Public Choice 107: 333–357, 2001.© 2001 Kluwer Academic Publishers. Printed in the Netherlands.

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The colour of the judge’s eyes: Efficiency as a criterion for thelegislature and for the courts ∗

DAN USHERDepartment of Economics, Queen’s University, Kingston, Ontario, K7L 3N6, Canada;E-mail: usher@qed.econ.queensu.ca

Accepted 20 November 1999

Abstract. Should courts adjudicate to promote efficiency in the economy, or should courts becontent to apply the law as they find it? The literature of law and economics has much to sayabout how to identify efficiency in the construction of the law, but little to say about whosebusiness it is to promote efficiency in the law, in so far as efficiency is warranted. It is arguedin this paper that efficiency belongs to the legislature and that adjudication for efficiency bythe courts is self-defeating.

“It is strange that a doctrine as faulty as that developed by Pigou should have been soinfluential, although part of its success has probably been due to the lack of clarity in theexposition. Not being clear, it was never clearly wrong. Curiously enough, this obscurityin the source has not prevented the emergence of a fairly well defined oral tradition”.

R.A. Coase, “The Problem of Social Cost”, p. 39

The major premise in the economic analysis of law is that the law ought tobe efficient. The premise is that, in choosing among alternative legal rules– in assessing the pros and cons of strict liability v. negligence, in settingthe severity of punishment, in evaluating no-fault insurance, in apportioninglegal fees between winner and loser at court, or in establishing the boundariesbetween property rights – the best rule is whatever promotes efficiency in theeconomy as a whole, where efficiency is synonymous with the maximizationthe national income or, equivalently, with the minimization the total cost ofwhatever harm the law seeks to constrain. Thus, Coase1 speaks of the max-imization of “the value of production” as the right criterion for the resolutionof disputes over property rights, Calabresi2 would place responsibility foraccidents upon “the low cost avoider”, Becker3 identifies optimal punishmentwith the minimization of the sum of the cost of crimes committed, the cost tothe innocent of evading crime and the cost to the state of detection and pun-ishment, and virtually every text-book in law and economics designs optimal

∗ With thanks for helpful comments to Dan Bernhardt, Steve Kaliski, Filip Palda andKlaus Stegemann, and to participants in seminars at Trent University, York University andthe committee on Austrian Economics at New York University.

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law on some such criterion.4 In effect the efficiency premise treats the choiceamong alternative laws as a sub-category of cost-benefit analysis. A proposedhighway, airport or hospital is built, or not as the case may be, according towhether the benefits exceed the cost “to whomsoever they may accrue”. Aproposed change in the law might be assessed accordingly.

The object of this paper is not to evaluate the efficiency doctrine per se,but to consider a related question that is not often discussed: If and in so faras efficiency is the right criterion for the law, whose business is it to fashionthe law appropriately? Is it the business of the legislature or is it the businessof the courts?

To say in this context that efficiency is the business of the legislatureis to say that the legislature may fashion law efficiently or otherwise as itsees fit with no appeal to the courts in the event that laws are not designed“appropriately”. The role of the courts is then limited to the enforcementof the laws as they are, regardless of whether efficiency is promoted andregardless of whether judges “know” that the law should be other than it is.Alternatively, to say that efficiency is the business of the courts is almost toelevate efficiency to a constitutional mandate. On this view, it becomes theduty of the courts to adjudicate in accordance with the law as it should be, onthe understanding that the law as it should be is whatever promotes efficiencyin the economy as a whole. It becomes the duty of the courts to save the dayby ignoring legislation when the legislature is so foolish as to pass laws thatfail to promote the efficiency of the economy as a whole.

Efficiency as a criterion for the courts is open to two distinct interpret-ations: Efficiency may be promoted by adjudication 1) in accordance withthe law as it should be or 2) in the case at hand. In a dispute between partiesover the ownership of resources or boundary between property rights, the firstprocedure is to resolve disputes in accordance with rules deemed best in thejudgment of the court for promoting efficiency in the economy in the long run,while the second procedure is to award ownership to whichever of the partiescan make the best use of the resources in dispute. For instance, in the famousdispute between the doctor and the candy maker,5 the first procedure is forthe court to ask whether existing zoning laws are conducive to efficiency inthe long run, while the second procedure is for the court to find for one partyor the other according to whether the cost to the doctor of the noise from thefactory of the candy maker exceeds the cost to the candy maker of adoptinga quieter mode of production. Both interpretations of efficiency as a criterionfor the courts will be discussed below.

My own view of the matter is that judicial activism in the name of effi-ciency is a preposterous doctrine to which almost nobody subscribes expli-citly, but which is worth discussing because, as illustrated in an appendix at

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the end of the paper, it creeps implicitly into the economic analysis of thelaw from time to time, or may be mistakenly inferred.6 The paper begins witha discussion of efficiency as a criterion for the citizen or for the legislature,reviewing what I believe to be a commonly-held and, in my opinion, correctview of efficiency as a criterion for public policy. The core of the paper isa discussion of two interpretations of efficiency as a criterion for the courts.The paper concludes with a brief discussion of efficiency as a criterion for thelegislature.

To locate these questions, it may be helpful to begin with Coase’s dis-cussion of efficiency in his analysis of Bass v. Gregory. The plaintiff wasthe owner of a pub. The defendant was the owner of adjacent cottages. Formany years, the cellar in the pub was ventilated by a shaft that opened ontothe defendant’s yard. One day, the defendant blocked the shaft because theoccupants of the cottages found the smell from the cellar of the pub to beunpleasant. The owner of the pub sued to recover his customary ventilation.The court sided with the plaintiff. The owner of the cottages had to unstopthe well and endure the smell. This is what Coase had to say:

“The judge therefore held that the public house had such a right by ‘thedoctrine of the lost grant’. This doctrine states ‘that if a legal right isproved to have existed and has been exercised for a number of yearsthe law ought to presume that it had a legal origin’. . . . The reasoningemployed by the courts in determining legal rights will often seem strangeto an economist, because many of the factors on which the decision turnsare, to an economist, irrelevant. Because of this, situations which are,from an economic point of view, identical will be treated quite differentlyby the courts. The economic problem in all cases of harmful effects ishow to maximize the value of production. In the case of Bass v. Gregoryfresh air was drawn through the well which facilitated the production ofbeer but foul air was expelled through the well which made life in the ad-joining houses less pleasant. The economic problem was to decide whichto choose: a lower cost of beer and worsened amenities or a higher costof beer and improved amenities. In deciding this question, “the doctrineof the lost grant” is about as relevant as the colour of the judge’s eyes”.7

This passage is puzzling in several respects:1) It is unclear when, if ever, “the doctrine of the lost grant” is valid. The

doctrine is that a lost grant might be presumed when rights are conveyed bypractice since time immemorial. Coase could be interpreted as saying no morethan that different professions have different preoccupations, doctors withhealth, bakers with bread, engineers with the stability of bridges, judges withlost grants and economists with efficiency. If that is all Coase is saying, the

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paragraph is true but uninteresting. Alternatively, Coase could be interpretedto mean that the economist’s ideal of efficiency ought to be an ideal for thelaw as well, that efficiency takes precedence over established rights and that,to generalize somewhat, the rights of property ought always to be subordinateto the maximization of the value of production. The question is whether ina dispute between two parties, the court should a) favour one or the other toenhance the efficiency of the economy as a whole or b) respect property rightsas they are in the community at large.

2) It is unclear by whom efficiency is to be invoked. Is Coase updatingBentham?8 Is efficiency the modern surrogate for utility as a guide to theprinciples of morals and legislation, or is efficiency to guide adjudicationas well? Obviously, when a law is intended to promote efficiency in somedomain of life, it is incumbent on the judge to recognize that purpose indeciding the case at hand. Once again, if that is all Coase is saying, he is notwrong but hardly original. The bite of “The Problem of Social Cost” is thatCoase is seen as going considerably further, as claiming that the law is whatpromotes efficiency, that Acts of Parliament which fail to promote efficiencyare subordinate to true law, and that such Acts of Parliament may be ignoredby the courts.9

3) It is unclear how efficiency is to be invoked by the courts. Is it as aprinciple for the recognition of supposedly-permanent legal rules, or is it asa criterion for adjudication of the case at hand? In a dispute between twoparties, should the court favour one or the other in accordance with the effi-cient rules ( rules revealed by the deep wisdom of the economist), or shouldthe court assign the disputed resources to whichever party can attain the lar-ger value of production? Coase’s examples are about disputes between twoparties over strands in the bundle of rights we call property. Most readerswould, I believe, be inclined to infer that the value of production from thedisputed resources is the only relevant consideration.

Accurately or not, Coase is commonly credited with the emergence of afairly well defined oral tradition – that it is the business of the courts to adju-dicate for efficiency – a tradition in sharp contrast with the more conventionalview, as enunciated by a Canadian judge, that10

“It is not the duty of the judiciary to permit the doctrine of utilitarianismto be used as a make-weight in the scales of justice. It is the duty of theState (and of statesmen) to seek the greatest good for the greatest number.To this end, all civilized nations have entrusted much individual independ-ence to their Governments. But be it ever remembered that no one is abovethe law. Neither those who govern our affairs, their appointed advisers,nor those retained to build great works for society’s benefit, may act so asto abrogate the slightest right of the individual, save within the law. It is

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for the government to protect the general by wise and benevolent enact-ment. It is for me, or so I think, to interpret the law, determine the rightsof the individual and invoke the remedy required for their enforcement”.

One can find passages in “The Problem of Social Cost” that are in conformitywith what I am calling the conventional view. In fact, the paragraph quotedabove finishes as follows:

“But it has to be remembered that the immediate question faced by thecourts is not what shall be done by whom but who has the legal right todo what. It is always possible to modify by transactions on the marketthe initial legal delimitation of rights. And, of course, if such markettransactions are costless, such a rearrangement of rights will always takeplace if it would lead to an increase in the value of production”.11

The difficulty with this passage is that it conforms poorly to what most readersfind interesting and challenging in “The Problem of Social Cost”. It appearsto take back with one hand what is intriguingly offered with the other.12 Re-gardless, it is my purpose in this paper to show that the conventional view islargely right and that the view about efficiency as a criterion for the courtswhich is commonly attributed to Coase is largely wrong .

Efficiency as a criterion for the citizen and for the legislature

Take as a premise for this article that efficiency – the maximization of thevalue of production – is the appropriate criterion for the law, though more asa rule of thumb than as an absolute standard admitting no exceptions whatso-ever. There are well-known deficiencies in the efficiency criterion. It sharesthe field with equality as a criterion for public policy. It ceases to be well-defined in the evaluation of changes large enough to affect relative prices. Inits manifestation as Pareto optimality, it may fail to prescribe a unique courseof action. It can be misleading in the evaluation of personal goods such asleisure, survival probability and personal injury.13 Nevertheless, efficiencyprovides the only clear guide for the design of commercial law and for muchelse besides. It is a working assumption of this paper that efficiency is thevalid criterion for the design of the law not because that is really so, butbecause the focus of the paper is elsewhere.

An analogy can be drawn between efficiency in the law and efficiency inpublic finance. The discipline of public finance is to a large extent about theefficiency of different modes of taxation and public expenditure. The efficientquantity of public goods is identified by the “Samuelson rule”. An excise taxis (with well-known exceptions) less efficient than an income tax. To whomwould such statements be addressed? Do they mean, for example, that the

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Ministry of Finance ought to set the quantity of public goods or refuse tolevy excise taxes regardless of the Budget as passed by Parliament. Of coursenot. The discipline of public finance is addressed in the end to the citizenwho pays through his taxes for the advice that academic economists provideand who decides at the ballot box what system of taxation and expenditureto adopt. Much of the citizens’ authority is delegated to the legislature andmuch of the legislature’s authority is delegated to the Ministry of Financewhich is expected to use its delegated authority to the best of its ability inthe public interest. But the authority belongs to the citizen, and it is he whomust be ultimately persuaded that the tax system is as it should be. Similarlywith the law. The judiciary has more delegated authority than the Ministryof Finance, but its authority is delegated nonetheless, and its appeal to anefficiency criterion is only warranted, if at all, within the domain of its del-egated authority. Otherwise, it is the duty of the judiciary “to interpret thelaw, determine the rights of the individual and invoke the remedy required fortheir enforcement”.

Long ago, in his classic study of the British constitution,14 A.V. Diceydrew a distinction between “The Sovereignty of Parliament” and “The Ruleof Law”. The basis of the distinction is a division of labour between institu-tions, each with absolute authority in its own domain. Parliament is seen asunconstrained in its authority to determine what the law shall be. It was said insimpler times that Parliament could turn a man into a woman or a woman intoa man. But, once the law is established, the courts acquire the sole right andresponsibility to apply the law impartially, favouring no man over any other.Admittedly, the line between the domains of authority was never as clear asDicey would have liked it to be, but such a line – as noted in the quotationfrom Stephens v. The Village of Richmond Hill above – is still respected inthe practice of the courts. Coase – the spectre over the discipline of lawand economics, if not the man himself – would dissolve the line altogether,empowering the courts to trespass in the name of efficiency upon territorythat is usually thought of as belonging to the legislature in the first instanceand, ultimately, to the citizen.

Efficiency as a criterion for the courts

One cannot begin to examine the suitability of efficiency as a criterion for thecourts without reference to a distinction that was of much less importance inthe discussion of efficiency as a criterion for the legislature. The distinction isbetween the efficiency of rules, presumed to remain in force for a long time,and efficiency in the case at hand. Efficient rules, or laws, are conducive tothe maximization of the entire national income in the long run. Efficiency inthe case at hand is the allocation of disputed resources between contending

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parties to maximize the value of production from those resources. As a cri-terion for the legislature, efficiency must pertain to rules because rule-makingis what legislatures do. Courts, on the other hand, have to decide particularcases and might interpret efficiency either way. Thus, as a criterion for thecourts, efficiency may be seen as requiring

i) adjudication to promote efficiency in the case at hand.ii) adjudication according to the law as the judges think it ought to be, on

the understanding that judges think the law ought to be efficient.Both interpretations of adjudication for efficiency may be contrasted with athird principle,

iii) adjudication in accordance with the received law, regardless of whetherthe received law is efficient or not.The interpretations of efficiency, (i) and (ii), will be examined in turn.2) Efficiency in the Case at Hand: The distinction between efficient law andefficiency in the case at hand may best be introduced by a simple examplewhere the two almost certainly diverge. Though “the Problem of Social Cost”is about the assignment of disputed strands in the bundle of rights we callproperty, the principle that rights should be assigned by the courts to theefficient party would apply – if it applies at all– to property rights as a whole,and it is best illustrated in that context. One person, called the victim, owns aresource yielding him an annual return of $V. Another person, called the in-novator, could make better use of the resource. The innovator, if he owned theresource, could earn $I, where I is assumed to be larger than V, perhaps verymuch so. Ordinarily, one would expect the “innovator” to buy the resourcefrom the “victim”, creating a surplus of I–V that would have to be allocatedbetween them. But the market is sometimes imperfect and the allocation ofthe surplus entails a cost of bargaining which might presumably be avoidedif the resource were assigned to the efficient party by the courts. The doctrinethat courts should adjudicate for efficiency in the case at hand must rest onthis presumption.

The innovator sues the original owner for the resource, claiming it to berightfully his because the value of production would be larger in his hands.Having studied law and economics, the judge awards the resource to theinnovator, and the victim is out of luck.

Well, why not? One knows, almost instinctively, that such gross usurpationof the market by the courts would be harmful on balance, but it is worthspelling out the harm in detail. Since the alleged virtue of adjudication forefficiency in the case at hand is the saving in transaction cost, it is useful toconstruct the example so that transaction costs in the market and in the courtsmay be compared. The key assumptions are that bargaining in the marketis expensive, that litigation is expensive and that courts are less likely to be

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mistaken in identifying established property rights than in their judgmentsabout efficiency in the economy.

An innovator can earn $100 by appropriating a resource yielding only $90to the original owner, his victim, so that the potential increase in the value ofproduction is $10. Assume,

a) When a sum S is in dispute between two parties, the bargaining cost ofresolving the dispute is S/2 and the net gain after bargaining cost is dividedequally between the parties, so that each party’s net gain is S/4. [If you and Iare disputing the allocation of $1 between us, our net gains are 25 cents each.]

b) The court attempts to award the property right to the efficient party, but,in the event of litigation, there is a 30% chance of error, so that the efficientparty has only a 70% chance of being awarded the property.

c) In the event of a trial, each party must bear a cost of litigation of $20.If – contrary to our assumption about the behaviour of the courts – the

courts were content to protect property rights as they are, a bargain wouldbe struck between innovator and victim in which half the surplus is wastedin bargaining cost and what is left of the surplus would be allocated equallybetween the two parties. The price would have to be $95, and each party’s netgain would be $2.50. The innovator’s net gain is the difference between the$100 he would be prepared to pay for the resource, the price he pays ($95)and his bargaining cost ($2.50). The victim’s net gain would be the differencebetween the $95 he receives for the resource, his valuation of the resource ifit is not sold ($90) and his bargaining cost ($2.50).

The situation is depicted in figure 1 below, with the income of the victimon the vertical axis and the income of the innovator the horizontal axis. Thepoint α (90,0) shows the incomes of the two parties if the would-be victimretains his resource and uses it as he had intended. The point β (0,100) showsthe incomes of the two parties if (contrary to what is being supposed) theinnovator could acquire the resource costlessly or if he had it all along. Theline through β at 45 degrees to both axes is the efficiency locus, the locus ofall allocations to the two parties when the maximal income from the resource($100) is divided with no deduction for bargaining cost. The net outcomewhen the victim has the secure property right is indicated by the point α∗(92.50, 2.50) north-east of α but, due to bargaining cost, only half of the wayto the efficiency locus. The innovator would, of course, prefer the point β

instead, but he cannot have it unless, contrary to assumption, adjudication inthe case at hand is free and infallible.

Now consider the innovator’s options when the court adjudicates for ef-ficiency. If the innovator goes to court, he acquires the resources with aprobability of 70% (the court’s assumed probability of identifying the moreefficient party correctly) at a cost of $20 in legal fees. So far, his expected

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gain is $50 [(.7)(100)–20]. But in the event that the court is mistaken in itsidentification of efficiency (if the innovator loses at court so that the victimretains the resources after all), there remains the prospect of an additional netgain of $2.50 by purchasing the property from the victim, exactly as if therehad been no trial. With this option accounted for, the innovator’s expectedincome increases from $50 to $50.75 [50 + (.3)(2.50)].

Had the numbers been chosen differently, the victim might have preferrednot to defend his property at court, but he does do so on the assumptions wehave chosen. His expected net income when he defends his property at courtis $7.75 [(.3)(90.00) – 20 + (.3)(2.50)], the difference between his expectedincome as determined in the trial and his cost of litigation.

Thus, the expected net incomes of victim and innovator in the event of atrial are $7.75 and $50.75 as indicated by the point δ. The combined expectednet income of innovator and victim together would be $95 if the courts werecontent to respect property rights as they find them. It falls to $58.50 whenproperty is assigned by the courts to the efficient party, an expected loss of$41.50 composed of $40 in legal fees plus an extra $1.50 of bargaining costin the event that the victim’s entitlement is upheld in court.

Figure 1.

But that is not the end of the story. Though the innovator can force theadoption of the point δ (which is better for him than the point α where heabandons the resource to the original owner), it remains possible for the twoparties to bargain their way around a trial. In that event, the net effect of

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the court’s willingness to assign rights to the efficient party is to provide theinnovator with the option of changing the starting point for bargaining. Bythreatening to go the court, the innovator can shift the starting point from α

to δ where δ is farther from the efficiency locus but more favourable to theinnovator. By assumption (a) above, the outcome of the bargain is δ∗ (18.125,61.125) which is due north-east of δ half way to the efficiency locus. Sincethe amount at stake in the bargain is $41.50, the total cost of the bargainis $20.75, and, of what remains, each party gets $10.375. Their net incomesafter bargaining cost are $18.125 for the victim and $61.125 for the innovator.

In the name of efficiency, the court has converted a potential gain of $10(that would otherwise be reduced by bargaining in the market to a net totalgain of $5) into a net loss of over $20! The outcome as evaluated by the sumof the expected net incomes of the two parties ($79.25) is worse not only thanit would be in the absence of bargaining cost ($100), but than it would be ifthere had been no innovator at all and the victim had used his resource as hehad originally intended ($90). Of course the numbers could have been chosento yield a different result.

What we have here is not a general proof of anything but a counter-example to the proposition that courts should adjudicate for efficiency in thecase at hand. The counter-example is, to me, quite persuasive. Courts areexpensive and do make mistakes. Worse still, with a large enough probabilityof error by the courts, it might pay an innovator to claim to be the moreefficient party when he is not because the expected probability of gainingthe resource exceeds the expected cost of litigation. It is hard to escape theconclusion that, in practice, it is best for the courts to accept property rightsas they find them on the understanding that society must live with a certainamount of bargaining cost in the economy. The example is generalized inAppendix I.

This potential increase in transaction cost is just the tip of the iceberg.With less than infallible courts, adjudication for efficiency in the case at handis an invitation to nuisance suits. With some chance of a mistake by the court,a bogus innovator claims that I > V, and there is some chance of his winninghis suit. The waste of resources in this process is the bargaining cost in thedeal where the victim pays the innovator not to proceed with his suit, thelitigation cost if the innovator proceeds regardless and the reduction in thevalue of production if the innovator is successful.

More importantly, security of ownership would be massively undermined,and investment would diminish accordingly. Potential investors would hes-itate for fear that the courts would one day take away the fruits of theirinvestment. Sunk cost, “lost grants” or present possession would all become

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irrelevant if, or on the pretext that, somebody else can make better use ofone’s property.

The disputed resource may not be unique. If not – if the innovator couldpurchase the resource he requires from any of a number of suppliers in amarket with a well-established price – and if the courts respected privaterights, the innovator would simply buy the resource he needs. His net revenuefrom the innovation would be I–V, there would be no transactions cost and anefficiency rule for adjudication would only serve to introduce unnecessarycomplications and expense. As there really are markets for most resourcesand as the judges are often unable to tell whether there are markets or not,adjudication for efficiency rule might in practice be ludicrous.

Even when judges assess efficiency correctly, an efficiency rule could beeasily manipulated by an inefficient innovator – one for whom I < V – bydelaying his demand for possession of resources until after some of his costsare sunk. Suppose in year 0, an innovator identifies a business requiring aninput of resources worth V1 in year 1, requiring a second input of resourcesworth V3 in year 3, and yielding a benefit of I in year 4, where V1 < I, V3 < I,but I < V1 + V3. [Ignore, for convenience, the interest on the investment.] Onthis assumption, the innovation is unprofitable as seen in year 0 and ought notto proceed, but would be worth undertaking in year 2 if the first installmentof cost in year 1 was already in place. With an efficiency rule and with a trialin year 0, the court would determine the project to be unworthy and wouldassign no property right to the innovator. But with a trial in the year 2 andif the innovator bore the cost V1 himself in year 1, the court would have todecide for the innovator, granting him the right to proceed, providing him witha profit of I–V1 and imposing a cost of V3 on somebody else. Knowing howthe courts behave, an innovator invests in year 1 even though the innovationfails to augment the value of production in the economy as a whole. Thereis no such problem with a ordinary property rights. The innovator would notundertake the initial investment in year 1 because the business would turn outto be unprofitable. Problems of this sort do not arise in markets with well-established prices. Such problems only arise when an unwary court adopts anefficiency rule.

The situation is identical in kind, though usually not in magnitude, whenthe dispute is over strands in the bundle of rights we call property. The candy-maker’s ownership of his land was not in dispute, only his right to imposemore than a certain amount of noise and vibration on his neighbour. The pub-owner’s ownership of his land was not in dispute either, only his right to a venton his neighbour’s land. But the principle would seem to be the same as thatin the conflict between innovator and victim in our example. Admittedly, thespecification of the boundary between people’s property rights is less clear-

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cut than one would like. Zoning laws delineate rights to some extent, butdo not cover all of the different ways for one person’s usage of his propertyto impinge upon the welfare of his neighbour. Doctrines of nuisance, “lostgrants”, adverse possession and trespass impose some law-like geographyonto the domain of conflicting uses of property, but they are less precise thanlaws in other domains of society. That being said, it does not follow that thecourts are free to do as they please, even to obtain what the courts see as anefficient regime.

ii) Adjudication in Accordance with the Law as it Should Be: The otherinterpretation of efficiency as a criterion for the courts is that judges decidecases in accordance with the law as it ought to be, on the understanding,of course, that the law ought to be efficiency-promoting. One version of thestory is that the common law embodies wisdom accumulated since time im-memorial. On this version, the appropriate rule for each new case is foundby judges within the vast accumulation of old cases in the common law.Another more modern version is that efficient law emerges in a process oftrial and error. Efficient law emerges when a) inefficient law is more likely tobe challenged in the court and b) in any challenge, there is a finite chance ofthe law being overturned.15 Against this optimistic assessment of the courtsas an instrument to promote efficiency are several considerations:

The efficiency criterion would be applied imperfectly because judges aresometimes mistaken in their assessments of what efficiency requires, becauseother considerations (such as the attainment of equality) may intervene andbecause class interest, limited experience or personal bias must affect thejudges’ predictions about the consequences of alternative rules. Worse still,the inevitable variability in the judge’s assessment of the requirements ofefficiency could easily undermine the stability of the law which is, in practice,the law’s greatest contribution to the efficiency of the market. The old dictumthat “it is more important that a rule be settled than that it be settled correctly”is especially pertinent in this context. Judges who can apply received law pre-dictably may prove unable to supply a consistent application of an efficiencycriterion. Different judges may hold different opinions about what efficiencyrequires. The certainty of the law and the security it supplies to the marketabout the consequences of one’s actions would be compromised. Not eventhe unifying authority of the Supreme Court can prevent that altogether. Thesearch for efficiency could prove self-defeating.

This problem is compounded by difficulty in correcting the courts’ mis-takes, especially when courts take it upon themselves to overturn legislationon constitutional grounds. If the legislature passes a dumb law today, it canrepeal that law after the next election tomorrow. If the Supreme Court inval-idates a law on constitutional grounds, that ruling may last for a generation

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until a constitutional amendment can be passed. The record of the SupremeCourt in Canada and the United States is not encouraging.16

Even if the courts could maintain an efficiency standard for the law, it ismost unlikely that they would be allowed to do so. The usurpation of thetraditional authority of the legislature would undoubtedly be resisted, andthe independence that the judiciary now enjoys could well fall victim in theensuing battle between the courts and the legislature. Assume for the sakeof the argument that the appointed judges are more able than the electedlegislators to identify efficiency and to set rules accordingly. Even so, thewilful disregard by the judiciary of the legislature could not be sustained.The rule of law may be tolerated, but not the rule of lawyers. Appointmentof judges by the executive and the legislature would soon enough bring thejudiciary to heel. Let it be known that the judges are prepared to apply goodlaw (or efficient law) as they see it, and elected politicians would appointjudges who could be trusted to see the law as their political masters wish.17

The present authority of the judges to apply the existing law impartially issurely conditional on the understanding that, within certain limits, the judgeswill enforce the law, efficient or otherwise, as the legislature intends it tobe. The citizen as voter empowers the judiciary to apply the law becausethe judiciary is expected to do so impartially and because the citizen knowsthat the alternative is chaos. But efficiency is different from impartiality, andthe willingness to trust the judiciary is attenuated when the one is allowedto displace the other. If the legislature chooses to pass laws that the judiciarydeems to be inefficient, then those are the laws that the judiciary must enforce.

Adjudification for efficiency is intrinsically self-defeating because it in-duces a waste of resources in the attempt to influence the law not only throughordinary politics, but by direct pressure on the courts. Want of confidence bythe citizen that he will be treated fairly in the courts induces an otherwiseunnecessary expenditure of resources to influence the choice of judges andofficials. The greater the influence of officialdom on one’s life, the more oneis prepared to spend in the attempt to determine who those officials will be.In the extreme, a want of confidence in the government and the courts to playfair with those who are not members of the right class or ethnic group maylead to a breakdown of the economy or to civil war.

All this is subject to major qualifications. Substantial authority is imposedupon the courts by the intrinsic ambiguity of the law, by the implied deleg-ation to the courts when the legislature is silent and by “the rule of law”.Some degree of law-making is imposed upon the courts by the “open textureof the law”.18 It may be literally impossible for the legislature to draft lawsso comprehensively that every application of the law is anticipated and themeaning of the law is beyond dispute in every new case that presents itself.

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Environmental protection laws may prescribe a benefit-cost criterion for de-ciding when, for example, an anti-pollution device is required, and the courtsmay be required to oversee the decisions of the environmental protectionagency. Law-making is also imposed upon the courts by the silence of thelegislature, by the inability or refusal of the legislature to pass laws governingcertain domains of life. The legislature may remain silent about, for example,whether abortion is legal or, if legal at some stage in the pregnancy, when it isno longer permitted. In such cases, the courts may be obliged to make law indeciding the case at hand. Some “judge-made law” is inevitable, and, subjectto a number of qualifications, it is often appropriate for the courts to em-ploy their delegated authority to promote efficiency in the economy.19 Thereis nevertheless an essential difference between use of delegated authorityefficiently and the overturning of the received law in efficiency’s name.

Over and above their responsibility to clarify the law in its application tothe case at hand, is the responsibility of the courts to challenge the legislaturein some circumstances, typically when the legislature appears to be acting inviolation of its own rules or in ways that might threaten the continuance ofdemocratic government. It is the business of the courts to uphold the rule ofthe law, to resist discrimination against individuals and groups, to maintain a“government of laws, not of men”, and to protect individuals and groups ofcitizens from victimization by the government. Hence the Bill of Rights in theUnited States and the Charter of Rights in Canada. I may not be subjected toad hominem taxation, consigned by gerrymandering to a disproportionatelysmall share of influence in the legislature or denied the right to run a busi-ness because I offend the officials of the party in office. There is, however,a fundamental difference between the court’s defiance of the legislature onmatters of procedure or in defense of constitutionally-guaranteed rights, andthe usurpation by the courts of the legislature’s authority to govern the eco-nomy as it sees fit. Deference by the courts to the legislature with regard toordinary law may be a precondition for the deference by the legislature to thecourts on matters where the preservation of democratic government may beat stake.

Conclusion

What are the best laws? and What ought the courts to do? The discipline oflaw and economics deals almost entirely with the first of these questions. It isthe application of cost-benefit analysis to the law on the working assumptionthat the law ought to be efficient in some broad sense of that term. The stanceof the practitioner of law and economics is that of a delegate at a hypotheticalconstitutional convention to forge a new social contract, or, equivalently, that

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of a law-giver for a new society. In practice, the discipline of law and econom-ics supplies advice to the electorate or to the legislature, designing law andevaluating existing law in more or less the same spirit that the discipline ofpublic finance supplies advice about tax and expenditure policy. The courts,on the other hand, are presented with an ongoing body of law that may or maynot be efficient. The task of the courts is to uphold existing property rights, toapply the law as it is and to protect citizens from discrimination at the handsof their fellow citizens or the state. The attempt by the courts to adjudicateaccording to the laws as the judges think they should be or, worse still, to beefficient in spite of the law is almost certain to be counterproductive and islikely to undermine the primary role of the courts. In Bass v. Gregory, the lostgrant, as a specification of property rights, is the relevant consideration.

Notes

1. Coase, R., “The Problem of Social Cost”, Journal of Law and Economics, 1960.2. Calabresi, G., The Cost of Accidents: A Legal and Economic Analysis, 1971.3. Becker, G., “Crime and Punishment: An Economic Approach”, Journal of Political Eco-

nomy, 1968.4. The role of efficiency in the law has always been problematic. It was primary in the

writings of Bentham. Efficiency’s most enthusiastic advocate today is probably R.A. Pos-ner. See his “Utilitarianism, Economics and Legal Theory”, Journal of Legal Studies,1979, together with “Symposium on Efficiency as a Legal Concern” Hofstra Law Review,1980 with contributions by J.L. Coleman, R. Dworkin (who has no use for the efficiencycriterion), G. Calabresi, L.A. Kornhauser, M.J. Rizzo, L.A. Bebchuck, and D. Kennedyand F. Michelman. However, except for a brief reference in Coleman, the distinction in thepresent paper between efficiency in the legislature and efficiency in the courts was ignoredin the Symposium, almost as though it was a shared premise among the participants thatthe law is the business of the judges alone. For a more wide-ranging critique of efficiencyas a criterion for economic policy, see D. W. Bromley, “The Ideology of Efficiency:Searching for a Theory of Policy Analysis”, Journal of Environmental Economics andManagement, 1990.

5. Sturges v. Bridgman (1879) discussed at length by Coase in “The Problem of Social Cost”.6. In Appendix II at the end of this paper, it is argued that what Coase actually says about the

courts in “The Problem of Social Cost” can be interpreted by the unwary as the advocacyof adjudication for efficiency, though that may not have been what Coase really meant.

7. “The Problem of Social Cost”, p. 15.8. Jeremy Bentham, Introduction to the Principles of Morals and Legislation, (1789).9. Courts might be supposed to apply the law as they find it, or to make law. If and in so

far as they make law, they may do so to promote the efficiency in the entire economyor at the behest of some group in society. In the latter case, that group might be theprincipal litigants (as suggested in P.H. Rubin, “Why is the Common Law Efficient?”,Journal of Legal Studies, 1977) or the collectivity of lawyers hoping to drum up business(as suggested in P.H. Rubin and M.J.Bailey, “The Role of Lawyers in Changing the Law”,Journal of Legal Studies, 1994) or the social class with whom the judges identify (assuggested in J.A.G.Griffith, The Politics of the Judiciary, 1977).

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10. Stephens v. The Village of Richmond Hill, 1955, cited in Elizabeth Brubaker, PropertyRights in the Defence of Nature, 1995. Differences between what the judge calls utilitari-anism and what Coase and others call efficiency are irrelevant in this context.

11. Ibid, 27.12. In an extended analysis of Sturges v. Bridgman, A.W.B. Simson (“Coase v. Pigou Reex-

amined”, Journal of Legal Studies, 1996, attacked Coase for asserting that judges oughtto apply cost-benefit analysis rather than the received law in the resolution of disputes andthat efficiency should take precedent over established property rights when neighbour-ing interests conflict. Simson’s concluding sentence is “. . . courts make their most usefulcontribution to efficiency in a capitalist system when they studiously avoid attempting tosecond-guess the operations of the hidden hand and confine their activities to the vigorousprotection of rights” (97). Unfortunately, the article, and Coase’s response immediatelyfollowing (“Law and Economics and A.W. Brian Simson”) get bogged down in the inter-pretation of what Pigou really said and on whether Pigou was a nice person. Coase lostthe opportunity to clarify his views about the subject of this paper. I agree entirely withthe quotation from Simson. Coase’s assessment of that quotation remains for me unclear.

13. I discuss this matter in “Personal Goods, Efficiency and the Law”, Discussion Paper #985, Institute for Economic Research, Economics Department, Queen’s.

14. A.V. Dicey, An Introduction to the Study of the Law and the Constitution, 1885.15. See George L. Priest, “The Common Law Process and the Selection of Efficient Rules”,

Journal of Legal Studies, 1977, 65–82 and Paul Rubin, “Why is the Common Law Effi-cient?”, The Journal of Legal Studies, 1977, 51–63. For a critique of the doctrine of thesurvival of the fittest as it applies to the law see Gillian K. Hatfield, “Bias in the Evolutionof Legal Rules”, The Georgetown Law Review, 1992. I would add that evolution in biologyhas taken place gradually over the last five billion years.

16. New legal ground was broken in Dred Scott v. Sanford(1857), invoking the authority ofthe Constitution for the doctrine that Blacks could not be citizens of the United States andprecipitating the American Civil War. Plessy v. Ferguson(1896) held off social legislationfor a generation. Pollock v. Farmers’ Loan and Trust C.o(1895) blocked the income taxand required a constitutional amendment to overturn. It is interesting to compare RobertBork’s objection to Roe v. Wade (on the constitutional right of a woman to have an abor-tion) in The Tempting of America, 1990 and Ronald Dworkin’s objection to Buckley v.Valeo (on the constitutional right of a candidate for office to spend as much as he pleaseson his own political campaign) in The New York Review of Books, October 17, 1996.In both cases, democracy is stymied because the citizen has no recourse other than aconstitutional amendment once the Court has spoken. The situation must be especiallyfrustrating for a judicial activist like Dworkin. What does a judicial activist do when anactivist court makes what he sees as a wrong decision? In RJR-MacDonald v. The AttorneyGeneral of Canada (1994), the Canadian Supreme Court saw fit to overturn an Act ofParliament banning tobacco advertising because “no direct evidence of a scientific natureshowed a causal link between advertising bans and decrease in tobacco consumption”.

17. The Clarence Thomas-Anita Hill controversy may be a sign that the judiciary is alreadydangerously politicized.

18. “Faced with the question of whether the rule. . . is applicable to some combination ofcircumstances in which it appears indeterminate, all that the person called upon to answercan do is to consider (as does one who makes use of a precedent) whether the present caseresembles the plain case ‘sufficiently’ in ‘relevant’ respects. The discretion thus left himby language may be very wide; so that if he applies the rule, the conclusion, even thoughit may not be arbitrary or irrational is in effect a choice”. H.L.A. Hart, The Concept of

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Law, 1961, 124. It is impossible, and possibly undesirable, to write law so precisely thatthe courts never need to exercise discretion in adjudicating a case. Invariably, courts havesome leeway in interpreting the words of the law and the intentions of the law-giver. If thelaw itself is intended to promote efficiency, then it would be reasonable to expect judgesto apply an efficiency rule within their domain of interpretation.

19. On judge-made law, see A. V. Dicey, Lectures on the Relation between Law and PublicOpinion in England During the Nineteenth Century, 1905, Lecture XI called “JudicialLegislation” and Appendix IV called “Judge-made Law”. Normal arrogance tempts thepractitioners of every learned profession (except economists who are uniformly sweettempered and modest) to imagine that they have the skill and the right to rule mankind.In the seventeenth century, Sir Edward Coke saw the common law as an immutable in-heritance of the people of England, not to be tampered with by King or Parliament, butto be interpreted by lawyers and judges alone. His modern counterparts in Law Schoolssee the common law as inherently efficient as distinct from legislation which is a preyto something called special interests. Yet the history of judge-made law is not uniformlyedifying. In Lecture XI, Dicey tells the story of how, between them, the rules of equity andthe common law subjugated poor married women to the absolute authority their husbandsin all financial matters, while providing an escape that only the daughters of rich familiescould afford. Legislation was required in the latter part of the nineteenth century to setmatters right.

20. A huge assumption is concealed in the innocuous language postulate d. The assumption(which is common, almost universal, in the literature of transaction cost) is that bargainingentails a cost like any other, that the cost of bargaining is as determinate and predictableas the cost of chalk or cheese. In reality, bargaining is not like that at all. Bargaining is acomplex interaction among people that may be effected costlessly, may entail consider-able expenditure or may fail altogether in the sense that a mutually-profitable exchange isblocked altogether because bargainers fail to agree on the allocation of the surplus. Eco-nomists have no model grounded in self-interest to determine which among many possibledeals, some favourable to one party, some favourable to another, will be struck. There areplenty of solutions to the bargaining problem, but, to the best of my knowledge, everysolution is obtained by adding structure to the crude bargaining problem. For instance,the Nash Bargaining solution is obtained by maximizing the product of utilities, and theRubinstein bargaining solution is obtained by imposing a sequence of offers and rejectionstogether with a postulated shrinking of the pie over time and with no allowance for thepossibility that one party can commit himself to any particular deal. See M. Osborne andA. Rubinstein, Bargaining and Markets, 1990.

21. A more realistic function would allow p to depend on I-V as well as LI and LV.22. Litigation expenditures are chosen by each side to maximize expected net gain. In an

equilibrium where each party chooses its litigation expenditure on the assumption that theexpenditure of its rival is invariant, the optimal legal expenditures are identified by theequations δTv/δLv = 0 and δT1/δL1 = 0. Both parties litigate up to the point where themarginal benefit per dollar of litigation is just equal to 1.

References

a) Law CasesBass v. Gregory (United Kingdom), 25 Q.B.D. 481 (1890).

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Buckley v. Valeo (United States), 424 US 1 (1976).Dred Scot v. Sanford (United States), 19 How 446 (1857).Plessy v. Ferguson (United States), 163 US 537 (1896).Pollock v. Farmers’ Loan and Trust Co. (United States), 158 US 601 (1895).RJR-MacDonald v. The Attorney General of Canada (Canada), 1 S.C.R. 311 (1994).Stephens v. The Village of Richmond Hill (Canada), O.R. 806 at 812–3 (1955).Sturges v. Bridgman (United Kingdom), 11 Ch. D. 852 (1857).

b) Books and ArticlesBecker, G. (1968). Crime and Punishment: An Economic Approach. Journal of Political

Economy: 169–217.Bentham, J. (1970). Introduction to the Principles of Morals and Legislation (originally

published 1789) J.H. Burns and H. L. Hart (Eds), Athlone Press.Bork, R. (1990). The Tempting of America. Simon & Schuster.Bromley, D.W. (1990). The Ideology of Efficiency: Searching for a Theory of Policy Analysis.

Journal of Environmental Economics and Management: 86–107.Brubaker, E. (1995). Property Rights in the Defense of Nature. Environment Probe: Earthscan.Calabresi, G. (1970). The Cost of Accidents: A Legal and Economic Analysis. Yale University

Press.Coase, R. (1960). The Problem of Social Cost. Journal of Law and Economics: 1–44.Coase, R. (1960). Law and Economics and A.W. Brian Simson. Journal of Legal Studies:

103–120.Dicey, A.V. (1982). An Introduction to the Study of Law and the Constitution (originally

published 1885), Liberty Classics.Dicey, A.V. (1981). Lectures on the Relation between Law and Public Opinion in England

during the Nineteenth Century (originally published 1905). Liberty Classics.Dworkin, R. (1996). The Curse of American Politics. The New York Review of Books, October

17, 19–24.Griffith, J.A.G. (1977). The Politics of the Judiciary. Manchester University Press.Hart, H.L.A. (1961). The Concept of Law. Clarendon Press.Hatfield, G. K. (1992). Bias in the Evolution of Legal Rules. The Georgetown Law Review:

583–616.Osborne, M. and Rubinstein, A. (1990). Bargaining and Markets. Academic Press.Posner, R.A. (1980). Utilitarianism, Economics and Legal Theory. Hofstra Law Review: 103-

140.Priest, G. L. (1977). The Common Law Process and the Selection of Efficient Rules. Journal

of Legal Studies: 65–82.Rubin, P.H. (1977). Why is the Common Law Efficient? Journal of Legal Studies: 51–63.Rubin, P.H., and Bailey, M.J. (1994). The Role of Lawyers in Changing the Law. Journal of

Legal Studies: 807–31.Simson, A.W.B. (1996). Coase v. Pigou Reexamined. Journal of Legal Studies: 53–102.Usher, D. (1999). Personal Goods Efficiency and the Law. Discussion Paper #985, Institute

for Economic Research, Economics Department, Queen’s University.

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Appendix I: The efficiency of efficiency as a criterion for the courts: Aweighing of transaction costs

Should courts adjudicate to promote efficiency in the market or to uphold the law bypreserving legally-established property rights whatever they may be? Would trans-action cost be reduced, or, as suggested in the text, would adjudication for efficiencyprovoke more transaction cost than it alleviates? A simple formal model may clarifythe issue to some extent. These are the postulates:a) An innovation requires a resource that the innovator does not possess or it imposesan externality on his neighbour. Let I be the benefit to the innovator and V be the costto his would-be victim.b) The resource is unique, not one of many identical resources that could be pur-chased at a going price on the open market. This assumption is crucial.c) Both parties are risk neutral.d) Bargaining is costly. A deal between innovator and victim for the sharing of anamount S entails a cost bargaining B, where B increases more than proportionallywith S. Specifically,

B = f(S) where f′ > 0, f′′ > 0 (6)

The cost of bargaining increases with the amount at stake but is never so high that thepotential gain is completely wasted. As mentioned in the text, the cost of bargainingis in reality indeterminate within a model of rational behaviour, but is treated forconvenience as analogous to conveyancing cost. When I > V and when the propertyright would automatically belong in the first instance to the victim, the bargainingcost in selling that right to the innovator is f(I - V).20

e) The net gain after bargaining cost is divided equally between the two parties tothe bargain. With an amount S at stake, each party’s net gain after bargaining is[S - f(S)]/2. [Together, assumptions (d) and (e) eliminate all uncertainty about theoutcome of bargaining.]f) Courts may or may not attempt to promote efficiency in the economy. The altern-ative is to leave the two parties to bargain between themselves. Call the first principleof adjudication an efficiency rule and call the second a property rule.g) Expenditures on litigation – LI for the innovator who is the defendant and LV forthe victim who is the plaintiff – are chosen independently by each party in a Nashequilibrium to maximize his expected benefit from litigation.h) Courts can always recognize established property rights, but courts are sometimesmistaken in their perception of efficiency in the market. Specifically,

i) Courts can identify the party with the established property right; innovator andvictim are always recognized as such.

ii) In applying the efficiency rule, courts are sometimes mistaken in their assess-ment of costs and benefits. There is a probability, p, that the efficient party willwrongly identified, i.e. that the court assigns the property right to the victim inthe mistaken belief that V > I when the truth of the matter is that I > V, or thecourt assigns the property right to the innovator in the mistaken belief that I >

V when the truth of the matter is the V > I.

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iii) The probability of error, p, is influenced by both parties’ litigation expenditure,i.e.

p = p(LI, LV), where each party’s litigation expenditure increases his probabilityof being recognized as the more efficient party and of being awarded the propertyright under the efficiency doctrine.21 The litigation function, p, must be such that, ifthe innovator is the efficient party so that an error would be to assign the propertyright to the victim (that is if I > V), the probability of an error increases with LV anddecreases with LI. The opposite is true if V > I.

When the court adopts a property rule and when I is really larger than V, thevictim has the unchallengeable right to block the innovation, but he will not do so.Instead, since the innovation yields a surplus, the victim sells his right to the innov-ator. Innovator and victim must now agree on the sharing of the surplus. They agreeon a payment that is greater than V but less than I, greater than the least the victimcan advantageously accept but less than the most the innovator can advantageouslyoffer. The gross surplus over which they bargaining cost is I−V. The net surplus afterbargaining cost is I–V -f(I - V). With the net surplus shared equally, the final outcomeis that the innovator attains an amount [I - V - f(I - V)]/2, which is half of the netsurplus, the victim attains an amount V + [I - V-f(I-V)]/2, comprising compensationfor the loss of his resource plus half of the net surplus from the innovation, and anamount f(I - V) is used up in bargaining.

When the court adopts an efficiency rule, it is still unnecessary for the parties togo to court, but the cost of adjudication frames the terms of the bargain by whichadjudication may be circumvented. The higher the cost of a trial, the larger the sumover which the parties must bargain if the trial is to be avoided. Suppose I > V andlet p be the probability, in the event of a trial, that the court will mistakenly supposethe opposite. With adjudication by an efficiency rule, the victim’s expected loss, Tv,in the event of a trial is

TV = LV + [1 − p(LI, LV)][V] − p(LI, LV)[I − V − f(I − V)]/2 (7)

The victim’s expected loss is his litigation cost plus his expected loss in the eventthat the court’s decision goes against him less his expected gain from his bargainwith the innovator if the court rules in his favour. His expected net income once thetrial is over is V − TV.

The innovator’s expected gain, TI , from adjudication is

TI = [1 − p(LI, LV)][I] + p(LI, LV)[I − V − f(I − V)]/2 − LI (8)

If the innovator wins, he acquires the full value of I. If he loses, he acquires half thenet surplus. In either case he must pay his legal fee. The innovator is prepared to suethe victim as long as TI is positive.22

A bargain to circumvent litigation – where it is understood that the transfer ofthe resource to the innovator is included within the bargain – is advantageous to thevictim as long as the payment from the innovator to the victim exceeds the victim’sexpected income under litigation, and it is advantageous to the innovator as long as

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the payment from the innovator to the victim is less than the innovator’s expectedgain from litigation.

Let M be the payment from the innovator to the victim when adjudication is basedon an efficiency and when, in the event of litigation, the expected loss to the victimand the expected gain to the innovator are TV and TI as defined above. The victim isprepared to defend his position in court if and only if his expected loss, TV, is lessthan V, which is what he stands to lose if he gives up the resource voluntarily, andthe payment, M, from the innovator to the victim must exceed (V - TV) which is thevictim’s expected gain from defending his case. Furthermore, since the innovator’sexpected gain from going to trial is TI, he would be unwilling to pay more than(I−TI) to avoid a trial. Pulling all this together, it follows that with an efficiency rule

(I − TI) > M > (V − TV) (9)

Thus, the surplus over which the parties bargain becomes I − V − TI + TV which isequal to

LI + LV + pf[I − V] (10)

where p is a function of litigation costs as specified above. The surplus from avoidinga trial is the sum of the litigation costs plus the expected bargaining cost in the marketif the property right is awarded in the end to the inefficient party.

On these assumptions, the choice between an efficiency rule and a property ruleturns on the relative magnitudes over a long series of cases of two bargaining costs,and this in turn depends on the relative magnitudes of the corresponding surpluses,(I − V) for the property rule and (LI + LV + pf[I − V]) for the efficiency rule. WhenI > V, the bargaining cost under an efficiency rule exceeds the bargaining cost undera property rule if and only if

LI + LV + pf(I − V) > I − V (11)

The litigation route under an efficiency rule is more expensive than the directbargaining route under a property rule when the cost of litigation plus the expectedbargaining cost in the event that the court fails to identify the more efficient party ex-ceeds the difference in the evaluations by the innovator and his victim of the disputedresource. Though one cannot say definitively which route is the more expensive, onecan make a few useful generalizations and one can reject outright the claim thatadjudication for efficiency is preferable come what may.– Adjudication for efficiency is preferable if the courts are infallible, for there is inthat case no incentive to devote resources to litigation and the inequality in equation(11) must hold. Similarly, if the court’s probability of error is very small, then thelitigants’ optimal LI and LV would be small as well, and, once again, an efficiencyrule is advantageous. The larger the risk of error in the courts, the more advantageousdoes the property rule become.– A property rule is preferable to an efficiency rule when I and V are close because,for any positive value of p, the surplus under the property rule is the differencebetween I and V while the surplus under the efficiency rule is depends on the optimal

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values of LI and LV which may still be substantial.– The advantage of an efficiency rule disintegrates completely in a well-functioningmarket where a perfect substitute for the disputed resource can be purchased at somemarket-clearing price. The key assumption in this appendix is (b) that the disputedresource is unique.

In the extreme, an efficiency rule is analogous to allowing the owner of thenew business to take the resources he needs from whoever happens to own them.The rule would empower the courts to transfer property from victim to innovatorin circumstances where the gain in value of production is negligible at best andpossibly illusory. Any gain in the value of production from the improved allocationof resources is likely to be swamped by the loss of resources in litigation as eachparty seeks to persuade the court of its superior efficiency. There would, in addition,be a serious risk to the integrity of the courts from the augmentation of their authorityover the market that an efficiency rule would entail. The courts’ role as the dispenserof justice would be jeopardized.

As discussed in the text, an efficiency rule introduces an extraneous uncertaintyin the economy, reducing investment because no prospective investor can be surethat someone else will not prove able to use his resource more profitably than he. Isuspect that this consideration is more important in practice than the risk of error bythe courts.

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Appendix II: Ronald Coase on adjudication for the efficiency in the caseat hand

“The Problem of Social Cost” is about the boundaries between property rights. Thequestion at issue here is whether Coase might be interpreted in that article as advoc-ating the transfer by the courts of strands in the bundle of rights we call propertyfrom people who use would them inefficiently to other people who would use themefficiently, regardless of the letter of the law. Nowhere does Coase specifically re-commend that the courts be free to disregard established laws or established propertyrights in the name of efficiency, but there are passages which, rightly or wrongly,do convey that impression. Much of the excitement in the article stemmed fromthe prospect of the take-over of the law by economics and from the vision of thereplacement by the courts of outmoded precedents and antiquated laws with correcteconomic principles. Also, if the courts are free to adjust the boundaries of propertyrights, it is hard to see why they might not be equally free to reallocate the rightsthemselves.

Recall Coase’s objection to the doctrine of the lost grant in the passage from Bassv. Gregory quoted at the beginning of this article. The passage can be interpreted asa plea for adjudication for efficiency in the case at hand, though there is just enoughambiguity to make room for a more conventional but less challenging interpretation.The same is true of other passages in “The Problem of Social Cost”.

On page 16, speaking of the disposition of rights when transfer through themarket is costly, Coase says “. . . the initial delimitation of legal rights does havean effect on the efficiency with which the legal system operates. One arrangement ofrights may bring about a greater value than any other. But unless this arrangementof rights is established by the legal system, the cost of reaching this same result byaltering and combining rights through the market may be so great that this optimalarrangement of rights, and the greater value of production it would bring, may neverbe achieved”. What are we to make of this passage? Is Coase just sad that the marketworks less well than we would like, or is he actually recommending something, and,if so, what is he recommending?

Later on page 19, Coase says, “It would therefore seem desirable that the courtsshould understand the economic consequences of their decisions and should, insofaras this is possible without creating too much uncertainty about the legal positionitself, take these consequences into account when making their decisions”. Again theimplications of the passage are obscure. Is “understanding economic consequences”a recommendation to assign rights to the more efficient party? How are the courtsexpected to weigh “uncertainty about the legal position” against other considera-tions, and would not the realization by the actors in the economy that the courtsweigh uncertainty about the legal position against other consideration create costlyuncertainties in the market about who owns what?

Then on pages 27 and 28, Coase says, “In a world in which there are costs ofrearranging the rights established by the legal system, the courts, in cases related tonuisance, are, in effect, making a decision on the economic problem and determininghow resources are to be employed. It was argued that the courts are conscious of this

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and that they often make, although not always in a very explicit fashion, a comparisonof what would be gained and what would be lost by preventing actions which wouldhave harmful effects”. I see an ambiguity here between what the courts should do andwhat they actually do. Coase seems to be saying that courts deliberately rearrangehistorically-given rights and that it is appropriate for the courts to do so, but a dif-ferent interpretation – that courts sometimes exceed their proper function – is notaltogether unreasonable.

Finally, on page 38, in summarizing a delightful discussion about the law of rab-bits, Coase says, “the law of nuisance, as it is in fact handled by the courts, is flexibleand allows for a comparison of the utility of an act with the harm it produces. . . Thisis not to say that the sole task of the courts in such cases is to make a comparisonbetween the harm and the utility of an act. Nor is it to be expected that the court willalways decide correctly after making such a comparison. But unless the courts actvery foolishly, the ordinary law of nuisance would seem to give economically moresatisfactory results than adopting a rigid rule”.

All of these quotations are open to the simple and innocuous interpretation that,in the law of nuisance and in some other matters, the courts must adjudicate forefficiency because the legislature requires them to do so. The argument would bethat, within limits, the legislature wants boundaries between the domains of differentproperty rights to be set efficiently, but cannot in practice specify in advance preciselywhat the efficient boundaries will turn out to be, and must rely on the courts toidentify the efficient boundaries when disputes between adjacent property-holdershave to be resolved. When a law is intended to promote efficiency in the economyand when the law cannot be specified in enough detail to cover every case that mightever present itself, the courts must adjudicate for efficiency within the scope of thelaw; just as, when a law is intended to assist impoverished children and when the lawcannot be specified in enough detail to cover every case that might ever present itself,the courts must adjudicate with the interests of impoverished children in mind. If thatis all Coase is saying, he is not wrong in my opinion, but neither is he particularlyinteresting or original.

Coase draws no inference from priority in time to priority of right: hence thealleged irrelevance of lost grants. Consider Coase’s example of the damage to sur-rounding woods caused by sparks from a railway engine. If the courts’ responsibilityto adjudicate for efficiency were delegated by the legislature, it would be of someimportance that the woods preceded the railway, and it would be appropriate for thecourts to consult the legislative mandate of the railroad. The building and running ofthe railroad required the acquisition by the railroad of at least two sorts of propertyrights: the outright ownership of the land on which the track is build and strands inthe bundles of rights of property-owners nearby, freedom from sparks and freedomfrom the noise and smoke of passing trains. Presumably, the railroad’s charter wouldhave said something about both rights. Perhaps, the railway was granted both rightsexplicitly, in which case there would be nothing for the courts to adjudicate unless thecourts are prepared to overrule the legislature in the name of efficiency or some othervirtue. Perhaps land for the track was purchased on the understanding that nearby

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landowners retain the right to quiet enjoyment of their property or to compensationfor its loss. In that case, it would be the responsibility of the courts to assess the mag-nitude of the damage. In neither case would the reciprocal aspect of the externality –that there is a cost to the railway in compensating the landowners – be relevant. Coasenever considers these matters. There is no reference in “The Problem of Social Cost”to the principles of eminent domain. The railroad and the surrounding land are seenas generating reciprocal externalities, and “The conclusion that the railway should bemade liable for the damage it causes is wrong”. (page 32). Not might, but efficiencymakes right, regardless of the circumstances. Coase’s analysis of this case and thestory of the innovator and victim in Appendix I are uncomfortably similar. There iseven a certain similarity between the role of the courts in “The Problem of SocialCost” and the role of the planner in old fashioned welfare economics.