Economic Analysis of European Private Law

From Max-EuP 2012

by Rainer Kulms

1. The use of economics in law—overview

The economic analysis of law gained ground in US legal thinking in the 1960s. Lawyers and decision-makers had come to appreciate that economics offered valuable insights on how to handle regulatory policy challenges in the context of antitrust and tax laws, regulated industries and the determination of damages. Almost half a century later, the economic analysis of law has made major inroads into all fields of law. Economics play a decisive role in assessing the impact of legal norms, judicial reasoning and interventionist government policies. The economic analysis of law goes well beyond a purely descriptive exercise. In fact, there are strong normative implications as regulatory policy-makers are advised to be mindful of social welfare, thereby discarding statutory interventions not motivated by notions of efficiency. In this context, the task of economics is to explore the implications of a set of behavioural assumptions in order to ascertain the (potential) effects of a norm and of the sanctions imposed thereunder. The addressees of norms are deemed to act rationally and to be utility-maximizing. Legal sanctions operate as prices; higher costs will be incurred for certain (unlawful) types of behaviour. The results flowing from a norm are considered to be efficient as long as they increase social welfare. The insights from this approach should inspire legislatures with bounded rationality as well as courts, which are urged not to diminish social welfare when disposing of the case at bar.

The economic analysis of law has its intellectual underpinnings in a legal system which builds on common law thinking and judicial precedent for settling disputes. This is not to suggest that common law is per se more efficient than the civil law codifications of continental Europe. But it should not be overlooked that the common law has been thriving on a regulatory concept which relies extensively on the stimulus from private ordering (ie contracts) and the evolutionary skills of courts in accommodating factual and economic changes without statutory intervention.

2. Economic analysis and the concept of private law

As the toolkit of economic analysis is applied to European private law, problems of classification and methodology are likely to occur. This is due to the specificities of European integration and the diversity of regulatory concepts promoted for supplying the European Union with meaningful private law principles. On a more descriptive note, comparative law studies will unveil overlap and intersections between the private law systems of the Member States. Comparative law studies will generate a normative momentum if they are motivated by the ambition to lay down common principles of law within the Union. This leitmotif emerges with great clarity from the European Parliament resolution of September 2008 on the Common Frame of Reference (CFR) for European contract law. The European Parliament emphasizes that the content and the legal effect of the common frame of reference may range from a non-binding legislative tool to an optional instrument in European contract law. Such a policy statement calls for a social welfare and efficiency analysis as to whether norms of Union law are a foregone conclusion of comparative law efforts. Arguably, a comparative law assessment might also pave the way for more leniency towards the parties’ choice of law, subject to efficient conflict of law rules.

The legal historians’ concept of private law should not be taken as to deny the relevance of social welfare and efficiency for evolutionary processes. In focusing on common law traditions, it is implicitly assumed that the day-to-day practice of private law will bring forth stable and efficient concepts of law, not grounded on a well-targeted codification. It does not require much imagination to discern some structural overlap with the discussion on regulatory competition, unleashed by the judgments of the European Court of Justice on the freedom of establishment. Moreover, these rulings call for an initial assessment as to whether private international law efficiently balances conflicting regulatory concepts in the face of parties who do not externalize their costs. If the answer is in the affirmative, any in-depth reflection on additional Union law rules can be dispensed with.

The policy decision for centralized norms of Union law is predicated on the finding that nation-state regulation is ill-equipped to address inefficiencies between the Union and its Member States, and that the evolution of regulatory competition is disappointing. EU private law sensu stricto consists of the norms of the acquis communautaire, as evidenced, for example, by the directives on labour law, consumer protection and company law matters. It is only at this stage that norms of Union law will be exposed to a genuine in-depth efficiency analysis. Union norms are examined with the help of micro-economic models originating from extensive US literature on the economic analysis of private law.

3. Aspects of law-making and the division of powers between Member States and the Union

Union law allocates law-making powers to both the Member States and the Union. Although a cornerstone of the Union constitution, this allocation invites closer inspection by employing economic analysis of federal law-making systems. In the legal orders of continental Europe, codifications are public goods supplied by the respective national legislature. Public goods are prone to being submerged by the ‘tragedy of the commons’. Federal law-making systems are likely to witness the over-usage of a public good if one subordinate legal order ‘exports’ its standards to another member within the federation, creating (positive) discriminatory effects for the benefit of the former. Conventional wisdom suggests that disruptions in the supply of public goods may be overcome by corrective legislative action. Union law offers a different policy response. The country of origin principle is to avert opportunistic Member State behaviour and monopoly rents which a Member State may extract by favouring its own legal system over that of another Union member. Advocacy for the country of origin principle, however, is not driven by a genuine concern for efficiency criteria. There is no systematic observance of the parties’ freedom to choose a legal order as they see fit. Moreover, in its current form, the country of origin principle does not advance the concept of private ordering.

The jurisprudence of the European Court of Justice (ECJ) gives ample evidence on how to overcome an under-supply of public goods by allowing for autonomous party action (ie private ordering). The Court’s holdings on the freedom of establishment have brought a new freedom of choice for non-listed private companies (European private company (Societas Privata Europaea), Gesellschaft mit beschränkter Haftung (GmbH)). Interested parties may now choose their appropriate (and least burdensome) form of organization from the menu of Member State company laws. There is a micro-economic nucleus in the mechanism of having public goods privately produced. Private utility-maximization is employed to bring forth ‘optimal’ company law structures. The macro-economic ‘repercussions’ of this approach should not be ignored. A corrective regulatory intervention by the host state is inapposite as long as the parties do not externalize the costs of setting up a ‘foreign’ type of company. Conversely, the host country will only succeed in exporting its own standards if it copes with the challenges of regulatory competition. For practical purposes, the equilibrium between private ordering and rule-making, regulatory competition and Member States’ policy preferences should be established by invoking private international law rules of conflict. This includes a balancing test, where the costs of supplying the public good of ‘law’ are to be weighed against the negative externalities of private entrepreneurial activities.

In its jurisprudence, the European Court of Justice has never subscribed to a rigid implementation of efficiency considerations. Thus, European competition law is informed by a model of workable competition that pays tribute to the characteristics of European integration. The court has shown little inclination to systematically favour private utility maximization through privately produced public goods over Member State law-making. Undoubtedly, Member States are entitled to invoke overriding requirements relating to the general interest in order to implement redistributive policies with private law statutes. In practice, micro- and macroeconomic aspects of private ordering and private rule-making, and conflicts between Member State law-making and Union law will be calibrated within the context of the principle of proportionality. De facto (mandatory) national private law norms prevail over private rule-making on the basis of the laws of another Member State only if there is a lack of information on the relevant market.

4. EU private law—elimination of information asymmetries

Scholars of institutional economics will acquiesce to harmonized legal rules for federal systems if transaction costs arising from trade between various legal systems cannot be eliminated. This conclusion rests on two assumptions: 1) private rule-making (by private ordering or contract) has collapsed and 2) private international law conflict rules are unable to contain the constitutive uncertainty generated by regulatory differences among the private law systems of the Member States. The harmonization of substantive rules of private law then becomes imperative.

Day-to-day Union politics tend to justify EU private law norms by highlighting the need to overcome—through harmonization—obstacles on the way towards the internal market. Nonetheless, an integrationist approach should not frustrate the enquiry as to what extent decision-making processes are driven by specific public choice considerations or by organized interests (regulatory capture). If regulatory competition fails to produce an acceptable solution, a market failure is believed to exist which the Union has to address by standardizing norms. Regrettably, regulatory policies to facilitate intra-Union trade may also serve as a pretext for interfering with successful regulatory competition in order to cartelize law-making. Under these circumstances, the economic analysis of Union norms will reveal how far the Union has deviated from exemplary efficiency criteria for the benefit of regulatory policy considerations.

Union policies on consumer protection are most noted for implementing an informational model that discards mandatory rules in favour of advising individual customers on the consequences of their actions. Similar considerations can be discerned from the holdings of the ECJ on the freedom of establishment in company law. Nonetheless, the Commission cannot always resist the temptation to over-regulate. Prescribing more information is counterproductive if there is too much information on the marketplace. Conversely, imposing (additional) mandatory warranties may effectively result in a loss of information: existing warranties may be deprived of their signalling function, thereby provoking market failure. At this stage, a micro-economic analysis is most appropriate to ascertain whether harmonized legal rules will generate the efficiency gains claimed by the Union legislature. This analytical approach should also be applied to other legal interests identified by the Union legislature as candidates for harmonized private law rules. The controlling test is whether a (unified) norm of EU private law does in fact significantly lower the transaction costs which would otherwise arise under conditions of regulatory competition and free choice of law.


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Retrieved from Economic Analysis of European Private Law – Max-EuP 2012 on 27 January 2022.

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