Cambridge Companion to Comparative Law (Mauro Bussani & Ugo Mattei, editors) Economic Analysis and Comparative Law

Nuno Garoupa (UIUC) and Tom Ginsburg (U Chicago) 1. Introduction: What is Law and Economics? The Economic Analysis of Law investigates the answer to two fundamental questions: (a) a positive question concerning the impact of laws and regulations on the behavior of individuals, in terms of their decisions and the implications for social welfare; and (b) a normative question concerning the relative advantages of laws in terms of efficiency and social welfare. To answer these two questions, the Economic Analysis of Law applies the methodology of microeconomic analysis. Microeconomic analysis makes certain simplifying assumptions, namely that individuals respond to incentives and make their decisions in a rational way, comparing costs and benefits, given all the available information. More recent developments have relaxed the assumption of full rationality to adopt a more realistic limited rationality assumption in the context of the so-called Behavioral Law and Economics. Another assumption is that the welfare of society is measured by aggregating the individual welfare of its members (Shavell, 2004). Law and Economics, or the Economic Analysis of Law, is today one of the most influential scholarly methodologies in American legal thinking (Duxbury, 1997; Garoupa and Ulen, 2008). The origins of the field can be traced back to the 18th and 19th centuries, for example, with the writings of Bentham (1789), but economic analysis of law gained notoriety with the articles of Nobel laureates Ronald Coase (1960) and Gary Becker (1968), and the of books of Guido Calabresi (1970) and Richard Posner (1972). In the last forty years, Law and Economics has expanded to all areas of the law, including those with more obvious economic significance (antitrust and regulation, tax, corporations, bankruptcy, employment), but also the hard core of legal studies (contracts, tort, property, crime, civil and criminal procedure) and new areas of interest for legal economists (such as family law, environmental law or constitutional structure). Comparative law is no exception (Mattei, 1996). In fact, the extension of recent applications of economic methodology to comparative law has raised the question of the extent to which Economic Analysis of Comparative Law is by now a new independent discipline (Faust, 2006; de Geest, 2009). The origins of this new discipline can be traced to the work of Adam Smith (de Geest, 2009). In this chapter we review the main literature in Comparative Law and Economics. We start by looking at micro level where contributions have been made to different areas of the law. We then look at macro level where economics has addressed legal families and jurisdictional legal differences. 2. Economic Analysis and Comparative Law at Micro Level: Rules a) Contracts Law and Economics develops the perspective that contractual parties engage in mutually beneficial exchanges that are efficient in nature. Contract law is designed to enhance the occurrence of such efficient exchanges. However, since they take place in context of imperfect or asymmetric information, it is possible that at some point after the formation of a given contract, the social benefits from
We are grateful to Gerrit de Geest, Francesco Parisi and Mark Ramseyer for comments. The usual disclaimers apply.

performing such contract do not justify the social costs, raising the possibility of optimal breach. Law and Economics investigates the extent to which remedies for nonperformance induce optimal breach, in particular specific performance and damages (Shavell, 2004). The shape and nature of contractual arrangements might vary across jurisdictions depending on the local determinants of transaction costs and risk behavior (Cheung, 1969). These questions have deserved attention from a comparative perspective given the general sense that Anglo-American legal systems tend to prefer monetary damages whereas civil law jurisdictions seem to favor specific performance even under conditions that make it unlikely to be efficient (Lando and Rose, 2004). Other important issues in contract law that have deserved attention from legal economists taking into account that there are significant differences across jurisdictions include precontractual liability (responsabilit prcontractuelle) in the context of the efficient breach theory (Wils, 1993; Ogus and Faure, 2002); quasi-contracts and gestion daffairs (Bouckaert and de Geest, 1995; de Geest, 2001); disclosure of information prior to contract formation (Ktz, 2000); and regulation of cooling-off periods (Rekaiti and van den Bergh, 2000). Another significant difference across legal families concerns the use of consideration in contract formation and penalty clauses (Mattei, 1996; Ogus and Faure, 2002). b) Torts The economic perspective on torts looks at the most efficient way of deterring accidents. Remedies and liability rules are assessed from the perspective of the benefit in avoiding accidents or tort wrongdoings (hence, deterring their occurrence) and the cost of prevention. Compensation of victims is discussed from the perspective of internalizing accident costs and providing the adequate incentives to potential tortfeasors (Shavell, 2004). Anglo-American tort doctrines have been compared to the civil law of obligations, and the way incentives are shaped in that context has been debated. Among the relevant topics addressed in the literature we can find variety of tort law (Levmore, 1986; Mattei, 1996), product liability (Finsinger, Hoehn and Pototschnig, 1991; Hamada, 1995), the different approach to strict liability and negligence rules across jurisdictions (Faure and Van den Bergh, 1987; Ott and Schfer, 1997; Faure, 2001; Schweizer, 2005; Mackaay and Rousseau, 2008; Salvador, Garoupa and Gomez, 2009), the particular case of liability in traffic law (such as the Loi Badinter; Faure, 2001; Ogus and Faure, 2002), the principle of no-cumul in contractual and tort liability (Ogus and Faure, 2002; Ogus, 2006), punitive damages in civil law (Mackaay, 2001), pure economic losses (Bussani, Palmer and Parisi, 2003 and Parisi, Bussani and Palmer, 2007), and the relationship between tort law as a deterrent mechanism and legal origin(Smith, 2005). c) Property From the viewpoint of Law and Economics, property law should be designed to assure maximization of property value, both in terms of transactions and use as collateral for development of capital markets. Moreover, following the basic insight of Coase (1960), the establishment of adequate entitlements and the adoption of legal rules that reduce transaction costs will help the necessary bargaining to internalize externalities. The fact that property law varies across jurisdiction as attracted the attention of legal economists to assess the extent to which certain aspects of property law are more or less efficient. A fundamental issue is of course titling of property (De Soto, 2000; Arruada, 2003; Arruada and Garoupa, 2005). Nevertheless, other significant topics include the different treatment of a bona fide purchaser (Levmore, 1987; Ogus, 2006), the rise of anticommons and its consequences for property market and investment (Heller, 1998; Heller, 2008), remedies in property law (Parisi, 2002a), codification in property law (Mattei, 1996) and the development of water law (Ramseyer, 1989).

d) Litigation and Civil Procedure There is a serious divergence between the private and the social motivation to litigate. Each party cares about the estimated benefit from litigation and the respective private costs. Society cares about the extent to which litigation incentivizes compliance with the law and helps the development of the legal system through articulating efficient rules. From this perspective, the rules of civil procedure and the institutional framework where litigation takes place should reduce transaction costs (thus favoring cheaper out-of-court settlements) and align the private interests of the litigants with the social welfare maximizing goals. Legal economists have used this perspective to access the design of civil procedure (Miller, 1997), settlement rates and litigation in different jurisdictions (Ramseyer and Nakazato, 1989; Ginsburg and Hoetker, 2006; Kaplan, Sadka and Silva-Mendez, 2008), pre-trial discovery and rules of evidence (Adams, 1995; Huang, 2009), litigation financing, in particular the American vs. the English rule concerning whether the winner or loser pays lawyers costs (Adams, 1995; Braeutigam, Owen and Panzar, 1984), the regulation of class actions (Backhaus, Cassone and Ramello, 2009), and the court system more generally (Djankov, La Porta, Lopez de Silanes and Shleifer, 2003; Cabrillo and Fitzpatrick, 2008; Balas, La Porta, Lopez de Silanes and Shleifer, 2009).

e) Criminal Procedure Criminal procedure establishes the rule under which criminal law is litigated. From the viewpoint of the economic theory of optimal law enforcement, criminal procedure should be designed to achieve efficient deterrence at minimal cost (Shavell, 2004). From a comparative perspective, the main differences that have attracted attention by legal economists are inquisitorial versus adversarial criminal procedure (Parisi, 2002b; Huang, 2008), the introduction of plea-bargaining (Garoupa and Stephen, 2008), the role of prosecutors (Garoupa, 2009), and the principle of double jeopardy (Garoupa and Gomez, 2004). f) Corporate Law and Governance Corporate law and economics has probably attracted the most attention of legal economists since the early 1990s. There is vast literature on the economic reasoning and consequences of the different legal frameworks under which companies are formed, investors operate and managers make decisions (the seminal contribution is Easterbrook and Fischel, 1991). The way legal systems have tackled the separation of control and ownership has been at the heart of the debate. In particular, the advantages and disadvantages of the Anglo-American market based system versus the long-term large investor model of Germany (Roe, Ramseyer and Romano, 1993; Hansmann and Kraakman, 2001; Hansmann et. al., 2004; Becht, Black and Khanna, 2007; Bolton and Rell, 2007). Recent literature has developed a new approach known as Law and Finance that investigates the extent to which corporate performance, ownership and organization is influenced by potential legal determinants (La Porta, Lopez de Silanes, Shleifer and Vishny, 1998 and 2000; La Porta, Lopez de Silanes and Shleifer, 1999, Beck, Demirg-Kunt and Levine, 2003, Armour et. al., 2009) or what particular forms of law enforcement provide a more successful regulation of the market for securities (La Porta, Lopez de Silanes and Shleifer, 2006). Another area that has been addressed is the significant differences in the legal treatment of trusts (Mattei, 1996; Hansmann and Mattei, 1998). e) Bankruptcy Law

The sharp contrast between corporate and personal bankruptcy law in the United States and in Europe has raised questions concerning the economic adequacy of each model. Corporate reorganization, liquidation, fresh start in the American tradition and the extent to which employment goals should prevail in bankruptcy in the French tradition have been analyzed by legal economists (White, 1996). At the same time, how the differential use of bankruptcy law affects credit markets, contractual performance and business environment has deserved attention (Ayotte and Yun, 2009; Claessens and Klapper, 2005). Finally, the identification of successful procedural and substantive rules of bankruptcy has been related to the broader issue of legal origin (Djankov, Hart, McLiesh and Shleifer, 2008) f) Antitrust and Intellectual Property Law Alongside corporate and bankruptcy law, antitrust law and economics is the field that more rapidly has been under the scrutiny of Law and Economics. In fact, antitrust law and economics is most probably the starting point of the whole movement. The convergence between American antitrust law and European competition law, the development of competition law in Asia and in Latin America, specific substantive differences (concerning cartel behavior, unilateral conduct, and mergers and acquisitions) and procedural approaches (judicial versus administrative enforcement of competition law), or the treatment of intellectual property have generated an extensive economic literature (Elhauge and Geradin, 2007). For example, with respect to intellectual property, the different treatment of authors and artists rights across jurisdictions has been assessed in terms of incentives (Hansmann and Santilli, 1997). g) Employment and Labor Law The disparity between the labor market-oriented approach in Anglo-American law (where employment is fundamentally regulated by contract law) and the more heavily regulated approach in civil law countries to employment contracts (where employment and labor law are a distinct area of the law that mixes elements of private and public law) has raised an important debate in terms of economic implications (Botero, Djankov, La Porta, Lopez de Silanes, and Shleifer, 2004). The extent to which the easiness of hiring and firing (and other characteristics of labor law) affects economic performance or influences corporate governance have raised controversy in the literature (Ahlering and Deakin, 2007; Deakin, Lele and Siems, 2007; Deakin and Sarkar, 2008). h) Family Law The most debatable issue in family law in the United States by legal economists has been the extent to which the introduction of no fault divorce has changed marriage and divorce. Inevitably the controversy has been carried out to a comparative perspective (Coelho and Garoupa, 2007; Gonzalez and Viitanen, 2009). 3. Economic Analysis and Comparative Law at the Macro Level: Structure Economic analysis has also been utilized to understand issues related to the structure of legal systems and the incentives of legal actors who work within the system. a) Judges and Prosecutors

As central actors in any legal system, judges are an understandable focus of comparative analysis. Judicial independence has been the focus of some important empirical work (Ramseyer and Rasmusen 2006). Georgakopolous (2000) distinguishes career judiciaries, in which judges serve in a bureaucratic hierarchy for an entire career, from recognition judiciaries in which judges are appointed to the bench relatively late in life. These systems can be distinguished as emphasizing different forms of monitoring agents: the career system emphasizes ex post controls on judicial decision-making, while the recognitions system involves ex ante screening of agents; an approach further expanded by Posner (2005). Selection mechanisms are also the focus of some attention. Ginsburg and Garoupa (2009a and 2009b) analyze the structure of judicial councils from the perspective of efficient design. The incentives provided by different institutional audiences and the way different legal systems tackled them have also been addressed (Hadfield, 2008 and 2009; Garoupa and Ginsburg, 2009c). Such work has developed a more nuanced approach than relying on the traditional common law-civil law distinction, examining micro-incentives and distinguishing judiciaries even within the same legal tradition. For example, Posner (1996) argues that the United Kingdom judiciary is more like its continental counterparts than that of the United States. There has to date been relatively little comparative work on prosecutors. In their analysis of Japanese conviction rates, Ramseyer and Rasmusen (2001) look at judicial incentives to help explain why judges are so conviction-prone, but also point out that prosecutorial incentives matter. In an under-resourced environment, we should expect that prosecutors will only bring cases they are likely to win. A high conviction rate thus may provide insight into prosecutor incentives as well as judicial propensities. Risk aversion and career goals also vary across legal systems (Garoupa, 2009). b) Constitutional Law Constitutional law and economics overlaps significantly with public choice theory (Buchanan and Tullock, 1962; Cooter, 2000). The two fields share a focus on the role of rules in structuring and constraining decision-making, shifting the terrain from choice within rules to the choice of higher order constitutional rules. (For more on the relationship among law and economics, public choice and constitutional political economy, see Voigt, 1997; Van den Hauwe, 2000). Constitutions are generally viewed as devices to minimize agency costs. By establishing structures that prevent capture by certain interest groups, constitutions can ensure superior governance. Another tradition emphasizes the role of constitutions in constraining intertemporal choice through precommitment (Sunstein, 2000). In this line of thought, constitutions function to take certain high-stakes issues off the table and to help ensure that winners do not overly dominate losers. Though generally pursued through the development of abstract propositions, some analysts draw on real world institutional designs to inform optimal choice (Cooter, 2000). Others draw on economic analysis to examine and evaluate real constitutions. For example, Brennan and Pardo (1991) evaluate the Spanish Constitution of 1978 critically, normatively questioning the provision of economic and social rights in the document. A separate branch considers the impact of constitutions on such dependent variables as economic growth (Persson and Tabellini, 2003). Elkins et al. (2009) take up the question of what factors help constitutions to endure, drawing on a large new database that should facilitate much more empirical testing of hypotheses generated by law and economics. Clearly, there is room for much more work informed by law and economics on comparative constitutional law from both positive and normative perspectives.

c) Lawyers, Legal Education and Legal Scholarship A comparative perspective on legal profession and the structure of law firms has looked at entry regulation, legal fees (the existence of contingent and conditional fees, in particular), organization of law firms, regulation of publicity and information disclosure in legal services, and rules of conduct (Garoupa, 2008). This vast literature provides important economic insights into the regulation of the market for legal services around the world. Important differences in legal education and legal scholarship on both sides of the Atlantic have been the object of economic analysis. Rather than relying exclusively on cultural preferences and path dependence, legal economists use incentives and a market approach to understand why legal education and the production of innovations in legal analysis have been persistently different across the world. A particular topic of interest is the asymmetric influence of Law and Economics in legal thinking in different jurisdictions (Ota 1991; Kirat, 2001; Garoupa and Ulen, 2008; Grechenig and Gelter, 2008). Generally speaking, it is safe to say the law and economics has been more influential in North America than in other regions of the world, and this fact itself is an interesting question for analysis. d) Legal Families and Economic Growth At the macro level, the economic literature has investigated the hypothesis that the common law system is particularly conducive to economic growth in opposition to civil law, in particular French law. This is a vein of literature essentially empirical (Mahoney, 2001; La Porta, Lopez de Silanes and Shleifer, 2008). This new literature defends the notion that legal systems originated in the English common law have superior institutions for economic growth and development than those of French civil law (Dam, 2006). According to the proponents of this view, there are essentially two reasons for the links between the common law and economic growth. First, common law provides more adequate institutions for financial markets and business transactions generally, and that in turn fuels into more economic growth (La Porta, Lopez de Silanes and Shleifer, 2008). These institutions might include more efficient substantive rules, as well as mechanisms by which the common law tends to develop such rules (Priest and Klein, 1984). Second, civil law presupposes a greater role for state intervention that is detrimental for economic freedom and market efficiency (Mahoney, 2001). The relationship between growth or economic performance and legal system carries an implicit assumption; law and legal institutions matter for economic growth (Cross, 2002). This has been a staple of institutional economics for decades (North 1991) but nevertheless debatable (Acemoglu, Johnson and Robinson, 2001; Acemoglu and Johnson, 2005). The alleged pro-market bias of the common law (the idea of some Hayekian bottom up efficiencies in the English legal system and top down inefficiencies in the French legal system) might be an important argument, but the existence of some anti-market bias in French law is debatable (Arruada and Andonova, 2008a & 2008b). Even the thesis that French law is less effective than the common law in protecting property rights from state predation has been disputed (Arruada, 2003; Arruada and Garoupa, 2005). In fact, the current models developed to explain these differences have been subject to serious criticism (Glaeser and Shleifer, 2001 and 2002; Cross, 2007; Klerman and Mahoney, 2007; Roe, 2006 & 2007; Rosenthal and Voeten, 2007; Hadfield, 2008; Voigt, 2008). Stability of the law is another possible argument to favor judge made law with deference to precedent against systematic and chaotic legislative production. However, in this respect, empirically it is not clear that case law is more stable than legislation (Cross, 2007). In addition, the argument that the common law is more stable undercuts

other claims that the mechanism for its efficiency lies in the selection of disputes for litigation (Priest and Klein, 1984). Another possible channel by which the common law might support growth is the enhanced willingness in common law jurisdictions to allow choice of law (Carbonara and Parisi, 2009; OHara and Ribstein, 2009). But globalization of business transactions has exerted enormous pressure for change in civil law jurisdictions in this respect. Overall, it might well be that the common law is more efficient and positively correlated with economic growth, but the causation remains under-theorized to a larger extent (Dam, 2006; Cross, 2007). The mechanism for the efficiency of the common law versus (French) civil law is intrinsically convoluted and debatable. Furthermore, the analysis is complicated by the fact that it is now largely the model for legal reform as embodied by the Doing Business promoted by the World Bank. There are good reasons to be careful about the implications of the Doing Business reforms in the economy (Arruada, 2007; Davis and Krause, 2007). e) Convergence of Legal Systems Legal economists have entered on the debate about the convergence of legal systems and the role of harmonization. When there is freedom of choice as to the legal regime to be used, competition between legal systems will emerge. Consequently convergence is expected in facilitative areas of the law whereas divergence due to different local preferences could be sustainable in interventionist areas of the law not subject to market pressure (Ogus, 1999 and 2007; Garoupa and Ogus, 2006). This would be true so long as jurisdictions are unconstrained to adopt rules and have good information about the effects of alternative arrangements. Divergences of legal systems are not necessarily a sign of inefficiency. There is no reason to think that there is only one single efficient rule for every legal problem (Ogus, 1999 and 2007). Yet, there are obstacles to convergence that result from local rent-seeking (essentially by the legal professions), legal culture and other forms of transaction costs (Ogus, 1999, 2002 and 2007; Garoupa and Ogus, 2006). In this context, harmonization that has so often been justified on economic grounds has encountered in legal economists a hostile audience (Mattei, 1994; Ogus, 1999 and 2007; van den Bergh, 2000; Garoupa and Ogus, 2006; Carbonara and Parisi, 2007). The clear preference for interjurisdictional competition and choice of law as a form to promote the emergence of rules of law has found wide support in Law and Economics (Buscaglia and Ratliff, 2000; Carbonara and Parisi, 2009; OHara and Ribstein, 2009). Hybrid legal systems can benefit from the competition of different legal arrangements within a single jurisdiction (Ogus, 2007).

f) Transplants Legal transplants raise two significant economic questions. First, when will a given jurisdiction prefer to merely adopt a solution already available in a different jurisdiction rather than develop their own rule (incurring the possibility of rediscovering the wheel). The development of internal rules or the adoption of transplants responds to a trade-off between benefits in terms of facilitating international interaction (economic or otherwise) and the internal costs of legal consistency and local preferences (Garoupa and Ogus, 2006). The existence of a strategic motivation that ignores externalities derived from the adoption of particular transplants might generate an inefficient level of transplant adoption (Garoupa and Ogus, 2006).

The second set of issues involves what legal systems or legal families are more prone to import or export successfully legal rules. It has been argued that the local conditions for transplanting and adopting a particular law are more important than the supply from a particular legal family. Pre-disposition and familiarity with the transplanted laws are more important than legal origin in assuring effective transplants (Berkowitz, Pistor and Richard, 2003a and 2003b).

g) Conflicts of law The economic approach to conflicts of law does not seem them as a problem but rather as an opportunity to benefit from international jurisdictional and search for the appropriate legal rule across jurisdictions. The efficient solution to conflict of laws should internalize the externalities created by the interaction of individuals located in different jurisdictions. A strategy oriented to apply the legal rule of the jurisdiction where the harm has been produced is not always efficient since there might be important detrimental incentives (Sykes, 2007). h) Rule of Law Rule of law is supposed to be associated with legal certainty, independent judiciary and serious limits to both private and state expropriation. Immediately a positive correlation is anticipated between a high adherence to rule of law, investment and economic development (this line of work can be traced back to North, 1991). Although generally there is a strong relationship between rule of law and economic development, the reasons are debatable once we recognize that the fastest growing economies do not have an effective court system. The interaction between rule of law and economic development might be more complex than initially anticipated, in particular the direction of causation is still unclear (Glaeser, La Porta, Lopez de Silanes and Shleifer, 2004; Kaufman, Kraay and Mastruzzi, 2008). The extent to which there is a direct relationship between rule of law and legal origin has also been considered (La Porta, Lopez de Silanes, Pop Eleches and Shleifer, 2004). i) Lawmaking Lawmaking varies across legal families. This raises the question on if there is a particular mix of statute law or codification with judge made law that is more efficient. In other words, it is debatable if there is a one size fits all lawmaking efficient arrangement (Depoorter, Fon and Parisi, 2005; Fon and Parisi, 2006; Ponzetto and Fernandez, 2008; Parisi and Fon, 2009). Depending on preferences, the role of precedent and idiosyncrasies of a particular legal system, different mixes of case law and statute law can be efficient (Ponzetto and Fernandez, 2008; Parisi and Fon, 2009). 4. Conclusion Comparative Law and Economics has generated a vast literature in the last decade both in terms of micro and macro analysis. However, as with economics itself in the mid 20th century, a microeconomic foundation of the macroeconomics of comparative law is still missing. The important empirical literature that points out for significant differences at the macro level between the Anglo-American legal family and the civilian families needs a sound micro based theoretical foundation. On the other hand, the economic analysis of particular legal rules in many areas of the law has been developed to a large extent

without recognizing the macro implications. Legal economists and comparativists are in an excellent position to mitigate this gap soon.

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