April 20, 1998 Economic Analysis of International An Invitation and a caveat effrey L Dunoff Joel P Trachtman"* chard Posner wrote in 1986 that the law and economics movement is perhaps the most important development in legal thought in the last quarter century. 0 Through its application of economic theories and methodologies to legal issues, this movement has revolutionized our understanding of many areas of common law and statutory regulation. Curiously, however, the law and economics revolution has, with few exceptions(see the Appendix), bypassed international law, I perhaps for some of the same reasons that realist political scientists ignore international law, or perhaps because of a concern that economic analysis is somehow less useful in the international context than in the domestic context. The purpose of this paper is to begin an inquiry into the actual and potential application of law and economics to international law With the rejection of both natural law theory and state-centered positivism as sources of Visiting fellow at the woodrow wilson School of International Affairs and Associate Professor of Law, Temple University School of Law Professor of International Law, The Fletcher School of Law and diplomacy Portions of this article were presented at the Harvard Law School Graduate Legal Studies Thesis Writing Workshop, the 1996 Conference of the American Society of International Law International Economic Law Group, the Harvard Law School Research Workshop on the World Trading System w. We are grateful for comments from participants. We are also grateful for nd the george Mason University Conference on the Economic Analysis of Atik, Dan Farber, David Kennedy, David Skeel, Paul Stephan, Al Sykes others], but we retain full responsibility for this paper. Prof. Dunoff's research for this project was supported by a summer research grant awarded by temple University School of Law 0 RICHARD A POSNER, ECONOMIC ANALYSIS OF LAW Xix(1986) But see economic dimensions in international law: comparative and empirical PERSPECTIVES (Jagdeep S. Bhandari alanO Sykes, eds. 1997), and especially the introduction by ronald A Cass
April 20, 1998 Economic Analysis of International Law: An Invitation and a Caveat Jeffrey L. Dunoff* Joel P. Trachtman** Introduction Richard Posner wrote in 1986 that the law and economics movement is “perhaps the most important development in legal thought in the last quarter century.”0 Through its application of economic theories and methodologies to legal issues, this movement has revolutionized our understanding of many areas of common law and statutory regulation. Curiously, however, the law and economics revolution has, with few exceptions (see the Appendix), bypassed international law,1 perhaps for some of the same reasons that realist political scientists ignore international law, or perhaps because of a concern that economic analysis is somehow less useful in the international context than in the domestic context. The purpose of this paper is to begin an inquiry into the actual and potential application of law and economics to international law. With the rejection of both natural law theory and state-centered positivism as sources of * Visiting Fellow at the Woodrow Wilson School of International Affairs and Associate Professor of Law, Temple University School of Law. ** Professor of International Law, The Fletcher School of Law and Diplomacy. Portions of this article were presented at the Harvard Law School Graduate Legal Studies Thesis Writing Workshop, the 1996 Conference of the American Society of International Law International Economic Law Group, the Harvard Law School Research Workshop on the World Trading System and the George Mason University Conference on the Economic Analysis of International Law. We are grateful for comments from participants. We are also grateful for guidance on these subjects, and in some cases comments on earlier drafts, from Ken Abbott, Jeff Atik, Dan Farber, David Kennedy, David Skeel, Paul Stephan, Al Sykes [others], but we retain full responsibility for this paper. Prof. Dunoff’s research for this project was supported by a summer research grant awarded by Temple University School of Law. 0 RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW xix (1986). 1 But see ECONOMIC DIMENSIONS IN INTERNATIONAL LAW: COMPARATIVE AND EMPIRICAL PERSPECTIVES (Jagdeep S. Bhandari & Alan O. Sykes, eds. 1997), and especially the introduction by Ronald A. Cass. 1
theory for international law, international lawyers seek both theory and methodology. 2 As a sult, international legal scholarship too often combines careful doctrinal description--here is what the law is--with unfounded prescription: here is what the law should be. This scholarship often lacks any persuasively articulated connection between description and prescription, undermining the prescription. International legal scholarship lacks a progressive research program. 3 In response, several international law scholars have turned to other disciplines. Some such as Kenneth Abbott and Anne-Marie Slaughter have led the way into international political theory, including international political economy, and have begun a thoughtful arbitrage. 4 At the same time, the international political scientists were engaged in their own rationalist arbitrage, borrowing from various components of economic theory and game theory. While there are valuable tools to be borrowed from political scientists, our focus here is on the rationalist tools that are in turn largely borrowed from economics, and in several cases from law and economics Economics is the study of rational choice. As such, it plays a leading role in evaluating the effects of rational maximizing behavior under conditions of scarcity. Economics enjoys a comparative advantage over other disciplines in rationality-based analysis, simply because this nalysis is central to economics, and economics has developed this analysis extensively. The development has largely been in the mathematical realm, the so-called"blackboard economics. 5 However, at this point in the development of economics--and of international law--the more mathematical models do not seem to engage the core issues of international law. Economics as practiced by lawyer-economists often involves complex cost-benefit analysis. This approach is often useful, but has important limitations due to problems of administrability, commensurability and interpersonal comparison of utility lowever, the more promising economic methodologies, in terms of their capacity to generate a progressive research program that might usefully address persistent international law problems, are not those that teach us to balance the costs and benefits of any particular policy, but For one account of this search, see Anne-Marie Slaughter Burley, International Law and International Relations Theory: A Dual Agenda, 87 AM. J. INT'L L. 205(1993) 3 See Imre Lakatos, Falsification and the Methodology of scientific Research Programmes, in CRITICISM AND THE GROWTH OF KNOWLEDGE 91(Imre Lakatos Alan Musgrave eds, 1970); Jason S Johnston, Law, Economics and Post-Realist Explanation, 24 L. Soc Y REV. 1217(1990) 4 See, e. g Kenneth w. Abbott, Modern international Relations Theory: A Prospectus for International Lawyers, 14 YALE J. INTL L 335(1989); Slaughter, supra note 2 5 See, e.g., Ronald Coase, The Institutional Structure of Production, 82 AM. ECoN. REV 3,719(1992) My remarks have sometimes been interpreted as implying that I am hostile to the mathematization of economic theory. This is untrue. Indeed, once we begin to uncover the real factors affecting the performance of the economic system, the complicated inter relations between them will clearly necessitate a mathematical treatment, as in the natural sciences, and economists like myself, who write in prose, will take their bow. May this
theory for international law, international lawyers seek both theory and methodology.2 As a result, international legal scholarship too often combines careful doctrinal description--here is what the law is--with unfounded prescription: here is what the law should be. This scholarship often lacks any persuasively articulated connection between description and prescription, undermining the prescription. International legal scholarship lacks a progressive research program.3 In response, several international law scholars have turned to other disciplines. Some, such as Kenneth Abbott and Anne-Marie Slaughter have led the way into international political theory, including international political economy, and have begun a thoughtful arbitrage.4 At the same time, the international political scientists were engaged in their own rationalist arbitrage, borrowing from various components of economic theory and game theory. While there are valuable tools to be borrowed from political scientists, our focus here is on the rationalist tools that are in turn largely borrowed from economics, and in several cases from law and economics. Economics is the study of rational choice. As such, it plays a leading role in evaluating the effects of rational maximizing behavior under conditions of scarcity. Economics enjoys a comparative advantage over other disciplines in rationality-based analysis, simply because this analysis is central to economics, and economics has developed this analysis extensively. The development has largely been in the mathematical realm, the so-called “blackboard economics.”5 However, at this point in the development of economics--and of international law--the more mathematical models do not seem to engage the core issues of international law. Economics as practiced by lawyer-economists often involves complex cost-benefit analysis. This approach is often useful, but has important limitations due to problems of administrability, commensurability and interpersonal comparison of utility. However, the more promising economic methodologies, in terms of their capacity to generate a progressive research program that might usefully address persistent international law problems, are not those that teach us to balance the costs and benefits of any particular policy, but 2 For one account of this search, see Anne-Marie Slaughter Burley, International Law and International Relations Theory: A Dual Agenda, 87 AM. J. INT’L L. 205 (1993). 3 See Imre Lakatos, Falsification and the Methodology of Scientific Research Programmes, in CRITICISM AND THE GROWTH OF KNOWLEDGE 91 (Imre Lakatos & Alan Musgrave eds., 1970); Jason S. Johnston, Law, Economics and Post-Realist Explanation, 24 L. & SOC' Y REV. 1217 (1990). 4 See, e.g., Kenneth W. Abbott, Modern International Relations Theory: A Prospectus for International Lawyers, 14 YALE J. INT’L L. 335 (1989); Slaughter, supra note 2. 5 See, e.g., Ronald Coase, The Institutional Structure of Production, 82 AM. ECON. REV. 713, 719 (1992): My remarks have sometimes been interpreted as implying that I am hostile to the mathematization of economic theory. This is untrue. Indeed, once we begin to uncover the real factors affecting the performance of the economic system, the complicated interrelations between them will clearly necessitate a mathematical treatment, as in the natural sciences, and economists like myself, who write in prose, will take their bow. May this period soon come. 2
rather those that focus on the balancers: international institutions(including the general international legal system). Indeed, the threshold issue in many, if not all, international legal blems is that of institutional choice. What institution--market, domestic legislature adjudicatory body or international rule-making body --ought to decide, for example, if one state's intellectual property standards are too low, or another's environmental standards are too high? The answer to questions like these ought to be informed by an understanding of the relative institutional ompetences and capacities of the various alternatives, as well as an appreciation of the strategic interactions among the various institutions We believe that economic analysis may be able to shed substantial light on precisely these sorts of inquiries. Significantly, this form of analysis is not limited to questions of wealth ization.As we note below, if economic analysis were limited to ealth maximiz zation, this would be reason alone to reject, or at least sharply limit the domain of, economic analysis of law In fact, the extension of economic analysis to fields beyond traditional markets requires economics values simultaneously. In this sense, the insights generated by the intersection of international law and law and economics run in two directions: just as economic analysis can deepen our understanding of international law, the application of law and economics to the unique features of the international system helps identify the uses and limitations of economic analysis To develop this thesis, this paper proceeds in seven parts. In Part I, we identify three reasons why international lawyers have not, to date, extensively used economic analysis, and demonstrate that none of these reasons is persuasive. This, " negative argument does not, of course, establish that international lawyers should use economic analysis. In Part Il, we provide a reason to believe that economic analysis will enrich our understanding of international law by oods g the analogy between the market of international relations and traditional markets for While others have alluded to this analogy before, we provide a typology of the ways in which"transactions" in international relations resemble market interactions Those who reject the analogy between international relations and private markets need not reject the economic analysis of international law. In the next three parts of the article, we test the hypothesis that economic analysis will be useful in understanding international law topics that are v explore the applicability of economic analysis to three important international law topics: the nd similar to domestic law topics where economic analysis has been fruitful. Thus, parts Ill, IV allocation of prescriptive jurisdiction, the law of treaties, and the competences of international organizations. In each section, we analogize the international legal issue to a domestic legal issue, and then explore whether the economic methodologies that have been useful domestically can be used on the international plane. Thus, in Part Ill, we outline an analogy between prescriptive jurisdiction and property, and then apply transaction cost economics and economic analysis regarding the design and protection of entitlements to jurisdictional issues. In Part IV, we outline the analogy between treaties and contracts, and explore whether the efficient breach hypothesis and the game theoretic analysis of default rules illuminate our understanding of treaty law. In Part V we analogize international organizations to business firms, and examine whether the theory of the irm can inform current debates over international organizations. To anticipate our conclusions, we will identify certain methodologies included in the new institutional economics and in the public choice branch of economics, such as game theory and transaction cost economics, as having much greater promise than other economic approaches, including price theory used without reference to transaction costs and strategic considerations Of course, like all theoretical approaches, economic analysis has its limitations. In Part VI we outline some of the problems associated with this type of analysis. Some of these problems
rather those that focus on the balancers: international institutions (including the general international legal system). Indeed, the threshold issue in many, if not all, international legal problems is that of institutional choice. What institution -- market, domestic legislature, adjudicatory body or international rule-making body -- ought to decide, for example, if one state’s intellectual property standards are too low, or another’s environmental standards are too high? The answer to questions like these ought to be informed by an understanding of the relative institutional competences and capacities of the various alternatives, as well as an appreciation of the strategic interactions among the various institutions. We believe that economic analysis may be able to shed substantial light on precisely these sorts of inquiries. Significantly, this form of analysis is not limited to questions of wealth maximization. As we note below, if economic analysis were limited to wealth maximization, this would be reason alone to reject, or at least sharply limit the domain of, economic analysis of law. In fact, the extension of economic analysis to fields beyond traditional markets requires economics to revise its approach to maximize additional values, or more accurately, to maximize multiple values simultaneously. In this sense, the insights generated by the intersection of international law and law and economics run in two directions: just as economic analysis can deepen our understanding of international law, the application of law and economics to the unique features of the international system helps identify the uses and limitations of economic analysis. To develop this thesis, this paper proceeds in seven parts. In Part I, we identify three reasons why international lawyers have not, to date, extensively used economic analysis, and demonstrate that none of these reasons is persuasive. This, “negative” argument does not, of course, establish that international lawyers should use economic analysis. In Part II, we provide a reason to believe that economic analysis will enrich our understanding of international law by outlining the analogy between the market of international relations and traditional markets for goods. While others have alluded to this analogy before, we provide a typology of the ways in which “transactions” in international relations resemble market interactions. Those who reject the analogy between international relations and private markets need not reject the economic analysis of international law. In the next three parts of the article, we test the hypothesis that economic analysis will be useful in understanding international law topics that are similar to domestic law topics where economic analysis has been fruitful. Thus, parts III, IV and V explore the applicability of economic analysis to three important international law topics: the allocation of prescriptive jurisdiction, the law of treaties, and the competences of international organizations. In each section, we analogize the international legal issue to a domestic legal issue, and then explore whether the economic methodologies that have been useful domestically can be used on the international plane. Thus, in Part III, we outline an analogy between prescriptive jurisdiction and property, and then apply transaction cost economics and economic analysis regarding the design and protection of entitlements to jurisdictional issues. In Part IV, we outline the analogy between treaties and contracts, and explore whether the efficient breach hypothesis and the game theoretic analysis of default rules illuminate our understanding of treaty law. In Part V, we analogize international organizations to business firms, and examine whether the theory of the firm can inform current debates over international organizations. To anticipate our conclusions, we will identify certain methodologies included in the new institutional economics and in the public choice branch of economics, such as game theory and transaction cost economics, as having much greater promise than other economic approaches, including price theory used without reference to transaction costs and strategic considerations. Of course, like all theoretical approaches, economic analysis has its limitations. In Part VI we outline some of the problems associated with this type of analysis. Some of these problems are 3
also present, although not as starkly, in the economic analysis of domestic law. Other difficulties arise from the particular features of the international legal system. We believe that our identification of these difficulties can inform a research agenda to further our understanding of the appropriate domain of economic analysis of law Finally, in Part VIl, we briefly set forth some ideas about a future research program. We provide, in an Appendix, a bibliography of articles that use economic tools to analyze internationa rather th wve emphasize that our analysis and examples are intended to be illustrative and suggestive be informed by economic analysis, or to apply every possible economic methodology to the international legal problems we do address. Instead, the paper represents an"invitation". we hope to stimulate a series of inquiries into the utility of different forms of economic analysis to analyze a ariety of international legal norms and institutions, and, in so doing, to enrich international le discourse and scholarship Why Have International Lawyers Avoided Law and Economics? While there may be many explanations for why international legal scholars have not articipated in the law and economics("l&E")revolution, we believe that many international lawyers would identify at least one of the following three concerns: (1)L&E's seemingly inaccessible methodologies; (2)L&E's supposedly conservative political prejudices; and (3)l&e's why they provide no rationale for declining to investigate whether L&E methodologies can 2 B these concerns rests upon a misunderstanding of relevant law and economics methodologies. In illuminate international legal problems.6 accessible Methodologies As George Stigler explains, there are two roles that economics may play in law. The first traditional, role of economics is to answer particular questions. For example, economics can speak to the question of market definition in antitrust or anti-dumping, or to the question of whether two oroducts are "like, with the result that discrimination between them is prohibited, 7 by reference to cross-elasticities of demand In this first role, economic analysis supplies inputs to a legal rul e might refer to this role as"economic analysis in law. " This role, which requires the full tools of the professional economist, and can be undertaken without any help from lawyers, is not the focus of our paper A second, more controversial role for economics is in the study of legal institutions and 6 In Part VI, infra, we identify more serious difficulties associated with the of international legal issues 7 E.g., under art. Ill of GATT, The General Agreement on Tariffs and Trade, Final Act Embody ing the results of the Uruguay round of Multilateral Trade Negotiations(Marrakesh, as signed on April 15, 1994), reprinted in H.R. Doc. No 316, 103d Cong, 2d Sess. 1381(1994) “GATT)
also present, although not as starkly, in the economic analysis of domestic law. Other difficulties arise from the particular features of the international legal system. We believe that our identification of these difficulties can inform a research agenda to further our understanding of the appropriate domain of economic analysis of law. Finally, in Part VII, we briefly set forth some ideas about a future research program. We provide, in an Appendix, a bibliography of articles that use economic tools to analyze international legal issues. We emphasize that our analysis and examples are intended to be illustrative and suggestive rather than exhaustive. We by no means attempt to explore every international legal issue that can be informed by economic analysis, or to apply every possible economic methodology to the international legal problems we do address. Instead, the paper represents an "invitation": we hope to stimulate a series of inquiries into the utility of different forms of economic analysis to analyze a variety of international legal norms and institutions, and, in so doing, to enrich international legal discourse and scholarship. I. Why Have International Lawyers Avoided Law and Economics? While there may be many explanations for why international legal scholars have not participated in the law and economics ("L&E") revolution, we believe that many international lawyers would identify at least one of the following three concerns: (1) L&E’s seemingly inaccessible methodologies; (2) L&E’s supposedly conservative political prejudices; and (3) L&E’s positivism and its presumed denigration of international law. However, we believe that each of these concerns rests upon a misunderstanding of relevant law and economics methodologies. In this section, we try to clear up the confusions underlying each of these objections, and to explain why they provide no rationale for declining to investigate whether L&E methodologies can illuminate international legal problems.6 A. Inaccessible Methodologies As George Stigler explains, there are two roles that economics may play in law. The first, traditional, role of economics is to answer particular questions. For example, economics can speak to the question of market definition in antitrust or anti-dumping, or to the question of whether two products are “like,” with the result that discrimination between them is prohibited,7 by reference to cross-elasticities of demand. In this first role, economic analysis supplies inputs to a legal rule. We might refer to this role as "economic analysis in law." This role, which requires the full tools of the professional economist, and can be undertaken without any help from lawyers, is not the focus of our paper. “A second, more controversial role for economics is in the study of legal institutions and 6 In Part VI, infra, we identify more serious difficulties associated with the economic analysis of international legal issues. 7 E.g., under art. III of GATT, The General Agreement on Tariffs and Trade, Final Act Embodying the Results of the Uruguay round of Multilateral Trade Negotiations (Marrakesh, as signed on April 15, 1994), reprinted in H.R. Doc. No. 316, 103d Cong., 2d Sess. 1381 (1994) (“GATT”). 4
doctrines. 8 This is"economic analysis of law, and is the domain we explore below Many of us are uncomfortable with economics, both because we distrust its theory and methodology, and, more embarrassingly, because we are uncertain that we have the quantitative or other skills needed to use these tools. Complex graphs, charts and multivariable equations do not often appear to be particularly inviting to those trained in the law. However, it does not appear that these tools are necessary for all types of economic analysis of law, and in fact, the highly mathematical formal analysis that economists often use has, to date shed little light on the issues that most interest international lawyers. Many of the most relevant and useful tools of analysis for our issues do not require great mathematical skill International legal scholars should find few obstacles to the use of the new institutional economics. "Modern institutional economics is economics as it ought to be. 9 New institutional economics seeks to integrate neo-classical economics, which has concentrated on the workings of the price system(in fields amenable to pricing), with institutional analysis. Institutions, by definition, are entities in which decisions are made outside the formal price system. In order to study institutions, it is necessary to add consideration of the cost of transactions( transaction costs and of the effects of strategic behavior(game theory ); both are areas that international lawyers are already familiar with In brief, new institutional economics incorporates price theory, transaction cost economizing and game theory. 10 It incorporates, and is also incorporated in, economic analysis of property rights, II public choice theory 12 and positive political economy. 13 A primary tool of this approach is comparative institutional analysis 14 -a form of analysis already at the heart of much 8 George Stigler, Law or Economics?, 35 J. L& ECON. 455, 467(1992). See also Guido Calabresi, The New Economic Analysis of Law. Scholarship, Sophistry, or Self-Indulgence, 68 PROC. BRIT. ACAD.(1982) 9 Ronald Coase. The New Institutional Economics. 140J INST. theo ecoN. 229. 231 (1984) econ >2, e. g, Douglass C. North, The New Institutional Economics, 142 J INST& THEO 230(1986) 11 See YORAM BARZEL, ECoNOMIC ANALYSIS OF PROPERTY RIGHTS(1997 12 See, e.g., DENNIS MUELLER, PUBLIC CHOICE II(1979); MAXWELL STEARNS, PUBLIC CHOICE AND PUBLIC LAW READINGS AND COMMENTARY(1996) 13 See, e.g., Daniel A. Farber and Philip P. Frickey, Positive Political Theory in the nineties, 80 GEO LJ.457(1992) 14 See, e.g., Ronald Coase, The New Institutional Economics, 140 J. INST& THEo ecoN 229(1984): Bruno S. Frey, Institutions Matter: The Comparative Analysis of Institutions, 34 EUR ECON REV. 443(1990); NEIL KOMESAR, IMPERFECT ALTERNATIVES: CHOOSING INSTITUTIONS IN LAW ECONOMICS AND PUBLIC POLICY(1994): Douglass North, Institutions, Transaction Costs and 5
doctrines.”8 This is "economic analysis of law," and is the domain we explore below. Many of us are uncomfortable with economics, both because we distrust its theory and methodology, and, more embarrassingly, because we are uncertain that we have the quantitative or other skills needed to use these tools. Complex graphs, charts and multivariable equations do not often appear to be particularly inviting to those trained in the law. However, it does not appear that these tools are necessary for all types of economic analysis of law, and in fact, the highly mathematical formal analysis that economists often use has, to date, shed little light on the issues that most interest international lawyers. Many of the most relevant and useful tools of analysis for our issues do not require great mathematical skill. International legal scholars should find few obstacles to the use of the new institutional economics. “Modern institutional economics is economics as it ought to be.”9 New institutional economics seeks to integrate neo-classical economics, which has concentrated on the workings of the price system (in fields amenable to pricing), with institutional analysis. Institutions, by definition, are entities in which decisions are made outside the formal price system. In order to study institutions, it is necessary to add consideration of the cost of transactions (transaction costs) and of the effects of strategic behavior (game theory); both are areas that international lawyers are already familiar with. In brief, new institutional economics incorporates price theory, transaction cost economizing and game theory.10 It incorporates, and is also incorporated in, economic analysis of property rights,11 public choice theory12 and positive political economy.13 A primary tool of this approach is comparative institutional analysis14 -- a form of analysis already at the heart of much 8 George Stigler, Law or Economics?, 35 J.L.& ECON. 455, 467 (1992). See also Guido Calabresi, The New Economic Analysis of Law: Scholarship, Sophistry, or Self-Indulgence, 68 PROC. BRIT. ACAD. (1982). 9 Ronald Coase, The New Institutional Economics, 140 J. INST. & THEO. ECON. 229, 231 (1984). 10 See, e.g., Douglass C. North, The New Institutional Economics, 142 J. INST. & THEO. ECON. 230 (1986). 11 See YORAM BARZEL, ECONOMIC ANALYSIS OF PROPERTY RIGHTS (1997). 12 See, e.g., DENNIS MUELLER, PUBLIC CHOICE II (1979); MAXWELL STEARNS, PUBLIC CHOICE AND PUBLIC LAW: READINGS AND COMMENTARY (1996). 13 See, e.g., Daniel A. Farber and Philip P. Frickey, Positive Political Theory in the Nineties, 80 GEO. L.J. 457 (1992). 14 See, e.g., Ronald Coase, The New Institutional Economics, 140 J. INST. & THEO. ECON. 229 (1984); Bruno S. Frey, Institutions Matter: The Comparative Analysis of Institutions, 34 EUR. ECON REV. 443 (1990); NEIL KOMESAR, IMPERFECT ALTERNATIVES: CHOOSING INSTITUTIONS IN LAW, ECONOMICS AND PUBLIC POLICY (1994); Douglass North, Institutions, Transaction Costs and 5