Friday, October 31, 2008

Lawyers and Economists: Division of Labor

Early last month, I posted some comments about the differences between the ways economists and lawyers think about problems. While any such observation surely oversimplifies, I noted that -- based on my experiences both as an economics professor and as a law professor -- each profession seems to instill certain tendencies in its practitioners. While lawyers seem to take an all-or-nothing approach to problems (leading them too often to reject useful partial solutions because "that won't solve the problem"), economists come to believe their models just a bit too much. On the latter point, Alan Greenspan's recent testimony before Congress to the effect that he has been in "shocked disbelief" at the failure of his long-held model of how the economy works (unregulated markets will lead to good results) has shown the potentially enormous negative consequences of the economist's default mindset.

Beyond the tendencies that are drilled into members of the two professions (or which, perhaps, lead to self-selection into the two professions), a more interesting question is what lawyers and economists actually do. More precisely, when we have a public policy problem, how do the skill sets of lawyers and economists determine their respective usefulness in dealing with the problem? Again, I make no claim that my answer is anything beyond a broad-brush summary and that individual cases will vary. Still, recent events suggest that, on big issues, economists' contributions are essential but can be either helpful or useless depending on what the lawyers do. Examining the current crisis and the policy responses to it will, I hope, clarify my meaning.

Regarding the ongoing financial crisis, it really does take some training in monetary economics and finance to understand the causes and consequences of the panic in the financial markets. It is especially helpful to understand the nature of financial contagions to understand why the current crisis is not merely a "too big to fail" phenomenon but rather a matter of the unique fragility of the psychology of financial markets. Economists who would never support the nationalization of, say, Wal-Mart (even if it were failing) understand that the failure of even much smaller financial firms threatens to lead to much more profound problems for the entire economy. As far as it goes, the insight from economics is that the bailout/rescue is both important and unique, and that partial and temporary nationalization of the banking system is currently called for in ways that need not set a precedent for bailouts of non-financial markets. (There are, to be sure, respectable economists who disagree about the wisdom of the financial rescue. The vast majority of economists, though, agreed that the rescue was unfortunately necessary.)

What do lawyers do? They make it work (or not). Earlier this month, the economist Alan Blinder wrote an article in the New York Times, "Got $700 Billion? Sweat the Details," in which he described all of the things that need to be done well in order to make sure that the rescue plan succeeds. Blinder tells us in so many words that the legal work is now what matters. Among the issues he raises is that the rescue plan can be disastrously derailed by conflicts of interest. Without adequate legal rules and procedures that will rein in individual self-interest among the recipients of government assistance, the plan could do more harm than good. Similarly, he describes the difficulty in setting prices for assets for which there is no market. When there is no reliable market indicator for determining the fair market value of assets, it becomes essential to write complicated laws and contracts that allow the government to include contingencies in their dealings with private actors. In principle, this is easy. "If X happens, then the parties' respective rights and responsibilities change." Anyone who has studied legislative drafting or contract law knows just how simple this is not.

It is tempting to think of this as a physicists-versus-engineers split. The economists are the theorists, and the lawyers actually implement the theory. That analogy, however, does not quite get at the nature of the problem. Economists still have things to say about, for example, the likely incentive effects of provisions to curb conflicts of interest; but their theories on the smaller-bore issues leave open much more room for uncertainty. That uncertainty must be filled in by the lawyers. The better they do their job, the more likely it is that the economists' policy prescriptions will actually work. As always, a neutral legal framework cannot be assumed into existence.

-- Posted by Neil H. Buchanan

[Today's post, in slightly edited form, is cross-posted
on the Concurring Opinions blog. My guest stint there ends as of today. I will, of course, continue to write my once- or twice-weekly posts here at DoL.]


Michael C. Dorf said...

I wonder whether this account perhaps under-sells what lawyers do. The division of labor Neil suggests is that the economists set the goals and broadly choose the means, while the lawyers refine the means. But we pragmatists (per Dewey, James, etc) tend to think that means and ends are reciprocal. So, if in the course of, say, re-negotiating terms of mortgages on homes for which that owners cannot afford payments, the govt lawyers discover that they have insufficient ability to deal with the owners of the multiple tranches into which each debt obligation flows, they might want to change their own mid-level goals. This sort of mid-course correction has already occurred several times from the top (e.g., Sec'y Paulson first resisting and then agreeing to take an equity stake in banks), but I'm suggesting that working through the details of any particular program will, if the program is structured right, lead to re-imagining the program itself.

Unknown said...

Superb posting! Being both an engineer and lawyer, I was especially interested in the analogy at the end of the post. It seems to me that engineers and lawyers both use tools provided to them to structure solutions to problems which, to the best of their abilities, won't result in new problems. I agree with Mike that the lawyer (or engineer) re-imagines the problem in order to solve it. However, I wonder if the analogy breaks down some when considering similarities between economists and physicists. Maybe physics theories are more readily testable (does the circuit work? do bits get from point a to point b?) than economics theories, which involve human responses.

Neil H. Buchanan said...

I did not mean to undersell what lawyers do, and I completely agree with Mike's suggestion that lawyers have to be adept enough to change course when unexpected problems arise. (One example of this is when I said that lawyers have to fill in the gaping hole of pricing criteria when the market provides none.)

Thus, Barry is right as well that economists' theories are less testable (if, indeed, they are testable at all) than physicists'. One example of this problem is that some economists continue to disagree with the broad consensus that a financial rescue was necessary. If economics were a science, at least something that basic would have to be beyond debate. (On many other issues, I am in the minority of economists. It's not a majority-rules situation, of course. It's more "we can't really prove it even among ourselves.")

Still, economists love to liken themselves to physicists, though MBA's are usually thought of as the engineers in the analogy. I've never thought the analogy apt.

Indeed, my broader point is that lawyers make or break the system -- and they also tend to be the ones who set the goals in the first place before the economists are even brought into the room. Hence, this even broader statement: A world without economists could work, but a world without lawyers could not.

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