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When law and economics do not understand each other
05 Oct, 2009 06:40:04
Oct 05, 2009 (LBO) - Both Law and Economics are two brothers born to the same mother: morality of the society. They both use the same working tool for producing their output: scientific approach.
They derive their subject matter from moral principles. Their mission is to uphold moral principles and ensure the maximum happiness for everyone through fair play, justice and equity.

When they adopt the scientific approach, they should necessarily be objective, unbiased, unprejudiced, impersonal, ready to accept errors and willing to be refuted.

But, like other siblings, as they grow into adulthood, they part ways and become strangers to both morality and the scientific approach. At that point, they fail to remember or recognise their common ancestry. It also makes it difficult for them to understand each other.

Many Attempts at Combining Law and Economics

Society has attempted to bring about reconciliation between the two by setting common meeting grounds for them. These meeting grounds take the form of associations of law and economics, journals of law and economics or combined educational qualifications in law and economics.

Yet, in many instances where law has to make judgments on economic matters or where economics has to observe legal principles, the miscomprehension between the two brothers becomes quite evident.

The corollary of this miscomprehension has been disastrous for the society. It has sometimes led the legal system to deliver spurious judgments on economic matters. By the same token, economists too have tended to disregard the principles of good governance and justice when making recommendations on economic issues which have legal implications.

A Hypothetical Case

Consider, for example, a hypothetical case.

Suppose a court of law is being required to pass judgment on whether a sale of a given public venture to certain private entrepreneurs is valid or not.

Suppose further that the venture in question is a semi public monopoly, its service standards are very low, it makes some profits but not the maximum profits which it could make and operates in a protected market where the state has delivered to it a captive customer-base.

Economists’ Justification of Privatising a Public Monopoly

Economists would have justified the sale of this enterprise on the following grounds:

In other parts of the world, such enterprises do not remain public monopolies and opening up the monopoly for competition has improved its efficiency, service standards and revenue for the government.

The government and tax payers have to take an incalculable risk if the public enterprise fails due to mismanagement or failure to adapt appropriately to changing market conditions.

The government can use the sales proceeds to ease its budgetary constraints thereby obviating the need for raising additional revenue through new taxes or financing government programmes by issuing new money and causing inflation.

Private sector has better talents to run such enterprises and its transfer to private hands will enable the society to tap such talents for the benefit of the society.

The efficiency gains made by the enterprise under private management will add to the nation’s wealth and people’s pleasure.

The higher tax payments by the enterprise under private management will help the government to provide more and better public services.

The sale of this public monopoly could serve as the first step of making the industry involved competitive and productive.

In economic terms, all these arguments are valid and indisputable

The Mistakes which Economists make

However, in their hurry to sell this enterprise, economists may have disregarded the basic principles of transparency, disclosure and fair play. In other words, they would have failed to act like scientists who have no bias for or prejudice against the prospective buyers. As a result, many in the society would have doubted the genuineness and integrity of the transaction. This general ill feeling may cause some in the society to appeal to courts of law to make a judgment on the legality of the transfer of the public venture to the private hands.

The courts now sitting in judgment on the case after the passage of a considerable period of time would not feel the sense of urgency or the necessity which would have prevailed at the time the original decision had been made. It would be inconceivable for judges sitting on the judgment after sometime to reconstruct in their mind the true picture of the earlier situation. They, would, therefore, simply look at the legality of the sales transaction and deliver their judgment confining themselves to that limited frame.

Its failure to take note of the economics of the sale in question in passing the judgment would result in a serious lapse and irreversible error creeping into the judgment.

Both Judges and Economists are Scientists

Both judges and economists are scientists and they should adopt the scientific approach when they handle the cases before them.

A scientist starts his inquiry with an open mind. He will gather all the evidence that he could acquire, treat such evidence with objectivity and ensure that personal feelings do not creep into his judgment. His final conclusions are then objective, impersonal, unbiased and unprejudiced.

In the same manner, a judge or an economist should not allow personal feelings, prejudices or biases to influence his analysis and conclusions. If he does so, he would be doing an irreparable damage to the society which looks up to him for fair play, justice and equity.

How Can Economists and Judges Avoid Pitfalls?

How can economists and judges avoid this pitfall? By recognising that they both derive their wisdom from the same source and consulting each other when there is a doubt about policies they are recommending or cases they are adjudicating. There is nothing like admitting ignorance and seeking wisdom from those who may be able to express a learned opinion on an issue.

The Role of the Society

The society which has suffered due to the polarisation of the two siblings should do matchmaking. There should be facilities for both economists and those in the legal profession to interact with each other on critical cases involving law and economics.

The curricula that intend to train economists should necessarily have law contents; in the same manner, the curricula that train those in the legal profession should necessarily have

There should be interdisciplinary academic publications that cover both law and economics. There should also be societies of law and economics which will combine the seemingly different, but in actuality well connected, twin subjects.

The writer is a retired deputy governor of the Central Bank of Sri Lanka. To read previous columns in the series go to the WatchTower section on the main navigation panel or click on the links below.

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5. Tharu22 Nov 06
The role of judiciary is to intepret the constitution. The people and firms of a country are bounded by the constitution. It is the duty of firms to make sure they follow the constitution in what they do. If they violate it they can not justify it based on economic grounds. (For example can I kill someone just because I know his presence is bad for the society.)

If the constitution is outdated or inadequate it's up to constituents to change it. But they have no right to ignore it.

4. mw Nov 03
Sir, this is the third time I have re-read this. Love this article; quite a lot of substance (even for a non Economist like me) - food for thought, rich food.

I will one day take on to Economics. I must say that I was never really interest in economics until the current global turmoil, and the actions taken by the Central Bankers.

3. W.A. Wijewardena Oct 06
To Cura @2.
You have very correctly drawn attention to the failure of society to exercise an effective check over the unscientific way the things are sometimes handled by the two powerful groups: the absence of social institutions to watch over their work and raise the voice in a democratic manner to say 'you are wrong'.

Individuals working as lone crusaders with their limited or lack of knowledge cannot do that.

2. W.A. Wijewardena Oct 05
To Cura @ 2.
You have very correctly identified why this polarisation has occurred between the two important subjects in developing countries: the lack of credible social institutions to highlight the errors made by both parties.

If their work is being observed, then, they would be extra careful when they make their respective decisions.

1. Cura Oct 05
It is the society that finally has to pay for the losses due to mismanagement of productive resourses irrespective of who take desastrous decisions and/or judgments.

Ignorance of the majority of the society in developing countries seem to allow the divorce between economics and law to continue sometimes with increasing distance.

Lack of credible threats of being questioned effectively by the society may have encouraged both parties representing law and economics not to give due regard to the public concerns about their decisions.