With the nomination of Judge Brett Kavanaugh to replace Justice Anthony Kennedy on the Supreme Court of the United States has come a renewed discussion of the importance of the Supreme Court and the role of its justices in our everyday lives. Should Supreme Court justices be strict constitutional constructionists or should justices interpret the Constitution taking into account changes in our culture and values? Alternatively, should Supreme Court justices simply interpret the law or should they, through their interpretation, make new law?
I must confess I enjoy hearing experts argue the various sides to these heady issues. I really enjoy a good explanation. After all, I have made a living simply explaining things.
Today, the question before us is should judges in general have a good understanding of economics, especially when making rulings on civil wrongs called torts? To this end I want to introduce you to Ronald Coase (1910-2013). Coase, best known for having been on the faculty of the University of Chicago School of Law, won the Nobel Prize in economics in 1991 for his work in the area economists call “transactions costs.” Using Adam Smith as an anchor, economists are very good at explaining how people, as they pursue their own self-interest, are guided by an invisible hand to promote the welfare of others. Furthermore, in a perfect world, this pursuit of private interest results in an allocation of economic resources that maximizes social welfare. This is the nature and benefit from competition.
The key phrase in the previous sentence is “perfect world.” The perfect world has many attributes, two of which are perfect knowledge and no transactions costs. This is to say, everyone in a market knows what everyone else knows and it is costless to get together and trade.
This is where Coase comes in. In his article entitled The Problem of Social Cost, he argued that in a lawsuit involving two people who are free to engage in trade, the resulting allocation of resources does not matter on what the judge rules. Here, judges don’t need to know economics. They just need to assign property rights — assign guilt.
An example may help. Assume that I live next to a noisy neighbor with a very loud stereo. I, however, like quiet. I go over and ask my neighbor nicely to turn it down and they tell me no. I ask again and all they do is turn it up louder. So, I call up my attorney friend, complain to the police, and then finally sue for quiet.
Let’s assume I win. By the judges ruling (giving me the property right of silence), I can have perfect quiet all the time. However, in the perfect world my neighbor might come over, offer me a little money, and ask is there a time I will be gone so they can make noise. Well, I will be gone some days and they did, after all, offer some money. So, yes, here are the dates. Give me the cash. In the end, I get some quiet and my neighbor gets some noise. This is the final allocation of resources that maximizes social welfare.
What happens if my neighbor wins and can have noise all the time? Again, in the perfect world, I may offer my neighbor some money to turn the stereo down on some days at some times, especially the days they are gone making noise somewhere else. They may very well agree. Here, like above, I get some quiet and they get some noise.
The ‘Coase theorem’ says that regardless of who wins — determined by the judge — we end up with the same amount of noise and the same amount of quiet. The key to this outcome is that my neighbor and I trade property rights after the judge rules.
However, what happens if there are transactions costs — we are unable to trade. In this case, the ruling of the judge matters. Here, the judge needs to understand the economic consequences of their ruling. Where is social welfare maximized? When I win or when my neighbor wins? How much quiet and how much noise?
The world is full of transaction costs. The beneficial impact of free trade and competition can be limited. We need to understand these limits. This is not to say we need to prevent competition and trade from occurring. The world is never quite perfect. Maybe we can get there with a judiciary that understands a bit of supply and demand. The economists at the Murphy Center are always glad to help.
Reg Murphy Center