《知识产权法》课程教学资源：Property Rules, Liability Rules, and Inalienability：One View of the Cathedral

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VOLUME 85 APRIL 1972 nUMBeR 6 HARVARD LAW REVIEW PROPERTY RULES, LIABILITY RULES AND INALIENABILITY ONE VIEW OF THE CATHEDRAL Guido calabresi and A douglas melamed s Professor Calabresi and Mr. Melamed develop a framework fe ve serves to integrate various legal relationships which are traditionally analyzed in separate subject areas such as Property and Tort using their model to suggest solutions to the pollution probler writers in the field, and by applying the model to the question criminal sanctions, they demonstrate the utility of such an integrated approach I. INTRODUCTION O NLY rarely are Property and Torts approached from a uni- fied perspective. Recent writings by lawyers concerned with economics and by economists concerned with law suggest, how ever, that an attempt at integrating the various legal relationships treated by these subjects would be useful both for the beginning student and the sophisticated scholar By articulating a concept of entitlements"which are protected by property, liability, or inalienability rules, we present one framework for such an ap- proach. We then analyze aspects of the pollution problem and of John Thomas Smith Professor of Law, Yale University. B.S. Yale, 1953; B, A. xford, I955; LL. B. Yale, I958; M A. Oxford, I959 * Member of the District of Columbia Bar. B A. Yale uni 1967: J D Harvard University, 197o See, e.g., Michelman, Pollution as a Tort: A Non-Accidental Perspective on Calabrest's CosTS, So YALE L.J. 647(1971)(analysis of three alternative rules in ollution problems); Demsetz, Toward a Theory of Property Rights, 57 AxE. CON. REv. 347(1967)(Vol. 2-Papers and Proceedings)(analysis of property ermalization which ignores liability rule alternatives a Since a fully integrated approach is probably impossible, it should be empha- d that this article concerns only one possible way of looking at and analyzin legal problems. Thus we shall not address ourselves to those fundamental legal questions which center on what institutions and what procedures are most suitable for making what decisions, except insofar as these relate directly to the problem of selecting the initial entitlements and the modes of protecting these entitlements. While we do not underrate the importance, indeed perhaps the primacy, of legal process considerations, see pp. III6-17 infra, we are merely interested in the light HeinOnline 85 Harv. L Rev. 10891971-1972

VOLUME 85 APRIL 1972 NUMBER 6 HARVARD LAW REVIEW PROPERTY RULES, LIABILITY RULES, AND INALIENABILITY: ONE VIEW OF THE CATHEDRAL Guido Calabresi * and A. Douglas Melamed Professor Calabresi and Mr. Melamed develop a framework for legal analysis which they believe serves to integrate various legal relationships which are traditionally analyzed in separate subject areas such as Property and Torts. By using their model to suggest solutions to the pollution problem that have been overlooked by writers in the field, and by applying the model to the question of criminal sanctions, they demonstrate the utility of such an integrated approach. I. INTRODUCTION O NLY rarely are Property and Torts approached from a unified perspective. Recent writings by lawyers concerned with economics and by economists concerned with law suggest, however, that an attempt at integrating the various legal relationships treated by these subjects would be useful both for the beginning student and the sophisticated scholar.' By articulating a concept of "entitlements" which are protected by property, liability, or inalienability rules, we present one framework for such an approach.2 We then analyze aspects of the pollution problem and of * John Thomas Smith Professor of Law, Yale University. B.S. Yale, i953; B.A. Oxford, T955; LL.B. Yale, 1958; M.A. Oxford, 1959. ** Member of the District of Columbia Bar. B.A. Yale University, 1967; J.D. Harvard University, 1970. See, e.g., Michelman, Pollution as a Tort: A Non-Accidental Perspective on Calabresi's Costs, So YAL_ L.J. 647 (1971) (analysis of three alternative rules in pollution problems); Demsetz, Toward a Theory of Property Rights, 57 Am. EcoN. REv. 347 (1967) (Vol. 2 -Papers and Proceedings) (analysis of property as a means of cost internalization which ignores liability rule alternatives). 2 Since a fully integrated approach is probably impossible, it should be emphasized that this article concerns only one possible way of looking at and analyzing legal problems. Thus we shall not address ourselves to those fundamental legal questions which center on what institutions and what procedures are most suitable for making what decisions, except insofar as these relate directly to the problems of selecting the initial entitlements and the modes of protecting these entitlements. While we do not underrate the importance, indeed perhaps the primacy, of legal process considerations, see pp. 1116-17 infra, we are merely interested in the light 1089 HeinOnline -- 85 Harv. L. Rev. 1089 1971-1972

HARVARD LAW REVIEW criminal sanctions in order to demonstrate how the model enables us to perceive relationships which have been ignored by writers in those field The first issue which must be faced by any legal system is one we call the problem of"entitlement "Whenever a state is pre sented with the conflicting interests of two or more people, or two or more groups of people, it must decide which side to favor. Absent such a decision, access to goods, services, and life itself wi be decided on the basis of "might makes right'-whoever stronger or shrewder will win. Hence the fundamental thing that law does is to decide which of the conflicting parties will be en- titled to prevail. The entitlement to make noise versus the en- titlement to have silence, the entitlement to pollute versus the entitlement to breathe clean air. the entitlement to have children versus the entitlement to forbid them -these are the first order of legal decisions Having made its initial choice, society must enforce that hoice. Simply setting the entitlement does not avoid the problem of"might makes right"; a minimum of state intervention is always necessary. Our conventional notions make this easy to compre- that a rather different approach may shed on problems frequently looked at pri marily from a legal process point of view. As Professor Harry Wellington is fond of saying about many discussions of w, this article is meant to be only one of Monets paintings of the Cathedral at Rouen. To understand the Cathedral one must see all of them. See G. HAMILTON, One could of course look at the state as simply a larger coalition of friends designed to enforce rules which merely accomplish the dominant coalitions desires. Rules of law would then be no more than "might makes right" writ large. Such decides too many issues in response to too many different coalitions. This fact, by itself, would require a different form of analysis from that which would suffice to explain entitlements resulting from more direct and decentralized uses of "might 4 For an excellent presentation of this general point by an economist, see Samuels, Interrelations Between Legal and Economic Processes, I4 J. LAw EcoN, 435(I97r) We do not intend to imply that the state relies on force to enforce all or most ly force wo win. The use by the state of feelings of obligation and rules of morality as means of enforcing most entitlements is not only crucial but terribly efficient. Conversely, bsent the state, individuals would probably agree on rules of behavior which rould govern entitlements in whole series of situations on the basis of criteria ther than "might makes right. "That these rules might themselves reflect the same for legal entitlements is, of neither here nor there. What is important is that these social compacts" would no less than legal entitlements, give rise to what may be called obligations. These ehave in accordance with the particular cases regardless of the existence of a predominant force. In this article HeinOnline 85 Harv. L Rev. 1090 1971-1972

HARVARD LAW REVIEW criminal sanctions in order to demonstrate how the model enables us to perceive relationships which have been ignored by writers in those fields. The first issue which must be faced by any legal system is one we call the problem of "entitlement." Whenever a state is presented with the conflicting interests of two or more people, or two or more groups of people, it must decide which side to favor. Absent such a decision, access to goods, services, and life itself will be decided on the basis of "might makes right" -whoever is stronger or shrewder will win.' Hence the fundamental thing that law does is to decide which of the conflicting parties will be entitled to prevail. The entitlement to make noise versus the entitlement to have silence, the entitlement to pollute versus the entitlement to breathe clean air, the entitlement to have children versus the entitlement to forbid them - these are the first order of legal decisions. Having made its initial choice, society must enforce that choice. Simply setting the entitlement does not avoid the problem of "might makes right"; a minimum of state intervention is always necessary.' Our conventional notions make this easy to comprethat a rather different approach may shed on problems frequently looked at primarily from a legal process point of view. As Professor Harry Wellington is fond of saying about many discussions of law, this article is meant to be only one of Monet's paintings of the Cathedral at Rouen. To understand the Cathedral one must see all of them. See G. HAMILTON, CLAUDE MONET'S PAINTINGS or ROUEN CATHEDRAL 4-5, 19-20, 27 (196o). ' One could of course look at the state as simply a larger coalition of friends designed to enforce rules which merely accomplish the dominant coalition's desires. Rules of law would then be no more than "might makes right" writ large. Such a view does not strike us as plausible if for no other reason than that the state decides too many issues in response to too many different coalitions. This fact, by itself, would require a different form of analysis from that which would suffice to explain entitlements resulting from more direct and decentralized uses of "might makes right." 4 For an excellent presentation of this general point by an economist, see Samuels, Interrelations Between Legal and Economic Processes, 14 J. LAW & EcoN. 435 (1971). We do not intend to imply that the state relies on force to enforce all or most entitlements. Nor do we imply that absent state intervention only force would win. The use by the state of feelings of obligation and rules of morality as means of enforcing most entitlements is not only crucial but terribly efficient. Conversely, absent the state, individuals would probably agree on rules of behavior which would govern entitlements in whole series of situations on the basis of criteria other than "might makes right." That these rules might themselves reflect the same types of considerations we will analyze as bases for legal entitlements is, of course, neither here nor there. What is important is that these "social compacts" would, no less than legal entitlements, give rise to what may be called obligations. These obligations in turn would cause people to behave in accordance with the compact in particular cases regardless of the existence of a predominant force. In this article 1o9o [Vol. 85:1o89 HeinOnline -- 85 Harv. L. Rev. 1090 1971-1972

I972] PROTECTING ENTITLEMENTS hend with respect to private property. If Taney owns a cabbage patch and Marshall, who is bigger, wants a cabbage, he will get it unless the state intervenes But it is not so obvious that the state must also intervene if it chooses the opposite entitlement, com- munal property. If large Marshall has grown some communal cabbages and chooses to deny them to small Taney, it will take state action to enforce Taney 's entitlement to the communal cab- bages. The same symmetry applies with respect to bodily in- egrity. Consider the plight of the unwilling ninety-eight-pound weakling in a state which nominally entitles him to bodily in tegrity but will not intervene to enforce the entitlement against a lustful Juno. Consider then the plight-absent state intervention -of the ninety-eight-pounder who desires an unwilling Juno in a state which nominally entitles everyone to use everyone elses body. The need for intervention applies in a slightly more com- plicated way to injuries. When a loss is left where it falls in an auto accident it is not because god so ordained it. Rather it is because the state has granted the injurer an entitlement to be free of liability and will intervene to prevent the victims friends, if they are stronger, from taking compensation from the injurer. The loss is shifted in other cases because the state has granted an entitlement to compensation and will intervene to prevent the stronger injurer from rebuffing the victims requests for com- e are not concerned as much with the workings of such obligations as with the reasons which may explain the rules which themselves give rise to the obligations. " Bigger"obviously does not refer simply to size, but to the sum of an indi- viduals resources. If Marshall,'s gang possesses superior brain and brawn to that e Different cultures deal with the problem in different ways. Witness the fol Life Insurance" Fee is 4 Bulls and $I2o0. Port Moresby, New guinea. Peter Howard proved that he values his life more than four bulls and SI20D. But he wants $24 and one pig in change. Mr. Howard gave the money and livestock to members of the jiga tribe, which had threatened to kill him because he killed a tribe member in an auto accident last October 29 The police approved the extortion agreement after telling the 38 year old Mr. Howard they could not protect him from the sworn vengeance of th ribe, which lives at Mt. Hagen, about 35o miles Northeast of Port Moresby. Mr. Howard, of Cambridge, England, was attacked and badly beaten by the tribesmen after the accident They said he would be killed unless the payment of money and bulls was made according to the tribal traditions. It was the first time a white man in New guinea had been forced to bow to tribal law After making the payment, Mr. Howard demanded to be the assault on him by the tribesmen. He said he wanted $24 and one pig. A Jiga spokesman told him the tribe would "think about it. "New York Times, Feb. I6, I972, at I7, col. 6 HeinOnline 85 Harv. L Rev. 1091 1971-1972

PROTECTING ENTITLEMENTS hend with respect to private property. If Taney owns a cabbage patch and Marshall, who is bigger, wants a cabbage, he will get it unless the state intervenes. But it is not so obvious that the state must also intervene if it chooses the opposite entitlement, communal property. If large Marshall has grown some communal cabbages and chooses to deny them to small Taney, it will take state action to enforce Taney's entitlement to the communal cabbages. The same symmetry applies with respect to bodily integrity. Consider the plight of the unwilling ninety-eight-pound weakling in a state which nominally entitles him to bodily integrity but will not intervene to enforce the entitlement against a lustful Juno. Consider then the plight - absent state intervention - of the ninety-eight-pounder who desires an unwilling Juno in a state which nominally entitles everyone to use everyone else's body. The need for intervention applies in a slightly more complicated way to injuries. When a loss is left where it falls in an auto accident, it is not because God so ordained it. Rather it is because the state has granted the injurer an entitlement to be free of liability and will intervene to prevent the victim's friends, if they are stronger, from taking compensation from the injurer.6 The loss is shifted in other cases because the state has granted an entitlement to compensation and will intervene to prevent the stronger injurer from rebuffing the victim's requests for compensation. we are not concerned as much with the workings of such obligations as with the reasons which may explain the rules which themselves give rise to the obligations. "Bigger" obviously does not refer simply to size, but to the sum of an individual's resources. If Marshall's gang possesses superior brain and brawn to that of Taney, Marshall's gang will get the cabbages. ' Different cultures deal with the problem in different ways. Witness the following account: "Life Insurance" Fee is 4 Bulls and $i2oo. Port Moresby, New Guinea. Peter Howard proved that he values his life more than four bulls and $12oo. But he wants $24 and one pig in change. Mr. Howard gave the money and livestock to members of the Jiga tribe, which had threatened to kill him because he killed a tribe member in an auto accident last October 29. The police approved the extortion agreement after telling the 38 year old Mr. Howard they could not protect him from the sworn vengeance of the tribe, which lives at Mt. Hagen, about 350 miles Northeast of Port Moresby. Mr. Howard, of Cambridge, England, was attacked and badly beaten by the tribesmen after the accident. They said he would be killed unless the payment of money and bulls was made according to the tribal traditions. It was the first time a white man in New Guinea had been forced to bow to tribal laws. After making the payment, Mr. Howard demanded to be compensated for the assault on him by the tribesmen. He said he wanted $24 and one pig. A Jiga spokesman told him the tribe would "think about it." New York Times, Feb. 16, 1972, at r7, col. 6. 1972] lO91 HeinOnline -- 85 Harv. L. Rev. 1091 1971-1972

Io92 HARVARd LAW REVIEW [Vol. 85: IoS9 The state not only has to decide whom to entitle, but it must also simultaneously make a series of equally difficult second order decisions. These decisions go to the manner in which entitlements are protected and to whether an individual is allowed to sell or trade the entitlement. In any given dispute, for example, the state must decide not only which side wins but also the kind of protec tion to grant. It is with the latter decisions, decisions which shape the subsequent relationship between the winner and the loser, that this article is primarily concerned. We shall consider three types of entitlements titlements protected by property rules, en- titlements protected by liability rules, and inalienabl e entitle ments. The categories are not of course, absolutely distinct; but the categorization is useful since it reveals some of the reasons which lead us to protect certain entitlements in certain ways An entitlement is protected by a property rule to the extent that someone who wishes to remove the entitlement from its holder must buy it from him in a voluntary transaction in which the value of the entitlement is agreed upon by the seller. It is the form of entitlement which gives rise to the least amount of state intervention: once the original entitlement is decided upon, the state does not try to decide its value. It lets each of the parties say how much the entitlement is worth to him, and gives the seller a veto if the buyer does not offer enough. Property rules involve a collective decision as to who is to be given an initial entitle- ment but not as to the value of the entitlement Whenever someone may destroy the initial entitlement if he is willing to pay an objectively determined value for it, an entitle ment is protected by a liability rule. This value may be what it is thought the original holder of the entitlement would have sold it for. But the holder's complaint that he would have demanded more will not avail him once the objectively determined value is set. Obviously, liability rules involve an additional stage of state intervention: not only are entitlements protected but their trans fer or destruction is allowed on the basis of a value determined by some organ of the state rather than by the parties themselves An entitlement is inalienable to the extent that its transfer is not permitted between a willing buyer and a willing seller. The state intervenes not only to determine who is initially entitled and to determine the compensation that must be paid if the en "A property rule requires less state intervention only in the sense that inter- vention is needed to decide upon and enforce the initial entitlement but not for the separate problem of determining the value of the entitlement. Thus, if a par- alar property entitlement is especially difficult to enforce- for example, the right personal security in urban areas-the actual amount of state intervention can e very high and could, perhaps, exceed that needed for some entitlements pro- tected by easily administered liability rules. HeinOnline 85 Harv. L Rev. 1092 1971-1972

HARVARD LAW REVIEW The state not only has to decide whom to entitle, but it must also simultaneously make a series of equally difficult second order decisions. These decisions go to the manner in which entitlements are protected and to whether an individual is allowed to sell or trade the entitlement. In any given dispute, for example, the state must decide not only which side wins but also the kind of protection to grant. It is with the latter decisions, decisions which shape the subsequent relationship between the winner and the loser, that this article is primarily concerned. We shall consider three types of entitlements - entitlements protected by property rules, entitlements protected by liability rules, and inalienable entitlements. The categories are not, of course, absolutely distinct; but the categorization is useful since it reveals some of the reasons which lead us to protect certain entitlements in certain ways. An entitlement is protected by a property rule to the extent that someone who wishes to remove the entitlement from its holder must buy it from him in a voluntary transaction in which the value of the entitlement is agreed upon by the seller. It is the form of entitlement which gives rise to the least amount of state intervention: once the original entitlement is decided upon, the state does not try to decide its value.' It lets each of the parties say how much the entitlement is worth to him, and gives the seller a veto if the buyer does not offer enough. Property rules involve a collective decision as to who is to be given an initial entitlement but not as to the value of the entitlement. Whenever someone may destroy the initial entitlement if he is willing to pay an objectively determined value for it, an entitlement is protected by a liability rule. This value may be what it is thought the original holder of the entitlement would have sold it for. But the holder's complaint that he would have demanded more will not avail him once the objectively determined value is set. Obviously, liability rules involve an additional stage of state intervention: not only are entitlements protected, but their transfer or destruction is allowed on the basis of a value determined by some organ of the state rather than by the parties themselves. An entitlement is inalienable to the extent that its transfer is not permitted between a willing buyer and a willing seller. The state intervenes not only to determine who is initially entitled and to determine the compensation that must be paid if the en- ' A property rule requires less state intervention only in the sense that intervention is needed to decide upon and enforce the initial entitlement but not for the separate problem of determining the value of the entitlement. Thus, if a particular property entitlement is especially difficult to enforce - for example, the right to personal security in urban areas - the actual amount of state intervention can be very high and could, perhaps, exceed that needed for some entitlements protected by easily administered liability rules. 1092 [VOL. 85:1o89 HeinOnline -- 85 Harv. L. Rev. 1092 1971-1972

PROTECTING ENTITLEMENTS titlement is taken or destroyed, but also to forbid its sale under some or all circumstances. Inalienability rules are thus quite different from property and liability rules. Unlike those rules les of inalienability not only "protect may also be viewed as limiting or regulating the grant of the en titlement itself It should be clear that most entitlements to most goods are mixed. Taney's house may be protected by a property rule in situations where Marshall wishes to purchase it, by a liability rule where the government decides to take it by eminent domain, and by a rule of inalienability in situations where Taney is drunk or incompetent. This article will explore two primary questions:(I) In what circumstances should we grant a particular entitlement? and(2)In what circumstances should we decide to protect tha entitlement by using a property, liability, or inalienability rule? II. THE SETTING OF ENTITLEMENTS butional preferences, and other justice consideration A il What are the reasons for deciding to entitle people to po or to entitle people to forbid pollution, to have children freely or to limit procreation, to own property or to share property? They can be grouped under three headings: economic efficiency, distri Perhaps the simplest reason for a particular entitlement is to minimize the administrative costs of enforcement. This was the reason Holmes gave for letting the costs lie where they fall in accidents unless some clear societal benefit is achieved by shifting them. By itself this reason will never justify any result except that of letting the stronger win, for obviously that result mini mizes enforcement costs. Nevertheless, administrative efficiency may be relevant to che taken into account. This may occur when the reasons accepted are indifferent between conflicting entitlements and one entitle ment is cheaper to enforce than the others. It may also occur when the reasons are not indifferent but lead us only slightly to prefer one over another and the first is considerably more expen sive to enforce than the second But administrative efficiency is just one aspect of the broader ncept of economic efficiency. Economic efficiency asks that we s See generaly G. CALABRESI, TEE CosTS OF AccIDENTS 24-33(Igo)[herein after cited as costs See O.W. HOLMES, JR, THE CoxnMoN LAW 76-77(Howe ed, 1963). For a criticism of the justification as applied to accidents today, see CosTs 26I-63. But cf. Posner, A Theory of Negligence, I J. LECAL STUD 29(I972) HeinOnline 85 Harv. L Rev. 1093 1971-1972

PROTECTING ENTITLEMENTS titlement is taken or destroyed, but also to forbid its sale under some or all circumstances. Inalienability rules are thus quite different from property and liability rules. Unlike those rules, rules of inalienability not only "protect" the entitlement; they may also be viewed as limiting or regulating the grant of the entitlement itself. It should be clear that most entitlements to most goods are mixed. Taney's house may be protected by a property rule in situations where Marshall wishes to purchase it, by a liability rule where the government decides to take it by eminent domain, and by a rule of inalienability in situations where Taney is drunk or incompetent. This article will explore two primary questions: (i) In what circumstances should we grant a particular entitlement? and (2) In what circumstances should we decide to protect that entitlement by using a property, liability, or inalienability rule? II. THE SETTING OF ENTITLEMENTS What are the reasons for deciding to entitle people to pollute or to entitle people to forbid pollution, to have children freely or to limit procreation, to own property or to share property? They can be grouped under three headings: economic efficiency, distributional preferences, and other justice considerations.' A. Economic Efficiency Perhaps the simplest reason for a particular entitlement is to minimize the administrative costs of enforcement. This was the reason Holmes gave for letting the costs lie where they fall in accidents unless some clear societal benefit is achieved by shifting them.' By itself this reason will never justify any result except that of letting the stronger win, for obviously that result minimizes enforcement costs. Nevertheless, administrative efficiency may be relevant to choosing entitlements when other reasons are taken into account. This may occur when the reasons accepted are indifferent between conflicting entitlements and one entitlement is cheaper to enforce than the others. It may also occur when the reasons are not indifferent but lead us only slightly to prefer one over another and the first is considerably more expensive to enforce than the second. But administrative efficiency is just one aspect of the broader concept of economic efficiency. Economic efficiency asks that we 8 See generally G. CALABRESI, Tnm Costs or AcclmDEs 24-33 (1970) [hereinafter cited as CosTS]. 9 See O.W. HoLmEs, JR., THE COMMON LAw 76-77 (Howe ed. x963). For a criticism of the justification as applied to accidents today, see CosTs 261-63. But cf. Posner, A Theory of Negligence, i J. LEGAL STUD. 29 (1972). 1972] 1093 HeinOnline -- 85 Harv. L. Rev. 1093 1971-1972

HARVARD LAW REVIEW TVol. 85: Io89 choose the set of entitlements which would lead to that allocation of resources which could not be improved in the sense that a further change would not so improve the condition of those who gained by it that they could compensate those who lost from it and still be better off than before This is often called Pareto opti- malityo To give two examples, economic efficiency asks for that combination of entitlements to engage in risky activities and to be free from harm from risky activities which will most likely lead the lowest sum of accident costs and of costs of avoiding accidents.11 It asks for that form of property, private or com munal, which leads to the highest product for the effort of produc Recently it has been argued that on certain assumptions, usually termed the absence of transaction costs, Pareto optimality or economic efficiency will occur regardless of the initial entitle ment. 12 For this to hold, "no transaction costs)must be under to We are not here concerned with the many definitional variations which en- circle the concept of Pareto optimality. Many of these variations stem from the fact that unless compensation actually occurs after a change (and this itself assumes a preexisting set of entitlements from which one makes a change to a Pareto op- ake a return to the prior position also seem Pareto optimal. There are any num- ber of variations on this theme which economists have studied at length. Since in the world in which lawyers must live, anything close to Pareto efficiency, even if desirable, is not attainable, these refinements need not detain us even though they are crucial to a full understanding of the concept. Most versions of Pareto optimality are based on the premise that individuals know best what is best for them. Hence they assume that to determine whether those who gain from a change could compensate those who lose one must look to the values the individuals themselves give to the gains and losses. Economic efficiency may, however, present a broader notion which does not depend up his individualistic premise. It may be that the state, for paternalistic reasons, see pp. III3-14 infra, is better able to determine whether the total gain of the winners is greater than the total loss of the losers I The word"costs " is here used in a broad way to include all the disutilities resulting from an accident and its avoidance As such it is not limited to mone- tary costs, or even to those which could in some sense be "monetizable, 'but rather includes disutilities or costs-for instance, the loss to an individual of his leg - the very expression of which in monetary terms wot costs"is that the market is of little use in gauging their worth, and this in turn gives rise to one of the perty rules may be used. article, The problens n Costs, Resource Alocation lity Rules-A Comment, II .LAW Theorem on Social Cost: A Footnote, II J. LAw EcoN, 503(1968). See also THE THEORY OF PRICE II3(3d ed. I966); Mishan, Pareto Optimality w, I9 OXFORD EcoN PAPERS 255(1967) HeinOnline 85 Harv. L Rev. 1094 1971-1972

HARVARD LAW REVIEW choose the set of entitlements which would lead to that allocation of resources which could not be improved in the sense that a further change would not so improve the condition of those who gained by it that they could compensate those who lost from it and still be better off than before. This is often called Pareto optimality.10 To give two examples, economic efficiency asks for that combination of entitlements to engage in risky activities and to be free from harm from risky activities which will most likely lead to the lowest sum of accident costs and of costs of avoiding accidents." It asks for that form of property, private or communal, which leads to the highest product for the effort of producing. Recently it has been argued that on certain assumptions, usually termed the absence of transaction costs, Pareto optimality or economic efficiency will occur regardless of the initial entitlement.' 2 For this to hold, "no transaction costs" must be undero We are not here concerned with the many definitional variations which encircle the concept of Pareto optimality. Many of these variations stem from the fact that unless compensation actually occurs after a change (and this itself assumes a preexisting set of entitlements from which one makes a change to a Pareto optimal arrangement), the redistribution of wealth implicit in the change may well make a return to the prior position also seem Pareto optimal. There are any number of variations on this theme which economists have studied at length. Since in the world in which lawyers must live, anything close to Pareto efficiency, even if desirable, is not attainable, these refinements need not detain us even though they are crucial to a full understanding of the concept. Most versions of Pareto optimality are based on the premise that individuals know best what is best for them. Hence they assume that to determine whether those who gain from a change could compensate those who lose, one must look to the values the individuals themselves give to the gains and losses. Economic efficiency may, however, present a broader notion which does not depend upon this individualistic premise. It may be that the state, for paternalistic reasons, see pp. 1113-14 infra, is better able to determine whether the total gain of the winners is greater than the total loss of the losers. " The word "costs" is here used in a broad way to include all the disutilities resulting from an accident and its avoidance. As such it is not limited to monetary costs, or even to those which could in some sense be "monetizable," but rather includes disutilities or "costs" -for instance, the loss to an individual of his leg -the very expression of which in monetary terms would seem callous. One of the consequences of not being able to put monetary values on some disutilities or "costs" is that the market is of little use in gauging their worth, and this in turn gives rise to one of the reasons why liability, or inalienability rules, rather than property rules may be used. " This proposition was first established in Coase's classic article, The Problem of Social Cost, 3 J. LAW & EcON. I (ig6o), and has been refined in subsequent literature. See, e.g., Calabresi, Transaction Costs, Resource Allocation and Liability Rules-A Comment, Ii J. LAW & EcoN. 67 (1968); Nutter, The Coase Theorem on Social Cost: A Footnote, ii J. LAW & EcoN. 503 (1968). See also G. STIoLER, THE THEORY Or PRICE 113 (3d ed. 1966); Mishan, Pareto Optimality and the Law, i9 OxFoRD EcoN. PAPERS 255 (1967). 1094 [Vol. 85=:l89 HeinOnline -- 85 Harv. L. Rev. 1094 1971-1972

I972] PROTECTING ENTITLEMENTS stood extremely broadly as involving both perfect knowledge and the absence of any impediments or costs of negotiating. Negoti ation costs include, for example, the cost of excluding would-be freeloaders from the fruits of market bargains. 3 In such a fric- ionless society transactions would occur until no one could b made better off as a result of further transactions without making someone else worse off. This, we would suggest, is a necessary, deed a tautological, result of the definitions of Pareto optimality and of transaction costs which we have given Such a result would not mean however that the same alloca tion of resources would exist regardless of the initial set of en titlements. Taney's willingness to pay for the right to make noise may depend on how rich he is; Marshall's willingness to pay for silence may depend on his wealth. In a society which entitles Taney to make noise and which forces Marshall to buy silence from Taney, Taney is wealthier and Marshall poorer than each would be in a society which had the converse set of entitlements Depending on how Marshalls desire for silence and Taney's for noise vary with their wealth, an entitlement to noise will result in egotiations which will lead to a different quantum of noise than would an entitlement to silence. This variation in the quantity 13 The freeloader is the person who refuses to be inoculated against smallpe because, given the fact that almost everyone else is inoculated, the risk of smallpox to him is less than the risk of harm from the inoculation. He is the person who refuses to pay for a common park, though he wants it, because he believes that others will put in enough money to make the park available to him. See Cost 137 n 4. The costs of excluding the freeloader from the benefits for which he re- fused to pay may well be considerable as the two above examples should suggest. This is especially so since these costs may include the inefficiency of pricing a good ike the park once it exists, above its marginal cost in order to force the freeloader to-disclose-his true desire to use it-thus enabling us to charge him part of the cost of establishing it initially. It is the capacity of the market to induce disclosure of individual preferences which makes it theoretically possible for the market to bring about exchanges lead- ing to Pareto optimality. But the freeloader situation is just one of many where no such disclosure is achieved by the market. If we assume perfect knowledge, defined more broadly than is normally done to include knowledge of individual preferences, then such situations pose no problem. This definition of perfect knowl edge, though perhaps implicit in the concept of no transaction costs, would not only make reaching Pareto optimality easy through the market, it would make it equally easy to establish a similar result by collective fiat. For a further discussion of what is implied by a broad definition of no trans action costs, see note 59 infra. For a discussion of other devices which may induce individuals to disclose their preferences, see note 38 infra See Mishan, Pareto optimality and the Law, I9 OxFORD EcoN. PAPERS 255 (I967). Unless Taney's and Marshall's desires for noise and silence are totally unaffected by their wealth, that is, their desires are totally income inelastic, a change in their wealth will alter the value each places on noise and silence and nce will alter the outcome of their negotiations. HeinOnline 85 Harv. L Rev. 1095 1971-1972

PROTECTING ENTITLEMENTS stood extremely broadly as involving both perfect knowledge and the absence of any impediments or costs of negotiating. Negotiation costs include, for example, the cost of excluding would-be freeloaders from the fruits of market bargains. 3 In such a frictionless society, transactions would occur until no one could be made better off as a result of further transactions without making someone else worse off. This, we would suggest, is a necessary, indeed a tautological, result of the definitions of Pareto optimality and of transaction costs which we have given. Such a result would not mean, however, that the same allocation of resources would exist regardless of the initial set of entitlements. Taney's willingness to pay for the right to make noise may depend on how rich he is; Marshall's willingness to pay for silence may depend on his wealth. In a society which entitles Taney to make noise and which forces Marshall to buy silence from Taney, Taney is wealthier and Marshall poorer than each would be in a society which had the converse set of entitlements. Depending on how Marshall's desire for silence and Taney's for noise vary with their wealth, an entitlement to noise will result in negotiations which will lead to a different quantum of noise than would an entitlement to silence. 4 This variation in the quantity "a The freeloader is the person who refuses to be inoculated against smallpox because, given the fact that almost everyone else is inoculated, the risk of smallpox to him is less than the risk of harm from the inoculation. He is the person who refuses to pay for a common park, though he wants it, because he believes that others will put in enough money to make the park available to him. See COSTS 137 n.4. The costs of excluding the freeloader from the benefits for which he refused to pay may well be considerable as the two above examples should suggest. This is especially so since these costs may include the inefficiency of pricing a good, like the park once it exists, above its marginal cost in order to force the freeloader to disclose his true desire to use it -thus enabling us to charge him part of the cost of establishing it initially. It is the capacity of the market to induce disclosure of individual preferences which makes it theoretically possible for the market to bring about exchanges leading to Pareto optimality. But the freeloader situation is just one of many where no such disclosure is achieved by the market. If we assume perfect knowledge, defined more broadly than is normally done to include knowledge of individual preferences, then such situations pose no problem. This definition of perfect knowledge, though perhaps implicit in the concept of no transaction costs, would not only make reaching Pareto optimality easy through the market, it would make it equally easy to establish a similar result by collective fiat. For a further discussion of what is implied by a broad definition of no transaction costs, see note 59 infra. For a discussion of other devices which may induce individuals to disclose their preferences, see note 38 infra. 4 See Mishan, Pareto Optimality and the Law, 19 OXFORD EcoN. PAPERS 255 (1967). Unless Taney's and Marshall's desires for noise and silence are totally unaffected by their wealth, that is, their desires are totally income inelastic, a change in their wealth will alter the value each places on noise and silence and hence will alter the outcome of their negotiations. 1972] 1095 HeinOnline -- 85 Harv. L. Rev. 1095 1971-1972

HARVARD LAW REVIEW [Vol. 85: I089 of noise and silence can be viewed as no more than an instance of the well accepted proposition that what is a Pareto optimal, or economically efficient, solution varies with the starting distribu tion of wealth. Pareto optimality is optimal given a distribution of wealth, but different distributions of wealth imply their own Pareto optimal allocation of resources. All this suggests why distributions of wealth may affect a ty's choice of entitlements. It does not suggest why economic eficiency should affect the choice if any transaction costs. But no one makes an assumption of no transaction costs in practice. Like the physicist's assumption of no friction or Says law in macro-economics, the assumption of no transaction costs may be a useful starting point, a device which helps us see how, as different elements which may be termed transaction costs become important, the goal of economic effi ciency starts to prefer one allocation of entitlements over Since one of us has written at length on how in the presence of various types of transaction costs a society would go about deciding on a set of entitlements in the field of accident law, it is enough to say here: (i) that economic efficiency standing alone would dictate that set of entitlements which favors knowledge- able choices between social benefits and the social costs of obtain ing them, and between social costs and the social costs of avoiding them;(2) that this implies, in the absence of certainty as to whether a benefit is worth its costs to society, that the cost should be put on the party or activity best located to make such a cost benefit analysis;(3) that in particular contexts like accidents or pollution this suggests putting costs on the party or activity which 15 There should be no implication that a Pareto optimal solution is in some sense better than a non-Pareto optimal solution which results in a different wealth distribution. The implication is only that given the same wealth distribution Pareto optimal is in some meaningful sense preferable to non-Pareto optimal 16 See Demsetz, When Does the Rule of Liability Matter?, I J. LEGAL STUD 13, 25-28(I972); Stigler, The Law and Economics of Public Policy: A Plea to the Scholars, I J. LEGAL STUD. I, II-I2(I972) The trouble with a term like "no transaction costs, is that it covers a multi ude of market failures. The appropriate collective response, if the aim is to ap- proach Pareto optimality, will vary depending on what the actual impediments to ull bargaining are in any given cases. Occasionally the appropriate response may be to ignore the impediments. If the impediments are merely the administrative costs of establishing a market, it may be that doing nothing is preferable to at- tempting to correct for these costs because the administrative costs of collectiv action may be even greater. Similarly, if the impediments are due to a failure of the market to cause an accurate disclosure of freeloaders' preferences it may be that the collective can do no better 17 See CosTS 135-97. HeinOnline 85 Harv. L Rev. 1096 1971-1972

HARVARD LAW REVIEW of noise and silence can be viewed as no more than an instance of the well accepted proposition that what is a Pareto optimal, or economically efficient, solution varies with the starting distribution of wealth. Pareto optimality is optimal given a distribution of wealth, but different distributions of wealth imply their own Pareto optimal allocation of resources."5 All this suggests why distributions of wealth may affect a society's choice of entitlements. It does not suggest why economic efficiency should affect the choice, if we assume an absence of any transaction costs. But no one makes an assumption of no transaction costs in practice. Like the physicist's assumption of no friction or Say's law in macro-economics, the assumption of no transaction costs may be a useful starting point, a device which helps us see how, as different elements which may be termed transaction costs become important, the goal of economic efficiency starts to prefer one allocation of entitlements over another.'" Since one of us has written at length on how in the presence of various types of transaction costs a society would go about deciding on a set of entitlements in the field of accident law,'" it is enough to say here: (i) that economic efficiency standing alone would dictate that set of entitlements which favors knowledgeable choices between social benefits and the social costs of obtaining them, and between social costs and the social costs of avoiding them; (2) that this implies, in the absence of certainty as to whether a benefit is worth its costs to society, that the cost should be put on the party or activity best located to make such a costbenefit analysis; (3) that in particular contexts like accidents or pollution this suggests putting costs on the party or activity which 15 There should be no implication that a Pareto optimal solution is in some sense better than a non-Pareto optimal solution which results in a different wealth distribution. The implication is only that given the same wealth distribution Pareto optimal is in some meaningful sense preferable to non-Pareto optimal. 16 See Demsetz, When Does the Rule of Liability Matter?, i J. LEGAL STUD. 13, 25-28 (1972); Stigler, The Law and Economics of Public Policy: A Plea to the Scholars, i J. LEGAL STUD. 1, 11-12 (1972). The trouble with a term like "no transaction costs" is that it covers a multitude of market failures. The appropriate collective response, if the aim is to approach Pareto optimality, will vary depending on what the actual impediments to full bargaining are in any given cases. Occasionally the appropriate response may be to ignore the impediments. If the impediments are merely the administrative costs of establishing a market, it may be that doing nothing is preferable to attempting to correct for these costs because the administrative costs of collective action may be even greater. Similarly, if the impediments are due to a failure of the market to cause an accurate disclosure of freeloaders' preferences it may be that the collective can do no better. " See CosTs 135-97. io96 [Vol. 85=I89 HeinOnline -- 85 Harv. L. Rev. 1096 1971-1972

PROTECTING ENTITLEMENTS I097 can most cheaply avoid them;(4) that in the absence of certainty as to who that party or activity is, the costs should be put on the party or activity which can with the lowest transaction costs act in the market to correct an error in entitlements by inducing the party who can avoid social costs most cheaply to do so; 1and (5 that since we are in an area where by hypothesis markets do not work perfectly - there are transaction costs-a decision will often have to be made on whether market transactions or collec tive fiat is most likely to bring us closer to the Pareto optimal re- sult the "perfect"market would reach. Complex though this summary may suggest the entitlement choice to be, in practice the criteria it represents will frequently indicate which allocations of entitlements are most likely to lead to optimal market judgments between having an extra car or taking a train, getting an extra cabbage and spending less time working in the hot sun, and having more widgets and breathing the pollution that widget production implies. Economic efficiency is not, however, the sole reason which induces a society to select a 1B In The Costs of Accidents, the criteria here summarized are discussed at length and broken down into subcriteria which deal with the avoidance of dif- erent types of externalization and with the finding of the "best briber Su detailed analysis is necessary to the application of the criteria to any specific are of law. At the level of generality of this article it did not seem to us necessary. 19 In accident law this election takes the form of a choice between general or market deterrence and specific deterrence, in which the permitted level and manner of accident causing activities is determined collectively. For example, society may decide to grant an entitlement to drive and an entitlement to be compensated for accidents resulting from driving, and allow decisions by individual parties to deter- mine the level and manner of driving. But a greater degree of specific deterrence could be achieved by selecting a different set of initial entitlements in order te accord with a collective cost-benefit analysis-by, for example, prohibiting cars of more than a certain horsepower. The primary disadvantage of specific deterrence, as compared with general de- terrence, is that it requires the central decisionmaker not only to determine the costs of any given activity, but also to measure its benefits, in order to determine the optimum level of activity. It is exceedingly difficult and exceedingly costly for ny centralized decisionmaker to be fully informed of the costs and benefits of a wide range of activities. The irony is that collective fiat functions best in a world of costless perfect information; yet in a world of costless transactions, including costless information, the optimum allocation would be reached by market trans- actions, and the need to consider the alternative of collective fiat would not arise One could, however, view the irony conversely, and say that the market works best under assumptions of perfect knowledge where collective fat would work perfectly, rendering the market unnecessary. The fact that both market and co lective determinations face difficulties in achieving the Pareto optimal result which perfect knowledge and no transaction costs would permit does not mean that the same difficulties are always as great for the two approaches. Thus, there are many situations in which we can assume fairly confidently that the market will do better than a collective decider, and there are situations where we can assume the oppo- site to be true. See CosTs HeinOnline 85 Harv. L Rev. 10971971-1972

PROTECTING ENTITLEMENTS can most cheaply avoid them; (4) that in the absence of certainty as to who that party or activity is, the costs should be put on the party or activity which can with the lowest transaction costs act in the market to correct an error in entitlements by inducing the party who can avoid social costs most cheaply to do so; " and (5) that since we are in an area where by hypothesis markets do not work perfectly - there are transaction costs - a decision will often have to be made on whether market transactions or collective fiat is most likely to bring us closer to the Pareto optimal result the "perfect" market would reach. 9 Complex though this summary may suggest the entitlement choice to be, in practice the criteria it represents will frequently indicate which allocations of entitlements are most likely to lead to optimal market judgments between having an extra car or taking a train, getting an extra cabbage and spending less time working in the hot sun, and having more widgets and breathing the pollution that widget production implies. Economic efficiency is not, however, the sole reason which induces a society to select a "I In The Costs of Accidents, the criteria here summarized are discussed at length and broken down into subcriteria which deal with the avoidance of different types of externalization and with the finding of the "best briber." Such detailed analysis is necessary to the application of the criteria to any specific area of law. At the level of generality of this article it did not seem to us necessary. 11 In accident law this election takes the form of a choice between general or market deterrence and specific deterrence, in which the permitted level and manner of accident causing activities is determined collectively. For example, society may decide to grant an entitlement to drive and an entitlement to be compensated for accidents resulting from driving, and allow decisions by individual parties to determine the level and manner of driving. But a greater degree of specific deterrence could be achieved by selecting a different set of initial entitlements in order to accord with a collective cost-benefit analysis -by, for example, prohibiting cars of more than a certain horsepower. The primary disadvantage of specific deterrence, as compared with general deterrence, is that it requires the central decisionmaker not only to determine the costs of any given activity, but also to measure its benefits, in order to determine the optimum level of activity. It is exceedingly difficult and exceedingly costly for any centralized decisionmaker to be fully informed of the costs and benefits of a wide range of activities. The irony is that collective fiat functions best in a world of costless perfect information; yet in a world of costless transactions, including costless information, the optimum allocation would be reached by market transactions, and the need to consider the alternative of collective fiat would not arise. One could, however, view the irony conversely, and say that the market works best under assumptions of perfect knowledge where collective fiat would work perfectly, rendering the market unnecessary. The fact that both market and collective determinations face difficulties in achieving the Pareto optimal result which perfect knowledge and no transaction costs would permit does not mean that the same difficulties are always as great for the two approaches. Thus, there are many situations in which we can assume fairly confidently that the market will do better than a collective decider, and there are situations where we can assume the opposite to be true. See CosTs 103-13. 1972] 1097 HeinOnline -- 85 Harv. L. Rev. 1097 1971-1972

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