Speaker 1: Hi, this is Chuck Snell from Kalamazoo College, Law and Economics, and what I'd like to look at today is the legal system as a framework for the market system. Markets depend on a functioning legal system in order to work. What I'd like to look at is the role that a minimal legal framework that we would need in order to have a market system. So we're looking just at the laws that we need to have in place in order for market transactions. So let's start with a typical market transaction, but one without a legal system. Let's say that you've saved up some money and you agree to buy some land from a classmate, and you have $200,000, which you agree to pay him in exchange for this land that he owns. Now, without a legal framework, there are two possible problems that could make this transaction fail. One is that you might not pay, you as the buyer, just take the property, or the other is that you do pay and the seller doesn't give you the property. And again, those are possibilities if we don't have laws. And so without laws, in either case, the exchange will fail. Markets don't work if parties don't follow through on their agreements. So our first role that we will need for a legal system in a market economy is to have enforceable contracts. Enforceable enforcement of contracts allows markets to function. The court can compel one party to pay, or the other party to turn over the property if they don't comply with their agreement. But we want to be careful here. Not every contract should be enforced. If the seller, if your classmate misrepresented the land, overstated the acreage, lied about the quality, perhaps didn't even own it himself, we wouldn't want that contract to be enforced. We wouldn't want you to have to pay for something that isn't what you expected to buy. So we don't want to enforce fraudulent contracts. Buyers and sellers should both know the truth about the property, the service, or the product that they buy. Similarly, agreements should be voluntary. We shouldn't have threats. There should be no physical force and no violence. And again, we're looking for agreements that make both parties better off. So while we want voluntary contracts to be enforced, we wouldn't want coercive contracts to be enforced. And in general, courts will not enforce agreements that were made by force. Now a related problem is if someone uses force to take the property. So you end up buying the land from your classmate, but some other person comes in and takes that land away from you. Now if you know that's possible, there's no reason to buy it. You could steal it yourself. Or if you were more honest, you simply would avoid owning something that you couldn't keep. And so if there is the possibility that someone else can take away your property, market transactions won't happen. The exchange will fail, in this case, often before it even starts. So a legal system not only needs to have enforceable contracts, but we also need to have property that is protected. And in this case, a court will compel the return of the property to its rightful owner. The legal system can prevent trespass and prevent violations or punish violations of one's property rights. So we want a legal system that has both enforceable contracts and protected property. We also want to think about another problem, and that is what if an accident occurs. So let's say that the person has sold the property to you and is moving out and hires a moving company to move his possessions. But the driver of the moving van inadvertently put the truck into reverse and crashes into the house, knocking it off its foundation and causing it to collapse and leaving just a pile of rubble. Obviously, this is no longer worth $200,000. There's been a lot of damage from this accident. The legal question is, who is responsible? Who should pay? Should it be the seller? It was his belongings, he hadn't turned the house over to you yet. Should it be you as the buyer? You get what you paid for, no matter what condition it's in, or should the driver have some responsibility, or should it be shared amongst some of the parties? So the legal system also needs to establish liability. So liability is who is responsible for those damages, and a court will order the responsible party to pay for the damages. Ideally, we could have a nice, simple, and complete legal system that covers all possibilities with enforceable contracts, protected property, and liability being easily determined. But in reality, this is impossible. There are all kinds of unseen contingencies that arise because contracts aren't perfect, gaps exist, and property and liability rights are incompletely defined. So we could look at just a simple thing like a collapse of the banking system. If you miss a payment to the seller, should you be punished for missing the terms of the contract when it wasn't your fault, when it was an unexpected collapse of the banking system? Or if there is a dispute because of a treaty with the Native Americans who had previously occupied the land going back a few hundred years, is that your fault? Is it the seller's, or does it go to some other party? Or if there was barrels of toxic waste buried under the land, should you be responsible for that cleanup now that you are the owner, which could be millions and millions of dollars, certainly much more than you paid for the property? Should it be the seller, although that seller didn't bury the waste himself? Or should it be some party from the distant past who we might not be able to reach? These kinds of problems come up much more frequently than we would like. Another set of related problems is what are the things we can do with land that we own? If there is an endangered species found nesting on your property, which prevents you from cutting the trees and selling them for lumber, should you get a partial refund? Or is that simply on you? The rights that an owner has to a property may vary. If a deer crosses from a neighbor's land, from a neighbor's property, are you allowed to shoot it during hunting season? If you can, what about a cow crossing from a neighbor's land? Can you shoot it during hunting season? Or if that cow eats your expensive landscaping, can you collect from your neighbor? What about if it was a deer from a neighbor's property that ate your expensive landscaping? Could you collect from the neighbor for that damage? Or maybe there's underground oil. Can you pump it out, even if it flows from under a neighbor's land? Could you slant drill to make sure you get the oil from under the neighbor's land? And could you build a structure so high, trying to get that oil, that it threatens to fall on the neighbor and damage their property or damage themselves? So there are endless possible contingencies. No law or contract can anticipate every contingency, and that means that conflicts will occur. So a fourth rule for the legal system is to resolve conflicts. Conflicts that arise when there is unclarity about whose responsibility and who has rights to do what. So that means that the legal system isn't just a set of laws that are put in place, but it's an ongoing process to define laws. So the legal system is part of an ongoing process where contracts are interpreted and regulated, where property rights are defined. And perhaps it's good, even at this early point, to start thinking about property not so much as a thing, but as a bundle of rights. The right to have certain uses, but perhaps not every possible use. Now that's really, really obvious for intellectual property. Things like copyrights or patents, where the thing of value is intangible, the intellectual property is not tangible. But even physical properties, even real estate, are better thought of as a bundle of rights than as a specific physical thing. So the creation of the legal system is an ongoing process. We continually develop new legal rules, and the exact details of the rules can have huge economic consequences. We will have winners and losers, depending on how those decisions are made, and potentially very different economic outcomes. So society should consider these rules carefully. Now of course, any situation with potential winners and losers will cause the parties to try and influence the outcome to gain favor for themselves. Conflicting parties will spend real resources to influence legal decisions. They'll hire expensive lawyers in court. They will lobby and make contributions to politicians. They will lobby government agencies, all trying to help their own cause. Economists refer to these kinds of behavior as a type of rent-seeking, trying to earn unearned profits, or trying to win unearned profits, through the political process, through the legal system. And so these are very real costs, and as economists, we want to recognize these costs as well. This has been Chuck Stahl from Kalamazoo College, Law and Economics. Thank you for listening.