Law and Economics Theory

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The "positive" economic theory of law argues that one can discern an economic logic implicit in law, constitutional as well as any other. Economic analysis can also play a normative role, providing a benchmark for assessing the soundness of any particular constitutional clause or interpretation. (As economics itself does not establish indisputable criteria of judgment, the benchmark itself may be blurry.) For some constitutional provisions or doctrines, the relevance of economics is obvious; the Fifth Amendment's takings clause is an example.

A market economy requires private property. One can imagine an economy of government firms relating to each other, to workers, and to consumers primarily through market operations. But if capital were allocated by government, this would be an odd parody of a market economy, and if capital were allocated by markets in the sense that individuals were free to place their capital where they chose, the firms would not be government firms. The Fifth Amendment's requirement of just compensation for the taking of property thus supplies a qualified protection for the market economy. The economist naturally asks how alternative constructions of the clause will affect incentives—the feature of a market economy that accounts in large measure for its productivity.

One might view the clause as aimed at assuring owners correct incentives to invest and improve property. The Supreme Court's focus on "investment-backed expectations" in penn central transportation co. v. new york city (1978) suggests such a concern. But insurance against such risks could be provided by private insurers, and so the question arises why the duty to pay should fall on government. At least one answer—again look ing at incentives—is that such a duty will improve incentives for government decision makers, deterring the pursuit of programs that sacrifice a greater value than they produce.

Does such a view lead to a rule that compensation is required for government acts that fail some sort of cost-benefit test, and not for ones that pass? Clearly not. To resolve claims on such a basis would require the courts to assess the wisdom of virtually every government decision, a costly repetition of other branches' work. Because many of the benefits and costs of a program are political, this inquiry would take courts into areas where other institutions might have a comparative advantage. Finally, the Constitution establishes rights. Whether created for instrumental or for ethical reasons (e.g., a sense of the moral fitness of people's owning themselves and what they receive in free exchanges with others), a right would hardly be worthy of the name if it succumbed whenever a cost-benefit test ran against it. Thus, the economist, along with everyone else, would not define the protections of the taking clause by reference to "case utilitarianism" (assessing particular acts in terms of their direct effect on aggregate utility).

But the criterion of maximizing utility may help define the rules that embody constitutional rights—"rule utilitarianism." Reading the takings clause to require compensation for all government acts, for instance, would provide a strong incentive against wasteful government acts. But such a rule would entail enormous administrative and information costs—though never the costs of evaluating the program's benefits, as the rejected case-utilitarian view would. The concern for administrative costs suggests a reading of the takings clause that requires compensation for any act (or class of acts), except where its costs are relatively widespread—in the extreme case, for example, those of a change in monetary policy—so that the administrative costs of awarding compensation are high. (The compensation itself is not a social cost, but a transfer from taxpayers or users to whoever's property is taken. Effecting the transfer through raising taxes will usually impose secondary costs, however, by reducing economic incentives to engage in the taxed activity.)

In fact, many features of taking law seem to fit such a notion comfortably: the refusal to view all regulatory losses as automatically compensable, coupled with compensability for at least some extreme cases; consideration of "average reciprocity of advantage," offsetting benefits that a property owner may gain from a scheme as a whole, such as a historic district, and that would complicate any effort to compute compensation; and award of compensation for even a very small loss where it takes the form of a complete taking of all rights in a diminutive piece of property.

On the other hand, the courts' relative indifference to regulations sweeping away much of the value of undeveloped land raises a question about the judicial vision of the clause. Focus on incentives for property owners might support such relative indifference; the existence of land, as opposed to buildings, typically requires no investor effort. (In Kaiser Aetna v. United States, 1979, where human effort had created a waterway, the Supreme Court extended protections to private interests beyond what it would have afforded similar interests in a natural waterway.) Focus on incentives for government and recognition of the opportunity costs of undeveloped resources preempted by government might tilt the balance toward protection in some of these cases.

The takings clause may seem easy territory for demonstrating a constitutional concern for economic incentives, but broadly defined, such a concern pervades the document. The Framers' fear of excessive governmental power led them to rely on institutional incentives as a check. The separation of powers rests on an assumption about human behavior familiar to economists: even in government, people will pursue personal advantage to a large degree. Thus, as in the private marketplace, the Constitution used private incentives to achieve a public end, ambition being made to counteract ambition, as james madison put it in the federalist #51.

The system of checks exposes a complex relation between effiiciency at different levels. While Judge Richard Posner has argued that seperation of powers is at least in part an effort to increase government efficiency by tailoring the institutional structure to particular government tasks, the structure also impedes government action, making it less efficient as an institution, But if some sort of overall efficiency by forstalling inefficient economic regulation. On the other hand, once inefficient regulations exist, seperation of powers may decrease efficiency by delaying deregulation long after a consensus has developed that government intervention is unwise.

Another example of a per se inefficient activity may be the first amendment ban on an establishment of religion, which would seem to negate even government subsidies to religion that offset market failure and would thus presumably be efficient. But reading the clause as a requirement of government neutrality in religion, one can readily find a justification in economics, broadly conceived. The Framers could easily have thought that the costs of any government nonneutrality, in social and political divisiveness, would generally outweigh benefits.

If the Constitution does prefer a set of social "goods," such as minimal government and government neutrality toward religion and speech, there remains the problem of defining the degree of preference. Few good things come without costs, and one would naturally expect courts to be wary of constitutional interpretations that extend constitutional goods to a point of extravagant cost. The Constitution is not a "suicide pact," as Justice robert h. jackson cautioned in terminiello v. chicago (1949). Similarly, if "cost-benefit" sounds like an economist's approach, "balancing" the costs of alternative rules is surely no more than recognition that at some point one set of rights must yield to another. Justice oliver wendell holmes, jr. , wrote in Hudson County Water Co. v. McCarter (1908), "All rights tend to declare themselves absolute to their logical extreme. Yet all in fact are limited by the neighborhood of principles of policy which are other than those on which the particular right is founded, and which become strong enough to hold their own when a certain point is reached."

Still, the economist's concern for cost may be special. The subject of economics is the problem of maximizing something (e.g., utility, wealth), subject to the constraint of scarcity. Whether the relevant scarcity is of conventional commodities or of constitutional goods, such as opportunities to communicate, the economist should have something useful to say. Indeed, an important insight of economics is that costs are simply benefits (goods) given up in pursuit of other goods. An economist should be quicker than most to spot opportunity costs and to dispel the fallacy that costs could ever be purely pecuniary. The costs of a policy, including a constitutional rule, are the goods, services, and benefits that it destroys or sacrifices. To the extent economic analysis of law flourishes, one may expect to find cost arguments more common, explicit, and sophisticated. Thus, although in cleveland board of education v. lafleur (1974) the Court declared that "administrative convenience alone is insufficient to make valid what is otherwise a violation of due process of law," mathews v. eldridge (1976) made such costs integral to its analysis of procedural due process.

What, then, is distinctive about the economic approach? Neither the interest in costs nor the balancing of the costs of various approaches seems unique to analysts of economic bent, even if economists typically press them furthest. There are, however, analytic tools employed by economists as a matter of course, but by others rarely, if at all.

One specialty of economics is the search for the true incidence of the costs of taxes, subsidies, and regulations. Inelastic suppliers and demanders bear these costs. A supply is inelastic if suppliers have few alternative uses of the relevant resources. A tax on coal production is likely to fall largely on the owners of coal in place, as there are few activities to which they can divert their coal-mining property. This is still more true if users of coal have many alternatives—that is, if demand is quite elastic. This is clearest where the coal tax of a single state is at issue, and demanders' substitutes include the supply of all coal producers outside the taxing state.

Use of the analysis is obvious for issues of the constitutionality of state taxes or regulations that are challenged as offending the dormant commerce clause, that is, the courts' implied authority to strike down state rules that unduly intrude on interstate commerce, even where Congress has been silent. Indeed, in assessing a coal severance tax against a commerce clause attack, the Court alluded in Commonwealth Edison Co. v. Montana (1981) to the elasticity of demand as an important consideration, but declined to pursue the matter. The decision not to pursue it appears correct, for the "export" of the tax seems unlikely unless the taxing state has market power in the good. This will not be true unless the state accounts for a high proportion of supply or colludes with other supplying states. In either case, the state is likely to be so drastically outnumbered by importing states as to make a congressional remedy easy.

The search for incidence is useful in other, less obvious areas. The Supreme Court's public forum jurisprudence, for example, rests on the notion that for a special class of speakers the burden of restrictions on the communicative use of public property is relatively severe because of their lack of alternative means of reaching an audience. Thus, Justice hugo l. black argued in Martin v. City of Struthers (1943) that "door to door distribution of circulars is essential to the poorly financed causes of little people." The question raised is a good one, but the asserted answer may be an oversimplification. Though doubtless the poor buy a lower per capita share of the food supply than the nonpoor, the nonpoor obviously do not "buy up" all the food. Similarly, it is far from clear that messages relating to causes involving the poor are underrepresented in market channels of communication. (To the extent that the poor are a demoralized underclass, they likely would not initiate many communications of any kind, including circulars and street demonstrations.)

The economist's training generally leads to a search for effects on ultimate consumers and providers. Where would-be speakers challenge a private property owner's speech restrictions, as at the shopping center in Lloyd Corp. v. Tanner (1972), or where a shopping center owner challenges a state's limits on his ability to restrain speech, as in pruneyard shopping center v. robins (1980), the Court has framed the dispute as one between the property rights of the owner and the free speech rights of speakers. But to the economist a more relevant formulation is the conflict between one set of property users' interest in communication and another set's interest in being free from the communications. A profit-seeking owner of a shopping center is a middleman, presumably seeking an economically optimal tradeoff: to allow speech up to the point where the benefit (captured by him in rents) exceeds the costs (suffered by him as diminished rentals as result of user resistance). The point suggests yet another perspective on the idea that the cost of communication on sidewalks, streets, or other government property is low. The speaker's out-of-pocket cost is low, to be sure, but in part because some of the burden is borne by those whose convenience or tranquillity is reduced. Of course, if government officials cannot charge fees to capture some of the benefits of free communication, yet do bear some of its costs (in the form of less personal tranquillity themselves), the public forum doctrine may be a justifiable subsidy to offset their skewed incentives in other branches.

If there is an economic logic implicit in constitutional law, is the reason that the Framers and the courts hace used the tools of ecconomic analysis intuitively rather than explicitly or that some process (e.g., the selectionof cases for litigation as a opposed to settlement) tends to screen out ecconomically unsound precedents? To the extent that the first explaination is sound, there may appear some tension between the positive economic theory—with incentives, with maximizing values subject to constraints, with tradeoffs at the margin, with identifying the true nature and incidence of costs—seem basic to any coherent approach to social nomic analysis thus seems inextricably linked to constitutional interpretation, with perhaps no more at stake than degrees of sophistication.

Stephen F. Williams

(see also: Economic Analysis and the Constitution; Economic Equal Protection; Economic Liberties and the Constitution.)


Coase, R.H. 1977 Advertising and Free Speech. Journal of Legal Studies 6:1–34.

Conference 1975 Economic Analysis of Political Behavior. Journal of Law and Economics 18:587–918.

Easterbrook, Frank H. 1984 Foreword: The Court and the Economic System. Harvard Law Review 98:1–60.

Epstein, Richard A. 1985 Takings. Cambridge, Mass.: Harvard University Press.

Mc Connell, Michael W. and Posner, Richard A. 1989 An Economic Approach to Issues of Religious Freedom. University of Chicago Law Review 56:1–60.

Posner, Richard A. 1986 Economic Analysis of Law, 3rd ed. Boston: Little, Brown.

Sowell, Thomas 1980 Knowledge and Decisions. New York: Basic Books.

Symposium 1987 The Constitution as an Economic Document. George Washington Law Review 56:1–186.

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Law and Economics Theory