have no previous knowledge of the social sciences, and who wish to become familiar with economic methods and to understand the appeal and the power of an economic argument in select legal contexts. The major areas of economic theory are briefly intro- duced, as far as they are relevant for legal studies. Furthermore, the book will give an overview of the empirical fundamentals of the social sciences, and of more recent approaches relating to behavioral theory. Therefore, the book differs in its approach from conventional textbooks on law and economics. The idea is not to study certain legal areas through the lens of economic theory. First and foremost, it is about imparting information on methods rather than certain content- related theories. The book does not outline how specific economic insights should be understood in a legal context. Rather, it intends to be an aid to understanding economic arguments better and applying them to legal issues. Obviously, this textbook cannot do entirely without content-r elated knowledge, so that short introductions to some basic theoretical concepts of economics are provided – from microeconomics to public goods and public choice. Despite this emphasis on methods, the authors have gone to great lengths to show the importance of their remarks for legal studies, using examples from many of the different legal fields. This textbook presents the basic economic models, since this project is about introducing economic methods to legal experts. In economics, too, as in jurisprudence, many of the assumptions and conclusions presented here without second- guessing are the subject of heated debate. Every topic presented in this volume is open to a host of theoretical and empirical vari- ations and refinements – indeed, these are too numerous to reference them in their entirety. Interested readers are advised to refer to more specialized literature, which usually contains more refined models. References are provided at the end of each chapter, and the footnotes contain further references for specific questions. The authors of the individual chapters are experts in their respective fields. However, the primary authors had the ambition to produce not an anthology of economic methodology, but rather a self- contained textbook. The concept and final harmonization are the work of the two primary authors. They revised all contributions in order to avoid overlaps and to ensure coherence and a consistent style. The book is based on the experi- ence of a German language textbook; Stefan Voigt and Patrick Leyens from the Institute of Law and Economics at Hamburg University urged us to write an English language textbook according to the same concept, bridging a gap for ‘black- letter law’ trained lawyers into social science Preface ix methods. Special thanks go to Brian Cooper for his thorough linguistic review of the individual contributions, to Rebekka Herberg for the final editing of the manuscript, and to Tara Gorvine, Erin McVicar, Claire Greenwell and David Fairclough at Edward Elgar for the professional and helpful handling of the publishing process. We hope this book will be well received and are always grateful for ideas for improvement. Emanuel V. Towfigh and Niels Petersen 1. Economic methods and legal reasoning Niels Petersen and Emanuel V. Towfigh I. DEVELOPMENT OF LAW AND ECONOMICS The modern economic analysis of law was developed in the United States in the second half of the 20th century.1 There are several factors that contributed to this development. However, the main reason is probably a cultural one. The critique of legal realism with regard to the power of legal doctrine to determine the results of legal decisions has had a much stronger influence on legal academia in the United States than in continental Europe. With the disenchantment of legal doctrine, US scholars had to look for different fields of research activity. The economic analysis of law was one approach that tried to bridge this gap.2 The emergence of the Law and Economics movement in the US is often traced back to Ronald Coase’s article on ‘The Problem of Social Cost’ in the Journal of Law and Economics in 1960. This article paved the way for the economic analysis of tort and contract law. In the 1960s, Guido Calabresi advanced the economic analysis of tort law, culminating in his book on accident law in 1970. Gary Becker then applied economic principles to areas of law which had previously not been susceptible to an economic analysis: to crime, racial discrimination or family life. In 1973, Richard Posner published his seminal textbook on the Economic Analysis of Law, in which he tried to present for the first time a comprehensive analysis spanning several different fields of law. 1 For a detailed account, see Kristoffel Grechenig and Martin Gelter, History of Law and Economics (Working Paper, MPI Collective Goods, 2014). 2 See Grechenig and Gelter, The Transatlantic Divergence in Legal Thought, 31 Hastings Int’l and Comp. L. Rev. 295 (2008). 1 2 Economic methods for lawyers II. POSITIVE AND NORMATIVE ECONOMIC THEORY In the scholarly discourse, two approaches to economic analysis can be distinguished. We will briefly touch upon this distinction again in Chapter 2. First, we can use economic theory as a descriptive tool (‘positive theory’). Economics, then, is a perspective to look at the world and to make sense of what we see. How do people behave – in terms of our theory? And why do they behave this way – in light of our theory? To see how well our positive theory reflects what we empirically observe, we derive hypotheses about the behavior we would expect to see in certain situations: We make predictions. We can then check in an empirical study (see Chapter 7) whether our predictions are correct, and evaluate our theory accordingly, adapting it if necessary. Second, we can use economic theory to postulate how the world should be (‘normative theory’) or we can evaluate different states of the world according to a normative standard. For example, welfare economics (as we will see in greater detail in Chapter 2) posits that a condition A ‘is better than’ a condition B if more people are better off materially under condition A. It thereby assumes a normative standard (it is good if people are prospering materially), and measured against this standard it makes a normative judgment (‘is better than’). Of course, the line drawn between positive and normative theory is not always that bright and clear. Positive theory can carry implicit normative assumptions; and even the mere labe- ling of a behavior as ‘rational’ may be understood to contain a judgment. Moreover, positive theory may not only describe, but also affect behavior if people informed by economic theory expect their environment to behave in a certain way, and condition their own behavior on this expectation: If I expect everyone else to behave selfishly, as positive economic theory seems to imply, then my best reaction is to behave selfishly myself; my selfish behavior may, in turn, induce my environment to behave selfishly, which proves my suspicion that everyone else behaves selfishly (‘self-f ulfilling prophecy’).3 The normative side of economic theory is the main reason why – despite the success of law and economics in the US – there has long been a fierce resistance against the economic analysis of law in other parts of the world, especially in continental Europe. This resistance was primarily based on the normative target that the economic analysis of law often had in 3 On this issue, see the very instructive study of Donald MacKenzie and Yuval Millo, Constructing a Market, Performing Theory: The Historical Sociology of a Financial Derivatives Exchange, 109 American Journal of Sociology 107 (2003).