Foundational Law, Behavioral Economics Notwithstanding

Microeconomics boils down to (i) finding inequalities that represent rational behavior and (ii) optimizing that behavior with respect to two or more constraints. The purpose of this type of inquiry is to define conduct for which self-interest is maximized. But there’s been talk in the economics community about the inadequacies of representing ideal human conduct with this model. Two prominent objections are that self-interest is definable only (i) within a specified context and (ii) to an arbitrary level of certainty.

When talking about the application of economics to legal rules, we can counter the first objector with appeal legal positivism, positing constructivist theories of social justice and fairness and normative conceptions of right and wrong. But the second objection remains, reinforced by the argument that the human intellect is incapable of accounting for all the contingencies of a given context. Behavioral economics call this notion bounded rationality, and I’d like to see if this idea has any consequences for how we think about the law.

Because of bounded rationality a complete analysis of self-interest in a given scenario is impossible, foreclosing the chance of finding a necessarily “better-than-the-rest” equilibrium. If the error term in the calculation of self-interest is large enough, due to lack of time or erroneous thinking, the calculating actor may choose a sub-optimal course of action. And even if we don’t consider the stronger claim that it is always impossible to account for all contingencies, in everyday decision-making we cannot expect people to account, on the fly, for all of the relevant factors germane to a particular decision.

But even in theory there may be small contingencies an actor rationally neglects to account for that makes a less than maximizing course of action appear rational. For example, say that given the constraints of time a fully rational individual decides to undertake analysis of competing decisions to the level of certainty that represents 4/5 of complete accounting. That is, he as decided that at that level of analysis the marginal cost of increased accounting are equal to the benefits (and is therefore optimal). Further assume that if he had increased his accounting by 1/20, he would discover a subtle contingency that would dramatically alter the result of his decision-making, and consequence higher returns. Economists would say he acted rationally ex ante (before the decision), but did not maximize his ex post (i.e. “after the fact”) returns.

Now say you have a group of actors that conduct themselves in this same way. You end up with a society of rational individuals who are less well off than they could be. This is strong evidence for a case against rationality as a tool for optimization. The solution may be to appeal to some higher-order rationality, to appeal to some form of meta-decision making that governs the substantive decision. We saw this above, when the agent made a rational decision as to the level of certainty he wished to achieve before making his substantive decision. But rationality is bounded at ever level, and even meta-decision-making may neglect to account for a subtle contingency with powerful, outcome alerting consequences.

What does the observation that suboptimal ex post results may result from optimal ex ante calculation mean for law and economics? As much as I’d like to say that it identifies some deeply rooted flaw in law and economics reasoning, or exposes some new ground for critique, it doesn’t. The law doesn’t rely on watertight rationality, doesn’t require a framework that maximizes returns to the individual. The law is a system of “best-we-can-do” reasoning and openly admits that people are never fully rational. It asks, “What should parties have done given the constraints they were faced with” and given not a narrow maximizing telos, but multifaceted policy goals. And as a constructivist practice – identifying its own criterion of optimal behavior, law is justified in doing so.