Legal rules and institutions: Coordination devices or restraints on behaviour?

In most examinations of legal systems, legal rules are viewed as restraining the behaviour of consumers and firms as they behave within market settings. For example, private property rights and nuisance law deter individuals from imposing uncompensated negative external costs on others. Contract law restrains opportunistic behaviour when unforeseen contingencies or unanticipated events occur. Using efficiency as the benchmark, the goal of the normative approach is to show that such restraints will lead to benefits which outweigh costs, relative to alternative rules and institutional arrangements.

An alternative but closely related view - which still sits firmly within the overall normative approach - is that legal rules serve as coordination devices between individuals, rather than as devices that restrain individual behaviour.4 Consider, for example, speed limits for automobiles.

One obvious role for speed limits is to restrain individuals from driving too fast. But another possible role is to coordinate behaviour. Lave (1985), for example, shows that there is a statistically significant relationship between the fatality rate and the variance of speed, rather than average speed, and suggests that this supports the view of speed limits as coordination devices, rather than restraining devices.

To understand the difference between the two possible ways in which legal rules may operate, consider the strategic game in Table 2.3.1. There are two individuals, 1 and 2. They both benefit if they drive at a fast speed, and their benefits are slightly lower if they both drive at slow speeds. But the worst outcomes occur when they drive at different speeds - if individual 1 is driving fast, then individual 2's slow driving imposes a negative externality on individual 1, since the flow of traffic is slower and it takes 1 more time to get to where he wants to go. Similarly, if individual 2 is driving at a slow speed, then individual 1's fast driving imposes a negative externality on individual 2.

The efficient outcome here is for both individuals to drive at a fast speed. But this is only one of two pure strategy Nash equilibria here. Setting a speed limit which drivers obey may serve as a coordination device for participants and does not alter their payoffs; it simply helps them choose among multiple equilibria, providing a focal point for individuals so that they voluntarily choose the best equilibrium action.

On the other hand, suppose that the role of speed limits is to restrain drivers from behaviour that would endanger others. Suppose that an accident is more likely if both drivers drive at a fast speed. In the game in Table 2.3.2, individual 1 benefits if he drives fast and individual 2 drives slow, but individual 2 is made worse off as a result of this. The efficient outcome is for both to drive at a slow speed, but the equilibrium is for both to drive at a fast speed. The role of speed limits in Table 2.3.2 is very different from the previous example: it is to somehow change the expected payoffs of individuals and restrain them, inducing them not to choose the equilibrium actions or to change the payoffs of the game so as to alter incentives and induce the players to choose the efficient outcome as an equilibrium.

Table 2.3.1 Payoffs from driving at different speeds: The coordination game

Individual 2

Individual 1

Fast

Slow

Fast

(100,100)

(20,10)

Slow

(10, 20)

(50,50)

Table 2.3.2 Payoffs from driving at different speeds: The restraining game

Individual 2

Individual 1

Fast

Slow

Fast

(30,30)

(60,10)

Slow

(10,60)

(50,50)

 
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