62 Pages Posted: 3 Apr 2014 Last revised: 6 May 2014

There are 2 versions of this paper

Date Written: May 5, 2014

Abstract

This Article draws lessons about the theory of law and economics from the recent financial crisis. It argues that the financial crisis teaches us that allocative efficiency, the main goal of law and microeconomics, proves an unattainable and relatively unimportant goal for laws addressing complex systems. It shows that complexity and the institutional role of law make calculation of optimal rules impossible for complex systems like those addressed through financial regulation, intellectual property, antitrust law, environmental law, and national security law.

Drawing primarily on the financial crisis, this Article identifies the features of complex systems that make mathematical calculation of costs and benefits impossible. Apparently recognizing that complexity defeats identification of optimal rules through cost-benefit analysis, law and economics scholars have used assumptions of rationality and perfect information as a substitute for quantitative analysis. The financial crisis teaches us that this CBA-substitute dangerously supports deregulatory ideology. Furthermore, the dynamic nature of complex systems renders any equilibrium between costs and benefits short-lived and therefore of relatively little value.

This Article also shows law’s institutional function as providing a framework that can accommodate a variety of transactions makes prediction of efficient outcomes extremely unlikely. For this institutional role implies that law does not usually determine resource allocation.

This Article addresses the question about what to do about law and microeconomics’ failure by proposing a more macroeconomic approach to law. This economic dynamic approach would treat law as an effort to countervail negative trends over time with a goal of avoiding systemic risks while keeping a reasonably robust set of economic opportunities open. It sketches a methodological approach to accomplishing these goals rooted in institutional economics and the best practices of law and economics scholars.