Economic Analysis of Law

Professor Antony W. Dnes, University of Hull

Interest has grown recently in the combined study often known as “law and economics”, for which the economic analysis of law is really a better description. Anyone with an interest in the institutional framework, i.e., the “rules of the game”, governing economic activity, will find the economics of law useful in understanding how laws affect human incentives. The economics of law may be defined as the application of economic principles to legal instruments, questions, and procedures. It has many practical applications, such as helping with the drafting of laws, or in assessing the amount of damages required to return a person to the level of welfare enjoyed before an accident occurred.

Legal instruments are devices like damages for breach of contract that feature regularly in the legal system and have implications for economic incentives. Legal questions, such as whether it would be appropriate to award damages for the interruption to production following an oil spill from a tanker, are also amenable to economic analysis. Legal procedures may also interact with economic incentives: for example when lawyers work for contingent fees on a “no-win, no-fee” basis.

The nature of a country’s law, and the reliability of its legal system, also has a direct impact on economic performance, as shown by the “law and finance” literature. Countries possessing independent, reliable, and relatively corruption-free legal systems tend to show higher growth, less inflation, and higher levels of employment. The relationship between the legal system and the economy is definitely a two-way link and “law and finance” even suggests that common-law systems are best of all at promoting economic efficiency and growth.

Economics of law has a respectable pedigree. In earlier times it was common for ‘political economists’ (as economists were once known) to have had exposure to legal training and to work on institutionally focused questions. It is only in recent years that many economists have become narrowly technical and have tended to ignore institutional questions. Following on the heels of the 2008 depression affecting Europe and America, the excessively technical nature was widely criticized, even to the extent of some economists writing a letter to the Queen making the criticism of the mainstream profession, after the monarch had asked why so many economists appeared to have missed accurately predicting the onset of the depression. It is a good time to increase one’s institutional focus by studying law and economics.