Law and economics – Econlib

For more than a century, economists have studied ways to make the law more efficient. While the Journal for law and economics (the main field journal) was not founded until 1958, in the early 20se 20th century economists such as Alfred Marshall, AC Pigou, John Maynard Keynes, and many others were busy studying how economics can influence legislation to improve outcomes.

However, the transition from the ‘blackboard economy’ to the real world is a difficult task. We have repeatedly seen economic policies fail to achieve their stated goals, from the USSR’s grand central planning to more mundane ‘market alignment’ such as carbon taxes. There is an extensive literature on these shortcomings, of which readers of this blog are surely aware: the knowledge problem highlighted by Hayek, issues of public choice such as rent-seeking and other problems in collective decision-making, and so on. But there is also a problem in translating theory into something useful. Economic theory uses many terms slightly differently than how they are typically used. Translating these terms into legislation is difficult. The example of dumping will demonstrate this point.

A few things before I begin: I am assuming here that the purpose of legislation is to improve economic outcomes, as defined in the neoclassical sense: maximizing aggregate welfare. My general point about the difficulty of aligning legislation with objectives will not change if this assumption does not hold, although the examples will.

Dumping is a process by which a company sells below cost in an attempt to gain market share by driving out competitors. There is an argument that such behavior is anti-competitive and will lead to worse economic outcomes. Economists generally reject this argument (indeed, one of the first papers in the Journal for law and economics is a classic piece that dispels this myth), although it can still be considered anti-competitive and not welfare-maximizing. To this end, there is legislation at both the U.S. federal government level and the international (World Trade Organization) level that prohibits dumping by domestic and international companies.

But there is a significant difference between them economic dumping (i.e., dumping as defined in economics) and legal dumping (i.e. dumping as defined in the legislation). In economics, dumping occurs when a good is sold below its average total cost. To the economist, ‘costs’ include both explicit (monetary) and implicit (opportunity) costs. Explicit costs are easy to identify, but implicit costs are much more difficult. Despite a clear definition, economic dumping is difficult to identify. So when legislation is written to improve economic outcomes, lawmakers should use something measurable. Thus the legal definition of dumping.

Legal dumping is something completely different. Legal dumping is simply a good being sold below its ‘fair value’. But what is fair value? The Department of Commerce and the U.S. International Trade Commission (the two agencies charged with investigating unfair international trade practices) have three ways to determine fair value: 1) what the price of the good is in the home country, 2) what the price of the good is good is in some 3rd country, 3) which is the ‘constructed’ price of the good (the cost of production of the good, plus a mark-up determined by the Ministry of Commerce).

Note that the legal definition of dumping differs greatly from the economic definition. The two describe very different practices indeed! From an economic perspective, deviating from any of the three descriptions of ‘fair value’ does not imply unfair or uncompetitive behavior. A departure could indeed be competition And increasing prosperity! We can expect prices to differ in different markets (supply and demand are local). Furthermore, where economics views the price of a good as emergent, depending on marginal benefits and marginal costs, the legal definition of dumping views the price as known in advance and the function simply of explicit costs.

Due to the vagueness of the legal dumping statute, it is highly susceptible to corruption. Companies tend to use dumping as a hammer to counter competition in particular domestic competition. The instrument intended to prevent unfair practices will ultimately encourage unfair practices. In short, by attempting to translate economic theory into legislation to actively manage outcomes, legislation generates the very outcomes it sought to prevent! (For a full review of the literature on the anti-competitive nature of anti-dumping legislation, see Free trade under attackChapter 5.)

You might reply: “But Jon, you cunning and clever devil, that just shows that the law can be further improved. There are no problems here.” But I don’t agree with that. A good scientist is comfortable with the fact that there are many things that influence our behavior that cannot be measured. In economics, costs are like that: costs are ephemeral, psychological, and subjective. Costs, and their interpretation, vary from person to person and situation to situation. For an outside observer that is impossible prior to to know what someone else’s costs are. The decision maker may not even be aware of the costs he faces. Legislation must relying on proxies, such as accounting fees, that do not translate the information in the same way. Consequently, translating economic theory into enforceable legislation faces a significant uphill battle.

Dumping is a particularly clear example of the difficulty of translating theory into law. But even when everything goes perfectly, there are always unintended consequences. While sticking to trade, Trump and Biden’s explicit goals with their tariffs were to raise the domestic prices of goods to discourage imports. That worked as intended. But the unintended consequence of reducing exports also happened. Let me end with what I call Jordan’s Law of Unintended Consequences (named after fantasy author Robert Jordan): “Law of Unintended Consequences, stronger than any written law. Whether or not what you do has the desired effect, it will have three effects you never expected, and one of them is usually unpleasant” (from The Path of Daggers by Robert Jordan, page 334).