Law and economics should be called law and microeconomics. The assumptions of law and economics are the same as those of microeconomics and classical macroeconomics. Prices adjust freely, and there is never a recession or depression caused by lack of demand—desired spending. Output may go up or down, but that is because of changes in technology and preferences rather than any demand-side problem. Under these assumptions, law should maximize the economy’s supply capacity because supply capacity, and not demand, determines output and employment.
These assumptions may be reasonable approximations in ordinary economic times. If demand falls short of supply temporarily, then central banks can relax monetary policy to stimulate demand. Even if demand matters for macroeconomics, law should stay out of demand management.
When interest rates hit zero, a situation known as a liquidity trap, however, central banks cannot stimulate inadequate demand. As a result, demand can fall short of the economy’s supply capacity, causing a prolonged recession or depression with sustained low output and high unemployment. Inadequate demand offers the best explanation of the Great Recession of 2007-2009 and the anemic recovery which followed (and continues in some countries).
In this context, law and economics can no longer blithely assume that law’s effects on demand don’t matter. The Great Recession and its aftermath cost tens of trillion of dollars in lost output and upset settled political orders in the U.S., U.K., and the E.U. With these stakes, we need to consider how laws affect macroeconomics as well microeconomics.
Since 2009, I’ve written several papers (the first is available here) arguing that law and economics needs to consider macroeconomics as well as microeconomics. In my most recent two papers on the subject, entitled Law and Macroeconomics: The Law and Economics of Recessions, and A Theoretical Framework for Law and Macroeconomics, I explore the effects of law on demand, output, and employment within a Keynesian macroeconomic framework. The first working paper outlines what law and macroeconomics might accomplish while the second paper embeds law within the IS-LM model —the workhorse model of Keynesian macroeconomics.
I make three primary claims.
- Law moves demand. When a construction project gets approved, for example, spending on construction (a component of demand) moves higher than if the construction project had been denied.
- In some circumstances, such as a liquidity trap, law’s effects on demand mean that legal decisions help determine the level of output and the employment level.
- When monetary policy is constrained by the zero lower bound and fiscal policy is constrained by fears of rising debt levels and political paralysis, legislators, regulators, and judges should prefer laws and regulations that increase spending over alternative laws, other things equal. Thus, law should vary with the business cycle.
To illustrate, consider the fiscal stimulus package enacted by the U.S. Congress in 2009, known as the ‘Obama Stimulus’. The law appropriated tens of billions of dollars in 2009 for ‘shovel ready’ infrastructure projects, aiming to quickly replace faltering private demand with government spending. But Federal, state and local laws, regulations and bureaucracies delayed otherwise ‘shovel ready’ government infrastructure spending in the worst years of the Great Recession in the U.S., leading President Obama to conclude that ‘there is no such thing as a shovel ready project.’ U.S. demand, depressed in 2009-2010, did not enjoy the stimulus associated with shovel ready projects for legal and regulatory reasons.
Law, as well as fiscal policy, should have responded to the urgent need for more spending. In addition to funding shovel ready projects, Congress should have passed laws preempting ordinary procedures and replacing them with expedited procedures. Regulators, judges, and bureaucrats overseeing the projects should also have recognized the urgent need for government spending by expediting reviews and avoiding injunctions wherever possible.
This is but one example of how law should sometimes change in response to macroeconomic conditions. Because law and regulation have an enormous cumulative effect on spending, a sustained attempt to stimulate the economy via law offers a new stimulus instrument when the traditional tools of macroeconomic policy, monetary and fiscal policy, do not suffice.
Not surprisingly (given the anemic economic performance of most economies in the last decade, which is hopefully coming to an end), there are a number of other scholars exploring the possibility of using law for macroeconomic purposes. To cite just two examples, a recent working paper discussed on this blog by Masur and Posner asks ‘Should Regulation be Countercyclical ?’. My colleague Zach Liscow recently published an article on Countercyclical Bankruptcy Law.
In a book manuscript that is forthcoming from Harvard University Press (publishing date to be determined), I discuss many avenues whereby law could stimulate demand and consider the costs and benefits of using law to do so.
Over time, I hope that the historical focus on microeconomics within law and economics gives way to a broader view of economics in which both macroeconomic and microeconomic considerations inform lawmaking and lawyers offer macroeconomists new tools to resolve pressing policy problems.
Yair Listokin is the Shibley Family Fund Professor of Law at Yale Law School.