Functional Law and Economics

Approaches to Law and Economics

Proponents of the Chicago School argue that market forces cause the common law to develop efficient, or wealth maximizing, legal rules. As suggested by the Coase Theorem, only transaction costs will impede first best efficiency. Much of positive law and economics scholarship involves explaining how common law rules provide individuals with proper incentives such that society's wealth is maximized. To the extent that positive law and economics has prescriptive elements, they tend to involve reducing the transaction costs that stand in the way of this wealth maximization. While the positive arguments apply less well to statutory law, adherents of the Chicago School often argue that market forces in the political arena will also tend to generate wealth maximizing outcomes, subject to the transaction cost proviso. In the choice between having politicians or courts govern individual behavior, the positive school favors the institution facing the lowest transactions costs.

The second major school of law and economics thought to emerge was the Yale, or normative, School of law and economics. As distinct from the positive school, the normative school is much more skeptical of the natural development of common law, because of the presence of market failures that impede the achievement of efficiency. Furthermore, proponents of the normative school suggest that efficiency is only [Page 609]one of many normative goals that one can and should pursue through the law. Of particular importance for these individuals is the potential for legal institutions to bring about redistribution of resources. In this worldview, legal tools are to be micromanaged to achieve broader social goals.

Individuals subscribing to the functional school of law and economics are both less sanguine about the efficiency tendencies of the common law and the ability of legal and political elites to micromanage decisions to achieve nonefficiency goals. While functional law and economics scholars do recognize the potential for market failures to inhibit the common law from naturally achieving wealth maximization, they also draw from the field of public choice economics to highlight the dangers of giving political or judicial policy makers substantial discretion.

Constitutional Design and Metarules

Drawing on the field of constitutional political economy, the functional law and economics school focuses on incentive-compatible metarules to which rational individuals would consent at the constitutional stage of decision making while they are uncertain as to how those rules will directly affect their own self-interest. This constitutional perspective was first used in economics by James Buchanan and Gordon Tullock in 1962 and bears a good deal of resemblance to the “veil of ignorance” mechanism introduced by John Rawls in 1971. The ex ante perspective avoids the temptation to engage in microlevel social engineering because it depends on committing to rules that will be optimal in expectation, while recognizing that those rules will likely generate undesirable outcomes from time to time.

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