Funcas Social and Economic Studies

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Law and economics. A productive relationship / Juan José Ganuza & Fernando Gómez Pomar (editors)
July - 2019

Sumario

Introduction / Juan José Ganuza and Fernando Gómez Pomar

There is a large body of empirical evidence showing how institutions, and among them, legal institutions (laws and regulations, judicial systems, and so on) have important effects upon economic development of societies and countries (Laporta et al., 2008). There is a growing consensus that poor quality law (both in terms of substantive rules and their implementation) may produce relevant harm in social and economic terms.

Thus, in order to fully grasp how economies evolve and eventually grow, it is important to analyze what are the channels through which laws and legal institutions affect the constraints and actions of firms, consumers and organizations. Theoretical and empirical inquiry on the consequences that legal rules and the functioning of legal institutions opens a wide area to the intellectual curiosity of economists and economically motivated legal scholars, especially in what touches the design and implementation of a range of legal policies.

For instance, in a country with the level of economic and legal development of Spain, making sense of the impact of the justice system over various economic variables seems crucial to enhance economic performance and the competitiveness of the Spanish economy. Just bearing in mind the mortgage crisis in Spain and the ensuing litigation wave, where Spanish (and EU) courts and judicial interpretations have had a deep influence on the shape and the contours of the Spanish financial environment constitute recent and dramatic proof of the above statements.

Modern Economics has theoretical and empirical tools to improve our understanding of the legal system. No one can doubt that the Law, as an intellectual field, has a longer pedigree than Economics has, and throughout its secular history, has been able to absorb the intellectual influences and perspectives of a number of disciplines (from theology to linguistics, from moral and political philosophy to history). In recent decades, one of the most conspicuous nutritious forces of legal thinking has been Economics.

The use of modes of thinking, analytical instruments and quantitative methods forged and proven in Economics has substantially transformed the way in which law as a social phenomenon is conceptualized and made, especially through the Law and Economics movement and, more recently, Empirical Legal Studies.

This book tries to illustrate both dimensions of the interaction between Law and Economics. On the one side, the long shadow of the legal system over the functioning of real-world economies. On the other, how the display of economic methods may contribute to improving our understanding, and eventually also, the design and performance of legal institutions.

To provide a flavor –necessarily incomplete, due to the ample space we intend to cover– of the interaction between economic thinking and the legal system, we have assembled a distinguished group of first-rate scholars in the field. Some of the contributions are more theoretical, others have an applied inspiration, and finally there is an empirical contribution. Taken as a whole, they illustrate the enormous potential of cooperative endeavors of Economics and Law and the range and importance of their ability to improve our knowledge of their interaction.

The first part of the book is devoted to mortgage credit. This is a crucial ingredient of the financial system and the cornerstone of people’s access to residential property, and the financial crisis bear witness to the fact that the malfunctions of the mortgage market easily propagate to the entire financial system with terrible social and economic consequences. The first three chapters of the book illustrate how Law and Economics (including Behavioral Law and Economics) may enhance our understanding of key features in mortgage credit: Oren Bar-Gill presents the foundations of the behavioral analysis of mortgage credit; Omri Ben-Shahar dissects disclosure mandates in mortgage loans; Matthias Lehmann and Isabel Schnabel explain the main characteristics of the German model of mortgage credit. Let’s consider the three of them in more detail.

Oren Bar-Gill, from Harvard Law School, emphasizes how in mortgage loans, as in other consumer contracts, market forces and consumers’ psychology clash: on the demand side, imperfectly informed and limitedly rational consumers lack full knowledge of the costs and benefits linked to contracting mortgage credit; on the supply side, sophisticated lenders design their contracts as a response –partially at least– to consumers’ misperceptions. The ensuing market failure works to the detriment of consumers and overall efficiency. This chapter focuses on the US mortgage market -and especially in its subprime segment-in the years prior to the financial crisis in order to illustrate the causes and consequences of behavioral market failures.

Omri Ben-Shahar, from the University of Chicago Law School, looks into the effectiveness of legal disclosure duties designed to enhance the informational position of consumers, especially in the mortgage market. The recent history of legal disclosure duties may be described as a persistent effort in pursuit of a vain and ill-grounded hope. Also as the widespread success in the adoption of a regulatory strategy with dubious results despite the prevalence of its use and the faith of its promoters. Given this dismal evaluation, what measures can be taken to protect consumers in a world without those ineffective disclosure duties? Alternative regulatory policies lack consensus, and it may prove risky or apt at creating unintended and undesirable side-effects. Thus, caps on fees or limits in mortgage design alternatives may help in some contexts but be hurtful in others. Advertising and marketing bans may also end up being beneficial or harmful depending on context. This is surely unsatisfactory, but perhaps unavoidable in light of the failure of disclosure policies.

Matthias Lehmann and Isabel Schnabel, from the University of Bonn, argue that even if the housing market is prone to acute cycles of expansion and corrections, countries show remarkable differences in this respect. Since the 1950’s and in clear contrast with other developed economies, even in Europe, Germany has enjoyed a remarkably stable mortgage market. Among other factors, this may be due to certain specific institutions in German Law. The chapter examines whether stability may be attributed to these idiosyncratic institutions (the mortgage bonds or Pfandbriefe, the construction savings banks or Bausparkassen) or the high level of tenants’ protection offered by German Law in rental housing. Recent price rises in the housing market are also considered as to their potential origins. In the end, the focus of the chapter is whether legal institutions may play a stabilizing role in the housing market and what are the most adequate to successfully accomplish such a task.

The second part of the book is less homogeneous in its subject matter, although all chapters share the common inspiration of showing “in action” how economic thinking may improve our understanding of key institutions within legal systems.

Marco Celentani, from Universidad Carlos III in Madrid, looks into an institution that, despite being present in most justice systems in developed countries has attracted little attention from an economic perspective: legal aid. This term describes a scheme of subsidized (with public money) access to civil and criminal justice of those people of limited financial resources. The chapter considers a number of reasons why legal aid programs my enhance efficiency through a reduction in social costs associated with asymmetric information in litigation.

In his chapter, Jorge Padilla (Compass Lexecon and Research Fellow in CEMFI, Madrid) reviews the impact of economic analysis in antitrust policy in the EU in the last fifteen years. In his Nobel Prize lecture, Jean Tirole had mentioned the tension between the lawyers’ and the economists’ views about competition policy. The former tend to prefer per se prohibitions, while the second privilege a more detailed consideration of the impact of a given conduct in each affected market. This chapter analyzes the importance of the economic view in the functioning and decision-making of EU antitrust authorities. It also evaluates to what extent is EU competition law actually consistent with economic reasoning, and the various experts’ views on the excessive (or insufficient) role that economic analysis plays in EU antitrust.

Next, Nuno Garoupa, from George Mason University, looks into law enforcement and criminal law with economic lenses. His chapter deals with the magnitude and probability of sanctions when there is a discrepancy between lawmakers and courts as to the proper size of the sanction for a given offense. The fact that the lawmakers’ plans may be altered by courts’ decisions cannot be simply corrected by an ex ante rise in the size of the sanctions, since this approach may easily backfire.

Finally, Sofia Amaral-Garcia, from DIW Berlin, using data form decisions on medical malpractice cases by the Spanish Supreme Court, explores several relevant dimensions of the actual functioning of tort law in this area, and how it works in terms of deterrence and compensation. More specifically, she looks into potential biases in favor of public administrations who run many hospitals, the differences between civil and administrative courts, the quantification of non-pecuniary damages, and procedural delays, and how these factors affect outcomes in court.

The quality and the broad coverage of the chapters in the book bear witness to the ability of economic analysis and economically-inspired thinking to shed light on important dimensions of the complex set of institutions that make up a modern legal system, and to understand the wide range of social and economic consequences that they may induce. This, we believe, will be a welcome addition to the debate, in Spain but also in other countries, particularly in Europe, about the role social sciences have to play in legal matters.

Mortgage Contracts: Law, Economics and Psychology / Oren Bar-Gill

Mortgage contracts, like other consumer contracts, are the product of an interaction between market forces and consumer psychology. Imperfectly informed and imperfectly rational borrowers fail to fully comprehend the costs and benefits of the mortgage contract. Moreover, sophisticated lenders design their contracts in response to consumer misperception. The resulting behavioral market failure hurts consumers and reduces efficiency. This Chapter uses the US mortgage market and, specifically, the subprime mortgage market before the financial crisis to illustrate the causes and effects of this behavioral market failure. Different legal policy responses are also considered.

The Unfulfilled Promise of Mortgage Disclosures / Omri Ben-Shahar

Mortgage markets are a good laboratory for evaluating the effects of mandated disclosures because there is a great deal of experience and data accumulated in these markets, and because there is a prevailing sense that the fundamental problems in mortgage markets are far from solved.

Can Legal Institutions Calm ‘Animal Spirits’ on the Mortgage Market? Insights from Germany / Matthias Lehmann and Isabel Schnabel

While the market for immovable property is prone to boom and bust, there are important differences depending on the country in question. Germany has benefitted from a particularly stable mortgage market since the 1950s. Amongst others, this may have been the result of institutions specific to German law. This contribution examines whether peculiarities such as the Pfandbrief (a version of the covered bond), the Bausparkassen (building savings banks) or the stringent protection of tenants were root causes of stability. It also describes possible challenges that have led to recent hikes in real estate prices. The question at the heart of this contribution is whether law can contribute to stabilize the market for immovable property.

The Case for Civil Legal Aid / Marco Celentani

Legal aid programs are in-kind transfer schemes aimed at providing assistance to people otherwise unable to afford legal representation and access to the court system. Because they target low income individuals, legal aid programs are normally viewed as redistributionally desirable. But as with other in-kind programs it is important to determine whether legal aid is an efficient redistribution tool. This paper addresses this issue by proposing an economic environment in which legal aid programs are welfare enhancing because they serve to mitigate the social costs of informational asymmetries in litigation.

The Role of Economics in EU Competition Law: From Monti’s Reform to the State aid Modernization Package / Jorge Padilla

This paper considers the role of economics in EU competition over the last fifteen years. It offers and personal, and thus subjective, account of policy developments and doctrinal debates. First, I explain the reasons why the European Commission decided to incorporate PhD economists to its ranks, describe the evolution of the Chief Competition Economist Team (CET) at Directorate General for Competition of the European Commission (DG Comp), and document the impact of the creation of the CET for the economic consulting industry. Then, I review the contributions made by the CET economists and economic academics and consultants to the development of EU competition law. I identify those areas where the law does not reflect current economic thinking and those where, on the contrary, the enforcement of competition law is well grounded in economics. I conclude with a brief account and a critical assessment of the views of economists and non-economists who have recently criticized the use –in their opinion abusive– of economics in EU competition law matters.

Optimal Magnitude and Probability of Fines when Courts Dislike Punishment / Nuno Garoupa

The economic literature on crime and punishment has focused on the trade-off between probability and severity of punishment for many decades. It suggests that detection probability and fines are substitutes. However, the literature assumes implicitly that courts are willing to enforce maximal fines. In this article, it is shown that, in presence of courts who dislike punishment, the optimal policy involves lower sanctions. The effect on the probability varies with the parameters of the model. In particular, when substantial underdeterrence caused by costly detection and punishment prevails, the probability might also go down. Policy implications are discussed.

Medical Malpractice Appeals to the Spanish Supreme Court / Sofia Amaral-Garcia

This short paper focuses on outcomes of medical malpractice claims decided by the Spanish Supreme Court from 2006 until 2010. Section 1 provides a brief introduction to the problem of medical malpractice. Section 2 describes the dataset and provides an overview of the main results in Amaral-Garcia and Garoupa (2015) and in Amaral-Garcia (2019). The former assesses whether administrative courts can favor the government (i.e., whenever the medical accident took place in a public hospital) in medical malpractice cases. The later focuses on non-economic damages and tests for differences between administrative and civil decisions (in general terms, it tests whether courts award different non-economic amounts to patients suffering harm in public and private hospitals). Section 3 briefly considers which medical specialties are more commonly sued and makes a comparison with other jurisdictions. Section 4 analyses the impact of legal reforms introduced in 1998 and 1999, which aimed at reducing the duration of legal claims. Finally, conclusions are presented in Section 5.