The Invisible Hand Meets the Internal Point of View: The Strange Mish-Mash of Law & Economics

Posted by Jeff Lipshaw

Richard Posner published an eminently sensible analysis of the bursting of the credit bubble in the Wall Street Journal the other day (a prelude, I assume, to his new book, The Failure of Capitalism, which he no doubt wrote in a couple nights of intense work).  I’m not sure what’s going on in his thinking, but the virtue of having what appears to be very few unpublished thoughts is that we ankle-biters have all sorts of grist for the mill when we find changes in thinking or contradictions.  For some reason, it got me thinking about some of the, well, (how should I say this?) odder results of the combination of economics and law, such as Judge Posner’s 1993 comment that “[a]t the heart of economic analysis of law is a mystery that is also an embarrassment: how to explain judicial behavior in economic terms. . . .”  In the spirit of Thomas Kuhn’s The Structure of Scientific Revolutions, it seemed to me fair to trace this particular convergence of philosophy, science, and economics.  (I’ve done it before, but more people will read this post in a couple hours than have combined read the essay!)

The image that comes to mind is that game in which you start with one word, and by changing it one letter at a time into a series of different words, you finally end up at a word that is the opposite of, or an ironic twist on, the original word.  Remember what Adam Smith’s invisible hand was?  The wealth of nations comes about from individual self-interest.  “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”  That is, each individual doesn’t worry about creating a better world, but a better world comes about regardless.  (That’s why Judge Posner correctly says that classical microeconomics doesn’t try to get inside the head of each actor – it just assumes the actors, as a whole, are rational in seeking their self-interest, like rational frogs.)  But the combination of law and economics has produced (incrementally, I think, like the word game) a “scientific” orthodoxy or paradigm (see Kuhn) in which it’s assumed that the butcher, brewer, baker, or frog actually has societal welfare maximization inside his or her head when making decisions.  (Steve Bainbridge expressed this in economic jargon the other day.  Corporate boards don’t generally make decisions based on pareto-optimality, i.e., making everybody better off; they make “Kaldor-Hicks” decisions, which means that they are looking to maximize the corporation’s share of any consumer surplus without regard to its overall impact on society.  That’s what we all do every time we haggle with somebody over the price of the goods or services.)  This transformation (or Kuhnian paradigm) completes itself in models like the justification of contract formalism proffered by Alan Schwartz and Robert Scott (contracting parties really do want to maximize the joint surplus, not their individual share of it), or Ronald Gilson’s justification of lawyering, in which he theorizes the only reason lawyers are present is because they have to increase the value of the total deal, not just each party’s Kaldor-Hicks share.  I’ve criticized both of those models in other pieces.

Here’s my Kuhnian thesis.  About a hundred years ago, the dominant philosophy of science was logical positivism.  (This was the Vienna Circle.)  The idea was that only the observable had any meaning at all – metaphysics was meaningless, including any attempt to posit a priori concepts like causation in the explanation of the world.  In other words, the only appropriate tools in the scientific tool box were observations of regularities, and the use of deductive logic.  The logical positivists viewed any attempt to explain one event in terms of another by way of “causation,” for example, as without meaning.  From this basis, Carl Hempel developed his “covering laws” thesis, Popper rejected the verification principle in favor of falsification, and so on.  The point is that philosophers of science were rejecting Kantian metaphysics in favor of a strict empiricism.  What we want to do is identify the regularities, not try to explain why they are occurring.

I don’t think it’s a coincidence that the concepts of legal positivism were developing at about the same time.  Hans Kelsen developed his “Pure Theory of Law” to identify positive law, but it turned on neo-Kantian metaphysics expressed in the fundamental Grundnorm, an a priori concept (i.e., one accessible to us merely by reason, and preceding our experience of the world) by which physical events took on legal consequence.  H.L.A. Hart’s positivism put aside the metaphysics, but substituted the Rule of Recognition, and the “internal point of view.”  That’s the key move:  the melding of the objective and observable (i.e., positive) with the subjective and internal.  Note the paradox that is now simply ignored.  We observe people stopping at red lights and going on green lights, but that only tells us there’s a norm.  What makes it law, objectively and positively, is the subjective view of the individual from the internal point of view – the placement of the traffic light traces back to a “Rule of Recognition” by which the subjective actor recognizes the light has having the force of law.

So, economics is a science in the logical positivist tradition.  It ought not try to speculate why things are happening, but to explain or predict regularities.  If marginal costs exceed marginal revenues, generally the firm will shut down production.  If interest rates go down, generally demand for houses will go up.  The explanation of law, on the other hand, in the positivist tradition at least, demands that we look at the internal point of view; otherwise we may be studying norms and not law.  Note again that there is a metaphysical paradox that Hartian legal positivism just doesn’t contemplate.  The incremental result of combining the two – the external point of view of economics and the internal point of view of law – is the mish-mash in which, against all intuitive good sense, the theory demands (see Schwartz and Scott or Gilson as evidence) individual actors incorporate the external point of view in their internal motivations!

To me, reading these accounts of motivation is as strange as if reading a theorist in quantum mechanics who felt obliged to explain the individual motivations of the electrons versus merely predicting where they’d be.