W EB N OTES
Sixth Edition
The following are the web notes for the sixth edition of Law and Economics by Robert D.
Cooter and Thomas S. Ulen. Our intent in these notes is to extend the material in the text by describing some additional issues, articles, cases, and books. Because the fields of law, economics, and law and economics are not standing still – because, that is, scholars are adding interesting new material all the time, we may supplement, alter, and add to these notes from time to time.
Each note begins with a copy of the material from the text about the content of the web note and the page on which that web note can be found. We will from time to time insert new material, update some of the entries, and add some additional material. You should be able to download pdf versions of each chapter’s web notes and of the entire set of web notes for all 13 chapters.
We have found that the very best students and their instructors from all over the world pay close attention to these web notes. They often have good ideas about how to add to the entries already here and suggestions about articles, cases, books, and topics that would be instructive to add. We would be grateful for any comments or suggestions about any of the notes.
(p. 9)
Besides efficiency, what other policy values should matter to making law and applying it? In Fairness Versus Welfare (2002), Louis Kaplow and Steven Shavell of the Harvard
Law School say “None.” Others disagree. See Chris Sanchirico,
Deconstructing the New
Efficiency Rationale, 86 C ORNELL L.
R EV . 1005 (2001), and Daniel Farber, What (If Anything) Can Economics Say About Equity?, 101 M
ICH
.
L.
R
EV
. 1791 (2003).
When law and economics first appeared in the late 1970s and early 1980s, there was a great deal of resistance from the legal academy to the notion that efficiency could contribute to an understanding of the law or could provide a normative standard to which law should aspire. In part
(but only in part), this resistance arose from some overselling on the part of proponents of law and economics and misunderstanding on the part of traditional, doctrinal legal scholars. The heart of the contention had to do with whether efficiency and justice (or equity or fairness) were substitutes or complements, to use economic jargon.
Scholars devoted a great deal of energy to exploring the appropriate relationship between efficiency and justice in the early 1980s. It is probably fair to describe the result of all this exploration to be a standoff or agreement to disagree. No general consensus on the appropriate relationship seemed to have been reached. Instead, the issue simply receded in importance.
Then, in a series of papers and subsequently, a book entitled Fairness and Welfare (2002),
Louis Kaplow and Steven Shavell of the Harvard Law School revived the issue by aggressively and forcefully arguing that efficiency (or welfare, as they call it) is a far more coherent concept than welfare and that, in fact, fairness considerations reduce to efficiency considerations. We think that this is an important enough topic that we ought to give you a sense of the debate.

Web Notes – Sixth Edition Cooter & Ulen
So, this note first summarizes the central argument in Kaplow and Shavell’s book and summarize a discussion from an earlier article in the Journal of Legal Studies regarding the appropriate division of authority between the tax-and-transfer system and adjudication for achieving distributive social goals. (We made favorable use of this argument in the text of Chapter 1.) We then briefly summarize an important criticism of the Kaplow-Shavell argument by Professor
Chris Sanchirico of the Wharton School and School of Law at the University of Pennsylvania.
We conclude with a summary of two articles: a very favorable review of Fairness Versus Welfare by Professor Richard Craswell of Stanford and a somewhat critical review by Professor
Daniel Farber of the University of California, Berkeley, School of Law (Boalt Hall).
A S UMMARY OF L OUIS K APLOW & S TEVEN S HAVELL , F AIRNESS V ERSUS W ELFARE
(2002).
The central claim of Kaplow and Shavell is that “the welfare-based normative approach should be exclusively employed in evaluating legal rules. That is, legal rules should be selected entirely with respect to their effects on the well-being of individuals in society.” They also argue that welfare economics evaluation reflects concerns about the distribution of income. Under their approach, notions of fairness such as corrective justice or retributive justice should receive no independent weight in the assessment of legal rules. Kaplow and Shavell argue that “these notions of fairness depend directly on characteristics of individuals’ acts (for example, whether injurers behave wrongfully) rather than on the effects of rules on individuals’ well-being (such as the extent to which penalizing injurers reduces the rate of injuries).”
Under welfare economics, policies are assessed exclusively in terms of their effects on the well-being of individuals. Accordingly, whatever is relevant to individuals’ well-being is relevant under welfare economics, and vice versa. The welfare economics conception of individuals’ well-being is all-encompassing. It recognizes not only individuals’ levels of material comfort, but also their degree of aesthetic fulfillment, their feelings for others, and anything else that they might value, however intangible.
In contrast to the common understanding of normative economic analysis under which legal rules are assessed by reference to wealth maximization or efficiency and which omits important aspects of individuals’ well-being, as well as distributive concerns, the welfare economics approach is similar to adopting the moral position that the design of the legal system should depend solely on concerns for human welfare.
The claim that the assessment of legal policy should rely only on welfare economics relies on two arguments. The first argument suggests that pursuing notions of fairness comes at the expense of individuals’ welfare. Whenever a notion of fairness led an analyst to choose a legal rule different from the one favored under welfare economics, every individuals’ well-being was reduced. Under the second argument, there are no rationales for notions of fairness that justify advancing them at the expense of the individuals’ welfare. Furthermore, in many instances, individuals who would seem to be the intended beneficiaries of a notion of fairness, such as the victims of accidents or of breaches of contracts, were worse off under rules that were supposed to be fair to them.
If the criticism of the notion of fairness has the force that is claimed, why does fairness possess so much appeal? The reason might be related to the fact that most notions of fairness seem to correspond to social norms that are principles that well-socialized members of society use to guide their behavior in everyday life and that because social norms have a powerful influence on our minds, it is not surprising that related ideas of fairness seem important. Nevertheless, notions
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Web Notes – Sixth Edition Cooter & Ulen of fairness should not be elevated to the status of independent evaluative principles when assessing legal policy. One of the reasons for this conclusion is that the formal legal system differs in a number of important ways from the operation of social norms in everyday life, and as a result, there is reason to expect that the best rule for everyday life may not be the optimal rule for the legal system. When decisions are based on the notion of fairness, they depend on instincts and intuitions. These instincts and intuitions have no place in the design of the research agenda of legal academics and other policy analysts who are engaged in the long-term enterprise of analyzing and empirically investigating the legal system in order to identify which legal rules are socially best.
Under welfare economics, the evaluation of a legal policy depends on how it influences individuals’ welfare and nothing else. It is easy to evaluate a policy when we deal with a case in which all the individuals are made better off or all are made worse off, but it is much more difficult when some individuals gain and some lose under a policy. In the latter case, the policy affects the distribution of income and well-being and therefore a distributive judgment must be the tool that should be used.
You should also read the chapters on “Welfare, Morality, and the Law” in Shavell’s Foundations of Economic Analysis of Law (2004). Professor Shavell there summarizes the argument on welfare (as defined by economists) as the only defensible measure of well-being.
Louis Kaplow & Steven Shavell,
“Why the Legal System Is Less Efficient Than the Income Tax in Redistributing Income,” 23 J. Legal Stud. 667 (1994) .
The argument in Fairness Versus Welfare extends a famous argument that Kaplow and
Shavell made earlier in an article in the Journal of Legal Studies . In the text, we paraphrased the central argument of that article (namely, that common law or private adjudication should strive for efficiency, while matters of distributive equity should be handled by the tax-and-transfer system). Here is a brief summary of that article.
Under the formal model—which the authors call-the “new efficiency rationale”—only the income tax system should be employed to achieve distributional goals. The common law adjudication system should be used only for efficiency ends and not to seek to achieve distributional goals. In order to make their point, Kaplow and Shavell make a “tax-substitution” argument. The gist of this argument is that, for every redistributional legal rule (including those conditioned on parties’ incomes), we can find an alternative tax surcharge that accomplishes precisely the same redistribution but also raises tax revenue. This tax revenue can then be distributed to the population or used for public goods. The conclusion reached under this argument is that any redistribution accomplished by adjusting legal rules away from efficient standards can be more efficiently accomplished by leaving the efficient legal rule as it is and accomplishing the equitable goal with taxes.
Chris Sanchirico, “Deconstructing the New Efficiency Rationale ,” 86 Cornell L. Rev.
1005
(2001).
Professor Chris Sanchirico of the Wharton School and the Law School at the University of
Pennsylvania has produced some extremely interesting criticisms of the Kaplow-Shavell argument. Here is a summary of his article from the Cornell Law Review.
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Web Notes – Sixth Edition Cooter & Ulen
In the matter of evaluating legal rules, for as long as law and economics has played a formative role in legal scholarship, its principal mode of analysis has been to evaluate legal rules according to the sole criterion of “efficiency.” This has meant that we should evaluate rules by the sum of the costs and benefits that they impose on individuals without regard to how those costs and benefits are distributed among different individuals.
However, recently there was an emergence and rapid acceptance of a new justification for efficiency, a “new efficiency rationale.” The new rationale is shunting distributional concerns across disciplinary boundaries from private law to tax. Furthermore, while proponents of the new rational conditionally concede the importance of equity (which is, in this context, the equality of economic well-being) as a political-philosophical value, they insist that the legal sphere is not the proper place to pursue distributional objectives. These proponents argue that the efforts to decrease economic inequality should be corralled into the tax code, while legal rules should be left in a pristinely efficient state, unsullied by distributive justice.
The “double-distortion argument” is the backbone of the new rationale. This argument rests on the idea that conditioning the application of legal rules on parties’ incomes will affect their decisions in the labor market in much the same way as directly taxing their earnings. Increasing an individual’s expected damages bill when she earns more affects her incentive to earn in the same way as does increasing her tax bill. Thus, effecting redistribution by conditioning legal rules on income distorts not only the behavior that the legal rule is meant to regulate, but also labor-leisure choices. However, redistributing income by taxing the income directly will create only a single distortion to labor market decisions. Therefore, only the income tax should be employed in pursuit of redistributional goals and it is thus appropriate for the economic analysis of legal rules to focus on efficiency. However, the conclusion under which legal rules should always be set solely on the basis of efficiency is not correct.
Professor Sanchirico opposes the new rationale and holds that the legal rule has a redistributional impact whenever it affects different individuals differently and that this redistributional impact should figure centrally in our evaluation of legal rules. Income, wealth, consumption, contractual activity, property owned, harm caused, harm suffered, and the like, are all “imperfect signals” of the underlying immutable characteristics of individuals upon which the state would ideally base its redistributive policy if only it had such information. While the double-distortion argument suggests that legal rules should never be informed by redistributive objectives, the
“imperfect-signals” framework implies the more-than-opposite proposition that legal rules should always be redistributionally informed.
Another claim in favor of the proposition that legal rules should always be redistributionally informed is that if we currently conduct no redistribution through the legal system, the legal system is initially available as a perfect means of transfer. If, in addition, we already have a substantial redistributional income tax in place, that tool’s redistributional efficacy is under strain, and every dollar transferred by that means exacts potentially significant efficiency costs. Consequently, it will always improve social welfare to enlist the legal system as a redistributional tool to relieve the income tax of some of its redistributional burden.
Relative to efficient standards, legal rules should be adjusted in a manner that tends to favor those who are less well off. In determining who the less well-off are, well-being should be measured across all spheres of economic activity and not just the regulatory ambit of the legal rule that is being adjusted. For example, if the poor are less well-off overall but happen to be better off within the system governing boating accidents, then tort rules for boating accidents should be
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Web Notes – Sixth Edition Cooter & Ulen adjusted to help the poor, even though this is actually disequalizing within the narrow sphere of boating torts.
Kaplow and Shavell have recently defended the new efficiency rationale against this contention. They asserts that the sort of equity adjustment suggested in the boating-accident example may well have the perverse effect of hurting those who are less well-off overall just because they happen to be relatively advantaged within the sphere governed by the legal rule. But Professor
Sanchirico thinks this defense fails. It is crucial to determine who the less well-off parties are, and the analysis directs us to consider all aspects of individuals’ economic lives, not just the regulatory sphere of the legal rule. Thus, in determining how to adjust a particular rule for an equity purpose, we look well beyond inequality arising within the particular rule’s regulatory ambit.
The optimal equity-motivated adjustment to each legal rule is intended to be part of a movement of resources from those who are better off overall to those who are less well-off overall.
Furthermore, even if legal rules were a relatively unimportant source of overall inequality or even if there are substantial costs associated with using any given instrument for redistributional purposes, this does not imply that legal rules should be set purely on the basis of efficiency.
When choosing to use the private law as a method of distribution we would improve social welfare because the legal rule will have only redistributional benefit and no efficiency cost at the margin. Hence, for example, in the court system, as it currently exists, many of the fixed costs of private-law redistribution have already been paid. There is already a system of laws, casereporting, courts, and lawyering in place.
The conclusion is that the redistributional impact of legal rules depends on the correlation between well-being of the parties to accidents and the impact of increasing damages. Roughly, if the less well-off tended to pay damages more often than they received them, then decreasing damages would be equity-enhancing. The same trade-off informs the analysis of how optimally to set tax rates. If we raise or lower the tax rate at a particular level of income, this will distort the choice of work effort. The redistributional impact will depend on whether the set of individuals whose tax bill increases as a result of the rate-change tend to be more or less well-off in the economy, taking account of not only income, but also leisure, and inherited wealth and advantage.
You might also want to see Chris William Sanchirico, Taxes Versus Legal Rules as Instruments For Equity: A More Equitable Approach , 29 J. Legal Stud. 797 (2002), and the response to
Sanchirico in Louis Kaplow and Steven Shavell, Should Legal Rules Favor the Poor? Clarifying the Role of Legal Rules and the Income Tax in Redistributing Income , 29 J. Legal Stud. 821
(2000).
Richard Craswell, “Kaplow and Shavell, on the Substance of Fairness ,” 32 J. Legal Stud .245
( 2003).
Under Kaplow and Shavell’s argument [in Fairness Versus Welfare], fairness should be disregarded when choosing legal rules. Their first argument, which rests on the Pareto principle, purports to apply to any theory of fairness, whatever its substance. But in a different argument
(which Craswell calls the “second argument”), Kaplow and Shavell criticize the substance of particular fairness theories, as those theories have been applied to particular fields of law.
The second argument represents the more significant part of Kaplow and Shavell’s analysis because, while the first argument may not succeed in refuting any theory of fairness, regardless
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Web Notes – Sixth Edition Cooter & Ulen of its content, the criticisms based on the substance of particular fairness theories still have considerable force.
Kaplow and Shavell’s arguments that are resting on a logical proof to the effect that anyone who accords any weight at all to fairness is thereby committed to supporting at least some rules even under circumstances where everyone in society would be made worse off, does not work against certain forms of hybrid fairness theories that (1) assign normative importance to fairness in most cases but (2) do not do so in evaluating any rule that would make everyone better off.
However, there is an alternative justification for Kaplow and Shavell’s position that is based on the substantive difficulties faced by any hybrid theory. One of the challenges facing any fairness theorist is to explain why certain actions are believed to be unfair. Thus, Kaplow and
Shavell’s attack on all such theories can be understood as raising the following question of substantive policy: In any case in which a fairness theory would conflict with welfarism, why should we believe that the fairness theory has properly identified those acts that are truly unfair?
In developing their argument, Kaplow and Shavell considered two distinct cases: one in which everybody in society is identical, or is identically affected by the legal rules, and one in which some members of society gain from the rule while other members lose. If everyone in society is identically affected by the rule, then either the rule will make everyone better off or it will make everyone worse off. A welfarist would, of course, endorse whichever rule makes everyone better off. In these cases, whenever a theory of fairness diverges from welfarism it can only do so by endorsing a rule that leaves everyone worse off. Thus, Kaplow and Shavell are correct that nonwelfarists must occasionally endorse rules that leave everyone worse off.
However, when some people would gain from a rule but others would lose, the rule cannot be evaluated without balancing the gains and losses to different individuals. Kaplow and Shavell take no position as to exactly how those gains and losses should be balanced. Instead, they follow standard welfare economics and posit that there is a social welfare function that reflects whatever trade-offs society is willing to make in this regard. They emphasize that this social welfare function might well reflect distributive considerations, so that rules whose losses would be borne by poorer members of society might be disfavored for that reason. For purposes of their argument, however, Kaplow and Shavell are content to leave the exact form of the social welfare function unspecified. Instead, they claim that legal rules should be selected on the basis of some such social welfare function rather than on the basis of a fairness theory.
In fact, Kaplow and Shavell have a more subtle argument, which does not require them to defend any particular social welfare function. They claim that any fairness-based social welfare function must endorse other rules that do make everyone worse off (“The Pareto argument”). In the view of Kaplow and Shavell, there is something suspicious about a moral premise that implies that it might, even in rare cases, be appropriate to make everyone in society worse off.
Although Kaplow and Shavell’s Pareto argument will not work against certain forms of hybrid fairness theories, in their presentation of the Pareto argument they do not even address hybrid theories because they frame the question in a way that implicitly excludes them.
This article is not intended to entirely dismiss the Kaplow and Shavell Pareto argument.
There are, after all, some settings where all individuals may well be affected identically by a rule. Settings such as these raise interesting hypotheticals for moral theorists, who would do well to consider whether their theories might leave everyone worse off. However, most moral theorists will find it easy to avoid hypotheticals in which everyone would be made worse off, simply by moving to a hybrid form of their preferred moral theory. Hybrid theories are not subject to
Kaplow and Shavell’s Pareto argument, so theorists who make this move might believe that they
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Web Notes – Sixth Edition Cooter & Ulen have thereby escaped all of Kaplow and Shavell’s criticisms. This moral theorists’ belief will be mistaken.
In addition to their Pareto argument, Kaplow and Shavell also make a number of substantive criticisms aimed at the content of particular fairness theories. All of these criticisms point to various undesirable consequences that a particular theory might lead to, consequences that a welfarist would clearly want to take into account. But all of these criticisms can also be seen as going to the substance of the fairness theory itself by asking why the act or the rule in question should in that case be regarded as unfair?
Obviously, no fairness theorist could ever come up with a satisfactory response to Kaplow and Shavell on this point. However, some such response is required. In that respect, Kaplow and
Shavell have made an important contribution to legal debate and a contribution that can stand entirely independent of their argument based on the Pareto principle.
Daniel A. Farber, “What (If Anything) Can Economics Say About Equity?: A Review of Louis
Kaplow and Steven Shavell, Fairness Versus Welfare,” 101 Mich. L. Rev. 1791 (2003).
Finally, Professor Dan Farber, a graduate of both the University of Illinois and the University of Illinois College of Law, and a Professor of Law at the University of California, Berkeley, has written a review of Fairness Versus Welfare for the Michigan Law Review . Here is a summary of that review.
In their book, Kaplow and Shavell argue that there is only one viable notion of equity: resources should be distributed so as to maximize overall social welfare. They believe that economics can restrict value judgments about equity to a single, sharply defined place in policy analysis: the choice of an appropriate social welfare function (“SWF”).
Kaplow and Shavell’s welfarist program has three fundamental flaws. First, except in the easiest cases where a decision benefits everyone, welfarism as such does not determine the outcome. Rather, the outcome depends entirely on the specific choice of a SWF. Thus, we need some standards for choosing the function. But these standards cannot be selected on welfarist grounds because we have not yet chosen a SWF. So, as a general matter, non-welfarist fairness norms are needed to select the SWF. Second, some set of procedures will be needed for society to decide on distributional norms. These procedures must themselves be chosen on non-welfarist grounds. The only way to avoid this argument is to assume that only one valid SWF exists, so that no procedure for choice is necessary. Kaplow and Shavell implicitly resolve this dilemma by assuming that the SWF will be utilitarian (it merely adds individual utilities). But, choosing a utilitarian SWF exacerbates the third problem with welfarism, which is the difficulty of defining and measuring utility.
Kaplow and Shavell do not limit themselves to the Pareto and Kaldor-Hicks standards in comparing different states of society. Instead, they base such comparisons on a SWF, which they define formally as a monotonic function of individual utilities. This means that, all else being equal, an increase in any individual’s utility increases the level of social welfare. The key point is that only individual utilities count in determining social welfare (rather than, for instance, individual rights). Defining an SWF requires that we be able to compare individual utility levels.
They also assume that it is irrelevant which utility levels are associated with which specific individuals. This assumption rules out the possibilities that we might view some people as having morally superior preferences to those of others, or that we might consider some people as being more or less deserving than others because of their past conduct.
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Web Notes – Sixth Edition Cooter & Ulen
Kaplow and Shavell reject any notion of fairness that gives weight to factors that are independent of individuals’ well-being. The core of the argument is that use of any intrinsic moral factors would conflict with the Pareto standard. They argue that ‘individuals will be made worse off overall whenever consideration of fairness leads to the choice of a regime different from that which would be adopted under welfare economics because, by definition, the two approaches conflict when a regime with greater overall well-being is rejected on grounds of fairness.’ Thus, anyone who believes in intrinsic moral values must be prepared to sacrifice human welfare.
The concept of a SWF is quite broad in range: any function of utility distributions increases whenever individual utility goes up. Kaplow and Shavell’s official position is that no basis exists for selecting a uniquely correct SWF. This position implies the existence of non-welfarist legal rules. Obviously, we cannot use welfarism to select the procedure itself. Moreover, it will not normally be the case that everyone in society just happens to agree on an SWF, even if we can get them to put aside the fact that the choice of an SWF will determine the choice of legal rules and thereby their own welfare. So, we must choose an SWF-selection procedure on some basis other than welfare. In Kaplow and Shavell’s terms, the value used to select the procedure must be a form of fairness, since it is non-welfarist.
Kaplow and Shavell’s “double-distortion argument” holds that the tax system is a more efficient way of engaging in redistribution than the regulatory system. Suppose we readjust some economically efficient legal rule so that the new rule redistributes income from the rich to the poor. Since we have moved away from the efficient rule, there is necessarily a direct efficiency cost to the rule change. But there is also a second distortion. Just as someone considering an additional hour of work might be deterred by an increase in the marginal tax rate, so they might be deterred by knowing that they are making themselves targets for disadvantageous legal rules.
Therefore, the conclusion of Kaplow and Shavell is that we can always transfer the same amount of funds more efficiently just by raising the tax rate. However, Kaplow and Shavell’s conclusion is not ironclad. If what we are trying to equalize is not income but rather some quantity that correlates with income, or if individuals differ in their responses to legal incentives, legal rules can add to the efficiency of redistribution.
In sum, Kaplow and Shavell claim to have established that ‘legal policy analysis should rely exclusively on welfare economics.’ Through pure ‘deductive logic,’ they maintain, they have shown that fairness is untenable: ‘logical consistency implies’ that if one endorses fairness ‘one has thereby endorsed the view that adopting a legal rule that makes everyone worse off may well be good.’
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