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Category: Economic Analysis of Law

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Thoughts on Driesen’s The Economic Dynamics of Law

David Driesen’s book, The Economic Dynamics of Law, offers a powerful new approach to law and policy analysis.  Like many others, Professor Driesen critiques neoclassical law and economics and the application of conventional cost-benefit analysis (CBA) to various areas of law and policy.  Unlike most others, however, Professor Driesen develops an alternative.

Professor Driesen emphasizes a host of broad framing points, the implications of which are not fully understood, generally and especially within conventional law and economics.  I take the following points to be, for the most part, uncontroversial (even if their implications are not fully understood).  Most people will agree that we live in an incredibly complex, dynamic world consisting of many interdependent, complex evolving systems; that law shapes these systems and critically how these systems change or evolve over time; that path dependencies make some changes irreversible and others incredibly costly to unwind; that law is necessarily normative as are the path setting consequences of law; that law operates as a framework that shapes but does not fully determine what people do.

The implications of these framing points demand serious attention, however, because they are too easily misunderstood or simply assumed away to make analysis tractable.  For example, the implications of the fact that preferences are endogenous and that law and the systems structured by law shape preferences are not fully accounted for in law and economics.  It is admittedly difficult to take such complications into account, and so the more tractable move is to assume preferences are exogenous and that law’s objective is efficient satisfaction of existing preferences.  Professor Driesen explains the errors in such a move.  Tractability is a poor excuse for failing to engage with reality and the normative stakes of law’s dynamics.  The fact that law shapes preferences and beliefs means that we cannot avoid confronting questions about how law shapes who we are and who we can even contemplate being.

Professor Driesen thus places analytical emphasis on law’s role in setting paths or choosing directions for society rather than determining outcomes or optimizing resource allocations.  He advances two broad normative commitments — avoiding systemic risk and providing opportunities for economic development.  He defines each and develops means for analyzing them that goes beyond conventional CBA.  As others have commented on the relationship of his approach and CBA, I’ll leave that aside.  With regard to systemic risk, I had two questions for Professor Driesen:  First, how would he deal with intergenerational issues?  He touches on CBA’s use of discount rates in the climate change context and how “CBA’s results depend on the policy views of the economist conducting the analysis,” but I didn’t fully understand what alternative he offered.  Second, what about systemic benefits?  Simply put, I wondered whether there is a symmetrical point to be made about systemic benefits.  I discuss related issues in my book, Infrastructure:  The Social Value of Shared Resources (Co-Op symposium), and connect the commitment to the idea of a social option, but it also ties into North’s adaptive efficiency argument, which Professor Driesen discusses.  Systemic benefits may be a broader way to think about his second normative commitment concerning opportunities for economic development, but it is hard to say because that commitment gets much less attention in the book.  Perhaps opportunities for economic development should be extended to include human development and Driesen’s approach could incorporate some of the ideas and lessons from Sen’s Capabilities Approach.  Certainly, many of the framing points noted above are also central to the CA project.

I was a little disappointed that the second normative commitment received less attention.  Much of the law is focused on opportunities for (human and) economic development.  Many of the applied chapters (e.g., contract, property, IP) seem to focus on it, but those chapters seemed mostly descriptive and backwards looking, with Professor Driesen saying something like, “Hey, wait a minute!  What’s really happening in these areas is dynamic change over time, with bounded rationality, …, it’s not classic law and econ!”  I would like to see more analysis of how Professor Driesen’s approach could better reconcile these areas of law with the second normative commitment he identified.

On IP, let me just say that I agree with Professor Driesen – IP scholars certainly think a lot about dynamic change.  He is right that we need to pay much more attention to path setting and how IP laws, for better or worse, shape the paths available and the paths taken.  This was a theme I explored in Intellectual Infrastructure, chapter 12 of my book.  In fact, many IP scholars are now working on this subject.

Let me end with a brief cautionary note on Professor Driesen’s appeal to macroeconomics.  I agree with him that legal scholars who employ economics tend to rely heavily on microeconomics and ignore macroeconomics.  He is also correct, in my view, when he suggest that overreliance on microeconomics, or at least certain aspects of it, has often sustained unrealistic assumptions, ideological commitments (sometimes hidden beneath the veneer of objectivity), and bad results.  I would only caution Professor Driesen that the same might be said of macroeconomics.

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Economic Dynamics and Economic Justice: Making Law Catastrophic, Middling, or Better?

Contrary to Livermore,’s post,  in my view Driesen’s book is particularly powerful as a window into the  profound absurdity and destructiveness of the neoclassical economic framework, rather than as a middle-ground tweaking some of its techniques.  Driesen’s economic dynamics lens makes a more important contribution than many contemporary legal variations on neoclassical economic themes by shifting some major assumptions, though this book does not explore that altered terrain as far as it might.

At first glance, Driesen’s foregrounding of the “dynamic” question of change over time may, as Livermore suggests, seem to be consistent with the basic premise of neoclassical law and economics:   that incentives matter, and that law should focus ex ante, looking forward at those effects.   A closer look through Driesen’s economic dynamics lens reveals how law and economics tends to instead take a covert ex post view that enshrines some snapshots of the status quo as a neutral baseline.  The focus on “efficiency” – on maximizing an abstract pie of “welfare”  given existing constraints –  constructs the consequences of law as essentially fixed by other people’s private choices, beyond the power and politics of the policy analyst and government, without consideration of how past and present and future rights or wrongs constrain or enable those choices.  In this neoclassical view, the job of law is narrowed to the technical task of measuring some imagined sum of these individual preferences shaped through rational microeconomic bargains that represent a middling stasis of existing values and resources, reached through tough tradeoffs that nonetheless promise to constantly bring us toward that glimmering goal of maximizing overall societal gain (“welfare”) from scarce resources.

Driesen reverses that frame by focusing on complex change over time as the main thing we can know with certainty.  In the economic dynamic vision, “law creates a temporally extended commitment to a better future.” (Driesen p. 52). Read More

Book Symposium: Driesen’s The Economic Dynamics of Law

Next week, we will be hosting a symposium on David Driesen’s book The Economic Dynamics of Law (Cambridge University Press, 2013). The symposium will be held from Mar. 31 to Apr. 3, 2014. As the press’s webpage explains,

This book offers a dynamic theory of law and economics focused on change over time, aimed at avoiding significant systemic risks (like financial crises and climate disruption), and implemented through a systematic analysis of law’s economic incentives and how people actually respond to them. This theory offers a new vision of law as fundamentally a macro-level enterprise establishing normative commitments and a framework for numerous private transactions, rather than as an analogue to a market transaction. It explains how neoclassical law and economics sparked decades of deregulation culminating in the 2008 financial collapse. It then shows how economic dynamic theory helps scholars and policymakers make wise choices about how to avoid future catastrophes while keeping open a robust set of economic opportunities, with individual chapters addressing the law and economics of financial regulation, contract, property, intellectual property, antitrust, national security, and climate disruption.

Our terrific line-up of commenters will include:

Sanja Bogojevic
Brett Frischmann
James Hackney
Michael Livermore
Martha McCluskey
Uma Outka
Arden Rowell
Jennifer Taub

Thanks to them, and to David, for being part of the symposium—we all look forward to the event. Given the topic of the 2014 Phillips Lecture, it’s clear that “avoiding future catastrophes while keeping open a robust set of economic opportunities” is a critical issue for our times.

Law and Economics: The Flow of Ideas is a Two-Way Street

Raul Carrillo and Rohan Grey have recently argued that “law students need macroeconomics…and macroeconomics needs us”—and I couldn’t agree more. They have launched several initiatives at Columbia to build on the excellent finance curriculum offered there:

As Professor Robert Jackson opined in The Modern Money Network’s recent seminar, “The way we talk about money systems in law school has been blocked in a way, because we’re not really honest with each other about the fact that our money system is a legal choice… We may have covered, in legal academia, microeconomics in reasonable depth, but we need to do much more work in macroeconomics.”

When we “do economics” in law school, we customarily confine it to the scale of individual entities, say, firm transactions in Contracts and Corporations. Broader discussion of political economy rarely creeps into the curriculum…. Whether you eventually practice or make policy, negotiate deals or craft legislation, every student can benefit from further integration of political economy into the curricula. This is why The Modern Money Network, a newly recognized student organization, exists. It is a transdisciplinary hub for learning about the interactions between money, finance, law, and the broader economy.

Carrillo has also observed that the Fed used to have far more input from attorneys, but has since become an intellectual monoculture of economists. That, too, has to change. We can only hope to reform the finance sector by addressing power dynamics among boards, CEOs, traders, and investors—the types of dynamics lawyers are expert at creating and manipulating. Moreover, attorneys need to understand the overall effect of finance on the broader economy, and not simply think of ourselves as mere hired guns for the highest bidders. I’ll be closely following the work of Carrillo and Grey, and suggesting some fruitful directions for political economy and law.

They are also looking to expand their approach to other law schools—so try to contact them (@ramencents for Carrillo, @rohangrey for Grey) if you’re interested. It’s great to see the legacy of Robert Lee Hale endure at Columbia!

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UCLA Law Review Vol. 61, Issue 1

Volume 61, Issue 1 (December 2013)
Articles

Against Endowment Theory: Experimental Economics and Legal Scholarship Gregory Klass & Kathryn Zeiler 2
Why Broccoli? Limiting Principles and Popular Constitutionalism in the Health Care Case Mark D. Rosen & Christopher W. Schmidt 66

 

Comments

“Let’s Have a Look, Shall We?” A Model for Evaluating Suspicionless Border Searches of Portable Electronic Devices Sid Nadkarni 148
An Article III Divided Against Itself Cannot Stand: A Critical Race Perspective on the U.S. Supreme Court’s Standing Jurisprudence Raj Shah 198

 

 

 

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The Dualities of Freedom and Innovation

What a rollercoaster week of incredibly thoughtful reviews of Talent Wants to Be Free! I am deeply grateful to all the participants of the symposium.  In The Age of Mass Mobility: Freedom and Insecurity, Anupam Chander, continuing Frank Pasquale’s and Matt Bodie’s questions about worker freedom and market power, asks whether Talent Wants to Be Free overly celebrates individualism, perhaps at the expense of a shared commitment to collective production, innovation, and equality. Deven Desai in What Sort of Innovation? asks about the kinds of investments and knowledge that are likely to be encouraged through private markets versus. And in Free Labor, Free Organizations,Competition and a Sports Analogy Shubha Ghosh reminds us that to create true freedom in markets we need to look closely at competition policy and antitrust law. These question about freedom/controls; individualism/collectivity; private/public are coming from left and right. And rightly so. These are fundamental tensions in the greater project of human progress and Talent Wants to Be Free strives to shows how certain dualities are pervasive and unresolvable. As Brett suggested, that’s where we need to be in the real world. From an innovation perspective, I describe in the book how “each of us holds competing ideas about the essence of innovation and conflicting views about the drive behind artistic and inventive work. The classic (no doubt romantic) image of invention is that of exogenous shocks, radical breakthroughs, and sweeping discoveries that revolutionize all that was before. The lone inventor is understood to be driven by a thirst for knowledge and a unique capacity to find what no one has seen before. But the solitude in the romantic image of the lone inventor or artist also leads to an image of the insignificance of place, environment, and ties…”.  Chapter 6 ends with the following visual:

 

Dualities of Innovation:

Individual / Collaborative

Radical/Incremental

Accidental /Deliberate

Global /Local

Passion / Profit

Art/Science

Exclusive/Shared

Inscribed/Tacit

 

And yet, the book takes on the contrarian title Talent Wants to Be Free! We are at a moment in history in which the pendulum has shifted too far. We have too much, not too little, controls over information, mobility and knowledge. We uncover this imbalance through the combination of a broad range of methodologies: historical, empirical, experimental, comparitive, theoretical, and normative. These are exciting times for innovation research and as I hope to convince the readers of Talent, insights from all disciplines are contributing to these debates.

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Individuals & Teams, Carrots & Sticks

I promised Victor Fleisher to return to his reflections on team production. Vic raised the issue of team production and the challenge of monitoring individual performance. In Talent Wants to Be Free I discuss some of these challenges in the connection to my argument that much of what firms try to achieve through restrictive covenants could be achieved through positive incentives:

“Stock options, bonuses, and profit-sharing programs induce loyalty and identification with the company without the negative effects of over-surveillance or over-restriction. Performance-based rewards increase employees’ stake in the company and increase their commitment to the success of the firm. These rewards (and the employee’s personal investment in the firm that is generated by them) can also motivate workers to monitor their co-workers. We now have evidence that companies that use such bonus structures and pay employees stock options outperform comparable companies .”

 But I also warn:

 “[W]hile stock options and bonuses reward hard work, these pay structures also present challenges. Measuring employee performance in innovative settings is a difficult task. One of the risks is that compensation schemes may inadvertently emphasize observable over unobservable outputs. Another risk is that when collaborative efforts are crucial, differential pay based on individual contribution will be counterproductive and impede teamwork, as workers will want to shine individually. Individual compensation incentives might lead employees to hoard information, divert their efforts from the team, and reduce team output. In other words, performance-based pay in some settings risks creating perverse incentives, driving individuals to spend too much time on solo inventions and not enough time collaborating. Even more worrisome is the fear that employees competing for bonus awards will have incentives to actively sabotage one another’s efforts.

A related potential pitfall of providing bonuses for performance and innovative activities is the creation of jealousy and a perception of unfairness among employees. Employees, as all of us do in most aspects of our lives, tend to overestimate their own abilities and efforts. When a select few employees are rewarded unevenly in a large workplace setting, employers risk demoralizing others. Such unintended consequences will vary in corporate and industry cultures across time and place, but they may explain why many companies decide to operate under wage compression structures with relatively narrow variance between their employees’ paychecks. For all of these concerns, the highly innovative software company Atlassian recently replaced individual performance bonuses with higher salaries, an organizational bonus, and stock options, believing that too much of a focus on immediate individual rewards depleted team effort.

Still, despite these risks, for many businesses the carrots of performance-based pay and profit sharing schemes have effectively replaced the sticks of controls. But there is a catch! Cleverly, sticks can be disguised as carrots. The infamous “golden handcuffs”- stock options and deferred compensation with punitive early exit trigger – can operate as de facto restrictive contracts….”

 All this is in line with what Vic is saying about the advantages of organizational forms that encourage longer term attachment. But the fundamental point is that stickiness (or what Vic refers to as soft control) is already quite strong through the firm form itself, along with status quo biases, risk aversion, and search lags. The stickiness has benefits but it also has heavy costs when it is compounded and infused with legal threats.

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A Time for Action: The Double Gain of Freer Regions and the Double Speak about Talent Droughts

As Catherine Fisk and Danielle Citron point out in their thoughtful reviews here and here, the wisdom of freeing talent must go beyond private firm level decisions; beyond the message to corporations about what the benefits of talent mobility, beyond what Frank Pasquale’s smartly spun as “reversing Machiavelli’s famous prescription, Lobel advises the Princes of modern business that it is better to be loved than feared.” To get to an optimal equilibrium of knowledge exchanges and mobility, smart policy is needed and policymakers must to pay attention to research. Both Fisk and Citron raise questions about the likelihood that we will see reforms anytime soon. As Fisk points out — and as her important historical work has skillfully shown, and more recently, as we witness developments in several states including Michigan, Texas and Georgia as well as (again as Fisk and Citron point out) in certain aspects of the pending Restatement of Employment — the movement of law and policy has actually been toward more human capital controls rather than less. This is perhaps unsurprising to many of us. Like with the copyright extension act which was the product of heavyweight lobbying, these shifts were supported by strong interest groups. What is perhaps different with the talent wars is the robust evidence that suggests that everyone, corporations large and small, new and old, can gain from loosening controls. Citron points to an irony that I too have been quite troubled by: the current buzz is about the intense need for talent, the talent drought, the shortage in STEM graduates. As Citron describes, the art and science of recruitment is all the rage. But while we debate reforms in schooling and reforms in immigration policies, we largely neglect to consider a reality of much deadweight loss of through talent controls.

The good news is that not only in Massachusetts, where the governor has just expressed his support in reforming state law to narrow the use of  non-competes, but also in other state legislatures , courts and agencies, we see a greater willingness to think seriously about positive reforms. At the state level, the jurisdictional variations points to the double gain of regions that void or at least strongly narrow the use of non-competes. California for example gains twice: first by encouraging more human capital flow intra-regionally and second, by its willingness to give refuge to employees who have signed non-competes elsewhere. In other words, the positive effects stem not only from having the right policies of setting talent free but also from its comparative advantage vis-à-vis more controlling states. This brain gain effect has been shown empirically: areas that enforce strong post-employment controls have higher rates of departure of inventors to other regions. States that weakly enforce non-competes are on the receiving side of the cream of the crop. One can only hope that legislature and business leaders will take these findings very seriously.

At the federal level, in a novel approach to antitrust the federal government recently took up the investigation of anti-competitive practices between high-tech giants that had agreed not to poach one another’s employee. This in fact relates to Shubha Gosh’s questions about defining competition and the meaning of free and open labor markets. And it is a good moment to pause about the extent to which we encourage secrecy in both private and public organizations. It is a moment in which the spiraling scandals of economic espionage by governments coupled with leaks and demand for more transparency require us to think hard. In this context, Citron is right to raise the question of government 2.0 – for individuals to be committed and motivated to contribute to innovation, they need some assurances that their contributions will not be entirely appropriated by concentrated interests.

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Talent Flow and the Theory of the Firm

Both Vic Fleisher and Shubha Ghosh in their thoughtful commentary about Talent Wants to Be Free invoke the theory of the firm to raise question about the extent of desirable freedom in talent and knowledge flows. In its basic iteration, the theory of the firm suggests that arms-length contracting will not be optimal when one party has the ability to renegotiate and hold the other party up, which is the conventional rational for the desirability of talent controls. This is what I describe in the book as the Orthodox Model of employment intellectual property: firms fear making relational investment in employees and then having the employees renegotiate the contract under a threat of exit. Firms respond through mobility restrictions aimed at eliminating the transaction costs of this kind of opportunism. In the book, I accept, at least for some situations, this aspect of the benefits and confidence that are created for firms in internalizing production and ensuring ongoing loyalty by all players. The orthodox model thus explains post-employment controls as necessary to encourage optimal investment within the corporation. More company controls = more internal R&D and human capital investment. The new model developed in the book doesn’t deny these benefits but argues that the orthodox model is incomplete. The Dynamic-Dyadic Model asks about the costs and benefits when controls are employed.  It suggests that yes, often, protecting human capital and trade secret investments is often in the immediate interest of a company, but that too much control becomes a double-edged sword. This is because of both the demotivating effects on employee performance when lateral markets are reduced and because over-time, although information leakage and job-hopping by talented workers may provide competitors with undue know-how, expertise, and technologies, constraining mobility reduces knowledge spillovers and information sharing that outweigh the occasional losses. The enriched model is supported by a growing body of empirical evidence that finds that regions with less controls and more talent freedom, such as California, have in fact more R&D investment, quicker economic growth and greater innovation.

Vic is of course right that one solution to this problem is to recreate high-powered (market-like) incentives for performance within the firm. This is an aspect that I am greatly interested in and I analyze it in Talent Wants to Be Free as the question of whether controls and restrictions can effectively alternate with the carrots of performance-based compensation, vesting interests, loyalty inducing work environments, employee stock options and so forth. I too like Shubha am a fan of Hirschman’s Exit, Voice, and Loyalty and have found it useful in analyzing employment relations. I view the behavioral research as shedding light on these questions of what these intra-firm incentives need to look like in order to preserve the incentive to innovate. In a later post I will elaborate on the monitoring and motivational tradeoffs that exist in individual and group performance.

More generally, though, the research suggests that at least in certain industries, most paradigmatically fast-paced, high-tech fields, innovation is most likely when the contracting environments have thick networks of innovators that are mobile (i.e. Silicon valley) and firms themselves are horizontally networked. The flow of talent and ideas is important to innovation and rigid boundaries of the firm can stifle that interaction even with the right intra-firm incentives. The benefits in terms of innovation rise in these structures of denser inter-firm connections, but also, the costs of opportunism that drive the conventional wisdom are in fact lower than the traditional theory of the firm would predict. This is because talent mobility is a repeated game and at any given moment, a firm can be on either side of the raiding and poaching.   Policies against talent controls have the effect of reducing the costs of opportunistic renegotiation by ensuring the firm can hire replacement innovators when it loses its people. To push back on Vic’s phrasing, talent wants to be appreciated and free. MIT economist Daron Acemoglu’s analysis of investments and re-investments in workers as a key ingredient of production and growth is helpful in understanding some of this dynamic. People invest in their own human capital without knowing the exact work they will eventually do, just as companies must make investment decisions in technology and capital funds without always knowing who they will end up hiring. Acemoglu describes the positive upward trajectory under these conditions of uncertainty: When workers invest more in their human capital, businesses will invest more because of the prospects of acquiring good talent. In turn, workers will invest more in their human capital as they may end up in one or more of these companies.  The likelihood of finding good employers creates incentives for overall investments in human capital.

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Human Capital Law and Innovation Policy

This is a thrilling week for Talent Wants to Be Free. I am incredibly honored and grateful to all the participants of the symposium and especially to Deven Desai for putting it all together. It’s only Monday morning, the first official day of the symposium, and there are already a half a dozen fantastic posts up, all of which offer so much food for thought and so much to respond to. Wow! Before posting responses to the various themes and comments raised in the reviews, I wanted to write a more general introductory post to describe the path, motivation, and goals of writing the book.

Talent Wants to Be Free: Why We Should Learn to Love Leaks, Raids and Free Riding comes at a moment in time in which important developments in markets and research have coincided, pushing us to rethink innovation policy and our approaches to human capital. First, the talent wars are fiercer than ever and the mindset of talent control is rising. The stats about the rise of restrictions over human capital across industries and professions are dramatic.  Talent poaching is global, acquisition marathons increasingly focus on the people and their skills and potential for innovation as much as they look at the existing intellectual property of the company. And corporate espionage is the subject of heated international debates. Second, as a result of critical mass of new empirical studies coming out of business schools, law, psychology, economics, geography, we know so much more today compared to just a few years ago about what supports and what hinders innovation. The theories and insights I develop in the book attempt to bring together my behavioral research and economic analysis of employment law, including my experimental studies about the effects of non-competes on motivation, my theoretical and collaborative experimental studies about employee loyalty and institutional incentives, and my scholarship about the changing world of work, along with theories about endogenous growth and agglomeration economies by leading economists, such as Paul Romer and Michael Porter, and new empieircal field studies by management scholars such as Mark Garmaise, Olav Sorenson, Sampsa Samila, Matt Marx, and Lee Fleming. Third, as several of the posts point out, these are exciting times because legislatures and courts are actually interested in thinking seriously about innovation policy and have become more receptive to new evidence about the potential for better reforms.

As someone who teaches and writes in the fields of employment law, I wrote the book in the hopes that we can move beyond what I viewed as a stale conversation that framed these issues of non-competes, worker mobility, trade secrets and ownership over ideas  as labor versus business; protectionism versus free markets (as is often the case with other key areas of my research such as whistleblowing and discrimination). A primary goal was to shift the debate to include questions about how human capital law affects competitiveness and growth more generally. Writing about work policy, my first and foremost goal is to understand the nature of work in its many evolving iterations. Often in these debates we get sidetracked. While we have an active ongoing debate about the right scope of intellectual property, under the radar human capital controls have been expanding, largely without serious public conversation. My hope has been to encourage broad and sophisticated exchanges between legal scholars, policymakers, business leaders, investors, and innovators.

And still, there is so much more to do! The participants of the symposium are pushing me forward with next steps. The exchanges this week will certainly help crystalize a lot of the questions that were beyond the scope of the single book and several new projects are already underway. I will mention in closing a couple of other colleagues who have written about the book elsewhere and hope they too will join in the conversation. These include a thoughtful review by Raizel Liebler on The Learned FanGirl, a Q&A with CO’s Dan Solove, and other advance reviews here. Once again, let me say how grateful and appreciative I am to all the participants. Nothing is more rewarding.