Suresh Naidu and Elliott Ash —
Our previous post dealt with the outsize influence of well-funded conservatives at the interface between economics and law, and in particular over the judiciary. This influence is the product of many decades of institution-building, which includes the adoption of a particular (and in our opinion outdated) approach to economics in legal research and teaching. Addressing the analytical imbalance requires an articulation of and investment in an updated approach to economics. This post introduces some idea of how such a modern law and economics might look, and highlights the diverse normative implications of state-of-the-art economics. As we will see, taking economics seriously is consistent with many different policy positions.
The place in law where economics has made its biggest impact is probably antitrust, where doctrine was transformed over the course of the 1980s. The key doctrinal achievement of this movement was the consumer welfare standard, based on the canonical economic model of monopoly. Mergers among previously competing firms will increase market power but may also lower costs, with potentially ambiguous effects on price. The doctrine states that the legality of mergers should be judged based on net benefits to consumers, with no attention paid to the distribution of returns across producers or factors of production (e.g. capital and labor).
One of the early advocates for the standard, Circuit Judge Robert Bork, justified it with dubious law and dubious economics. First, he forwarded the legal argument that consumer welfare was the statutory intent of the Sherman Act (wrong: Senator Sherman was particularly invested in protecting small producers). Second, Judge Bork forwarded the economic argument that “consumer welfare” was equivalent to economic efficiency (also wrong: this would normally include profits and the welfare of non-consumers such as workers).
The consumer welfare standard has now completely taken over antitrust regulation while coming under sharp criticism from legal scholars (many of whom are on this blog!). In the meantime, the standard has spawned an industry of analysts making complex quantitative models assessing the incidence of a given merger on consumer welfare. Unsurprisingly, the consumer gains predicted by pro-merger expert witnesses rarely materialize in ex-post merger evaluation by disinterested analysts. And industrial concentration levels are the highest in a century.
The focus on consumer welfare is not completely crazy – for example, ignoring positive effects of a merger on firm profits (owned by a small minority) is roughly progressive. But the rule (as applied) is coarse and ambiguous, and a more inclusive view of “consumer welfare” could incorporate myriad interests besides low prices for high-quality goods. Consumers are also citizens, workers, borrowers, lenders, and (rarely) owners of firms. A consumer welfare standard that internalized all the welfare margins would be quite comprehensive. It would force authorities to handle threats to the political process, to free flow of information, to wages, and to the structure of financial markets. It would be closer to the notion of “social welfare” that is more familiar in normative economics.
In practice, these other considerations appear to have motivated the courts, who have often deviated from the consumer welfare standard to account for them. One reading of antitrust law suggests that it ought to protect the “competitive process, in service of preserving the welfare of the merging parties trading partners, whether buyers or sellers.”
But the comprehensive view of consumer welfare implies even more foundational changes. For example, it would address the curious omission from antitrust of labor market power, which has been cleanly detached despite the availability of economic tools to diagnose employer concentration and wage fixing. Including labor market power in merger analysis would widen the consumer welfare standard toward a “worker welfare standard” and have a deeper distributional reach. The Roosevelt Institute has proposed an “effective competition standard” which directly targets market structure. Even more comprehensive would be a “public interest standard” that values not only economic but also political and potentially cultural impacts of mergers. This approach would attempt to empirically document and anticipate this wider range of responses by firms to an expansive antitrust mandate.
And yes, this would involve statistical work integrated with mathematical models, to keep track of sophisticated business practices across a complex, dynamic political and economic system. Developing these tools so that they speak to broader antitrust criteria and are believable by a wide set of stakeholders is the kind of research challenge that would keep economics graduate students up late in the computer lab.
Antitrust is concerned with market power – the power to set prices on consumer goods. This is just one example of the more pluralistic notions of power that have entered economics discourse and research. The power of bosses over unionized workers is another example, where our own research shows how these notions can inform empirical work in law. In that paper, we developed new measures of worker authority constructed from the text of collective bargaining contracts and documented effects of bargaining power on contract terms. In addition to bargaining power (share of surplus won in transaction), short-side power (power over quantities e.g. credible threat of firing) and market power (power over prices) feature in workhorse models of the labor market and help explain various empirical anomalies. For example, employer market power over wages helps explain the repeatedly estimated zero effect on employment of the minimum wage. In the presence of monopsony power in the labor market, minimum wages can be seen as equivalent to price regulations in a monopolized product market. More generally, economic transactions can be understood as rife with power, meaning, and norms – far removed from Abba Lerner’s criticism that the field treats “an economic transaction” as “a solved political problem.”
Importantly, modern economics is overwhelmingly empirical, more focused on extracting robust insights from data than deriving results about abstract, frictionless economies. These empirical results – ranging from the effect of minimum wages to the returns to schooling to the measurement of inequality – have yielded insights valued across a variety of social sciences. In commentary on Piketty, for example, some legal scholars believe the empirical research in economics is basically sound, but discount the theory (even the idea of general theories) rather than dialoguing with it. This is a mistake, as a lot of economic theory goes into the statistics, from price indices to accounting identities, and there is economic theorizing baked into the assumptions behind many empirical measurement exercises. Further, despite plenty of blunders and dead ends, economic theory is one of the most powerful tools social science has developed to comprehend complex interactions among purposive actors.
In particular, mainstream economic theory has internalized the lessons of behavioral economics. Well past cognitive “nudges,” behavioral economics has documented pervasive altruism, spite, and reciprocity. Economists are catching up with sociologists, anthropologists, and psychologists in examining the social forces that shape preferences, rendering obsolete slogans like “De Gustibus Non Est Disputandum.” This is not simply rediscovering insights from other disciplines, but building on them to integrate the full range of human behavior into the study of markets and economic life.
Meanwhile, political economics (or “political economy” as done in economics departments) includes the remnants of public choice but also prioritizes the roles of history, culture, politics, power, and institutions. Political economists have accepted that these concepts are crucial to generating (or impeding) economic development and inequality. This research owes a debt to the insights of historians such as Robert Brenner (although most economic history may be too reductionist for the tastes of contemporary historians).
One upshot of these trends in empirical, behavioral, and political economics is that legal scholarship is more important than ever to economists. The details of laws and regulations, and how they are understood by legal actors, are integral to understanding the empirical and institutional context of most economic data. We are optimistic that the next generation of collaborations in law and economics will find fruitful ground for research.
For lawyers interested in this new view of economics, a good distillation is CORE’s “The Economy,” an introductory textbook written “as if the last 30 years happened.” Implicit in CORE is a different paradigm for how economics should be introduced. Ecological constraints, fairness, and inequality (alongside economic efficiency) are brought in as normative outcomes. The change in values then leads to a change in focus: integrating finance into the macroeconomy, explaining why workers are afraid to lose their jobs, and understanding when companies get to set prices. CORE features a pluralistic library of models, rather than a singular focus on supply and demand as a benchmark from which the “real” economy deviates. Examples from economic history are used throughout. It is also produced collectively, largely by volunteer academic labor (ourselves included), and distributed under a Creative Commons license. The open-source values embodied in CORE’s production process are far away from the dated view of actors as purely self-interested profit maximizers.
This new approach to economics could begin to take hold even in legal academia, for example through the adoption of CORE curriculum concepts in courses on economic analysis of law. A new baseline course for introducing law students to economics is overdue, as law-and-economics analysis is too important to be confined to 1970s price theory. To bring a political economy of law worthy of the name requires an economics up to the task.
Suresh Naidu (@snaidunl) is Associate Professor of Economics and Public Affairs at Columbia University. Elliott Ash (@ellliottt) is Assistant Professor of Law, Economics, and Data Science at ETH Zurich.