Renovating the Efficiency of Common Law Hypothesis

Abstract

The efficiency of common law hypothesis provides a set of first principles for lawyer-economists who examine the evolution of legal rules over time. Recent work, however, observes a trend toward redistribution, especially in tort. This Chapter attempts to reconcile the conflicting accounts by introducing externalities in individual activity to the original litigation model. As externalities increase, organizing costs among potential parties increase. If the sum of organizing costs and remaining transacting costs is not prohibitive, then all of those allocatively affected reach an agreement. I call this a pan-efficient equilibrium. However, if the sum of costs is prohibitive, litigation may ensue. Parties litigate pan-inefficient rules when their expectations of victory differ. For this reason, plaintiffs may forgo immediate litigation in favor of waiting for organizing costs to recede and for the probability of victory to increase. Once party expectations of victory differ, they litigate, and courts discern the merits of pan-inefficient precedents. Over time, the tendency for pan-inefficient rules to arise more frequently in litigation will lead to their disproportionate overruling relative to pan-efficient precedents. This framework explains the apparent instability between redistribution and efficiency and provides an updated interpretation of the efficiency of common law.

Keywords: efficiency of common law hypothesis, economic loss rule, tort misalignments, Baconian judges

JEL Classification: K13, K15, K41