1. Judicial Rulemaking in Western Law Benito ARRUÑADA (UPF) Veneta ANDONOVA (ITAM)

2. Motivation Previous work on property rights (JLEO03): Courts end up conditioning market transition Pro-market intent & nature of civil law reform in 1800s(e.g., mortgage market) Common / civil law divide nonexistent Reinvigorated efficiency claims of common law (La Porta, Shleifer et al.) GOAL: Explore an adaptation hypothesis for explaining modern Western law

3. Analytical framework A key design difference b/w common & civil law: allocation of rule making power to judges: Rule making power of the whole judiciary Centralization of this powerbinding precedent Four areas of trade-offs: Self-interest (1) Information (2) Cognitive: Rationality (allegedly decisive) Bias and heuristics (3) Unnaturalness of markets (4)

4. Drivers of rulemaking inefficiency (1): Self-interest Parties Legislators retain rulemaking supremacy Judges do not need rules to be corrupt Rent-seeking by parties to contracts require biased rule-maker Depends on fields of law (?) In private law, less legislative rent seeking Choice of field temporary and endogenous

5. Drivers of rulemaking inefficiency (2): Lack of information Geographic scope of markets advantage for centralized standards (?) But, in any case, binding precedent enough (especially if centralized) Speed of technical change need faster adjustment But unclear which system adapts faster

6. Drivers of rulemaking inefficiency (3): RationalityBiases & heuristics Guthrie, Rachlinski & Wistrich (2001), judges fail The same in Hindsight, Anchoring & Egocentrism advises constraining judicial rulinge.g., liability standards Less in Framing & Representativeness Doubt how judges process key experimental info Is a defendants move for dismissal irrelevant when testing for anchoring effects? Hindsight: applicable, more than to negligence, to: Emphasis on balanced compensation ex post Prejudice against asymmetric contracting But affects equally judges from all jurisdictions

7. Drivers of rulemaking inefficiency (4): RationalityUnnaturalness of markets Sharing redistributive rulemaking Identifiable persons tendency to ignore rule-setting effects of individual sentences (justice vs. efficiency) Greater bias against abstract transactions (capital, intangibles, perhaps trade)

8. Cognitive gap between continental legislators and judges in 19 th century Legislators Aristocratic democracy made political leadership possible instead of political agency (20 th ) more rational (pro-market) elites Also had market experience & profit opportunities? Judiciary Continent: judicial nobility, more Canon law England: former barristers

9. Hypothesis: Western law as pro-market adaptation Common law evolved within a slow transition to the market economy Civil law changed from above, as part of a pro-market liberal revolution, by constraining judges rulemaking powers Historical test: 19 th and 20 th centuries

10. Test: Western law in the 19 th century Few changes in common law Needed Roman law introduced w/o codification Binding precedentnational markets Pro-market revolution of the civil law Freedom of contract achieved by combining: Codification Default rules Minimal judicial discretion: Sentence according to law & bound by centralized precedents Also: Codification doctrinal changes diluting Canon law influence: credit, penal clauses, lesion, cause Mandatory law to reduce transaction costse.g., land titling

11. Test: Anti-market trends in Western law Changes: statue law in new fields and: Common law: courts interfere with contractual freedome.g., unconscionability (= Canon Law) Civil law: greater judicial discretion Cognitive hypotheses Increased uncertainty in 1910-30s sharing Why not before? Political change: Elites as political agents instead of leaders Exogenous?

12. Alternative perspectives The efficiency debate is not a comparative exercise analyses internal consistency, not efficiency Comparative performanceLa Porta et al. Self-selection Measurement nightmare Correlation Causation Need to Consider self-selection Use institutional dimensions as independent variables (e.g., judicial discretion) instead of labels (civil & common law)

13. Concluding remarks (1) How to create market friendly institutions the rule of lawin transition & developing economies Adaptation Constrain judgesbut does a cognitive gap exist? Lack of market-wise judges But political elites more often agents (South America) than leaders (Asian tigers) Self-enforcing institutions Example: community mortgage systems

14. Concluding remarks (& 2) How to preserve market friendly institutions in developed economies A doses of redistribution required b/c of the cognitive anti-market bias?