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Its one of the many novel ideas from David K. Levine:  the non-journal.  You write your papers and you put them on your web site.  Congratulations, you just published!  Ah, but you want peer review.  The editors of NAJ just might read your self-published paper and review it.  We supply the peer-review, you supply the publication.  Peer-review + publication = peer-reviewed publication. That was easy.

(NAJ is an acronym that stands for NAJ Ain’t a Journal.)

Its been around for a few years with pretty much the same set of editors.  Its gone through some very active phases and some slow periods.  David is trying to breathe some new life into NAJ by rotating in some new editors.  So far so good.  Arthur Robson is a new editor and he just reviewed a very cool paper by Emir Kamenica and Matthew Gentzkow called “Bayesian Persuasion.”

The paper tells you how a prosecutor manages to convict the innocent.  Suppose that a judge will convict a defendant if he is more than 50% likely to be guilty and suppose that only 30% of all defendants brought to trial are actually guilty.  A prosecutor can selectively search for evidence but cannot manufacture evidence and must disclose all the evidence he collects.  The judge interprets the evidence as a fully rational Bayesian.  What is the maximum conviction rate he can achieve?

The answer is 60%.  This is accomplished with an investigation strategy that has two possible outcomes.  One outcome is a conclusive signal that the defendant is innocent.  Since the judge is Bayesian, the innocent signal occurs with probability zero when the defendant is actually guilty.  The other outcome is a partially informative signal.  If the prosecutor designs his investigation so that this signal occurs with probability 3/7 when the defendant is innocent (and with probability 1 when guilty) then

  1. conditional on this signal, the defendant is 50% likely to be guilty (we can make it strictly higher than 50% if you like by changing the numbers slightly)
  2. 3/7 of the innocent and all of the guilty will get this signal.  (3/7 times 70%) + 30% = 60%.

The paper studies the optimal investigation scheme in a general model and uses it in a few applications.

 

 

I have read and heard anecdotal evidence that litigation in the United States is countercyclical.  Usually this is cynically explained by saying that when times are tough everybody is looking to make an extra buck.  But of course everybody is looking to make an extra buck when times are good too.

All of business activity relies on relationships that are partially supported by contracts and partially supported by trust.  Trust fills in the gaps of incomplete contracts.  When the contract is not followed to the letter, your interest in maintaining a healthy relationship smooths things over.

Bad times raise uncertainty about whether there are any gains left from this relationship in the future.  This undermines trust and the result is that the courts are called in to fill the gaps.

There are a couple of natural ways to test this theory.  First the countercyclical nature of litigation should vary across sectors.  Thick markets with relatively anonymous actors should see less impact of economic downturns on the rate of litigation.  Also, the effect outlined above is based on the assumption that contracts are written in good times and litigated in bad times.  If the downturn is expected to last, then new contracts should tend to be more complete, taking into account the increased appetite for litigation.  The result should be less litigation in longer downturns than in shorter ones.

I thank Rosemary for the conversation.

You are out for dinner and your friend is looking at the wine list and gives you “There’s a house wine and then there’s this Aussie Shiraz that’s supposed to be good, what do you think?”

How you answer depends a lot on how long you have known the person.  If it was my wife asking me that I would not give it a moment’s thought and go for the Shiraz.  If it was someone I know much less about then I would have to think about the budget, I would ask what the house wine was, what the prices were, etc.  Then I would give my considered opinion expecting it to be appropriately weighed alongside his.

This is a typical trend in relationships over time.  As we come to know one another’s preferences we exchange less and less information on routine decisions.  On the one hand this is because there is less to learn, we already know each other very well.  But there is a secondary force which squelches communication even when there is valuable information to exchange.

As we learn one another’s preferences, we learn where those preferences diverge.  The lines of disagreement become clearer, even when the disagreement is very minor.  For example, I learn that I like good wine a little bit more than my wife.  Looking at the menu, she sees the price, she sees the alternatives and I know what constellation of those variables would lead her to consider the Shiraz. Now I know that I have a stronger preference for the Shiraz, so if she is even considering it that is enough information for me to know that I want it.

Sadly, my wife can think ahead and see all this.  She knows that merely suggesting it will make me pro-Shiraz.  She knows, therefore, that my response contains no new information and so she doesn’t even bother asking.  Instead, she makes the choice unilaterally and its house wine here we come.  (Of course waiters are also shrewd game theorists.  They know how to spot the wine drinker at the table and hand him the wine list.)

In every relationship there will be certain routine decisions where the two parties have come to see a predictable difference of opinion.  For those, in the long run there will be one party to whom decision-making is delegated and those decisions will almost always be taken unilaterally.  Typically it will be the party who cares the most about a specific dimension who will be the assigned the delegate, as this is the efficient arrangement subject to these constraints.

Some relationships have a constitution that prevents delegation and formally requires a vote.  Take for example, the Supreme Court.  As in recent years when the composition of the court has been relatively stable, justices learn each others’ views in areas that arise frequently.

Justice Scalia can predict the opinion of Justice Ginsburg and Scalia is almost always to the right of Ginsburg.  If, during delibaration, Justice Ginsburg reveals any leaning to the right, this is very strong information to Scalia that the rightist decision is the correct one.  Knowing this, Ginsburg will be pushed farther to the left:  she will express rightist views only in the most extreme cases when it is obvious that those are correct.  And the equal and opposite reaction pushes Scalia to the right.

Eventually, the Court becomes so polarized that nearly every justice’s opinions can be predicted in advance.  And in fact they will line up on a line.  If Breyer is voting right then so will Kennedy, Alito, Roberts, Scalia, and Thomas.  If Kennedy is voting left then so are Breyer, Souter, Ginsberg, and Stevens.  Ultimately only the centrist judges (previously O’Connor, now Kennedy) are left with any flexibility and all cases are decided 5-4.

When a new guy rotates in, this can upset the equilibrium.  There is something to learn about the new guy.  There is reason to express opinion again, and this means that something new can be learned about the old guys too.  We should see that the ordering of the old justices can be altered after the introduction of a new justice.  (Don’t expect this from Sotomayor because she has such a long paper trail.  Her place in line has already been figured out by all.)

At Volokh Conspiracy, Ilya Somin writes:

This week, many of my former students will be undergoing the painful experience of taking the Virginia bar exam. My general view on bar exams is that they should be abolished, or at least that you should not be required to pass one in order to practice law. If passing the exam really is an indication of superior or at least adequate legal skills, then clients will choose to hire lawyers who have passed the exam even if passage isn’t required to be a member of the bar. Even if a mandatory bar exam really is necessary, it certainly should not be administered by state bar associations, which have an obvious interest in reducing the number of people who are allowed to join the profession, so as to minimize competition for their existing members.

What changes would we see if it was no longer necessary to pass the bar in order to practice law?  We can analyze this in two steps.  First, hold everything else about the bar exam fixed and ask how the market will react to making it voluntary.

The first effect would be to encourage more entry into the profession.  Going to law school is not as much of a risk if you know that failing the bar is not fatal.  There would be massive entry into specialized law education.  Rather than go to a full-fledged law school, many would take a few practical courses focused on a few services.  Traditional law schools would respond by becoming even more academic and removed from practice.

Eventually the bar will be taken only by high-level lawyers who work in novel areas and whose services require more creativity and less paper pushing.  But the bar will no longer be the binding entry barrier to these areas.  The economic rationale for the entry barrier is to create rents for practicing lawyers so that they have something to lose.  This keeps them honest and makes their clients trust them.

Now reputation will provide these rents. Law firms, even moreso than now, will consist of a few generalist partners who embody all of the reputation of the firm and then an army of worker-attorneys.  All of the rents will go to the partners.  The current path of associate-promoted-to-partner will be restricted to only a very small number of elites.

As a result of all this, competition actually decreases at the high end.

All of these changes will alter the economics of the bar exam itself.  Since the bar is no longer the binding entry barrier, bar associations become essentially for-profit certification intermediaries.   This pushes them either in the direction of becoming more selective, extracting from further increases in rents at the high end or less selective and becoming effectively a driver’s license that everyone passes (and pays a nominal fee.)  Which direction is optimal depends on elasticities.  Probably they will offer separate high-end and low-end exams.

My bottom line is that banning the bar increases welfare but perhaps for different reasons than Somin has in mind.  Routine services will become more competitive and this is good.  Increased concentration at the high end is probably also good because market power means less output and for the kinds of lawyering they do, reduced output is welfare-improving.

Senator Kaufman from Delaware asked Judge Sotomayor about the Leegin case which overturned the per se illegality of resale price maintanence.

Senator Kaufman: But what’s the role of the court in using economic theory to interpret acts of Congress?

SOTOMAYOR: Well, you don’t use economic theory to determine the constitutionality of congressional action. That is a different question, I think, than the one that Leegin addressed.

What Leegin addressed was how the court would apply congressional act, the antitrust laws, to a factual question before it. And that’s a different issue, because that doesn’t do with questioning the economic choices of Congress. That goes to whether or not, in reviewing the action of a particular defendant, what view the court is going to apply to that activity.

SOTOMAYOR: In the Leegin case, the court’s decision was, “Look, we have prior case law that says that this type of activity is always anti-competitive,” and the court, in reconsidering that issue in the Leegin case, said, “Well, there’s been enough presented in the courts below to show that maybe it’s not in — some activities anti- competitive. And so we’re not going to subject it to an absolute bar; we’re going to subject it to a review under rule of reason.”

That’s why I said it’s not a question of questioning Congress’ economic choices or the economic theories that underlay its decisions in a legislation. They weren’t striking down the antitrust laws. What the Court was trying to do was it figure out how it would apply that law to particular set of facts before it.

As a part of a broader revival of Section 2 of the Sherman Act, the anti-trust division of the Department of Justice, under Obama appointee Christine Varney, has opened a review of potentially anti-competitive practices by the dominant telcom providers.  One specific issue that has received attention is exclusionary contracting between wireless carriers (AT&T) and handset manufacturers (Apple iPhone.) The FTC is reportedly also exploring these contracts.  Exclusive contracts bind a manufacturer’s handsets to specific carriers thereby hindering or preventing end-users from migrating to other carriers.  The widespread nature of these contracts may create a barrier against entry by new, smaller wireless providers who cannot offer their users handsets that compete with the top models.

The review is reported to be at an early stage and may not lead to a formal investigation, but as this develops there are a few basic economic arguments to keep in mind.  To start with, there is the benchmark “Chicago School” view which starts with the observation that exclusionary contracts require the voluntary agreement of the handset manufacturers.  The manufacturers internalize the costs of the entry barrier because without entry they will have fewer competitive carriers to sell their phones to.  Therefore, exclusive contracts must compensate manufacturers for this loss impying that these contracts will be in place only when the total surplus from exclusion exceeds the cost, i.e. when it is efficient. The Chicago argument is a longstanding pillar of regulatory policy that still holds sway today.  From the article:

Jon Muleta, former wireless bureau chief of the FCC, said exclusive handset deals won’t be an issue the government can pursue on antitrust grounds unless major handset makers say they’re being forced into the deals. “The equipment providers enter into these deals willingly,” Mr. Muleta said.

The Chicago argument ignores the costs to end users from reduced competition in wireless service.  It would apply only if manufacturers internalize all of the benefits to consumers from increased competition. But under any reasonable model of the wireless market structure, end-user consumer surplus would increase with more competition for wireless service and this becomes an externality relative to the parties in the Chicago bargain.

Secondly, the Chicago argument has been discredited as it takes a naive view of the way contract negotiation would work.  Implicitly, the Chicago argument assumes that handset manufacturers must be compensated at least what they would earn if entry were to occur.  But scale economies imply that a new carrier will enter only if sufficiently many, or sufficiently large, manufacturers remain free of exclusive deals.  The dominant carriers can use a “divide and conquer” strategy which exploits the difficulty for handset manufacturers to coordinate severing their exclusive deals.  Without this coordinated threat, manufacturers cannot extract the compensation envisioned in the Chicago argument, and again efficiency breaks down.

The definitive references here are Rasmusen, Rasmeyer,  and Wiley “Naked Exclusion” and a follow-on comment by Segal and Whinston, both in the American Economic Review.

There is a separate defense of exclusive contracts, often cited and also reflected in the article.

Paul Roth, AT&T’s president of retail sales and service, told Congress last month that the billions of dollars the company invests in its network and services would be put at risk if government were to “impose intrusive restrictions on these services or the way that service providers and manufacturers collaborate on next-generation devices.” Mr. Roth said there is plenty of competition and innovation in the wireless industry.

AT&T’s tremendous investment in its 3G network will pay off only because of its exclusive deal with Apple to market the iPhone.  Thus, it is often argued that exclusive contracts are in fact pro-competitive as they reward investment with profits that would otherwise be subject to hold-up or competed away.  I will take up this argument in a subsequent post.

This article (wig wiggle: The Browser) discusses various ways the Chinese judicial system differs from Western courts.  One significant difference is summarized by Columbia Law Professor Benjamin Liebman:

Yet China’s courts are as deeply committed to populism as they are to professionalism. If Chinese judges decide to ignore a law in order to preserve thousands of jobs, they aren’t violating a sacred legal precept. “They’re supposed to take into account popular interests,” Liebman explains.

The article presents this in a way that presupposes that it will be obvious to us that this is a bad approach to judging.  Indeed, public debate in the US about “judicial philosophy” also takes for granted that judges should base their opinions on the law, and not on popular opinion. But why is this so obvious?  Why shouldn’t the job of a judge be to decide on a case-by-case basis what is in the public interest?

Put aside the obvious reasons.  Popular opinion may be hard to read and political voice may not be equally allocated.  Judges are administering justice, especially for those without political voice.  Popular opinion may be short-sighted and judges are expected to be immune to short-run pressures and make decisions with better long-run consequences.

But even in cases where it is transparent and uncontroversial what the public interest is and there is no short-run/long-run trade-off, judges still should not decide cases on that basis alone.  In fact, one of the most important functions of the court is to act against the public interest.  Because incentives to make good decisions typically require that we expect a bad outcome if instead we make bad decisions.  And ex post that bad outcome is typically not in the public interest.  A court that is committed to uphold the law and act against the public interest ex post advances the public interest ex ante.

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