The Origins of Law And Economics
Most economic analysis consists of tracing out the consequences of assuming that people are more or less rational in their social interactions, in the case of the activities that interest the law, these people may be criminals or prosecutors or parties to accidents or taxpayers or tax collectors or striking workers-or even law students. Students treat grades as prices, so that unless the university administration intervenes, unpopular professors, in order to keep up their enrollments, will sometimes compensate students for the low perceived value of the course by giving them higher grades, that is, by raising the price that the professor pays for the student.
I said that the economist's tracing out of the consequences of a practice or policy is subtle as well as simple, and here is an example. A 'spendthrift trust' is a trust, very common, indeed standard, in which the trustee is forbidden to pay out any of the money or other property in the trust to the creditors of the trust's beneficiaries- The law will enforce such a restriction, yet it has seemed to many students of the law a fraud on creditors: for the trust beneficiary, assuming that his whole wealth is in the spendthrift trust, can borrow all he wants, spend what he borrows, and not be coercible by law to repay the lenders. But a moment's thought, provided it is economic thought, will drive one to the opposite conclusion-that, provided the provision preventing creditors from reaching into the trust is not concealed, a spendthrift trust limits borrowing by the trust beneficiary because he can't offer security to the lender: he thus can't make a credible commitment to repay. The next step in the analysis is to see how increasing the rights of debtors in bankruptcy, far from causing an avalanche of reckless borrowing, could reduce the amount of borrowing, and so the incidence of bankruptcy, by causing lenders to make smaller loans to risky borrowers. So lenders may oppose easy bankruptcy not because they fear that there will be more defaults, but because they fear a reduction in the volume of loans, (Just imagine how few loans there would be if borrowers had no obligation to repay.) Notice also how creditors are as badly hurt by excessively stringent as by excessively lenient bankruptcy rules: if creditors had the legal right, as under ancient Roman law, to carve up a defaulting borrower into as many pieces as there were creditors, the default rate on loans would be very low but most people would be afraid to borrow. One understands now why loan sharks break the legs of defaulting borrrowers, but do not kill them.