DECIDING WHO DECIDES IN CONFLICT OF LAWS:

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1 DECIDING WHO DECIDES IN CONFLICT OF LAWS: AN INSTITUTIONAL PERSPECTIVE Toshiyuki Kono and Paulius Jurčys Working draft 6 June 2014 Prepared for the Asian Law and Economics Society Congress July 2014 National Taiwan University Abstract This paper aims to review the current law and economics debate of the issues that surround private international law disputes. There have been various attempts to explain various aspects of cross-border disputes between individuals. The existing theories tend to focus on efficiency (cost-and-benefit) analysis focusing on the interests of states or private individuals. While efficiency perspective unraveled some of the core problems with traditional legal theories, in this paper we try to suggest that the current debate does not capture the institutional aspect of the Coasean proposition about transaction costs. Drawing upon the insights of scholars who conducted comparative institutional analysis or private property regimes, we discuss international intellectual property matters which help to move away from a rather static which prevails in the current literature. Instead of fusing on the question how market mechanisms function in different settings; comparative institutional analysis pus to the forefront a broader perspective focusing on how market, adjudicative and political processes interact with each other. Institutionalism offers a dynamic view on the functioning of institutions in increasingly complex environments. It is suggested that neither of three institutions are perfect; rather that they tend to deteriorate as the number of participants and complexity increases. The example of international IP law offers a nice case study showing the shifts and cycles between strong and weak rights; as well as cycling between highly imperfect institutional alternatives. Professor, Faculty of Law, Kyushu University (Japan). Assistant Professor, Faculty of Law, Kyushu University (Japan). pjurcys@gmail.com 1

2 Table of Contents 1 Introduction Efficiency in Conflict of Laws Three Approaches of Efficiency Public Model Private Model Mixed Model Criticism of Efficiency Perspective in Conflict of Laws Institutional Choices and the Law Development of Institutional Approach Market Process Adjudicative Process Political Process Imperfect Alternatives Deciding who Decides in Cross-Border IP Disputes Concluding Considerations Introduction Conflict of laws is one of the most archaic fields of law. In the age where the global community transacts via digital communication networks, traditional conflicts of laws scholarship and practice still remains founded on the classical notions, principles and concepts. This raises many doubts about the ability of this discipline to provide for an adequate legal framework in dealing with truly global conflict of laws. In last few decades, however, conflict of laws literature has been increasingly permeated with the ideas even if only to quite limited degree coming in from law and economics literature. 1 A growing number law review articles, collective works and monographs try to take a look at traditional conflict of laws problems using interdisciplinary / law and economics approach. 2 This attempt to broaden the understanding of conflict of laws is certainly welcome. Yet, for a more acute follower of the debates in law and economics literature, the economic analysis of conflict of laws could be seen as stuck in the valley of death: the interest in economic analysis of cross-border disputes between private individuals epitomized at the turn of the millennia and has been loosing momentum

3 This paper aims to facilitate the interdisciplinary perspective to cross-border problems and offer a take comparative institutional approach. This is done in three steps. Firstly, we begin this paper by outlining the status quo of the economic analysis of conflicts of laws. We refer mainly to several studies conducted by Prof. Ralf Michaels where he identifies three models of conflict of laws: public, private and mixed. 3 The foundations of those three models are laid in the stakeholder perspective and the resulting juxtaposition of different interests of states and private parties. He provides a neat description of how these thee interest-oriented models have been reflected in the theories of conflict of laws. In his works Michaels takes a rather skeptical view arguing that efficiency perspective has nothing much to offer. 4 Although we share the same view with Michaels about the current state of conflicts literature, we believe that there is much to add to the proposed taxonomy. In the following sections we challenge the stakeholder perspective for being descriptive, static and blind emphasis to the utilities of different groups of stakeholders. In order to support our criticism and offer a more solid ground for our approach, in following section we introduce some of the main postulates of comparative institutional approach. Institutional perspective was developed by two Nobel Prize winners Oliver Williamson and Elinor Ostrom and their followers. In economic sciences, institutional perspective places a great emphasis on the role of formal and informal governance mechanisms such as Conflict of laws is one of the most archaic fields of law. In the age where the global community transacts via digital communication networks, traditional conflicts of laws scholarship and practice still remains founded on the classical notions, principles and concepts. This raises many doubts about the ability of this discipline the market as well as adjudicative and political processes. The crucial question for the proponents of the institutional approach is not whether market works better in one setting than another, but whether the market is better or worse than other alternative institutional settings (i.e., political and adjudicative process). 5 The proponents of institutional approach agree that even though individuals and institutions try to act rationally; nevertheless, they also suggest that in reality such rational-decision making processes are rare. While individuals are subject to cognitive bias, 6 institutions also not perfect. 7 The third chapter of the present paper largely relies on the findings of Neil Komesar. 8 Komesar is one of the leading figures in this venture to apply comparative institutional approach to the actual issues of legal regulation. One of the main propositions of Komesar is that the actual role of such institutional processes as law, governments, regulation and capitalism is determined by the various systemic variables such as the number of participants and complexity. 9 Comparative Sunstein, Nudge 7 8 Komesar s 2 books 9 3

4 institutional perspective helps fill in the existing gap in the current literature and explain institutional shifts and cycles from market to adjudicative process and from adjudicative process to political process. In his works Komesar vividly elaborates that neither of institutional processes are perfect: cognitive/minority/majority biases, complexity and other factors contribute to the deteriorating character of those institutions. Taking into account such an imperfect nature of those institutions, Komesar tries to figure out the way how to make choices among those imperfect decision-making alternatives. Comparative institutional approach is useful because it offers a dynamic perspective to the static view of stakeholder interests by introducing the notion of cycling. Building up on the main insights of authors who conducted comparative institutional investigations, in the fourth section of this paper aim to contribute to the academic discussion by offering an institutional perspective to the recent developments in international intellectual property law. Cross-border enforcement of IP rights has been a hotly debated issue in recent decade in various areas of law. Increasing number of disputes concerning multi-state licensing or infringements of IP rights have brought to daylight the need to reconcile two deeply rooted notions related to jurisdiction and choice of law to the changing realities of global markets. Comparative institutional approach offers a nice methodology to explain the shifts which have been taking place international IP law and practice. In particular, we believe that usefulness of comparative institutional could be best shown by the shifts from vaguely defined IP standards such as national treatment of foreign proprietors of IP rights to a set of clear rules concerning the reach and limits of IP rights. Comparative institutional approach also helps to highlight the shifts and cycles between imperfect institutional alternatives in the international IP cases. By adopting comparative institutional approach we aim to achieve two main objectives. First, we want to contribute to the conflict of laws debate by offering a dynamic perspective. As mentioned above, stakeholder perspective based on resource allocation efficiency considerations tells little about the role of law or how institutional choices affect the strength and or weakness of rights and remedies. Second, we also want to facilitate the discussion in law and economics discourse. Since the development of the digital communication technologies, we have witnesses the confluence of two distant areas of law intellectual property and private international law. Much of the focus both in academic literature as well as in IP practice has been placed on the legal technicalities pertaining to cross-border exploitation of IP rights. It is widely agreed that interests of states, proprietors of IP rights and users often collide. 10 However, a more general and understanding about the institutional choices in international IP law is still missing. At the same time, the proponents of comparative institutional approach mainly followed Coasean view and focused on traditional property such as land ownership, trespass and nuisance. This paper could be seen as a new case study whereby comparative institutional perspective to a rapidly evolving issues of international exploitation of IP. 10 4

5 2 Efficiency in Conflict of Laws 2.1 Three Approaches of Efficiency Economic analysis of law has gained momentum since the mid-twentieth century, some time after Ronald Coase brought to the daylight transaction costs. 11 Scholars mainly in Anglo-Saxon world were aware of the utilitarian ideas proposed by Jeremy Bentham 12 more than a century ago and subsequent expositions of John Stuart Mill, 13 Judge Oliver Wendell Holmes. 14 The notions of welfare maximization, resource allocation efficiency as well as cost-benefit analysis were further espoused by Richard Posner who became the foremost proponent of economic analysis of law. 15 Individual utility has been used as a tool to investigate how various regulatory schemes could affect the behavior and contribute to the enhancement of general welfare in the society. Not surprisingly, conflicts of laws soon also fell into the radar of the proponents efficiency perspective. Traditional conflict of laws doctrines were meant to align the interests of sovereign states by providing a set of tools to allocate legislative and adjudicatory powers. Based on the assumption that states are equal, the main function of choice of law rules is to provide for some guiding factors to determine where a particular legal relationship (e.g., contractual or tortious claim) has its seat. 16 Such approach is widely accepted also nowadays in most countries of the world. Moreover, choice of law rules are often considered to be value-neutral for they are meant merely to facilitate lawfinding but not to resolve differences that result from the application of substantive different substantive laws. 17 Efficiency perspective, however, revealed some of the hidden truths that have been concealed in the classical conflict of laws doctrines. The assessment of transaction costs and benefits can be only made once it is clear who is bearing costs and who will be better off. In multi-state disputes, there are two main groups of stakeholders whose interests often collide: states and private individuals. The following sections provide a brief overview of the debate among scholars who dared to dwell upon such juxtaposition of interests. Based on efficiency considerations, conflicts scholars distinguished public, private and mixed models and also tried 11 The Nature of the Firm; The Problem of Social Cost, The Firm, The Market and the Law 12 See J. Bentham, The Principles of Morals and Legislation () 13 John Stuart Mill 14 Who is known for the so-called prediction theory of law, see! 15 R. Posner, Economic Analysis of Law (Aspen Publishers, first edition published in ) 16 Savigny. 17 5

6 to find corresponding choice of law approaches. 18 The following sections address some of the main tenets of each of these three models which will serve as a depiction of the current state in the academic debate (the summary is provided in the table below). EFFICIENCY (STAKEHOLDERS) PIL THEORY POLICY OBJECTIVES LEGAL FRAMEWORK PUBLIC MODEL (State) INTEREST ANALYSIS (Currie) LEGAL CERTAINTY RULES (ex ante) PRIVATE MODEL (Private Parties) PRIVATE ORDERING (party autonomy) FLEXIBILITY STANDARDS (ex post) MIXED MODEL (States & Private Parties) PRAGRMATIC APPROACHES (Leflar s choice-influencing considerations) LEGAL CERTAINTY & FLEXIBILITY 2 nd Restatement or Hague Judgments Project Public Model Traditional conflicts doctrines were mainly founded on the principles of sovereignty, comity, and territoriality. In the nineteenth century, each nation state was seen as absolutely sovereign to deal with its domestic matters: by adopting statutes states could compel individuals to act in a particular manner. Such statutes had effects within the territory of the sovereign. As it was just mentioned, this was the status quo in the post-westphalian international law ideas permeated also the understanding of the main function of conflict of laws: i.e., to provide for a set of tools that would determine which country s laws should be applied in cross-border civil disputes. In the public model, efficiency is viewed from the angle of states. Sovereign states are deemed as the only rational actors in the international scene; 19 and private international law was considered an extension of public international law. 20 As rational actors, states aim to enforce their own policies in cross-border situations. In 18 See, generally, Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), pp Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), p A. O. Sykes, The Economics of Public Internaitonal Law, Chicago John. M. Olin Law and Economics Working Paper No. 215 (2004), available at: law.uchicago.edu/files/files/216-aoshandbook.pdf. 6

7 order to achieve that, states try to shape choice of law rules in a way that would maximize their own interests. For instance, Joseph Story, who drafted the First Restatement on Conflicts (year) 21 held the opinion that the application of foreign law should be inadmissible if it runs counter to the sovereign interests of the forum state. 22 The utility of states were became the central point of analysis in Brainerd Currie s government interest theory. One of the main assumptions in Currie s theory was that states have their own governmental interests embedded in the policies of domestic laws which have to be safeguarded if a particular transaction or controversy bears a close relationship with such a state policy. 23 He employed the notion of state interests in order to argue that each state aims to maximize their benefits at the expense of other states policies. 24 Currie disapproved of the rigid choice of law rules embodied in the First Restatement and argued that they have not worked and cannot be made to work ; 25 nullified states interests and struck down such policy considerations such as certainty and predictability. 26 This led him to a revolutionary 27 position that we would be better off without choice-of-law rules. 28 In order to fill the gap and determine the governing law Currie suggested to apply ordinary process of construction and interpretation which courts 29 a method which was applied by courts to determine the spatial reach of domestic statutes. 30 In Currie s conceptual framework, before applying foreign law, the court firstly has to investigate the underlying state policies and whether it is reasonable for each state to assert interest in the dispute. Once the state policies are identified, the court then has to analyze the relationship between the existing contacts of the dispute with the state policies. Currie identified three possible situations: (a) when only one of the states is interested in the application of its laws ( false conflict ); (b) when more than one state is interested ( true conflict ); and (c) when none of the states are interested in the application of their laws ( unprovided-for case). In normal circumstances the court should apply the law of the forum even if a case at hand involves foreign elements. 31 Currie argued that a court is not only entitled to, but also 21 First Restatement 22 See, e.g., Joseph Story, Commentaries on the Conflict of Laws (4th Ed., 1852), 36 where he refers to the mutual utilities of states. 23 Cf. B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), at p B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), which contains most the relevant articles. 25 See e.g., B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959) at p. 174; B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), at p B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959), at pp Cf. S. C. Symeonides, American Private International Law (Kluwer Law International, 2008), para B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959), at p. 177 and B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), at p B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), at pp B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959), at p. 178 and B. Currie, Selected Essays on the Conflict of Law (Durham, 1963), at pp B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959), at p

8 should apply its own law in cross-border disputes. 32 Foreign law should be applied only in exceptional cases when the forum state has no real interest in the application of its own law or when the dispute constitutes a matter which is subject to constitutional limitations. More precisely, in the case of false conflicts, 33 the law of the sole interested state should be applied. Practically, in most cases the interested state happens to be the forum state. But if the sole interested state is a foreign state, then its law should be applied. This approach was a significant departure from the traditional conflicts methodology which would often tends to sacrifice forum state interests by applying the law of uninterested foreign state. 34 In the case of true conflicts (where more than one state has an interest in the application of its own law), a court should give preference to the policy or interest of the forum state and apply its own law. This is so because, in Currie s opinion, forum state interests cannot be subjected to the interests of another state 35 and that courts neither have constitutional powers nor the ability to weigh colliding governmental interests. 36 In so-called unprovided-for cases (where neither state has an interest and where the application of the law of any state would not advance the interest of that state), forum law has to be applied. 37 In such cases the application of foreign law was deeded to provide for a pragmatic solution because courts are not trouble by ascertaining foreign law Ibid. 33 A typical example of a false conflict situation is Babcock v. Jackson case where the place of injury was in Ontario and all other connecting factors were located in New York. The underlying policy goal of Ontario s guest statute was to avoid insurance fraud (i.e., to pre-empt fraudulent assertion of claims by injured passengers); the goal of the New York statute was to ensure that the victim is compensated for injuries caused due to the fault of the tortfeasor. Currie noted that there was no conflict of underlying state policies because the interests of Ontario are not facilitated by the application of its law since the automobiles that were involved in the car accident were garaged and insured not in Ontario, but in New York. In other words, although the underlying policies of Ontario and New York differ, both of them ultimately point to the connecting factors in New York, and therefore the law of New York should be applied. See also Hurtado v Superior Court, 11 Cal. 3d 574 (1974). 34 See S. C. Symeonides, American Private International Law (Kluwer Law International, 2008), p. 99, para. 183 and B. Currie, The Disinterested Third State 28 Law and Contemporary Problems (1963) at p. 754 et seq. 35 B. Currie, Comments on Babcock v Jackson A Recent Development in Conflict of Laws 63 Columbia Law Review (1963), at p. 1233, and especially pp B. Currie, Notes on Methods and Objectives in the Conflict of Laws 8 Duke Law Journal (1959), at p Lilienthal v Kaufman, 239 Or. 1, 395 P.2d 543 (1964) is an example of a true conflict between the policies of Oregon and California. In that case, the Oregon court issued a declaration that the defendant was a spendthrift and thus had to be placed under guardianship. Despite the court s order, the defendant concluded a loan agreement with a Californian plaintiff. Later the guardian declared the loan contract void and the plaintiff brought an action in Oregon. In its judgment the court took note of conflicting governmental policies: while the Californian interest was to facilitate the security of contracts; the interest of Oregon was to protect the family of the spendthrift as well as the state treasury. Although laws of both US States could be potentially applied, the court followed Currie s approach and applied the law of the forum. 37 B. Currie, Survival of Actions: Adjudication versus Automation in the Conflict of Laws 10 Stanford Law Review (1958) Currie, supra note 76, at p Examples of unprovided-for constellations could be Erwin v Thomas 264 Or. (1973) 454, or Neumaier v Kuehner, 335 N.Y.S.2d 64 (1972), see also Aaron D. Twerski, Neumeier v. Keuhner: Where Are the Emperor s Clothes? 1 Hofstra Law Review (1973)

9 What implications does the assumption that states seek to benefit their own policies have to the private international law? In public international law, the most desirable way of aligning the interests among states is by means of international treaties. 39 States as rational actors are able to enter into bargain with other states and thus pave the way to the incorporation of state preferences into a binding treaty. International treaties often contain rather proclamations or codify principles as to the reach of states powers. Some international treaties may also provide for a comprehensive set of precise rules. In the previous literature it had been argued that states prefer muddy entitlements of jurisdiction 40 between sovereign powers. In private international law terms, however, states prefer certain rules which clearly prescribe the rights and duties of the citizen and designate the governing law. Such clear-cut choice of law rules were favored by proponents of the vested rights theory and were later enshrined in the First Restatement: contracts had to be governed by the law of the state where the contract is concluded (lex loci contractus) and the law of the place of injury (lox loci delicti) was applied for torts. Such a clear allocation of sovereign interests justifies the desire to have ex ante certainty with regard to the limitations of a state s jurisdiction. The reference to the law of the place of injury allows the state to maximize its utilities by applying its own law. 41 It could also explain why the First Restatement does not give private parties any freedom to designate the law which governs their contract. Similarly, Currie s governmental interest approach could be also considered as an attempt to provide ex ante legal certainty. As it was shown earlier, almost in all cases the law of the forum (lex fori) was preferred and only in very rare situations foreign law could be applied Private Model The private law model focuses on the interests of individuals who act rationally and seek the maximization of their own utilities. 42 Focusing efficiency and transaction costs and benefits incurred by private parties raises a number of questions about the functioning and methodology of private international law which have been left aside in the public model. Private model suggests that the purpose of choice of law rules should be maximize individuals welfare. In other words, choice of law rules should 39 Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), p. 168, Guzman, Choice of Law: New Foundations, p J. E. Trachtman, Economic Analysis of Prescriptive Jurisdiction 42 Vanderbilt Journal of International Law (2001) Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), pp Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), pp ; M. J. Whincop and M. Keyes, Policy and Pragmatism in the Conflict of Laws (2001); E. O Hara and L. E. Ribstein, From Politics to Efficiency in Choice of Law 67 University of Chicago Law Review (2000)

10 reduce transaction costs and give incentives to engage into welfare-maximizing conduct. In the private international law level, cooperation and coordination among private parties could be better facilitated by adopting flexible standards which allow the private parties to choose the most efficient set of actions. Open standards facilitate market-conform behavior and case-by-case justice. The adoption of standards is a relatively easy task for states, and the courts have more discretion to apply them in a given case. In private international law, party autonomy principle could be deemed as a standard which best meets the interests of private parties. Party autonomy gives the necessary freedom for the individuals to adjust their behavior to their own needs. It also reduces the information costs because the parties do not have to waste their resources in trying to determine the content of the law which would have to be applied if party autonomy was not allowed. 43 Notably, if parties are given freedom to choose possible tools for the maximization of the aggregate welfare, existing differences among the substantive laws of different states and the search for a better law becomes obsolete. More precisely, by focusing on individual s welfare maximization, the principle of party autonomy renders such factors as the place where a legal act occurred or where the parties have their residence of secondary importance. The principle of party autonomy also has another far-reaching consideration in court proceedings: allowing the parties to choose the law governing the determination of damages indirectly facilitates settlement Mixed Model The third mixed model brings private and public utilities together. As in the previous two cases, efficiency criterion is used as a normative guidance of behavior; however, the mixed model aims to reconcile utilities of both groups of actors (states and individuals). The rational choice theory in the mixed model is used to propose that states attempt to act rationally when they enact efficient laws which enhance general welfare, facilitate the growth of domestic economy and minimize transaction costs. 44 Choice of law rules should therefore be based on the objective to maximize the utilities of individuals as well as states. This mixed model places great emphasis on the regulatory competition among states to pass efficient laws. Such a pressure to enact efficient laws arise not only because of fierce competition with other states, but perhaps more because of the domestic pressure to internalize costs and facilitate welfare maximizing behavior. Hence, choice of law rules are considered to function as an incentive for states to pass efficient domestic laws. States act engage in a little 43 Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), p. 157 who refers to costs of ascertaining the applicable law, costs of compliance, and costs of application of a particular choice of law rule. 44 Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006), pp

11 cooperative game of regulatory competition and try to adjust their domestic legal framework according to the steps taken by other states. In conflicts literature such an amalgam of states and individual interests has not been unnoticed; a number of scholars, especially at the second half of the twentieth century and the turn of the millennia. 45 In the American conflicts revolution debate, the movement against rigid rules of the First Restatement obtained various shapes. Besides a Currie s governmental interest analysis, there was an attempt to identify certain factors that guide courts in determining the choice of law. 46 Robert Leflar was one of the most outstanding figures in this debate. He strongly criticized such conflicts methodologies as depeçage, procedure/substance dichotomy or public policy, considering them as gimmicks. Instead, Leflar noted that courts try to coverup the real reasons why the law of a specific state is applied. Focusing on the idea that the states interests should be carefully considered, he proposed five choiceinfluencing considerations that should help assess the rightness of choice-of-law rules and decisions. 47 Leflar argued that conflict rules should facilitate predictability and uniformity of results which play an important role in litigation. 48 The protection of parties justified expectations has even broader socio-economic implications which should legitimize parties anticipation that a transaction is valid. 49 At the same time, the interests of market players should not run counter to the sovereign interests of the states. 50 Leflar strongly believed in the need to simplify judicial tasks. 51 He also suggested that a reasonable judge should not merely try to apply his own law but rather prefer rules of law which make good socio-economic sense at the time when the decision is made. 52 Another figure which stood out among American conflicts thinkers was David Cavers. He continued to ambush the traditional conflicts methodology by comparing 45 See generally, A. F. Lowenfeld, International Litigation and the Quest for Reasonableness (Clarendon Press, Oxford, 1996). 46 See e.g., E. E. Cheatham and W. L. M. Reese, Choice of the Applicable Law 52 Columbia Law Review (1952) at p. 959 who identified nine policy factors: (i) the needs of the interstate and international systems; (ii) a court should apply its own local law unless there is a good reason for not doing so; (iii) court should seek to effectuate the purpose of its relevant local law rule in determining a question of choice of law; (iv) certainty, predictability, uniformity of result; (v) protection of justified expectations; (vi) application of the law of the state of dominant interest; (vii) ease in determination of applicable law, convenience of the court; (viii) the fundamental policy underlying the broad local law field involved; and (ix) justice in the individual case. See also H. E. Yntema, The Objectives of Private International Law 35 Canadian Bar Review (1957) at pp These were: (i) predictability of results; (ii) maintenance of interstate and international order; (iii) simplification of judicial task; (iv) advancement of the forum s governmental interests; and (v) application of the better rule of law. See R. A. Leflar, Choice-Influencing Considerations in Conflicts Law 41 New York University Law Review (1966), at p. 267; and R. A. Leflar, Choice of Law Statutes 44 Tennessee Law Review (1977) p Leflar, supra note 132, at p Ibid. 50 Ibid. 51 Leflar, Choice of Law Statutes 44 Tennessee Law Review (1977) p Leflar, supra note 132, at p Leflar s ideas had been quite persuasive: the five choiceinfluencing considerations were applied by various courts in different states; see e.g., Milkovich v. Saari, 295 Minn. 155, 203 N.W.2d 408 (1973) or Heath v. Zellmer, 35 Wis. 2d 578, 151 N.W.2d 664 (1967). 11

12 it to a slot machine: for Cavers, traditional contacts such as place of contract or place of tort in the First Restatement operated merely as a coin, which when inserted in the doctrinal slot machine, produces the appropriate jurisdiction. 53 He criticized such a mechanical approach and argued that courts, dealing with a particular case, should not keep their eyes closed to the substance of the chosen law, but rather try to do justice in the particular case. 54 Cavers proposed the so-called principles of preference that seek to solve choice of law problems. 55 Cavers came up with these principles because he did not agree with the idea that false conflicts should be solved by routine application of the forum law because he feared that this might lead to injustice for the parties. Cavers admitted that his methods favor territorial bias and called his approach neo-territorial : the principles of preference were not simply founded on a system of territorial contacts, but looks at the factual circumstances of the case and the presence of the right. 56 A practical illustration of the choice of law rule which aims to take into consideration both interests of states as well as private individuals could be found in the Second Restatement (1971). 57 The Second Restatement aims to balance party autonomy with more pragmatic considerations which should assist the courts and parties in determining the governing law. The Second Restatement adopted a more flexible approach which required to identify the most significant relationship. To facilitate the task of the determination of the governing law Restatement indicates seven factors. 58 The most significant relationship test adopted in the Second Restatement was described as a compromise of the various competing theories. 59 It also stands in the middle of rules/standards dichotomy. Such an approach was also supported in at least 20 states. 60 Similar attempts to draw the wedge between public and private utilities could be identified on an international law making level as well. Since 1990, intense negotiations have been taking place at the Hague Conference for Private International Law regarding the adoption of an international treaty that would harmonise the basic principles of how courts should act in exercising jurisdiction in civil and commercial 53 Cavers, supra note 47, at David F. Cavers, The Choice of Law Process (1965) at p Cavers came up with seven principles, five of which were designed for torts cases and two for contract cases. For example, the first principle could explain Cavers reasoning: 1. Where the liability laws of the state of injury set a higher standard of conduct or financial protection against injury, than do the laws of the state where the person causing the injury has acted or had his home, the laws of the state of injury should determine the standard and the protection applicable to the case, at least where the person injured was not so related to the person causing injury that the question should be relegated to the law governing their relationship. See Cavers, supra note 151, at p. 139 et seq. 56 Ibid., p. 134 and (a) The needs of the interstate and international systems; (b) the relevant policies of the forum; (c) the relevant policies of other interested states and the relative interests of those states in the determination of the particular issue; (d) the protection of justified expectations; (e) the basic policies underlying the particular field of law; (f) certainty, predictability and uniformity of result; as well as (g) ease in the determination and application of the law to be applied ( 6(2)). 59 Thiel, supra note 37, p See Symeonides report for 2000 in American Journal of International Law (2001) who also notes that there are 13 states that follow the First Restatement. 12

13 matters. 61 The draft of the Convention contained three sets of rules which aimed at balancing the certainty and flexibility: the so-called white list provided grounds when a court shall assert jurisdiction; grey list indicated grounds when a court may assert jurisdiction; and black list enumerated prohibited grounds of jurisdiction Criticism of Efficiency Perspective in Conflict of Laws Interdisciplinary perspective undoubtedly broadens the understanding of legal issues. However, there has been also notable resistance in legal scholarship to broaden the perspective and embrace the efficiency perspective. In so far as choice of law matters are concerned, a number of arguments against economic perspective could be identified. First, it is often submitted that economic abstractions do not help in solving specific private international law problems. In other words, the economic approach is usually based on oversimplified solutions that do not reflect the complex reality. 63 More generally, it has been argued that there is even a discrepancy among current law and economics approaches that aim to address conflict of laws issues. 64 In trying to illustrate the point, some authors referred to the fact that focusing on different stakeholders presupposes conflicting normative objectives and leads to different outcomes. 65 Secondly, it has been also argued that the notion of efficiency which is at the heart of the costs and benefits perspective has multiple meanings and therefore is intrinsically ambiguous. 66 The application of the efficiency criterion could be criticized by taking into consideration the fact that there is no alternative mechanism on an international law level which would provide for tools to re-allocate wealth (e.g., such as taxes or subsidies on a domestic law level). The efficiency criterion offers little help in making a choice between difficult policy questions; it can only suggest which economic model applies when, and therefore is inconclusive 67 Hence, it has See P. Nygh and F. Pocar, Report on the preliminary draft Convention on Jurisdiction and Foreign Judgments in Civil and Commercial Matters, available at 63 Michaels Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006) p Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006) Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006) Ralf Michaels, Two Economists, Three Opinions? Economic Models for Private International Law Cross-Border Torts as Example in J. Basedow and T. Kono (eds.), An Economic Analysis of Private International Law (Mohr Siebeck, 2006) p

14 been suggested that the law and economics perspective is just a refined comparative law method and is too abstract to provide any guidance for lawyers. 68 As with every methodology, law and economics has also shortcomings and limitations. Nevertheless, some of the above-mentioned criticisms do not necessarily undermine the added value of the efficiency perspective to conflict of laws. It should be noted that the efficiency perspective does lend itself as a one-size-fits-all approach; instead, it provides for a distinctive normative framework to identify and analyze legal issues which otherwise would remain a black box. Critics of the economic approach which uses assumptions to build hypothetical models tend to ignore the fact that abstract provisions often appear in legal statutes. Moreover, simplified models which are applied in law and economics literature are not necessarily unrealistic. On the contrary, various levels of simplification and abstraction are necessary depending of the specific purposes (e.g., large and small scale maps could be used in different occasions). By placing emphasis on the utilities of various stakeholders, timing and information asymmetry, economic analysis enables us to have a different perspective from what could be considered optimal regulation. 3 Institutional Choices and the Law 3.1 Development of Institutional Approach The foundations of institutional economics could be found in the works of economics scholars. The need to make an institutional choice was first of all emphasized by Ronald Coase, 69 and elaborated in works of other economics writers, most notably Oliver Williamson. 70 Early studies of Ronald Coase and Oliver Williamson focused in the organization of a firm and business decisions concerning the production process. Firms were viewed as vertically organized structures where the decisions are made from the top to the bottom and the enforcement of internal rules are mainly hierarchical. When it comes to production process, the key question is whether a firm should produce itself or enter into transactions with other firms. Coase made a visionary observation that when transaction costs of bargaining and negotiation with other firms are relatively higher, firms may choose to manufacture themselves. However, relatively lower transaction costs facilitate firms to enter into transactions 68 R. Michaels, The Second Wave of Comparative Law and Economics? 59 University of Toronto Law Journal (2009), p. 158 and R. Michaels, The Second Wave of Comparative Law and Economics? 59 University of Toronto Law Journal (2009), p Ronald Coase, The Nature of the Firm and The Problem of Social Cost 70 Williamson, Economic Institutions 14

15 others and outsource the production process. The enforcement of agreements in an intra-firm setting is not based on a hierarchical relationship, but on cooperation. In other words, the relationship among the firms is peer-to-peer and it is very different from hierarchical structure of one single firm. The debate about the structure of the firm and intra-firm relations was further advanced by Oliver Williamson who highlighted that intra-firm relationships are always based on incomplete contracts which are embedded in complex organizational settings. In such an environment, firms have to deal with other firms who are rational only to a certain degree (bounded rationality). Oliver Williamson also emphasized the fact that long-term relations between firms have some peculiar features: firms often rely on informal routines, and those relationships have to be constantly adjusted. In such a setting, the important rule is played by architectures of organization. 71 The ideas of economists were further developed by political scientists who engaged into more practical investigations of the management of common pool resources (e.g., lands, rivers, forests, beaches). Political scientists were unsatisfied to overly theoretical considerations being developed by economics scholars. Political scientists criticized economists for their failure to provide for a positive research agenda 72 and provided for a number of practical insights that moved forward the debate about institutions. At the forefront of this political discussion was Professor Elinor Ostrom, who proposed a more neutral and general framework to deal with particular problems, which she calls action situation. Ostrom notes that every action situation requires considering the characteristics and positions of actors, set of possible actions, available information, outcomes that actors jointly affect, as well as benefits and how they are related to actions and outcomes. 73 The notion of institution here has a relatively broader meaning that it is traditionally understood in legal scholarship. Douglas North talked about the rules of the game 74 while E. Ostrom defined institutions as prescriptions that humans use to organize all forms of repetitive and structured interactions. 75 Neil Komesar adopts the approach proposed by Ronald Coase and invites to give more attention to institutional choice between three main institutions: market process, judicial/adjudicative process and political process. 76 Differently from the earlier transaction-costs approach, institutional economics moves away from the focus on resource allocation efficiency. This notion of resource allocation efficiency is deemed as inappropriate and limiting; in other words, there could be other social goals than resource allocation efficiency. Instead, the proponents of institutional approach emphasize that the attention should be placed to decision-making processes that shape social reality. Markets mainly constitute what 71 Williamson, Markets and Hierarchies 72 Williamson Ostrom, Douglas North, Ostrom Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Publis Policy (Chicago University Press, 1994) 15

16 we get and what we can pay, but the opportunities of private actors usually depends on the decisions made by bureaucracies, legislatures or courts. Institutional law and economics help to identify a number of elements that have been left aside by earlier scholars who focused on transaction costs and benefits. First, traditional law and economics literature exclusively focused on the functioning only of one institution (mainly, markets). The missing element was the focus on goal choice and institutional choice that are crucial for any public policy decision. Second, previous law and economics debate focused only on one social value: resource allocation efficiency. Such a narrow approach has been criticized because it is not sufficient normatively and descriptively. Mere focus on efficiency does not inform much about the public policy outcomes or what they should be. The missing element in the previous analysis was the so-called institutional choice which emphasized that the implementation of a certain social goal depends on the choice of institution. For instance, if the goal is to protect private property, certainly courts are better suited to achieve that goal than the political process. 77 Third, the earlier debate also did not take into consideration timing perspective. Timing is very important because most of the interactions among private individuals are long-term relations that need to be adjusted and modified over time. In terms of decision making, compared to institutional approach, the previous law and economics debate failed to consider the costs of decision-making and the costs associated to the maintenance of agreed decisions. This could have important ramifications in law-making process and law-enforcement. Figure 1: Choice between alternative institutions 77 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Publis Policy (Chicago University Press, 1994), p

17 Fourth, institutional choice means a choice between highly imperfect alternatives. Any of the previous studies have tried to take institutional analysis seriously. Even the most renowned law and economics scholars such as Richard Posner 78 or John Ely 79 have failed to take institutional choice seriously and merely focused on one institution. According to the leading proponents of institutional choice, the analysis should focus not on how one institutional alternative (such as market) operates in a particular setting; but whether market is better or worse than other available alternatives such as political process or judicial process. 80 One of the reasons why comparative institutional analysis has not been widely employed in legal scholarship is its complexity. Institutions are large and a comparison of institutional capabilities requires a sophisticated strategy. Participation centered approach offered by Neil Komesar is based on the assumption that actions of the participants is a helpful factor to understand how institutions function. The participation-centered approach helps to identify costs associated with the expenses that individuals have to bear in different institutional settings. Comparative institutional analysis rests upon the notion transaction costs first highlighted by Ronald Coase. 81 A comparative institutional perspective has been described as a revisionist law and economics 82 because only by comparing alternative processes one can better understand the connection between the resource allocation efficiency and public policy. Comparative institutional analysis not only requires to identify the existence of alternative institutions, but also to evaluate the relative merits of those alternatives by comparing one institution to another. One of the first important assumptions in the comparative institutional analysis the fact that neither of alternative processes are perfect. Neither of the three processes mentioned above are frictionless: increasing number of actors increases the costs of bargaining and other transaction costs. In the market process the bargaining becomes more and more difficult with an increasing number of relevant parties. In the case of court process, the costs of bringing a claim and litigation in creases with every new party to the proceedings; and the proceedings become more and more complex. The ability of courts the properly analyse the views of all of the parties decreases. The crux here is that it is not possible to make a general ( one size fits all ) conclusion about the comparative advantages of one alternative institution over the other. On the contrary, the finding of relative merits depends on particular factual considerations of a given case. 78 Focusing on how market works in common law setting. 79 Constitutional law scholar focusing on the political process in different settings. 80 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Publis Policy (Chicago University Press, 1994), p The Nature of the Firm; The Problem of Social Cost 82 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p

18 3.1.1 Market Process The market process refers to transactions between various market players, e.g., the owners of a factory and the neighbors. Participation through transactions means that transactions play an important role in the society: the set the price and determine output, allocate scarce economic resources, distribute wealth and determine opportunities. 83 The market process is atomistic for there is no need of a central authority to steer the transactions. It was further noted that not all transactions are atomistic: there is a need to protect certain groups of actors (such as consumers or employee-inventors) or monitor the activities of monopolistic corporations. Most of the business arrangements are long term and require certain adjustments over time. Hence the degree of certain desirable goals are implemented in the market process such as efficiency or fairness depends the patterns of participation in the market process. If the possibility of participation in bargaining is low, then it is also unlikely that a market solution can be attained. Monopoly or monopsony as examples of market failure and lack of participation. In situations such as the monopoly, increasing range of profits will open new incentives for greater participation. But for comparative institutional analysis market failure is quite irrelevant because it cannot determine policy outcomes. In other words, market failure could be relevant if it is tied to the social goal of resource allocation efficiency; it is related only to the performance of a single institution. Therefore, comparative institutional analysis invites to look at alternative forms of participation in political and adjudicative process. 84 The focus on transacting and its dynamics over time is certainly not new in law and economics literature. 85 Ronald Coase is one of the pioneers in identifying the importance of transaction costs in business structure. In his landmark paper The Nature of the Firm weighty evidence was provided about the role of transaction costs for business decision on whether production should occur within the firm or whether it should be organized through market transactions with other firms. One of the most important components of transaction costs is costs of information. 86 In more recent literature of institutional economics, the positive aspects of transacting are given more weight. Arguably, the benefits side of transacting appears to be more useful in understanding the functioning of market process. Law and economics studies mainly tend to focus on the choice between the firm and the market (so called intra-market choices). Comparative institutional approach requires to look at such market transaction from a different point of view: the right question should be not whether it is more efficient to produce within the firm 83 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p Cf. Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p Coase, 86 Coase, The Problem of Social Cost 18

19 or outsource the production, but who should decide how production and distribution should be organized. Market and political process should be seen as complementing and substituting one another. The works of Oliver Williamson showed that in reality we live in transaction-costly world. 87 Those costs are so tremendously high, that much effort is devoted to curtail the excessively high transaction costs. A closer look at the regulation of antitrust or labor markets help better understand the centrality of the role played by the government. In many cases where private ordering is costly, a recourse is often made to the powers of the state in protecting property and enforcing contracts. Governmental mechanisms allow to alleviate the transaction costs and maintain the viability of complex market economies. To put it in different terms, the state functions as a facilitator in promoting the market-conform ecosystem. According to Komesar, the protection of property and individual freedoms always involves an institutional question of protection by whom and under what circumstances Adjudicative Process Adjudicative process may be the first institutional alternative to correct market imperfections. The performance of the adjudicative process depends on the following variables: number of participants, complexity of the environment, competence and abilities of judges and juries, as well as material capacities of the courts. These factors affect not only judicial decision making, but also shape the characteristics of law and rights. 89 Furthermore, compared to institutional alternatives, courts bear three distinctive characteristics. First, the adjudicative process is much more formalized. In judicial proceedings parties have to meet more stringent formalities which also lead to higher costs of participation in judicial process. Second, adjudicative process is much smaller and has significantly less resources. Moreover, it is much more difficult to increase the size of adjudicative process. Thirdly, judges are more independent from surrounding forces than the participants in market or political processes. In addition, the adjudicative process is more specific due to the safeguards for judges independence and evenhandedness of the adjudicative process. Judges serve for life and can be usually removed from their offices only in specially prescribed and limited cases. Moreover, their compensation is fixed. Judges are less interested in alternative job offerings because often they come to serve at the bench at the final stage of their career. 90 Strict rules of procedure and handling of relevant information often gives an impression of evenhandedness and impartiality of adjudicative process. Differently from bureaucrats, the anonymity and random selection of jurors makes it difficult to influence their decision making. These features of the adjudicative process provide 87 Williamson, Economic Institutions () 88 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p N. K. Komesar, Law s Limits, p N. K. Komesar, Law s Limits, pp

20 for both comparative advantages and weaknesses compared to other two kinds of participation processes. 91 Highly formalized institutional setting of courts leads to noticeable limitations of judicial activities: even a most aggressive judges are much more restrained from making decisions than the legislator. A number of requirements for filing a case and examining the factual circumstances significantly increase transaction costs of dispute settlement before courts. Due to the complexity of procedures and inability to accumulate all the necessary information, private parties need to employ expert attorneys. In the case of political and market processes, voters or firms can pursue the attainment of their needs in a less expensive way. A number of informal ways of interaction are available to participants in market and political processes: e.g., in cases when producers or politicians become aware that there is a significant consumer or voter interest, they try to adjust their behavior accordingly. Market and political processes offer a possibility of 24/7 communication, while courts usually are located in distant areas and are seldom available. 92 From a social interest point of view, courts nevertheless possess a comparative advantage because of independence of judges and the expectation that judicial process would lead to less biased outcomes than it would be in the case of political or market processes. A closer look to a litigation between the parties could help better illustrate how social issues are revealed in adjudicatory process. An analysis conduced by Neil Komesar is again very informative. 93 First, in the case of uniform low stokes, that is when there are multiple dispersed plaintiffs and multiple dispersed defendants, the costs of litigation are so high that the litigation simply disappears. This is especially true in controversies over the use of public goods (e.g., air pollution or use of lakes or rivers) is at stake. Judges are simply unable to resolve such controversies and the process therefore is concentrated in the political sphere. Second, in the case of uniform high stakes (i.e., limited number of participants with a high per capita stake) litigation is much more likely to occur. Even though court process is quite an attractive alternative, the resolution of disputes among few participants with high stake at hand is even more efficient in market process constellation. Bargaining and complex contracts may still be less costly than long and expensive litigation. Moreover, rather than formal judicial proceedings, informal mechanisms are more attractive in order to adjust long-term relationships among private individuals. Third, situations of skewed distribution where there is concentration only on one side offers further insights to the comparative institutional studies. Where there is a huge concentration on the side of plaintiffs, class actions may prove to be a workable solution. Nevertheless, especially in cases related to the exploitation of public goods, the adjudicative process may be of little assistance when it comes to the enforcement 91 N. K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994) 93 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), pp

21 of injunctive reliefs against multiple tortfeasors. Cases over public goods tend to reach courts only after significant policy decisions are made; and even then free bargaining may be more efficient than the adjudicative process. Although adjudicative process may be rather unapt to deal with situations involving great number of participants and potentially huge losses, in some instances it may nevertheless be a better alternative to other institutional settings. The most notable example is actions for compensation of damage sustained in a car accident. In car accident disputes, the initial (ex ante) situation involves many potential victims who have very little at stake. However, after the dispute arises there is only one of very few victims with high loss. Such dynamics of stakes and participants mean that courts comparatively better placed to solve a retroactive question related to the compensation for damage. The function of adjudicative process in car accidents is therefore different from the function which is performed in the political process. In the political process, the main concern is the regulation of risk prevention and insurance services. The political process is therefore prospective and mainly focuses on car accidents in the future. While the political process affect the position of potential victims and tortfeasors, the adjudicative process is mainly related to the actual victims and tortfeasors. 94 In sum, insulation from external influence places less pressure on courts in making socially important decisions. 95 However, relatively higher costs of participation may lead to inequalities during the litigation especially for less able stakeholders. 96 The demand for courts increases when other institutions deteriorate; yet, due to the fact that size and scale of courts cannot be easily expanded courts too become quite powerless in increasingly complex situations. Class actions to some degree contribute to the information asymmetry in the market and reduce the costs of access to judicial process. However, even though dispersed plaintiffs could manage their claims in class action proceedings, limited capacities of the courts become less able to assess competing interests in highly complex cases. Although courts tend to lack trust in the political process, limited institutional capacities may lead to the shift of decision making from judicial to political process Political Process Political process may become more desirable than market or courts when the number of participants and the complexity augments. In increasingly complex environments clearly defined property rights tend to disappear the right-holders find it difficult to utilize their rights. 98 However, as it was shown in the discussion about function market and political processes, political process also contains some inherent 94 Neil K. Komesar, Imperfect Alternatives: Choosing Institutions in Law, Economics and Public Policy (Chicago University Press, 1994), p N. K. Komesar, Law s Limits, p N. K. Komesar, Law s Limits, p N. K. Komesar, Law s Limits, pp N. K. Komesar, Law s Limits, p

22 shortcomings and dangers. This section briefly discussion two of the main features of such political malfunctioning: minoritarian/majoritarian bias and how they affect institutional choice. Informal communities tend to function well when the degree of complexity is low. Trespass and other abuses of property rights could be prevented or minimized by imposing informal sanctions or other gossiping. In clearly defined property rights systems market process functions well. Yet, once the number of stakeholders with competing interests increases, alternative institutional mechanisms may appear more desirable. In complex property systems, government regulation may become more desirable than market or court process. 99 In such complex systems, markets and courts may defer to the political decision making due to the allegedly higher institutional and human capital capacities that governments tend to posses. The previous comparative institutional studies have shown that also the political process often operated in the shadow of the phenomenon which could be described as agency capture. Depending on surrounding environments political process may be taken over by certain interest groups that have larger stake in managing certain property. Agency capture phenomenon refers to the situation where one group obtains major control over the decision-making agencies; while the less organized groups remain underrepresented. In the Coasean example of a polluting factory, the manufacturing industry is very much concentrated and has a great interest at stake. They may seek to gain more influence over the political process and thus push forward decisions which would be favorable to manufacturers. On the other hand, the owners of surrounding houses may turn into an underrepresented group with little. Such underrepresentation of house owners could be explained by the fact that their separate interests are too low to induce them to take a collective action against the manufacturers. In this case the minority (factory owners) are better organized and have more influence over the political process; and it is accustomed to refer to this phenomenon as minoritarian bias. There may be another possible situation of agency capture: when the majority of stakeholders get control over the political process. In such a case it is usually he majority (owners of surrounding houses) gets more influence over the agency decisions than the manufacturers (majoritarian bias). Agency capture phenomenon is likely to occur both in economically advanced as well as economically developing communities. Political malfunctioning and agency capture may be explained by such variables as the number of participants, complexity and information asymmetry. Dispersed groups face problems of information and organization. 100 Political process largely depends on the per capita distribution of costs of participation. These costs of political participation depends on various elements: e.g., the costs of information, sophistication of the issue at stake, the size of the political agenda etc. Interest group theory provides for a number of insights about the costs and benefits consideration that are decisive for engagement in the political action. Small interest groups with large per capita stakes have greater 99 N. K. Komesar, Law s Limits, p Komesar, Law s Limits, p

23 incentives in joining the political process. Their advantage over the majority is that majority s per capita impact is too little to organize and recognize the issue. 101 Even if the problem is recognized by the majority and the members of majority organize to take active steps, the net benefits of the individual members are even greater if they do not have to contribute to the political action. 102 In such constellations, a concentrated minority with high per capita stakes are nonetheless better organized and are able to influence the political process. Comparative institutional scholars have made a number of telling observations about the political process and institutional choice. The participation costs and benefits could vary greatly depending on the cultural, social or economic background. Market failure could be described as failure of participation; and the efficiency of participation in the political process is determined by the quality of participation. Hence, the dynamics between minoritarian and majoritarian bias have a broader societal implications because unequal participation may lead to problems in the society. Political malfunctioning may lead to judicial responses. Courts may provide strong property rights thus denying paternalistic claims of state to regulate private matters. 103 Courts may also refuse to provide strong property rights thus leaving the decision making to the market process. Judicial responses often depend on the surrounding variable factors: complexity, cultural environment as well as capacities and trust in the functioning of alternative institutions. Also here, the powers of judicial oversight depends al the capacities of courts themselves. 104 At the same time, biased political process may remain uncooperative and be reluctant to align political decision making to the opinions of the courts Imperfect Alternatives The previous economic literature placed much emphasis on the functioning of market and alternative mechanisms to manage property rights. Clear-cut property systems bear different characteristics from abstract entitlements. In some instances, clearly defined property rights may facilitate market-oriented transactions by reducing transaction costs. This is particularly the case where the number of actors and complexity is low. In other cases, muddy standards may be more advantageous than crystal-clear rules; this is so because standards may offer more freedom and flexibility for the market to adjust to case-specific needs. Conventional law and economics debate failed to identify the process of cycling between mud and crystal rules of property: replacement of muddy standards with crystal rules and vice versa. 106 Increasing complexities and numbers are the main 101 Komesar, Law s Limits, p Komesar, Law s Limits, p Komesar, Law s Limits, p Komesar, Law s Limits, p Komesar, Law s Limits, p Rose, (1994)

24 determinants of institutional choice: as complexity increases, the role of informal communities based on mutual trust deteriorates; and alternative institutional mechanisms come to rescue. Richard Posner is known for his suggestion to replace markets with common law courts could arguably enhance resource allocation efficiency, and this should be viewed as a move away from the market. 107 Yet, this is a one-sided and static view which does not capture cycling between imperfect institutional alternatives. Indeed, in increasingly complex societies, judicial process could perhaps at certain stage serve as a replacement of market imperfections; nevertheless, once the degree of complexity increases beyond the capacities of courts, judicial process becomes unable to serve as a mechanism for market imperfections. Figure 2: Institutional shifts and cycles Some scholars tried to put an emphasis to the market approach and suggest that informal decision making at the community level should be a predominant strategy. However, this approach is not that persuasive because of several reasons. First, markets flourish, when the situation is simple and norms and practices are trustworthy. 108 However, when the complexity and in numbers increase, trust in norms, social practices, informal relations and communities diminishes. Second, this reliance on the community or the market is not always feasible in this highly globalized world. One of the main lessons of comparative institutional approach is that institutions tend to move together. Not only market, but also judicial and political process functions relatively well in in simple settings. In reality, however, such a romantic vision of perfect institutions is merely an illusion: each of the institutional alternatives have inherent shortcomings. Hence the real question concerns institutional choice: and this question can not have a universal solution due to local differences. Court made law is neither stable nor clear; instead it can be better characterized by shifts and cycles between strong rights and weak rights. 109 In situations where courts refuse to confer strong rights, political process gains more leeway over the decision-making. However, if courts shift to grant moderate property rights, the axis of decision-making may shift from the political process to courts. 107 Komesar, Law s Limits, p Komesar, Law s Limits, p Komesar, Law s Limits, p