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86 Tul. L. Rev. 135 (2011-2012)

handle is hein.journals/tulr86 and id is 137 raw text is: False Efficiency and Missed Opportunities in Law and Economics Shawn J. Bayern* 7his Article points out a simple flaw common to many law-and-conomics analyses, ngmg frnm fundamental models like the Hand Formula to narrwer arguments like those that oppose the doctrie ofunconscionability The flaw is straghtforwar: economic analyses oflaw often assume, either knplcitly or explicitly that when it is more efficient for an activity to occur than for it not to occur it is efficient for legal rules to encourage the activity Even on grounds of efficiency alone, however knowing in isolation whether an activity poduces more wealth than its absence is isufficient to conclude that the activity is efficient The determiation of efficient legal rules requires an answer to a further question too oflen neglected by legal economists: what are the activity& alternatives? Even if an activity is more efficient than its absence, it may poduce less wealth (perhaps significantly less wealth) than its alternatives, once its harms are taken into account Encouraging all activities that appear to produce wealth on their own runs the nsk of encounigmg opportunistic behavior whose effect is more to transfer wealth than to crate it As a simple example, a legal regime that followed the Hand Formula would encourage businesses to earn $100,000 by causing $95,000 worth of unavoidable harms to others; that incentive alone, while probably objectionable for other reasons, is not mefficient because, bistrumentally spealking, the $100,000 social gains justify the $95,000 social losses. But a rule based on the Hand Formula would also encourage economic actors to engage in that $100,000- earning activity rather than one that paid $90,000 but caused no harms; that incentive is inefficient. Some economic analyses acknowledge related points, but the law-and-economics movement hisufficiently understands the flaw that thisAticle describes. Similarly cntics ofthe law-and-economics movement-while aware of other fundamental flaws in legal-economic analysis, such as the inapplicability of the rational-actor model in many chrumstances-do not radiy enough engage economic models on their own terms. ThisArticle attempts to remedy those oversights, and in doing so, it suggests greater caution in applymg economic reasoning to law I. INTRODUCTION............................................... 136 II. THE DISTINCTION BETWEEN OPTIMAL AcTIVITY AND AcTIvITY THAT IS BETTER THAN ITS ABSENCE ................. 138 A. ThelBdden, FalseAssumption ThatAllActivity That Is More Efficient than ItsAbsence Will Occur........ 144 B. The Reasons forFactor-Market Imperfection................... 145 * © 2011 Shawn J. Bayern. Assistant Professor, Florida State University College of Law; J.D., University of California, Berkeley; B.S., Yale University. I thank Mel Eisenberg, Larry Garvin, Gregg Polsky, Mark Seidenfeld, and Manuel Utset for valuable and interesting discussions, some of which related at least obliquely to this Article. All errors reflect false efficiencies and missed opportunities. 135

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