Category: Economic Analysis of Law

Net Neutrality: Law, Money, and Culture

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Bill Moyers enters the fray in the raging legal debate over net neutrality tonight, with a documentary on PBS. The Wu/Yoo debate on the topic gets the central issues on the table: should we permit dominant ISP’s (like Verizon and Comcast) to discriminate among the “bits” on their networks, giving more rapid service to preferred sites? I’ve offered some tentative thoughts on the matter, and these continue in that vein.

The net neutrality battle may offer us a classic efficiency-equity tradeoff. Imagine a world where everything on the internet came to you four times faster, but dominant ISP’s could cut deals with certain sites that made their content come 10 times faster. On many classic economic accounts, that would be Pareto-optimal–everyone’s better off. As some very smart people (like Philip Weiser) have claimed, that differential pricing could finally lead to revenue levels that would remedy the US’s unacceptably slow pace of getting people connected to broadband (and faster) networks.

But on the other hand, what about the competitive disadvantage of those unable to cut the deals? Compare this article reprinted in the Boston Pilot (the Boston Roman Catholic Archdiocese’s official paper) touting net neutrality and this piece from Brookings-AEI disparaging it as a form of “price control.” The economists just tend to miss the cultural importance of media consolidation. That’s what convinced me that the stakes are ultimately a “battle for mindshare” (to use Hannibal Travis’s evocative metaphor), and can’t be cast in simple economic terms.

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Extraterritorial effects of non-enforcement of the antitrust laws

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The League Championship Series are starting, whether the Mets have any starting pitchers or not. But today’s baseball news concerned the importation of a quality starter from Japan, Daisuke Matsuzaka. Matsuzaka was the MVP of the inaugural World Baseball Classic this year, a kind of World Cup for baseball.

What does this have to do with law? Matsuzaka, unlike say, Hideki “Godzilla” Matsui, does not have 10 years in Japanese baseball, and so he is subject to an agreement between Japanese baseball and American Major League Baseball (MLB), in which MLB teams will submit silent bids for his services to MLB’s league office, and then the highest bidder will get exclusive rights to negotiation with Matsuzaka. The amount of the winning team’s bid will go to Matsuzaka’s former team (the Seibu Lions) as a transfer fee. And then, since he will be unable to take bids from any other team, Matsuzaka will probably take less from his new American employers than a free agent would.

It seems to me that Matsuzaka might well be better off if, free from this system, he could negotiate a higher salary as a free agent by receiving bids from several American teams, and then just buy himself out of his contract with Seibu — an efficient breach. Indeed, the fact that MLB and the Japanese leagues agreed on this system after the high-profile move of Hideo Nomo seems to imply that it takes $/¥ out of Matsuzaka’s pocket, and puts it in theirs. But this appears to be a case where baseball’s antitrust exemption in the U.S. has been extended outside our borders by contract with the Japanese leagues. While no one cries for baseball millionaires, it may be worth noting that while other countries sometimes take offense at U.S. antitrust law sprawling into their economies, tolerance of anticompetitive practices can also have extraterritorial effect.

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Outsourcing and Agency Costs

The Times reports that the exploding outsourcing industry in India has run into two sorts of problems: (1) domestic political instability resulting from a federal system; and (2) duty of care problems resulting in data breaches. The two articles, fronted together, remind me that I’ve not yet had a chance to plug George Geis’ provocative article on Business Outsourcing and the Agency Cost Problem. From his abstract:

Why has business outsourcing increased so rapidly over the past decade? The question is important for corporate law scholars because it raises foundational issues underlying the theory of the firm. Indeed, the decision to pool resources under centralized control presents a fundamental tension between the benefits of scale and the dangers of unchecked managerial discretion. The location of a firm’s borders – and thus the extent of outsourcing – can be viewed as an equilibrium of these competing effects.

The conventional explanation for the rise in business outsourcing is that falling interaction costs have changed this balance by opening new markets where firms can source economic inputs for less. This Article offers a second account, however, for the outsourcing phenomenon – one that is rooted in agency theory. Like many other economic relationships, outsourcing projects generate agency risk because a vendor makes decisions that affect the wealth of the outsourcing firm.

This Article argues that business outsourcing has thrived in recent years not only because globalization has unlocked inexpensive production markets, but also because it is becoming easier for firms to monitor and prevent the agency costs of outsourcing. Drawing upon a detailed analysis of outsourcing contracts, it explores several strategies to minimize agency costs – shedding new light on the structure and terms of a typical outsourcing project. It then contends that the same forces that are opening new markets are also making it economical for firms to mitigate outsourcing agency risk. Taken together, this work adds another important, but previously neglected, context for understanding the essential tradeoffs that arise when economic ownership is divorced from control.

It is a terrific paper, I think, which might lead some folks to new applications of AC theory. One question I have concerns the role of consultants as norm entrepreneurs, and as developers of strategies to monitor outsourced agents. (If, indeed, outsourced firms ought to be thought of as agents). It is also interesting to think about agency costs and remedies in transnational contracts. If, as the Times reports, Bangalore will shut down today, which jurisdiction’s contract law on force majuere will shadow the resulting dispute?

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Substance, Institutions, and the Real Value of Commercial Law Scholarship

Slums.jpgAs anyone who spends any time reading scholarship on contract law or commercial law can tell you, efficiency is a big deal. There are a lot of very smart people who spend a lot of their time worrying about whether this or that remedies rule is efficient or whether giving secured lenders complete priority in collateral is inefficient. I wonder, however, whether any of this stuff matters. What I am talking about is not the normal grumpiness that law and economics invokes in some — objections to the rational actor model, furious citations to Dworkin on the evils of efficiency as a normative criteria, or ritual invocations of various behavioral arguments — but rather the basic question of how much the content of the law matters. Imagine for a moment that you think that the primary goal of contract and commercial law ought to be the generation of wealth. Does the content of that law matter all that much?

In the context of American law this may seems like an odd question. After all, if we aren’t arguing about the content of the law, then what exactly would we be arguing about? The problem, it seems to me, is that the very success of American private law makes many of our discussions about it rather surreal. One can, of course, have lots of arguments about the extent to which the American markets that rely on American private law are efficient, or whether they would be made more efficient if we were to tweak this or that section of the Uniform Commercial Code. Yet, on the whole, it is difficult to deny that in the aggregate American markets are tremendously successful at creating wealth, indeed more wealth than has ever been seen by any society on the face of the planet ever in the history of the world. No small accomplishment that. On the other hand, there are places in the world where private law doesn’t seem to work particularly well, where whole societies are extremely poor, and the markets aren’t producing much in the way of wealth. My question, however, is the extent to which economic failure in such societies is a function of their substantive law or of their legal institutions.

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The Law and Economics of Smoking Bans

smoking.jpgThe big news out of Philly recently is Mayor Street’s decision to begin enforcing the City’s smoking ban. But, as commentators have observed, the City isn’t putting real resources into enforcement: only two officers will be assigned to the smoking beat, and will not work after business hours. That’s City time, not Bar time. Given the miniscule probability of being caught, the $25 fine seems ludicrously low.

Nevertheless, the City is confident that the ban will have bite. Although anecdotes from Kentucky suggest otherwise, the City argues that:

“The majority of the people will comply,” [interim Health Commissioner Carmen Paris] said. “The majority of the people will put that cigarette away. Those that don’t, then the establishment owner is required to call us and file the complaint.”

Self-policing by bar owners and smokers themselves should be effective, said Joe Minott, the executive director of the Clean Air Council.

“People do it because it’s required by law,” he said. “I suspect that after a settling-in period there’s not going to be a lot of problems.”

The law and economics of the enforcement of regulatory offenses interests me. Traditional analysis would suggest that self-enforcement is unlikely (or discounts the role of social pressure). But I suspect that Philly is onto something. Because of the long, public, debate about the utility of smoking bans, most citizens know about the issue, and probably feel invested in the compromise that finally emerged from the City Council. Unlike, say, a normal low-enforcement regulation (e.g., an EPA rule, or the rule against home poker games), the smoking ban will be pushed along by significant social norms of compliance. Dirty looks, over-loud coughs, muttered comments, and (ultimately) illegal self-help will clear the air.

Theorists of deterrence might consider whether the success of low-enforcement/high-compliance rules provides a model to rescue low compliance rules where social-enforcement is possible (like anti-drug and anti-graffiti criminal codes, and plagarism in school). Maybe we need to sunset the existing criminal code every ten years, and force legislators to re-authorize the law through public debate. That debate, in turn, will increase public buy-in and lower deterrence costs. This analysis (not incidentally) explains the need to publish federal regulations, but also suggests that mere publication isn’t enough: real, political, debate is necessary to ensure that social sanctions help legal rules penetrate and affect their intended audiences.

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Politicians Try to Make Lemonade

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The traditional economic analysis of law analyzes the market for lemons by assuming that folks will try to signal honesty through warranties or other contractual mechanisms, but may fail. A political case in point:

A number of Nigerian politicians have been conned out of thousands of dollars by people selling papers purporting to certify them as “corruption-free”.

The scam follows a warning by Nigeria’s anti-graft agency EFCC that anyone guilty of corruption would be banned from contesting next year’s elections.

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Law School Admissions Standards As Law

Harvard’s decision to end its early admission program was the big story early week. As President Bok explained, the university worried about the social consequences of its admissions process:

“Students from more sophisticated backgrounds and affluent high schools often apply early to increase their chances of admission, while minority students and students from rural areas, other countries, and high schools with fewer resources miss out . . . . Others who apply early and gain admission to the college of their choice have less reason to work hard at their studies during their final year of high school.”

Harvard’s decision got me to thinking about the relationship between admissions standards at high-prestige universities and legal rules.

Both legal rules and admissions standards are conduct shaping regulations. When you set admissions standards to select for trait behavior X, the prevalence of X in the applicant universe will increase. Such an increase will not be uniform, for the reasons that Bok gives, and there will be further distortions depending on individual (or mass) psychology. But there are reasons to believe that law school admissions address a particularly sophisticated and resource-rich audience, who are well suited to governance. Thus, law school admissions are ripe for evaluation as a form of law itself.

I thought about this after talking with a friend last night who told me about business schools’ strong emphasis on community service as a part of the application of a well-rounded applicant. This probably creates a class of business school students who are more likely to be civic-minded after graduation. But it also (and more simply) results in a great deal of public service by pre-MBA types in the world. The question is: why don’t law schools use the application process to improve the world too?

You might object: “this is paternalistic social engineering.” Yes, yes it is. But law schools, like HLS, already require onerous mandatory pro bono commitments during school. The problem with such programs is that the incentives are all wrong – toward clock management instead of results. But if you made pro bono service an important part of the admissions decision, and suggested that particularly effective public service would be highly weighted, then you’d set folks incentives well to achieve good. Elite schools might collude to create a list of potential law-related public work that candidates would be “well-advised” to perform in order to increase their chances of admission: volunteering for a public interest firm or tax law clinic; working for the PD or DA as a part-time investigator; assisting social security ALJs as a paralegal, etc.

To be clear, I don’t mean to say that admissions committees aren’t already considering public service. Surely, they are. But they aren’t communicating the idea that public service counts in a meaningful way. Check out HLS’ admissions FAQ, and note the silence on this point. The silence is shared by other top schools. The point is that law faculties (at least those I’ve seen) have traditionally seen the admissions committee as wearing a judicial, rather than legislative, hat. As a result, faculty might tend to think of admissions as a necessary chore accomplished by the folks who run the operations side of the school, instead of an extension of the pedagogical mission. [Update: Even the affirmative action debate, which is a policy choice effectuated through admissions, isn’t intended to shape the conduct of pre-law students.] Perhaps its time to rethink that model.

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Post-Nuclear Holocaust Movies and the Academic Job Market

thunderdom.jpgGordon Smith has a post about interview questions for prospective law professors. Having recently run the gauntlet of the meat market, this is a topic where memories are still fresh in my mind. I remember one question in particular. It was during an on-campus call back interview. I gave my job talk — a piece on the relationship between autonomy theories of contract and corporations — and then waited for the faculty questioning. By this time I had given the paper about a half dozen times, and I thought that I pretty well knew what points were going to get raised. Not so. A faculty member raised his hand and asked the following question: “Can you please explain to me how autonomy theories of contract would deal with the remedy provided for breach in Mad Max Beyond Thunderdome where the rule is ‘break a deal, face the wheel’?”

Mad Max Beyond Thunderdome, of course, is the classic Mel Gibson-Tina Turner movie about life in Australia after a nuclear holocaust has destroyed civilization as we know it. Those who breach their contracts in the post-apoclyptic world must spin a wheel — rather like the Wheel of Fortune — on which are written various punishments. Whatever punishment the wheel lands on is meted out to the breaching party.

I replied by pointing out that a commitment to an autonomy theory of contract requires a rather more expensive enforcement mechanism, because it is necessary for adjudicators to invest resources in discerning the actual intent of the parties in so far as they are able, rather than relying on cheaper, more formalistic modes of interpretation. Presumably in the post-apoclyptic world, the resources that society has available for the resolution of contractual disputes are reduced, and therefore they adopt remedies rules that require less fact finding. Spinning the wheel, for example, doesn’t require that the court invest any additional resources in calculating the value of the disappointed promisee’s expectation measure. In a world, however, that has not been devastated by nuclear war, society has the resources to devote to a more nuanced approach to contractual disputes, although if we take efficiency as the sole goal of contract law, then a process of largely randomized remedies like the wheel may be superior.

I thought it was a pretty good answer. On the other hand, I didn’t get an offer from that school…

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If It Can’t Be Sold, It’s Worthless

tiger.jpgThom Lambert offers this post on a “property rights” theory of endangered species protection (in essence, creating a market to increase supply). The arguments (also found in this Times’ opinion piece) are standard neo-classical economics. Trading, not regulation, increases supply of “goods,” therefore permitting endangered species to be “farmed” by hunters and others will ultimately “manage” them toward a sustainable population. “Some objections might be raised to this scheme,” to quote Daniel Farber’s An Economic Analysis of Abortion, “but rigorous analysis shows them to be unfounded.”*

Even though the arguments are hoary, I still feel torn about this issue.

On the one hand, as Lambert observes, some empirical evidence suggests that prohibitions don’t work well to preserve populations against development pressure. On the other hand, (1) the approach is useless for species that are commercially worthless (the owl, for example); and therefore (2) it has all of the problems of ordinary market valuations, and produces irreversible results (extinction) among the losers. (For a really good discussion of this problem, I recommend Matthew Scully’s Dominion: The Power of Man, the Suffering of Animals, and the Call to Mercy. The chapter on hunting, economics, and commodification is amazing.)

*The fun goes on in Farber’s footnote: “One commentator has said that this approach ‘seems almost pathological in its disregard of the moral values on both sides.’ . . . That commentator’s work evidences all too clearly a lack of rigorous economic training.” 3 Const. Comment. 2 (1986)

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Judge Posner and Limits of Smartness

brain.jpgRichard Posner, while explaining why he dislikes affirmative action, argues:

As discrimination declines, replaced by affirmative action, explanations for lagging achievement that are based on discrimination lose their plausibility. They were never entirely plausible, given Jewish achievement in the face of fierce discrimination, though it is argued by Stephen Pinker in a recent issue of the New Republic that discrimination against Jews in the Middle Ages, by forcing them into middleman occupations where intelligence is a more valued asset than in farming or soldiering, resulted in the more intelligent Jews having a higher birth rate (because they were better off) than the less intelligent Jews and so, through the operation of natural selection, discrimination can be “credited” with some of the responsibility for the high average IQ of Jews today–even its genetic component. (Hitler may have had something to do with this as well, as it is plausible that the most intelligent European Jews saw the handwriting on the wall earliest and left Europe in the 1930s before it was too late.)

Although I admire Judge Posner and have learned a great deal from his writing, I think it is fair to say that I disagree with much of this analysis. It isn’t just that the evolutionary science of intelligence is extremely complicated, which should lead us to doubt claims about the effect of time-limited selection pressures on economic outcomes. Nor is it just that Posner has violated Godwin’s Law.

The problem is rather that smart people are often anti-social geeks, who don’t make better life choices under conditions of uncertainty. It is true that there is evidence that intelligence and ability to perform statistical calculations under controlled conditions are related. But I haven’t seen any good real-world evidence that smarter folks are better able to discount those emotions/biases (such as patriotism, risk aversion, optimism) that would have led Jews in Europe to stay put. Indeed, the conventional wisdom is that smarter people have weaker “street-smarts”, which is another way of saying they are likely to be bad at reading others for social cues. So even if intelligence were hereditable in the way Posner evidently postulates, it seems unlikely to me that the smarter portion of European Jewry escaped the Holocaust.