Decentralized law for a complex economy: the structural approach to adjudicating the new law merchant.

AuthorCooter, Robert D.
PositionSymposium: Law, Economics, & Norms

The collapse of communism, decline of socialism, and deregulation of markets provoked rethinking of economic law. This Article carries that line of thought to law in general. I develop an account of decentralized law, which percolates up from the bottom, as opposed to centralized law, which is imposed from above. Decentralized law begins with customs and contracts. I use game theory to develop an analysis of custom. According to economic theory, the justification of regulation begins with the identification of a failure in the incentive structure of markets. Similarly, I argue that the justification for centralized law begins with the identification of a failure in the incentive structure of social norms. Much of this Article concerns why some norms succeed and others fail relative to the standard of fairness and efficiency.

Part I is an extensive introduction to my major themes. Part II sketches the foundations of a theory of social norms by combining philosophical concepts and game theory. Part III uses this theory to characterize conditions under which fair and efficient norms will evolve and then shows how judges and other lawmakers can use this information.

  1. Introduction

    1. Legal Centrism

      The Soviet magazine Crocodile published a cartoon that depicted a cart containing one gigantic nail being pulled by some men, one of whom was saying to a bystander, "What's it for? We don't know what it's for, but it satisfies our nail quota for the month." This cartoon epitomizes the economic critique of central planning according to which a planned economy does not generate the information or motivation required for economic efficiency.(1) Like the workers in the cartoon, the people and enterprises under socialism often lack the knowledge and the will to produce valuable goods.

      Central planning is a way of making law, not just commodities. To implement the central plan, officials must have the power to allocate resources. To possess this power, the orders issued by planning officials at the top must trump the rights of property and contract enjoyed by people and enterprises at the bottom. Thus public law crowds out private law.

      Only communist dictatorships have practiced central planning as a total system. Democracies, however, sometimes adopt procedures similar to central planning to solve specific economic problems. To illustrate, when Professor Richard Stewart stepped down from his position as the highest-ranking environmental lawyer in the Department of Justice, he remarked that "America's environmental laws are based upon Soviet-style centralized planning.(2) He meant that America controls pollution through a system of quotas imposed upon businesses by federal officials. Such procedures have been called "command-and-control" regulations.(3)

      The imperative theory of law, which has a long history in legal philosophy, defines "law" as a command backed by a threat.(4) This tradition builds upon the fact that many laws impose obligations and attach sanctions to their violation. Similarly, the paradigm for centralized lawmaking is a decree, in which government officials formulate the state's goal, embody the goal in a rule, and force people to conform to it. Information and motivation move along a one-way street from the top to the bottom.

      Rather than proceeding from top to bottom, lawmaking can proceed from bottom to top.(5) Decentralized lawmaking has several forms. To illustrate, one form induces people to create a market by assigning property rights, such as the tradable emissions rights created by recent amendments to the Clean Air Act.(6) The subject of this Article is another form of decentralized lawmaking: enacting custom. To illustrate, courts may determine fault and liability for accidents by applying the norms of the community in which the accident occurred. When courts apply community standards, they find law, rather than make it.

      Many scholars have detected a movement in modern history from decentralized to centralized law. John Salmond concluded that customary law is important in the early stages of legal development, but gradually cedes its place to statutes when "the state has grown to its full strength."(7) In a recent article, Ott and Schafer point out that modern German law has moved away from customary law and toward statutes.(8) Many intellectuals believe that centralized law is inevitable, just as they once believed that socialism was inevitable.

      In fact, centralized law, like socialism, is not even plausible for a technologically advanced society. The forces that reversed the trend toward socialism and destroyed central planning are also undermining legal centrism. An advanced economy involves the production of too many commodities for anyone to manage or regulate. As the economy develops, the information and incentive constraints tighten upon public policy. These facts suggest that efficiency requires decentralization to become more important, not less, as economies become more complex. Specifically, efficiency requires that as economies develop, the enforcement of custom in business communities becomes more important relative to the regulation of business.

    2. New Law Merchant

      A community of people is a social network whose members develop relationships with each other through repeated interactions. The modern economy creates many specialized business communities. These communities may form around a technology such as computer software, a body of knowledge such as accounting, or a particular product such as credit cards. Wherever there are communities, norms arise to coordinate the interaction of people.(9) The formality of the norms varies from one business to another. Self-regulating professions, like law and accounting, and formal networks like Visa(10) promulgate their own rules. Voluntary associations, like the Association of Home Appliance Manufacturers, issue guidelines.(11) Informal networks, such as the computer software manufacturers, have inchoate ethical standards.

      Following private international law,(12) I refer to all such norms of business communities as the "new law merchant."(13) The new law merchant arises outside of the state's apparatus for making law. Lawmakers, however, are pulled into the affairs of business communities by insiders who look to the state to resolve their disputes. Lawmakers are also pushed into the affairs of business communities by outside critics of private wealth and power. This Article concerns the appropriate response of the state's lawmakers to these pulls and pushes.

      The traditional account of the "law merchant," from which the phrase "new law merchant" is adapted, provides a model for how lawmakers might respond. The merchants in the medieval trade fairs of England developed their own courts and practices to regulate trade.(14) The extent to which the medieval law merchan't was substantive, rather than procedural, is disputed, and its relationship with common law and admiralty law is difficult to reconstruct. In any case, as the English legal system became stronger and more unified, English Judges increasingly assumed jurisdiction over disputes among merchants. The English judges often did not know enough about these specialized businesses to evaluate alternative rules.(15) Instead of making rules, the English judges allegedly tried to discover those rules that already existed among the merchants, and then selectively enforced them. Thus, the judges dictated conformity to merchant practices, not the practices to which merchants should conform.

      A well-documented example concerns the assimilation of financial instruments, especially notes and bills of exchange, into the common law in the eighteenth century. Notes and bills of exchange, which circulated among eighteenth-century merchants as means of payment and credit, raised difficult questions of risk allocation. To illustrate, suppose that A delivers goods to B. Upon receipt of the goods, B gives a note to A promising to pay a certain sum of money on a future date. A sells B's note to C. In the mean time, B discovers a defect in the goods that he purchased. Now B holds defective goods, and C holds B's promise to pay for them. Can B refuse to pay C on the grounds that A delivered defective goods? Or, alternatively, must B pay C and then sue A for breach of contract?

      Such legal questions became acute with the rapid expansion of commerce in the eighteenth century. Judge Mansfield is usually credited with supplying most of the answers. Mansfield knew that he did not understand fully how businesses use financial instruments. Consequently, he did not try to invent better rules than the ones in practice. Rather, he carefully scrutinized business transactions and tried to identify and enforce the best practices.(16) His elegant solutions were taught in courses on commercial law long after the relevant financial instruments ceased circulating.(17)

      In common law systems, intensive litigation alerts judges to The need to change the law.(18) Empirical evidence indicates an intensification of litigation around The time that judges adopt a new precedent.(19) Judges respond to a proliferation of novel disputes by making new law.(20) Thus, the priorities for legal development in a common law system are determined by litigation rates. When judges make common law, however, They cannot do as they please.(21) According to an old principle in jurisprudence, judges cannot make law except when they find a social norm worthy of enforcement by the state. This principle is embodied in the saying, "Judges must find common law."(22) Thus Judge Mansfield examined the commercial practices of his day in order to find the foundations of modern commercial law.

      Since the eighteenth century, common law countries have developed new institutions to aid the law's evolution. Organizations conduct studies to scrutinize current law and issue reports recommending changes to it. In Britain, the law commissions perform these...

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