Legal efficiency and consistency

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Abstract

We analyze the efficiency and consistency of court decisions under common and civil law. As a leading example, we study the enforcement of property rights. Judges are of two types: some are conservative and follow the precedent or the statute, while others maximize social welfare. When courts intervene ex-post, after the relevant economic choices have been made, welfare-maximizing courts face a “commitment problem.” Such an ex-post bias has implications on the relative “consistency” and efficiency of each legal system. Surprisingly, we find that court decisions are more consistent under common law than under civil law. The welfare comparison between the two systems is, instead, ambiguous. However, in changing economic environments, common law is more likely to dominate civil law because of its greater adaptability.

Introduction

In the last two decades, a large empirical literature has investigated the implications of “legal origins” on a wide range of economic variables, such as investor protection, contract enforcement and labour market regulation.1 As pointed out by La Porta et al. (2004), “…despite the evidence, the exact mechanism through which legal origin matters has remained uncertain.” To investigate this issue, this paper models in a stylized way judicial decision making under common and civil law. We compute the welfare consequences of the two legal regimes and investigate the conditions under which one regime is preferable to the other. Besides efficiency, we also identify an additional desideratum of the legal system: the “uniformity” or “consistency” of the law as embodied by court decisions.2 We ask whether legal consistency is achieved under the two legal systems and whether there is a trade-off between legal consistency on the one hand and equitable decisions and flexibility on the other.

Following traditional comparative law doctrine, we assume that common law is established by judicial precedents and decisions.3 Stare decisis is what requires courts under common law to conform to decisions reached by previous courts.4 Conversely, under civil law the center of authority is the legislature, and the role of civil law judges is to interpret and apply a body of statutes and administrataive regulations.5 We recognize that in practice it is hard to identify “pure” forms of either system (Zweigert and Kötz, 1998). Under common law the body of statutes has expanded dramatically through time (Calabresi, 1982) and precedents play some role also under civil law (Hondius, 2005). Nevertheless, we believe that our analysis can shed new light on the relative merits of precedents and statutes.6

We assume that judges can be of two types. A fraction of judges are “conservative” and mechanically follow the precedent (under common law) or the statute (under civil law). The remaining judges are “active” and maximize social welfare. To some extent, this distinction captures the two main legal theories in jurisprudence (Summers, 1982). On the one hand, proponents of legal formalism argue that judicial discretion poses a threat to legal certainty and to democratic legitimacy.7 On the other hand, the followers of instrumentalism believe that judges retain a considerable amount of discretion to fill in the gaps in existing laws and that the law should be used as a tool to balance competing societal interests.

A key feature of our analysis is that “active” judges suffer from time-consistency problems. Consider an environment in which the ex-ante optimal law is suboptimal ex-post, when the relevant economic choices are sunk. Such an ex-post bias generates a hold-up problem and may have serious consequences on economic outcomes. A leading example is the enforcement of property rights. Consider a possible investment that increases output. Active courts have the incentive to announce strict property-right enforcement in order to encourage investment. However, after investment has been sunk, judges are tempted to choose a weaker ruling. Foreseeing this, investment will be sub-optimally low.8 As we show below, the common and civil law regimes deal differently with the ex-post bias. This has novel implications in terms of relative efficiency and consistency.

While the literature has devoted considerable attention to the study of judicial partisan bias, stemming from courts that have preferences favoring one of the two sides in the legal dispute,9 time-inconsistency problems in court decision-making remain relatively understudied. Anderlini et al. (2014) analyzes the implications of time-inconsistency problems that afflict courts in the common law regime, and is in some sense a point of departure for this paper.10

Aside from numerous modeling differences, the main contribution of this paper relative to Anderlini et al. (2014) is twofold. First, we provide a model of the civil law regime. This allows us to compare the two legal traditions. Given that time-consistency problems are pervasive in courts, we believe that our comparative analysis constitutes a meaningful extension to the legal-origin literature. Second, we introduce stochastic shocks which change the optimal law. This modeling choice is novel and distinguishes our paper from most of the related literature which assumes that the optimal law is constant (see for example Ponzetto, Fernandez, 2008, Gennaioli, Shleifer, 2007a, Gennaioli, Ponzetto, 2017). By considering a time-varying optimal policy, we are able to identify the degree of adaptability of the two legal traditions. The “adaptability” channel is often put forward to explain why legal institutions have real consequences (Beck, Demirgüç-Kunt, Levine, 2003a, Beck, Demirgüç-Kunt, Levine, 2005). A widespread view (Hayek, 1973) is that judge-made law is more responsive than statutes to changing economics circumstances. Our set up in this paper allows this claim to be tested.

Civil law partly solves time-inconsistency problems by limiting court discretion. Decisions by courts must lie in an interval centered around the written statute. This assumption captures the idea that judicial discretion can be limited but it cannot be completely taken away from civil law judges. We show that under civil law, the statute is set strategically to offset the incentives of active courts to deviate ex-post. In anticipation of the application of the law, statutes prescribe “stricter” rules than the ex-ante optimum. This improves civil law welfare, but cannot generally lead to full efficiency. We show that the application of the law is not uniform. Conservative judges are excessively strict because they interpret the law literally, while the active ones are excessively lenient. Judicial heterogeneity leads to legal inconsistency in the sense we have discussed above.11

Under common law, instead, lawmaking power has been delegated to judges, making time-consistency problems potentially severe. We show that the rule of precedent has a disciplinary role. The threat that in the future conservative judges will follow inefficient precedents helps sustain the ex-ante optimal law. The disciplinary role of stare decisis is more effective when the proportion of conservative judges is higher, because this implies that deviations from the ex-ante optimal decision have more lasting consequences. We also show that the rule of precedent helps achieve legal consistency by linking current judicial decisions to future ones. Thanks to stare decisis, all types of common law court enforce the same decisions, making common law more consistent.

However, the welfare comparison of the two legal systems is ambiguous. We show below that civil law dominates in terms of efficiency when judges are relatively homogenous (that is, they are mostly conservative or mostly active) and/or when judicial latitude under civil law is sufficiently narrow. On the other hand, we show that in the context of our model, common law is unambiguously better in achieving legal consistency than civil law. Notice that this result goes against the common view, especially among civil law advocates, that statutes lead to greater consistency in the law than precedents.12 We emphasize that this result is obtained in a model where judges have the same preferences, but differ with respect to their legal reasoning (some judges are conservative, while others maximize welfare). This drives the difference between our findings and those in the literature that studies partisan judges.

In the second part of the paper, we introduce shocks to the environment that change the optimal law and study how the two legal traditions adapt. Shocks introduce a fundamental trade-off between commitment and flexibility: on the one hand, rules (either statutes or precedents) provide valuable commitment, thus limiting inefficient decisions. But on the other hand, there is a cost of reduced flexibility as rules cannot be made contingent on every single shock or contingency, and some discretion may be optimal. In the context of our stylized model, we find that civil law courts do not respond to shocks to the environment. Conversely, the common law regime does innovate, but it proceeds by “slow advances”.13 Because of the inertia introduced by the rule of precedent, common law courts are cautious in changing the precedent when facing a shock because they are afraid that in the next period — when a new shock occurs — this new precedent may not be justified. With respect to the “size” of the adjustment, what matters is the persistence of the shock (common law courts change the law by a smaller amount after a temporary shock) as well as the proportion of judges that strictly apply the rule of precedent (if this proportion is high, the expected inertia of common law is stronger and current adjustments are smaller as a result). We find that when shocks are persistent, welfare under common law is strictly higher, because of its greater adaptability, than welfare under civil law for a broader range of parameters.

It is generally believed that precedents are more adaptable than statutes to changing economic conditions. Such adaptability might account for the findings of La Porta et al. (1998) of the superior development of financial markets in common-law compared to the civil-law countries. This paper shows that common law courts respond to shocks more than civil law courts, but less than optimally, especially when shocks are temporary.

The remainder of the paper is organized as follows. Section 2 reviews the literature. The model is introduced in Section 3. Section 4 and 5 solve the model under common law and under civil law. In Section 6 we compare the two regimes while in Section 7 we analyze how the two legal traditions adapt to changing economic conditions. Section 8 concludes. For ease of exposition, all proofs have been relegated in the Appendix.

Section snippets

Literature review

The hypothesis that common law is efficient (and, possibly, superior to civil law) has been widely investigated by the literature on law and economics. According to Posner (2003), possibly the most influential scholar to endorse this view, judge-made laws are more efficient than statutes, mainly because courts, unlike legislators, have personal incentives to maximize efficiency.14

The model

We build a stylized model to capture the courts’ trade-off between providing incentives and ex-post efficiency. Consider an economy with a continuum of locations distributed on the interval [0,1]. Time is indexed by t with t=1,,. Complete information of preferences and of the structure of the game form is assumed throughout. The model includes two types of players: private agents and courts.

Civil law

Under civil law the role of judges is to interpret and apply a body of statutes and administrative regulations. We denote the statute by l ∈ [0, 1]. We assume that the statute is written once and for all at the beginning of time 1.34

Common law

Common law is established by judicial precedents and decisions. We assume that active judges can potentially make any decision p in the entire interval [0, 1]. In other words, past decisions do not restrict the set of feasible judgements of active courts.40 Notice that, for simplicity, we make the following two assumptions on the evolution of

Common law vs civil law: efficiency and consistency

In this section, we compare common law and civil law along two dimensions of interest: the consistency of legal decisions and overall efficiency.

Concerning the variability of legal decisions, notice that as soon as the law is enforced by an active court, common law will reach an “absorbing state” and both types of courts select the same law. Under civil law, however, the law is not applied uniformly and there is variability of legal decisions. We stress that this result is obtained in a model

Legal adaptability

In the previous section, the only source of uncertainty in the economy concerned the type of court making decisions. In this section, we introduce an additional source of uncertainty by assuming that there are shocks that change the optimal law p* of Proposition 1. It is often argued that common law deals better with an uncertain environment and allows for a perfect mix between change and continuity. This section tests this claim.

We focus on shocks to the parameter z. In each t, the parameter z

Conclusions

This paper sets up a stylized model to analyze judicial decision making. The related literature has mostly focused on judicial partisan bias. Instead, here we focus on another source of judicial bias. We analyze a setting in which courts face commitment problems in enforcing the law. We compare court decisions under common and the civil law regimes. Our model generates different economic implications under the two legal systems which are not based on differences in preferences between judges

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  • This paper supersedes and substantially extends two previous papers by the same authors: “Statute Law or Case Law?” and “Courts’ Decision Making without Commitment”. We are grateful to the editor of this journal, Steffen Huck, and three anonymous referees for providing very helpful comments and suggestions. We also greatly benefited from comments from Henry Hansmann and seminar participants at Paris-Dauphine. Luca Anderlini and Alessandro Riboni thank EIEF (Rome) and LUISS University for their generous hospitality. Alessandro Riboni acknowledges the financial support of Investissements d’Avenir (ANR-11-IDEX-0003/Labex Ecodec/ANR-11-LABX-0047).

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