Encyclopedia of Law & Economics - 0520 Institutional Law And Economics

0520

Institutional Law And Economics

Steven G. Medema

Associate Professor of Economics, University of Colorado at Denver

Nicholas Mercuro

College of Natural Sciences, Michigan State University

Warren J. Samuels

Professor of Economics, Michigan State University

© Copyright 1998 Steven G. Medema, Nicholas Mercuro and Warren J. Samuels



Contents

Abstract  
1. Introduction  
A. Institutional Economics  
2. Overview  
3. Factors Contributing to the Institutionalist School of Thought  
4. Modern Elements of Institutional Economics  
B. Institutional Law and Economics: Origins and Development  
5. Ayres and Hale  
6. John R. Commons and His Impact on the Development ofInstitutional Law and Economics  
7. Contemporary Institutional Law and Economics: The CommonsTradition  
C. Central Themes of Institutional Law and Economics  
8. The Evolutionary Nature of Law and Economy  
9. Continuity versus Change  
10. Mutual Interdependence, Conflict, and the Problem of Order  
11. Rights, Power, and Government  
12. The Problematic Nature of Efficiency  
13. Toward a Comparative Institutional Analysis  
14. Summary  
Acknowledgments  
Bibliography on Institutional Law and Economics (0520)  
Other References  
Cases  






Abstract  

From its beginnings in the late nineteenth century, institutional economics hasbeen concerned with the analysis of the interrelations between legal andeconomic processes. The institutional approach to law and economics examinesboth the influence of economy upon law and legal reasoning and the influenceof law and legal change upon economic activity and performance. This essayexamines the central tenants of institutional law and economics, dating from theearly work of individuals such as Robert Lee Hale and John R. Commons andthrough its modern manifestations. As such, it emphasizes the evolutionarynature of law and economy, the tension between continuity and change, theproblem of order, the reciprocal nature of legal-economic problems and theattendant dual nature of rights, the problematic nature of efficiency, and theneed for a comparative institutional approach to the practice of law andeconomics. By recognizing the multiplicity of potential solutions tolegal-economic problems and the underlying value premises attending each, thecomparative institutional approach to law and economics attempts to flesh outboth what is actually going on within the legal-economic nexus and thealternative possibilities open to society within the legal-economicdecision-making process.

JEL classification: K00

Keywords: Law and Economics, Institutional Economics, Efficiency, Rights,Government



1. Introduction  

From its beginnings in the late nineteenth century, institutional economics hasbeen concerned with the analysis of the interrelations between nominally legaland economic processes. The earliest roots of law and economics are in partwithin the institutionalist tradition of economics but, as recognized by WarrenJ. Samuels (1993) , go well beyond that school of economic analysis. Earlycontributions to the institutional approach to law and economics include thework of Henry Carter Adams (1897) on economics and jurisprudence, Richard T.Ely (1914) on the relation of property and contract to the distribution of wealth,and, especially, John R. Commons (1924 , 1925) on the legal foundations of theeconomic system. Important elements of the institutional approach to law andeconomics can also be found in the work of Thorstein Veblen (1899 , 1904) ,lawyer-economists Robert Lee Hale (1952) and Walton H. Hamilton (1932) , andlegal scholars such as Karl Llewellyn (1925) , Jerome Frank (1930) , and RoscoePound (1911a , 1911b , 1912) . Institutional economics is essentially an Americancontribution to economic thought, one that, like Legal Realism in jurisprudence,is said to have 'had its heyday in the 1920s and early 1930s' ( Bell, 1967 ).Nonetheless, it continues to have a relatively strong presence today in both theU.S. and Europe.





A. Institutional Economics  

2. Overview  

Institutional economics developed as a rather heterodox approach to the studyof economic society and has been amply reviewed by John Fred Bell (1967, pp.539-571) , Robert A. Gordon (1964, pp. 123-147) , K. William Kapp (1976) , WesleyC. Mitchell (1937) , Malcolm Rutherford (1994) , Henry William Spiegel (1971, pp.628-641) , S.K. Srivastava (1965, pp. 470-487) , and more recently by Karl Pribram(1983, pp. 355-62; 424-29) and Charles J. Whalen (1996) . There also are extensiveoverviews/anthologies of institutional economics including those by GeoffreyM. Hodgson, Warren J. Samuels, and Marc R. Tool (1994) , Samuels (1988) , and Tool (1988,   1993) . As its name implies, institutional economics places at thecenter of analysis the study of the institutions of the economic system.Institutions are variously and broadly defined within institutional economics. John R. Commons (1934) defined an institution as 'collective action in control ofindividual action' and as 'collective action in restraint, liberation, and expansionof individual action' thereby emphasizing the social bases of the individualwhich orthodox economists took as given and self-subsistent. Thorstein Veblen(1899) defined institutions as 'widely followed habits of thought and thepractices which prevail in any given period', thereby emphasizing theirproblematic and belief oriented nature. Herbert J. Davenport essentiallycombined the two definitions in his description of an institution as 'a workingconsensus of human thought or habits -- a generally-established attitude ofmind and a generally-adopted custom of action as for example, private property,inheritance, government, taxation, competition, and credit' (cited in Srivastava,1965, p. 470 ).

Institutional economics has often been described as part of 'a revolt againstformalism' ( Spiegel, 1971, p. 629 ), a revolt that took place in law, in history, andin economics at about the same time. Institutional economics, as part of thatrevolt, was led by a group of young American scholars who, after World WarI, engaged in a critique of the predominate, formalistic economic doctrines of theday. In economics, formalism was taken to be the abstract deductive reasoningof orthodox economic analysis that enthroned universally valid reason, assumedpassive, rational utility maximizing behavior, and demonstrated an inordinateconcern over the equilibria of comparative statics (in particular utility analysisof consumer behavior and the marginal productivity theory of distribution).

Reflecting their belief that this methodology was inadequate forunderstanding many important facets of the economic system, institutionalistsfocused their attention on inductive analyses of specific institutional aspects ofthe American economy. While their principal emphasis was on using theinductive method to describe the constituent elements of the economy, theinstitutionalists never employed the inductive method to extremes and thereby,were still able to make substantive theoretical generalizations. As noted by Walter S. Buckingham (1958, pp. 107-108) , 'the development of generalizationsgave institutional economics more of a theoretical content than the largelydescriptive [German] historical school was ever able to attain. Institutionaltheory is by no means as refined and exact as orthodox theory, but is not soabstract and lacking in empirical content either'.



3. Factors Contributing to the Institutionalist School of Thought  

Charles J. Whalen (1996) has traced the emergence of institutional economics tothree distinct sources of influence. One was the German historical school, whichinfluenced such early institutionalist thinkers as Richard T. Ely. The Germanhistorical school, founded by Wilhelm Roscher (1817-94) and later dominated byGustav von Schmoller (1838-1917), emerged at least in part as a reaction againstclassical economic thinking in the mid-nineteenth century. The historical schoolemphasized the dynamics of economic development, the need to use empiricaldata (rather than abstract ideas) to ground economic theories, and the necessityof paying particular attention to human institutions. This emphasis on gatheringfacts and studying them in relation to their historical significance rather than asisolated, objective data in static, timeless models had a direct bearing on themethodology of emerging institutionalist economics.

The second influence was from American pragmatic philosophy as set forthby, among others, Charles Peirce, William James, and John Dewey. Proponentsof American pragmatic philosophy recognized an uncertainty inherent inunderstanding and looked for philosophical methods for establishing themeaning of concepts and beliefs. The analysis of social phenomena had to beconducted within systems of relationships among individuals in their empiricalsettings. They largely replaced a priori abstract reasoning with empiricalstudies. Contrary to the narrow, uniform 'rational behavior' assumption inorthodox microeconomics, choices were pragmatically perceived -- to be madein a world of ever-changing empirical objects and emerging economic, political,and social institutions. 'True' ideas are those to which responsible investigatorswould assent after thorough examination - that is, after considering whatconceivable effects of a practical kind a theory or object holds. Thus, only thosehypotheses that contributed to organizing data garnered through senseperceptions related to the real world (i.e. held practical significance), and did soin a progressive and unifying manner, were taken to be legitimate. In short, anidea was right if it had 'fruitful' consequences. The pragmatist emphasis on theuncertainty inherent in understanding served to provide an epistemologicalfoundation and a social philosophy upon which to erect the basic tenets ofinstitutional economic thought.

The third influence came through Thorstein Veblen's turn-of-the centurywritings focusing on the Darwinian, non-teleological evolutionary nature ofeconomic change to which one can trace many of the origins of and earlyinsights into institutional economic thought. After short sojourns at a varietyof universities, including Johns Hopkins, a doctorate degree in philosophy fromYale University in 1884, and several years (1891-96) as an economics fellow atCornell University and the University of Chicago, Veblen was given a teachingpost at the University of Chicago in 1896, becoming an assistant professor ofeconomics in 1900 at the age of forty-three. The previous year he published hisfirst and most renowned book, The Theory of the Leisure Class , ( Veblen 1899 ).

Here, as in his other writings, Veblen emerged a strong critic of orthodoxeconomic thinking, rejecting the mechanistic view of economic society asreflected in static equilibrium analysis. As observed by Spiegel (1971, pp.631-632) , Veblen rejected the orthodox 'hedonistic conception of man as alightning calculator of pleasures and pain' as overly narrow and outmoded.Consequently, he characterized the conventional approach to economics astaxonomic, overly concerned with classification and systematization thatdepicted human behavior in passive, inert, hedonic terms and, at the same time,brushed aside the 'disturbing factors' that did not fit into the received doctrine'spursuit of truth. With respect to conventional economics' pursuit of truth, in arevealing statement in an address in 1908, Veblen asserted that 'the outcome ofany serious research can only be to make two questions grow where onequestion grew before' ( Spiegel 1971, pp. 631 ).

Veblen focused on what he called an evolutionary method of economicanalysis. He believed that the material environment, technology, andpropensities of human nature condition the emergence and growth ofinstitutions. Because he believed that social change implied changes in habitsof thought and customs as crystallized in institutions, he insisted on a criticalexamination of capitalistic institutions -- especially what he termed industry and business , along with the economic power they were able to exercise -- to bettercomprehend economic society. Toward that end, he emphasized that it wasnecessary to understand both the 'widespread social habits' and the institutions,and not merely how prevailing institutions worked, but with finding out how theinstitutions of capitalism evolved.

In another of his books, The Theory of Business Enterprise , ( Veblen 1904 ),Veblen identifies the price system as the leading economic institution in theso-called pecuniary economy. Many contributing factors, most of which areinherent in the economic system including 'businesslike technicians', 'labororganizations', 'technological advances', ...etc. lead to economic tensions amongthe interrelated forces of production and profit. These tensions manifestedthemselves in a class system - (1) the productive class, comprised of those whowere socially productive, and (2) the leisure class, comprised of those who cameto depend upon acquisition. And, as described by John F. Bell (1967, pp.548-549) , these manifested themselves in 'custodians of absentee-credit' whowere certain to engage in 'capitalistic sabotage' and further, that 'the struggle foreconomic advantage for their own vested interests' would result in both laborand business technicians engaging in a 'conscious withdrawal of efficiency'.'Cultural lags' brought on by technological change altered the institutions andhuman behavior resulting in an ever-present class conflict ( Srivastava 1965, pp.474-475 ). Thus, as Veblen described it, it is the very factors within the institutionof the price system that led business to experience fewer intervals of short-termdepressions that ultimately gave way to more chronic stagnation. For Veblen,the pecuniary aspects of life are all-pervading and become an integral part of theanalysis of the evolution of society.



4. Modern Elements of Institutional Economics  

From the writings of Thorstein Veblen and other contributors (to be reviewedbelow) such as Wesley C. Mitchell, Clarence E. Ayres, Walton H. Hamilton,Robert Lee Hale, and John R. Commons, institutional economics emerged as arather heterodox approach to analyzing economic society. As will becomeevident, many of the founders of and present contributors to institutionaleconomics stress the evolutionary facet of institutions and, thus, the economy.This continuing concern with the evolutionary nature of the economy underliesthe name of the association -- The Association For Evolutionary Economics --that has maintained some intellectual continuity and focus among this group ofeconomists. The Association publishes its own journal, the Journal ofEconomic Issues . The Review of Political Economy regularly publishes workembodying the institutionalist perspective (often with a somewhat moreEuropean flavor), as do the Cambridge Journal of Economics , Economy andSociety , Industrial and Corporate Change , and the Review of InternationalPolitical Economy .

In its modern form, institutional economics, as set forth by Robert A. Gordon(1964, pp. 124-125) is embodied in a series of propositions defining an approachboth alternative to and complementary to mainstream economic analysis. Thesepropositions, together with the particular and specific focus contributed byCommons, provide the foundation upon which institutional law and economicsrests.

Economic behavior is strongly conditioned by the institutional environmentwithin which economic activity takes place, and, simultaneously, economicbehavior affects the structure of the institutional environment.

The mutual interaction between the institutions and the behavior ofeconomic actors is an evolutionary process, hence the need for an 'evolutionaryapproach' to economics.

In analyzing the evolutionary processes contained therein, emphasis isdirected to the role played by the conditions imposed by modern technologyand the monetary institutions of modern, mixed-market capitalism.

Emphasis is centered upon conflicts within the economic sphere of societyas opposed to harmonious order inherent within the cooperative, spontaneous,and unconscious free play of economic actors within the market.

There is a clear and present need to channel the conflicts inherent ineconomic relationships by structuring institutions to establish a mechanism ofsocial control over economic activity.

Institutionalism requires an interdisciplinary approach calling onpsychology, sociology, anthropology, and law to help understand the behaviorof economic actors and thereby generate more accurate assumptions indescribing their behavior.

These propositions offer a partial rejection of the mechanistic price-theoreticapproach proffered by the more orthodox neoclassical microeconomics. Thepropositions are a manifestation of the institutionalist position that theframework of orthodox economic analysis does not allow it to get at certainfundamentally important features of economic activity.

Further, evolutionary institutional economics is proffered as being based onmore 'realistic' behavioral assumptions derived from a broad array of socialscience knowledge and a fuller appreciation for and understanding of theinstitutions driving a mixed-market economy. This drive for realistic assumptionsled the early institutionalists to extensive data-collection efforts. A pioneer inthis regard, and a leading institutionalist, was Wesley C. Mitchell, a student ofVeblen's at the University of Chicago. Mitchell spent most of his academic careerat Columbia University (from 1913-1944). His book, Business Cycles , ( Mitchell1928 ) was his greatest research work. In it, he maintained that all institutionswere subject to forces that brought about change in response to changingconditions and behavior. His concern was with the behavior of institutionalfactors which would provide a basis for generalizations; thus the need toproduce the empirical evidence (statistical records and quantitative verificationof change) that would thereby permit the development of more realistic theoriesof economic change ( Bell, 1967, p. 565 ). The book was a historical description ofthe economic organizations of four countries (U.S., Germany, Great Britain, andFrance) and of the pecuniary aspects of their economies. In his research hecompiled all of the data necessary to recount the business cycle theories withineach country. Mitchell demonstrated that trade cycles were not accidentaldisruptions in the economy but were instead systematic fluctuations brought onby the changing economic organization of the economy together with itschanging culture. It should be noted in passing that in furtherance of thistradition, Mitchell founded the National Bureau of Economic Research, whichhas become a major center for empirical work in economics. Mitchell succeededin helping to expand the scope of economics beyond static equilibrium analysisthereby fulfilling his mission 'to explain at once the current working and thecumulative changing of economic processes' ( Mitchell, 1914, p. 37 ).





B. Institutional Law and Economics: Origins and Development  

5. Ayres and Hale  

Because institutional economics has always been concerned with legal facets ofthe economy, (i.e., the relationship between the law and the development andperformance of the economy), there is no clear dividing line or simplistictransition between institutional economics and institutional law and economics.Thus, an understanding of the nature of the analyses and the concerns of themajor contributors to institutional economics concomitantly provides anunderstanding and appreciation of the scope and content of present-dayinstitutional law and economics. This and the next section are intended to helpmake this transition.

Certain of Thorstein Veblen's ideas described above were given furtherdevelopment by Clarence E. Ayres. Ayres received his Ph.D. in philosophy fromthe University of Chicago in 1917 writing on the relationship between ethics andeconomics. He started his teaching career at Amherst College assisting thelegal-economist, Walton H. Hamilton in his course, 'Social and EconomicInstitutions'. After a brief sojourns at the University of Wisconsin and New YorkUniversity, in 1930, his former colleague, Hamilton was influential in urgingAyres to move to the University of Texas at Austin where he influenced ageneration of institutionalist scholars.

Ayres's perspective on the economy is found in his treatise The Theory ofEconomic Progress ( Ayres 1944 ). As described by William Breit (1973) , it is atheoretical work that attempts to explain the forces that have shaped theeconomy, focusing on those factors that accelerated the economy'sdevelopment as well as those that have impeded it. For Ayres, the challengeconfronting economics is to 'devise new organizational forms, to pragmaticallydevelop organizational arts to match, rather than contradict, our science andtechnology' ( Breit, 1973, p. 255-256 ).

Ayres saw human activity as reflective of two basic and ever-present forces:'technological' behavior, a productive and progressive force, and 'ceremonial'behavior (as manifested in, for example, hierarchies, mores, culture, andideology), which is counterproductive and inhibits change, acting as a curb ontechnological progress. The central theme of this work is that an exponentiallyexpanding and advancing 'technology' (defined broadly as all human activitiesinvolving the use of tools, and thus including both human and physical capital)is responsible for the enormous changes in the welfare of society. The focus isnot so much on the individuals, but on technological progress as related to theadvancement of the tools (that is, the objective instruments capable of beingvariously combined) and the role of technology in enhancing economicprogress. Since the ceremonial institutions resist change, he argued, progressis a function of the relative strength of these progressive and inhibiting forces,with the variance of their relative strengths helping to explain the differentialrates of development across societies and cultures.

Robert Lee Hale received his L.L.B. from Harvard University in 1909 and hisPh.D. in economics from Columbia University in 1918. As recounted by JosephDorfman (1959) , Warren J. Samuels (1973) , and Neil Duxbury (1990 , 1995) , Haleinitially held a joint appointment in the economics department and the lawschool at Columbia University and then moved to the law school on a full-timebasis in 1928. His emphasis on the integration of economics and law wasreflected both in his teaching -- particularly his course on 'Legal Factors inEconomic Society' -- and in his writing, much of which dealt with the regulationof railroads and public utilities, fields in which an understanding of the interfacebetween economics and law has always been fundamental. Hale wroteextensively on the legal and economic theory of rate-base valuation, as well ason the regulation of rate structure and level. His writings were instrumental in theadoption by the courts of the 'prudent investment' doctrine of valuation forpublic utilities ( Dorfman, 1959, p. 161 ).

Hale is perhaps best described as a Legal Realist who drew upon theemerging tradition of institutionalism ( Duxbury 1995, pp. 107-108 ). Consistentwith the Realists of the day, Hale's work was very much a challenge to andcritique of the dominant tradition of laissez-faire capitalism. And, while RichardPosner (1995, p. 3) contends that the Legal Realists had little influence on thecontemporary law and economics movement, he does allow that Hale 'anticipatedsome of the discoveries ... of law and economics' as we know it today.

Like John R. Commons (whose contributions will be reviewed below), Halewas influenced by Wesley H. Hohfeld's articulation of 'fundamental legalconceptions', which, in Hohfeld's mind, were the 'lowest common denominatorsof law' ( Cotterrell, 1989, p. 88 ). Hale's paradigm was comprised of the conceptsof voluntary freedom, volitional freedom, coercion, power, and government.Legal and economic processes were viewed as inseparable and the economydescribed as a structure of coercive power arrangements and relationships whichnecessitated an understanding of the formation and structure of the underlyingdistribution of economic power. As such, the economy was seen as a system ofpower operating through a system of coercion, and thus the economic freedomexpressed by the courts of the day was merely freedom to engage in economiccoercion ( Samuels, 1973 ).

Hale did not view coercion as something to be condemned, but, rather, as abasic fact of economic life. For example, he argued that if income is in factacquired through coercion, abetted actively or passively by government, thenit cannot be said that overt coercive redistributions of income by governmentare themselves wrong ( Dorfman, 1959, pp. 162-163 ). Hale's Hohfeldianperspective on rights led him to view nearly every statute with economicimplications as impacting negatively upon someone's liberty or property. Giventhis, he believed that it was essential for the courts to undertake an intelligentbalancing of the gains and losses brought about by the particular statutesbrought before them -- a process which, he said, requires 'a realisticunderstanding of the economic effect of the legislation' (quoted in Dorfman,1959, p. 163 ). While Hale believed that ethical judgments must ultimately be thebasis upon which the court's decisions are made, he felt that the judicialapplication of economic principles was necessary in order to ascertain theeconomic consequences -- allocative and distributive -- of the legislation whoseconstitutionality the court was asked to evaluate ( Hale, 1924 ; 1927 ). Hale's brandof legal economics -- as reflected in both his writing and his teaching -- graduallyevolved into a 'theory of the economy as a system of mutual coercion and thelegal basis thereof' ( Samuels 1973, p. 25 ), with his perspective being most fullyspelled out in his classic book Freedom Through Law ( Hale 1952 ).



6. John R. Commons and His Impact on the Development of Institutional Lawand Economics  

John R. Commons stands as the central figure in the development of theinstitutional approach to law and economics. Unlike his contemporaries,Commons never earned a Ph.D. degree and after a slowly developing academiccareer, in 1904, at the age of forty-two, he was given an appointment at theUniversity of Wisconsin where he and his associates quickly brought theeconomics department to the forefront of the discipline ( Spiegel, 1971, p. 630 ).

Commons became associated with the progressive government of the Stateof Wisconsin, engaging in what he termed 'investigational economics'(preparatory fact-finding reports produced by Commons and his students)necessary for the drafting of legislation and the formulation of innovativepolicies in a wide variety of areas including industrial relations, labor law reform(including workman's compensation and unemployment insurance), public utilityregulation, and price stabilization. Besides teaching and writing at the Universityof Wisconsin, he was also very involved in public life serving on an array ofstate and federal commissions. In his distinguished academic career, Commonswrote several books, two of which now serve as a benchmark for institutionallaw and economics: Legal Foundations of Capitalism ( Commons 1924 ) and Institutional Economics: Its Place in Political Economy ( Commons 1934 ).

As Henry William Spiegel (1971, p. 628-629) has pointed out, there was apronounced linkage between Commons' institutional economics and the Germanhistorical school (due in part to his teacher Ely's attachment to the Germanschool). The influence of the American pragmatic philosophers on his thinkingwas much less significant, although its presence is evidenced in his emphasison the pragmatic importance of using inductive analysis. And unlike ThorsteinVeblen, who sought a near total rejection of orthodox economic theory,Commons (as well as Wesley C. Mitchell) held a much more conciliatory positionseeing institutional economics as a complement to, rather than a substitute for,neoclassical analysis.

Commons' institutional economics was conceived as a broad synthesis oflaw, economics, and ethics; it recognized both conflicts of interest and theirmutual dependencies as well as the need for security of expectations and order( Spiegel 1971, p. 638 ). In contrast to the strict methodological individualism andthe harmony of interests paradigm that imbued orthodox economics, Commonsplaced a greater emphasis on the role of collective and corporate activities in theeconomy and centered his analysis on the conflicts of interest inherent in amodern economy. Human action was seen to be socially or culturallydetermined; that is, human action and cultural determinants were seen to interactwith each other. Consequently, the free will of individuals contributes to thecultural environment and is, in turn, molded by that environment ( Buckingham,1958, p. 104 ).

As characterized by Kenneth Parsons (1957, p. 23) , for Commons, the maintask of economics consisted of determining the 'reasonableness of the workingrules underlying the general economic order in an age in which citizens,corporations, and labor unions have economic power'. (See also Parsons, 1985 )Institutional economics for Commons was an economics of rights, duties,liberties, and exposures, and he looked at the economy as a series of intendedand purposeful changes -- so-called 'managed equilibria'. He believed that theprimary economic institutions were formed on the basis of definite patterns ofsocially sanctioned habits and could be reshaped. This belief led him to probeextensively the impact of institutions, particularly the operation of the legalsystem (including the judiciary, the legislature, and the regulatory commissions)in working out solutions to conflicts, and the impact of those solutions oneconomic structure and performance.

In Legal Foundations of Capitalism ( Commons 1924 ) Commons's chiefconcern was with uncovering the development, evolution, and workings of theinstitutions that ultimately impact the performance of the economic system. Itwas a theoretical work that examined the legal foundations of the capitalisteconomic system. The treatise was unlike anything that had come before, andbenefited from Commons's close contact with law through his extensiveaforementioned involvement with the courts, his service on governmentcommissions, and his drafting of legislation. The emphasis of the book is on therole of law and the courts and how they determine the structural elements of aneconomic system. Like his predecessors, Commons believed all economicinstitutions are subject to evolution. Whether describing the institution ofcapitalism, private property, or the state itself, each was shown to receive itssanction from the authorities -- the church, the state, the courts -- through anevolutionary process.

Commons analysis showed, on the one hand, how economy influences lawas the economic system brings to bear pressures on political and legal systemsfor legal change that facilitates a particular evolutionary path, and, on the otherhand, how law influences the economy -- that is, how legal change facilitates thedevelopment of economic activity in a particular direction. In order to bring outthe nature and extent of this mutual interdependence, he undertook an analysisof a wide variety of cases, working rules, and statutes to probe their impacts onthe development of modern capitalism, and thereby to illuminate theinterrelations between legal and economic processes. Of particular import hereis his analysis of the role played by rights and working rules within theeconomic system, where he lays out, in a systematic way, why rights (and thuslaw) matter within the economic system, and why the development of economictheory should proceed with attention to the role of law and legal change instructuring economic activity and performance.

Commons was particularly concerned in Legal Foundations to uncover thevalues both underlying and ensconced in the working rules that governsocial-economic relations. He found them in the courts' use of the term'reasonable value' -- whether reasonable value in public utility regulation, thereasonable wage in labor law, the reasonable safety as related to workman'scompensation, or the reasonable conduct of private and public citizens. Heobserved that legal history demonstrated certain well-defined tendencies on thepart of the courts to eliminate those practices of capitalistic institutions deemeddestructive, while at the same time to reaffirm the 'reasonable' policies thatshould be encouraged and followed in a competitive system. Determinationshave to be made as to whose interests are to count or, said another way, todetermine whose preferred practices would be given protected status.'Reasonable value' could be used by the courts to ground policies that wouldbring about compromises in arenas of economic conflict, including labordisputes, public utility rate-making, tax policy, pricing, etc. ( Bell, 1967, p.556-557 ). As the definition of what types of activities were consideredreasonable evolved over time, so too did the legal rules governingsocial-economic relations, the structure of markets, and the structure ofcapitalism itself, as seen in the effects of the transformation of the legaldefinition of property and its impact on business, and the effects of law on theemployment relation within the firm, on the market mechanism, and on the wagebargain. Thus, in the West, a movement was engendered from a feudal andagrarian society to a capitalist system, with economic change driving legalchange, which in turn facilitated the economic transformations. (See Samuels(1996) for a 'Reader's Guide' to the Legal Foundations of Capitalism .)



7. Contemporary Institutional Law and Economics: The Commons Tradition  

Virtually all of contemporary institutional law and economics follows in thetradition of Commons, and much of this emanates from Michigan StateUniversity through the work of Warren J. Samuels and A. Allan Schmid, bothtrained at the University of Wisconsin by students of Commons. Others atMichigan State University who continue to contribute to this tradition are HarryTrebing, whose works exhibit many of the same concerns as Hale with regard tothe analysis of regulation and public utilities Trebing (1976 , 1989) and Trebingand Estabrooks (1993) ; and Robert A. Solo, much of whose work focuses onmonopoly regulation and institutional change Solo (1967 , 1974 , 1982) . Formerstudents of Samuels and Schmid who have gone on to focus their research onthe relations between legal (or governmental) and economic processes, ratherthan the application of microeconomic theory to the law include Steven G.Medema and Nicholas Mercuro writing individually and together on topicsincluding the Coase theorem ( Medema 1994 , 1996a ; Medema and Zerbe 1997 ),the policy implications of Coasean economics ( Medema and Samuels 1997 ), thecommonalities between the work of the Institutionalists and the work of Coase( Medema 1996b ), law, economics and public policy ( Mercuro and Ryan 1984 ),the comparative institutional approach to law and economics ( Mercuro 1989b ),and on the various schools of thought comprising law and economics, includingthe institutionalist school ( Mercuro 1989a ; Mercuro and Medema 1995 , 1997 ); Philip Wandschneider (1984 , 1986) on water rights; and Josef Broder (1981 , 1983) on the judicial process.

Other examples of the institutional approach to law and economics can befound in H.H. Liebhafsky (1987) , Daniel Bromley (1989) , Robert Seidman (1973) , Elinor Ostrom (1986) , Kenneth Parsons (1974) , Don Kanal (1985) , and MichaelCarter (1985) .

Much, though not all, of the work of A. Allan Schmid and Warren J. Samuels(see the extensive references to their respective work at the end of this essay)can be best understood in the context of the structure-conduct-performanceparadigm:

law or legal structure   behaviour or conduct in the mixed marketeconomy   economic peformance


For institutional law and economics, the emphasis is on the interrelations and mutual interaction between government and the economy, with the effect thatits perspective is described by the relation

law or legal structure   behaviour or conduct in the mixed marketeconomy   economic performance


Both Samuels's and Schmid's practices of institutional law and economics areavowedly positive. As they describe it in the 'Introduction' to their book oninstitutional law and economics ( Samuels and Schmid 1981, p. 1 ), 'Our principalgoal is quite simply to understand what is going on -- to identify theinstrumental variables and fundamental issues and processes -- in the operationof legal institutions of economic significance', and to promote 'the developmentof skills with which to analyze and predict the performance consequences ofalternative institutional designs'. The focus of their institutional approach is ondelving into the workings of the legal-economic nexus in order to understand itsprocesses and thereby analyze the processes and consequences of choice.Resource allocation and the distribution of income and wealth are explained 'interms of a complex causal chain involving both allocation and distribution asfunctions of market forces that depend in turn on power, rights, and the use ofgovernment' ( Samuels and Schmid 1981, p. 4 ).

Samuels and Schmid's respective approaches are best understood as twocomplementary branches that differ only with respect to the relative emphasisgiven to 'structure' and 'conduct'. The work of Schmid has tended to concentrateon the interdependence of structure and performance, with an emphasis onempirical work that explores the economic impact of alternative legal structures.A concise statement of Schmid's approach to institutional law and economics iscontained in his book Property, Power, and Public Choice: An Inquiry IntoLaw and Economics ( Schmid 1987 ), which includes examples of empirical studiesundertaken by Schmid (see Schmid 1987, pp. 257-291 ). In his approach, he bringsto the forefront the many varieties of human interdependence, focusing both on(1) the various types of transactions -- bargained, administrative, and status andgrant transactions, and (2) the varied interdependencies that emerge --technological, pecuniary, and political externalities. Schmid's analysis takes placeunder a situation-specific structure-conduct-performance paradigm, in whichalternative institutional structures (e.g., different definitions and assignments ofproperty rights) are identified, together with the (dis)incentives created, theirconsequences for individuals, firms, and government behavior are identified, andtheir effects on economic performance and quality of life are assessed. As such,it reflects a 'total' approach to policy analysis ( Schmid 1987, pp. 257-258 ), onethat emphasizes the link between structure and performance. As posed by Schmid (1987, p. 188) , the institutional approach to law and economics must ask:

How do the rules of property structure human relationships and affectparticipation in decisions when interests conflict or when sharedobjectives are to be implemented? How do the results affect performanceof the economy?

The work of Samuels, in contrast, has tended to concentrate on describing theinterdependence between conduct/behavior of individuals and groups andlegal-economic performance. For Samuels, the organizing concept is that of thelegal-economic nexus, wherein 'the law is a function of the economy, and theeconomy (especially its structure) is a function of law. . . . [Law and economy]are jointly produced, not independently given and not merely interacting' Samuels (1989a, p. 1567) . Through the legal-economic nexus are worked out thestructures of the law and the economic system, where each serves as bothdependent and independent variable in the construction of legal-economicreality. Legal rules govern 'the terms of access to and participation in theeconomy by potential economic actors', and 'property and other rights . . .govern whose preferences will be given effect through the market' ( Samuels1975, p. 66 ).





C. Central Themes of Institutional Law and Economics  

8. The Evolutionary Nature of Law and Economy  

As noted above, one of the factors emphasized by the institutionalists andespecially John R. Commons in his discussion of the legal foundations of thecapitalist economic system is the evolutionary nature of the economic system.The import of the evolutionary perspective is that it broadens the frame ofanalysis beyond the 'idea of mechanistic maximization under static constraints'( Hodgson, 1994, p. 223 ) to the longer-run processes (gradual or in leaps) ofeconomic development - structural transformations owing to technical, legal, orother forces, knowledge acquisition, and so on. While not eschewing staticanalysis or denying its value, the role of legal change in affecting the course ofthis evolution makes the institutional approach to law and economics inherentlyevolutionary, as exemplified in Commons' analysis, and in particular in hisdiscussion of the evolution of the law of property.

Prior to the late nineteenth century, the U.S. courts held to a physicalconception of property, a view that defined property as value in use rather thanvalue in exchange ( Commons 1924, p. 12 ). One of the implications of thisdefinition of property was that governmental deprivations of exchange value didnot require compensation under the Fifth and Fourteenth amendments. As Commons (1924, pp. 12-14) points out, it was only in the 1870s that the idea ofproperty as value in exchange first began to creep into dissenting opinions ofthe U.S. Supreme Court, and it was not until the 1890s that the Court finally madethe transition from a definition of property as a thing having only use value toa definition that conceived of property as the exchange value of something. Inmaking this transition, the Court was saying not only that physical things areproperty, but that 'the expected earning power of those things is property', andthus '[t]o deprive the owners of the exchange value of their property isequivalent to depriving them of their property' ( Commons 1924, p. 16 , emphasisin original). No longer were physical seizures of property the only 'takings'requiring compensation; it now became the case that activities (includinggovernment regulations) that reduced the exchange value of things could giverise to claims for compensation. The concept of property was further expandedin the Allgeyer case of 1897 to include liberty of access to markets, an importantcomponent in the determination of exchange values ( Commons 1924, p. 17 ). Thereceived definition of property as corporeal property had been expanded toinclude both incorporeal property, -- e.g., debt instruments or promises to pay-- and intangible property -- 'anything that enables one to obtain from others anincome in the process of buying and selling, borrowing and lending, hiring andhiring out, renting and leasing, in any of the transactions of the modernbusiness' ( Commons 1924, p. 19 ).

The import of this expanded definition of property for the development of thecapitalist system is set forth by Commons in the context of farming:

The isolated, colonial or frontier farmer might produce and consume things,attentive only to their use value, but the modern farmer lives by producing'social-use-values' and buying other social-use-values produced and sold by otherbusiness men. In this way he also 'produces' exchange-value, that is, assets. Hefarms for sale, not for use, and while he has the doubtful alternative of fallingback on his own natural resources if he cannot sell his products, yet his farm andcrops are valuable because they are business assets, that is, exchange-values,while his liabilities are his debts and his taxes, all of them measured by hisexpectations and realizations on the commodity markets and money markets, interms of exchange-value or price ( Commons 1924, p. 21 ).


That is, what in part distinguishes capitalism from the colonial and feudalsystems it replaced is the transition from production for one's own use to'production for the use of others and acquisition for the use of self' ( Commons1924, p. 21 ), and it was the adoption of this more expansive definition of propertythat helped to facilitate this economic transition.

Following Commons, the contemporary institutional approach to law andeconomics is evolutionary, emphasizing the importance of historical process andevolutionary change of law through time. As described by Samuels (1989a, p.1578) , the legal-economic nexus 'is a continuing, explorative, and emergentprocess through which are worked out ongoing solutions to legal problems ...'.The legal-economic nexus is that sphere of decision making that reflects theworking out of whose interests are to count as rights, whose values are todominate, and who is to make these decisions. The resolution of these issuesdetermines not just rights, but the allocation and distribution of resources insociety, and hence power, income, and wealth. The structure of legal-economicinstitutions -- the state (whether in the context of the legislature, thebureaucracy, or the judiciary), the firm, and the market -- channelslegal-economic decision making, and this structure is seen as the outcome of anevolutionary process of legal-economic change rather than as movement to asteady-state equilibrium ( Schmid 1989, p. 66 ). Legal change, while gradual, hasbeen continuous, and 'has led to major transformations of the legal system andof the pattern of rights and, thereby, of the system of economic organization andcontrol' ( Samuels and Mercuro 1979, p. 167 ). The pervasiveness of legal changeand the ongoing process of legal-economic reconstruction through the nexusprocess thus makes necessary an evolutionary-historical approach thataccounts for the array of factors and forces promoting both continuity andchange over time. Illustrative examples of this type of analysis are provided by Alexander J. Field (1979 , 1981 , 1984 , 1991) and Daniel Bromley (1989) .

Field (1979 , 1984) argues that a meaningful analysis and explanation of rulesstructures that organize and regulate economic activity cannot be accomplishedby incorporating the rules into an endogenous neoclassical model. Rather, heasserts, a thorough understanding of the determinants and consequences ofinstitutions and rules requires a case-by-case approach that maintains particularsensitivities to the historical, cultural, and legal facets of the particularlegal-economic institution being studied, including the norms that influencelegal-economic behavior. In an analysis critical both of Chicago law andeconomics and of neoinstitutionalist law and economics (particularly the worksof Posner and North and Thomas), Field (1981) asserted that some subset ofinstitutional structures needs to be treated as parametric in the generalequilibrium models and granted an explanatory status analogous to thattraditionally accorded tastes, technology, and endowments in the neoclassicalmodel. More recently, Field (1991) has urged that legal-economic scholarsdevote more extensive attention to the effects of legal rules (particularly throughincome-expenditure effects) on aggregate or macroeconomic variables.

Bromley (1989) , too, criticizes the narrowness of the Chicago andneoinstitutional (or new institutional) models of institutional change -particularly their contention that institutional change is driven solely byconsiderations of efficiency. Against this, he presents an analysis ofinstitutional change that makes such change hinge on four factors: (1) thealteration of the economy's productive efficiency, (2) the redistribution ofincome, (3) the reallocation of economic opportunity, and (4) the reallocation ofeconomic advantage - all worked out over time in the context of individuals andcollectivities pursuing their interest within a larger social-political context.



9. Continuity versus Change  

The recognition of the evolutionary nature of legal-economic relations brings tothe fore a second fundamental theme of institutional law and economics: theever-present tension between continuity and change in legal-economic relations.The evolutionary path of the legal-economic system is derivative of thelegal-economic policy choices that are made over time. Continuity and changeare the outcome of the policy-making process, more specifically, of theinteraction between the groups supporting the respective forces of continuityand change and the power that each can bring to bear on this process ( Samuels1966, pp. 267-273 ). Within this policy-making process (be it legislative,bureaucratic, or judicial) arise and operate forces that, through acts ofcommission or omission, serve to maintain the status quo structure oflegal-economic institutions and relations -- that is, continuity -- while otherforces promote an alteration in these institutions and relations -- that is, change.The ongoing choice process within the legal-economic arena determines boththe institutional structures that obtain at any given point in time and whether the status quo institutional structures, or some other, will prevail in the future, thatis, whether there will be change, and if so how much.



10. Mutual Interdependence, Conflict, and the Problem of Order  

Institutional law and economics views the legal-economic system as a systemof mutual interdependence rather than one of atomistic independence. Theeconomy, says A. Allan Schmid (1989 p. 59) , is 'a universe of human relations',not merely 'a universe of commodities', and within this world each individual hasscarcity relationships with others. While it may be that part of life deals withmovements from positions off of contract curves to positions on contract curvesin the process of exhausting gains from trade, the institutionalist approachplaces strong emphasis on (1) who gets to play, (2) where one starts in the game,and (3) the rules governing the game.

Given the importance of human interdependence and the emphasis on whoplays and what are the starting points, the focus of institutional law andeconomics is on conflict rather than harmony, where '[t]he role of the legalsystem, including both common and constitutional law, is to provide aframework or a process for conflict resolution and the development of legalrights' ( Samuels and Mercuro 1979, p. 166 ). The fundamental problem here is thatof order, which Warren J. Samuels (1972a, p. 584) defines as 'the reconciling offreedom and control, or autonomy and coordination including hierarchy andequality, with continuity and change'. 'The ultimate meaning of the legal andeconomic processes', says Samuels (1971, p. 449) , 'is in terms of their functioningtoward resolving the problem(s) of order'. The existence of conflicting interestsnecessitates both a process (or processes) for deciding between thesecompeting interests and a method (or methods) for determining how theseconflicts are to be resolved.

At the micro level, the firm is seen as something more than a nexus ofcontracts among isolated individual agents. It is a community designed in partto suspend narrow, individualistic calculations of advantage and facilitate thelearning of standard objectives. This is more fully explored by Geoffrey Hodgson(1988) , Melvin Eisenberg (1990) , William Lazonick (1991) , and HarveyLeibenstein (1987) , who focus not only on the social origins of individualpreferences and goals but on the complex processes by which individual utilityfunctions are constructed and revised and by which the meaning of 'profitmaximization' is worked out by agents within the firm. Present within this andother literature is a rich array of analyses of individual psychology, goingbeyond the simplistic rationality assumption; of organizations, going beyondtheir treatment as homogeneous, predetermined entities; of behavior in general,going beyond the singular focus on isolated individuals to the institutional andorganizational environment in which they operate; and so on. Among thesources of these analyses are modern Darwinian evolutionary theory, cognitivepsychology, organization theory, and comparative economic systems. Some ofthe analyses can appear to be either extensions of or departures fromneoclassical economic theory, while other analyses are intended to bealternatives to mainstream economics. One result is the showing that the uniquedeterminate optimal equilibrium solutions of the neoclassical research protocolare both presumptive and forced, heuristically useful for analytical exercises butnot representative of actual economic processes in all their evolutionarycomplexity.

In all this, society is recognized, at least in part, as a cooperative venture formutual advantage where there are both identities and conflicts of interests inongoing human relations. Within this system of mutual interdependence,societal institutions, including the legal system, both enhance the scope ofcooperative endeavors and channel political-legal-economic conflict towardresolution ( Mercuro, 1989b, p. 2 ). The resolution of these conflicts, of whoseinterests government will give effect through law and otherwise, is the resolutionof the problem of order in society -- a working out of a societal structure thatpromotes coherence, security, and orderliness in human relations. Indeed, themanner by which a society comes to channel conflict says much about itsultimate character.



11. Rights, Power, and Government  

Law is fundamentally a matter of rights creation and recreation. Consistent withthe positive, descriptive nature of their approach, institutionalists are concernedwith the rights (re)creation process and the impact of this process onlegal-economic decision making and activity. To understand the importance ofrights from the institutional perspective, it is first necessary to understand thesphere of activities open to individuals and the institutionalist conception of thedetermination of the individual choice process.

Individual decision making is a function of one's opportunity set, which'consists of the available alternatives for action or choice, each with a relativeopportunity cost, which are open to the individual' ( Samuels 1974, p. 120 ).However, these opportunity sets are limited in their scope: owing to humaninterdependence and scarcity, each individual's opportunity set is constrainedand shaped by the opportunity sets of others in society. Since each individualdesires to make choices from a set that is as unconstrained as possible,individuals will wish to control the choices, and hence opportunity sets, ofothers who may constrain their choice. The extent of each individual's ability todetermine his or her own choices and to influence the opportunity sets, andhence choices, of others is the outcome of a process of mutual coercion, wherethe ability to coerce is simply the ability of A to impact B's opportunity setwithout B's consent. An individual's capacity to exercise coercion is, in turn, afunction of that individual's power, defined as 'the means or capacity with whichto exercise choice', and this power is relative to the power of others. Thus, '[t]heopportunity set of the individual, within which he attempts a constrainedmaximizing equilibrium, is a function of the total structure of mutual coercion,grounded upon relative power'. Moreover, power is also a dependent variablein this process, being a function of the choices made from opportunity sets thatexist and evolve through time ( Samuels 1972b, pp. 65-66 ). Opportunity sets, then,are endogenously worked out rather than being exogenously given.

The ongoing attempts to delineate and redefine opportunity sets, throughthe machinations of power and mutual coercion in the face of conflicts, give riseto disputes which necessitate resolution. For example, the upstream pollutingfactory's choice of production technology impacts and conflicts with the choiceof activities of the downstream water user, and conversely. The upstream usercannot exercise choice without impacting the choice of downstream users, andconversely. The resolution of such conflicts comes through the creation andassignment (or reassignment) of legal rights, which define the scope of choicesopen to each individual and the degree to which each is exposed to the choicesof others. Thus, power, and hence coercion, and the resulting opportunity setsand choices, are a function of rights.

The origin of rights, as well as the (re)defining and the (re)assigning of rightsthrough the resolution of conflicts of interest bring to the fore the point thatrights have a dual nature -- 'the opportunity set enhancement of those who haverights and the opportunity set restriction of those who are exposed to them'( Samuels 1974, p. 122 ). Virtually every legal change imposes both benefits andcosts, the enhancement of some opportunity sets and the simultaneousrestriction of others. Externalities are thus ubiquitous and reciprocal -- any(re)definition, (re)assignment, or change in the degree of enforcement of rightsbenefits some interests and harms others; the externality remains, in differentform; it is merely shifted, as was made clear by Ronald Coase in The Problem ofSocial Cost (1960) . From the institutionalist perspective, systems of property,tort, and contract law, then, do not provide solutions to situations of externality,but rather only resolutions, as externalities, and hence benefit and harm, arechanneled in a particular direction through the legal delimitation of rights.

Government is seen to play a central and inevitable role within this process,for rights are not rights because they are preexisting, but rather are rightsbecause they are protected by government. As Warren J. Samuels has written,'Rights are whatever interests government protects vis-à-vis other interestswhen there is a conflict' ( Samuels, 1974, pp. 118-119, 127 ). Rights are thus relativeto and contingent upon 'the legal limitations inherent in their identification andinterpretation, the exercise by others of their rights, and legal and nonlegalchange' ( Samuels 1974, p. 118 ). Each of these factors is a function of therights-creation (and re-creation) process, and hence of the ability of individualsto secure rights (or a change therein) through the use and control ofgovernment. Government thus becomes an object of control for those seekingprivate legal-economic gain or advantage, 'a mode through which relative rightsand therefore relative market (income securing) status is given effect' ( Samuels1971, pp. 441-442 ). The question is not, then, one of more versus lessgovernment, but rather of whose interests government gives effect to throughlaw -- that is, through the process of rights creation and recreation. Contributorsto institutional law and economics thus see terms such as regulation,deregulation, and government intervention as misleading, in that government isomnipresent. For example, it is often said that the adoption of workplace safetyregulations constitutes an intervention of government into the market, yet, suchactivity represents merely a change of the interests to which government giveseffect, as rights -- a movement which expands the rights/opportunity sets ofworkers and reduces the rights/opportunity sets of employers. The issue as towho will have rights thus turns on whose interests government allows to berealized and who is able to use government for what ends. The critical matter iswho is able to control and use the legal-economic nexus in order to controllegal-economic continuity or change ( Samuels 1971, p. 440 ; Samuels 1989a, p.1578 ).

The central implication of the reciprocal nature of externalities is that thedecision over whose interests are protected as rights is necessarily a functionof a choice process -- choice as to who will have rights and who will be exposedto the exercise of those rights, of who will be able to inflict gains and losses onothers, and to what extent ( Samuels and Mercuro 1979, pp. 172-174 ). Thisinevitable necessity of choice reveals that law is not something that is given orto be discovered, but is instead a human artifact marked by deliberative andnondeliberative human choice ( Samuels 1981, p. 168 ). The fact that law is ahuman choice process means that value judgments will necessarily beintroduced in choosing between competing interests, and legal-economicoutcomes are thus 'an expression of the values of those who have participatedand prevailed at each stage of choice in the political-legal-economic arena' -- thatis, those who are able to most effectively use government to further their ownends ( Mercuro 1989b, p. 10 ). Justice, then, reflects not some given set of highfoundational principles, but rather a normative valuational process thatdetermines the laws, norms, and values that are to govern living ( Samuels 1971,p. 444 ; Samuels and Mercuro 1979, pp. 160-163 ).



12. The Problematic Nature of Efficiency  

Institutional law and economics has, on occasion, been characterized asrejecting outright Chicago law and economics. This is not so. Indeed while theinstitutional law and economics literature has been quite critical of certain facetsof the Chicago approach, Warren J. Samuels (1981, pp. 148-149) , for one, haspraised Posner for the usefulness of his analysis in once again bringing to theattention of economists and legal scholars alike how economic conditions affectthe law, and conversely. Nonetheless, one of the hallmarks of the institutionalapproach to law and economics is the rejection of the Chicago and generalneoclassical emphasis on the determination of the efficient resolution of legaldisputes. The institutionalists do not reject efficiency as an important variablein legal-economic analysis, but rather maintain that efficiency alone cannot, andshould not, determine the assignment of rights ( Samuels 1989a, p. 1563 ).

The starting point for the institutionalist critique of the efficiency criterionis the recognition that economic activity -- prices, costs, outputs, risk, income,wealth, etc. -- is not some sort of natural phenomenon, but rather is determinedby the structure of rights that exists in society, with the levels of and changesin each of these variables being in part a function of the legal structure and legalchange over time ( Samuels 1971, p. 440 ; 1989, p. 1565 ; and Schmid 1989, p. 67 ).Each particular rights structure will give rise to a particular set of prices, costs,outputs, etc., and thus to a particular efficient allocation of resources. Hence,there is no unique efficient result. For the institutionalists, the purportedlypositivist Chicago-school rhetoric of 'atomistic industries' or 'contestablemarkets' and the associated concept of 'price-taking behavior' is exposed asnothing more than deeply normative 'rights-taking behavior' ( Samuels andMercuro 1984 ). The institutionalists maintain that inasmuch as rights underlieproduct prices and thus costs, to talk of 'price-takers' bypasses virtually all thatis (or should be) important in Chicago law and economics and much of publicchoice theory.

Because efficiency is a function of rights, and not the other way around, itis circular to maintain that efficiency alone can determine rights. Since costs,prices, outputs, wealth, and so on are derivative of a particular rights structure,so too are cost minimization, value-of-output maximization, and wealthmaximization. (For a detailed examination of the determination of costs in thisregard, see Samuels and Schmid, 1997 .) Different specifications of rights will leadto different (and economically noncomparable) minimizing or maximizingvaluations. The result is that an outcome that is claimed to be efficient is efficientonly with regard to the assumed initial structure of rights ( Schmid 1989, pp.68-69 ) the latter of which is often the very matter at issue. Thus, as Samuels(1981, p. 154) asserts, '[t]o argue that wealth maximization [or any other efficiencycriterion] can determine rights serves only to mask a choice of which intereststo protect as rights. Legal decisions or changes can be said to be efficient onlyfrom the point of view of the party whose interests are given effect through theidentification and assignment of rights'.

Moreover, the definition of 'output' -- of what it is that one is to be efficientabout -- requires an antecedent normative specification as to the appropriateperformance goal for society. Social output (the aggregate well-being of society),consumptive output (the value of goods from the consumer point of view), andproductive output (the value of goods from the producer point of view, i.e.,profits) are three examples of the alternatives that are available. The value-ladenchoice of a particular definition of output as the maximand, which in effect is thechoice of a particular social welfare function where many are possible, will drivethe decision as to what constitutes the efficient allocation ( Samuels 1978, pp.102-104 ).

Further, due to the non-uniqueness of efficiency, efficiency is inevitablybound up with distribution; as Samuels and Schmid (1981, p. 2) describe it, 'theconcept of efficiency as separate from distribution is false'. Rights determinationis a normative activity with both efficiency and distributional consequences,determining which efficient allocation and which distribution of benefits andcosts will carry the day. Rights determine the distribution of income and wealth,which in turn determines the efficient solution that is reached. But at the sametime, the specification of rights, and the resulting efficient outcome, structure thefuture distribution of income and wealth in society. The choice of rights, then,is ultimately a distributional issue: 'With no unique optimal use of resources andopportunities independent of rights identification and assignment, the legalsystem must select the [distributional] result to be pursued: the definition of theefficient solution is both the object and the subject of the legal system ' ( Samuels1978, p. 106 , emphasis in original). In institutional law and economics '[t]hedistribution problem, viz., of power, income, wealth, opportunity, exposure, andsacrifice, is critical to legal-economic research and policy ' ( Samuels, 1975, p. 70 ).Thus, as described by Schmid (1989, p. 69) , 'the whole point is that global welfaremaximization is meaningless', and '[t]o recommend one right over another,analysts must take their stand as naked normativists without the comfort of thePareto-better cloak or any other formalism'.

The recognition of the multiplicity of efficient solutions and the contingencyof any given efficient solution on the presumed structure of rights (the definitionand assignment) and the definition of output reveals the inherent normativeelement that is present in efficiency-based decision making. Each possible legalsolution points to a different efficient outcome, and '[t]here is no independenttest by which the law's solutions can be said to be the efficient solution'( Samuels 1981, p. 155 ). The determination of a particular efficient solutioninvolves a normative and selective choice as to whose interests will beaccommodated, who will realize gains, and who will realize losses.

This line of reasoning leads institutionalists to reject the efficiency theory ofthe common law. Any given rights structure will produce an efficient orwealth-maximizing outcome, and thus '[t]he so-called efficiency of the commonlaw is an "empirical regularity" only in the sense that every common lawspecification of rights can produce a unique, wealth-maximizing outcome'( Samuels 1981, p. 162 ). If different interests had been protected as rights,different efficient outcomes would have occurred. The choice of certain rightsstructures reflects a normative choice for a particular efficient pattern of law andeconomic development over time, where different decisions would have led todifferent patterns of efficient development. Thus, the literature purporting toexplain the efficient development of the common law 'explains everything andnothing' Samuels (1981, p. 162) . 'Wealth maximization cannot ... explain theevolution of the common law: any developmental logic concerning rights in amarket economy would have led the common law to some wealth-maximizingresult' ( Samuels 1981, p. 154 ).

In a similar vein, proponents of institutional law and economics also rejectthe standard theory of rent seeking, which defines rent-seeking activities as'resource-wasting activities of individuals in seeking transfers of wealth throughthe aegis of the state' ( Buchanan, Tollison, and Tullock, 1980, p. ix ). Rent-seekingtheory thereby argues that expenditures of scarce resources by agents in anattempt to garner a privileged position (e.g., an exclusive monopoly franchise)from the state, or, the use of the state (e.g., through legislative activities orlobbying) to alter product price and/or factor prices to enhance profits withouta concomitant increase in output, is wasteful in that resources are expendedsolely for the purpose of effecting a transfer of rents from one party to another.The normative thrust of this theory thus becomes one of promoting policiesdesigned to avoid wasteful, rent-seeking activities, which often involves agreater, more exclusive reliance on markets and a scaling back of government.

The intellectual construct employed by proponents of the rent-seekingliterature is that of the competitive market economy and the legitimized productand factor prices and thus profits that obtain therefrom. Prices and profits thatoccur consequent standard marketplace phenomena -- such as the entering andexiting of firms into and from industries, adopting new technologies, altering thescale of plant, etc. -- are all legitimate. However, when prices and profits arealtered by and/or through the aegis of the state, this is said to result in waste.

From the standpoint of institutional law and economics, this characterizationof rent seeking is an exercise in selective perception and market legitimation( Samuels and Mercuro, 1984, pp. 55-70 ). As the institutionalists have pointedout, to use today's market prices and profits as a basis to determine rents andwastes is to give propriety to extant laws governing the production of goodswhile at the same time selectively culling out one subset of rights to make claimsof wasteful, rent seeking activity. It is the proponents' reliance on the model ofcompetition that gives effect to this selective perception. As is made clear ininstitutional law and economics, models of the economy predicated onprice-taking behavior are in reality models of rights-taking behavior. Marketprices are not absolute, predetermined, and independent of law, but, rather, area partial function of rights -- the latter related directly to the government'subiquitous role in creating, defining, assigning, enforcing, and altering rights.Moreover, today's prevailing market prices of products and factors ofproduction are all predicated upon the past use of the state and pastrent-seeking activities. Market-generated product and factor prices that make upa firm's revenue-cost calculation are property-rights specific; as a consequence,so too is its net revenue calculation a function of rights. The government's rolein the economy remains ubiquitous, and, accordingly, a theory that purports toidentify rent-seeking behavior and the economic wastes therefrom is questionbegging. There are no correct rights, prices, profits, or correct structure of rents.Thus, rent-seeking theory is characterized as an artificial, misguided normativetheory that will 'mislead positive analysis and generate artificial distinctions andthereby provide no real basis for distinguishing between permissible andimpermissible activities' ( Samuels and Mercuro, 1984, p. 67 ; see also Medema,1991 ).



13. Toward a Comparative Institutional Analysis  

The driving force behind institutional law and economics is the need to come togrips with the interrelations between legal and economic processes. Warren J.Samuels (1975, p. 72) identifies three efforts that are central to this process: (1)'models of legal-political and economic interaction' must be developed; (2)'objective, positive, empirical studies of government as both a dependent andindependent variable, and of economic activity as both an input and an outputof political-legal processes' must be undertaken; and (3) efforts must be made 'towed both theoretical and empirical analyses toward a self-consciously objective,positive comprehension of law and economics'. Such analysis will serve the twinpurposes of deepening the understanding of legal and economic processes andtheir interrelations, and providing a more sound basis upon which to predict thepotential consequences of legal-economic change.

The import of this becomes clear in the institutionalist assertion that theessential normative element in political-legal-economic decision making meansthat a choice must be made between alternative efficiency-distributional resultsand hence between alternative political-legal-economic institutional structures.This, in turn, necessitates a comparative institutional approach tolegal-economic analysis. The institutional structure cannot, in this view, merelybe assumed away or taken as given. Rather, it must be the subject of study and,more specifically, the legal-economic decision-making process must involve acomparison of the effects of institutional alternatives on social well-being. Theneed for a comparative institutional approach to legal-economic policy, and notonly by the institutionalists, has long been recognized. Other proponents of acomparative institutional approach, coming from somewhat differentperspectives include Ronald Coase (1960, esp. pp. 42-44) , Harold Demsetz (1969) , Neil K. Komesar (1981 , 1994) , Richard Stewart (1987) , and Kenneth Shepsle andBarry Weingast (1984) generally, though not exclusively working under thebanner of the New Institutional Law and Economics.

The comparative institutional approach is general rather than partial ( Samuels1972a, pp. 582, 585 ), and consists in describing and analyzing

the systematic relationship between 1) the structure ofpolitical-legal-economic institutions, focusing on the rights and rules bywhich they operate; 2) the conduct or observed behavior in light of theincentives (penalties and rewards) created by the structure ofinstitutions; 3) the consequent economic performance, i.e., the allocation and distribution of resources that determine the character of economiclife under these institutions ( Mercuro 1989b, p. 11 , emphasis in original).

Within this structure-conduct-performance paradigm, the object, then, is toexplain and compare the outcomes that will occur under real, discrete, alternativeinstitutional structures. A comparative institutional approach to law andeconomics emphasizes the need to explain and analyze the available alternativesand the consequences of choice at three distinct stages: (1) the constitutionalstage of choice -- the social contract that binds people together, which is subjectto reinterpretation and revision; (2) the institutional stage of choice -- thestructuring and restructuring of political-legal-economic institutions; and (3) theeconomic impact stage of choice -- describing the economic impacts of existingor potentially revised legal-economic relations, be they in the form of privateproperty rights, status rights, communal property ( Mercuro 1989b, pp. 3-6 ) andopen-acces resources ( Mercuro, 1997 ).

The analysis must be done at each of these levels, and not solely in terms ofefficiency, but also in terms of the distribution of income and wealth,employment rates, and any other factors that may affect the quality of life or theproductive capacity of firms. As ( Samuels 1981, p. 165 ) has argued, '[f]or law tobe preoccupied solely with economic maximization would rob law of life and ofmuch of what makes for human meaning and significance'. The goal here is notnormative judgment, but description: 'A viable approach to the study of theinterrelations between law and economics should be content with describing thefull array of economic impacts (including both the allocation and distribution ofresources) of alternative institutions and legal arrangements together with anarticulation of whose interests will be served and at whose expense' ( Mercuro1989b, p. 12 ). Such analysis will not privilege one set of interests over others, butit will enable those who study and participate in the processes of thelegal-economic nexus to better understand these processes and their resultingeffects on law and economy ( Samuels 1989a, p. 1578 ). Institutionalist-orientedcase studies include the works of Carter (1985) , Seidman (1973) , Schmid (1985) ,and Wandschneider (1986) . Carter (1985) criticizes the neoclassicalmicroeconomic explanation of institutional arrangements as at best partial andat worst mystifying. Employing a Wisconsin institutionalist perspective thatrecognizes both the relevance of economic power and the historical contextwithin which exchange occurs, Carter revisits Commons's analysis of 'yellowdog' labor contracts and analyzes the interlinked tenure-credit contracts. Seidman (1973) contrasts the classical and anticlassical perspectives onfacilitative law and finds the latter, which recognizes the asymmetric status andpower of parties to a contract to be controlling, to better describe whattranspired in the colonial African economies of Kenya and Ghana. Schmid (1985) ,writing on biotechnology-related property rights issues in the agricultural sector,demonstrates that attempts to provide exclusivity may inadvertently createadded costs and affect the choice of breeding method and agriculturaltechnologies, was well as the division of rents between inventors and the public. Wandschneider (1986) analyzes the property rights institutions that allocatewater in the northwest U.S. He finds that, as compared to the EPR [efficientproperty rights] model, an institutionalist model that recognizes (1) that socialnorms may supersede economic rationality, and (2) that conflict overdistributional issues may block Pareto-better outcomes, is better able to explainthe development of rights to water in the U.S.

Of course normative judgments must be made in the process of reachinglegal decisions. Recognizing this, the institutional approach emphasizes the needfor openness and value clarification in the political-legal-economicdecision-making process, clearly a legacy of the Legal Realist movement withinthe field of law ( Samuels 1989a, p. 1573 ). Economists, legal scholars,policy-makers, and judges should strive to make the value premises underlyingtheir conclusions as explicit as possible, so that the choice process can beeffectuated 'carefully and overtly' rather than 'carelessly and covertly' ( Samuels1978, p. 113 ; 1989b ). This call for openness is clearly tied to the comparativeinstitutional method:

Not only should normative premises be made explicit, but an array of studiesshould be conducted on the basis of alternative normative (and factual)assumptions. To do only one study is to give effect to only one perception andspecification of outputs, costs, benefits, and rights. Alternative studies callattention to the subtle intrusion of ideology and partisanship, emphasize thenecessary and inevitable critical choice of underlying values, highlight thefundamental distributional consequences that depend on the politicaldetermination of output definitions, and so forth ( Samuels 1978, p. 112 ,emphasis in original).


The obfuscation of values and underlying normative premises within so muchof the Chicago school of law and economics and public choice theory is thebane of the comparative institutional approach. Relying solely on the Paretoefficiency criterion serves to obfuscate and impede the normative choice processthat is necessarily at work in the legal-economic nexus. Examples of scholarshipthat avoid much of the obfuscation brought on by solely relying onPareto-efficiency analysis include Bromley (1989) , Guido Calabresi (1985 , 1991) , Mahlon G. Lang (1980) , Ronald Griffin (1991 , 1995) , and Ezra Mishan (1972) .

Calabresi (1991) demonstrates that the frequently-made distinction betweenremoving inefficiencies (making moves to the Pareto frontier) and innovating(pushing the Pareto frontier outward ) is a false dichotomy. He argues thatmoves from the status quo are not possible without either (1) disadvantaging atleast one party (hence making distributional considerations unavoidable, or (2)trying to shift the frontier outward (a process that also typically entailsdistributional consequences). As a consequence, Calabresi, in a combinedconcern for efficiency and distribution, calls for a method of analysis thatattempts to answer the following question: Which actions are most likely, atleast cost, to shift the frontier outward, and who will gain and who will lose fromsuch moves?

Calabresi (1985) also argues that ideals, beliefs, and attitudes matter inshaping the law. Recognizing that legal entitlements alter our perception ofbenefits and costs, he examines the legal response to beliefs and attitudes. Thefocus on ideals, beliefs, and attitudes highlights the limitations inherent in theeconomic analysis of legal rules. Calabresi poses the hypothetical question: Howdoes or should a society contemplate 'improvements' - be it the automobile orany such improvement that spreads benefits and costs across society? He asks:"Is it worth the price we pay as a society?" "Who should pay the price?" And,given law's commitment to the concept of reasonableness, he asks: "Who'svalue system determines what is reasonable?" The thrust of the book is tocompel society to understand and articulate the tradeoffs being made betweenthe values of different segments of society as we embrace new technologies orways of life. Consequently, the call is for an honest and open approach toresolving issues involving conflicting values and beliefs.

Lang (1980) critically examines several concepts of efficiency as related topolicy analysis, exposing their normative content and thereby demonstrating thelimits to efficiency-based policy analysis. He observes that property rightsissues arise from different sets of values which, if reflected in policy, lead todifferent Pareto-efficient allocations of resources. He calls for policy analysis to(1) undertake a greater use of economic analysis to determine the incidence ofbenefits and costs associated with alternative remedies, or (2) pursue an'instrumental economics' which places a greater degree of emphasis on thedesign of policies and institutions which will achieve a specified social andeconomic end. In a similar vein, Mishan (1972) critically examines Hochman andRodgers' (1969) position that one can resolve the distribution problem forsociety by promoting Pareto-efficient redistributions. After exploring theundesirability of efficiency-derived distributions, Mishan concludes thateconomists ought to concede that welfare economics is founded on ethics andmake policy recommendations or proposals consistent with the ethics of thesociety for which the policy is intended.

Griffin (1991) critiques the traditional market- and price-guided policies forinternalizing externalities offered within the context of neoclassical theory -policies which, he argues, are insufficient for this purpose. He contends that themajor omission in neoclassical theory is a mechanism to incorporate institutionaloptions (and their associated transaction costs) to resolve the problems broughton by negative externalities, and he advances a method of explicitlyincorporating institutional transaction costs into welfare diagrammatics. In a laterpaper, Griffin (1995) examined the differences between the economic criteria ofpotential Pareto improvements and Pareto improvements as normativefoundations from which to assess public policy. He demonstrates that potentialPareto criteria have greater disciplinary acceptance than their normativefoundations merit and that the Pareto criterion has suffered undue criticismconsequent the former.



14. Summary  

In contrast to some other approaches to law and economics, the institutionalapproach draws no distinction between jurisprudential, legislative, bureaucratic,or regulatory treatments. All are seen as particular parts or manifestations of theinterrelation of government and the economy, or of legal and economicprocesses. Underlying the major thrust of the institutional approach to law andeconomics are two complementary modes of analysis. Instead of concentratingon a unidirectional sequence in which the law or legal structure governsbehavior or conduct in the mixed market economy which in turn drives economicperformance, for institutional law and economics the emphasis is on theinterpenetration and interrelations between government and the economy, sothat law or legal structure, and behavior or conduct in the mixed marketeconomy, and economic performance are dependent on each other in a processof circular and cumulative causation.

Correlatively, whereas some of the more orthodox approaches to law andeconomics seek unique, determinate optimal equilibrium solutions, institutionallaw and economics finds such solutions to be question-begging andconcentrates on identifying and analyzing the processes by which the variouslegal structures, the conduct, and the economic performance are worked out.Similarly, those contributing to institutionalist law and economics do not feelobliged to identify particular legal arrangements as 'optimal'. They argue thatputatively optimal solutions to problems of policy only give effect to selectivepreconceptions and assumptions as to whose interests are to count, for whicheconomists have no particular basis on which to choose, especially given thatso-called optimal solutions are driven by and specific to the choice of rights etc.which produce them -- ironically with those very rights structures which are atcenter stage in virtually all schools of thought of law and economics.

Although institutionalists are interested in identifying the alternatives opento policy and trying to say something of their consequences, they are reluctantto substitute their preferences for those of actual legal and economic actorsengaged in the processes of working solutions out by and for themselves.Along comparable lines, institutional law and economics distinguishes between1a) a market economy (typically a mixed-market economy, often somewhat vagueon 'the mix'), 1b) a conceptual market (a market typically characterized with avaguely described 'minimalist government' in the context of 'pure competition'),and 1c) markets in general (typically a euphemism invoked to avoid theimportant factors and details inherent in the previous two conceptions of themarket) on the one hand, and 2) actual institutionalized markets , on the other.Accordingly, they question the blind reliance on 'the market' -- whether type a,b, or c to solve problems inasmuch as institutionalized markets, in their view, area function of the institutions and power structures which form and operatethrough them. To affirm solution by a 'market' together with the outcome whichobtains and purported to be optimal, is to give effect to a particular structure oflaw, rights, and therefore power and thus beg the operative issue(s). For thosewho narrowly seek markets and putatively optimal solutions to problems ofpolicy, institutional law and economics will be disappointing.

It may well be that since the overtly positive and even agnostic approach ofinstitutional law and economics is not comforting to those who would seekrefuge in determinate solutions to the questions of legal-economic policy, thensome may be inclined to dismiss it on this ground. Against this, Schmidresponds: 'If [institutional law and economics] has no dispositive answer toresolve policy arguments, what is it good for? It can identify many less thanobvious sources of power in an economy so that people can know where theirwelfare comes from. It can raise the level of normative debate so that issues canbe joined and people can live with tragic choices rather than ignoring anddismissing them' ( Schmid 1994, pp. 36-37 ). While singular solutions tolegal-economic issues reflect only one particular set of value premises and oneparticular conception of the facts, benefits, and costs at issue, the comparativeinstitutional approach, by recognizing the multiplicity of potential solutions andunderlying value premises, attempts to flesh out both what is actually going onin the legal-economic nexus and the alternative possibilities that are open tosociety in the ongoing social construction and reconstruction of legal-economicreality.



Acknowledgments  

We wish to thank the Fritz Thyssen Foundation for its generous support and thefaculty and staff of the Erasmus Program in Law and Economics at the Universityfor Hamburg in providing Professor Mercuro a productive environment in thetime during which this project was completed. We are indebted to A. AllanSchmid, the editors, and two anonymous referees for their insightful commentson earlier drafts of this material. The excellent research assistance of MaryTherese Cogeos is also gratefully acknowledged.



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Cases  

Allgeyer v. Louisiana

© Copyright 1998 Steven G. Medema, Nicholas Mercuro and Warren J. Samuels