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Substantive Fairness

VIEWS: 3 PAGES: 90

									Substantive Fairness


F.H. Buckley
Sciences Po
Buckley 136-56
                The agenda


     The overlap between fairness and
      efficiency

     How economics provides the
      analytical tools to explain
      fundamental instincts about the
      law



2
    Rational Choice: Five assumptions
     1. Perfect rationality

     2. Full Information

     3. Non-satiation

     4. Completeness or comparability

     5. No third party effects (externalities)


3
           1.   Perfect Rationality

     Let’s leave this one till we get to
      Paternalism




4
            2.   Full Information
     This would assume full information
      about product quality, and also about
      the other party’s preferences.

     Obviously, this assumption is never
      satisfied.

     Yet this does not impeach the
      contract.

5
             Full Information
    Misrepresentation and Nondisclosure
     A simple informational asymmetry does
      not constitute fraud. In general, the
      informed party is not obliged to make an
      affirmative disclosure.

     Bargaining over antiques.

     Land assembly in Texas Gulf Sulfur.

     Insider trading in Texas Gulf Sulfur.


6
             Full Information
      Why no liability for nondisclosure?

     Because information is itself a
      commodity, with a cost of production,
      and disclosure duties would eliminate the
      incentive to produce the information.

     Some examples…
       Trade secrets
       Patentable inventions
       Market information



7
             Full Information
      Why no liability for nondisclosure?


     In general, the misfeasance-nonfeasance
      distinction upheld at law

     A presumption that information is costly

     Some exceptions
       Half-truths
       Fiduciary relationships


8
             3.   Non-satiation: B > A


    Time 1

                           More is always better


                      B

                  A




        0                                     Time 2

9
           Non-satiation is not inconsistent
           with diminishing marginal utility

     Utility


                               Utility increases
                               at a declining rate




          0                               Good

10
     Non-satiation not the same as Greed


     • Does non-satiation commit us
     to a view of homo economicus
     as selfishly aquisitive?

     • A positive, not a normative view.

     • We do suggest that a person’s
     preferences are wholly self-centered.

11
         4.       Comparability:
              No incommensurabilities



     Time 1



                              No black holes




        0                               Time 2



12
       Incommensurability: Tragic Choices

     • Sophie’s Choice

     • You are a member of a hospital’s ethics
       committee. You have to choose between
       allocating a kidney to an alcoholic former
       sports idol or a mother of two.

     • Can you think of other examples?
13
            5.   Third party effects:
             Bargaining with a third person


     Mary

                     Ann


                               Representing Ann’s utility
                               on a third dimension




                                      Beth


14
                What happens
      if third parties can’t be joined?



      Paretian norms don’t work—if it’s an
       external cost

      Externalities and Tort Law




15
            But nearly everything
           has third party effects…
      Do we then abandon the concept of
       efficiency?

      A more relaxed standard: Kaldor-Hicks
       efficiency

      A transformation is Kaldor-Hicks
       efficient when the winners could
       compensate the losers (“Potential
       Pareto-Efficiency”)


16
Examples of Kaldor-Hicks Efficiency
      It is proposed to abandon steel tariffs
       that impose costs of $10B on the
       economy but provide steel
       manufacturers with a gain of $1B.

      The bankruptcy of a failing business
       imposes a cost to shareholders of
       $1M, but provides a benefit of $5M to
       creditors.


17
            C is Kaldor-Hicks Efficient to A:
At C Beth is better off than she is at A; She could also give up CB
roses to move to B and still be better off than she was at A, while
                    Mary would be no worse off
                                                        Beth


                 A
                     

                           B
                 C       



     Mary

18
          Substantive Fairness:
      Dividing the bargaining surplus


      The Edgeworth Box Function teaches
       us that bargaining is a non-zero sum
       game

      But at the heart of the bargaining
       game is a zero-sum game



19
                   The Contract Curve:
            Can we shift from commodity to utility space?

                                                       Beth


                                           E
                  A
                      
                            F       C
                                 
                                 G
                           B
                      D

     Mary


20
     Blowing up the bargaining lens


                           C
        A                  •
            •

                 F•

                      •G




                B•     We’re still in commodity space




21
     Blowing up the bargaining lens
                               At C Mary is much better
                               off than at A, and Beth is
                               neither better nor worse
                           C   off
        A                  •
            •

                 F•

                      •G




                B•




22
     Blowing up the bargaining lens


                                 C
        A                        •
            •

                    F•

                           •G




                  B•

            At B Beth is much better
            off than at A, and Mary
            is neither better nor
            worse off
23
     Blowing up the bargaining lens


                           C
        A                  •
            •

                 F•

                      •G
                           At G both parties are
                           better off than at A

                B•




24
     Blowing up the bargaining lens
                                       At C Mary is much better
                                       off than at A, and Beth is
                                       neither better nor worse
                                 C     off
        A                        •
            •

                    F•

                           •G
                                  At G both parties are
                                  better off than at A

                  B•

            At B Beth is much better
            off than at A, and Mary
            is neither better nor
            worse off
25
                Let’s see that again

                                          Beth


                                     E
            A
                
                      F       C
                           
                           G
                     B
                D

     Mary


26
     Blowing up the bargaining lens


                                   At C Mary is much better
                               C   off than at A, and Beth is
        A                      •
            •                      neither better nor worse
                                   off
                  F•

                         •G
                                At G both parties are
                                better off than at A

                B•
                At B Beth is much better
                off than at A, and Mary
                is neither better nor
                worse off

27
     Now let’s suppose we can measure
             Mary’s utility levels



                      The units of
                      measurement are
                      now in utilities, not
                      commodities




        A        G           C



28
     Now let’s suppose we can measure
             Mary’s utility levels




        A                G                  C
            Cardinal, not ordinal utility

29
And suppose we can do the same for Beth

     Beth’s utility

         B




        G'            Utility Space




                                          Mary’s utility
             A            G           C



30
We can then represent the contract curve
             in utility space
                        BC represents the “presolution”
        B               to the game: it is feasible and
                        efficient


     Beth




            A    Mary           C



31
We can then represent the contract curve
             in utility space
                        BC is concave (bends outward)
        B               because we assume that joint
                        utility is maximized when gains
                        are shared

     Beth




            A    Mary           C



32
        To simplify we normalize the utility
          functions of both from 0 to 1.0

        1.0



     Beth




              0                1.0
                       Mary


33
    The “solution” to the two-person
bargaining game picks one point at which
            the parties agree
        1.0



     Beth




              0          1.0
                  Mary


34
The Nash Solution is one such solution
 to the two-person bargaining game

                     Russell Crowe
                     as John Nash in
                     A Beautiful Mind




                               Can you spot the
                               bargaining lens?



35
The Worst Reason to turn down a job
  at the University of Chicago is …
                     Because I expect
                     to be named the
                        Emperor of
                        Antarctica!




36
                         The Nash Solution
                  Nash maximizes the product of the utility gains




        1.0
                                            Nash solution of
                                            (.75* .8 =) .6
     Beth                               •




              0                                     1.0
                                     Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
37
                   The Nash solution rests on
                  four simplifying assumptions
                            1. Efficiency: Solution is
        1.0                    on the contract curve


     Beth                        •




              0                          1.0
                              Mary


38
                   The Nash solution rests on
                  four simplifying assumptions
                            1. Efficiency: Solution is
        1.0                    on the contract curve

                                     2. Symmetry: doesn’t matter
     Beth                        •      who is Beth and who Mary




              0                          1.0
                              Mary


39
                   The Nash solution rests on
                  four simplifying assumptions
                            1. Efficiency: Solution is
        1.0                    on the contract curve

                                     2. Symmetry: doesn’t matter
     Beth                        •      who is Beth and who Mary

                                         3. Independent
                                         of irrelevant alternatives




              0                          1.0
                              Mary


40
                   The Nash solution rests on
                  four simplifying assumptions
                            1. Efficiency: Solution is
        1.0                    on the contract curve

                                     2. Symmetry: doesn’t matter
     Beth                        •      who is Beth and who Mary

                                          3. Independent
                                          of irrelevant alternatives


                                               4. Doesn’t matter
                                               how utilities are scaled
              0                          1.0
                              Mary


41
                  The Nash solution does not
                      depend on scaling

        1.0
                                           Nash solution
                                           of (75* .8 =) 60
     Beth                              •




              0                                    100
                                    Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
42
                    The Equi-util Solution
                        Equi-util equalizes utility gains




        1.0
                                           Nash solution
                                           of (.75* .8 =) .6
     Beth                              •
                                        •
                                                   “Equi-util” solution of
                                                   (.77*.77 =) .5929




              0                                    1.0
                                    Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
43
                      The Equi-util Solution
                         Equi-util equalizes utility gains




        1.0
                                           Nash solution of
                                           (.75* .8) = .6
     Beth                              •
                                        •
                                                   “Equi-util” solution of
                                                   (.77*.77 = ) .5929
                  Equi-util seems
                  more egalitarian,
                  Nash more utilitarian



              0                                    1.0
                                    Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
44
              The Nash and Equi-util solutions
                  may be quite dissimilar

                          •
                              Nash (.50, 1.0)
        1.0



     Beth
                                    •      Equi-util (.67,.67)




              0                                   1.0
                                    Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
45
     The equi-util solution depends on scaling
                    Equi-util solution of
                    (.9 * .9 =) .81
        1.0 •
                                            Nash solution
                                            of (75* .8 =) 60
     Beth                              •




            0                                       100
                                    Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
46
     The equi-util solution depends on scaling
                     Equi-util solution of
                     (.9 * .9 = ) .81
        1.0 •
                                                 Nash solution of
                                                 (75* .8 =) .60
     Beth                                    •



                The “utility monster”?




            0                                            100
                                       Mary

Howard Raiffa, The Art and Science of Negotiation (1982)
47
But do people bargain to the Nash solution?
           The ultimatum game

     • We have $1,000 to divide between us.
     • I first decide how the money is to divided.
     • In the second stage you decide whether or
       not to accept the split I propose.
     • If you accept the split we both take our
       respective shares.
     • If you reject the split neither of us get
       anything.
48
               The ultimatum game


     • In the first stage I propose the following
       split: I get $990, you get $10.

     • In the second stage, do you accept or
       reject this?

     • What is the Nash solution?
49
                     The Tenth Man

     • Ten hostages are held by terrorists. They are
       told that one will be executed tomorrow and are
       asked to pick straws. The lot falls to the richest
       man. He sells the short straw to the poorest man
       for $1,000,000, who is executed the next day,
       after arranging to give the money to his family.
     • What is the Nash solution? Is this an efficient
       agreement?
     • Is there nevertheless a problem here?


50
 The Nash solution to the Tenth Man?


        1.0



     Beth            •




              0          1.0
                  Mary


51
       Should substantive fairness norms
                 be enforced?


     • Cooperation Theories

     • Incentive Theories

     • Screening Theories



52
                  1.   Cooperation Theories

                          At the heart of each non zero-sum
                          bargaining game is a zero-sum game
        1.0



     Beth                       •




              0                        1.0
                             Mary


53
                  1.   Cooperation Theories
                               Efficiency gains are exploited
                               when the parties bargain to
                               the contract curve (presolution).
        1.0                    But that doesn’t tell us how they
                               split the bargaining surplus
                               (solution)
     Beth                      •




              0                        1.0
                            Mary


54
                  The hard bargainer

                       Mary insists on a payoff of at least .95
        1.0



     Beth                    •




              0                    .95 1.0   .
                          Mary               9
                                             5

55
                  The hard bargainer


        1.0



     Beth                   •



                                          Qu. How many such
                                          bargains will be lost
                                          through bargaining
                                          breakdown?

              0                 .95 1.0    .
                         Mary              9
                                           5

56
     The hard bargainer:
      Is this a game of chance?



                                  Not the way
                                   I play it..




57
              The hard bargainer:
          Wanna shoot with Fast Eddie?


              It’s like a
               church…               Yeah. The
                                   church of the
                                    good hustle




     Jackie Gleason, Paul Newman in The Hustler
58
     (L’Escroc)
                          Getting to Yes:
            Suppose we resist enforcing hard bargains?

       1.0                         Assume that an arbitrator can measure
                                   utilities and refuses to enforce bargains
       .95                         that allocate .95 of the gains to one party


     Beth                               •



                 Some contracts will not be
                 enforced. But might more
                 be entered into because
                 hard bargainers have been
                 chilled?

             0                                .95 1.0
                                    Mary


59
        Now back to the ultimatum game



     • Suppose we refused to enforce bargains
       that appear wholly one-sided?




60
         Now back to the ultimatum game



     • Suppose we refused to enforce bargains
       that appear wholly one-sided?

     • This would result in an efficiency loss. But
       would chilling the hard bargainers result in
       a greater number or bargains, and a net
       efficiency gain?

61
         2. Incentive Theories:
Would enforcing a contract lead the parties
 to overinvest in pre-contract expenses?


     • Blackmail

     • Rescue contracts




62
               Incentive Theories
          What’s wrong with blackmail?


     • Suppose Blackmail were legalized—the
       rise of Blackmail Inc.

     • Blackmail enforces social norms--So
       what’s wrong with that?



63
               Incentive Theories
          What’s wrong with blackmail?


     • “The problem with blackmail is that the
       blackmailer invests in the production of
       information about deviance and then does
       not publish it.” Comment on this.

     • What happens to deviance when the cost
       goes up?

64
     Ex ante, how would people react to the
           legalization of blackmail?

     • Blackmailers would invest in the
       production of information about deviance

     • There would be less transgressive
       behavior by victims.

     • Victims would also invest in techniques to
       hide their behavior.
65
      Let’s assume that all social norms are
                     benign

     • Can you come up with an argument
       against blackmail?

     • There would be less transgressive
       behavior by victims.

     • Even then, blackmail might be wasteful.


66
      Let’s assume that all social norms are
                     benign


     • Let B = the benefit of reducing deviant
       behavior

     • Where B < IB + IV, then blackmail may be
       wasteful, where:
       – IB = investment by blackmailer
       – IV = investment by victim in hiding his activity

67
      Let’s assume that all social norms are
                     benign

     • Where B < IB + IV, then blackmail may be
       wasteful, where:
       – IB = investment by blackmailer
       – IV = investment by victim in hiding his activity


     • Some examples:
       – Nude beaches
       – Dirty jokes

68
      Let’s assume that all social norms are
                     benign

     • Where B < IB + IV, then blackmail may be
       wasteful, where:
       – IB = investment by blackmailer
       – IV = investment by victim in hiding his activity

     • Would you like to lie your entire life as
       though you were on public display? Do
       rights of privacy have anything to do with
       this?

69
              Should we assume that
           all social norms are benign?

     • We are at times prompted by envy or
       prejudice, and our emotions are fueled by
       hatred. Should we assume that our social
       norms are more moral than we are? Might
       they pander to base desires?

     • Qu. blackmail of homosexuals (who might
       be “outed” by other gays).

70
     Or course one can tough it out
                        Publish and
                        be damned!




71
     But that doesn’t always work
                              No man shall
                              have the right
                                to fix the
                             boundary to the
                                march of a
                               Nation, right
                                  Kitty?




                 Charles Stewart Parnell




72
      Suppose then that the victim should be
     permitted to hide behind a veil of privacy


     • All expenditures by Blackmail Inc. to
       produce information are wasteful

     • Victims will adhere to norms of dull
       conformity



73
              Incentive Theories:
                Rescue Contracts




     The cutter Eastwind cruises around the
     still floating stern section of the SS Fort Mercer.

74
                    Rescue Contracts
                  The Bargaining Surplus

     • Let’s say the rescuer and victim bargain over a
       rescue.

     • The rescuer will undertake to attempt a rescue
       provided that L > R, where:

       – L, the cost of the loss if no rescue
       – R, the cost of the actual rescue

     • The bargaining surplus to be divided between
       them is thus L – R.

75
                  Rescue Contracts
             The Social Costs of Rescues

     • What are the costs associated with a
       rescue?

       – L, the cost of the loss if no rescue
       – R, the cost of the actual rescue
       – x, the pre-rescue costs born by the victim in
         anticipation of the loss
       – y, the pre-rescue costs born by the rescuer in
         anticipation of the reward from the rescue

76
                    Rescue Contracts
              The Social Costs of Rescues

     • The Social Costs of the rescue C are then a
       function of pre-rescue care x and y:

       C(x,y) = pV(1-pR)L + pVpRR + x + y, where

       pV is the probability that the victim will need a rescue,
         and
       pR is the probability of a successful rescue




77
                   Rescue Contracts
              The Social Costs of Rescues

     • Assume that, by investing in pre-rescue care x
       the victim can reduce the probability that he’ll
       need to be rescued
       – He might avoid dangerous places
       – He might take extra precautions or extra care

     • Assume that, by investing in pre-rescue care y
       the rescuer can increase the probability of a
       successful rescue.
       – He might frequent dangerous places
       – He might take extra precautions or extra care

78
                  Rescue Contracts
             The Social Costs of Rescues




     • Is it possible for the parties to take
       excessive care?




79
                   Rescue Contracts
                 The Starving Millionaire

     • Livingston is an explorer who finds himself
       without food or water, alone in the desert. After a
       week he comes across an inn, owned by
       Conrad. “I’ll give you food and water,” says
       Conrad, “in exchange for all your money.”
       Livingston is a millionaire. “Think it over…,” says
       Conrad.

     • This is a rescue contract where the rescuer
       bargains for L in exchange for the rescue.

80
                     Rescue Contracts
                   The Starving Millionaire

     • This is a rescue contract where the rescuer bargains for
       L in exchange for the rescue.

     • The optimal pre-rescue costs of the rescuer might
       however be 0. In that case, the rescuer is adequately
       compensated if he is given R for the rescue.

     • Enforcing a rescue contract which gives him L gives him
       an excessive incentive to take pre-rescue care; the
       victim will also take excessive care in this case.



81
           Rescue and “status” obligations

     • A rule of efficiency would minimize social costs, which
       include victim’s harm costs, rescuer’s rescue costs, and
       pre-accident care investments by both parties.

     • Where rescue contracts are enforced in extreme cases,
       what does this do to pre-rescue investment costs?

     • The law of rescue at sea.

     • Status contracts: Hotelkeepers



82
                 Incentive Theories
                3.    Screening Theories

     • What’s wrong with slavery?

     • Could a contract of slavery (as opposed to
       forced servitude) ever be efficient? What does
       slavery do to the slave’s incentives?

     • Do you see a parallel to personal bankruptcy
       protection?


83
                 Incentive Theories
                3.    Screening Theories

     • What’s wrong with slavery?

     • Let’s assume, per impossibilia, that the master
       really does want to purchase a person’s services
       as a slave. But would anyone every want to sell
       his services for life in this way?

     • Let’s assume that one person in a billion might
       wish to do so. Do we enforce the contract?

84
                 Incentive Theories
                3.    Screening Theories

     • As a judge, would we not want to take care to
       ensure that this really is that one in a billion
       case? Would we not want to review the evidence
       carefully as to the slave’s consent to the
       contract?

     • Given the extreme likelihood that consent was
       not freely given, as well as the presumed
       inefficiency where consent is not freely given,
       would the benefits of enforcement not be
       outweighed by judicial screening costs? If so,
       does that explain the rule of illegality?

85
                Incentive Theories
               3.     Screening Theories

     • This suggests that, for contracts which
       seem egregiously unfair, refusal to enforce
       the agreement may economize on both:
       – (1) judicial screening costs, and
       – (2) consumer screening costs.




86
                Incentive Theories
               3.   Screening Theories

     • In Thornborow v. Whitacre, the defendant
       borrowed £5 and in return promised
       plaintiff two grains of rye-corn the first
       week , four the second, eight the third, and
       so on for a year. (2+22+23+…+252)
     • There was no enough grain in the world to
       satisfy the agreement.
     • Held: Contract was illegal.

87
                Incentive Theories
               3.   Screening Theories

     • In James v. Morgan, defendant bought a
       horse in return for a barley-corn for the
       horse’s first shoe nail, two for the second
       nail, four for the third nail, and so on.
     • The price came to six tons of barley
     • Held: Contract was illegal.



88
               Incentive Theories
              3.   Screening Theories

     • But just how often does one want to have
       recourse to these theories?

     • The case of penalty clauses.

     • The example of exemption clauses.



89
              Incentive Theories
             3.    Screening Theories

     – The special concern for standard form
       contracts or contrats d’adhesion

     – Friedrich Kessler on a new form of fascism

     – Can you offer some economic explanations
       for the use of standard form contracts other
       than oppression?


90

								
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