Saturday, January 08, 2011

Lars Klöhn: On Law and Economics Principles and the Role of Public or Private Enforcement of Law

The state in general, and law-state systems in particular, have been waging aggressive campaigns of late on several fronts.  Well known to transnationalists is the great battle over the privileging of law over governance, and the law-state system over polycentric governance regimes, for the management of behavior. But the law-state system itself is transforming its internal organization.  At the heart of this transformation is a great battle over the authority of individuals to enforce law, the rise of the regulatory state as an alternative to the traditional law-state enforcement mechanisms of the state applying its police power through public law and the individual enforcing her rights through the judicial mechanism. See, Edward L. Glaeser and Andrei Schleifer, The Rise of the Regulatory State, Journal of Economic Literature XLI:401-425 (2003).

Traditionally private law was grounded on the assumption that while the state provided the standards and the mechanisms for enforcement, individuals were expected to protect their own interests.  The state could facilitate that activity, and it might also seek to protect its own interests (that is, the public interest) against law breakers (through civil and criminal proceedings), but but individuals protecting their rights were at the heart of systems of enforcement.   By the mid 20th century, that system has been substantially supplemented, but not displaced, by an enormous  machinery of government that engaged in much more comprehensive management of private behavior by a combination of regulation, monitoring, enforcement and dispute resolution.  Glaeser and Schleifer, supra.  Almost a government within a government, what has become the administrative state extended the state's power to manage behavior beyond the pronouncements of law and the serendipity of judicial decision making through cases.    

But the tendency toward supplementation  through administrative mechanisms did not produce a new equilibrium.  Instead, the end of the 20th century saw a renewed effort, this time not so much to supplement the traditional role of individuals as protectors of their own interests, but to substitute the state for the individual for whose benefit law is enacted and the administrative mechanism operates. This has been well illustrated in the changes to the enforcement mechanisms in U.S. securities law, a process that was well formed by the time of the passage of the Sarbanes Oxley Act. See, Larry Catá Backer, Surveillance and Control: Privatizing and Nationalizing Corporate Monitoring after Sarbanes-Oxley. Law Review of Michigan State University, 2004.  Yet the process is not exactly linear.  The state  was moving on three fronts.  The first I have described already--the effort to substitute the state for the individual in the vindication of individual rights under law.  The second and third were meant to make that process more efficient and to protect the integrity of the system created. These involved the nationalization of authority over the issues to be managed in the federal government.  See, Larry Catá Backer, The Sarbanes-Oxley Act: Federalizing Norms for Officer, Lawyer and Accountant Behavior. St. Johns Law Review, Vol. 76, pp. 897-952 (2002).  The other was to change the role of the individual--from the principal source of enforcement through private law actions in court, to state agents.  See, Larry Catá Backer, The Duty to Monitor: Emerging Obligations of Outside Lawyers and Auditors to Detect and Report Corporate Wrongdoing Beyond the Securities Laws. St. John's Law Review, Vol. 77, No. 4, p. 919, 2003.  

By the start of the 21st century, then, the law-state moved from the source of normative values and the forum for private enforcement to serving as the agent of individuals for the vindication of their individual claims, now amalgamated with the state interest in its regulatory system.  But it retains the rhetorical tropes and structures of the traditional law state.  And sometimes it suggests a nostalgia for a regulatory environment which it abandoned with the turn of the last century.   It is in this context that one can better understand the importance of the law and economics movements in law.  As the structure of government, and its relation to the production and deployment of law, changed from the old model (pronouncement and public-private enforcement) to a new governance model geared to the management of behavior.  Law and economics can suggest a framework for determining the appropriate mix  of public and private enforcement of law and regulation for the most efficient regulation of behavior.

 Professor Lars Klöhn

Some recent work from Europe has begun to spotlight some of the issues that result from this socio-legal state of things in a very useful and refreshing way.  Among those working in this area is Lars Klöhn, Professaor of Law at the Institut für Handels-, Wirtschafts- und Arbeitsrecht at Philipps-Universität Marburg.  He has recently distributed an interesting paper, “Private Versus Public Enforcement of Laws - a Law & Economics Perspective,” which was presented at the conference “Compensation of Private Losses – The Evolution of Torts in the European Business Law” on November 25, 2010 which will be published in a conference volume edited by Professor Reiner Schulze (University of Münster).

When should laws be enforced by private actors and when should society rely on law enforcement by public authorities? This question has been analyzed in great detail in law & economics scholarship. This article surveys the literature and outlines a framework of criteria for deciding whether private or public enforcement of laws is preferable. To exemplify the criteria, the framework is then applied to some “real-life” enforcement issues. As there are several contributions on specific areas of law such as antitrust, securities regulation, consumer protection and so forth in this book, this exemplification is limited to two rather obvious cases – the enforcement of contract law and criminal law. (Klöhn, supra, at 1).

The issue, of course, is efficiency, an appropriate privileging for a system grounded in the techniques of aggregate management.  Klöhn suggests that it is not yet time to completely substitute the state for the individual, and pubic for private enforcement.  He explains, "there seems to be little dispute that the choice between public and private enforcement means searching for a “second-best solution,” requiring complex considerations of various criteria as well as being dependent on the factual context of regulation."  (Id., at 6).  He posits a framework of criteria, grounded in the efficiency principles of law and economics, for determining under what conditions either public or private enforcement might better) in a world in which structural inefficiency makes "best" solutions impossible.
Klöhn argues that "Private incentives to enforce the law seem to be optimal when private parties are the victims of the violation of the law." (Id., at 9).  But such enforcement must be appropriately managed if it is to approach optimality.  
First, the incentives of private enforcers might be set at the right level if the state provides them with some monetary compensation. . . .  Second, setting compensation at the right level involves a valuation problem. Regulators would have to determine the money value of evading prison to the average perpetrator. . . Third, the above mentioned argument assumes that private parties will be driven to enforce the law only for monetary rewards. Therefore, the problem of under-enforcement might not be as severe if we assume that people are driven by some desire for fairness, as is clearly the case in some areas of law such as environmental law. (Id., at 9-10).

 Interior, U.S. Supreme Court Building

This is no easy task.  "regulators would be forced to solve complicated, almost impossible calculations such as measuring the external damage from drug use or the monetary value of a loss in faith in the integrity of capital markets." (Id., at 10).  But then, this tends to strengthen the policy assumptions behind public takeover of enforcement.  Or it buttresses arguments for an enhanced administrative environment which would create a public body to monitor and set the appropriate levels of compensation to ensure private action optimality. But at that point, is there much private left in enforcement?

But the bigger problem is the inefficiency of private attorneys general.  The state is efficient because it can bring a single action and resolve a regulatory issue or sanction misbehavior.  But individuals tend to avoid collaboration.  They tend, therefore, in the aggregate to clog the courts.  Though each is legitimately asserting rights in the protection of their distinctive interests, from a regulatory management perspective,these actions are wasteful. That, in essence, suggests the policy determinations in two decades worth of American legislative efforts to limit private securities lawsuits under the federal securities laws.  Klöhn makes the American case well:  "While this danger is present in public enforcement of laws as well, it does not seem as high because public law enforcers do not profit monetarily from their enforcement, have a limited budget, and are held politically accountable for their actions." (Id., at 11).

But Klöhn also reminds us of the dangers of efficiency in public policy--corruption.   "Private enforcement renders it almost impossible to cooperate with regulated industries and to incentivize regulated industries to adopt self-regulation. It is true that private litigation remedies the capture problem when an agency is inclined to collude with those regulated against society." (Id.).  But the state cannot control private enforcement,  It may just react to it.  That puts the state in a passive and reactive position.  The state enacts law (or regulation), the individual seeks the protection of her rights in courts, courts make a determination of the application of law in rendering judgment in private disputes, those individual decisions have a collective effect both on behavior and the understanding of law, and in the aggregate  serves to control behavior.   The legislature can intervene only by changing law, and in this way influencing the perspective of disputes and their resolution.  Where the state both legislates and enforces (for the benefit of the individual and the collective), it avoids this issue of regulatory management.

And thus Klöhn restates the current conventional case for private enforcement:
Assuming that private actors bring more suits to court than public agencies, the judiciary will have more opportunities to refine vague and general standards contained in the law. This can create a public good and might well be worth the litigation costs not internalized by the plaintiffs. Of course, this is a consideration which can be taken into account by public enforcement agencies when exercising discretion not to enforce a law. However, some scholars argue that private parties are more likely than agencies to develop novel legal theories, creative approaches to dispute settlement and new techniques of investigation and proof. (Id., at 13).
And Klöhn restates the case against private enforcement regimes. The primary case for public enforcement is efficiency (minimizing the social and economic costs, to the state and society, of attaining policy objectives) and effectiveness (the likelihood that the state will focus on the attainment of aggregate welfare maximizing activity rather than individual welfare maximization that may reduce overall welfare).  Under private enforcement regimes there will likely be more suits than under a public enforcement system (efficiency).  This individual and self serving litigation is both good (the traditional role of private litigation as producing public goods without investing public funds int he process) and bad (inefficient) to the extent there is excessive litigation (that is where the social value of litigation is small compared to its social costs, even where individual value continues to be positive).  This inefficiency can be reduced where individuals litigation can be aggregated (and self interest subsumed to some extent to communal value).  But even here, the business of non-governmental public interest enterprise, creates its own set of self-serving incentives because. Public interest litigation enterprises seek to build their reputation (and increase their reputation, income and status, what Klöhn might describe as the entity's "notoriety") by engaging in litigation.  This problem of the excessive in enforcement is less severe under public enforcement regimes (though not absent there--again for the reasons of institutional survival and the personal agendas of individual actors within the state apparatus) because of constraints in budgets and the political constraints on the basis of which a government operates.

The result, of course, is mixed.  Private enforcement regimes appear to be most efficient in contract law (id., at 14).  It is least efficient in criminal law (id.).  For everything else, mixed regimes may serve society best.  But the construction and regulation of that mixture will remain contentious. This conclusion is both sensible and a reminder that ideology, either of private or public enforcement, taken to its limits, can produce a disconnect between theory and practice that is likely to produce disaster.

This might be well illustrated by the assumptions and tensions inherent in the notions of efficiency.  Klöhn correctly notes the connection, in the private enforcement context, between the amount of litigation and efficiency concerns (and also effectiveness concerns as a second order consequence).  The notion of litigation optimality becomes a central concern of law and economics approaches to the management of enforcement and the distribution of enforcement power among individuals, non-governmental organizations, and the state.

But "excessiveness" becomes a curious concept in this case.  The principal reason is the underlying assumption that efficiency requires that law is not always to be enforced.  One of the most interesting consequences of a law and economics approach, when grounded in the efficiency of the state as the managers of the collective welfare of a political society, is that the law is not meant to be uniformly applied.    
Another disadvantage of private enforcement is that it renders it almost impossible to exercise discretion not to enforce the law when non-enforcement is beneficial to society. This point assumes that laws are usually overinclusive. Taken literally, they cover cases which the legislator would have chosen not to cover if it had known the particular case in advance. . . . Such tailoring is left to ex-post adjudication of individual cases by the courts. Private enforcers have no incentive to exercise discretion with regard to overinclusive laws. Profit-driven private enforcers will seize the opportunity to enforce the law any time a positive return on the investment of enforcement costs can be expected. In contrast, a public enforcement agency can choose not to enforce the law in cases in which the social costs of enforcing the law exceed its benefits. (Klöhn, supra, at 12).
The principal problem, of course, is that in the face of regimes of individual legal rights, individual action to vindicate those rights cannot be efficiently coordinated or managed by the state (except perhaps in the most clumsy way).  In common law states, like the United States, this inefficiency used to be understood as structurally efficient, in the sense that it preserved the connection between customary law practices and the state apparatus.  This consideration, though, may trouble civil law states less. But this management suggests a tension between law and economics' focus on welfare maximization and the ideological constraints of "rule of law" that is worth further study.   "Rule of law" objectives may be maximized only at the cost social welfare maximization.  Jesús Alfaro Aguila-Real suggested this in his own reflections on Klöhn's essay.  He notes in a recent consideration of Klöhn's essay:  "¿Recuerdan eso que dicen nuestros tribunales continuamente acerca de que no hay igualdad fuera de la Ley? Pues eso. Que hay que permitir a los public enforcers un cierto grado de discrecionalidad en la persecución de las infracciones. Curiosamente, en ese punto, el control de los tribunales europeos sobre la decisión de la Comisión Europea de iniciar o no un procedimiento es bastante intenso" Jesús Alfaro Aguila-Rea, Public vs. Private Enforcement, Derecho Mercantil, Dec. 24, 2010 (translation: "Recall that our courts continuously remind us that  equality does not exist outside the law? That's it, then. One must enable public enforcers a degree of discretion in the prosecution of infringements. Curiously, on this point, the control by the European courts of the European Commission's determination on whether or not to initiate proceedings is quite intense" Id.). And that may be the ultimate lesson of the exercise of law and economics approaches to issues--law and economics insights will invariably lead its practitioners astray as and to the extent that its utility as a tool of analysis is transformed into an ideology the imposition of which can be, itself, inefficient.


Anonymous said...

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Anonymous said...

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