Recht und Ökonomie (Law and Economics)

Transcription

1 Prof. Dr. Friedrich Schneider Institut für Volkswirtschaftslehre Recht und Ökonomie (Law and Economics) LVA-Nr.: SS 2015 (5) Institutionalism: Origin, Economics & Coase SS 2015 Law & Economics 1 / 49

2 Content Institutionalism: Origin, Economics & Coase (1) Introduction (2) Fundamental Theories Conventional Theory of the Firm Neoclassical Theory British Marginalism Before Coase Old Institutionalism Darwinism (3) Institutionalist Economics The Rise of Institutionalism The Business Firm and Institutionalism J. M. Clark: Overhead Costs (4) Coasean Institutionalism Coase and Old Institutionalism Coase and the Business Firm (5) Conclusion: From Coasean Institutionalism to Law & Economics SS 2015 Law & Economics 2 / 49

3 1. Introduction Ronald H. Coase transformed the understanding of the role of transaction costs [ Transaktionskosten ] in the economic and legal systems. It can be said that he invented the modern discipline of law and economics. Coase s most important work seemed to merge neoclassic theory [ Neoklassische Th. ] with certain elements of institutionalism [ Institutionalismus ] by incorporating marginalist analysis [ Marginal- / Grenzanalyse ] into the study of institutions. SS 2015 Law & Economics 3 / 49

4 1. Introduction (cont.) Like other neoclassicists [ Neoklassiker ], R. H. Coase was not concerned about the source of preferences [ Präferenzen, Vorlieben ] but only with the mechanisms by which these preferences are asserted. More explicitly, by recognizing individual preference orderings [ Präferenz-Reihungen ] and market exchange as the principal movers of resources, R. H. Coase reduced the problem of resource movement to one of transaction costs. SS 2015 Law & Economics 4 / 49

5 1. Introduction (cont.) While R. H. Coase barely acknowledged the existence of the first generation of institutionalists [ Institutionalisten ], he still shared with them a focus on the movement of resources in (very small) markets. Result: A new brand of institutionalism [ Institutionalismus ] that was far more acceptable to neoclassicists but largely unacceptable to old institutionalists New Institutional Economics [ Neue Institutionenökonomik ] (abbreviated NIE ). SS 2015 Law & Economics 5 / 49

6 1. Introduction (cont.) Today New Institutional Economics (NIE) occupies a prominent position within the mainstream of economic thought. This revised brand of institutionalism has been a principal intellectual source of theory for modern law and economics. SS 2015 Law & Economics 6 / 49

7 2. Fundamental Theories 2.1. Conventional Theory of the Firm Economic theory of the firm theory of production, NOT theory of the firm as a legal entity [ juristische Person ]. Firm = production function or production possibilities set; a black box that transforms inputs into outputs. Given technology, input prices and a demand schedule a firm maximizes money profits subject to the constraint that its production plans must be technologically feasible. Firm modeled as a single actor, facing a series of simple decisions: what level of output to produce, how much of each factor to hire,. SS 2015 Law & Economics 7 / 49

8 2. Fundamental Theories 2.1. Conventional Theory of the Firm (cont.) Firm s size & product range usually explained in terms of production costs: o (positive) economies of scale imply larger firms; [ Größenvorteile, Skaleneffekte ] o economies of scope [ Verbundvorteile, -effekte ] justify multiproduct firm. Conventional theory = useful for understanding pricing and output decisions and how these vary with competitive conditions. SS 2015 Law & Economics 8 / 49

9 2. Fundamental Theories 2.1. Conventional Theory of the Firm (cont.) BUT: Production-function approach provides little insight into the boundaries of the firm. Black-box model : Theory about a plant or production process, NOT a firm firm and plant are distinct. Single firm: Can own and operate multiple production processes, just as two or more firms can contract to operate jointly a single production process (example: research joint venture). SS 2015 Law & Economics 9 / 49

10 2. Fundamental Theories 2.1. Conventional Theory of the Firm (cont.) Consequence for Production-function approach: Cannot fully explain real-world business practices as vertical and lateral integration, acquisitions, geographic & product-line diversification, franchising, long-term commercial contracting, transfer pricing and joint ventures. No adequate guide for antitrust and regulatory policy. SS 2015 Law & Economics 10 / 49

11 2. Fundamental Theories 2.2. Neoclassical Theory Fundamental assumptions neoclassical theory ["Neoklassische Theorie ] : (1) Individuals have rational preferences [ Präferenzen, Vorlieben ] with values. among outcomes; these can be associated (2) Individuals maximize utility [ Nutzen ] and firms maximize profits. (3) Individuals act independently on the basis of full and relevant information. SS 2015 Law & Economics 11 / 49

12 2. Fundamental Theories 2.2. Neoclassical Theory (cont.) Economic agents (e.g. households, firms) optimizing, subject to all relevant constraints. Producers (like business firm) maximize profits by producing units of a good so that the cost of producing the marginal unit is just equal to the revenue this marginal unit generates. In general, neoclassical price theory assumed a frictionless system in which firms were rational maximizers constrained by competition. SS 2015 Law & Economics 12 / 49

13 2. Fundamental Theories 2.2. Neoclassical Theory (cont.) Critique on neoclassical theory: The firm in neoclassical economics was largely an abstraction. Presence of the firm on the market known as purchaser and seller, but its internal workings [ interne Funktionsweise / Abläufe ] were largely a mystery. Example Marshallian business firm : Can be seen as black box consisting of cost functions and responding to demand functions. SS 2015 Law & Economics 13 / 49

14 2. Fundamental Theories 2.3. British Marginalism Before Coase Two important characteristics of Cambridge economics: I. Marginalism [ Marginalismus ] as conception of a rational actor and decision making at the margin; and II. a belief that interpersonal comparisons of utility [ interpersonelle Nutzenvergleiche ] were a useful part of economic inquiry. Marginalism provided a rigorous theory of individual incentives and valuation. Marginal utility theory [ Grenznutzen-Theorie ] revolutionized economics in a number of ways [next slide]: SS 2015 Law & Economics 14 / 49

15 2. Fundamental Theories 2.3. British Marginalism Before Coase (cont.) (1) Marginal utility theory was forward looking. Value became a function of willingness-to-pay [ Zahlungsbereitschaft ] for the next unit, rather than an average of previous values or some theory about how much labor went into production. (2) Marginalism s rational actor received decreasing marginal value from goods, and maximized his position by exchange until the marginal value of each was the same, that is in equilibrium. In The Nature of the Firm (1937), Coase simply applied this principle to the business firm rather than the individual as an economic actor. SS 2015 Law & Economics 15 / 49

16 2. Fundamental Theories 2.3. British Marginalism Before Coase (cont.) (3) Marginalism [ Marginalismus ] was quite unconcerned with how people actually experienced needs and wants, or what the (inherited or environmental) sources of wants might be. Marginalism simply presumed that its actors were rational a set of transitive preferences over goods that could be freely exchanged. Firms marginalists were very attentive to the mathematics of competition and monopoly [ Monopol ], but paid little attention to the firm s internal operations or decision making. SS 2015 Law & Economics 16 / 49

17 2. Fundamental Theories 2.3. British Marginalism Before Coase (cont.) (4) Marginalist economics was heavily preoccupied with equilibrium, or the place where resources ended up as people, firms, and markets reflected the assertion of individual preferences. Prior to Arthur Cecil Pigou marginalists largely ignored cost of moving resources from one place to another they assumed that individuals and firms arranged their own preferences and also that markets reflected interpersonal trading. Consequence: Marginalists presupposed that all economic actors shift resources from one use to another without any frictions in the system lack of attention to the costs of movement. SS 2015 Law & Economics 17 / 49

18 2. Fundamental Theories 2.4. Old Institutionalism Institutionalism [ Institutionalismus ] historically refers to a group of mainly American economists whose work stretched from the beginning of the twentieth century until after the New Deal. Popularity of first generation of (or old ) institutionalism within economic theory was short lived. Old institutionalists believed that in a world in which resources are scarce and their movement is costly, a variety of institutions emerge for determining the course of movement by forcing individuals to make trade-offs. SS 2015 Law & Economics 18 / 49

19 2. Fundamental Theories 2.4. Old Institutionalism (cont.) First generation of institutionalists / old institutionalists: emphasized importance of human-created institutions that serve to allocate power or resources, the rules that these institutions develop and employ, and their effect in overall economy. rejected (or severely restricted) marginalist analysis [ Grenz- / Marginal-Analyse ], as well as the emergent neoclassical creed that the study of naked individual preference [ Präferenz, Vorliebe ] is the exclusive methodology of economic science. SS 2015 Law & Economics 19 / 49

20 2. Fundamental Theories 2.4. Old Institutionalism (cont.) Main critique on theories neoclassicism & marginalism: They were too abstract; lack of empirical content. They elevated rationality over evolution as a device for explaining human choice. They overly focused on market exchange as the dominant method of social interaction. SS 2015 Law & Economics 20 / 49

21 2. Fundamental Theories 2.4. Old Institutionalism (cont.) Neoclassicism did not develop a coherent theory that the movement of resources from one place to another is costly, and that institutions are the devices that humans create in order to effect this movement. By contrast, old institutionalism understood the need for institutions well enough and thus was able to study the relationship between law and economics in a way that was previously unknown. Without marginalism as an analytic lever, however, old institutionalism was unable to do much more than catalog and classify. SS 2015 Law & Economics 21 / 49

22 2. Fundamental Theories 2.4. Old Institutionalism (cont.) Merger of marginalism into institutionalism new brand of institutionalism (= new institutionalism). One characteristic of institutionalism, both new and old: By broadening the reach of economic analysis beyond traditional markets, institutionalism was able to capture a more complete set of the mechanisms by which resources are moved from one place to another. SS 2015 Law & Economics 22 / 49

23 2. Fundamental Theories 2.5. Darwinism Darwinism [ Darwinismus ]: Offered a principle of physical development, and also a theory of society and culture, as well as notions about welfare and the role of the state. Offered a powerful theory of preference that is quite different from the radically individualistic and subjective preference that is the topic of marginalist economics. Starting point for analysis = environment rather than individual. A sharp (ideological) divide exists between Social Darwinists ( no state interference) and Reform Darwinists ( environment & individual could and should be manipulated). SS 2015 Law & Economics 23 / 49

24 Thorstein B. Veblen: 3. Institutionalist Economics 3.1. The Rise of Institutionalism He attacked marginalism and neoclassicism for not taking Darwinian theory into account. He was the most explicitly Darwinian of the major institutionalists, emphasizing the role of survival instincts in forming individual preferences as well as social institutions. He thought of human choice in terms of habits rather than preferences, and habits were entirely the product of evolution. SS 2015 Law & Economics 24 / 49

25 3. Institutionalist Economics 3.1. The Rise of Institutionalism (cont.) T. B. Veblen [cont.] : He believed that marginalism s continual search for equilibrium was misguided, given that evolution knows no equilibrium but is continuously rematching environment and the organisms contained in it. For him, institutions were human creations for directing wealth, power, and social control. They were entirely a product of evolution, and they were worthy of economic study because they tended to be of much longer duration than the individuals who lived in them. SS 2015 Law & Economics 25 / 49

26 3. Institutionalist Economics 3.1. The Rise of Institutionalism (cont.) One of institutionalism s most durable contributions was that it increased economic analysis of the legal system, particularly the role of property rights in economic exchange. [ Eigentumsrechte ] Legal scholars at elite institutions (Yale, Columbia) began to pay more attention to economic markets and to the relation between markets and legal rules (both common law and statutory) Legal Realists. SS 2015 Law & Economics 26 / 49

27 Legal Realists : 3. Institutionalist Economics 3.1. The Rise of Institutionalism (cont.) They saw various institutions, such as the legal system and the market system, as coordinate and as having their own values and operating rules they did not view all institutions through the lens of price theory. They did not accept marginalism as exclusive / dominant theory of value. Their theory of choice was heavily behaviorist [ behavioristisch ] ; they were Darwinian in their thinking about the relationship between people and their environment. SS 2015 Law & Economics 27 / 49

28 3. Institutionalist Economics 3.1. The Rise of Institutionalism (cont.) Legal Realists [cont.] : Traditional markets they saw a great deal of monopoly [ Monopol ], market failure [ Marktversagen ], and coercion rather than competition. They viewed markets and governments as alternative ways of allocating resources; tended to have at least as much confidence in government as in markets as resource allocation devices. SS 2015 Law & Economics 28 / 49

29 3. Institutionalist Economics 3.1. The Rise of Institutionalism (cont.) Summarizing, Institutionalists were very conscious of the power that some social institutions had over individuals: They rejected the neoclassical search for models of competition in which individual actors were powerless and everyone was regarded as having infinite freedom to make any exchange that he or she pleased. They tended to view business corporations as institutions that wielded great power and were inclined to use it irresponsibly. SS 2015 Law & Economics 29 / 49

30 3. Institutionalist Economics 3.2. The Business Firm & Institutionalism For institutionalists, the business firm deserved special study an obvious exception to the neoclassical supposition that resources are allocated through markets. Firms are aggregations of individuals, collections of plants and other productive units related both horizontally & vertically, and composed of owners, managers, and workers. At least in private commerce, most resource re-deployment occurred with the involvement of at least one firm. Relationships among the numerous individuals that functioned inside a firm hardly fit the neoclassical idea of a market. SS 2015 Law & Economics 30 / 49

31 3. Institutionalist Economics 3.2. The Business Firm & Institutionalism (cont.) View of institutionalists neoclassical economics solved problem with firms by murder, because: They largely ignored questions about nonmarket relationships and decision making inside the firm. The firm was simply an economic agent a black box that transacted in the market in the same way that a natural person transacted. One big difference between the firm and the human being firm had a profit function that maximized wealth, while the human being maximized utility. SS 2015 Law & Economics 31 / 49

32 3. Institutionalist Economics 3.2. The Business Firm & Institutionalism (cont.) R. H. Coase article The Nature of the Firm (1937): Merger of marginalism and institutionalism by applying marginal analysis to the firm s internal decision making questions about its size and structure. However, R. H. Coase was not the first economist dealing with the problem in this way; e.g.: Lawrence Kelso Frank (theory of vertical integration). John Maurice Clark (internal decision making next slides) SS 2015 Law & Economics 32 / 49

33 3. Institutionalist Economics 3.3. J. M. Clark: Overhead Costs John Maurice Clark (early 1920s) used marginalist analysis to explore the internal decision making of the business firm. Fixed costs = investment in something like land, plant, equipment, or typically research and development ( R&D ) that does not vary with production and that must be paid whether or not the firm produces anything. Fixed costs create the concept of overhead costs [ Gemeinkosten / indirekte Kosten ], or costs unrelated to the marginal costs of making an additional unit and selling it. SS 2015 Law & Economics 33 / 49

34 3. Institutionalist Economics 3.3. J. M. Clark: Overhead Costs (cont.) Fixed costs and high volume machine output: Manufacturing and orders cannot be synchronized on a day-byday basis machines must either run or be shut down. Need for constancy of output in the face of cycling business conditions created a huge coordination problem. Fixed costs could lead to inefficient risk distribution: Firms with mainly variable costs would be in a position to shift risks of oversupply & undersupply to firms with high fixed cost. SS 2015 Law & Economics 34 / 49

35 3. Institutionalist Economics 3.3. J. M. Clark: Overhead Costs (cont.) Summarizing J. M. Clark: Contracting & coordination costs determine when a firm will choose outside procurement or internal production. Choices related entirely to the firm s search to maximize its own value within an environment that included fixed costs, specialization and shortness of information. Pricing above short run cost and price discrimination no unique attributes of monopoly; can exist in any market with fixed costs. SS 2015 Law & Economics 35 / 49

36 Ronald H. Coase: 4. Coasean Institutionalism 4.1. Coase and Old Institutionalism Institutions do matter & neoclassical economics tended toward too much abstraction he shared these two fundamental principles with the first generation of institutionalists. But rejection of old institutionalists severe limitations on marginalist analysis [ Marginal- / Grenzanalyse ]. Usage of marginalist criteria to define the behavior of economic agents ( The Nature of the Firm [1937]; The Problem of Social Cost [1960]). SS 2015 Law & Economics 36 / 49

37 4. Coasean Institutionalism 4.1. Coase and Old Institutionalism (cont.) For R. H. Coase (as for any neoclassicist) the firm was no different than the individual equating utilities at the margin, except that the firm s utilities were in fact profits and losses that could be quantified by price theory. Welfare gains occur only when: parties are able to bargain at suitably low cost, or else when the legal system emulates the outcome that people would have achieved if they had been able to bargain with each other. SS 2015 Law & Economics 37 / 49

38 4. Coasean Institutionalism 4.1. Coase and Old Institutionalism (cont.) In sum, Coasean analysis is purely neoclassical in the sense that it identifies the welfare maximizing outcome as the one that people would reach through voluntary exchange, provided that transaction costs are suitably low. SS 2015 Law & Economics 38 / 49

39 4. Coasean Institutionalism 4.2. Coase and the Business Firm New institutional approach to the business firm is usually traced to Coase s The Nature of the Firm (1937). R. H. Coase & business firm: Boundaries of the firm depend not only on the productive technology, but on the costs of transacting business. Decision to organize transactions within the firm as opposed to on the open market the make-or-buy-decision depends on the relative costs of internal and external transactions. SS 2015 Law & Economics 39 / 49

40 4. Coasean Institutionalism 4.2. Coase and the Business Firm (cont.) Market mechanism entails certain costs discovering relevant prices, negotiating & enforcing contracts, Within the firm, the entrepreneur can reduce these transaction costs by coordinating these activities himself. However, internal organization causes another kind of transaction costs problems of information flows, incentives, monitoring and performance evaluation. SS 2015 Law & Economics 40 / 49

41 4. Coasean Institutionalism 4.2. Coase and the Business Firm (cont.) Generally, all feasible modes of economic organization incur costs. The nature of the firm, then, is determined by the relative costs of organizing transactions under alternative institutional arrangements. Firms are always seeking to minimize costs. As long as the marginal costs of internal production are lower than the marginal costs of using the market, the firm will produce internally, and conversely. SS 2015 Law & Economics 41 / 49

42 4. Coasean Institutionalism 4.2. Coase and the Business Firm (cont.) Coase s analysis applied to every decision a firm made: from relatively macro decisions about whether or not to build a new plant to extremely micro decisions about whether to sweep one s own floors rather than hiring a cleaning service. R. H. Coase concluded: "To determine the size of the firm, we have to consider the marketing costs that is, the costs of using the price mechanism and the costs of organizing of different entrepreneurs and then we can determine how many products will be produced by each firm and how much of each it will produce." SS 2015 Law & Economics 42 / 49

43 5. Conclusion: From Coasean Institutionalism to Law & Economics Within neoclassical economics prior to A. C. Pigou resources were assumed to be unambiguously assigned and costless traded. In that regime the need for a legal system was limited to the enforcement of contracts, prohibition of fraud, and control of monopoly. Except for the concern about monopoly, the neoclassicists did not trouble themselves all that much about the interaction of the legal system and the market. SS 2015 Law & Economics 43 / 49

44 5. Conclusion (cont.): From Coasean Institutionalism to Law & Economics The rise of institutionalist economics in the early 20th century changed that, as the old institutionalists examined the many forms of nonmarket organization through which resources move. Today the Coasean vision of the relationship between institutions and law has largely swept the field. SS 2015 Law & Economics 44 / 49

45 5. Conclusion (cont.): From Coasean Institutionalism to Law & Economics Merger of old institutionalism with neoclassicism = NIE: Enabled institutionalism as a theory to have more coherence and explanatory power than the old institutionalism had. A heavy critique against old institutionalism was that it quickly turned into little more than historical description with very little analytic power. Whether regarded as an individual economic actor or as a collection, the firm s goal is to maximize its own value. One thing that makes modern law & economics both insightful and controversial is that this same goal, maximization of value, is used to explain nonbusiness institutions as well. SS 2015 Law & Economics 45 / 49

46 5. Conclusion (cont.): From Coasean Institutionalism to Law & Economics Restriction of economic study of legal institutions to the role of transaction costs, with transaction defined to include: resource transfer that result from bargains between legally independent people, and nonmarket transfers that occur within the economic agent itself. SS 2015 Law & Economics 46 / 49

47 5. Conclusion (cont.): From Coasean Institutionalism to Law & Economics Modern law and economics grew out of the premise that institutions count, and that the legal system is the principal institution for seeing to it that resources end up in their most valuable use. Within law and economics, the initial assignment of property rights and the transaction costs of bargaining are responsible for the creation of all economic agents larger than the single individual. SS 2015 Law & Economics 47 / 49

48 5. Conclusion (cont.): From Coasean Institutionalism to Law & Economics Every economic event becomes a study in transaction costs. Transaction costs explain (for example): Why the person who prefers the new Toyota to her Chevrolet might chose to stay with the car she already has nevertheless. How large the business firm, the family or some other institutions will become, and how many activities it pursues internally rather than on a market. In its most formal mode why the common law is more efficient than legislation. SS 2015 Law & Economics 48 / 49

49 References Herbert J. Hovenkamp (2010), Coase, Institutionalism, and the Origins of Law and Economics, University of Iowa Legal Studies Research Paper No 10-07, University of Iowa College of Law, USA. Klein, Peter G. (1999), New Institutional Economics, Department of Economics, University of Georgia. SS 2015 Law & Economics 49 / 49