THE EVOLUTION OF THE COMMON LAW

KHCZ builds on KH.6 Its characteristics are: 1 the use of the willingness to payWTP for gains and the willingness to accept WTA for losses; 2 the use of WTP andWTA from a legal status qu

THE EVOLUTION OF THE COMMON LAW

Richard O Zerbe, Jr

“The first and chief design of every system of government is to maintain justice; toprevent the members of a society from encroaching on one another’s property, or seizingwhat is not their own The design here is to give each one the secure and peaceablepossession of is own property — When this end, which we may call internal peace issecured, the government will next be desirous of promoting the opulence of the state

(Adam Smith, Dec 23, 1762, “Of Jurisprudence”)

I INTRODUCTION

Empirical evidence shows, and theory suggests, that the common law tends towardeconomic efficiency.1 While many theories attempt to explain this phenomenon, nosingle one is well accepted This article attempts to provide a simple explanation.2 Itsuggests that efficiency arises as a matter of justice and that justice is a social norm withits own sanctioning force The requirement of justice and hence efficiency arise mostpowerfully from experience, and experience is the life of the common law When socialconditions change rapidly, experience is in shorter supply and changes in the commonlaw are less likely to be efficient.3

II ECONOMIC EFFICIENCY

1 The evidence is too extensive to cite Some of it is summarized in two textbooks, Cooter and Ulen (1997), and Posner (1992) Skepticism is evidenced in a series of articles by Mark Kelman, who sees the proposition as ideologically based See Kelman (1988) The first attempt to provide an explanation can

be found in Rubin (1977) Other explanations have come from Priest (1977), Goodman (1978), and Cooter and Kornhauser (1990)

2 Cooter has expressed the view also captured here that social norms explain common law efficiency (1990) This view is also expressed in Zerbe (2001a) The authors have arrived at this view independently  

3   It follows that societies without a social norm of justice are less likely to have common law efficiency  

If justice is sought, efficiency will be achieved only if justice and efficiency tend tocorrespond Mainstream efficiency is represented by Kaldor-Hicks (KH), which, bydefinition, eschews issues of equity and arguably moral sentiments generally so that itsperfect correspondence with justice is not to be expected Thus it is not difficult to findcommon law examples that are not KH-efficient.4

It is more difficult to find common law exceptions to efficiency as measured bywealth maximization Wealth maximization appears to add to KH an accommodation forequity insofar as there is a willingness to pay for it A further expansion of the definition

of efficiency to include moral sentiments generally has been proposed by Zerbe (2001a,2004) under the rubric of Kaldor-Hicks-Coase-Zerbe (KHCZ).5 As this definition is moreinclusive of sentiments generally, it will better correspond with the requirements ofjustice and thus is more likely to be consistent with the common law

KHCZ builds on KH.6 Its characteristics are: (1) the use of the willingness to pay(WTP) for gains and the willingness to accept (WTA) for losses; (2) the use of WTP andWTA from a legal status quo; (3) the exclusion of gains or losses that are legallyillegitimate, as with goods held by the thief, or that violate well-accepted moral principles(benefit-cost rationale is provided for this); (4) a recognition and inclusion of non-pecuniary effects; (5) an efficiency test that is passed when and only when the aggregatebenefits exceed aggregate losses (no use of the potential compensation test); (6) theinclusion of all goods, including moral sentiments, as economic goods as long as there is

a WTP from them; (7) an assumption of equal marginal utility of income so that eachperson is treated the same; (8) the absence of reliance on market failure or externalities tojustify the use of benefit-cost analysis; (9) the inclusion of transactions costs of operating

a project; and (10) an understanding that the role of benefit-cost analysis is to provideinformation to the decision process and not to provide the answer We are concerned herewith these ten characteristics only to the extent to which they concern our exploration ofcommon law efficiency.7

4   For examples see Zerbe (2004).

5 In the 2001 work, the term “KHZ” represents Kaldor-Hicks-Zerbe In the 2004 work, the term ”KHCZ” stands for Kaldor-Hicks-Coase-Zerbe

6 This view is essentially identical to the view that has been presented elsewhere (Zerbe 2001) as the KHZ view

7 This list of characteristics is explored more fully elsewhere (Zerbe, 2001a, 2004).

KHCZ efficiency differs from KH by its grounding in legal rights (assumptions 2and 3); by its inclusion of all sentiments for which there is a willingness to pay(assumptions 5 and 6); its reliance on transactions costs rather than market failure todetermine where to apply benefit-cost analysis (assumption 8); by its inclusion oftransactions costs of operating a project, by including transactions costs (assumption 9);and by its view of efficiency as a technique to provide information relevant to the answer,not to provide the answer (assumption 10)

KHCZ differs from tautological efficiency, a concept introduced by Zerbe (1991)and Barzel (2000).8 Barzel (p 241) explains tautological efficiency as a state in which

"individuals must spend resources to discover inefficiencies and arrange to takeadvantage of their profit potential Suppose that after taking account of these costs, some

of these activities are still found profitable but some are not The former will beeliminated whereas the latter will be allowed to stand The latter ones, however, are notworth eliminating It is tautological that given profit maximization efficiency willprevail." To this explanation I add that spending on discovery is itself assumed to be atthe efficient level

KHCZ differs from tautological efficiency as it excludes of the costs of moving to

a new state of the world The discovery of a new rule that would be efficient were itimplemented would be KHCZ-efficient but might not be implemented due to high costs

of effecting the necessary changes and might not therefore be tautologically efficient,though it would be KHCZ-efficient Under the KHCZ measurement, a rule changeoccurs when there is a shift in laws and regulations

III KHCZ EFFICIENCY AND LEGAL RIGHTS

A MEASUREMENT OF BENEFITS AND COSTS

Benefits and costs are measured, respectively, by the WTP and by the WTA under KHCZ

as well as under KH.9 The WTP represents the amount that someone who does not own agood would be willing to pay to buy it; it is the maximum amount of money one wouldgive up to buy some good or service, or would pay to avoid harm.10 The WTA represents

8 In most cases, or certainly in many, a new rule that is KH-efficient would also be KHCZ-efficient.

9 See Zerbe and Dively (1994)

10 These are non-technical definitions and, as such, are not wholly accurate The compensating variation

the amount that someone who owns a good would accept to sell it; it is the minimumamount of money one would accept to forgo some good, or to bear some harm Thebenefits from a project may be either gains (WTP) or losses restored (WTA) The costs

of a project may be either a loss (WTA) or a gain forgone (WTP) Both the benefits andthe costs are the sum of the appropriate WTP and WTA measures Thus, the relation ofbenefits and costs to the WTP and the WTA may be measured in the following manner:

Benefits: The sum of the WTPs for changes that are seen as gains and of the WTAs for changes that are seen as restoration of losses

Costs: The sum of the WTAs for changes that are seen as losses and of the WTPs for changes that are seen as for e gone gains.

The justification for adopting these methods of measurement is that they correspond withthe psychological sense of gains and losses.11 The measurements are summarized in table3.1 below.12 Note that whether a change is a benefit or cost is a different question fromwhether it is a gain or a loss The point here is that benefits are not measured exclusively

by the WTP, nor costs exclusively by the WTA Benefits are measured by the WTA,where benefits include losses restored, and costs are measured by the WTP, where theyinclude gains foregone

Table 1 The Measurement of Benefits and Costs in Terms of Gains and Losses

The Compensating Variation (KH and KHCZ Measure)

(CV) is the sum of money that can be taken away or given to leave one as well off as one was before the

economic change The equivalent variation (EV) is money taken or given that leaves one as well off as

after the economic change See Zerbe and Dively for a derivation of these concepts in terms of

indifference curves

11 See Kahneman and Knetsch (1991)

12 The difference between benefits and costs is simply their sign: positive for benefits and negative for costs Thus, without loss of accuracy, costs can be counted as negative benefits and benefits can be counted as negative costs

Costs LOSS: WTA — the sum of CVs for a

negative change — could be infinite

GAIN FOREGONE: The sum of CVs isfinite

B RIGHTS AND THE USE OF WTP AND WTA

Economic theory takes for granted, far more extensively than either economists or thecritics explicitly recognize, the normative force of established rights and obligations.13

For some time it has been recognized that the policy and welfare implications of anysubstantive economic analysis depend upon the legitimacy of the property rights thatunderlie the relevant supply and demand functions.14 Heyne (1988, p.11) notes that,

“Because this legitimacy depends on existing law the foundations of economics may

be said to rest in the law.” It is fair to say, however, that economists have not always, oreven usually, been clear on this point And with this lack of clarity, the connectionbetween normative analysis and existing institutions gets lost

Mishan (1982) assertsnotes that an economist might as well flip a coin whentrying to decide whether to use the CV measure (which attempts to use the WTA forbenefits and the WTP for costs) or the EV measure (which uses the WTP for benefits andthe WTA for costs) Indeed as Knetsch (1990) notes, the conventional assumption hasbeen that the WTP and WTA measures will usually lead to similar valuations 15

13 See Heyne (1988, p 53f)

14 Id at 53–71.

15 See R EPORT OF THE U NITED S TATES E NVIRONMENTAL P ROTECTION A GENCY 60 (2000); see also Willig (1976).

This usually shadowy connection is explicitly considered under KHCZ analysis.The connection of KHCZ to the legal system adds to KH’s grounding in legal rights andpsychological expectations, and provides a rationale for choosing between a WTP orWTA approach.16 KHCZ’s rationale for choosing between WTP and WTA is based onlegal ownership and its connection to psychological expectations Benefits and costs are

to be measured as changes from the status quo Gains from the status quo are measured

by the WTP, losses by the WTA.17 The status quo position is determined by one’sexpectations and primarily legal rights define these expectations.18

From a legal perspective, the use of the WTA to measure losses and the WTP tomeasure gains rests on a normative decision to recognize ownership Gains and lossesare to be measured from a psychological reference point, which stems from one’s beliefsabout ownership Legal rights largely determine one's beliefs about ownership TheWTP measure assumes that one does not have psychological or legal ownership of thegood, and asks how much one would pay to obtain it The WTA measure assumes thatone owns the good, and asks how much one would accept to sell it.19

Ownership establishes a reference point, from which losses are to be calculated

by the WTA, and gains by the WTP In a sense, this has long been noted Atiyah (1979)pointed out that David Hume and Adam Smith both said that expectations arising out ofrights of property deserved greater protection than expectations in regard to something

16 KH recognizes the potential relevance of both the WTP and the WTA measures, but it does not provide a

methodology for choosing between WTA and WTP in measuring an individual’s interest in a good

17 See Kahneman and Tversky (1979); Kahneman and Thaler (1991); and Knetsch (1995).

18

The older generation of economists, generally those writing before the 1940s, well recognized the complexity of the notion of a standard of living, of measuring economic value and the role of human perceptions Hewins, for example, providing a description of economics for the 1911 edition of

Encyclopedia Britannica, notes:

The concept of the standard of life involves also some estimate of the efforts and

sacrifices people are prepared to make to obtain it; of their ideas and character; of the

relative strength of the different motives which usually determine their conduct It

is doubtful whether the most complete investigation in terms of money (q.v.) would

ever enable us to include all the elements of the standard of life in a money estimate

See E NCYCLOPEDIA B RITANNICA 900 (1911)

This insight was lost in subsequent developments until the 1970s, when economists were confronted with the unpleasant fact that many of their predictions about human behavior under uncertainty were incorrect Kahneman and Tversky were instrumental in clarifying gains and losses as psychological concepts as well

as measures of economic value The psychological issues they addressed in the 1970s were not ones of

individual idiosyncrasies, but rather concerned the way most people actually thought, valued, and made

decisions.

19 See Levy and Friedman (1994).

that had never been possessed To deprive somebody of something which he merelyexpects to receive is a less serious wrong, deserving of less protection, than to deprivesomebody of the expectation of continuing to hold something that he already possesses.20

The law has long recognized that it is more serious to stop an owner fromconducting an ongoing activity than to prohibit the owner from undertaking the sameactivity if he has not yet begun it The currently fashionable expression of this may be

found in Justice Brennan’s phrase in Penn Central Trans Co v City of New York,21 that arestriction is more likely to cause a taking if it destroys “investment backedexpectations.”

One’s sense of psychological ownership will usually conform to one’s knowledge

of legal ownership Most people feel that they have a moral right to what they legallyown, and do not feel that they have the moral right to something they do not own Formost cases, then, the law will determine whether the WTP or WTA will be used even ifthe economic standard is psychological ownership The common assumption is that achoice based on assigned legal entitlements will usually be correct, but it is correctbecause of the correspondence between the legal and psychological states; it is notcorrect as a matter of principle, and it is incorrect in important cases Levy and Friedman(1994, p 509) incorrectly assert “the determination of the conceptually appropriate form

of CV22 query is a matter of property rights, not economics or psychology.” This impliesthat the law ought to govern in the event of a conflict between rights given by law andthose recognized as a psychological reference point.23 This result is contrary to economicefficiency Economic efficiency in the KHCZ form would recognize the psychologicalstatus quo as primary and change ownership to conform to it The psychologicalreference point is, however, not just that of the individual but of society generally, so that

in so far as the law embodies the general understanding, Levy and Friedman are correctthat the law should govern Because the underlying basis is the general psychological

20 See Atiyah (1979).

21 Penn Central Trans Co v City of New York, 438 U.S 104 (1978) The author would like to thank

William B Stoebuck for this reference

22 The authors use the term “CV query” in reference to questionnaire studies “CV” here stands for

“contingent valuation,” not compensating variation.

23 See id.

reference point, however, where this differs from the law, it furnishes a guide for furtherdevelopment as indeed it has done with the development of common law.24

IV JUSTICE AND EFFICIENCY

The moral characteristics of KHCZ efficiency rest on the following properties: (1) increating new rights, existing rights are recognized; (2) when parties have equal prior legalclaims, their respective claim is determined by a combination of their WTP and theirWTA; (3) that action or decision is best that, subject to existing rights, creates the largestnet product; and (4) moral sentiments about the welfare of others are relevant goods to beincluded in the benefit-cost calculus

The question I raise is: Are these characteristics fair?25 Do they satisfy basicrequirements of justice? The criteria of benefit-cost analysis, especially in its moral formillustrated by KHCZ, reasonably accord with common principles of justice Todemonstrate this, it is unnecessary to present a theory of justice This is fortunate becausethere is no widely agreed upon theory.26 It is, however, sufficient to show that thebenefit-cost criteria accord with the usual precepts of justice

By the “usual precepts of justice,” I mean those that are true for most people inmost times and places and under most circumstances These moral principles may beregarded as provisional in the sense that scientific facts are provisional.27 As with any

24 See Zerbe (2001b) This approach makes clear the irrelevancy of the critical legal studies objection to benefit-cost analysis as Heyne has shown The KHCZ approach shows the failure of the critical legal studies argument that the measurement of benefits and costs is incoherent Put briefly, the critical legal studies argument is that one cannot use the concept of efficiency without endorsing some concept of property rights, from which it is seen to follow that the concept of efficiency cannot be used to resolve disputes over property rights without begging the question Benefit-cost analysis takes, as does the law, the existing structure of rights as extant But there are disputes that reflect uncertainty about some small portions of these rights Benefit-cost analysis merely furnishes information relevant to the legal decision about the allocation of such a right Take a simple case: A change in technology makes valuable rights to the radio wave spectrum that has hitherto been unowned No party has a superior claim The assignment

of the right to a particular party will be a gain Gains in economic analysis are to be measured by the WTP The WTP will in turn be partly determined by the pattern of wealth that rests on the existing system of rights Economic analysis suggests auctioning off the right The right in general should go to that party who would pay the most for it if transactions costs were zero Cases where conflicting prior claims exist raise more difficult questions, but these are answerable and elsewhere I have provided answers See Zerbe (2001b).

25 For a summary of fairness experiments, see Fehr and Schmidt (2001).

26 As Nussbaum (2000, p 1032) correctly notes, “We badly need an independent ethical theory of basic entitlements ….”

27 See Shermer (2004, p 166).

scientific fact, confirmation is always a matter of degree rather than of certainty Inprovisional ethics, “fair,” “moral” or “just” means confirmed to such an extent that itwould be reasonable to offer provisional assent.28

A EXISTING RIGHTS ARE RECOGNIZED

The law as well as benefit-cost analysis takes existing rights as given As Heyne (p 53)notes, “How could it be otherwise.” Both the law and benefit-cost analysis are concernedwith creating new rights or goods at the margin, or with marginally altering existingrights or claims to goods If existing rights are largely unfair, or unjust, then neitherbenefit-cost analysis nor judge-made law will make it right, though correspondencewould remain between justice at the margin and efficiency

B CREATING NEW RIGHTS

Justice can be defined as meeting reasonable expectations Reasonable expectations willform a sense of psychological ownership for a right or a good KHCZ recognizes thispsychological ownership, assigning a WTA standard to such owned goods in contrast to aWTP standard for goods or rights not owned

In this respect, KHCCHZ is consistent with justice, and can indeed helpilluminate it Suppose, for example, that both parties A and B have a sense ofpsychological ownership with respect to some property This sense of ownership may beless than 100 percent Let Pa and Pb represent the subjective sense of psychologicalownership by A and B, respectively; the entitlement should go to the party to whom it isworth the most, which is correctly determined by considering both the WTP and WTA.The gains to A and B are measured by the WTP, and their losses are measured by theWTA The logic of KHCZ is that the right should go to A when the following condition

is satisfied:

WTPa (1-Pa)- WTAb (Pb) > WTPb (1-Pb) - WTAa (Pa) (1)The gain to A is A’s WTP, weighted by the extent to which A lacks psychologicalownership Similarly for B, the loss to B is B’s WTA, weighted by the extent to whichshe does have psychological ownership The right goes to A when the gain to A fromhaving the right is greater than the loss to B from being deprived of his expected right.Equation (1) can be equivalently expressed as

28 See generally Shermer.

WTPa + Pa(WTAa - WTPa) > WTPb + Pb(WTAb - WTPb) (2)

This is an interesting result, because it says that the divergence between the WTA and

WTP is relevant to deciding who should receive the entitlement Consider a contestbetween two parties over an entitlement, wherein which the first party is willing to paymore than the second, but the second is willing to fight to the death for it Equation 2suggests that the one who is willing to fight harder should get it

In a famous anecdote, King Solomon, called on to decree which of two womenshould have ownership of the baby both of them claimed, proposed that the baby be cut

in half His proposal may be regarded as a clever device for determining their respectiveWTAs The false claimant readily assented to the plan, but the true mother agreed to give

it up so that it might live The baby, then, went to the person who loved it the most

Suppose that Richard and Ronald each believe — with a probability of 50 percent

— that they own the same piece of land along the Elwha River, and that the strength oftheir legal claims is also equal In assigning the property right, the court is then creating

a new right Richard has, say, a WTP of $200,000 and a WTA of $680,000 Ronald has aWTP of $300,000 and a WTA of $325,000 In this case, the value to Richard of receivinggood title is his WTP of $200,000, plus 50 percent of the divergence between his WTA of

$680,000 and his WTP, for a total of $440,000.29 The value to Ronald of receiving goodtitle is his WTP of $300,000, plus 50 percent of the divergence between his WTA of

$325,000 and his WTP, for a total of only $312,500 Thus, even though Ronald is willing

to pay more for the title, it should go to Richard.30 Efficiency suggests that the landshould go to Richard, and in this case the WTA figure dominates If, however, eachbelieves with a probability of only 10 percent that he owned the land, then the value toRichard is $248,000 and to Ronald is $302,500, so that the land should go to Ronald.Contrary to Hovenkamp (1991), the outcome should not be dominated by the WTA.Rather, both the WTA and the WTP should play a role

Suppose there is no psychological ownership by either party Then equation 1reduces to

29 The calculation is as follows: $200,000 + 0.5($680,000 - $200,000) = $440,000

30 The calculation is as follows: $300,000 + 0.5($325,000 - $300,000) = $312,500

That is, the right or good should go to who would pay the most The efficient allocation

of the good would take place by auction When the psychological ownerships of A and Bare equal, and are both 100 percent, then the above condition reduces to the suggestion ofHovenkamp that the WTA determine ownership That is, the relevant equation becomes:

In general, as one party’s sense of ownership is greater, the likelihood is greater that thatparty should receive the right When A has a 100 percent sense of ownership and B has

none, it is never more efficient to give the right to B (assuming transactions costs are

zero) If transactions costs are not zero, it will be more efficient to give the good to Awhen

which is simply the condition that B has to be willing to pay more than A will acceptbefore a change of ownership should occur Note that in the real world, if A and B have alegal dispute over a good, and A has 100 percent ownership and B has zero, the court willproperly be skeptical of B’s claim that his WTP is higher than A’s WTA; if this were true

we would expect A to voluntarily sell the good to B

Different customs and legal regimes will result in different expectations ofownership Consider the issue of whether public use of a path across private propertyestablishes a right of way In Britain, public use for a period of 20 years establishes apublic right of way

In Cornwall, England, near the village of Magwan, there is a dispute between Mr.Jed Trewin and Sir Ferers Vyvyan over use of a path across Vyvyan’s property.31 Trewinbelieves that public use has established a public right of wayright of public use Vyvyan

31 International briefs, New York Times, Oct., 22, 1997, at A4

believes that no such right exists as he has always closed the path for six months eachyear Suppose that each believes with 100 percent probability that he has the right — touse the path in Trewin’s case, and to close it in Vyvyan’s case In this situation, the KHcriteria suggest that the right should be allocated solely on the basis of the WTA

Suppose that no such right of public right of way existed Then Trewin wouldhave no expectation that he had a right, and thus the KH criteria would compare the WTP

of Trewin with the WTA of Vyvyan Clearly, the understanding of the law and customitself will determine in many cases the sense of ownership

C CREATING THE LARGEST NET PRODUCT SUBJECT TO EXISTING RIGHTS

The simple moral argument for the benefit-cost approach is that it has a reasonablechance to increase net wealth for most people, particularly if applied with due regard forrights and concerns for those less fortunate or those more deserving Losers from aproject today will be winners tomorrow The benefit-cost approach results in an increase

in wealth across all projects that meet the benefit-cost standard by definition As netwealth is increased, there is a clear potential for all to be winners; the systematicapplication of a net-benefits approach has some reasonable potential to satisfy a Paretotest at the end of the day Consider the following problem in judgment: When two carsmeet at a one-way bridge, which one will back up? One might predictsuggest that thesmaller car or the smaller driver would back up, but in fact it tends to be the car with theleast distance to go to the turnout The behavior follows a least-cost rule consistent withmaximizing net gains

D MORAL SENTIMENTS COUNT

Moral sentiments about the allocation of rights and goods must be included as a matter ofjustice if actions that increase net social gains subject to existing rights are just Withoutsuch inclusion, projects will be undertaken that do not increase net gains, counting thevalue of moral sentiments, and projects will be avoided that do increase net gains (Zerbe,Bauman and Finkle, 2004)

The simple argument for the KHCZ requirement to consider moral sentiments issimply that KHCZ reveals more information about actual preferences and is thus moreinformative That is, the basic argument is that the KHCZ framework provides usefulinformation not provided by KH

KHCZ will find as efficient rulings that are seen as just, while KH is silent in thissituation Consider, for example, a project by a state government to place a wasteincinerator in one of the two neighborhoods Neighborhood A is rich and B is poor, andneither neighborhood wants it The amount required to hypothetically compensate thericher neighbor will be more than for those in the poorer neighborhood, thus the WTApayment to put up with the incinerator by the rich will be greater than the WTA payment

by the poor In addition, the land for the incinerator will generally be cheaper in thepoorer neighborhood Thus the benefit-cost criteria will lead to location of a NIMBY in apoorer rather than a richer neighborhood This result is efficient by KH standards

Suppose, however, the court is considering the legality of requiring the state tocompensate neighborhood B, financially or in kind Compensation for neighborhood B,which is otherwise sacrificing to serve other areas of the state, would likely be seen asfair Thus a ruling by the court in favor of the legality of compensation would be seen asjust, other things being equal, as well as KHCZ-efficient The ruling would be KHCZ-efficient because the incinerator is located in the lower cost neighborhood and becausethe compensation is supported by moral sentiments, representing a WTA for a just result.For example, suppose that each neighborhood had a right to reject the incinerator Thestate would then have to purchase the right from the neighborhood so that there would beactual rather than hypothetical compensation The result would still be the placement ofthe NIMBY in the poorer neighborhood, but the poorer neighborhood would be better off,assuming informed consent and honest agency; it would in fact now be somewhat richer

V A STATIC SOCIETY IS EFFICIENT

A static society is one where there is no change in sentiments, in technology, or in

knowledge, and where rights are fully specified If a right is mis-specified in a staticsociety, so that net costs are higher or net benefits lower than in an alternativespecification of law, fairness and therefore justice will suggest a change in rights Asociety that has a mis-specified right but that is otherwise static, I call quasi-static.Quasi-static societies will be transformed into static societies by the legal process Forexample, suppose residents in a hot climate have no right to run noisy air conditionerswithout approval of their neighbors The aggregate willingness to pay to run noisy air

conditioners is greater than the willingness to accept payment to allow them to be run.Overheated residents are able to purchase or obtain approval from their neighbors, buttransactions costs are higher and the net social surpluses are lower than they would be ifall residents had the right to run air conditioners Because all residents do not have theright to run noisy air conditioners, rights are mis-specified and the society is inefficient

In a static society, better evidence will exist about which result, among competingoutcomes and legal rules, is efficient Unchanging conditions over time will providecleaner and less ambiguous information As society members gather knowledge aboutmis-specified rights, pressure arising from a sense of fairness and justice, as well as self-interest, will build to change existing rules Knowledge will become cheaper to acquirewith time As the price to attain additional knowledge decreases, rules will be changed toreallocate mis-specified rights Judges will adjust rights at common law as a matter ofjustice so that society becomes KHCZ-efficient When this reallocation occurs, a quasi-static society will be transformed into a static society that is KHCZ-efficient

VI ADOPTION OF UNCONTENTIOUS NORMS IS EFFICIENT

A norm is a set of rights or ownership established by custom A norm contributes toefficiency by setting or clarifying rights A norm is perfect when the aggregate WTPpayment required to change the norm exceeds the aggregate WTA that would be accepted

to allow the change A norm establishes economic but not legal ownership Legalownership is ownership recognized by law

Uncontentious norms are more likely to be efficient By definition, uncontentiousnorms are widespread, long established and without controversy (Blackstone, 1900).Norms lacking one of these elements are contentious An uncontentious norm is more apt

to be efficient than a contentious norm Property rights established under anuncontentious norm are likely to be settled, accepted, better known and clearer than thoseestablished under a contentious norm When uncontentious norms are in effect, it is lesslikely that an efficient rule change will exist.32 If a rule is uncontentious, it is settled andenforced through social pressure Inefficiency under an uncontentious norm is limited to

32 There is likely to be an exception to this statement when a rule change can harness the enforcement power of government and in this way improve on a norm.

the costs of changing it; thus, an uncontentious norm is KHCZ-efficient but notnecessarily tautologically efficient

A court that adopts uncontentious norms into the common law establishes legalproperty rights where they did not exist before and ensures that these legal rightscorrespond with established economic ownership In so far as a norm establishesownership, the measure of loss from a change in ownership is properly measured by theWTA and the gains from a change by the WTP For the same individual, the WTA for agood will equal or exceed the WTP Thus, the aggregate WTA will tend to exceed theaggregate WTP, and a rule that adopts uncontentious norms is almost certainly KHCZ- orKH-efficient where conditions are not changing.33

Suppose, for example, that the norm in a community is that group A has the right

to collect driftwood along a certain beach to the exclusion of group B Psychologicalownership in driftwood among group A has been established Controversy brings theissue to court Suppose, however, that members of group B are the more efficientcollectors of driftwood Were group B to have the right to collect driftwood, thecommunity product would be greater and the existing norm (that A has the right to collectthe driftwood) would be inefficient Suppose the court adopts the existing norm as a law,giving the right to collect driftwood exclusively to A If the members of group B aremore efficient collectors, group A will sell the right to group B, so that at most the lossfrom adopting the norm is the transactions costs of the sale; if no sale takes place, the loss

is nonexistent, or in any event less than the transactions costs of the sale

In the absence of knowledge that rights have been mis-specified, the assignment

of rights to A is more likely to be efficient A’s loss — were the right to be assigned to B

— would be measured by its WTA, but B’s gain would be measured by its WTP Even ifgroup B were the least-cost collector, the WTP may be less than the WTA of A if the righthas more than purely commercial value And, even if B is the least-cost collector,assigning the right to A will result at most in a resale to B so that there is at most some

33 Thus, Ellickson’s (1991) discussion of the conditions under which norms are efficient, and his discussion

of why norms in whaling and norms with respect to wandering cattle are more efficient than other hypothetical norms, fails to recognize that, by definition, norms are efficient if they are stable and uncontentious Ellickson’s own examples, if read from the perspective illustrated here, demonstrate just this point His interesting discussion indicates why norms of closely knit groups may be different from those of more diverse groups, and why it might to better to belong to a closely knit group than not; but it does not explain why norms are efficient.

loss of transactions costs Assigning the right to A is likely to be the efficient assignmenteven if B is the least-cost collector First, to assign the right to B, without compensation

to A, when it has psychologically belonged to A, will be seen as unfair by others Societymembers’ moral sentiment that the rule change was unfair would be measured as anefficiency loss resulting from the assignment to B Second, it will be expensive todetermine that B is the least-cost collector The main role for the courts in this sort ofsituation is to simply specify property rights and thus lower the transactions costs of A’sselling the right to B, so that the right is more likely to transfer When the existingpsychological ownership is accommodated, any transfer from the group withpsychological ownership will be compensated, and thus will be more likely to be seen asfair

A court’s decision to reallocate a right away from party A, who holdspsychological ownership, to party B would involve greater risk To determine that it ismore efficient to assign a right to party B, the court would need to determine that theright was worth more to B than to A, and this determination would be both expensive anderror-prone The court knows, moreover, that if it allocates rights according to existingsocial norms, parties will likely reallocate rights to solve any inefficiency if transactioncosts are low enough.34 The court recognizes that any loss caused by allocating the right

to collect driftwood to party A instead of party B is limited to the transaction costs oftransferring the property right, and is mitigated by the gains made by accommodatingexisting moral sentiments These transaction costs are likely to be less than the costs ofhaving the courts attempt to determine whether B is the efficient holder of the right.Thus, granting the right to A rather than to B and following the norm is more likely thannot to result in efficiency

VII INCORPORATING CUSTOM INTO THE COMMON LAW

To establish rights that correspond to economic ownership when conditions areunchanging is by definition efficient Norms that are uncontentious and longstandinginvolve the establishment of economic rights When a norm is adopted by law, legalownership corresponds to and codifies economic ownership When conditions change,

34 Transaction costs may be prohibitively high in the case of public goods.

the common law seeks an efficient adoption of norms and may or may not find one,depending on the pace of change and the corresponding difficulty of determining theefficient rule.35 A wide variety of common law was developed by judges in response tosuch scenarios (Cohen and Knetsch, 1992).

In his treatise, written in 1900, Blackstone provided a list of criteria judges shouldconsider before codifying norms into the common law Blackstone contended that normsmust be long established and uncontentious before being incorporated into the commonlaw Azo (YEAR, PAGE #), the civilian jurist who was according to Plucknett (1956, p.308) held in high esteem by Bracton, noted that “a custom can be called long if it wasintroduced within ten or twenty years, very long if it dates from thirty years, and ancient

if it dates from forty years.” This requirement helped ensure that the public’s willingness

to accept the changes was greater than their willingness to maintain the status quo(Blackstone) Blackstone suggested that prior to codifying a norm, a social sanction forfailure to obey the norm should already exist in order to guarantee that only importantcustoms became enshrined into law Thus, Blackstone’s criterion ensured theincorporation of only true norms, which are norms that are efficient.36

Judges have historically sought out custom to incorporate into common law One

of the earliest attempts to codify social norms was made by Lord Mansfield, who acted aschief justice of the court of King’s Bench in England from 1756 to 1788 During histenure, Mansfield adeptly incorporated the merchant law into the common law; thusfashioning what had been a body of special customary law into general rules within thecommon law (Hogue, 1966) Hogue (pp 248-249) noted that, “When a case touchedcommercial law, [Mansfield] saw to it that reputable merchants of the city of Londonformed the jury Thus he secured in his court the participation of jurors who presumablyunderstood every detail of material evidence Outside court, on social occasions, hecultivated the acquaintance of merchants to acquire for himself a precise knowledge oftheir ways of doing business.”37

35 Underlying this proof is a notion that preferences are to be taken as given It is true that in benefit-cost analysis, preferences are usually taken to be given However, efforts to change the law to accord with preferences may themselves be KH-efficient Underlying this proof is the notion that changing preferences to be in accord with the law cannot be described as efficient

36 Again, Blackstone’s (1900, pp 56-57) norms represent the ideal along a continuum, not a rigid requirement.

37 See also Plucknett (1956, pp 350, 664).

VIII WHY JUDGES ADOPT NORMS AS COMMON LAW

This paper contends that judges act according to a norm of justice.38 According to Glick(1990), empirical evidence suggests that judges seek to do justice in deciding cases AsJohn Chipman Gray (1909, p 114) points out, “The essence of a judge’s office is that heshall be impartial ” A similar sentiment was expressed by the commission of fourbishops, two earls and six other barons who were appointed after the triumph of Henry IIIover the baronial faction: “Furthermore, we ask the same lord king that, for doing andrendering justice, he will nominate such men as, seeking not their own interests, but ofthose of God and the right, shall justly settle the affairs of subjects according to the

praise-worthy laws and customs of the kingdom” (Hogue, p 67, citing Dictum of

Kenilworth).

Posner’s (1990) view of judges is not apparently at variance with the one

expressed here Posner (1981, p 17) notes that Holmes’s The Common Law (1881) is an

extended paean to judges’ skill in adapting common law doctrines to durable publicopinion Durable public opinion, of course, is what we mean when we speak of norms.This opinion then helps to define efficiency, so that the efficiency of the common law, farfrom being unusual, should be expected Judges act according to a norm — a norm thatexpects them to dispense justice;39 they use the language of justice I will cite oneexample among almost endless possibilities because, first, it uses the language of justice;,

second, it illustrates the regard for others;, third, it shows concern for the incomedistribution;, and fourth, it keeps with my custom here of using historical references

In Gilmore v M’Kelvey (MacDevitt, 1884, p 10), a case arising out of the Irish

land law of 1881, the court writes, “With respect to the question of value, the court isperfectly unanimous One cannot help having a certain feeling with respect to agentleman who having in 1878 voluntarily and without coercion taken a couple of fieldsoutside the town from a lady, not very wealthy, at a rent of £30 a year, comes in the year

38 This view is not universal See, for example, Everson (1919) and Blanck (1996).

39 The trickier question, of course, is what it means to say that a judge should “do justice.” Under the jurisprudential doctrine of positivism, a judge does justice (especially in a democratic country) by following the “plain meaning” of statutes (Allen, 1992, p 692) Under the natural law and legal realist theories of law, a judge does justice by recognizing either transcendent moral values (natural law) (Pennington, 1997, p 1097) or public policy and common sense (legal realism) (Allen, p 692).

1882, and seeks to get a perpetuity in that land as against her at a rent of £12 15s I have

no doubt Mr Gilmore reconciled himself to the transaction, but there are many people

who would not” [emphasis added].

Attempts such as those of Landes and Posner (1975) to explain judicial behaviorfrom an interest-group perspective are “simply unconvincing,” as North (1981, p 57) andBuchanan (1975) have pointed out As Hogue (p 253) statespoints out, “When judges inmedieval England failed to maintain the high standards of learning and disinterestedaction expected of them, English feudal barons, churchmen, and merchants insisted onreform.”

Efficiency itself is such an important norm that we should not be surprised whenimpartial judges advance changes in rules that are efficient Gray argued that judges andjurists approached the law from the side of public welfare, and sought to adapt it to thecommon good Holmes assertedpointed out that when revenge was a prevailingsentiment, the law provided a remedy for a wrong that approximated what would havebeen considered necessary to give victims their traditional vengeance Later, whenrevenge became less important relative to the values of deterrence and compensation, theold doctrines were ingeniously adapted to the new sentiments (Posner, 1981)

In the more modern era, when the pace of changes in conditions has been morerapid, greater reliance undoubtedly has been placed on judicial judgment of what isefficient, as compared with well-established custom in the development of efficientcommon law As Friedman (1959, p 26) notes, “Since the First World War the tempo ofsocial change has accelerated beyond all imagination With it the challenge to the lawhas become more powerful and urgent.”40

A full explanation of the origin of the norm that judges should dispense justicewould require a treatise on English history, which I do not provide.41 The relationship

40 Friedman (1959, p 26f) notes the law’s response to some of these changes Examples of common law

adapting to change may be found in McPherson v Buick, 217 N.Y 382, 111 N.E 1050 (1916); Donoghue v Stevenson NEED FULL CITATION(1932) at 562 A host of similar examples are mentioned by Friedman

41 I will, however, note that a straightforward extension of the work of Weingast (1997) and of Calvert (1995) suggests that a norm of justice arises as an equilibrium condition in a “game” that produces stable democracies The equilibrium condition requires that citizens agree on the boundary of the state and that those boundaries be self enforcing (Weingast) In a game-theory setting, this occurs when constitutional or other provisions are held in sufficiently high esteem that citizens are willing to defend them I note also that disturbing a norm is costly because it fuels opposition.

between the British king and the judiciary may explain the norm in part Efficient normsthat promote the wealth of a nation are likely to increase the sovereign’s wealth as well,and will in general then be left undisturbed Thus, norms such as those requiring thatdebts be paid or that contracts be honored among citizens are wealth-increasing, and willnot be disturbed by the sovereign The sovereign’s judges have, then, an incentive to seethat those norms become legally enforceable.42

IX INEFFICIENCY ARISES FROM A CHANGE IN CONDITIONS

Inefficiency, in a society with a norm of justice, arises only from changing conditions Itoccurs when one points out a rule change such that economic efficiency would increase ifthe change was made, ignoring the costs of the rule change The world is, of course,neither static, nor wholly efficient Changes in sentiments, technology and knowledgecreate a dynamic world, which guarantees the existence of inefficiencies A social changemay render a previously efficient rule inefficient when the change results in ambiguousownership, as with a new valuable resource, a shift in economic or psychologicalownership that may differ from legal ownership, a change in moral sentiments reflected

in the regard for others, or a shift in transactions costs Thus, generally it is efficient tochange the legal precendentstatus quo only when conditions change

A change in conditions creates inefficiencies and a more rapid change will creategreater inefficiencies More rapid change increases the pressure for efficient rule changesbut also increases the costs of discovering what rule changes are efficient Hogue notesthat in every generation both lawyers and laypeople seem to have been drawn toward twodesirable — but separate and contradictory — goals The first of these is the goal ofpermanence, stability, and certainty in legal doctrines The second is the goal offlexibility and adaptability, permitting adjustment of the law to social necessity.43

A change in conditions implies, as North noted, a change in relative prices Asrelative prices change, behavior will change in response, and so, also, will the efficient

42 Myers (1971, p 1) notes the puzzling fact that England produced a more stable democracy earlier than other European countries but also had a stronger monarch earlier This puzzle may be resolved by considering the role of norms A stronger monarch produces a more uniform system of norms This more uniform system will make it more difficult for the monarch to play off some groups against others.

43 Hogue (p 8) also notes that “[t]he result of the pull in these two directions has been an unresolved tension between factions, parties, or groups of men; not always a tug-of-war between conservatives and radicals The dual objectives can exist in the legal thought of a single jurist.”

equilibrium change North has attempted to explain historical change on the basis of justsuch responses to changes in relative prices

The slower the pace of change, the easier it is for changes in custom to precedelaw The slower the pace of change, the easier it is for judges to accurately determine thesocial standards of the age and incorporate custom into law Thus, I would expectcommon law to be more efficient in a quieter age.44 This can be expressed as:

X THE GREATER THE PACE OF CHANGE, THE LESS LIKELY IT IS THAT THE

COMMON LAW WILL BE EFFICIENT

Custom has changed over time, and the law has changed with it Plucknett (p 308) notes,

“The Middle Ages seem to show us bodies of custom of every description, developingand adapting themselves to constantly changing conditions.” He continues, “Indeednothing is more evident than that custom in the Middle Ages could be made and changed,bought and sold, developing rapidly because it proceeded from the people, expressedtheir legal thought, and regulated their civil, commercial and family life.”

The more rapidly conditions change, there is less opportunity for uncontentiousnorms to develop and the more difficult it is for judges to determine what is in factefficient When conditions change more rapidly, there may be no particular custom orparticular norm that the common law can incorporate There may be, however,reasonable generalizations from existing particular customs that represent the reasonableexpectations of rights-holders and that are thus efficient There will also be generalnorms or general custom that can be applied, although it may be doubtful that a generalnorm will be superior if a particular norm exists By “general custom,” I refer to generalnorms that may be regarded as principles Such norms may include an expectation thatone is entitled to what one earns, that promises should be honored, or that equals should

be treated equally

44 It does not follow, however, that the common law should not be used in eras of rapid social change —simply that we should recognize that using it imposes certain costs Just as the common law runs into trouble during eras of rapid social change, so too would any other system of law which attempted to match norms and laws In a civil law system, judges are simply administrators, and play little or no role

in creating law In such a system, it is the legislature that would run into trouble, as it attempted to find

an uncontentious norm when no uncontentious norm existed If a common law or civil law country attempted to ignore norms, this would create inefficiency, by definition.

The more rapidly conditions change, the less likely it may be that even a generalcustom could be found When social conditions change, the analogy between past casesand the current issue may become strained, which may make it difficult for the parties topredict how the law will be applied to a current dispute The harder it is to predict how alaw will be interpreted, the higher transactions costs will be, as hordes of lawyers andexperts are enlisted as consultants (in the hopes of avoiding a lawsuit) or litigators(afteronce a lawsuit beginsoccurs)

Today, courts recognize that the law must change in response to changes insentiments, knowledge, and custom For example, the U.S Supreme Court noted in 1997that antitrust law must change to reflect “new circumstances and new wisdom,” and thatthe common law cannot remain “forever fixed where it was” in a previous era.45 Theproblem is that in a period of rapid change it is more difficult for a judge to determinewhether sentiments, knowledge, or customs are changing, and to determine the course oftheir change (Friedman)

These propositions will be examined through the following case studies

XI EFFICIENT CHANGES IN COMMON LAW

A AN CHANGE IN KNOWLEDGE: ANTITRUST LAW

One area where changes in knowledge have had a dramatic effect on the common law isantitrust law Even though a federal statute governs antitrust law, it is generallyaccepted that Congress intended for courts to supply the content of the antitrust law bycreating an antitrust “common law.”46 In deciding antitrust cases, courts recognize thatthe law should change to reflect new economic theory and data.47

In particular, changes in knowledge have made it efficient to change the law ofvertical restraints In antitrust vernacular, a “vertical restraint” is an attempt by amanufacturer to control the activities of wholesalers, distributors, or retailers There aretwo basic categories of vertical restraints First, there are price restraints, where themanufacturer sets either a minimum or a maximum price at which a retailer may sell itsproducts to customers Second, there are non-price restraints, where the manufacturer

45 See State Oil v Khan, 522 U.S 3, 21 (1997).

46 See Khan, 522 U.S at 20, 21.

47 See id.

limits the customers to whom a retailer may sell its products Non-price restraints usuallytake the form of territorial restraints, where a retailer is given an exclusive right to sell themanufacturer’s product within a certain area, in return for promising not to sell theproduct to any customers outside of the area.

Horizontal restraints, on the other hand, refer to agreements between firms at the

same level –– i.e., two or more manufacturers or two or more retailers — not to compete.

Like vertical restraints, horizontal restraints usually involve either price-fixing orterritorial market divisions

Although the Sherman Act prohibits “every contract, combination, or conspiracy”

to suppress competition, the courts quickly realized that every contract suppressescompetition in some sense (because an agreement to sell 100 widgets to one person is animplicit agreement not to sell those particular widgets to anybody else) and that Congresscould not have intended to outlaw every business agreement, or even every agreementbetween competitors.48 Therefore, courts developed a “rule of reason” stating that only

“unreasonable” restraints — those that harm competition more than they benefit it — areviolations of the antitrust laws.49 On the other hand, the courts realized that some types

of agreements — such as horizontal price-fixing — were so likely to harm competitionthat an in-depth analysis of each one was not justified.50 Such agreements are unlawful

“per se.” If it is proved that a defendant engaged in an agreement subject to the per serule, the defendant will be punished, and cannot escape liability by arguing that hisagreement had pro-competitiontive effects In holding that a type of agreement is

unlawful per se, the court is essentially making an economic prediction that the

probability that an agreement of that type would injure competition is so much greaterthan its probability of benefiting competition that it is not worth the court’s time toanalyze the competitive consequences of a particular agreement of that type.51 Therefore,economics is of great aid to judges who must decide whether to hold a type of agreementunlawful per se.52 In characterizing an agreement as unlawful per se, the court is denying

48 See Chicago Board of Trade v United States, 246 U S 231, 238 (1918).

49 See United States v Standard Oil Co of New Jersey, 221 U.S 1, 59-60 (1911).

50 See Northern Pacific Railroad Co v United States, 356 U.S 1, 5-6 (1958).

51 See Khan, 522 U.S at 10.

52 Id.

the defendant economic standing: indeed, Justice Harlan once noted in dissent that the per

se rule is a “no trial rule.”53

Surprisingly enough, the first case involving a vertical restraint was White Motor

Co v United States, decided in 1963.54 In White Motor Co., a truck and auto parts

manufacturer placed both price and non-price restraints on distributors.55 Thegovernment argued that both the price and non-price restraints should be subjected to theper se rule, and the lower court agreed.56 White Motor Company did not contest theruling that vertical price-fixing was illegal per se, but it did argue that vertical non-pricerestraints should be governed by the rule of reason The Supreme Court agreed withWhite Motor Company Specifically, it held that because the application of the per serule is a prediction that agreements of a certain type are almost always profoundlyanticompetitive, the per se rule should not be applied to a type of agreement that thecourts did not have enough experience to make a reliable prediction.57 In other words, thecourt decided that too little was known “about the economic and business stuff out ofwhich [non-price restraints] emerge” to say, with certainty, that vertical non-priceagreements would almost always harm competition.58 Therefore, the court remanded thecase to the district court, to determine whether White Motor Company’s non-pricerestraints could be justified under the rule of reason.59 Specifically, the court speculatedthat vertical non-price restraints, unlike horizontal territorial restraints, might benefitcompetition by allowing small companies to break into a business, and such restraintsmight be necessary to save a failing manufacturing company.60

Four years later, in United States v Arnold, Schwinn & Co., the court imposed the

per se rule on vertical non-price restraints, unless the restraint was part of a consignmentcontract.61 Schwinn manufactured bicycles and sold them through retailers About 75

53 See Albrecht v Herald Co., 390 U.S 145, 159 (1968).

54 White Motor Co v United States, 372 U.S 253 (1963)

61 See United States v Arnold, Schwinn & Co., 388 U.S 365, 379 (1963) In a consignment contract, a

manufacturer delivers a product to a distributor, but retains title to the product until it is actually sold to a customer The distributor keeps some of the sales money for itself, and sends the rest to the

percent of the sales to retailers were characterized as “consignment contracts,” while theother 25 percent were described as “sales contracts.” Both the consignment and salescontracts with retailers placed territorial restraints on the sellers’ ability to sell thebicycles.62 The court apparently felt that it had become familiar enough with verticalnon-price restraints to make a reliable economic prediction about their competitiveeffect.63 It began its analysis by interpreting White Motor Co narrowly, stating that

White Motor Co extended the rule of reason to non-price restraints only when the

manufacturer was a new, small company or a failing business, noting that Schwinn wasneither.64

In analyzing the competitive effect of vertical non-price restraints, the Schwinn

court concluded that some small companies could compete with manufacturing giantsonly if they could offer dealers exclusive sales contracts which involved vertical non-price restraints.65 On the other hand, the court felt that “prudence” dictates that it would

be foolish to allow a company to give a dealer an exclusive contract while retaining

“title” to and “dominion” over the goods.66 Therefore, the court compromised byapplying the rule of reason to non-price restraints in consignment contracts, but appliedthe per se rule to restraints in sales contracts.67 The court justified this compromise by

arguing that it was consistent with the “ancient rule against restraints on alienation.”68

The court dismissed Schwinn’s argument that its exclusive dealerships enabled it tocompete more effectively with larger competitors, because Schwinn was not a failingbusiness.69

Justice Stewart, in a forceful dissent, argued that the majority’s reliance on an

“ancient” rule to resolve a difficult antitrust issue was misplaced, because the fact that

manufacturer, at a previously agreed upon ratio See id.

62 See id.

63 See id at 373-374.

64 See Schwinn, 388 U.S at 374-375; White Motor Co., 372 U.S at 263.

65 See Schwinn, 388 U.S at 379 This is almost certainly a misreading of White Motor Co., since there is

no evidence that White Motor Company itself was a new company or a failing business See White Motor Co., 372 U.S at 263 The references to new companies and failing businesses were intended to be examples of situations in which the rule of reason might be satisfied, not to constitute an exclusive list See id.

66 See Schwinn, 388 at 378-379.

67 See id at 379.

68 See id (emphasis added).

69 See id at 374-375.

there was an “ancient” rule against restraints on alienation is of little help in predictingwhether a vertical restraint will benefit competition today.70 He noted that, in any event,the “ancient” rule against restraints on alienation outlawed only unreasonable restraints,and therefore operated much more like the rule of reason than the per se rule.71 Heagreed with the majority — and Schwinn — that being able to offer exclusive dealershipswas necessary if a company was to attract quality retailers and distributors, but he feltthat whether a transaction with a retailer was characterized as a consignment or a salesagreement made little practical difference in the manufacturer’s ability to restrictcompetition, and therefore should not determine whether an agreement violates theantitrust laws.72

One year later, the Supreme Court extended the per se rule to vertical price-fixing

agreements, in Albrecht v Herald Co.73 Albrecht involved a newspaper company that

terminated a paperboy’s route when he charged more than the maximum price specified

in its contract with him.74 Although the price the Herald set was not predatory, and the

Herald’s low prices would obviously benefit its consumers, the court applied the per se

rule,75 offering three justifications First, the court noted that part of the purpose of theantitrust law is to preserve an entrepreneur’s independent business judgment, and that anentrepreneur’s judgment was restricted regardless of whether he was forced to offer lowprices or forced to offer high prices.76 The court insisted that a firm should not be able tosubstitute “the perhaps erroneous judgment of the seller for that of the competitive forces

of the market.”77 Specifically, a manufacturer might set prices so low that the dealer wasunable to make a profit, or it might set prices that would prevent the dealer from offeringessential services to customers.78

Second, the court argued that the Herald could not justify its

maximum-price-setting rule on the ground that it protected consumers from paperboys who themselves