Economic Theory in the 1L Curriculum

This is a revision of the draft by Daniel Margolskee.

Transcendental Nonsense in Law and Economics

In standard 1L Contracts and Torts classes, Justice Holmes’ prediction that while “the blackletter man may be the man of the present, the man of the future is the man of statistics and the master of economics” has come half true. 1Ls are expected to be able to analyze the consequences a proposed rule of law would have in society, under a set of assumptions of economic theory: that people and firms are utility maximizers, that some amount of money damages is enough to make a person indifferent to suffering a given injury, and that markets are perfectly efficient. Unfortunately, these economic thought experiments replace any foray into discovering the actual empirical effect of a given rule of law. Compounding the problem, the proposed rule is judged according to the predicted theoretical results, rather than the actual social interactions that are produced by the rule.

The result is that while moral language is largely displaced, the notion that ideal rules of law can “be worked out like mathematics from some general axioms of conduct” has not been completely expelled.

Full Compensation Theory in the Efficient Breach Hypothesis

In “The Path of the Law,” Holmes describes the “bad man,” to whom the “duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it--and nothing else.” Conceivably, for the bad man, there is no tangible difference between a “cancellation option” and a “breach.” This is similar to the analysis a standard Contracts textbook gives in describing the Efficient Breach Hypothesis. Our Contracts textbook suggests that we think of a promisor as having the equivalent of an “‘option’ to breach and pay expectation damages instead of performing, when it is in her economic interest to do so.” Farnsworth et al., Contracts, 20 (7th ed. 2008).

The Contracts text, though, makes a further point: as long as the promisee is “fully” compensated for his expected benefit under the contract, a breach by the promisor will “leave the promisee just as well off as he would have been had the promisor performed. In principle, then, breaches of this sort make promisors better off without making promisees worse off.” Id. It is hypothesized that there exists a sufficient level of compensation which will be enough to make the aggrieved party indifferent to the breach; when damages are fixed at that point, society as a whole is made “better off”, since performance of inefficient contracts is discouraged. Let us refer to this notion as the Full Compensation Theory.

A Two Scoop Serving of Transcendental Nonsense

The Full Compensation Theory leaves us with an Efficient Breach Hypothesis that is supported by two assumptions: (1) it assumes that parties are indifferent between “full” breach-induced compensation and contract performance; (2) it assumes that where breaches and damages are fixed at a certain optimal point, society is better off.

It is tempting to argue that the first assumption is wrong because the Full Compensation Principle disregards “specific idiosyncratic value in performance and the general moral value of promise-keeping.” While this alternative argument has intuitive appeal, it is also just speculation.

Instead of turning to such speculation, perhaps it is best to fall back on Holmes’ exhortation: discover facts that explain how things actually work. Empirical analysis would surely be able to shed light on whether parties can be fully compensated through damages for contract breaches, or whether parties place other values on contract performance. By undertaking this analysis, we would not fall victim to speculation.

Of course, I don’t have the empirical background to formulate an answer here, but that is not what’s important. The key lies in the uncertainty: 1Ls are being taught this principle of efficient breach and full compensation as if it is an economic truth; but no backing for that conclusion is presented.

More dangerous, though, is the second assumption. Here, a definition of welfare has been assumed. The full compensation theory doesn’t allow for a dispute regarding what is best for society – it simply assumes that this optimal breach/peak efficiency point is the goal. In this class, we have been learning that, in addition to adequate remuneration, meaningful work is necessary for individual welfare. Extrapolating to society as a whole, isn’t it at least conceivable that there is another component (let us call this “X”) that works alongside the compensation component? So, perhaps society is not best off when breaches and compensation are at an optimal level, but when breaches, damages and X are optimized (here, X could be any of a number of things, including what Mr. Margolskee suggested – moral value of promises kept).

Where To From Here?

Perhaps the problem is not that the Full Compensation Theory is taught, but that it is presented as a general axiom of conduct. How much more enlightening if statistics were given showing whether the theory predicts how things actually work. How much more enlightening if opposing theories, different predictors of behavior, were presented.

In essence, though, this is not a conclusion, but a launching point to a whole new discussion – one that is concerned with how the law is taught. That, I don’t have room to fully discuss here, but I offer a few questions: So that 1Ls are not overburdened, should first-year courses continue to display the law as an uncomplicated, all-explaining whole? Or should courses, while remaining broad survey explorations, present opposing theories, brief mentions of statistics, and incite some questions as to whether the theories are actually just transcendental nonsense? Or should first-year courses take the route some philosophy seminars take: spend an entire semester, or even a year, working on a specific theory, so that there is time for statistics, for debate, for refining of assumptions, for the development of a framework that accurately predicts how things actually work? In this latter case, perhaps 1Ls won’t “learn the law”, but they may wind up learning how to think about the law.