A Philosophical Approach to the Economic Analysis of Contract Law

---

JODY KRAUS
A Philosophical Approach
to the Economic Analysis of
Contract Law
JODY KRAUS HAS DEVOTED MUCH OF HIS SCHOLARLY CAREER
to understanding the fi eld of contract theory. In Kraus’s view, con-
temporary contract theory began when Christopher Columbus Langdell
joined the Harvard Law School
faculty in 1870 and decided to
teach contracts. At that time
When Kraus fi rst started
contracts treatises were orga-
nized largely on the basis of the
teaching law, the dialogue
traditional common-law “forms
of action.” Although the forms of
between autonomy and
action had been abolished more
than 20 years earlier, Langdell
effi ciency theories was
was the fi rst legal academic to
attempt to understand how con-
one-way.
tract doctrines together might
comprise a distinct area of law
apart from their common procedural ancestry. When Langdell exam-
ined the contracts cases, he claimed to discern a set of legal rules that
were logically deducible from coherent legal principles.
Langdell’s inspired and historic attempt to understand contract law as
a principled and coherent body of law marked the inception not only of the
University of Virginia School of Law
| 7

---

A PHILOSOPHICAL APPROACH
modern American understanding of contract doctrine but of contemporary
contract theory as well. By the time Jody Kraus joined the University of
Virginia Law School faculty in 1990, the core of Langdell’s understanding
of American contract law remained viable, but Langdell’s vision of a uni-
fying contract theory had endured half a century of withering criticism.
Legal Realists and Critical Legal Studies scholars argued that express
judicial reasoning was mere window dressing, causally irrelevant to which
party prevailed in a dispute. According to the Realists, results actually
turned on informal commercial practices or the psychological idiosyncra-
sies or policy preferences of judges. According to CLS scholars, the rhetoric
of judicial decisions masked decisions based on politics. Pluralists, in turn,
argued that express legal reasoning was relevant to deciding common-law
cases but that no single theory could comprehend all the disparate values
that necessarily bear on those decisions. For pluralists, case outcomes
resulted from wise judgment, based on years of judicial experience, about
how to reconcile the multiple and often incommensurable values at stake
in adjudication. Legal Realism, CLS, and pluralism each argued, against
Langdell’s most basic conviction, that no area of law, including contract
law, could be rationalized under a set of coherent, let alone morally defen-
sible, principles.
Against this accumulating skepticism, two theoretical movements
emerged side-by-side in the last quarter of the 20th century. Building on
long traditions and recent developments in moral and political philosophy,
Charles Fried wrote his now classic monograph, “Contract as Promise.” In
Fried’s view, the basic core of American contract law could be explained and
justifi ed by the principle of autonomy: that everyone has equal value and
therefore an equal right to make, revise, and pursue their life plans subject
to the equal right of others to do the same. Contract law maximizes indi-
vidual autonomy by enabling individuals to undertake obligations to one
another, thereby expanding their life choices, without fear of detrimental
reliance. The legal enforcement of promises ensures that promise-breakers
compensate their victims for the harm they cause.
At the same time Fried was unifying contract law under the single moral
8 |
Virginia Journal Volume 9 | 2006

---

JODY KRAUS
principle of autonomy, Richard Posner and others had begun the economic
analysis of law. Posner argued that contract law could be explained and
justifi ed by a single principle of effi ciency. According to Posner, contract
law should be understood as part of a broader legal effort to provide indi-
viduals with incentives to take effi cient precautions and to enable them to
transfer resources to higher-valued uses. Specifi cally, Posner argued that
much of contract law consisted of “default” rules that allocated contractual
risks to the party who could bear it at least cost, even if that party had not
agreed to bear it. Posner ultimately claimed that much of law, and virtually
all of contract law, could be explained and justifi ed as a mechanism for
effi ciently allocating resources.
Both the autonomy and effi ciency theories of contract share Lang-
dell’s conviction that contract law can be explained and justifi ed as an
objectively reasoned and principled institution. They would therefore
seem to be kindred spirits, united by their unequivocal rejection of the
theory-skepticism that dominated much of the 20th century. When the
economic analysis of law fi rst emerged, however, autonomy theorists such
as Jules Coleman and Ronald Dworkin leveled deep philosophical objec-
tions to its explanatory and normative credentials. After an initial round
of responses by Posner and others, the autonomy theorists returned seem-
ingly decisive replies. Indeed, even Posner appeared to concede that he
had no satisfactory defense of the central idea of effi ciency as a normative
criterion for evaluating legal regimes. Yet despite the apparent victory of
the autonomy theorists, the economic analysis of contract law continued
unabated. Indeed, there is no question that economic analysis has been
and continues to be the dominant mode of analysis of American contract
law. While a few autonomy theorists of contract have continued to labor
in relative obscurity, their theories have never achieved prominence or
signifi cant infl uence in the American legal academy.
When Kraus fi rst started teaching law, the dialogue between autonomy
and effi ciency theories was one-way. The autonomy theorists continued to
raise fundamental fl aws with economic analysis. The economic analysts
ignored those criticisms and continued to produce analyses that became
University of Virginia School of Law
| 9

---

A PHILOSOPHICAL APPROACH
the legal academy’s received wisdom for contract doctrines. The core moti-
vation of Kraus’s scholarship is to understand contract theory from Langdell
through today’s debate between autonomy and effi ciency. His scholarship,
just as his teaching, is marked by intense intellectual rigor, curiosity, and a
willingness to take a fresh look at academic debates that seem stalled.
Kraus began with two contemporary puzzles. The fi rst is why the eco-
nomic analysis of contract law has thrived despite its failure to provide
a sustained, let alone compelling, response to the trenchant objections
autonomy theorists have leveled against it. The second is why autonomy
theories, despite their evident rigor and eminent philosophical credentials,
have not captured a greater audience in the American legal academy. Over
the years, Kraus’s scholarship has expanded to use the lens of contract
theory to examine the nature of legal theory in general.
Already a trained philosopher, Kraus had developed views in political
philosophy before he came to the legal academy. His fi rst scholarly efforts
were devoted to refi ning those views, which he published in his fi rst book,
The Limits of Hobbesian Contractarianism (1993). That book focuses on
the power of hypothetical consent to justify the exercise of political coer-
cion. Not coincidentally, one of the central normative claims of economic
analysis at that time was that hypothetical consent could justify a number
of legal doctrines and decisions. Kraus argued that, upon careful analysis,
even the most sophisticated efforts to explain the normative force of hypo-
thetical consent failed. Later, in “Political Liberalism and Truth,” 5 Legal
Theory 45 (1999) Kraus argued that John Rawls’ fi nal attempt to provide a
justifi cation for coercion could not avoid taking positions on the controver-
sial philosophical questions on which it claimed to remain agnostic.
Before comparing autonomy and effi ciency theories directly, Kraus
fi rst deepened his understanding of economic analysis by practicing it. In
“Decoupling Sales Law from the Acceptance-Rejection Fulcrum,” 104 Yale
L.J. 129 (1994), Kraus provided an original economic analysis of the cen-
tral doctrines of Article 2 of the U.C.C., arguing that current law should
be revised to facilitate more effi cient transactions. In “Legal Design and
the Evolution of Commercial Norms,” 26 J. Legal Stud. 377 (1997), Kraus
10 |
Virginia Journal Volume 9 | 2006

---

JODY KRAUS
challenged the conventional view that the evolution of informal commer-
cial practice would produce effi cient practices. That idea was based on
an analogy to the concept of “survival of the fi ttest” in biological evolu-
tionary theory. Using a state-of-the-art theory of the evolution of social
norms, Kraus demonstrated that ineffi cient evolution was not only possible
but likely, given the actual mechanisms for cultural evolution that would
operate on commercial norms. Just as biological evolution has produced
countless biological mechanisms that are obviously inferior to mechanisms
humans can design, so too commercial practices are often sub-optimal.
As a result, Kraus rejected the received view that commercial law should
without exception simply incorporate informal commercial norms. Instead,
Kraus argued that legal scholars should question the effi ciency of informal
practice and that law-makers should welcome careful attempts to design
new commercial law regimes.
Drawing on his understanding of philosophical theories of explanation
and justifi cation, Kraus then turned directly to analyzing the relation-
ship between autonomy and effi ciency contract theories. In “Reconciling
Autonomy and Effi ciency in Contract Law: The Vertical Integration
Strategy,” Philosophical Issues, supplement to Nous (2000), and “Legal
Theory and Contract Law: Groundwork for the Reconciliation of Autonomy
and Effi ciency in Contract Theory,” 1 J. S. Pol. & Legal Phil. 385 (2002),
he traced the fundamental confl ict between autonomy and effi ciency theo-
ries of contract law to the well-known divide between two different kinds
of moral theory. Kraus argued that “[a]s normative theories, economic
contract theories would seem to be logically incompatible with autonomy
contract theories for the same reason that consequentialist moral theories
are logically incompatible with deontological moral theories: The former
claim that moral justifi cation is solely a function of consequences, while
the latter claim that moral justifi cation is logically independent of conse-
quences.”
Kraus then identifi ed three strategies for reconciling these two
approaches. The fi rst is the convergence strategy, which “attempts to
demonstrate that effi ciency and autonomy contract theories happily con-
University of Virginia School of Law
| 11

---

A PHILOSOPHICAL APPROACH
verge in their normative assessment of most contract doctrines, even
though they do so on logically incompatible grounds.” The second is the
horizontal independence strategy, which reconciles both kinds of theories
“by construing them as making either different kinds of claims or claims
about different kinds of things.” For example, autonomy theories might
claim only to evaluate the justifi cation of contract law, while economic
theories might claim only to explain the content of contract law. Alterna-
tively, autonomy theories might claim to explain the express reasoning in
contracts cases, while economic theories might claim only to explain case
outcomes. Finally, the vertical integration strategy reconciles effi ciency
and autonomy contract theories by construing them as logically distinct
elements within one unifi ed theory. Ultimately, Kraus supports a verti-
cally integrated contract theory in which there is a “division of theoretical
labor” between autonomy and effi ciency principles. Kraus argues that effi -
ciency theories should play the role of providing fi ne-grained, institutional
prescriptions for the resolution of hard cases, in part because the vague-
ness of key moral concepts in autonomy theory often disable them from
accomplishing that task. On the other hand, Kraus claims autonomy theo-
ries should play the role of providing the moral justifi cation of contract law
because they are rooted in a philosophically credible moral theory. Unlike
autonomy theories, economic theories derive their justifi catory force
entirely from the principle of effi ciency, which long ago was discredited as
a free-standing moral principle.
In “Philosophy of Contract Law,” Jules L. Coleman and Scott Sha-
piro, eds., The Oxford Handbook of Jurisprudence and Philosophy of
Law (Oxford University Press, 2002), Kraus identifi ed four methodological
commitments that divide and defi ne contract theories. The fi rst issue is
whether express judicial reasoning should be viewed as legal theories or as
legal data for theories to explain. Economists offer theories to explain out-
comes and pay less attention to judicial explanation, while philosophers
focus on the reasoning offered by judges as the starting point for their own
accounts. The second methodological issue is the relative priority accorded
to explaining and justifying contract law. Kraus claims that “[t]he primary
12 |
Virginia Journal Volume 9 | 2006

---

JODY KRAUS
goal of deontic theories is to demonstrate that contract law is a morally and
politically legitimate institution, rather than to explain how contract law
determines outcomes in particular cases. In contrast, economic theories
are principally concerned with explaining how contract law determines
outcomes in particular cases.” The third methodological issue is whether
the theory aspires to explain the distinctiveness of contract law. As Kraus
explains, philosophers are much more concerned about what makes con-
tract law distinct than are economists. The fourth methodological issue
dividing autonomy and effi ciency theories is whether they take an ex post
or ex ante perspective on adjudication. Deontic theories take an ex post
perspective because they view adjudication as an occasion to resolve a
dispute by vindicating pre-existing rights. In contrast, economic theorists
take an ex ante perspective by viewing adjudication as an occasion for
prospective regulation.
Kraus concludes that these four differing methodological commitments
effectively demonstrate that autonomy and effi ciency theories of contract
are not really competing theories. Since their conceptions of what contract
law is (express doctrinal statements versus outcomes), what contract theo-
ries should do (explain versus justify contract law, explain or explain away
the distinctiveness of contract law), and the object of adjudication (retro-
spective dispute resolution versus prospective regulation) are so different,
these theories cannot be meaningfully compared. Thus, for example, when
effi ciency theories analyze the doctrine of consideration differently than
autonomy theories, there is no meaningful disagreement over the doctrine
of consideration. Instead, the real debate is the over the methodological
presuppositions to which each theory is committed.
Building on his previous views, Kraus then turned to the autonomy
theorists’ most trenchant criticism of effi ciency-based explanations of con-
tract and tort law. In “Transparency and Determinacy in Common Law
Adjudication: A Philosophical Defense of Explanatory Economic Analysis,”
__ Va. L. Rev. __ (forthcoming 2007), Kraus defends economic analysis
against the claim that it fails what philosophers have labeled “the transpar-
ency criterion.” That criterion holds that a legal theory’s explanation must
University of Virginia School of Law
| 13

---

A PHILOSOPHICAL APPROACH
provide a plausible account of the relationship between the reasoning it
claims judges actually use to decide cases and the express reasoning judges
provide in their opinions. The deontic theorists claim that the economic
analysis cannot satisfy the transparency criterion because the judicial rea-
soning in contracts cases is usually cast in deontic moral terms.
Kraus claims that effi ciency theories can account for the divergence
between the non-consequentialist, moral language of judicial opinions and
the consequentialist nature of economic analysis by offering an evolu-
tionary theory of how the terms in judicial opinions acquire their meaning.
In brief, Kraus’s claim is that while contract and tort law might have fi rst
evolved with the aspiration to apply common deontic moral concepts to
resolve disputes, the common law’s focus on hard cases, in which the moral
answer is unclear, forced judges to turn to consequentialist reasoning.
Since no clear moral answer resolved the disputes before them, judges nat-
urally used adjudication as an opportunity to set a sensible precedent for
regulating future conduct. As the common law evolved, judges came to use
deontic moral language to express essentially consequentialist reasoning.
The difference between the plain meaning of express judicial reasoning
and the best (economic) theory of the outcome of judicial decisions using
that reasoning is therefore only superfi cial. According to economic anal-
ysis, the real meaning of express judicial reasoning in hard cases is given
by economic, not deontic moral, theory.
Kraus also argues in this article that legal explanatory theories are
subject not only to the transparency criterion but also to two additional
criteria, which he calls “determinacy” and “normative force.” The deter-
minacy criterion holds that reasons fully explain an outcome only if they
determine it, and that all else being equal, more determinate explanations
are to be preferred to less determinate explanations. Since Kraus argues
that economic theories are better at explaining case outcomes than deontic
theories, they are preferred by the determinacy criterion. The normative
force criterion holds that the reasons that explain an outcome must also
constitute a plausible justifi cation for the outcome. Kraus argues that while
deontic theories can trace the normative force of their reasons directly to
14 |
Virginia Journal Volume 9 | 2006

---

JODY KRAUS
credible moral theories, economic analysis need not make the unsustain-
able claim that its normative force derives from the justifi catory power of
the principle of effi ciency. Instead, economic analysis can claim that its
reasons justify outcomes because of the role the principle of effi ciency
plays in the overall set of institutions sanctioned by the normative political
theory justifying political authority. Kraus recently expanded on the deter-
minacy criterion in “Determinacy and Justifi cation in Adjudication,” 48
Wm & Mary L. Rev. 4 (forthcoming 2007).
Finally, in “The Jurisprudential Origins of Contemporary Contract
Theory,” a work in progress, Kraus returns to the classic “death of con-
tract” debate famously begun by Grant Gilmore. Gilmore’s claim was that
Langdell and his fellow travelers in classical contract theory fraudulently
represented the content of contracts precedents in order to provide prec-
edential authority for what was, in fact, a wholly novel theory of contract
law. Kraus argues that Gilmore’s entire critique rests on the assumption
that the precedential authority of cases resides in their express judicial
reasoning rather than their outcomes. Yet Langdell and the classical theo-
rists clearly believed the precedential authority of cases resides in their
outcomes alone, and that express judicial reasoning is just one theory of
the doctrinal precedent set by those outcomes. Building on that insight,
Kraus demonstrates that the economic analysis of law is Langdell’s contem-
porary legacy. The economic analysis of contract law is equally committed
to Langdell’s twin jurisprudential convictions: that case outcomes are the
legal data express reasoning seeks but sometimes fails to explain and that
contract law can be explained and justifi ed by unifying it under a single set
of coherent principles. In short, Kraus shows that the economic analysis of
contract law is the classical theory of our day.
So how does Kraus answer the puzzles of autonomy and contract
theory? Economic analysis has thrived, despite its failure to respond to
deep philosophical criticism, because it does a better job of explaining
outcomes. Since lawyers and law professors prize the ability to explain
and predict outcomes above all else, the success of economic analysis in
explaining common-law cases explains its dominance in the legal academy.
University of Virginia School of Law
| 15

---