Intuition:a poor substitute for empirical evidence

There is too little economics in English commercial law, says Professor Roy Goode. He blames the narrowness of law courses and the short-termism of law makers

Legal systems round the world vary significantly in their approach to the role of the courts and to judicial reasoning.

In some jurisdictions the emphasis is on formal reasoning. Solutions to legal problems are found through the application of existing legal concepts and doctrines rather than by reference to economic, political or social considerations. Transactions are characterised according to the legal form in which they are cast rather than according to their economic substance and function.

In other countries, the concern is to ensure that the law reflects relevant policy and what is perceived to be the reality of transactions.

These fundamentally different approaches have been well described by Professor Patrick Atiyah and his co-author Professor Robert Summers, in their trail-blazing work Form and Substance in Anglo-American Law.

It is clear that while the English and US legal systems both employ a mixture of the two forms of approach, the emphasis in English law is very much on formal reasoning while in US law substantive reasoning is more important.

The US emphasis on substantive reasoning is scarcely surprising, given its constitutional framework and the fact that, in a federal system, the national law school has to take a broad view of legal issues and reflect this in its teaching trends across the country rather than engaging in minute analyses of local law.

Form versus substance is what divides the legal from the accountancy profession. Both legal and accounting conventions require that a company's accounts reflect a true and fair view of its financial position, but the accountant's view of truth is markedly different from that of the lawyer. The latter focuses on the legal form of a transaction, the former on its economic substance.

Of course, even in England form is not everything. The courts will not be bound by the label the parties attach to the transaction if it is a sham, in that it does not truly record what the parties have agreed, or if, although the agreement is genuine, the terms as a whole show that its legal character is other than that designated by the parties.

But where the transaction is not a sham the court will give it effect according to its terms and will not normally go outside the document to examine its economic substance or purpose except where it is so artificial as to possess no function apart from evasion of tax or other mandatory law.

An important aspect of the form versus substance debate is the role of economic theory in shaping commercial law.

As the result of the pioneering work of such scholars as Calabresi, Coase and Posner we have come to see that economic theory has a role to play in legal policy.

In particular, through the development of concepts of rational behaviour, it provides the tools by which we can evaluate the economic efficiency of law and predict more accurately the outcomes of particular legal rules.

There is no doubt that in our contract and commercial law we have regard to concepts of economic efficiency. These include, for example, the so-called “duty” of the innocent party to mitigate loss resulting from the guilty party's breach of contract; the limits on the right to hold a contract open for performance; the rule that a decree of specific performance will usually be inappropriate where damages are an adequate remedy; and the principle that risk should be imposed on the party best able to control it or to insure against it.

But these principles and rules are often applied intuitively rather than on the basis of hard evidence. In certain areas of decision-making, such as competition policy, economics plays an important role in England. However, it has had less influence on commercial law than in the US, where the law and economics movement was born.

This is, in part, due to the fact that the curricula for our university law courses are narrower and less multidisciplinary than they are in North America or in continental Europe.

That is a matter for regret. But there are other factors at work. We are not able, or at any rate not willing, to take law reform as seriously in this country as it is taken in the US. We live in an era of short-termism, in which reforms lacking political appeal are unlikely to engage the attention of politicians.

In addition, the preference for speedy results over sustained thought and investigation inhibits the work of even the most well-intentioned committee. Consequently, much of our legislation is based on anecdotal evidence and intuitive reasoning.

My view is that economics has a greater potential role to play in legislation than in litigation. Economic theories result from the construction of sophisticated models designed to predict the outcome of legislative or judicial law making.

But it is necessary to remember that these are only models and that they rest on certain hypotheses which do not necessarily correspond with external facts. Even if we were prepared to accept that the rational being actually exists, we would have to admit that the complexities of business life are such that no group of economists, however eminent, could expect to take into account all the myriad factors that go to making up a rational decision.

That is not a criticism of law and economics theory, because theories are, by nature, abstract, and it is precisely their generality that makes them useful. But theory needs to be tested against experience.

In addition, the law cannot be concerned solely with economic efficiency as the yardstick by which to measure the success of social goals.

There are other factors at work – moral, political and psychological – which have to be considered. Finally, there is the practical problem of reaching decisions within a limited time and without disproportionate expense.

It is this last problem, in particular, that limits the efficacy of economics as a tool for day-to-day litigation.

The admission of expert economic evidence in ordinary litigation would be likely to lead to protracted trials and greatly increased expense, with relatively few members of the judiciary on either side of the Atlantic having sufficient inter-disciplinary expertise to deal with such cases.

But what we can learn from at least an introductory study of law and economics is that intuition is a poor substitute for empirical evidence and that in seeking to move the law in a particular direction we should not be too ready to make assumptions that, for example, insurance is available and affordable or that the imposition of a liability will induce or discourage desirable or undesirable behaviour.

Let me conclude with an epigram from the poet Thomas Middleton, who anticipated Professor Ronald Coase by some 400 years in linking law and economics.

In The Phoenix, wrote Middleton: “Whoso loves the law dies either mad or poor.”

Professor Roy Goode is professor of law at St John's College Oxford. This piece is an extract from a series of Hamlyn lectures on “Commercial Law in the Next Millennium” which he gave last month and which will be published by Sweet & Maxwell in May 1998.