ALIGARH MUSLIM UNIVERSITY

FACULTY OF LAW
TOPIC:-

“LAW & ECONOMICS”

SESSION: - 2019-20
SUBMITTED BY:- SUBMITTED
TO:-
1. FARAZ KHAN MUHAMMAD NASIR

19BALLB73

GK1016

2. SADAF WARSI
19BALLB72
GJ3068
GROUP IV(I SEM.)
 CONTENTS

1. INTRODUCTION
2. ECONOMIC ANALYSIS OF LAW
3. GOALS OF LAW AND ECONOMICS
4. EMERGENCE OF LAW AND ECONOMICS AS A DESCIPLINE
5. CONCLUSION
 INTRODUCTION

A century and a half ago John Stuart Mill said of English philosopher and political
radical Jeremy Bentham, in effect, that he approached the world as a stranger. And, if the world
did not fit his theory, utilitarianism, he dismissed what the world did as nonsense. Mill then said
that what Bentham did not realize was that often that nonsense reflected the unanalyzed
experience of the human race. Sometimes, Mill implied, the theory was right. But sometimes it is
the world that is more sophisticated than the theory.

Law and Economics, today, reflects a similar division. There are many Benthamites—Economic
Analysts of Law—around. These scholars look at the legal world from the standpoint of existing
economic theory. And if the world does not do what that theory seems to suggest it ought to do,
they dismiss the world as irrational. But there are followers of Mill among Law and Economics
scholars as well. These also start out by looking at the world from the standpoint of economic
theory. If the theory and practice don’t mesh, however, they don’t simply dismiss the world.
They instead examine whether it might be the theory that is inadequate. And, having done so,
they try to make the theory more nuanced, while still theoretically sound. They then see if the
amplified theory can explain why the legal world is what it is. And, if it proves out, they go on to
use this more complex theory in analyzing areas of law often far removed from that which first
led them to modify the theory.

The Benthamites have been immensely effective in the last fifty or so years in bringing about
changes in many areas of law. But sometimes these reforms have not been beneficial, because
they have been grounded in the assumption that the theory was necessarily correct and the world
was inadequate, when the opposite was in fact the case. Making law the handmaiden of
economic theory in this way, rather than using the analytical strengths of economics in
conjunction with the empirical data about human wants and needs that the law furnishes,
impoverishes both fields. It can also lead to bad policy results.

One can see this by looking at any number of real world arrangements that are not adequately
explained by economic theory. Among these is the widespread existence of altruistic behavior—
by individuals, in firms, and in government. Economic theory has long failed to explain
adequately why there is so much beneficence around and why so many non-profit institutions
exist. Self-interest, it is said, would be more effective in getting things done. Why then does so
much altruism perdure? There is a good, simple, and important theoretical answer to this!
Similarly, lawyer-economists often criticize our unwillingness to let certain goods, like
education, health care, body parts (kidneys and blood) be allocated in the market. Why don’t we
just let such so-called merit goods be the subject of individual purchases and sales? Prohibiting
such transactions is often decried as unjustifiably paternalistic. But is it? I think not. If relatively
few changes were made in economic theory changes that are quite consistent with the field—
such real world behavior, like altruism and the treatment of merit goods, can be easily explained
and justified. Moreover, that deeper and more nuanced economic theory can then be used to
structure that behavior better and make the rules that accompany it more effective. Not only that,
but that better theory will prove helpful in many, many other areas as well.
The future of Law and Economics lies in this sort of mutual relationship. It lies not in making
law subservient to economics, but in using the analytical strength of economic theory in
conjunction with the empirical insights into people s wishes that the legal system gives. So
combined, both theory and practice will become better able to serve our wants and needs.
 Economic Analysis of Law

Law rests on the principle of justice, equity and good conscience. The black letter of law
is concerned with the goals of equity that is justice is delivered. In a pure legal
discussion, economic costs are often not taken into consideration. The introduction of the
tools of economics is in a sense an attempt to redefine this approach, as it introduces the
principles of efficiency into deliberation.

The ‘statute of law’ oblivious to the identity of the parties involved, delivering equitable
justice, symbolically speaking, signifies the holy trinity of justice, equity and good
conscience. For a Common Law country like ours, they are holier then thou words. But
this egalitarian & impartial symbol of justice sometimes needs to have the ‘eyes of
economics’, while delivering justice with the unprejudiced hands of law. The objective
is thereby to evaluate the equitable law against the quantifiable parameter of
efficiency. This in essence, is Law & Economics.1

Economic Analysis of Law can thus be defined as an analysis of law from efficiency perspective
to analyze if the law has been effective in delivering its goals. Economics analysis of Law or
Law & Economics, are often used interchangeably and refer to the same discipline of application
of principles of microeconomics to the discipline of law. The terms will thus, be used inter-
changeably in the book. It is an inter-disciplinary approach to the study of law. One of the
important contributions of the economic principles, as we will observe in the course of book, is
the introduction of efficiency debate in the legal analysis.

Neoclassical Economics focuses on individual choices. It focuses on subjective preferences and

beliefs and allocation of a given set of constrained resources amongst alternative uses. Arguing
for the rationality of man, the neoclassical tradition focuses on utility maximization and
production efficiency as the aims of economic policy

GOALS OF LAW & ECONOMICS

1
Transaction Costs are the costs employed in an economic exchange. In the Law & Economics literature it relates to all the costs
incidental to the allocation of rights, such as cost of negotiation, bargaining, litigation, search & information costs & policing and
enforcement costs. See R.H. Coase, The Nature of the Firm, Volume 4, Issue 16, pp 386-405, November 1937
A society is said to be efficient, if given the level of its resources, they are completely
employed and the members of the society have reached the highest possible level of
utility. Take the case of Sifire group economies. Singapore, a small island with almost
no natural resources, is a developed economy and a legal and financial hub of Asia. It has
effectively utilized its constrained resources and emerged as one of the developed
Nations. Likewise Finland and Ireland, the other two resource-poor economies of the
European Union, created a sustainable growth rate for decades. Notwithstanding their
constrained resources and small size, the Sifire (Singapore, Finland and Ireland)
economies today are amongst the most developed and enjoy high standards of living.
What can possibly explain this. Through policy-making and effective implementation,
these economies have attained efficiency in employing their constrained resources. The
Sifire economies managed to effectively build an ecosystem of inclusive development by
strategically creating institutions that trained and attracted highly qualified human
capital and created a research infrastructure to foster innovation. 1 Contrast this with the
dark continent of Africa or emerging economies like the BRICS(Brazil, Russia, India,
China and South Africa). Richly endowed with mineral and natural resources, Africa
continues to struggle with inefficiency, poverty and malnutrition. Likewise BRICS,
though fast emerging, yet are far from efficient. As Policy makers, one has to think that
could there be a legal system that leads the society to efficiency. However, thinking of
efficiency alone is not sufficient, as there an inherent drawbacks a stand-alone efficiency
criterion. A highly efficient state, USA, for instance, is definitely not the most equitable
state. Increasingly, there have been concerns of rising inequalities in the developed
economy. Contrast this with Continental Europe, which with its focus on social market
economics and social solidarity, has attained a relatively egalitarian development. For
instance, US has a GINI index1 of 37, compared with EU- member state Denmark’s 24.3
GINI index.2
Thus, there are two dimensions to growth, efficiency and efficiency with equity.
Economic Analysis of Law, as tool for policy maker, helps evaluate the equality criterion
against the efficiency benchmark and thereby, creating a model for sustainable growth.
As a policy- maker, one may choose a straight-jacket application of neo-classical
principles of efficiency which means development first and building equity into the
system later(as in the US model) or efficiency with equity model(as in the context of
Continental Europe) wherein the two grow simultaneously. Which is the best possible
model, is a question of policy-making.
we observe, laws do not act in a vacuum. Theoretically speaking, even though a given
system may have many laws and some very good laws, but this doesn’t necessarily
translate into an efficient system. Thus, there must be a descriptive and normative
standard to evaluate if the laws & policies are implemented, if they have successfully met
their goals and are efficient. In other words, there should be an implementation
mechanism and a benchmark to evaluate their success. In the Indian context, take the
case of Bihar. Bihar was rated until recently as the most under-developed and corrupt
State in the country. Under the regime of Chief Minister Nitish Kumar, the State has in
the last five years, observed an average economic growth rate of 11% per annum, which
is second only to Gujarat’s, India’s industrial powerhouse; a conviction of 66,000
criminals, including sitting MPs and an infrastructure of 33,0000 km. Thus, it is the
implementation of policies and rule of law that have made a difference in the context of
said State. From an equity & efficiency perspective, the goals have been met successfully
as it has lead to an accelerated development in the State. It has also provided
employment opportunity to thousands of labour, previously unemployed who had to
travel to other States for employment. This has also enabled the State to attain its goal of
distributive justice. 2
Principles of distributive justice are normative principles that are designed to ensure that
the goods are allocated in the society in a socially just manner. An important
contemporary philosopher of the principle is John Rawls. While formulating policies, in
the efficiency versus equity debate, recourse is taken to the basic principles enunciated in
the Constitution whose goal is to promote social justice and the Directive Principles of
State Policy. Chapter IV of the Constitution of India deals with these Principles. Though
non-justiciable in the court of law, these principles are a guiding beacon of light for the
governance of our country. The objective of these principles is to ensure social &
economic justice and welfare of the citizens. If the law seeks to attain distributive justice,
the important question is how it attains its goals. Is the remedy in private law or public
laws.
The goals of distributive justice cannot be attained through private law as the latter
concerns itself with the rights between two parties. For instance consumer laws cannot be
an instrument to attain distributive justice as it will lead to the problem of imprecise
targeting. A customer of Bata shoes and one of Louis Vuitton bags are both customers
and governed by the same laws. Yet they are very different as they both belong to a very
different social class (generally). Secondly, implementation of these rights would also
involve high transaction costs1 such as resorting to litigation. And the results can finally
be very unpredictable. For instance, producers will incorporate this risk to pay high
damages into their product which can lead to an unprofitable production and will impact
the interest of shareholders. This will lead to more expensive products, detrimental to the
interests of consumers and shareholders alike. Thus, a law with the objective of
distributive justice may fail to meet its goal through the instrument of private law.

EMERGENCE OF LAW & ECONOMICS AS A DISCIPLINE

2
Thottam J, Breaking Free: How Nitish Kumar Turned Bihar into a Model of Indian Reform. Times of India, 7th
November 2011.
In the year 1937, Coase wrote the article, The Nature of the Firm , wherein he provided an
economic rationale for choice of partnerships, companies and other business entities rather then
trading through simple bilateral contracts. The article also introduced the concept of Transaction
Costs & attributed it as the raison d’être for existence of companies. This was followed by
another landmark article by Coase, The Problem of Social Cost, wherein he stated the
breakthrough principle that in the absence of Transaction Costs, the efficient outcome will
always prevail, irrespective of the initial allocation of rights. When Coase presented his thoughts
before his colleagues at the University of Virginia, twenty colleagues disagreed and only one
agreed with him. What followed was long discussions, a Noble prize in Economics and
eventually a foundation for what we today call Law & Economics.3

At around the same time, Guido Calabresi wrote his views on liability rules titled,
‘Some Thoughts on Risk Distribution and the Law of Torts’, wherein he argued that the
major objective of liability rules is to minimise the cost of accidents. Calabresi divided
accident costs into three categories: Primary costs that are determined by the number and
severity of accidents; Secondary costs that occur in the absence of optimal risk spreading
and tertiary costs that are incurred by the legal system to establish and enforce liability.
To ensure minimization of costs, Calabresi proposed, the focus must be on reducing the
primary and tertiary costs. These costs should, accodingly be allocated to the ‘cheapest
cost avoider’. Calabresi’s analysis not just led to the foundation of the discipline that we
now call Law & Economics; it also formed the seminal basis in Tort Law from issues as
diverse as accident claims to medical malpractice to environmental damages.

Another major work by Calabresi, co-authored with Douglas Melamed deserves mention,
‘Property Rules, Liability Rules and Inalienability: One view of the Cathedral’. The
paper is the most cited in the literature of Law & Economics.4 A discussion on the
evolution of Law and Economics, will be void without referring to Richard Posner. A
prolific writer with over 40 books to his credit, Senior Lecturer at the Chicago school &
judge on the US Court of Appeals for the Seventh Circuit in Chicago, Richard Posner, is
highly influential figure on the school of thought. He has also made an important
influence on what is often referred to as the Chicago School. Posner’s important works
include Economic Analysis of Law, The Economics of Justice, Sex and Reason,
Antitrust Law, The Economic Structure of Intellectual Property Law and Law,
Pragmatism and Democracy. Posner belongs to the neo-classical school. With his
resonate faith in homo-economicus, Posner believes that a neo-classical approach to law
is the best way to attain most efficient outcomes. He has been admired and equally

3
Posner R.A. , Economic Analysis of Law , Aspen Law and Business, 1998 at pp 30
4
Garoupa N & Ulen T.S. The Market for Legal Innovation: Law and Economics in Europe and The United States
criticized for his opinions. For instance his argument that free market forces should
determine the future of children, rather then present government regulated adoption is
highly criticized. Posner’s controversial thoughts apart, his works make an enduring
contribution and his work2 & judgment on Antitrust are particularly appreciated and
have been an important influence on the Antitrust policy in the US.5

Highly acclaimed works by Coase, Calabresi and Posner, together led to the
establishment of an economic approach to law as a well-recognized inter-disciplinary
field. As an academic discipline, however, Law & Economics gained recognition, when
Henry Maine developed the first-ever Law & Economics Center (now part of the George
Mason University School of Law). Maine is also credited with developing the first ever
law school curriculum developed along the application of economic principles to law.
Among his works, most notable is the 1966 book ‘Insider Trading and the Stock Market’.
In the book, Maine argues that insider trading does not harm investors and can infact be
an efficient manner to compensate insiders, when they enhance an issuer’s stock price.
He developed the ‘theory of market for corporate control’, which began the floodgate of
application of economic principles to corporate law.

Conclusion

The study of Law without the knowledge of other related social sciences i.e., Political theory,

5
Amartya stresses close link between law and economics’, Times of India, 21st December 2003.
http://articles.timesofindia.indiatimes.com/2003-12-21/kolkata/27177559_1_economics- nujs-kaushik-basu, last
accessed 11th May 2013.
Sociology and Economics, etc, is incomplete. In any law curriculum the study of Economics and
Law and their interaction is increasingly found necessary.

Law and economics, also known as the economic analysis of law, differs from other forms of
legal analysis in two main ways. First, the theoretical analysis focuses on efficiency. In simple
terms, a legal situation is said to be efficient if a right is given to the party who would be willing
to pay the most for it. There are two distinct theories of legal efficiency, and law and economics
scholars support arguments based on both. The positive theory of legal efficiency states that the
common law (judge-made law, the main body of law in England and its former colonies,
including the United States) is efficient, while the normative theory is that the law should be
efficient. It is important that the two theories remain separate. Most economists accept both Law
and economics stresses that markets are more efficient than courts. When possible, the legal
system, according to the positive theory, will force a transaction into the market. When this is
impossible, the legal system attempts to “mimic a market” and guess at what the parties would
have desired if markets had been feasible.