More than twenty years ago, Professor (now Judge) Richard Posner suggested that many features of the common law could be explained by the conjecture that it was a set of legal rules that maximized economic efficiency.[0] To what degree the conjecture is correct is still a matter of debate, but, true or false, it has played a major role in the development of the economic analysis of law.
One weakness in Posner's argument was and is the absence of a plausible mechanism to generate efficient Common Law.[1] What he and his supporters offer instead is extensive analysis of the common law as it actually exists, designed to show that its rules are close to the rules that would have been chosen by an economist attempting to maximize economic efficiency. Lacking a compelling theory, they offer empirical evidence--although a considerable addition of economic theory is required to argue that the rules observed to exist are the efficient ones.
My project in this chapter is the mirror image of Posner's. The legal system I will be describing does not exist, so I cannot observe its rules.[2] What I will be proposing is a theoretical analysis of why that legal system, if it existed, could be expected to generate efficient rules.[3]
Imagine a society with no government. Individuals purchase law enforcement from private firms. Each such firm faces possible conflicts with other firms. Private policemen working for the enforcement agency that I employ may track down the burglar who stole my property only to discover, when they try to arrest him, that he too employs an enforcement agency.
There are three ways in which such conflicts might be dealt with. The most obvious and least likely is direct violence-a mini-war between my agency, attempting to arrest the burglar, and his agency attempting to defend him from arrest. A somewhat more plausible scenario is negotiation. Since warfare is expensive, agencies might include in the contracts they offer their customers a provision under which they are not obliged to defend customers against legitimate punishment for their actual crimes. When a conflict occured, it would then be up to the two agencies to determine whether the accused customer of one would or would not be deemed guilty and turned over to the other.
A still more attractive and more likely solution is advance contracting between the agencies. Under this scenario, any two agencies that faced a significant probability of such clashes would agree on an arbitration agency to settle them-a private court. Implicit or explicit in their agreement would be the legal rules under which such disputes were to be settled.
Under these circumstances, both law enforcement and law are private goods produced on a private market. Law enforcement is produced by enforcement agencies and sold directly to their customers. Law is produced by arbitration agencies and sold to the enforcement agencies, who resell it to their customers as one characteristic of the bundle of services they provide.[4]
The resulting legal system might contain many different law codes. The rules governing a particular conflict will depend on the arbitration agency that the enforcement agencies employed by the parties to the conflict have agreed on. While there will be some market pressure for uniformity, it is logically possible for every pair of enforcement agencies to agree on a different arbitration agency with a different set of legal rules.[5]
Indeed, one could have more diversity than that. Suppose there is some small group within the population with specialized legal requirements. An example might be members of a religious sect that forbade the taking of oaths, in a society where conventional legal procedure required such oaths. Such a group might have its own enforcement agency and let that agency negotiate appropriate legal rules on its behalf. Alternatively, an agency might produce a specialized product for members of the group by negotiating agreements under which those customers, if involved in litigation, were not required to swear the usual oaths.
As this example suggests, the potential legal diversity of such a system is very large; in principle, a different set of legal rules might apply between every pair of persons. In practice, such diversity will be constrained by costs of negotiation and by costs of legal diversity. The transaction costs of separately negotiating a different law code between every pair of persons would be prohibitively high, so it is likely that each pair of enforcement agencies will agree on a single law code interpreted by a single arbitration agency, with provisions for occasional variances of the sort described above.
Legal diversity has substantial costs. If, for example, contract terms enforceable against customers of agency A may be unenforceable against customers of B, that makes it more difficult and expensive for firms to draw up satisfactory contracts. Such costs will provide an incentive for arbitration agencies to adopt more uniform law, to be balanced against the incentive for non-uniform law provided by the differing desires of different customers.
Suppose a set of law codes of the sort I have described exists, and that that there is some potential change in the legal rules prevailing between two enforcement agencies that would yield net benefits to their customers, and thus improve the efficiency of the legal system. If the change benefits both sets of customers, it is in the interest of the enforcement agencies either to persuade their arbitration agency to make the change or to shift to one that follows the superior set of rules. If it benefits the customers of one agency but imposes costs on the customers of the other, with net costs smaller then net benefits, it is in the interest of the two agencies to agree to the change, with the loser compensated either directly or by some other change elsewhere in the legal rules. In practice, since it is the arbitration agencies that specialize in legal rules, we would expect them to try to identify all such improvements and include them in the legal codes they offer to their customers.
This argument suggests that any change in the existing set of codes that would produce a net improvement will occur. The result should be a set of legal codes that are economically efficient in the conventional sense.[6]
That result must be qualified in several ways. To begin with, in a world of non-zero information and transaction costs, an enforcement agency does not perfectly internalize the welfare of its customers, since it cannot engage in perfect discriminatory pricing. Furthermore, negotitions between enforcement agencies are not costless, so some opportunities for mutual gain may go unexploited. For these reasons, what we would expect is not a perfectly efficient set of legal rules but a set of legal rules with tendencies towards efficiency. Where a legal change benefits almost everyone we would expect to see it, but where it generates both substantial benefits and substantial costs, we would expect the system to do an imperfect job of balancing costs and benefits, and thus to at least occasionally get the wrong answer. One additional reason why the result will fall short of complete efficiency will be discussed later in this chapter.
Readers familiar with the economic literature on efficiency may notice that my argument owes more to Coase than to Marshall. I have relied on the idea that parties will negotiate towards efficient contracts, rather than on the conventional analysis of a competitive industry. The reason for that choice is that this marketplace, despite the very large number of buyers and sellers, is not competive in the sense necessary for the standard economic proofs of efficiency.
To see why, let us eliminate from our analysis the intermediaries, the enforcement and arbitration agencies, and consider the market for legal agreement in terms of the individual producers and consumers of that good. Each individual wishes to buy the assent of every other individual to some legal code or codes, in order that future disputes between them, if they occur, may be peacefully resolved. Each individual is thus both a buyer and a seller of legal assent, buying from and selling to every other individual.
The reason that the large number of buyers and sellers does not produce a competitive market is that the goods they are selling are not substitutes. I desire legal agreement with both A and B; if I am equally likely to be involved in a dispute with either, I may have the same value for legal agreement with each. But getting A's agreement to apply some legal rule in disputes with him does not eliminate the value to me of B's agreement with regard to disputes with him, so the two are not substitutes. Unlike the case of an ordinary good, I cannot simply agree with A on a price and then buy all the agreement I want from him. It follows that despite the large number of participants, the interaction is essentially one of bilateral monopoly. Only A can sell me his assent to legal rules between me and him, and only I want to buy it.
Because of this, a conventional analysis of a uniform good sold at a single price by all sellers and to all buyers does not work for this market. One way of seeing this is to try to construct such an analysis:
Consider a particular legal change, a shift from strict liability to negligence for some class of cases. The shift benefits defendants at the expense of plaintiffs. If total benefits are larger than total costs, summed over all plaintiffs and defendants and including not only direct costs and benefits when litigation occurs but also all of the associated indirect benefits and costs,[7] then the change increases economic efficiency.
When A and B agree to a negligence rule for disputes between them, they are agreeing to two things: that A's liability will depend on A's negligence when A is the defendant, and that B's liability will depend on B's negligence when B is the defendant. For purposes of analysis, those are separate agreements; one could imagine one without the other.[8] We may think of A buying from B (at a positive price) B's assent to the rule for cases in which A is the defendant and B the plaintiff, and B buying from A (at a positive price) A's assent to the rule for cases in which B is the plaintiff and A the defendant.
Assume, for simplicity, that every pair of individuals is equally likely to become involved in a dispute[9] and that the nature of the potential disputes is the same across individuals, so that the value to A of legal assent from B is the same as the value to him of legal assent from C, D, etc. Parties differ, however, in their value for consuming and cost of producing legal assent. Thus A may be willing to pay, if necessary, up to two dollars each to buy agreement from B, C, D, ... to a negligence rule that will apply when A is the defendant. B may be similarly willing to pay up to three dollars to each of the others. Meanwhile, A may be willing to sell his assent, to agree to a negligence rule in cases where he is the plaintiff, for any price above one dollar, and B similarly for any price above two dollars. Following the analogy to an ordinary good, we would say that A values the assent of others at $2 per person, B values it at $3 per person. A's cost of producing assent is $1 per person, B's cost is $3 per person. The efficient rule is for each party to sell his assent to anyone who values it at more than its cost, thus maximizing the gains from trade. If B values assent at more than its cost to A (as he does: $3>$1) it is efficient for A to agree to accept a negligence rule if he sues B. If A values assent at less than its cost to B (as he does: $2<$3) it is efficient for B not to agree to accept a negligence rule if he sues A.
Suppose, in analogy to an ordinary market, that each seller specifies a price at which he will sell assent to anyone willing to pay, and that each buyer than buys assent from anyone selling it at a price less than the buyer's value. Will this produce the efficient result?
It will not. Consider the situation from the standpoint of A. If he offers to sell his assent at $1 to any buyer, the result will be efficient, since any buyer who values it at more than $1 (A's cost) will buy it. But A will get no benefit from the transaction, since he is selling the good for its cost to him; all of the gain from trade is going to the buyer. If A raises his price to $2, some potential sales (to buyers with a value between $1 and $2) will be lost, but the remaining sales (to buyers with a value greater than $2) will be made at a gain for A of $1 each. Exactly what price maximizes A's net gain will depend on the distribution of values among the other sellers, but it will be more than $1. So the result will be inefficient: buyers who value A's assent at more than its cost but less than its price will not buy.
This is the familiar deadweight problem of a single price monopoly. A monopolist maximizes his profit at a price above his cost, eliminating some efficient transactions. It seems out of place here because we seem to be dealing with a market of many buyers and many sellers. But one seller cannot substitute for another, so it is really a market with a very large number of bilateral monopolies.
One could reverse the form of the transaction by having sellers state a price and buyers decide whether to buy or not. The result would be essentially the same. Buyers would state a price below their real value, giving up some (efficient) transactions in order to increase their gain on the remaining transactions. This time we would call the situation monoposony instead of monopoly.
If this analysis is correct, and I believe it is, conventional models of perfect competition do not apply to the market for legal agreement. It is more appropriately modeled as bargaining among the parties buying ans selling legal assent, as in the previous section. Such a model implies an efficient outcome subject to the limits imposed by bargaining costs.
In practice, a number of features of the situation are likely to hold down those costs. In many cases, the optimal rules (ex ante , before an actual dispute has occurred) are the same for almost everyone. This is particularly likely to be the case if the bargaining is over symmetrical rules. My agreement to accept a court that operates under negligence rules makes me worse off when I am the plaintiff, but better off when I am the defendant. If negligence is a significantly more efficient rule, it is likely that most people will prefer it.
A second reason is that I must pay for the advantages of a favorable legal rule not only in the process of negotiating it but also in the price of transactions with others who will be bound by it. Suppose, for example, I manage to get a "favorable" legal rule for conflicts between me and any attorneys I hire: if they advise against settling and I lose the case, I can sue them for malpractice with a good chance of winning. One consequence of that rule will be to raise the cost to me of hiring a lawyer. In this and in many other cases, a "favorable" legal rule, like a "favorable" term in a contract, must be paid for in every transaction it applies to, and if it is inefficient the price is likely to be more than it is worth. That is part of the reason why, as Judge Posner and others have argued,[10] the legal system is a poor instrument for income redistribution.
These arguments suggest that the bargaining problems implied by the bilateral monopoly nature of the market for legal assent should not be insuperable, that bargaining among enforcement agencies representing groups of customers ought to be able to produce something close to an efficient outcome. Absent some theoretical structure more powerful than Coasian bargaining, it is hard to be more precise than that.
In my discussion so far I have assumed the existence of some baseline, some initial set of law codes from which bargaining begins. While the location of that base line does not affect the argument for the efficiency of the eventual equilibrium legal rules, it does affect what that equilibrium looks like. Many steps in the process of bargaining towards efficiency will involve some parties agreeing to a legal change that makes them worse off, in exchange for some balancing benefit. If we start with a rule of strict liability, to take the example above, a shift to negligence may require individuals who prefer the latter rule[11] to pay individuals who do not for their assent. If we start with a rule of negligence, a shift in the other direction will require payments the other way. So although the baseline does not determine the efficiency of the outcome, it may well affect the associated distribution of income.[12]
It is not immediately obvious what that base line is.[13] If two enforcement agencies fail to agree on a mutually acceptable arbitrator to settle their dispute, after all, the result is not that the dispute is resolved according to the UCC or the Delaware Commercial Code but that it is resolved by force.
This suggests that the ultimate baseline is the solution to a bilateral monopoly bargaining game among the agencies. Each agency can threaten to refuse to agree to any arbitrator, subjecting both to the costs of occasional violence, or at least of ad hoc negotiation to avoid violence. Each knows that the other would prefer even a rather unfavorable set of legal rules to no agreement at all. Each knows that if no agreement is reached, they are both at risk of losing their customers to other agencies that have been more successful in negotiating agreements.
The situation is analogous to a union management negotiation or the negotiations determining borders, trade policies, and the like between neighboring countries. While there is no good theoretical account of exactly what determines the outcome of bilateral monopoly bargaining, experience suggests that some tolerably stable equilibrium usually exists. Most unionized firms manage to settle their differences without lengthy strikes, and most nations are at peace with most of their neighbors most of the time.[14]
So we may imagine the market for law as starting out with a set of default rules between each pair of protection agencies, representing the result of bargaining backed by threats of refusal to agree on an arbitrator. From there, the agencies bargain to an efficient set of rules. The distributional outcome is the result of an implicit threat game between the agencies; the allocational outcome is the result of a (logically subsequent) bargaining game to move the agencies (and their customers) from the starting point to the Pareto frontier.
Experience suggests that there is enormous inertia in mutual threat games of this sort. National boundaries do not move half a mile one way or the other each time one nation becomes a little richer or a little more powerful. In practice, an anarcho-capitalist society will probably be built not so much on an ongoing mutual threat game as on a mutual threat game played out in the distant past. That suggests that, once the initial equilibrium has been established, the success of a protection agency will be based mainly on its ability to produce protection for its customers, not its ability to defeat rivals in open warfare.
While it is always possible for one firm to threaten to withdraw from its arbitration agreement with another unless the terms are renegotiated de novo , such threats are unlikely to be either common or successful. Other agencies have a strong incentive to insist on basing their bargaining on the existing rules, in order to prevent the costs both of continual renegotiation and of violence when negotiations break down.
The stability of a status quo in part reflects the influence of Schelling Points, outcomes recognized by both parties as unique, upon the outcome of bargaining.[15] Where the alternative to agreement is costly, almost any agreement is better than none, so both parties have an incentive to look for alternatives that they can converge on. This suggests the possibility that if anarcho-capitalist institutions evolve out of an existing state-run legal system, the rules of that legal system might function as the status quo from which further bargaining preceded. Whether or not such rules are efficient, they are familiar to the parties and they specify answers to most of the relevant questions. They therefore provide a potential point of initial agreement from which to conduct further bargaining.
I have argued that the market will tend to generate efficient law, for much the same sort of reasons that markets in general tend to generate efficient outcomes, although the argument depends on Coasian bargaining rather than perfect competition. But even if markets tend towards efficiency, that tendency is limited by various forms of market failure. Are there forms of market failure to which this market is particularly vulnerable, and, if so, what are their implications?
The answer, I think, is that there is a special sort of market failure relevant to this market. It is plausible to imagine a pair of enforcement agencies bargaining to an outcome close to the set of rules that maximize the net welfare of their customers. It is not I think plausible, pace Coase, to imagine a set of a hundred enforcement agencies bargaining together to a single outcome maximizing the welfare of all of their customers. So we can expect the legal rules between A and B to maximize their joint welfare, even to maximize the joint welfare of all of the clients of their enforcement agencies, but we cannot expect the rules applying between A and B to maximize the joint welfare of everyone, including customers of other enforcement agencies.
It follows that the rules will be optimal only when the legal rule between A and B produces no net third party effect on C, C being a customer of some other agency. In many cases this seems plausible, at least as a reasonable approximation. The rule that determines what happens if A breaks his contract with B, or breaks into B's house, or breaks B's arm, should have relatively little effect on C.[16]
Consider, however, intellectual property law. When B agrees to respect A's intellectual property, the result is an increased incentive for A to produce such property, which may benefit others who use it. Such benefits will not be taken into account in the negotiations that determine whether or not B makes such an agreement. The result will be a lower than optimal level of intellectual property law.
Indeed, the result may well be no protection for intellectual property at all. To see why, imagine that A, a producer of intellectual property, is bargaining with B, a consumer, for protection. If they agree on protection, B will be liable to pay A $10 for each copy of A's computer program that B makes. What are the cost and benefits of such an agreement.
The most obvious benefit is that A will receive $10/copy. This, however, is exactly balanced by the cost to B of paying $10/copy. If these were the only costs and benefits, agreement and disagreement would be equally efficient.
There are at least two other costs and one other benefit. One cost is that B will make fewer copies of the program than if copying were free--perhaps he will put a copy on his desktop machine but not on his portable. Perhaps he will buy copies of two of A's programs, but not a third, since it is worth only $5 to him. This cost is the familiar deadweight cost of copyright--the inefficiency due to the difference between the (positive) price of making an addition copy to the user and the (zero) marginal cost of permitting an additional copy to the copyright owner, resulting in an inefficiently low number of copies.
A second cost is the cost of enforcing the agreement. Keeping track of what copies A has made will be costly, perhaps impossible, and any resulting dispute will lead to expensive litigation.
To balance these costs there is an important benefit: The incentive that A has to write computer programs if he will be paid for them and does not have if he will not. If we were considering the question of requiring or not requiring all consumers of A's intellectual property to pay for it, that benefit might well outweigh the costs we have described, making copyright protection for programs economically efficient. After all, if A does not write any programs there will be nothing for B to copy.
But we are considering the question not with regard to the whole world but only with regard to B. The additional revenue A will receive as a result of B being covered by his copyright is very small, and will produce only a very small increase in output. That increase will benefit everyone who uses A's programs, but only the small part of that benefit that goes to B will be relevant to the negotiation between them. It follows that the benefit is vanishingly small, implying net costs, hence no protection.
The result is similar but less extreme if we consider negotiation, not between individuals, but between enforcement agencies. The agency will take into account not merely the benefit to B from the increased output due to B being bound by A's copyright, but the benefit to all of its customers due to the increased output from all of them being bound by A's copyright. The result is still only a small fraction of the total benefit from copyright law, assuming that there are many enforcement agencies each serving only a small fraction of the population, but a larger fraction than in the case of individual negotiation. The fraction becomes larger still if we allow for the possibility of copyright negotiations among groups of enforcement agencies, with each agreeing to recognize the copyrights of the customers of all of the others if they will all agree similarly. Such negotiations would be analogous to the negotiations among nations by which international intellectual property rights are now established.
Even allowing for the possibility of such multiparty negotiations, our result, although weaker, still remains; we would expect an inefficiently low level of protection for intellectual property. We might well get no protection at all. This raises two questions, both outside the range of this chapter. One, whether intellectual property protection is desirable, and if so how desirable, has been discussed at some length in the intellectual property literature.[17] The other, whether the equivalent of intellectual property protection could be provided in other ways, for instance by contract, is discussed (in the context of computer networks and encryption) in a forthcoming article of mine.[18]
Similar problems will arise with pollution law, where A's right to sue B for polluting his air results in a reduction of B's emissions and thus an external benefit for A's neighbor C. They may well arise in other important contexts as well. In all of these cases, we would expect the legal rules generated by the private market to be inefficient. Whether they will be less efficient than the rules currently generated by courts and legislatures is not clear. Pace Posner, we have no good theoretical reason to expect those legal rules to be efficient either.
While there are no modern anarcho-capitalist societies with legal system to be analyzed, there are a number of real world institutions, past and present, that are in some ways analogous. Evidence on the working of such institutions may help us answer two related questions about the private market for law: whether conflicts would be settled by law rather than violence and whether the resulting legal rules would be efficient.
Consider the settlement of legal claims between insurance companies at present. Company A's client runs into and injures Company B's client, giving the latter a possible tort claim against the former. The two companies can resolve the dispute at a low cost by settling out of court, provided they can agree on an outcome (or an arbitrator), or they can settle it at a high cost in court.
Their situation is analogous to the "arbitrate or fight" decision faced by a private enforcement agency every time one of its clients has a legal conflict with a client of another agency. There too, there is a low cost solution (arbitration) which depends on an agreement between the two agencies and an alternative (violence) with high costs for both parties. In both cases, the parties (insurance companies and enforcement agencies) can expect to have many such conflicts with each other, so they are engaged in a repeated game in which considerations such as reputation will play a large role.
The argument is not, of course, limited to auto accidents. It applies wherever parties are faced with the decision to settle or litigate, since that is a bilateral monopoly problem of the same sort I have been describing. The evidence suggests that the overwhelming majority of parties in such cases settle.[19]
Evidence on settlement rates provides some reason to believe that, under the institutions I have described, almost all disputes would be settled peacefully, but it does not tell us what the rules under which disputes were settled would be like. The literature on norms as a private substitute for law suggests that such institutions might produce a reasonably efficient set of rules.
In his book Order Without Law, Robert Ellickson described his investigations into how conflicts were settled in modern day Shasta County, California. He found that interactions between neighbors, with regard to straying cattle and many other things, were controlled not by law but by a system of norms, a private law code having no connection to courts, legislatures, or any other agency of state power. When a rancher was informed that one of his animals was trespassing, he was expected to apologize, retrieve the animal, and take reasonable precautions to keep it from happening again. If significant damage had been done, the rancher was expected to make up for the damage.
The system was self enforcing. If a rancher consistently let his animals stray, or failed to offer to make up for significant damages, the victim would respond by initiating true negative gossip, spreading the word that that particular rancher was not behaving in a proper neighborly fashion. If that failed to work, straying animals could be transported far from the victim's (and owner's) property, imposing significant costs on the owner who had to retrieve them. In extreme cases trespassing animals might even be deliberately injured. The one thing good neighbors did not do, even under severe provocation, was go to court.
Straying cattle were not the only thing to which legal rules were irrelevant. California has quite detailed laws specifying under what circumstance one of two adjoining landowners can build a fence between their properties and charge part of the cost to his neighbor. Landowner's in Shasta county build fences, and their neighbors sometimes end up paying for them. But what fences get built and who pays for how much of the cost are unaffected by what ought to be the relevant law. Nor do such norms apply only in modern-day Shasta County. Ellickson's examples of societies with such norms included orchard men in the Pacific Northwest, whalers in the 19th century, and modern American academics.
Ellickson's central thesis was that close-knit groups tend to develop efficient norms. He concluded that while formal law is important and useful in human affairs, it is less important and less useful than generally believed. In a wide variety of situations, people not only succeed in resolving their conflicts without recourse to law, they do it by mechanisms that work considerably better than the legal system.
I have discussed elsewhere the reasons why I believe that his thesis is a plausible one, and offered some evidence that the norms he describes are in fact efficient.[20] The relevance of that discussion to this chapter is that the system of norms and norm enforcement that he describes is a simpler version of the sort of private market for law discussed in this chapter. There are no middlemen or arbitrators; everyone is his own enforcement agency; the only available court is the court of (local) public opinion. But the structure of the market for norms is the same as the structure of the market for law. Each person can choose whether to act in a neighborly fashion towards each other person, and each pair of persons must in some way reach agreement on what that implies. If individuals fail to agree (or violate their agreements), the result is costly conflict. If, as Ellickson argues, such a structure tends to generate efficient norms, that is at least some evidence that a similar structure would tend to generate efficient laws.
The attentive reader, and especially the attentive libertarian reader, will have noticed that I have said nothing about what the laws generated by the market will be, other than efficient. In particular, I have said nothing about whether those laws will be consistent with either justice or liberty. That omission was deliberate. My purpose here is to discuss what outcomes we can expect a competitive market for law to produce, not what outcomes we want it to produce. This is an essay in economics, not moral philosophy.
Whether these outcomes will be consistent with either justice or liberty depends on whether either justice or liberty is economically efficient. In the case of liberty, I think there is good reason to believe that, as a general rule, it is. A considerable part of libertarian writing, my own included,[21] as well as a good deal of economic theory from Adam Smith on, defends the thesis that, on the whole, leaving people free to run their own lives maximizes total human happiness--for which economic efficiency may be considered a rough proxy.[22]
Whether justice is efficient is a harder problem, and comes in two parts. The first is the question of whether the rules implied by justice are themselves efficient rules; to that I have no answer, since I have no theory of justice to offer other than that implied by individual liberty. The second is the relation between individuals' beliefs about justice and their preferences for law.
Suppose that almost everyone in a society shares certain beliefs about justice-perhaps that the conviction of innocents is a very bad thing, to be avoided even at high cost, or that murderers should be executed, or that children should not be executed, even for murder. Those beliefs will affect but not determine what laws the people in that society demand. Justice is only one of the things people value; an individual might favor a legal rule he considers unjust if he thinks it benefits him. So we would expect the efficient set of legal rules generated by the market to represent some compromise between the legal rules that would be efficient absent specific beliefs about justice and the rules implied by those beliefs. To put it differently, beliefs about justice affect the value to individuals of being under particular legal rules, which affects what legal rules are efficient, which affects what legal rules the market will produce.
I have argued that there is reason to expect a system in which legal rules are generated by firms competing in a private market to produce efficient rules. Richard Posner has argued that there is considerable empirical evidence to suggest that the actual rules of anglo-american common law are efficient. This raises an obvious and interesting question: can the mechanisms I have been describing explain the observed efficiency of the common law?
I do not know the answer to that question. Certainly some forms of competitive law have contributed to the creation and development of the common law. The common law had its origin in the legal system of Anglo-Saxon England, whose early form involved a large element of private enforcement and private arbitration.[23] It evolved in an environment of multiple court systems--church, royal, and local--where litigants had at least some control over where their disputes were resolved. Some common law rules originated as private norms, and I have argued that norms are produced on something like a competitive market. Some rules may have been borrowed from the medieval Fair Courts, which had some of the characteristics of the system I have described.
It is thus possible that what Posner observes in present day common law is fossilized efficiency, produced by institutions that no longer exist[24] and preserved by the conservative nature of the common law. That conjecture is consistent with the observation that the efficiency of the common law seems to have decreased over time, at least in this century, with the long retreat from freedom of contract providing the most striking example. It is also consistent with Posner's claim that it is common law, not legislated law, which tends to be efficient. But it would require a much more extensive knowledge of the history and content of the common law than I have to say whether such a conjecture provides a plausible account of such efficiency as modern common law possesses.[25]
In any case, the principal purpose of this chapter is not to offer a solution to the puzzle of why the common law is efficient, supposing that it is. My purpose is to show why the law generated by the institutions of private property anarchy would tend to be efficient, and to explore some of the limitations of that tendency. Although the arguments I offer do not imply anything like a perfectly efficient legal system, they may provide better reasons to expect efficient law under anarchy than we have to expect efficient law under other forms of legal system, including the sort we now have.
David Friedman
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Thomas C. Schelling, The Strategy of Conflict, (Oxford: Oxford University Press 1960).
Shapo, Marshall S., Reporter, Towards a Jurisprudence of Injury: The Continuing Creation of a System of Substantive Justice in American Tort Law, Report to the American Bar Association, 1984.
Viscuzi, W. Kip, "The Determinants of the Disposition of Product Liability Claims and Compensation for Bodily Injury," 15 Journal of Legal Studies 321-346 (1986).
[0]The book was the first (1972) edition of The Economic Analysis of Law. So far as I know, this was the first appearance in print of the conjecture. In the current (1992) edition Posner writes "the theory is that the common law is best (not perfectly) explained as a system for maximizing the wealth of society."Posner prefers the term "wealth maximization," but uses it in a sense corresponding to conventional ideas of economic efficiency. For a more detailed discussion of such ideas, see Friedman (Price Theory) Chapter 15, Posner (1992) esp. pp. 13-16.
[1]Some arguments for such a mechanism can be found in Rubin (1977) and Priest (1977), and Posner (1992, pp. 254-255, 535-536. For arguments on the other side, see Rubin and Bailey (1994).
[2]I will offer some evidence based on existing markets with a similar economic structure.
[3]The original for of this argument appeared in Friedman (1973), pp. . Interested readers will also find there, and in the current (1989) edition, discussions of other problems raised by an anarcho-capitalist society, including defense against foreign states and stability against the reintroduction of the state.
[4]Economists are accustomed to the idea that the principal justification for government is as a producer of public goods. Law enforcement, although it has some public good elements, is both crowdable--it costs a police force more to protect all the citizens of a town than to protect half of them--and excludable. Arbitration is an ordinary private good, although one of its outputs and inputs, information in the form of precendents, shares the public good characteristics of other forms of information. See Landes and Posner (1976, 1979).
[5]A single arbitration agency might supply different law codes to different customers, so the number of law codes could be greater than the number of arbitration agencies. If, on the other hands, customers valued the simplicity and predictability of uniform law, many arbitration agencies might choose to adopt identical, or at least very similar, law codes.
[6]For one explanation of economic efficiency, see Friedman (1990) Chapter 15.
[7]Such costs and benefits include costs of precautions taken by parties to avoid liability and benefits due to accidents prevented by such precautions.
[8]In many legal systems, legal rules are not symmetrical between parties. Even in our legal system, that is true if one of the parties is a government protected by sovereign immunity, or a minor, or some other party with special status.
[9]If one wanted to drop this assumption, one could do so by introducing a "quanity" [pi]ij, representing the probability of a dispute between i and j. A uniform price P for legal assent would then be per unit, making the price at which i bought assent from j P[pi]ij.
[11]Perhaps something about their circumstances makes them particularly likely to be accidental (but not negligent) tortfeasors.
[12]Imagine, for example, the baseline rules with regard to race that we might expect if an anarcho-capitalist society had somehow been established in the American south in the 1840's. Even if the system succeeded in bargaining its way to the (efficient) outcome of freedom for slaves, it would presumably be freedom on very unfavorable terms.
[13]This problem was first called to my attention by James Buchanan, in a perceptive review of Friedman (1973). See Buchanan (1974).
[14]For one approach to understanding how the solution to such conflicts is determined and maintained, see Friedman (1994,2).
[15]Friedman (1994,2), Schelling (1960).
[16]Little, but not none. A might break B's arm without first ascertaining B's enforcement agency. If so, the fact that C's enforcement agency has obtained severe penalties for assault in its negotiations with A's agency may provide some protection to B.
[17]For discussions of whether intellectual property protection is desirable, see Breyer (1970) and Machlup (1958).
[18] D. Friedman, "A World of Strong Privacy: Promises and Perils of Encryption," forthcoming in Social Philosophy and Policy, also available from the author.
[19]Danzon and Lilliard (1983) found that fewer than 10% of malpractice claims were tried; Viscuzi (1986) found that 95% of product liability claims that were not dropped were settled either before or during trial. Department of Transportation research on bodily injury and uninsured motorist claims found that "less than 1% of all claimants went all the way to a verdict." (Shapo (1984) quoting from 1 Department of Transportation, Automobile Personal Inury Claims 121 (1970)). Hammitt (1985) reported that, of the bodily injury cases in their study, only about 1% were tried to a verdict; about an additional 1/2% of the cases settled during trial. I do not know what fraction of the cases in any of these studies were conducted by insurance companies against insurance companies. I conjecture that, if one could separate out such cases, the settlement rates would be even higher, because of the discipline imposed by repeat dealing.
[20]David Friedman, "Less Law than Meets the Eye," a review of Order Without Law, by Robert Ellickson, The Michigan Law Review vol. 90 no. 6, (May 1992) pp. 1444-1452. In that review I suggest limitations to the efficiency of norms corresponding to those offered here with regard to the efficiency of privately generated law.
[21]Specifically, large parts of Friedman (1973, 1989). See also Friedman (1990), Chapter 15, pp. 455-465.
[22]Friedman (1990) Chapter 15, pp. 434-454.
[23]See Friedman (1979) for a discussion of similar legal institutions in saga period Iceland.
[24]Although the common law still imports some rules from commercial practice, and thus may continue to be influenced by private systems of norms.
[25]Readers interested in this subject may want to look at Bruce Benson's book The Enterprise of Law.
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