Modes of mixing law and economics

Larry Ribstein —  12 April 2011

Geoff Miller has a new must-read paper on the relationship between law and economics:  Law and Economics versus Economic Analysis of Law.  Here’s the abstract:

This paper distinguishes law and economics – conceived as an equal partnership between two disciplines – and economic analysis of law, conceived as the application of economic reasoning to legal rules and institutions. I explore the difference by contrasting Robert Aumann’s economic analysis of a text from the Talmud with an analysis of the same text conducted from within the framework of law and economics. The paper demonstrates that law and economics and economic analysis of law offer complementary means for obtaining information about the social world.

Here’s Miller’s brief overview of the distinction between the two concepts:

The economic analysis of law is the use of economic principles and reasoning to understand legal materials. It is a branch of economics. Law comes into the picture as an object of study. Just as macroeconomics looks at matters such as employment, growth and productivity, economic analysis of law looks at legal rules and institutions and seeks to analyze them from an economic point of view. Law and economics, on the other hand, is a genuine partnership of two disciplines, each with something to contribute. Economics adds the insights of economic science; law adds the understanding of complex institutions, politics, and social policies.

Miller’s analysis is based on a problem analyzed by Robert Aumann in Risk Aversion in the Talmud, 21 Economic Theory 21, 233–239 (2003).  Here’s Miller’s description of the problem:

Prior to their marriage a husband‐to‐be signs a marriage contract promising to pay his wife‐to‐be 500 zuz in the event of divorce. Later, the wife sues her husband, claiming that he has obtained a divorce but refuses to pay the money called for in the contract. As required under the applicable law of evidence, she introduces two witnesses, W1 and W2, who testify that the divorce occurred. Based on this testimony the judge orders the husband to pay 500 zuz to the wife. The husband pays up.

In the next stage, the husband sues W1 and W2, claiming that they perjured themselves when they testified that the couple had divorced. The judge agrees with the husband, finding that the witnesses had perjured themselves. The judge now has to determine the amount of damages.

* * *

[T]he perjurers must pay the husband an amount equal to the harm that was imposed by their perjury. But how is this standard to be implemented? * * *The measure of damages they adopted was, in effect, the amount the husband paid as a result of the perjured testimony discounted by the probability that the couple would have divorced in any event. * * *

But this raises an additional issue Aumann analyzed:  The damages should also reflect risk aversion.  The presumably risk averse husband avoided the risk of divorce when the witnesses made it happen, while the presumably equally risk averse wife gained that much more as a result of realizing her previously contingent asset.  Two rabbis differed as to whether the court should adopt the wife’s or the husband’ perspective.

So far, according to Professor Miller, we are in the land of the economics of law — that is, using a legal question as an opportunity for applying economic principles, in this case risk discounting and risk aversion. But law and economics accomplishes the further task of combining economics with social policy to resolve the legal issue. 

Miller notes that the witnesses’ testimony was part of a legal fiction.  Everybody in the small community must have known no divorce occurred, and the wife and husband each could buy equally perjured witnesses to achieve his or her desired result. Yet the rabbis accepted the fact of the divorce because they must have thought this was a just result.  They then could do more precise justice between the husband and wife by adjusting the damages, reasonably assuming that the wife or her family will indemnify the witnesses for their damages.

Miller surveys three potential results. First, the wife may be opportunistically creating a split because she would be happier with somebody else, then seeking damages under her agreement.  Discounting the damages for probability at least deprives the wife of any reward for this misbehavior. ‘

Second, the marriage may have broken down but the husband is misbehaving to get the wife to waive her rights.  The court can adjust the probability of divorce to 100% and increase the wife’s damages. 

Third, the marriage may be unhappy but the parties are simply deadlocked.  Now the probability of divorce is 50%.  The rabbis get to split the baby in half, so to speak, and give the wife some relief but no excessive reward.

Miller says:

In each of these cases, the court can use the measure of damages as a means for advancing important social policies: giving wives relief from loveless marriages, reducing disparities in power, protecting the family against instability, and policing against opportunism by either party. Accordingly, law and economics provides a supplemental explanation for the Talmudic measure of damages – one not inconsistent with the economic interpretation advanced by Professor Aumann, but arguably more informative (if also less precise) because it is based on the institutional details that a lawyer can bring to the table.

And now back to the distinction between economic analysis of law and law and economics.  Miller concludes:

Each approach has advantages and disadvantages. Economic analysis of law brings to the table the well‐understood methodology and a precision of analysis that is emblematic of economics as a whole. On the other hand economic analysis of law also carries with it the limits of its method, which include the fact that, to achieve analytical precision, the approach must abstract away from many features that make a difference in the real world.

Law and economics is inherently more complex and less analytically rigorous than economic analysis of law. These might be considered weaknesses. On the other hand, law and economics, because it does not abstract from the real world, also offers a potentially richer menu of explanations for the phenomena under investigation. At its worst, law and economics can be muddied, as when we mix many colors into an ugly brown. But at its best, law and economics can be a rainbow that adds vibrancy and depth to an analysis drawn from the purely economic approach.

We see these debates being played out in many different contexts in legal academia, from academic conferences to hiring to curriculum.  And they are being replicated with other disciplines such as philosophy and psychology.  Legal academia needs more of the sort of self-conscious analysis displayed in Miller’s article to decide how to achieve the best mix of law and other disciplines.

Larry Ribstein


Professor of Law, University of Illinois College of Law