Economics, Law and Individual Rights

Economics, Law and Individual Rights This is the ﬁrst book to examine individual rights from an economic perspective, ...

Author: Hugo M. Mialon | Paul H. Rubin

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Economics, Law and Individual Rights

This is the ﬁrst book to examine individual rights from an economic perspective, collecting together leading articles in this emerging area of interest and showing the vibrant and expanding scholarship that relates them. Areas covered include: • • • • • •

The implications of constitutional protections of individual rights and freedoms, including freedom of speech and of the press, The right to bear arms, The right against unreasonable searches, The right against self-incrimination, The right to trial by jury, The right against cruel and unusual punishment, including capital punishment.

The focus of these papers is both theoretical and empirical, examining how economics can illuminate the entire sequence of crime and punishment, from the decision to commit a crime, to police methods for apprehending and arresting criminals, to the rules used in trials to the scope of punishment for the convicted. This book will be of interest to lawyers and legal scholars engaged in analyses of Constitutional Law, as well as students and researchers engaged with the economics of law. Hugo M. Mialon is Assistant Professor of Economics at Emory University. Paul H. Rubin is Samuel Candler Dobbs Professor of Economics and Law at Emory University and Editor in Chief of Managerial and Decision Economics.

THE ECONOMICS OF LEGAL RELATIONSHIPS Sponsored by the Michigan State University College of Law STATEMENT OF SCOPE The Economics of Legal Relationships is a book series dedicated to publishing original scholarly contributions that systematically analyze legal-economic issues. Each book can take a variety of forms: (1) It may be comprised of a collection of original articles devoted to a single theme, edited by a guest volume editor or co-editors. (2) An individual may wish to (co)author an entire volume. (3) It may be a collection of refereed articles derived from the Series Editors’ “call for papers” on a particular legal-economic topic. Each book in the series is published in hardback, approximately 250–300 pages in length and is dedicated to: •

• • • •

Formulate and/or critique alternative theories of law and economics— including—Chicago law and economics, the economics of property rights, institutionalist law and economics, neoinstitutionalist economics, public choice theory, Austrian law and economics, or social norms & law and economics. Analyze a variety of public policy issues related to the interface between (1) judicial decisions and/or statutory law and (2) the economy. Explore the economic impact of political and legal changes brought on by new technologies and/or environmental and natural resource concerns. Examine the broad array of legal/economic issues surrounding the deregulation/re-regulation phenomena. Analyze the systematic eﬀects of legal change on incentives and economic performance.

CALL FOR AUTHORS/VOLUME EDITORS/TOPICS An individual who is interested in either authoring an entire volume, or editing a future volume of The Economics of Legal Relationships should submit a 3–5-page prospectus to one of the series editors. Each prospectus must include: (1) the prospective title of the volume; (2) a brief description of the organizing theme of the volume whether single authored or edited; (3) an identiﬁcation of the line of literature from which the proposed topic

emanates, and (4) either a table of contents or, if edited, a list of potential contributors along with tentative titles of their contributions. Send prospectus to either series editor. Please note that the series editors only accept individual manuscripts for publication consideration in response to a speciﬁc “Call for Papers.” Send prospectus directly to either series editor: Professor Nicholas Mercuro Michigan State University College of Law East Lansing, MI 48824 phone: (517) 432–6897 e-mail [email protected]

Professor Michael D. Kaplowitz Michigan State University Department of Community Agriculture, Recreation, and Resource Studies East Lansing, MI 48824 phone: (517) 355–0101 e-mail [email protected]

Compensation for Regulatory Takings Thomas J. Miceli and Kathleen Segerson

The End of Natural Monopoly Deregulation and competition in the electric power industry Edited by Peter Z. Grossman and Daniel H. Cole

Dispute Resolution Bridging the settlement gap Edited by David A. Anderson The Law and Economics of Development Edited by Edgardo Buscaglia, William Ratliﬀ and Robert Cooter

Just Exchange: a Theory of Contract F. H. Buckley Network Access, Regulation and Antitrust Edited by Diana L. Moss

Fundamental Interrelationships Between Government and Property Edited by Nicholas Mercuro and Warren J. Samuels

Property Rights Dynamics A law and economics perspective Edited by Donatella Porrini and Giovanni Ramello

Property Rights, Economics, and the Environment Edited by Michael D. Kaplowitz

The Firm as an Entity Implications for economics, accounting and the law Edited by Yuri Biondi, Arnaldo Canziani and Thierry Kirat

Law and Economics in Civil Law Countries Edited by Thierry Kirat and Bruno Deﬀains

The Legal–Economic Nexus Warren J. Samuels Economics, Law and Individual Rights Edited by Hugo M. Mialon and Paul H. Rubin

*The ﬁrst three volumes listed above are published by and available from Elsevier

Economics, Law and Individual Rights

Edited by Hugo M. Mialon and Paul H. Rubin

First published 2008 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 This edition published in the Taylor & Francis e-Library, 2008. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” Routledge is an imprint of the Taylor & Francis Group, an informa business © 2008 selection and editorial matter, Hugo M. Mialon and Paul H. Rubin; individual chapters, the contributors. All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Economics, law, and individual rights / edited by Hugo M. Mialon and Paul H. Rubin. p. cm. – (The economics of legal relationships ; v. 14) Includes bibliographical references and index. 1. Civil rights–Economic aspects–United States. I. Mialon, Hugo M. II. Rubin, Paul H. KF4749.E26 2008 342.7308′5–dc22 2007034549 ISBN 0-203-93088-6 Master e-book ISBN

ISBN10: 0–415–77281–8 (hbk) ISBN10: 0–203–93088–6 (ebk) ISBN13: 978–0–415–77281–5 (hbk) ISBN13: 978–0–203–93088–5 (ebk)

Contents

List of ﬁgures List of tables Acknowledgements 1 Introduction

ix x xiii 1

HUGO M. MIALON AND PAUL H. RUBIN

2 The economics of the First Amendment: the market for goods and the market for ideas

6

R. H. COASE

3 An economic analysis of the law of false advertising

22

ELLEN R. JORDAN AND PAUL H. RUBIN

4 Freedom of speech vs. eﬃcient regulation in markets for ideas

31

ALBERT BRETON AND RONALD WINTROBE

5 A free press is bad news for corruption

49

AYMO BRUNETTI AND BEATRICE WEDER

6 The market for news

73

SENDHIL MULLAINATHAN AND ANDREI SHLEIFER

7 The impact of gun laws: a model of crime and self-defense

87

HUGO M. MIALON AND THOMAS WISEMAN

8 Crime, deterrence, and right-to-carry concealed handguns

107

JOHN R. LOTT, JR., AND DAVID B. MUSTARD

9 The eﬀect of concealed handgun laws on crime: beyond the dummy variables HASHEM DEZHBAKHSH AND PAUL H. RUBIN

129

viii Contents 10 Eﬀects of criminal procedure on crime rates: mapping out the consequences of the exclusionary rule

222

RAYMOND A. ATKINS AND PAUL H. RUBIN

11 An economic theory of the Fifth Amendment

248

HUGO M. MIALON

12 The eﬀects of a right to silence

271

DANIEL J. SEIDMANN

13 Noisy juries and the choice of trial mode in a sequential signalling game: theory and evidence

303

GERALD D. GAY, MARTIN F. GRACE, JAYANT R. KALE AND THOMAS H. NOE

14 Runaway judges? Selection eﬀects and the jury

328

ERIC HELLAND AND ALEXANDER TABARROK

15 Reasonable doubt and the optimal magnitude of ﬁnes: should the penalty ﬁt the crime?

355

JAMES ANDREONI

16 The deterrent eﬀect of capital punishment: a question of life and death

370

ISAAC EHRLICH

17 Does capital punishment have a deterrent eﬀect? New evidence from postmoratorium panel data

398

HASHEM DEZHBAKHSH, PAUL H. RUBIN AND JOANNA M. SHEPHERD

Index

427

Figures

5.1 8.1 10.1 14.1 14.2 15.1 15.2 15.3 17.1

Corruption and press freedom The eﬀect of concealed handguns on violent crimes Dynamic impact of Mapp Kernal estimation of all cases: judge and jury Estimation procedure Standard result of optimal deterrence Expected utility of a potential criminal Wealthy criminals and jail sentence Murder rates in executing and nonexecuting states

75 158 237 332 337 360 361 364 403

Tables

5.1

Dependent variable: average corruption from 1994 to 1998 5.2 Ordered probit estimation; dependent variable corruption in 1995 5.3 Sample tests and two-stage least-square estimates using various instruments 5.4 Testing the eﬀects of press freedom for alternative corruption measures 5.5 Testing alternative measures of press freedom (dependent variable: average corruption from 1994 to 1998) 5.6 Panel data evidence 5A.1 Descriptive statistics 5A.2 Correlation matrix 7.1 Normal form of the game of crime and self-defense 7.2 The game of crime and self-defense with full gun control 7.3 The game of crime and self-defense with a severe gun-crime penalty 8.1 Comparing the deviation in crime rates between states and by counties within states from 1977 to 1992 8.2 National sample means and standard deviations 8.3 The eﬀect of “shall issue” right-to-carry ﬁrearms laws on the crime rate 8.4 Questions of aggregating the data: national state-level crosssectional time-series evidence 8.5 The eﬀect of concealed handguns on victim costs: what if all states adopted “shall issue” laws? 8.6 Questions of aggregating the data: do law enforcement and “shall issue” laws have the same eﬀect in high and low crime areas? 8.7 Controlling for the fact that larger changes in crime rates are expected in the more populous counties where the change in the law constituted a bigger break with past policies

77 80 81 82 82 83 86 86 124 126 126 134 138 141 147 148

149

151

Tables 8.8

8.9 8.10 8.11 8.12 8.13

8.14 8.15

8.16 8.17

8.18 9.1 9.2 10.1 10.2 10.3 10.4 10.5 10.A1 11.1 11.2 11.3 13.1 13.2 13.3

Using other crime rates that are relatively unrelated to changes in “shall issue” rules as a method of controlling for other changes in the legal environment: controlling for robbery and burglary rates Rerunning the regressions on diﬀerences Controlling for other laws regulating gun use Regression estimates of the causes and eﬀects of the adoption of concealed handgun laws Changes in murder methods for counties over 100,000, 1982–91 Changes in composition of murder victims using annual state-level data from the uniform crime reports supplementary homicide reports, 1977–92 Oregon, Pennsylvania, and Arizona sample means and standard deviations Using Pennsylvania data on the number of permits issued to measure the diﬀerential impact of Pennsylvania’s 1989 “shall issue” law on diﬀerent counties: data for counties with populations over 200,000 Oregon data on the number of permits issued, the conviction rate, and prison sentence lengths Arizona data on the number of permits issued, the convicton rate, and prison sentence lengths, 1990–95 Did carrying concealed handguns increase the number of accidental deaths? County-level data, 1982–91 The predicted eﬀect of adopting concealed handgun laws on crimes in states without such laws in 1992 Determinants of the magnitude of the change in crime induced by concealed handgun laws Mean percentage change in total per capita crime rates Changes in crime rates by type: state data Changes in crime rates by type: city data Eﬀect of the Mapp and Gideon rulings on crime Eﬀect of the Wolf ruling on crime Percentage change in total per capita crime rates Likelihood matrix representing evidence quality Information structures without mandatory disclosure Information structures with mandatory disclosure Characterizations and empirical restrictions of equilibria in the choice between trial by bench or jury Proportion of defendants selecting trial by bench, Pˆ(B), in the the Florida Circuit Courts during 1982–1985 Proportion of defendants selecting trial by bench, Pˆ(B), in the Texas District Courts during 1981–1986

xi

154 156 160 164 171

172 174

178 180

183 186 213 216 223 229 231 234 236 239 253 253 255 314 316 317

xii

Tables

13.4

Conviction rates for trials by judges and juries in the Florida Circuit Courts during 1982–1985 13.5 Conviction rates for trials by judges and juries in the Texas District Courts during 1981–1986 13.6 Comparison of judge and jury verdicts in identical trials 14.1 Judge/jury diﬀerences (all trials) 14.2 Award regressions 14.3 Forum choice, trial, and win sequential probit results 14.4 Award equation results for Heckit estimation 14.5 Marginal eﬀects, judge and jury win equations 14.A1 Descriptive statistics 14.B1 Time to trial results 16.1 Behavioral implications 16.2 Variables used in the regression analysis, annual observations 1933–69 16.3 Modiﬁed ﬁrst diﬀerences of murder rates (in natural logarithms) regressed against corresponding modiﬁed ﬁrst diﬀerences of selected variables set 1 (1933–69) 16.4 Modiﬁed ﬁrst diﬀerences of murder rates (in natural logarithms) regressed against corresponding modiﬁed ﬁrst diﬀerences of selected variables set II: alternative time periods and other tests 17.1 Executions and executing states 17.2 Status of the death penalty 17.3 Two-stage least squares regression results for murder rate (Models 1–3) 17.4 Two-stage least squares regression results for murder rate (Models 4–6) 17.5 Estimates of the execution probability coeﬃcient under various speciﬁcations (robustness check)

318 319 321 331 333 341 344 347 348 350 373 384

385

386 401 402 411 412 418

Acknowledgements

We are very grateful to Bogdana Georgieva and Chang Liu for research assistance. Professor Ronald H. Coase and American Economic Association for permission to reproduce extracts from Coase, Ronald H. ‘The Market for Goods and the Market for Ideas’ (1974). 64 (2) American Economic Review 384–391. Copyright © 1974 American Economic Review. Professor Paul H. Rubin and The Journal of Legal Studies for permission to reproduce extracts from Rubin, Paul H. and Jordan, Ellen R. ‘An Economic Analysis of the Law of False Advertising’ (1979). 8 (3) Journal of Legal Studies 527–553. Copyright © 1979 The University of Chicago. All rights reserved. Professor Albert Breton, Professor Ronald Wintrobe and Elsevier Science for permission to reproduce extracts from Breton, Albert and Wintrobe, Ronald ‘Freedom of Speech vs. Eﬃcient Regulation in Markets for Ideas’ (1992). 17 (2) Journal of Economic Behavior & Organization 217–239. Copyright © 1992 Elsevier. Professor Aymo Brunetti and Elsevier for permission to reproduce extracts from Brunetti, Aymo and Weder, Beatrice ‘A free press is bad news for corruption’ (2003). 87 (7–8) Journal of Public Economics 1801–1824. Copyright © 2003 Elsevier. Professor Sendhil Mullainathan, Professor Andrei Shleifer and American Economic Association for permission to reproduce extracts from Mullainathan, Sendhil and Shleifer, Andrei ‘The Market for News’ (2005). 95 (4) American Economic Review 1031–1053. Copyright © 2005 American Economic Review. Professor Hugo M. Mialon, Professor Tom Wiseman and Elsevier for permission to reproduce extracts from Mialon, Hugo M. and Wiseman, Tom ‘The Impact of Gun Laws: A Model of Crime and Self-Defense’ (2005). 88 (2) Economic Letters 170–175. Copyright © 2005 Elsevier.

xiv Acknowledgements Professor John R. Lott, Jr., Professor David B. Mustard and The Journal of Legal Studies for permission to reproduce extracts from Lott, John R. Jr. and Mustard, David B. ‘Crime, Deterrence, and Right-to-Carry Concealed Handguns’ (1997). 26 (1) Journal of Legal Studies 1–68. Copyright © 1997 The University of Chicago. All rights reserved. Professor Paul H. Rubin and Elsevier for permission to reproduce extracts from Dezhbakhsh, Hashem and Rubin, Paul H. ‘The Eﬀect of Concealed Handgun Laws on Crime: Beyond the Dummy Variables’ (2003). 23 (2) International Review of Law and Economics 199–216. Copyright © 2003 Elsevier. Professor Paul H. Rubin and The Journal of Law and Economics for permission to reproduce extracts from Atkins, Raymond A. and Rubin, Paul H. ‘Eﬀects of Criminal Procedure on Crime Rates: Mapping Out the Consequences of The Exclusionary Rule’ (2003). 46 (1) Journal of Law and Economics 157–180. Copyright © 2003 The University of Chicago. All rights reserved. Professor Hugo M. Mialon and RAND Corporation for permission to reproduce extracts from Mialon, Hugo M. ‘An Economic Theory of the Fifth Amendment’ (2005). 36 (4) Rand Journal of Economics 833–848. Copyright © 2005 RAND Corporation. Professor Daniel Seidmann and Blackwell Publishing for permission to reproduce extracts from Seidmann, Daniel ‘The Eﬀects of a Right to Silence’ (2005). 72 (2) Review of Economic Studies 593–614. Copyright © 2005 Blackwell Publishing. Professor Gerald D. Gay, Professor Martin F. Grace; Professor Jayant R. Kale, Professor Thomas H Noe and RAND Corporation for permission to reproduce extracts from Gay, Gerald D. et al. ‘Noisy Juries and the Choice of Trial Mode in a Sequential Signalling Game: Theory and Evidence’ (1989). 20 (2) Rand Journal of Economics 196–213. Copyright © 1989 RAND Corporation. Professor Eric Helland, Professor Alexander Tabarrok and Oxford University Press for permission to reproduce extracts from Helland, Eric and Tabarrok, Alexander ‘Runaway Judges? Selection Eﬀects and the Jury’ (2000). 16 (2) The Journal of Law, Economics, & Organization 305–333. Copyright © 2000 Oxford University Press. Professor James Andreoni and RAND Corporation for permission to reproduce extracts from Andreoni, James ‘Reasonable Doubt and the Optimal Magnitude of Fines: Should the Penalty Fit the Crime?’ (1991). 22 (3) Rand Journal of Economics 385–395. Copyright © 1991 RAND Corporation. Professor Isaac Ehrlich and American Economic Association for permission to reproduce extracts from Ehrlich, Isaac ‘The Deterrent Eﬀect of Capital

Acknowledgements

xv

Punishment: A Question of Life and Death’ (1975). 65 (3) American Economic Review 397–417. Copyright © 1975 American Economic Review. Professor Paul H. Rubin and Oxford University Press for permission to reproduce extracts from Dezhbakhsh, Hashem, Shepherd, Joanna M. and Rubin, Paul H. ‘Does Capital Punishment Have a Deterrent Eﬀect?’ (2003). 5 (2) American Law and Economics Review 344–376. Copyright © 2003 Oxford University Press. Every eﬀort has been made to contact copyright holders for their permission to reprint selections in this book. The publishers would be grateful to hear from any copyright holders who is not here acknowledged and will undertake to rectify any errors or omissions in future editions of this book.

1

Introduction Hugo M. Mialon and Paul H. Rubin

This book brings together for the ﬁrst time the emerging but still small and fragmented literature that employs economics to analyze the implications of constitutional protections of individual rights and freedoms, including freedom of speech and of the press, the right to bear arms, the right against unreasonable searches, the right against selfincrimination, the right to trial by jury, and the right against cruel and unusual punishment. Most of these constitutional protections involve tradeoﬀs, including the balance between preserving freedom of speech and allowing harmful ideas to be communicated; between arming victims and arming criminals; between protecting against crime and invading individual privacy; and between punishing the guilty and punishing the innocent. Therefore, issues related to constitutional safeguards of individual rights are actually in the realm of economics, a science uniquely suited to the study of decisions involving tradeoﬀs between beneﬁts and costs. Several of the papers included in the book employ economic theory to analyze the social eﬃciency of policies related to these constitutional protections, and others formulate empirical models to estimate the eﬀects of these policies on measurable outcomes of concern to society. Many of the results are directly relevant to current debate and policy-making. These studies are brought together here for the ﬁrst time, resulting in a new, rigorous, and uniﬁed understanding about how best to protect important individual rights against encroachment by government. Studies of freedom of speech and of the press are presented ﬁrst because these freedoms are essential for creating and enforcing all other individual rights. Economic analysis of freedom of speech starts with the notion of a marketplace for ideas, formally introduced by Coase (1974). Free speech is free competition in an ideas market. If an ideas market fails to produce a socially optimal outcome, intervention to restrict speech in that market might be justiﬁed. However, as Breton and Wintrobe (1992) argue, restrictions on freedom of speech in an ideas market can lead to a monopoly on ideas, which can also lead to social ineﬃciency. Under monopoly restrictions on speech, ideas could be unduly repressed.

2

Hugo M. Mialon and Paul H. Rubin

The danger and costs of monopoly restrictions on freedom of speech are particularly high in the case of political speech. Political parties in power have a natural tendency to restrict the speech of their political rivals to retain their power. Moreover, speech is the principal means by which politicians compete for power. Restrictions on political speech could therefore directly paralyze political competition and result in a monopoly over governmental power. Abuse of such a monopoly would entail costs that could easily outweigh all other considerations. Restrictions on speech can also limit economic freedom. Rubin and Jordan (1979) show that there are costs to regulation of commercial speech, and that markets for advertising and other forms of commercial speech work well without regulation. Like restrictions on the freedom of political speech, restrictions on the freedom of the press can also limit political competition, and could even subvert democracy. If voters are not well informed about the actions of elected politicians, then the elected politicians are free to be corrupt. A free press might reduce the informational asymmetry, thereby curbing corruption. Brunetti and Weder (2003) empirically investigate the eﬀects of freedom of the press on aggregate measures of corruption across countries. Their results indicate that freedom of the press does indeed signiﬁcantly reduce corruption. Mullainathan and Shleifer (2005) show that with reader heterogeneity a free press will lead to a variety of views such that a reader could become accurately informed. Freedom of speech and freedom of the press are essential for creating and enforcing other rights. If a government can violate a right and nobody can hear of the violation, then the government incurs no cost from the violation. The freedoms of speech and of the press increase political competition and government accountability, which in turn determine the extent of all other individual rights. The rest of the book is devoted primarily to individual rights related to crime and punishment. Economic studies of the right to bear arms, the right against unreasonable searches, the right to trial by jury, and the right against cruel and unusual punishment are presented in that order. The studies are ordered by topic in a way that follows the history of a crime and its punishment—from decisions about methods used to commit or defend against a crime, to the behavior of police in seeking a criminal, to rules of trial, to punishment. In the ﬁrst stage of a crime, citizens choose whether to obtain a gun to commit or defend against a crime. Here, the individual’s right to bear arms comes into play. Mialon and Wiseman (2005) develop an economic model of crime and self-defense that provides a rationale both for having a basic right to bear arms and for regulating this right. An absolute prohibition on gun carrying would completely disarm both criminals and potential victims. Under such a rule, a criminal would not likely be severely hurt if he attacked a victim, since the victim would be unarmed. Moreover, the criminal’s chance

Introduction

3

of winning an unarmed confrontation could be quite high given the criminal’s ﬁrst-mover advantage. If the values of victims’ assets are suﬃciently high, criminals would then attack even though they do not have guns, leading victims to lie low to avoid losing their assets. Therefore, full gun control would lead to a situation in which potential victims usually lie low and suﬀer a large loss of freedom. Thus, a basic right to bear arms might be fundamental to individual freedom. However, once a basic right to bear arms is established, any further strengthening of the right involves an important social tradeoﬀ. Guns may have a “deterrent eﬀect” on crime, because criminals are less likely to attack if they fear an armed response. However, guns may also have a “facilitating eﬀect” on crime, because they may end up in the hands of criminals. Given this tradeoﬀ, it may be eﬃcient to regulate or limit gun carrying. If the deterrent eﬀect of guns is greater than the facilitating eﬀect of guns, then allowing guns will reduce crime. However, if the facilitating eﬀect is greater, then allowing guns will increase crime. Lott and Mustard (1997) examine the eﬀects of “shall-issue” laws on crime rates. These laws mandate the issuance of permits to carry concealed weapons for most adult non-felons requesting such licenses. The authors use a comprehensive panel data set of all counties in the United States from 1977 to 1992. They ﬁnd that allowing easy issuance of gun licenses led to very large reductions in crime. In other words, they ﬁnd that the “deterrent eﬀect” of guns greatly outweighed the “facilitating eﬀect.” Many studies in the literature have examined these results, and the paper remains controversial. Dezhbakhsh and Rubin (1998) ﬁnd that when the Lott–Mustard coeﬃcients for states that allow shall-issue laws are plugged into the data for states that do not allow the laws, the eﬀects on crime are small and ambiguous; some crimes in some states increase and some crimes in other states decrease. As of now, the weight of evidence is against the Lott–Mustard hypothesis, but more testing is still necessary. The Supreme Court will soon hear a challenge to the ruling that the District of Columbia law outlawing most guns possessed by civilians violates the Second Amendment. If the Court upholds this ruling, then the laws of many states will be overturned, and this will present an excellent opportunity to empirically test the eﬀect of gun control on crime rates. In the second stage of a crime, after each citizen has chosen whether and how to commit or defend against crime, evidence about whether a crime has been committed is generated, and the police choose whether to search a citizen based on the available evidence against him. Here, the individual’s right against unreasonable searches comes into play. In practice, the right against unreasonable searches is enforced through the exclusionary rule: if the police search a citizen when the evidence does not provide probable cause against the citizen, then any additional evidence that they uncover through the search is thrown out or excluded from court.

4

Hugo M. Mialon and Paul H. Rubin

The exclusionary rule might reduce police searches and increase individual privacy, but it might also increase crime. If the rule is enforced, we would expect the police not to violate the rule because they know that its violation will lead to losing the case. Instead, they will adapt by using methods other than searches to ﬁnd criminals. However, if searches are in some circumstances more eﬃcient, having to turn to substitute alternative methods will lead to lower arrest and conviction rates, and in turn to higher crime rates. Atkins and Rubin (2003) examine empirically the eﬀect of the exclusionary rule on crime rates in the United States. Precedent for the exclusionary rule in state crimes was set by the 1961 Supreme Court case of Mapp v. Ohio. Even before Mapp, exactly one half of the states had adopted a version of the exclusionary rule on their own. Atkins and Rubin ﬁnd that the 1961 ruling signiﬁcantly increased crime rates only in those states that did not previously have the exclusionary rule, controlling for other factors that might also aﬀect crime. The 1961 ruling caused an increase in most types of crime, including larceny, auto theft, burglary, robbery, and assault. These results suggest that rules enforcing the right against unreasonable searches have a signiﬁcant cost in terms of increased crime. However, these rules also protect against privacy invasion and police errors. From a social standpoint, the right against unreasonable searches should be strengthened up to the point where the marginal social beneﬁts in terms of reduced privacy invasion and police errors are exactly equal to the marginal social costs in terms of reduced security. In the third stage of a crime, after police have chosen whether to search and arrest a citizen, a citizen who is arrested must choose whether to disclose possibly incriminating evidence to police and prosecutors before and at trial. Here, the individual’s right to remain silent comes into play. Seidmann (2005) and Mialon (2005) analyze the eﬃciency of a right to silence, which attempts to block any adverse inference from a criminal suspect’s or defendant’s silence in the face of accusation. Seidmann shows that given the possibility of perjury, a right to silence can beneﬁt the innocent even if the right is exercised only by the guilty. Without a right to silence, the guilty might be forced to lie and make false exculpatory statements. Then the innocent would not be able to signal their innocence to the jury by making exculpatory statements since the guilty would also make such statements. As a result, the jury would not be able to distinguish the innocent from the guilty from their statements, and the innocent might be convicted. However, with a right to silence, the guilty would exercise the right and remain silent. Then, the innocent could signal their innocence through exculpatory statements, and would be less likely to be convicted. As Mialon argues, the innocent might also beneﬁt from a right to silence more directly. The accuracy of the evidence regarding a defendant’s culpability is rarely perfect. Even if the defendant is innocent, the evidence might indicate that he is guilty, in which case he would choose to remain silent if lying is not an option. Moreover, the defendant might not know the

Introduction

5

evidence, in which case he would have to remain silent. In either case, the innocent defendant might be wrongfully convicted if the adverse inference from silence is not blocked, but rightfully acquitted if it is blocked. Thus, even without the possibility of perjury, a right to silence can reduce wrongful convictions and help the innocent. Of course, a right to silence can also help the guilty. If a guilty defendant does not know the evidence, or knows the evidence and it correctly indicates that he is guilty, he might be rightfully convicted without the right to silence, but wrongfully acquitted with it. By reducing convictions, a right to silence might reduce wrongful convictions, but only at the expense of increasing wrongful acquittals. A right to silence might directly improve social welfare if society prefers a wrongful acquittal suﬃciently more than a wrongful conviction. However, a right to silence can only directly increase social welfare if the jury’s preferences are biased relative to society’s preferences. If the jury’s and society’s preferences over court outcomes coincide, and the jury rationally takes into account all available evidence, then the jury’s decision problem is the same as society’s. Thus, preventing the jury from making a rational inference from silence cannot improve social welfare. If some juries are unduly biased against a defendant, a right to silence can, but still need not, improve welfare. A right to silence is more likely to enhance welfare if the police are more corrupt or biased. Innocent suspects are more likely to end up in court if the police are prejudiced or they disregard rights of suspects in their investigations. In such circumstances, more innocent defendants end up in court and stand to beneﬁt from a right to silence. Thus, if jury and police discrimination is more of a problem, a right to silence is more likely to improve welfare. In the fourth stage of a crime, after the defendant and prosecutor have chosen what evidence to present, the judge or jury evaluates the evidence and chooses whether to convict the defendant. Here, the right to trial by jury comes into play. A jury might evaluate the evidence diﬀerently than a judge, and therefore might arrive at a diﬀerent verdict. The right of defendants to have their criminal culpability determined by a jury of their peers is a safeguard against overzealous prosecutors and biased judges. Imposing an all-judge system in criminal cases might be inconsistent with the objective of trial fairness. But then, why not impose an all-jury system? Gay et al. (1989) argue that a right to unilaterally waive a jury trial increases the accuracy of trial outcomes relative to a system in which jury trials are mandated. In general, juries might not process evidence as eﬃciently as judges; that is, juries might be “noisier” than judges. As long as this is the case, the right to waive a jury trial strictly beneﬁts the innocent, because waiving the right allows them access to a more accurate fact-ﬁnder. Therefore, innocent defendants are always better oﬀ in a system with the right to waive a jury trial than in an all-jury system. Moreover, conviction rates for the guilty would be the same under both systems, because the guilty would

6 Hugo M. Mialon and Paul H. Rubin rationally choose jury trials even when they had the right to waive a jury trial, since juries are more likely to make mistakes than judges. Therefore, the right to waive a jury trial enhances the objective of trial accuracy. Helland and Tabarrok (2000) empirically investigate the eﬀects of the right to trial by jury in civil cases. Awards granted by juries are signiﬁcantly higher on average than awards granted by judges. Moreover, plaintiﬀs are more likely to win cases before juries than before judges. However, the authors ﬁnd that much of these diﬀerences can be attributed to the types of cases that are brought before judges and juries. Juries tend to see more high-award cases, such as medical malpractice and product liability cases, whereas judges tend to see more low-award cases, such as premises liability cases. This is an example of the economic signiﬁcance of a non-criminal constitutional protection. In the ﬁfth stage of a crime, if the judge or jury has decided to convict the defendant, the nature and severity of the punishment are determined. Here, the right against cruel and unusual punishment comes into play. Punishment that is excessive relative to the severity of the oﬀense is deemed cruel and unusual. Capital punishment might also be considered cruel and unusual. Andreoni (1991) shows that scaling the punishment according to the severity of the oﬀense is eﬃcient if maximal deterrence is the objective. As the punishment increases, the cost of convicting an innocent person increases, while the cost of acquitting a guilty person remains the same, so rational juries are less likely to convict. There is a maximal punishment beyond which jurors are not willing to convict at all. However, the cost of acquitting a guilty person is higher if the severity of the oﬀense is higher. Therefore, if the oﬀense is more severe, the maximal punishment at which jurors are still willing to convict is higher. Hence, the punishment scheme that ensures maximal deterrence is one in which the severity of punishment grows with the severity of the oﬀense. An increase in the severity of punishment could deter more potential criminals from committing crime as long as it does not reduce the probability of conviction too much. However, it would also result in a harsher punishment for wrongly convicted innocent people, which will be inevitable since the justice system is not perfectly accurate. Therefore, there is a potential tradeoﬀ between deterrence and wrongful punishment. It is diﬃcult to estimate the frequency of wrongful convictions, because in many cases, culpability can never be ascertained completely. However, it is possible to measure the deterrent eﬀects of punishments. Ehrlich (1975) provides the ﬁrst empirical analysis by an economist of the deterrent eﬀects of capital punishment. This work was highly controversial and led to extensive additional analysis, most of it a reanalysis of Ehrlich’s data. Results have been mixed: several authors found a deterrent eﬀect, while several did not. Recently, several more authors have reexamined the possibility of a deterrent eﬀect using more advanced statistical techniques than those used by Ehrlich, and analyzing more complete data.

Introduction

7

Dezhbakhsh, Rubin and Shepherd (2003) examine the deterrent eﬀect of capital punishment using county-level panel data from 3,054 U.S. counties over the period 1977–1996. This study ﬁnds a substantial deterrent eﬀect; both death row sentences and executions result in decreases in the murder rate. A conservative estimate is that each execution results in, on average, 18 fewer murders. The main ﬁnding, that capital punishment has a deterrent eﬀect, is robust to several diﬀerent ways of performing the statistical analysis and to several ways of measuring the probability of an execution. Several other studies ﬁnd similar results, although there has also been heavy criticism of these results in the literature. The papers collected in this book demonstrate how economics can be fruitfully applied to analyze individual rights and freedoms. We believe that this is a very fruitful area for further research. For example, game-theoretic analysis can be applied to additional legal protections, since the adversarial legal system exactly lends itself to this form of analysis. One area of research that could be fruitfully explored is the interaction between various rights. For example, the right to avoid illegal searches is much more valuable because of the right to legal representation at trial, and conversely. Additional exploration of such interactions would be very productive. It should also be possible to empirically analyze the eﬀects of various Supreme Court rulings. This would be especially useful in cases where the Court ruling aﬀects different states diﬀerently because this would create a natural experiment that can be exploited for additional insights.

References Andreoni, James (1991). “Reasonable Doubt and the Optimal Magnitude of Fines: Should the Penalty Fit the Crime?,” RAND Journal of Economics, Vol. 22, 385–395. Atkins, Raymond A. and Rubin, Paul H. (2003). “Eﬀects of Criminal Procedure on Crime Rates: Mapping Out the Consequences of The Exclusionary Rule,” Journal of Law and Economics, Vol. 46, 157–180. Breton, Albert and Wintrobe, Ronald (1992). “Freedom of Speech vs. Eﬃcient Regulation in Markets for Ideas,” Journal of Economic Behavior and Organization, Vol. 17, 217–239. Brunetti, Aymo and Weder, Beatrice (2003). “A Free Press is Bad News for Corruption,” Journal of Public Economics, Vol. 87, 1801–1824. Coase, Ronald H. (1974). “The Market for Goods and the Market for Ideas,” American Economic Review, Vol. 64, 384–391. Dezhbakhsh, Hashem and Rubin, Paul H. (1998). “Lives Saved or Lives Lost: The Eﬀect of Concealed Handgun Laws on Crime,” American Economic Review, Vol. 88, 468–474. Dezhbakhsh, Hashem, Rubin, Paul H. and Shepherd, Joanna M. (2003). “Does Capital Punishment Have a Deterrent Eﬀect?,” American Law and Economics Review, Vol. 5, 344–376. Ehrlich, Isaac (1975). “The Deterrent Eﬀect of Capital Punishment: A Question of Life and Death,” American Economic Review, Vol. 65, 397–417.

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Gay, Gerald D., Grace, Martin F., Kale, Jayant R. and Noe, Thomas H. (1989). “Noisy Juries and the Choice of Trial Mode in a Sequential Signalling Game: Theory and Evidence,” RAND Journal of Economics, Vol. 20, 196–213. Helland, Eric and Tabarrok, Alexander (2000). “Runaway Judges? Selection Eﬀects and the Jury,” Journal of Law, Economics, and Organization, Vol. 16, 306–333. Lott, John R. Jr. and Mustard, David B. (1997). “Crime, Deterrence, and Right-toCarry Concealed Handguns,” Journal of Legal Studies, Vol. 26, 1–68. Mialon, Hugo M. (2005). “An Economic Theory of the Fifth Amendment,” RAND Journal of Economics, Vol. 36, 833–848. Mialon, Hugo M. and Wiseman, Tom (2005). “The Impact of Gun Laws: A Model of Crime and Self-Defense,” Economics Letters, Vol. 88, 170–175. Mullainathan, Sendhil and Shleifer, Andrei (2005). “The Market for News,” American Economic Review, Vol. 95, 1031–1053. Rubin, Paul H. and Jordan, Ellen R. (1979). “An Economic Analysis of the Law of False Advertising,” Journal of Legal Studies, Vol. 8, 527–553. Seidmann, Daniel (2005). “The Eﬀects of a Right to Silence,” Review of Economic Studies, Vol. 72, 593–614.

2

The economics of the First Amendment The market for goods and the market for ideas R. H. Coase

The normal treatment of governmental regulation of markets makes a sharp distinction between the ordinary market for goods and services and the activities covered by the First Amendment—speech, writing, and the exercise of religious beliefs—which I call, for brevity, “the market for ideas.” The phrase, “the market for ideas,” does not describe the boundaries of the area to which the First Amendment has been applied very exactly. Indeed, these boundaries do not seem to have been very clearly drawn. But there can be little doubt that the market for ideas, the expression of opinion in speech and writing and similar activities, is at the center of the activities protected by the First Amendment, and it is with these activities that discussion of the First Amendment has been largely concerned. The arguments that I will be considering long antedate the passage of the First Amendment (which obviously incorporated views already held) and there is some danger for economists, although not necessarily for American lawyers, in conﬁning our discussion to the First Amendment rather than considering the general problem of which it is a part. The danger is that our discussion will tend to concentrate on American court opinions, and particularly those of the Supreme Court, and that, as a result, we will be led to adopt the approach to the regulation of markets found congenial by the courts rather than one developed by economists, a procedure which already has gone a long way to ruin public utility economics and has done much harm to economic discussion of monopoly problems generally. This approach is conﬁning in another way, since, by concentrating on issues within the context of the American Constitution, it is made more diﬃcult to draw on the experience and thought of the rest of the world. What is the general view that I will be examining? It is that, in the market for goods, government regulation is desirable whereas, in the market for ideas, government regulation is undesirable and should be strictly limited. In the market for goods, the government is commonly regarded as competent to regulate and properly motivated. Consumers lack the ability to make the appropriate choices. Producers often exercise monopolistic power and, in any case, without some form of government intervention, would not act in a way which promotes the public interest. In the market for ideas, the position

10

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is very diﬀerent. The government, if it attempted to regulate, would be ineﬃcient and its motives would, in general, be bad, so that, even if it were successful in achieving what it wanted to accomplish, the results would be undersirable. Consumers, on the other hand, if left free, exercise a ﬁne discrimination in choosing between the alternative views placed before them, while producers, whether economically powerful or weak, who are found to be so unscrupulous in their behavior in other markets, can be trusted to act in the public interest, whether they publish or work for the New York Times, the Chicago Tribune or the Columbia Broadcasting System. Politicians, whose actions sometimes pain us, are in their utterances beyond reproach. It is an odd feature of this attitude that commercial advertising, which is often merely an expression of opinion and might, therefore, be thought to be protected by the First Amendment, is considered to be part of the market for goods. The result is that government action is regarded as desirable to regulate (or even suppress) the expression of an opinion in an advertisement which, if expressed in a book or article, would be completely beyond the reach of government regulation. This ambivalence toward the role of government in the market for goods and the market for ideas has not usually been attacked except by those on the extreme right or left, that is, by fascists or communists. The Western world, by and large, accepts the distinction and the policy recommendations that go with it. The peculiarity of the situation has not, however, gone unnoticed, and I would like to draw your attention to a powerful article by Aaron Director. Director quotes a very strong statement by Justice William O. Douglas in a Supreme Court opinion, a statement which is no doubt intended as an interpretation of the First Amendment, but which obviously embodies a point of view not dependent on constitutional considerations. Justice Douglas said: “free speech, free press, free exercise of religion are placed separate and apart; they are above and beyond the police power; they are not subject to regulation in the manner of factories, slums, apartment houses, production of oil and the like” (Beauharnis v. Illinois). Director remarks of the attachment to free speech that it is “the only area where laissez-faire is still respectable.” Why should this be so? In part, this may be due to the fact that belief in a free market in ideas does not have the same roots as belief in the value of free trade in goods. To quote Director again: “The free market as a desirable method of organizing the intellectual life of the community was urged long before it was advocated as a desirable method of organizing its economic life. The advantage of free exchange of ideas was recognized before that of the voluntary exchange of goods and services in competitive markets.” In recent years, particularly, I think in America (that is, North America), this view of the peculiar status of the market for ideas has been nourished by a commitment to democracy as exempliﬁed in the political institutions of the United States, for whose eﬃcient working a market in ideas not subject to government regulation is considered essential. This opens a large subject on

The market for goods and the market for ideas

11

which I will avoid comment. Suﬃce it to say that, in practice, the results actually achieved by this particular political system suggest that there is a good deal of “market failure.” Because of the view that a free market in ideas is necessary to the maintenance of democratic institutions and, I believe, for other reasons also, intellectuals have shown a tendency to exalt the market for ideas and to depreciate the market for goods. Such an attitude seems to me unjustiﬁed. As Director said: “the bulk of mankind will for the foreseeable future have to devote a considerable fraction of their active lives to economic activity. For these people, freedom of choice as owners of resources in choosing within available and continually changing opportunities, areas of employment, investment, and consumption is fully as important as freedom of discussion and participation in government.” I have no doubt that this is right. For most people in most countries (and perhaps in all countries), the provision of food, clothing, and shelter is a good deal more important than the provision of the “right ideas,” even if it is assumed that we know what they are. But leave aside the question of the relative importance of the two markets; the diﬀerence in view about the role of government in these two markets is really quite extraordinary and demands an explanation. It is not enough merely to say that the government should be excluded from a sphere of activity because it is vital to the functioning of our society. Even in markets which are mainly of concern to the lower orders, it would not seem desirable to reduce the eﬃciency with which they work. The paradox is that government intervention which is so harmful in the one sphere becomes beneﬁcial in the other. The paradox is made even more striking when we note that at the present time it is usually those who press most strongly for an extension of government regulation in other markets who are most anxious for a vigorous enforcement of the First Amendment prohibitions on government regulation in the market for ideas. What is the explanation for the paradox? Director’s gentle nature does not allow him to do more than hint at it: “A superﬁcial explanation for the preference for free speech among intellectuals runs in terms of vertical interests. Everyone tends to magnify the importance of his own occupation and to minimize that of his neighbor. Intellectuals are engaged in the pursuit of truth, while others are merely engaged in earning a livelihood. One follows a profession, usually a learned one, while the other follows a trade or a business.” I would put the point more bluntly. The market for ideas is the market in which the intellectual conducts his trade. The explanation of the paradox is self-interest and self-esteem. Self-esteem leads the intellectuals to magnify the importance of their own market. That others should be regulated seems natural, particularly as many of the intellectuals see themselves as doing the regulating. But self-interest combines with self-esteem to ensure that, while others are regulated, regulation should not apply to them. And so it is possible to live with these contradictory views about the role of

12

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government in these two markets. It is the conclusion that matters. It may not be a nice explanation, but I can think of no other for this strange situation. That this is the main explanation for the dominance of the view that the market for ideas is sacrosanct is certainly supported if we examine the actions of the press. The press is, of course, the most stalwart defender of the doctrine of freedom of the press, an act of public service to the performance of which it has been led, as it were, by an invisible hand. If we examine the actions and views of the press, they are consistent in only one respect: they are always consistent with the self-interest of the press. Consider their argument that the press should not be forced to reveal the sources of its published material. This is termed a defense of the public’s right to know— which is interpreted to mean that the public has no right to know the source of material published by the press. To desire to know the source of a story is not idle curiosity. It is diﬃcult to know how much credence to give to information or to check on its accuracy if one is ignorant of the source. The academic tradition, in which one discloses to the greatest extent possible the sources on which one relies and thus exposes them to the scrutiny of one’s colleagues, seems to me to be sound and an essential element in the search for truth. Of course, the counterargument of the press is not without validity. It is argued that some people would not express their opinions honestly if it became known that they really held these opinions. But this argument applies equally to all expressions of views, whether in government, business, or private life, where conﬁdentiality is necessary for frankness. However, this consideration has commonly not deterred the press from revealing such conﬁdences when it was in their interest to do so. Of course, it would also impede the ﬂow of information to reveal the sources of the material published in cases in which the transmission of the information involved a breach of trust or even the stealing of documents. To accept material in such circumstances is not consistent with the high moral standards and scrupulous observance of the law which the press expects of others. It is hard for me to believe that the main thing wrong with the Watergate aﬀair was that it was not organized by the New York Times. I would not wish to argue that there are not conﬂicting considerations in all these cases which are diﬃcult to evaluate. My point is that the press does not ﬁnd them diﬃcult to evaluate. Consider another example which is in many ways more striking: the attitude of the press to government regulation of broadcasting. Broadcasting is an important source of news and information; it comes within the purview of the First Amendment. Yet the program content of a broadcasting station is subject to government regulation. One might have thought that the press, devoted to the strict enforcement of the First Amendment, would have been constantly attacking this abridgment of the right of free speech and expression. But, in fact, they have not. In the forty-ﬁve years which have passed since the formation of the Federal Radio Commission (now transformed into the Federal Communications Commission), very few doubts about the policy have been expressed in the press. The press, which is so

The market for goods and the market for ideas

13

anxious to remain unshackled by government regulation, has never exerted itself to secure a similar freedom for the broadcasting industry. Lest you think that I manifest a hostility to the American press, I would like to point out that the British press has acted in a similar fashion. In this case the contrast between actions and proclaimed beliefs is even stronger since what was established in Britain was a government-controlled monopoly of a source of news and information. It might have been thought that this aﬀront to the doctrine of freedom of the press would have appalled the British press. It did not. They supported the broadcasting monopoly, mainly, as far as I can see, because they saw the alternative to the British Broadcasting Corporation (BBC) as commercial broadcasting and, therefore, as involving increased competition for advertising revenue. But if the press did not want competition for advertising revenue, they also did not want increased competition in the supply of news. And so they did their best to throttle the BBC, at least as a purveyor of news and information. When the monopoly was originally established (when it was still the British Broadcasting Company), the BBC was prohibited from broadcasting news and information unless obtained from certain named news agencies. No news could be broadcast before 7 p.m. and broadcasts likely to aﬀect adversely the sale of newspapers faced other restrictions as well. Gradually, over the years, these restrictions were relaxed as a result of negotiations between the press and the BBC. But it was not until after the outbreak of World War II that the BBC broadcast a regular news bulletin before 6 p.m.1 But, it may be argued, the fact that businessmen are mainly inﬂuenced by pecuniary considerations is no great discovery. What else would one expect from the money-grubbers of the newspaper world? Furthermore, it may be objected, because a doctrine is propagated by those who beneﬁt from it does not mean that the doctrine is unsound. After all, have not free speech and a free press also been advocated by high-minded scholars whose beliefs are determined by what is true rather than by more sordid considerations? There has surely never been a more high-minded scholar than John Milton. As his Areopagitica “for the liberty of unlicensed printing” is probably the most celebrated defense of the doctrine of freedom of the press ever written, it seemed to me that it would be worthwhile to examine the nature of his argument for a free press. Milton’s work has another advantage for my purpose. Written in 1644, that is, long before 1776, we can see the character of the argument before there was any general understanding of how competitive markets worked and before the emergence of modern views on democracy. It would be idle for me to pretend that I could act as a guide to Milton’s thought. I know too little of seventeenth century England and there is much in Milton’s pamphlet the meaning of which I cannot discern. Yet, there are passages which leap across the centuries and for whose interpretation no scholarship is needed. As one would expect, Milton asserts the primacy of the market for ideas: “Give me the liberty to know, to utter, and to argue freely according to

14

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conscience, above all liberties” (p. 44). It is diﬀerent from the market for goods and should not be treated in the same way: “Truth and understanding are not such wares as to be monopolised and traded in by tickets and statutes and standards. We must not think to make a staple commodity of all the knowledge in the land, to mark and license it like our broadcloth and our woolpacks” (p. 29). The licensing of printed material is an aﬀront to learned men and to learning: “When a man writes to the world, he summons up all his reason and deliberation to assist him; he searches, mediates, is industrious, and likely consults and confers with his judicious friends; after all which done he takes himself to be informed in what he writes, as well as any that writ before him. If in this the most consummate act of his ﬁdelity and ripeness no years, no industry, no former proof of his abilities can bring him to that state of maturity as not to be still mistrusted and suspected, unless he carry his considerate diligence, all his midnight watchings . . . to the hasty view of an unleisured licenser, perhaps much his younger, perhaps far his inferior in judgment, perhaps one who never knew the labour of book-writing, and, if he be not repulsed or slighted, must appear in print like a puny with his guardian and his censor’s hand on the back of his title to be his bail and surety, that he is no idiot or seducer, it cannot be but a dishonour and derogation to the author, to the book, to the privilege and dignity of learning” (p. 27). Licensing is also an aﬀront to the common people: “Nor is it to the common people less than a reproach; for if we be so jealous over them, as that we dare not trust them with an English pamphlet, what do we but censure them for a giddy, vicious, and ungrounded people, in such a sick and weak state of faith and discretion, as to be able to take nothing down but through the pipe of a licenser” (p. 30). In the market for ideas, the right choices are made: “Let [truth] and falsehood grapple; who ever knew Truth put to the worse in a free and open encounter” (p. 45). Those who undertake the job of licensing will be incompetent. A licenser should be, according to Milton, “studious, learned, and judicious.” But this is not what we are likely to get: “we may easily foresee what kind of licensers we are to expect hereafter: either ignorant, imperious, and remiss, or basely pecuniary” (p. 25). The licensers are more likely to suppress truth than falsehood: “if it come to prohibiting, there is aught more likely to be prohibited than truth itself; whose ﬁrst appearance to our eyes bleared and dimmed with prejudice and custom is more unsightly and unplausible than many errors . . .” (p. 47). Nor does Milton fail to tell us that the licensing scheme against which he was writing came about as a result of industry pressure: “And how it got the upper hand . . . there was in it the fraud of some old patentees and monopolisers in the trade of bookselling” (p. 50). In the formation of Milton’s views, self-interest may perhaps have played a

The market for goods and the market for ideas

15

part, but there can be little doubt that his argument embodies a good deal of intellectual pride of the kind to which Director refers. The writer is a learned man, diligent and trustworthy. The licenser would be ignorant, incompetent, and basely motivated, perhaps “younger” and “inferior in judgment.” The common man always chooses truth as against falsehood. The picture is a little too one-sided to be wholly convincing. And if it has been convincing to the intellectual community (and apparently it often has), it is surely because people are easily persuaded that what is good for them is good for the country. I do not believe that this distinction between the market for goods and the market for ideas is valid. There is no fundamental diﬀerence between these two markets and, in deciding on public policy with regard to them, we need to take into account the same considerations. In all markets, producers have some reasons for being honest and some for being dishonest; consumers have some information but are not fully informed or even able to digest the information they have; regulators commonly wish to do a good job, and though often incompetent and subject to the inﬂuence of special interests, they act like this because, like all of us, they are human beings whose strongest motives are not the highest. When I say that the same considerations should be taken into account, I do not mean that public policy should be the same in all markets. The special characteristics of each market lead to the same factors having diﬀerent weights, and the appropriate social arrangements will vary accordingly. It may not be sensible to have the same legal arrangements governing the supply of soap, housing, automobiles, oil, and books. My argument is that we should use the same approach for all markets when deciding on public policy. In fact, if we do this and use for the market for ideas the same approach which has commended itself to economists for the market for goods, it is apparent that the case for government intervention in the market for ideas is much stronger than it is, in general, in the market for goods. For example, economists usually call for government intervention, which may include direct government regulation, when the market does not operate properly— when, that is, there exist what are commonly referred to as neighborhood or spillover eﬀects, or, to use that unfortunate word, “externalities.” If we try to imagine the property rights system that would be required and the transactions that would have to be carried out to assure that anyone who propagated an idea or a proposal for reform received the value of the good it produced or had to pay compensation for the harm that resulted, it is easy to see that in practice there is likely to be a good deal of “market failure.” Situations of this kind usually lead economists to call for extensive government intervention. Or consider the question of consumer ignorance which is commonly thought to be a justiﬁcation for government intervention. It is hard to believe that the general public is in a better position to evaluate competing views on economic and social policy than to choose between diﬀerent kinds of food.

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Yet there is support for regulation in the one case but not in the other. Or consider the question of preventing fraud, for which government intervention is commonly advocated. It would be diﬃcult to deny that newspaper articles and the speeches of politicians contain a large number of false and misleading statements—indeed, sometimes they seem to consist of little else. Government action to control false and misleading advertising is considered highly desirable. Yet a proposal to set up a Federal Press Commission or a Federal Political Commission modeled on the Federal Trade Commission would be dismissed out of hand. The strong support enjoyed by the First Amendment should not hide from us that there is, in fact, a good deal of government intervention in the market for ideas. I have mentioned broadcasting. But there is also the case of education, which, although it plays a crucial role in the market for ideas, is subject to considerable regulation. One might have thought that those who were so anxious to obstruct government regulation of books and other printed material would also ﬁnd such regulation in the ﬁeld of education obnoxious. But, of course, there is a diﬀerence. Government regulation of education commonly accompanies government ﬁnancing and other measures (such as compulsory school attendance) which increase the demand for the services of intellectuals and, therefore, their incomes. (See E. G. West, p. 101.) So self-interest, which, in general, would lead to support for a free market in ideas, suggests a diﬀerent attitude in education. Nor do I doubt that detailed study would reveal other cases in which groups of practitioners in the market for ideas have supported government regulation and the restriction of competition when it would increase their incomes, just as we ﬁnd similar behavior in the market for goods. But interest in monopolizing is likely to be less in the market for ideas. A general policy of regulation, by restricting the market, would have the eﬀect of reducing the demand for the services of intellectuals. But more important, perhaps, is that the public is commonly more interested in the struggle between truth and falsehood than it is in the truth itself. Demand for the services of the writer and speechmaker depends, to a considerable extent, on the existence of controversy—and for controversy to exist, it is necessary that truth should not stand triumphant and alone. Whatever one may think of the motives which have led to the general acceptance of the present position, there remains the question of which policies would be, in fact, the most appropriate. This requires us to come to some conclusion about how the government will perform whatever functions are assigned to it. I do not believe that we will be able to form a judgment in which we can have any conﬁdence unless we abandon the present ambivalence about the performance of government in the two markets and adopt a more consistent view. We have to decide whether the government is as incompetent as is generally assumed in the market for ideas, in which case we would want to decrease government intervention in the market for goods, or whether it is as eﬃcient as it is generally assumed to be in the market for

The market for goods and the market for ideas

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goods, in which case we would want to increase government regulation in the market for ideas. Of course, one could adopt an intermediate position—a government neither as incompetent and base as assumed in the one market nor as eﬃcient and virtuous as assumed in the other. In this case, we ought to reduce the amount of government regulation in the market for goods and might want to increase government intervention in the market for ideas. I look forward to learning which of these alternative views will be espoused by my colleagues in the economics profession.

Note 1

For a discussion of the attitude of the press to the monopoly of British broadcasting, see Coase, pp. 103–10 and 192–93.

References Coase, R. H. British Broadcasting, A Study in Monopoly, Cambridge, Mass. 1950. Director, A. “The Parity of the Economic Market Place,” J. of Law and Econ., Oct. 1964. Milton, J. Areopagitica, A Speech for the Liberty of Unlicensed Printing, with introduction and notes by H. B. Cotterill, New York 1959. West, E. G. “The Political Economy of American Public School Legislation,” J. of Law and Econ., Oct. 1967. Beauharnis v. Illinois, 343 U.S. 250, 286, 1952.

3

An economic analysis of the law of false advertising Ellen R. Jordan and Paul H. Rubin *

The past twenty years have produced a substantial literature suggesting the relevance of economic principles to the analysis of legal processes.1 A seminal line of inquiry has evaluated the proposition that the common law, despite its diversity, is founded upon a unifying principle: courts behave rationally as if to achieve economic eﬃciency.2 To explain why these eﬃcient outcomes are likely, Rubin,3 Landes and Posner,4 and Goodman5 have proposed evolutionary models where eﬃciency is most likely to result if the opposing parties have symmetric, ongoing interests in cases of the sort being disputed.6 Disputes between competitors, characterized by the law as “unfair competition,” would appear to be an area where the litigants would have the kind of ongoing interest which provides economic incentive to litigate to an eﬃcient outcome. But in apparent contradiction to this expectation, the common law relating to false advertising has been criticized as being ineﬃcient. Assume, for example, that ﬁrm A makes false claims about its product and, due to the deception, some consumers purchase the product. Although each consumer may well have a legal action against the seller, no one consumer is likely to have lost enough to make litigation worthwhile.7 Competitors of ﬁrm A may also have lost sales because of the deception and might have enough incentive to seek redress in the courts. To the surprise of commentators,8 however, the common law has generally discouraged such suits. Even Posner has argued that statutory law may have been necessary to correct the common law’s mistake: “[I]n section 43(a) of the Lanham TradeMark Act Congress created a new right of action for competitors injured by misrepresentation that, although little utilized, may well have repaired any deﬁciencies of the common law in this area.”9 If the common law treatment of false advertising is ineﬃcient, even though the litigants ﬁt the evolutionary models, then those models are thrown into question. Our contention in this paper is that, contrary to appearances, the common law outcome with regard to false advertising is indeed consistent with eﬃciency. A straightforward application of the economics of information and advertising explains the common law position. Furthermore, a study of the eﬀect of the “correction” by statute sheds further light on the question. If

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the common law was in fact ineﬃcient, the Lanham Act and other statutory interventions should have led to increased eﬃciency in resource allocation. Conversely, if the common law had arrived at optimal rules, the statutes should not have improved upon common law outcomes. In short, a reversal of the common-law rule by statute provides a good test of common law eﬃciency. In Part I we will consider the economics of advertising, with particular reference to the models of Phillip Nelson. Part II discusses the legal treatment of consumer and competitor suits against misrepresentation. Part III provides some evidence about eﬀects of changing the legal environment. Part IV summarizes our conclusions.

I. Economics of advertising Until recently advertising presented something of a puzzle to economic theory. Much advertising is patently uninformative: rational consumers should not care what sort of breakfast cereal is eaten by famous baseball players, nor should they expect any relationship between the cleanliness of their clothes and the catchiness of the tune used to advertise a washpowder. Nonetheless, advertisers spend large sums of money on these sorts of messages as well as many others of equal value as information. Rational consumers should not be inﬂuenced by such messages, and rational advertisers should not spend money on messages without inﬂuence. Economists, believers in rationality by both consumers and producers, were puzzled. Phillip Nelson has oﬀered an explanation for this behavior.10 Nelson argues that there are two types of goods: search goods and experience goods. A search good is one whose salient characteristics can be ascertained by presale inspection (e.g., the comfort of a pair of shoes); experience goods are those which must be consumed to be evaluated (e.g., the taste of a candy bar). Nelson has shown that this distinction can account for many otherwise puzzling aspects of market behavior. The role of advertising diﬀers depending on which type of good is involved. In the case of search goods, where the consumer can and will easily determine for himself whether the goods are what he wants, advertisers have little incentive to misrepresent the quality of their goods. Thus, advertisers simply urge the consumer to make the inspection, and their message should be largely informative and truthful. Note, however, that the time and eﬀort rational purchasers devote to search are directly related to the magnitude of the purchase.11 If a mistake would not be very expensive, the cost of acquiring information is likely to exceed the cost of purchase error. If, on the other hand, a mistake would be very costly, it pays to invest in reducing the probability of error. In homely terms, one might throw away the wrong color of a $1.00 lipstick, but most people cannot view with equanimity buying another car if they don’t like the ﬁrst one. Consequently, sellers should provide considerable information on high-risk, big-ticket purchases, since consumers should be willing to pay for it.12

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In the case of the experience good, the consumer can determine quality only by purchasing and using the good. The function of advertising, therefore, is to get the consumer to try the product. Here, advertisers might have an incentive to mislead and make false claims. For low-priced, often-purchased goods,13 however, it would not pay to make such claims, since the consumer can be fooled by them only once. Hence, a seller of such goods (e.g., soaps, which are very heavily advertised) would appear to be wasting his money to mislead. Nelson argues that advertising of such products does serve an informative purpose: by his outlay, the advertiser demonstrates his conﬁdence that the consumer will be satisﬁed with the good and will purchase it more than once. In this instance the truth of any information is irrelevant, since the message conveys conﬁdence in the quality of the product and consumers come away with little else. At the other end of the scale, false claims for higher-priced experience goods may result in enough damage to raise a realistic threat of consumer lawsuits, which should adequately deter those falsehoods. Market checks on the eﬃcacy of false advertising break down in that vast range of purchases which produce losses too great to shrug oﬀ but too small to sue about. In this area, however, the market does provide some protection for the consumer: reputation in and of itself is valuable as an indicator of responsibility and honesty, qualities likely to produce substantial future beneﬁts to the ﬁrm. Conversely, false advertising is likely to provoke negative consumer response. Hence, advertising expenditures can be capitalized much the same as other investment expenditures. For example, positive brand recognition contributes to the present value of the ﬁrm, but misrepresentation is likely to diminish it.14 Where the individual item sought is not heavily advertised, the consumer may choose to trust an intermediary, such as a department store or travel agent, to insure the quality of what he buys. The department store, in particular, deals in diverse products, not only in the particular merchandise being advertised; thus it stands to lose a great deal by misrepresentation. In short, no matter what kind of goods or services are involved, a decision to advertise conveys information: that the advertiser is willing to invest in his reputation and stands to lose if the customer is unhappy. This argument has especial force in another situation, identiﬁed by Darby and Karni.15 Some goods or, more often, services have “credence” qualities, deﬁned as characteristics whose quality cannot be monitored by the nonexpert, even after consumption. For instance, if an automobile repair shop sells a consumer a part which he does not need, he will probably not detect any fraud if his car now runs better, even if it would have run equally well without the part. (Similar examples may be drawn from repair to humans, for example, unnecessary surgery.) Thus, the nonexpert consumer relies on the reputation of the seller, and the seller who has invested in his reputation has more to lose by practicing deception than one which has not.16

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With respect to advertising, then, the characteristics of goods and services form a continuum, from those in which it is very easy to detect the truth or falsity of advertising claims (search goods: the truth of the claim can be ascertained before purchase) through experience goods (where the truth of the claim can be detected only after purchase and use) through credence goods (where the validity of advertisements may never be determined). As we move along this continuum from search to credence characteristics, misrepresentation becomes relatively more proﬁtable, since detection by consumers becomes more expensive. Conversely, if consumers are aware of this problem, as goods and services acquire more credence characteristics, consumers should begin to rely more heavily on specialized buyers and on brand names as assurances of quality17 in order to avoid being defrauded. Nonetheless, it is in the case of credence characteristics that self-protection becomes most diﬃcult and in which some legal remedy would seem most important. Even if we assume that there is in fact much advertising which is misleading, how much policing of false advertising would be likely if competitors were allowed to perform such policing? For theoretical reasons, we would not expect much. First, in a competitive industry no one ﬁrm would lose much from false advertising by competitors and therefore no ﬁrm would have much of an incentive to take legal action. Similarly, if a monopolist falsely advertises, there would be no ﬁrm which would lose much since, by deﬁnition, monopolists have no close competitors. It would only be in the case of oligopolistic industries that there would be any incentive for competitors to sue for false advertising, provided the advertising be about one particular ﬁrm’s product. If there were false advertising about the merits of the good made by all of the oligopolists, there would again be no incentive for legal action.18 Thus, even in an oligopolistic environment, there would be little gain from allowing policing of misleading advertising since ﬁrms have little incentive to undertake policing activities. Moreover, because it would be harder for new entrants to document all claims and because such ﬁrms advertise more heavily than established ﬁrms,19 we might expect that much of the policing which would occur would be by established brands against new entrants. If threat of suit is used as a barrier to entry, there might be costs of allowing such litigation. Although the data are not extensive, we will provide some evidence on this point in Part III. To summarize, this section has considered the costs and beneﬁts of allowing more private policing of advertising. First, the analysis indicates that all advertising is informative; and even though its informational content may be nominal, the fact that the advertising exists is information in its own right. If advertisers were subject to suit, they might restrict their advertising, which would serve both to reduce information and to decrease the incentive to acquire a good reputation. Second, producers of new products rely heavily on advertising in order to create a market share. Claims of new entrants are particularly diﬃcult to prove (or easy to challenge as being misleading) since such ﬁrms have no past history on which to base their claims. Thus, we might

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expect that, if competitors’ remedies for misrepresentation became easy, such remedies would be used disproportionately against new entrants into the market, thereby imposing substantial costs on consumers in the form of forgone opportunities for new and innovative products. In short, there appear to be few beneﬁts and sizable costs from policing advertising, especially at the instance of competitors.

II. The common law’s response to false advertising Purchasers’ remedies If consumers are misled by advertising and choose a product because of a falsehood, they have suﬀered an injury and resources have been misallocated. Accordingly, the common law20 aﬀorded the consumer redress for his injury, predicated on somewhat overlapping theories of breach of contract and misrepresentation. Some recently enacted consumer protection statutes provide additional causes of action, both state and federal. On the theory that the seller has failed to deliver what was promised, the buyer may assert a claim based on the contract of sale. Part of the seller’s obligation is to deliver “conforming” goods,21 and the buyer may reject goods which are not as promised.22 If he has already accepted the goods, a substantial nonconformity entitles him to revoke his acceptance if his failure to reject was either induced by the seller’s assurances or caused by a latent defect.23 The buyer in either case has an action for damages against the seller, computed by determining the amount it will cost him to obtain conforming goods, as well as so-called incidental and consequential damages, including personal injuries.24 If the buyer elects to keep the goods or if he cannot meet the standards for revocation, he may notify the seller that the goods do not conform to what he was promised,25 and may claim the diﬀerence in value between the goods as promised and the goods actually delivered.26 He may be barred from any remedy if he fails to notify the seller of his objection within a reasonable time.27 This scheme obviously hinges on determining what was in fact promised or warranted by the seller. The sales article of the Uniform Commercial Code recognizes that sellers often make express representations about the goods,28 but in addition protects buyer expectations by providing certain implied terms in sales of goods.29 In the case of false advertising, however, the complaint will normally be a breach of an express warranty if the goods do not correspond to the advertising claims made for them. Several roadblocks may confront a plaintiﬀ here. First, he must show that the falsehood in the advertising rose to the level of a warranty or promise. The law requires that the representation in question must become “part of the basis of the bargain,”30 and hence seems to require some showing that the information was material in the purchase decision. Second, the seller is given

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considerable latitude to “puﬀ” or extol the virtues of his goods in a general way without incurring warranty obligations.31 Third, if the advertising is sponsored by the manufacturer, as it often is, the buyer may have to overcome the objection that he is not in a contractual relationship with anyone but his immediate seller, who made no false representation. But this privity-ofcontract defense seems to be crumbling, particularly when personal injury results, but also where the only loss is monetary.32 Fourth, the consumer must give proper notice or be barred from any remedy.33 A ﬁnal and very important issue is whether the seller has attempted to limit his liability or restrict the buyer’s remedies by their “agreement,” often the closely printed form presented for the buyer’s signature. The code recognizes that parties may wish to bargain over the risks of product defects and to reﬂect those risk allocations in the price term. Thus, the seller is permitted to sell without warranties, provided certain requirements are met.34 In the false advertising situation, the seller may attempt to cut back on the claims made by his advertising by oﬀering a much more limited undertaking in his forms. The code insists that such limiting language must be consistent with any express warranty the seller has created,35 and refuses to give eﬀect to attempts to mislead the buyer by promising much in ads but cutting enforceable rights through the forms. One important loophole in such buyer protection is the code’s parol evidence rule,36 which allows seller and buyer to deny eﬀect to representations made before the ﬁnal agreement is signed. If buyer and seller in fact agree that the sum total of their understanding is what is on the paper they sign, the parol evidence rule causes no great injustice since, if a term is omitted, the signer should have objected before signifying assent. But where there is no negotiation at all and the buyer is unaware of the necessity to double-check the long, densely printed form, sellers may be able to exclude responsibility for very relevant point-of-sale representations. The seller may also undertake to limit the buyer’s remedies if a warranty has been breached, by oﬀering a so-called “repair or replacement” guarantee.37 The code does seek to protect the buyer, too, providing that if such a limited remedy “fails of its essential purpose,”38 the buyer can assert all the remedies the code otherwise aﬀords. If the buyer can establish that the advertising claim did amount to a warranty that was part of the enforceable bargain, his road to recovery is an easy one. The seller’s liability is absolute and the buyer’s fault, if any, is irrelevant, unless his own conduct and not the misrepresentation is the cause of his injury. If, however, he stumbles on any of the contractual defenses outlined above, he may elect to sue for breach of duty imposed by law, the duty not to deceive. The law of torts has long oﬀered a remedy for misrepresentation on which the plaintiﬀ has relied to his economic detriment. To avoid a too-easy upsetting of transactions, however, this remedy is diﬃcult to obtain and requires proof of the defendant’s fault. In most situations, the purchaser must show the defendant knew or should have known the falsity of his statement and

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that he intended to deceive. Furthermore, the plaintiﬀ must demonstrate that he justiﬁably relied on the misrepresentation and establish the causal connection between it and his damages.39 If the complaint is that the advertisement in question was only a half-truth, the problem becomes more complex since the seller’s duty to disclose has traditionally been very limited.40 If deceit can be proved, the buyer may choose to disaﬃrm the sale and get his money back, or sue for damages. In egregious cases, punitive damages may also be awarded. Any or all of these remedies could be asserted by a consumer who thinks he has been “taken” by false or deceptive advertising.41 All of them, however, share a common, major disadvantage: the cost of resorting to the courts in many cases far outstrips the relief available, even if the consumer has an airtight case. Hence, excluding those cases where the falsity of the advertised claim results in personal injury, or the magnitude of the loss is large,42 it is not surprising that there are very few cases where consumers have sued. Attempts to lower the barrier of the cost of suit by legislative action are evaluated in Part III. Competitors’ remedies False claims In addition to those consumers who are misled, competitors of the misrepresenting ﬁrm are also harmed: some sales which they would have made have been diverted to the other ﬁrm. Moreover, we would expect such competitors to lose substantially more than individual consumers. Thus, eﬃciency considerations suggest that competitors should be permitted to sue for damages or injunctions when false advertising has occurred. This is precisely the point made elsewhere by Posner.43 But the common law did not allow such suits. In American Washboard v. Saginaw Manufacturing Co.,44 the court held that misrepresentation did not in fact provide an action for competitors. This same opinion was upheld by the Supreme Court in Mosler Safe Co. v. Ely-Norris Safe Co. 45 In an earlier decision in the same dispute, Judge Hand explicitly stated that “The Law does not allow him [the damaged competitor] to sue as a vicarious avenger of the defendant’s customers.”46 This would seem a curious result, since it is unlikely that the customers would sue in their own behalf; thus, the decisions seemed to indicate that no legal penalty would be imposed on misleading advertisers. What would be the eﬀect of these decisions on consumers? Consumers could not assume that there was any presumption of truth in advertising; rather, they would be forced to rely on their own devices to determine which products to purchase. In the case of search goods, inspection would be relatively more intensive than otherwise. In the case of experience goods, perhaps more sampling would occur than if consumers could believe the accuracy of advertising. In the case of credence goods consumers would be forced to rely

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on reputation and intermediaries.47 Thus there would be some eﬃciency loss if advertising could not be believed. In an optimal world there would be no misleading advertising. As we have argued above, however, suits by competitors would probably have little real impact, except as a new barrier to entry. In disallowing such suits, then, the common law probably had little eﬀect on whether or not advertising is truthful. Claims about competitors’ product One form of misrepresentation consists of making unjustiﬁed claims about one’s own product. An advertiser may also make unfavorable statements about competitors or their products. This latter claim may be characterized as either disparagement or defamation. Disparagement occurs when the claims refer to goods made by rivals; defamation refers to making claims about the personality or other characteristics of the competitor rather than his goods. This distinction is important: In most states if a statement is defamatory per se, no actual ﬁnancial damage need be proved, injury being conclusively presumed; in an action for disparagement, on the other hand, only special damages can be recovered, and usually they must be alleged and proved with considerable speciﬁcity. This requirement has been particularly troublesome since injunctions classically have been unavailable against either disparagement or defamation. Other diﬀerences also tend to make disparagement the more diﬃcult path to recovery: in disparagement the plaintiﬀ must prove the defendant’s statement false, whereas in defamation the defendant bears the burden of proving truth; in disparagement, unlike defamation, “malice” is a requisite to recovery.48 These distinctions have been puzzling to commentators on the law.49 Economic analysis, however, can explain the common law’s greater solicitude for competitors who claim defamation rather than disparagement. If ﬁrm A claims that ﬁrm B is owned by a devil worshipper, this will cost ﬁrm B money (in forgone sales) if customers believe the claim and prefer not to do business with devil worshippers.50 There may be no eﬃcient way for consumers to ascertain the truth of the devil-worshipper claim, for it is a credence characteristic. In contrast, if ﬁrm A claims that the product of ﬁrm B will not work well, then consumers can presumably determine the truth of this claim for themselves. Thus the relative ease with which a plaintiﬀ may make out a case for defamation as compared with making out a case of disparagement, which appears mysterious when considered in terms used by courts, may be explicable in terms of the ability of consumers to determine truth and, hence, discount disparagement more than defamation. It is at least arguable that this distinction makes sense in economic terms. Speciﬁcally, false claims about product quality are claims about search or experience

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characteristics where consumers will not be misled. Claims about the personal characteristics of manufacturers, on the other hand, are claims about credence qualities, which cannot be veriﬁed and where the legal process may be the most eﬃcient way to lay false claims to rest. In cases where an action for disparagement has been permitted, there is some evidence consistent with this contention. In at least some of these cases, the disparaging statements were not of the sort that consumers could verify for themselves; rather, such statements often dealt with actions of some third party. In Testing Systems, Inc. v. Magnaﬂux Corp.,51 part of the disparaging statement dealt with the product of Testing Systems; but in addition, it was alleged that the government had decided not to continue to use the product. While it may be argued that consumers should be able to determine for themselves the quality of the product, it seems less plausible that they would be able to determine what decisions the government had made about the product. Similarly, in Black & Yates, Inc. v. Mahogany Association, Inc.,52 at least one of the disparaging statements made about “Philippine mahogany” by the association was that the Federal Trade Commission was about to rule that Philippine mahogany could no longer be called mahogany; again, consumers could probably not check the validity of this sort of statement. Producer identity The argument thus far has been that misleading advertising will not have much of an eﬀect, either because it can be checked by purchasers (in the case of search goods) or because the message contained in advertising is basically irrelevant (in the case of experience goods). Therefore the common law’s reluctance to entertain actions based upon such advertising is explicable in economic terms. To further strengthen this argument, consider an area in which the common law has generally provided injunctions against misrepresentation. This is the area of “passing oﬀ”—of misrepresenting the manufacturer of goods. In cases where B sells goods and claims that they were made by A, then the courts have not hesitated to enjoin this action.53 The original common law of trademark was aimed precisely at this practice. The economic value of identiﬁcation of the manufacturer is obvious. A producer will not invest in gaining a reputation by producing high-quality goods unless he can be sure of capturing the value of the brand name.54 Trademark identiﬁcation, moreover, imparts useful information to the consumer—information whose falsity would be diﬃcult to detect. The name of the producer is perhaps the most important credence characteristic of a good. For example, when a consumer buys a pair of blue jeans marked “Levis” he must rely totally on the truth of the label; it is completely impossible for him to trace back the movement of the goods from retailer to wholesaler to the manufacturer and check this claim. The ﬁrm should be permitted to establish a property right in the brand name of the product inasmuch as that right will lead to eﬃcient investment in quality and

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reliability. Presumably if ﬁrm A spends money in advertising its product, it is to tell consumers that products made by this ﬁrm are worth buying— information which is useless unless consumers are able to tell which products are in fact made by ﬁrm A. Therefore eﬃciency considerations dictate that the law should protect trademarks as the common law has done. Another interesting area is the protection of geographic designation. In Grand Rapids Furniture Co. v. Grand Rapids Furniture Co.,55 the courts held that a furniture store could not advertise that its furniture was made in Grand Rapids when in fact it was not; this is consistent with other cases, such as Pillsbury-Washburn Flour Mills v. Eagle Co.56 But in California Apparel Creators v. Wieder of California,57 the court did not enjoin New York clothing manufacturers from using the name “California” in their business. The court distinguished these cases on the basis of the loss involved—in the Grand Rapids case the Grand Rapids manufacturers had a tight trade association, and virtually all of them were involved in the case; thus the court reasoned that any business diverted by the misrepresentation would have otherwise gone to these manufacturers and that therefore they had a substantial interest in the injunction. In the California case there were approximately 4,500 manufacturers in California, only a few of whom were represented in the suit. Here the courts believed that losses were not signiﬁcant enough to the plaintiﬀs to grant relief. This reasoning does not make economic sense. If consumers are misled about the place of origin of goods and if the place of origin is relevant, then it should not matter whether there are 5 or 5,000 manufacturers who lose by the misrepresentation; eﬃciency would require an injunction in either case. However, though the reasons provided by the court are not useful, the decision is nonetheless probably correct. Consumers presumably care, not about the actual location of the manufacturing plant, but about the reputation of the ﬁrm or manufacturer. If there are few enough ﬁrms so that they can form a tight trade association and sue as a class, then there are probably few enough manufacturers so that they can self-police the use of the geographic name and thus insure the quality of the goods bearing this name. Conversely, when there are so many ﬁrms that they cannot all join in a class for the purposes of legal action, there are probably too many to guarantee that any level of quality can be maintained by the ﬁrms bearing the geographic name. Hence, when there are many ﬁrms suﬀering the supposed loss, consumers probably do not rely on the name as a proof of quality, and thus there is not any loss in not protecting the mark. This seems to be a situation where the law has reached the economically correct decision, though the judicial reasoning is couched in other terms. There are other areas of the law of producer identity which are subject to economic analysis, if not to economic solution. For example, consider the law of “trade names.” A trade name at common law was a name or descriptive word with some meaning in addition to its use to identify a particular brand. An example is given in American Aloe Corp. v. Aloe Creme Laboratories,

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Inc.; 58 here, a company that produced products derived from the aloe verde plant with names such as Aloe-Creme and Aloe-Ointment brought suit against a competitor producing products with names such as Aloe Essence. The issue was whether the name Aloe was subject to trademark-type protection; the courts ruled that it was not. The economic analysis is reasonably straightforward: the cost of maintaining “aloe” as a trademark or trade name would have been the lost information by consumers about ingredients in competing products; the beneﬁts would have been the relatively greater incentive of the ﬁrst company to protect its reputation. Economic analysis indicates that protection should be given to the point where marginal cost equals marginal beneﬁts—that is, to the point where the incremental value of the greater incentive to protect reputation would just equal the incremental value of the additional information possessed about ingredients by consumers. Economic theory alone merely states the question; much as proof of facts is necessary to decide legal issues, concrete empirical data are required to estimate where this point lies. Therefore, it is not surprising that courts must consider each case on its facts, and have not derived clear-cut rules in this area. Similar issues arise in determining what symbols associated with a product should be protected as trademarks (e.g., the picture of a shredded wheat biscuit in Kellogg Co. v. National Biscuit Co.).59 Again the courts seem to have recognized the economic issue involved and attempted to deal with it. It is impossible to determine how successful they have been.

III. Some evidence Our argument has been that allowing competitors to sue for misrepresentation would have been ineﬃcient, except in the case of producer identity. Conversely, if suits were permitted, gains would have been minimal, inasmuch as market forces substantially limit the likelihood that ﬁrms engage in false advertising. In addition, the increased danger of suit would increase the risk, and thus the cost, of truthful advertising. Finally, such suits may have been used to restrict entry by new competitors, thus creating a net loss in social welfare. To bolster our conclusion that the common law perhaps struck the best balance, we have examined the results of various steps taken to remedy the “deﬁciencies” of the common law in this area. First, government has assumed responsibility for consumer protection from false and misleading advertising. Second, legislation has been passed to encourage purchasers and competitors to undertake policing of false advertising. Finally, evidence is available from the German experience, where competitors are permitted to sue rather freely. The Federal Trade Commission Richard Posner has analyzed in detail Federal Trade Commission cases dealing with misrepresentation and false advertising for 1963, 1968, and

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1973. His conclusion is “. . . that only a small fraction of the Federal Trade Commission’s activities in the false-advertising area is consistent with a proper allocation of commission resources, considering the character of the false-advertising problem and the limitations of the commission’s sanctions.”60 Posner blames this poor eﬀort on the lack of a theory by the commission as to where intervention would be likely to prove valuable. However, an alternative theory which is also consistent with his evidence has been developed here: there is simply not much harmful false advertising which occurs; therefore, commission intervention would be unproductive, no matter what rule it might apply. (In fact, this argument is consistent with Posner’s other policy suggestion, which is that the commission be given powers to enforce a federal antifraud law and that it conﬁne its eﬀorts to deliberate attempts to defraud.) The uselessness in economic terms of most FTC proceedings may be due to ineptness on the part of the commission; but it may also be due simply to the small population of costly deceptions which occur. Both the FTC and commentators have explained the FTC’s poor performance by pointing out that the only sanction formerly available to the FTC, the cease-and-desist order, was not eﬀective against consumer deception.61 That problem has now been remedied; the FTC has been granted vastly greater enforcement powers by the Magnuson-Moss Act of 1975.62 In addition to validating FTC power63 to promulgate trade regulation rules which have the force of law,64 the act provides stiﬀ penalties for violations. The FTC may now sue and obtain an injunction,65 sue to exact a penalty for the violation of an existing cease-and-desist order by anyone (not merely the named respondent) who does so with actual knowledge that the act was unfair and unlawful,66 or sue for violation of an FTC legislative (as distinguished from interpretative) rule.67 Fines of up to $10,000 per day may be imposed for each violation. The act also empowers the FTC to seek redress for competitors and consumers if it can show that the act or practice “. . . is one which a reasonable man would have known under the circumstances was dishonest or fraudulent.”68 The FTC may seek rescission, reformation, return of property, and damages as relief for competitors or consumers.69 Although no private suit may be brought for violation of the FTC act,70 several states have passed little FTC acts71 or other laws against deceptive trade practices, which provide private actions for consumers or competitors, often oﬀering incentives to encourage private enforcement.72 It remains to be seen whether a more potent FTC will “clean up” a marketplace in which false advertising has run rampant and unchecked. New remedies for purchasers Recognition that a rational person will not spend money for a lawyer, court fees, and whatever his own time is worth to collect miniscule amounts has led to a number of proposals to make it easier to assert rights. Historically the ﬁrst eﬀorts were to lower the cost of suit by establishing informal small claims

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courts.73 Although many have noted that these courts serve more as a collection agency against the consumer than as a forum for him to present his grievances,74 consumers who do go to these courts to seek justice often do very well.75 But even consumers who make use of these courts do not seek redress for misrepresentation, except in such small numbers that they are not separately classiﬁed in a major empirical study of small claims courts.76 Moreover, it is impossible to tell whether those consumers who alleged misrepresentation were complaining about advertising or about point-of-sale inducements by sellers. Another response to the problem of the high cost of dispute resolution has been to set up alternatives to courts, such as governmental arbitration and mediation services.77 A recent study78 of the workings of one very active Bureau of Consumer Protection, located in Illinois, remarked that only 18 percent of complainants mentioned misrepresentation, deception, or undue inﬂuence by the seller as the primary grievance.79 As might be expected, larger transactions (in dollar amounts) generated more complaints of this sort.80 Perhaps if false advertising is in fact a problem, buyers still prefer to absorb their small losses rather than to invest in these proceedings. Finally, some consumer advocates have argued for a system which provides incentives for private enforcement of consumer claims, such as multiple damage recovery, exemplary damages, and award of attorneys’ fees to a victorious consumer.81 Along these same lines, others have urged that consumers (or their legal representatives) be able to sue in a class action as representatives of all consumers who have been victimized.82 But the dynamics of litigation and its costs may shift the balance too far: groundless suits become too easy to bring and too expensive to defend against, oﬀering the unscrupulous a kind of blackmail against legitimate business who may prefer to settle for some sum rather than to defend.83 Some state consumer legislation has attempted to build in safeguards against so-called “strike suits,” while still encouraging private enforcement of meritorious claims. In Oregon, for instance, the defrauded consumer who proves a willful violation can collect his actual damages or $200, whichever is greater, as well as punitive damages and attorneys’ fees and costs.84 Even where generous bounties such as these are available, however, research discloses only two cases in which consumers complaining about false advertising availed themselves of the provisions of the act. Interestingly, in both cases, the goods would seem to be search goods. In one85 the consumer wanted a tent for use in the winter, which requires special characteristics. Had the purchaser taken the precaution of inspecting a tent on display or opening the package in the store, he would have seen that the tent in question did not match the picture on the package and would not serve his purposes. In the other86 the consumer bought an automobile engine at a gas station. The size of an automobile engine seems to be a matter that would be of suﬃcient importance to the purchaser to expect him to inspect before he buys. Regardless of whether these cases should have been brought at all, two reported

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cases in seven years indicate that even where consumers have been oﬀered every inducement to come forward, no great ﬂood of litigation seems to have engulfed the courts. The Lanham Act The Lanham Act, passed in 1946, greatly broadened rights of competitors to sue for misleading advertising.87 A test of the hypotheses in this paper would be to examine cases under this act in order to determine the eﬃciency eﬀects of this broadened right of action. We have undertaken such an examination. All 182 cases citing 15 U.S.C. § 1145(a) reported in Shepard’s 1970 edition and 1972 and 1975 supplements were read. The vast majority of these cases were simply standard trademark infringement actions, coupled with a claim of unfair competition under the Lanham Act. Of the 182 cases cited, 16, or fewer than 10 percent, could be classiﬁed as complaints about a competitor’s false advertising. (Excluded from this total were a number of complaints that a competitor’s advertising used a picture of the plaintiﬀ’s goods, since such situations are merely variations of the tort of “passing oﬀ.”) Those 16 cases can be further subclassiﬁed. Perhaps most important, from an economic viewpoint, are those claims which consumers cannot easily verify by inspection or inexpensive experience (credence qualities), and where the amount of injury is so small that no individual purchaser will resort to the courts. In such instances, deceptive advertising may be proﬁtable and result in harm to honest competitors, as well as misallocation of resources. Six of the eighteen cases at least arguably fall into this category. Perhaps the clearest case for a competitor’s remedy is John Wright, Inc. v. Casper Corp.88 Two rivals in the sale of mechanical penny banks were the litigants. The plaintiﬀ was the successor in interest to a ﬁrm which had gone to trouble and expense to produce authentic detailed reproductions of nineteenth-century banks. The defendant produced inexpensive imitations of the plaintiﬀ’s banks on Taiwan yet advertised them as “authentic reproductions.” Those consumers to whom authenticity and faithfulness to the original were important were being deceived, the true source of authentic reproductions was being deprived of sales, and yet no consumer would ﬁnd it worth his while to sue. Equally compelling is Skil Corp. v. Rockwell International Corp.,89 where the plaintiﬀ complained that the defendant falsely and extensively advertised the results of tests conducted by an independent testing concern which compared the defendant’s power tools with the plaintiﬀ’s and those of two other manufacturers. The credence quality here was the impartiality of the investigator; consumers might well place more faith in the result of a third party’s testing than they would in a claim originating with the seller. If those test results were misrepresented, both the consumer and other manufacturers would suﬀer injury. Actual injury to any one purchaser would be too small

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to justify litigation, although the consumer would not be getting what he wanted. A competitor’s remedy also seems sensible in Bohsei Enterprise Co. v. Porteous Fastener Co.90 In that case an importer of industrial fasteners complained that its rivals repackaged imported fasteners and either omitted the true country of origin or on occasion marked them “United States,” thereby creating the false impression that these were domestic rather than imported goods. The complaint also alleged that consumers associate domestic manufacture with higher-quality goods.91 If the allegations were true, the defendants were violating federal law92 as well as misrepresenting their goods; in addition, they were diverting sales from other importers and those domestic manufacturers who would otherwise be preferred. Again, individual purchasers would have too small a stake to assert any claim. A fourth case presents a slightly diﬀerent situation. In Cutler Hammer, Inc. v. Universal Relay Corp.,93 the defendant had allegedly bought surplus relays manufactured by the plaintiﬀ and changed the part numbers to make it appear that they met current military speciﬁcations for aircraft use. In this instance, however, the court noted that reliance on the misrepresentation could cause death or personal injury. In a sense the seriousness of the consequences mitigates against the need for a competitor’s remedy, since the large potential liability to injured consumers should itself discourage representations of this sort. A case which provides shakier support for a competitor’s remedy is Natcontainer Corp. v. Continental Can Co., Inc.94 The misrepresentation alleged was that Natcontainer’s boxes conformed to minimum standards established by the Interstate Commerce Commission when in fact they did not. Here the boxes were sold to businesses, rather than consumers, in such quantities as to make a breach-of-contract action feasible, although no such actions appear in the record. Indeed, the Lanham Act claim was asserted as a counterclaim by the defendant in an antitrust action brought by Natcontainer against one of its rivals. In this case, the Lanham Act complaint served as a weapon to discourage antitrust enforcement. Perhaps the weakest case for a competitor’s remedy, even where credence qualities were involved, was presented by Ames Publishing Co. v. WalkerDavis Publications, Inc.95 There, one magazine publisher complained about another’s attempts to launch a rival magazine. In the defendant’s presentation to potential advertisers, circulation projections were asserted as facts, and veriﬁcation of subscriber lists was claimed but never done. Although one would think that a competitor’s remedy would be the only viable one here, the defendant was able to show that the plaintiﬀ had engaged in exactly the same conduct when promoting its magazine. The court refused to recognize an “unclean hands” defense and granted an injunction. Ubiquity of the practice, however, may indicate that potential advertisers presented with these claims by all competitors would not be misled by one any more than by any other, and in fact might discount them all.

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On the other end of the scale, several cases involve claims that would surely be veriﬁed by consumers before purchase. For instance, Saxony Products, Inc. v. Guerlain, Inc.,96 was part of a long-running battle between name-brand perfume manufacturers and those who market much cheaper perfumes as indistinguishable from them. When defeated in their claim that the copyists were impermissibly using their trademarks,97 the name-brand manufacturers countered by alleging that the claim that the scents were similar was false and hence a Lanham Act violation. Consumers would clearly rely on their own olfactory sense and not on an advertising claim in this instance, since they were invited to make the comparison at the point of sale. Any falsehood would be immediately apparent, making proof of damage diﬃcult and injunctive relief superﬂuous. The only possible explanation for such an action would be harassment of a cut-rate competitor. In similar fashion Bose Corp. v. Linear Design Labs, Inc.98 involved complaints about statements that the defendant’s stereo system produced the “most life-like reproductions” and the “most exacting reproductions ever heard.” A potential purchaser of a stereo system will surely rely on his own ears, not on advertising copy, in such judgments. Any such statements, which can only be classiﬁed as seller’s puﬀ, can hardly produce harm to anyone, and litigation about them must be viewed as harassment of a newcomer. What can we conclude from these cases? First, there have been extremely few of them—sixteen cases over a ten-year period. Part of the reason may be that competitors, rather than suing directly, would prefer to use the indirect, but free, remedy provided by complaint to the Federal Trade Commission. In the period from October 1977 to July 1978 there were 306 complaints ﬁled with the FTC alleging deceptive advertising.99 The FTC will not divulge the identity of complainants, so we are unable to determine whether these were ﬁled by consumers or by competitors. Nonetheless, it is at least possible that this method is used. But for whatever reason, the small number of complaints ﬁled with the commission and the much smaller number of Lanham Act cases indicates that there was not in fact a huge demand for legal remedies for misrepresentation which the common law was restraining. Moreover, we have been charitable in deciding which cases might arguably have been eﬃcient; none of the cases mentioned above seem to create large ineﬃciencies. The cases which we have not discussed (dealing with matters such as whether a hair rinse really rinses out easily100 or whether a cigarette can advertise that it is “lowest” in tar and nicotine when in fact it is only tied for lowest)101 also do not seem to be of signiﬁcance. Those Lanham Act cases which do seem to involve substantial ineﬃciencies are generally passing-oﬀ cases, and remedies would have been available under common law. Moreover there is at least some evidence that ﬁrms have used the Lanham Act to harass new entrants. For example, in Smith-Victor Corp. v. Sylvania Electric Products, Inc. 102 the allegation was that a new type of photographic light would not in fact provide as much light as claimed. Since the two lights could be compared before purchase, this was clearly an attempt to harass a

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Ellen R. Jordan and Paul H. Rubin

new competitor, who was at somewhat of a disadvantage since he did not have a long history of success with light. Defendants were clearly new entrants in seven of the sixteen cases selected for study. For instance, in Saxony Products, Inc. v. Guerlain, Inc.103 it was the newcomer’s frank and open imitation of plaintiﬀ’s “Shalimar” fragrance which led to the litigation. Cheap imitations were also the issue in John Wright, Inc. v. Casper Corp.104 In Ames Publishing Co. v. Walker-Davis Publications, Inc. 105 the advertising attendant on launching a new publication led to the suit. Bose Corporation, an established manufacturer of stereo equipment, challenged the claims of newcomer Linear Design Labs, Inc.106 Likewise, H. A. Friend & Co. v. Friend & Co. 107 involved a son who set up an unauthorized “branch” of the family business in California and began competing with it. The Potato Chip Institute took oﬀense when General Mills began marketing its “Chipos,” and tried to stop any advertising of the new product as potato chips.108 One of the most interesting of the cases involved Honeywell, Inc., a giant in the ﬁeld of control systems, which was being sued by Electronics Corporation of America. Honeywell, in attempting to enter the market for replacement parts for Electronics Corporation equipment, was charged with misrepresenting the ease with which Honeywell parts could be substituted. Here Honeywell was trying to enter a new, although very limited, market and was advertising a “search” characteristic.109 Other cases, however, indicate that two already established brands may extend their competitive battle into the courts.110 In American Brands, Inc. v. R. J. Reynolds Tobacco Co.,111 instead of being used against the new entrant, the lawsuit seemed to be part of the challenger’s campaign to launch a new low-tar cigarette. The new entrant charged in its Lanham Act complaint that advertising for the defendant’s established Now brand falsely claimed that Now was “lowest” in tar when in fact the plaintiﬀ’s new cigarettes were as low. Defendant promptly counterclaimed for inaccuracies in the plaintiﬀ’s advertising (e.g., that plaintiﬀ’s Carlton brand was the “fastest growing”). As the judge remarked, actual tar content of cigarettes must be disclosed and is easily discovered by purchasers, making it unlikely that anyone had been misled. Nonetheless, an injunction was granted directing Reynolds to stop claiming its cigarettes were “lowest” in tar without some qualifying information. In the remaining cases, it is diﬃcult to ascertain the relative market positions of the plaintiﬀ and defendant.112 The foregoing suggests that although Lanham Act claims may be asserted to block new entrants, they are used at other stages in the competitive struggle as well. In any case, claims of misrepresentation seem to be used as a method of harassing rivals rather than as a method of encouraging truthful statements.

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The German experience Rudolf Callmann113 and Walter Derenberg,114 two leading authorities on the American law of unfair competition, were strong advocates of strengthening the rights of competitors to sue for false advertising. Both had experience with the German system, which depends on competitor action, not government regulation, to prevent deception in the marketplace. More recently Grimes115 has studied the German system and holds it up as a model. Although we have not independently assessed the data summarized by Grimes, some observations follow based upon it. In Germany the Law Against Unfair Competition has governed the regulation of misrepresentation and false advertising since 1909. The important section of this law, section 3, “prescribes injunctive relief, [which is freely granted]116 against those who, in the course of competitive business activities, make deceptive assertions concerning business matters, speciﬁcally concerning the ‘nature, origin, manner of manufacture or the value of goods or services,’ ” or “concerning ‘price lists, the manner or source of acquisition of goods, . . . the receipt of awards, . . . the motive or purpose of the sale, or the amount of available supplies.’ ”117 This law may be enforced by competing ﬁrms, by trade associations, or (since 1965) by consumer groups. In fact consumer enforcement seems to be a small part of total enforcement. The most inﬂuential group in enforcing this law is the Zentrale zur Bekämpfung unlauteren Wettbewerbs e.V., an organization consisting of more than 1,100 members, mostly chambers of commerce, trade organizations, and larger business entities. In 1967 this organization handled about 3,000 cases. Almost 93 percent of the complaints brought by this organization are directed against nonmembers. This is consistent with our argument that the larger, better-established ﬁrms who have invested in their reputations are less likely to practice deception. Indeed, in the United States, the worst oﬀenders in consumer frauds are said to be the ﬂy-by-night door-to-door operators who strike once and disappear.118 Nevertheless an economist might question whether all the organization’s energies are directed against such truly fraudulent practices. In fact “[t]he Zentrale has been accused of being a tool of the large and established ﬁrms.”119 Presumably, one use for such a tool might be to stiﬂe competition by nonmembers, particularly smaller ﬁrms or new entrants. We have no direct evidence on this point, but in general the value of competition is less important in European jurisprudence. European law countenances anticompetitive collusion by business rivals which would be per se violations of American antitrust laws.120 Hence an adverse eﬀect on competition would raise fewer problems for German courts than in this country.

36 Ellen R. Jordan and Paul H. Rubin

IV. Summary The major issue discussed in this paper has been the common law treatment of suits by competitors for false advertising consisting either of untrue claims about one’s own goods or about those of a competitor. In general the common law discouraged such suits, except in the special case of passing oﬀ. Although purchasers may have a right of action, in the general case consumers will not lose enough in any one transaction to bring legal action for misrepresentation. Competitors, however, may suﬀer enough loss to make legal action worthwhile, and commentators have urged that suits by competitors may be a better remedy for misrepresentation than government action. Thus the common law ban on such suits has been considered puzzling and potentially in conﬂict with the view that the common law is generally explicable in terms of economic eﬃciency. Except in the case of producer identity, our analysis casts doubt upon a need for any legal action for competitors premised on false advertising. We have shown that the economics of advertising, primarily as analyzed by Nelson, indicates that there generally will be little incentive to mislead in advertising.121 Moreover in only a few cases would there be competitors who were suﬃciently damaged by misleading advertising to ﬁnd it worthwhile to sue. The one situation where such suits are favored is in the case of the actual name of the manufacturer; this is a credence characteristic, whose truth consumers could not ascertain for themselves. If there is in fact little misleading advertising and if competitors would not usually sue, then there would be little loss if such private policing were discouraged. Moreover it is at least possible that allowing competitor suits for misrepresentation would give established ﬁrms a competitive weapon to use against new entrants. This is especially likely when we consider that new entrants advertise more heavily than established ﬁrms and that it may be more diﬃcult for new ﬁrms to establish the truth of advertising claims than for established ﬁrms to do so. Thus if we did allow ﬁrms to sue easily for misrepresentation, there might be substantial costs in terms of reduced competition in markets. The economic argument indicates that there would be little beneﬁt and substantial costs from allowing competitor suits. In support of these arguments we have relied on several pieces of evidence. First, Posner has found that the Federal Trade Commission in its attempts to police false advertising has in fact accomplished little. Second, the evidence from Germany indicates that most suits for misrepresentation are undertaken by established ﬁrms. While there are other arguments which might explain this pattern, it is consistent with the hypothesis that such suits would be used to discourage competition, especially given the much lesser importance of competition as a value in German law. Third, and most persuasive, is the evidence showing the eﬀects of statutory reversal of this position. Although the Lanham Act now allows competitors to sue for false advertising which damages them, there have been a trivial number of such suits. Of those which

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have been brought, moreover, only an extremely small number have been economically eﬃcient, even with a broad construction of such eﬃciency. Many have been aimed at new entrants. Thus, this natural experiment with a statutory reversal of a common law position has served to buttress our theoretical arguments and to demonstrate that the common law was probably eﬃcient in this area.122 Another consideration is the burden on advertisers if all advertising is scrutinized: even accurate advertising must run the risk of a charge of being “misleading.” If such burdens exist, the law may hinder eﬃcient consumer choice since more information for consumers is better than less. The First Amendment to the United States Constitution clearly reﬂects that judgment when the information in question is political. On the other hand the Supreme Court only recently decided that commercial speech has any claim to First Amendment protection,123 and then the Court took pains to note that “untruthful speech, commercial or otherwise, has never been protected.”124 In the terms developed here, however, competing political claims seem to exhibit more credence characteristics than most claims about goods or services in that their truth or falsehood is much harder for the consumer to determine. Yet even if the need to guard against falsehood is greater, the government is prohibited from intervening because of the dangers and distortions such intervention might cause. As both Coase125 and Director126 have pointed out, it is diﬃcult to understand why governmental intervention in the marketplace for goods is regarded by many as a blessing, while its role as a regulator of ideas is so vehemently opposed. Market, not government, regulation in the realm of commerce as well as ideas may be a better idea.127

Notes *

1 2 3 4 5 6 7

The authors would like to thank Richard Posner, Walter Hellerstein, Gregory Alexander, James Kau, and Carl Jordan for helpful comments. An earlier version of this paper was presented at the Law and Economics Workshop at the University of Chicago, and thanks are also due to the participants, especially Edmund Kitch. That literature is summarized in Richard A. Posner, Economic Analysis of Law (2nd ed. 1977). Diﬀerent dynamics operate to shape the law created by legislatures. No economist has suggested that statutory law is economically eﬃcient. Paul H. Rubin, Why Is the Common Law Eﬃcient? 6 J. Legal Stud. 51 (1977). William M. Landes & Richard A. Posner, Adjudication as a Private Good, 8 J. Legal Stud. 235 (1979). John C. Goodman, An Economic Theory of the Evolution of the Common Law, 7 J. Legal Stud. 393 (1978). Similar evidence has been marshaled by Marc Galanter. See Marc Galanter, Why the “Haves” Come Out Ahead: Speculations on the Limits of Legal Change, 9 Law & Soc. Rev. 95, 100–102 (1974). “In its Final Report the National Commission on Product Safety stated that it was impractical for consumers to press claims . . . unless the claim is at least

38

8 9 10 11 12 13 14

15 16 17

18

19

Ellen R. Jordan and Paul H. Rubin in the $5,000 to $10,000 range.” D. Gould, Staﬀ Report on the Small Claims Court submitted to the National Institute for Consumer Justice 16 (1972) [hereinafter cited as Small Claims Report]. See also Arthur Allen Leﬀ, Injury, Ignorance, and Spite: The Dynamics of Coercive Collection, 80 Yale L.J. 1, 21 (1970). See, e.g., Milton Handler, False and Misleading Advertising, 39 Yale L.J. 22 (1929); Rudolf Callmann, False Advertising as a Competitive Tort, 48 Colum. L. Rev. 876 (1948). See Richard A. Posner, The Federal Trade Commission, 37 U. Chi. L. Rev. 47, 66 (1969). Phillip Nelson, Information and Consumer Behavior, 78 J. Pol. Econ. 311 (1970); and also his Advertising as Information, 82 J. Pol. Econ. 729 (1974). See Richard H. Holton, Consumer Behavior, Market Imperfections, and Public Policy, reprinted in David Rice, Consumer Transactions 57 (1975). George J. Stigler, The Economics of Information 69 J. Pol. Econ. 213 (1961), reprinted in George Stigler, The Organization of Industry (1968). See Holton, supra note 11, at 58. Rubin makes this point in another context. See Paul H. Rubin, The Theory of the Firm and the Structure of the Franchise Contract, 21 J. Law & Econ. 223 (1978). See also Keith Leﬄer, The Role of Price in Guaranteeing Quality (1977) (mimeographed paper), for an argument that advertising can be used to guarantee quality to consumers. See generally Kristian S. Palda, The Measurement of Cumulative Advertising Eﬀects (1964), who demonstrates that advertising should be treated as an investment. Michael R. Darby & Edi Karni, Free Competition and the Optimal Amount of Fraud, 16 J. Law & Econ. 67 (1973). This may be another reason for allowing advertising by professionals such as doctors. The advertising will create an additional value in the brand name and hence provide additional incentives for quality service. For any one purchase where credence qualities are involved, the consumer cannot be sure that he is getting a desirable good; i.e., there is a low probability of his ﬁnding out whether claims about any one good are true or false. However, if the consumer buys many goods from the same source, the probability of ascertaining that claims about one of those goods are false would be increased. Thus, if there are ten goods sold by a store and if there is only a 1 percent chance of ﬁnding out that any claim is false, the larger number of claims increases the chance of ﬁnding out that one or more of them are false. In this situation, claims about individual goods have credence characteristics; but the reputation of the seller of all of the goods is an experience characteristic. It may be that consumer trust in the reputation of the intermediary is misplaced in the situation of mail order advertisements carried by magazines. Although the consumer may rely on the publisher of the magazine to police their advertisers, Consumers Union claims that in fact such policing is minimal or nonexistent. Delusions of Vigor: Better Health by Mail, Consumer Reports, January 1979, at 53. Striking evidence is provided by a case brought by the state of Arizona against ﬁve manufacturers of rigid polyurethane foam insulation materials, charging a conspiracy to falsely advertise the ﬂammability characteristics of the product. State of Arizona v. Cook Paint & Varnish Co., 391 F. Supp. 962 (D. Ariz. 1975). If the allegations of the complaint are true, far from trying to keep one another honest, all the oligopolists banded together to deceive. See Yale Brozen, Entry Barriers: Advertising and Product Diﬀerentiation, in Industrial Concentration: The New Learning 115–16 (Harvey J. Goldschmidt, H. Michael Mann, & J. Fred. Weston, eds 1974).

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20 The common law of sales has been largely replaced by statute, the Uniform Commercial Code. Given the unique drafting history of this statute, however, the fact that it is a “case-law code” makes it appropriate to include UCC provisions in this discussion. See Soia Mentschikoﬀ, The Uniform Commercial Code, An Experiment in Democracy in Drafting, 36 A.B.A.J. 419 (1950); Grant Gilmore, In Memoriam: Karl Llewellyn, 71 Yale L.J. 813, 814 (1962). 21 U.C.C. § 2–503(1) 22 U.C.C. § 2–601. 23 U.C.C. § 2–608. 24 U.C.C. §§ 2–711–2-717. 25 U.C.C. § 2–607. 26 U.C.C. § 2–714. 27 U.C.C. § 2–607(3)(a). 28 U.C.C. § 2–313. 29 U.C.C. §§ 2–312–2–315. 30 U.C.C. § 2–313. 31 U.C.C. § 2–313(2). 32 See generally William L. Prosser, The Fall of the Citadel (Strict Liability to the Consumer), 50 Minn. L. Rev. 791 (1966). 33 U.C.C. § 2–607(3)(a). 34 U.C.C. § 2–316. 35 U.C.C. § 2–316(1). 36 U.C.C. § 2–202. 37 U.C.C. § 2–719. 38 U.C.C. § 2–719(2). 39 See William L. Prosser, The Law of Torts § 105 (4th ed. 1971). 40 See id. 41 We make the same distinction between the consumer who complains he has been “taken,” and the one who has received a defective product or “lemon,” as do Page Keeton & Marshall S. Shapo in Products and the Consumer: Deceptive Practices 3 (1972). 42 Jacobson v. Art Storage & Moving Co., 16 N.Y.S.2d 906 (N.Y. City Ct. 1939), appeal denied, 260 App. Div. 809, 22 N.Y.S.2d 928 (1940). 43 See Posner, supra note 9. 44 103 F. 281 (6th Cir. 1900). 45 273 U.S. 132 (1927). 46 7 F.2d 603, 604 (2d Cir. 1925). 47 See text at note 17 supra. 48 Developments in the Law: Competitive Torts, 77 Harv. L. Rev. 888, 893 (1964). 49 Id. at 893–95. 50 This very rumor bedeviled McDonald’s. See Wall Street Journal, Nov. 16, 1978, at 14, col. 2. 51 251 F.Supp. 286 (E.D. Pa. 1966). 52 129 F.2d 227 (3d Cir. 1941). 53 See Developments in the Law, supra note 48, at 908. 54 From time to time, it has been reported that dealers in illegal drugs have tried to use a trademark to guarantee the quality of their goods. Since such manufacturers cannot rely on the legal system to protect their trademarks, these attempts invariably fail. 55 127 F.2d 245 (7th Cir. 1942). 56 86 F. 608 (7th Cir. 1898), cert. denied, 173 U.S. 703 (1899). 57 162 F.2d 893 (2d Cir. 1947). 58 420 F.2d 1248 (7th Cir.), cert. denied, 400 U.S. 820 (1970). 59 305 U.S. 111 (1938).

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60 Richard A. Posner, Regulation of Advertising by the Federal Trade Commission 31 (Am. Enterprise Inst. 1973). 61 See, e.g., Developments in the Law—Deceptive Advertising, 80 Harv. L. Rev. 1005, 1082–83 (1967). 62 See Note, 29 Baylor L. Rev. 559, 563–67 (1977). 63 Pub. L. 93–637, 99 Stat. 2183 (1975). Such power had been upheld as “implied,” even without explicit legislative authority, in National Petroleum Reﬁners Ass’n v. FTC, 482 F.2d 672 (D.C. Cir. 1973). 64 15 USC § 57a(a)(1)(B)(1976). 65 15 USC § 53e(b) (1976). 66 15 USC § 45(m)(1)(B) (1976). 67 15 USC § 45(m)(1)(A) (1976). 68 15 USC § 57b(a)(2)(1976). 69 15 USC § 57b(b) (1976). 70 Holloway v. Bristol-Myers Corp., 485 F.2d 986 (1973). 71 See John A. Sebert, Jr., Enforcement of State Deceptive Trade Practices Statutes, 42 Tenn. L. Rev. 689, 698–704 (1975). 72 William A. Lovett, State Deceptive Trade Practice Legislation, 46 Tulane L. Rev. 724, 743–49 (1972). These statutes are considered in Part III-B infra. 73 For the history of the small-claims-court movement, which dates back to 1605 in England, see Small Claims Report, supra note 7, at 3 (1972). Eﬀorts to reduce the cost of consumer suits continue: a bill to provide federal funds to states for establishing and promoting procedures for resolving minor consumer disputes passed the Senate but was defeated in the House. Cong. Q. Weekly Rept., Oct. 21, 1978, at 3082. 74 See, e.g., Note, 4 Stan. L. Rev. 237 (1952); Note, 21 Stan. L. Rev. 1657 (1969); Judge Tim Murphy, Small Claims Court—The Forgotten Court, 34 D.C. Bar J., February 1967, at 14. 75 See Small Claims Report, supra note 7, at 11–12. 76 John Montague Steadman & Richard S. Rosenstein, “Small Claims” Consumer Plaintiﬀs in the Philadelphia Municipal Court: An Empirical Study, 121 U. Pa. L. Rev. 1309 (1973). Their survey found that 18 percent of the 614 cases studied fell into a “miscellaneous” category, which included fraudulent advertising (id. at 1327, n. 133). Fraudulent advertising was not separately mentioned as one of “the more prominent miscellaneous claims categories.” (Table B, id. at 1347.) 77 See generally, David A. Rice, Remedies, Enforcement Procedures, and the Duality of Consumer Transaction Problems, 48 Boston U. L. Rev. 559, 588–95 (1968). 78 Eric H. Steele, Fraud, Dispute, and the Consumer: Responding to Consumer Complaints, 123 U. Pa. L. Rev. 1107 (1975). 79 Id. at 1131. 80 Id. at 1135–36. 81 See Rice, supra note 77, at 570–76. 82 The literature on consumer class actions is extensive. See the exhaustive report of Gould, in Small Claims Report, supra note 7. 83 See, e.g., Note, Consumers, Class Actions, and Costs: An Economic Perspective on Deceptive Advertising, 18 U. C. L.A. L. Rev. 592, 603–05 (1971). See also, Jonathan M. Landers, Of Legalized Blackmail and Legalized Theft: Consumer Class Actions and the Substance-Procedure Dilemma, 47 S. Cal. L. Rev. 842 (1974). Landers also points out that the cost of resort to the courts means that businesses, too, cannot obtain legal redress for small injuries. Landers suggests that the legal system may reﬂect a social judgment that such small losses should lie where they fall, instead of using resources to reallocate the loss through the legal system. In other words, court time should be reserved for more weighty problems.

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84 85

86 87

88 89 90 91

92 93

94 95 96 97 98 99

100 101 102 103 104

41

See also Hacket v. General Host Corp., 455 F. 2d 618, 626 (3d Cir.), cerl. denied, 407 U.S. 925 (1972). Or. Rev. Stat. § 646.638 (1971). Scott v. Western International Surplus Sales, Inc., 267 Ore. 512, 517 P.2d 661 (1973). The real bone of contention appeared to be the store’s refusal to give a cash refund. The retailer oﬀered the consumer a credit, which he claimed was worthless to him. Wolverton v. Stanwood, 278 Ore. 341, 563 P. 2d 1203 (1978). Some courts have questioned whether the Lanham Act was intended to do any more than give a federal right of action “false descriptions of substantially the same economic nature as those which involve infringement or other improper use of trademarks.” Samson Crane Co. v. Union National Sales, Inc., 87 F. Supp. 218 (D. Mass. 1949), aﬀ’d per curiam, 180 F. 2d 896 (1st Cir. 1950). The Third Circuit gave the section a more expansive reading in L’Aiglon Apparel v. Lana Lobell, Inc., 214 F.2d 649 (3d Cir. 1954). The controversy is reviewed in Universal Athletic Sales Co. v. American Gym, Recreational & Athletic Equipment Corp., 397 F. Supp. 1063, 1071–73 (W.D. Pa. 1975), aﬀ’d mem., 566 F. 2d 1171 (3d Cir. 1977). 419 F. Supp. 292 (E. D. Pa. 1976), aﬀ’d sub nom., Donsco, Inc. v. Casper Corp., 587 F. 2d 602 (3d Cir. 1978). 375 F. Supp. 777 (N. D. III. 1974). 441 F. Supp. 162 (C. D. Calif. 1977). If “Made in USA” is perceived as a proxy for better quality by consumers, one may question the part of Posner’s critique of the FTC which condemns devoting resources to combatting such deceptions. Consumers may not be xenophobic, as he points out, but they may prefer better-made goods. See Richard A. Posner, supra note 9, at 73. 19 U.S.C. § 1304 (1976). 285 F. Supp. 636 (S.D.N.Y. 1968). This case also points up the necessity of permitting a ﬁrm to guard its trademark. If the misnumbered part in fact caused a crash and blame could be traced to that part, injured parties would look to the original manufacturer, identiﬁed on the part, for redress. Although current law places the burden on the plaintiﬀ to prove that the defect existed at the time the product left the manufacturer (Restatement (Second) of Torts § 402A (1965)), in fact the original manufacturer would have to put the intervening alteration of the part into evidence in order to put the plaintiﬀ to his proof. On misuse of trademark grounds alone, the plaintiﬀ may have had a good cause of action. 362 F. Supp. 1094 (S.D.N.Y. 1973). 372 F. Supp. 1 (E.D. Pa. 1974). 513 F.2d 716 (9th Cir. 1975). R. G. Smith v. Chanel, Inc. 402 F. 2d 562 (9th Cir. 1968). 467 F. 2d 304 (2d Cir. 1972). Letter from Carol M. Thomas, Secretary, Federal Trade Commission to authors (Nov. 22, 1978), in response to Freedom of Information Act request. One widely publicized instance of competitor complaint to the FTC occurred in the hotly contested beer marketing battle between Miller and Anheuser-Busch. Miller complained that Anheuser-Busch’s advertising its beers as “natural” was “misleading.”. See Wall Street Journal, Mar. 14, 1979, 48, col. 2. Alberto-Culver Co. v. Gillette Co., 408 F. Supp. 1160 (N.D. Ill. 1976). American Brands, Inc. v. R. J. Reynolds Tobacco Co., 413 F. Supp. 1352 (S.D.N.Y. 1976). 242 F. Supp. 302 (N.D. Ill. 1965). 513 F.2d 716 (9th Cir. 1975). 419 F. Supp. 212 (E.D. Pa. 1976), aﬀ’d sub nom., Donsco, Inc. v. Casper Corp., 587 F.2d, 602 (3d Cir. 1978).

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105 106 107 108 109 110

372 F. Supp. 1 (E.D. Pa. 1974). Bose Corp. v. Linear Design Labs Inc., 467 F.2d 304 (2d Cir. 1972). 276 F. Supp. 707 (C.D. Cal. 1967). Potato Chip Inst. v. General Mills, Inc., 461 F.2d 1088 (8th Cir. 1972). Electronics Corp. of Am. v. Honeywell, Inc., 358 F. Supp. 1230 (D. Mass. 1973). Skil Corp. v. Rockwell Int’l Corp., 375 F. Supp. 777 (N.D. Ill. 1974); AlbertoCulver Co. v. Gillette Co., 408 F. Supp. 1160 (N.D. Ill. 1976) (Tame v. Earth Born Creme Rinses); American Consumer, Inc. v. Kroger Co., 416 F. Supp. 1210 (E.D. Tenn. 1976) (Kroger’s “Price Patrol” report); American Home Products Corp. v. Johnson & Johnson, 436 F. Supp. 785 (S.D.N.Y. 1977) (Anacin v. Tylenol). 413 F. Supp. 1352 (S.D.N.Y. 1976). Universal Athletic Sales Co. v. American Gym, Recreational & Athletic Equipment Corp., 397 F. Supp. 1063 (W.D. Pa. 1975); Bohsei Enterprises Co. v. Porteous Fastener Co., 441 F. Supp. 162 (C.D. Calif. 1977). 1 Rudolf Callmann, The Law of Unfair Competition, Trademarks, and Monopolies § 8.2(c)(3d ed. 1965). See, e.g., Walter J. Derenberg, Federal Unfair Competition Law at the End of the First Decade of the Lanham Act: Prologue or Epilogue? 32 N.Y.U.L. Rev. 1029 (1957). Warren S. Grïmes, Control of Advertising in the United States and Germany: Volkswagen Has a Better Idea, 84 Harv. L. Rev. 1769 (1971). Id. at 1789–90. Id. at 1781–82. See, e.g., David Caplovitz, The Poor Pay More 153–54 (1967). Grimes, supra note 115, at 1784. F. M. Scherer, Industrial Market Structure and Economic Performance 158 (1970). What incentive there is will be strongest in the case of credence qualities. Consistently with its congruence with economic rationality, the common law most freely permitted private actions when such claims (as, for example, manufacturer identity) were at stake. The law of false advertising discussed here is part of the general body of law called “unfair competition,” which deals in general with torts committed by one business ﬁrm against another. We have found economic analysis fruitful in examining one part of this law, and would predict that it should also be useful in understanding other aspects of the legal treatment of relationships between competitors. As one example, a preliminary analysis by Paul H. Rubin (unpublished paper at Univ. of Ga.) of the rights of employees to compete with former employers indicates that many aspects of the employment contract can be understood in terms of the concepts of human capital developed by Gary Becker. See Gary S. Becker, Human Capital (2nd ed. 1975). Another example is the common law treatment of price competition. In fact, the common law said virtually nothing about such competition. See Edmund W. Kitch & Harvey S. Perlman, Legal Regulation of the Competitive Process 193 (1972). Strictures on such behavior, which ban unfairly low prices, are clearly ineﬃcient; such restrictions are creatures of statute, such as the Robinson-Patman Act. In this area the failure of the common law to interfere is a clear sign of its eﬃciency. Virginia State Board of Pharmacy v. Virginia Citizens Consumer Council, Inc., 425 U.S. 748 (1976). Id. at 771. R. H. Coase, Advertising and Free Speech, 6 J. Legal Stud. 1 (1977). Aaron Director, The Parity of the Economic Market Place, 7 J. Law & Econ. 1 (1964). But see the contrary view expressed by Vern Countryman, who argues that

111 112 113 114 115 116 117 118 119 120 121

122

123 124 125 126 127

The law of false advertising

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we must trust government to protect the consumer against defective goods “which he has neither the information nor the skill to identify for himself.” Vern Countryman, Advertising Is Speech, in Allen Hyman & M. Bruce Johnson, Advertising and Free Speech 35, 37 (1977). Our argument is that the consumer has considerable information and sources of advice without governmental intervention, most of it provided by advertising.

4

Freedom of speech vs. eﬃcient regulation in markets for ideas* Albert Breton and Ronald Wintrobe

Introduction This paper is concerned with the operation of markets for ideas. For concreteness and to focus the discussion we shall consider four speciﬁc markets: the market for judicial decisions (the courts, viewed strictly as a marketplace for ascertaining the truth), those for scientiﬁc ideas, for advertising messages and the market for political ideas. The problem to be investigated was ﬁrst posed by Coase (1974, 1977), and can be understood by looking brieﬂy at the market for political ideas. In the United States free competition in that market is guaranteed by the First Amendment which prohibits Congress from making any law ‘abridging the freedom of speech, or of the press; . . .’. Similar legislation or implicit rules exist in all democratic countries; it would, indeed, seem to be an essential requirement of democracy. Free speech is easy to justify on ethical grounds; to many, it is desirable for its own sake. Can it, however, also be justiﬁed on eﬃciency grounds? Does freedom of speech result in the election to public oﬃce of the best candidates and in the adoption by governments of the best policies? John Milton must have thought so when he wrote: ‘Let (truth) and falsehood grapple; who ever knew Truth put to the worse in a free and open encounter?’1 If, under freedom of speech, truth always triumphs over falsehood, one would have a powerful justiﬁcation for its enactment. One would not have to assume that it is desirable for its own sake: it would be desirable on eﬃciency grounds because it would sort out good from bad ideas. But this view leads to a number of paradoxes, as Coase (1974, 1977) pointed out. Let us consider them in turn. First, if free competition is always desirable in the market for ideas, why is it not so in markets for goods? One can argue that the presence of externalities or of public goods make regulation desirable in certain goods markets. But the case for regulation on these grounds would appear to be, if anything, considerably stronger for ideas, since these possess all of the properties of public goods. It follows that, as

Freedom of speech vs. eﬃcient regulation in markets for ideas 45 Coase put it, liberal intellectuals are inconsistent in favoring government regulation in goods markets while at the same time ﬁercely defending freedom of speech as a basic right [Coase (1974, pp. 384–385)]. A second paradox concerns commercial speech or advertising. If competition in the market for ideas leads to eﬃciency, how can the regulation of advertising be justiﬁed? The United States Supreme Court, for example, draws a sharp distinction between commercial and political advertising and holds that the second is protected by the First Amendment, while the ﬁrst is not. If free speech distinguishes truth from error in the market for political ideas, presumably it does so in the market for advertising also. Yet the U.S. Supreme Court consistently draws the distinction, an attitude which Coase found incomprehensible [Coase (1977, pp. 13–32)]. Finally, there is the puzzle of the courts, viewed as a marketplace for sorting truth from error. Competition within the courtroom is heavily regulated. Who can speak, when, the order of speaking and the kinds of things which can be said are all subject to numerous rules and regulations and to interpretation of them by the presiding judge. Many kinds of evidence cannot be introduced at all. It must be presumed that in courtrooms the sorting of truth from error is of paramount importance; why then is that market so heavily regulated if unregulated competition can be counted on to sort truth from error? In this paper, we contend that the paradoxes can be clariﬁed by reference to a basic proposition (elaborated below) which states that under unregulated competition error tends to drive out truth. Our analysis provides a consistent explanation for the broad pattern of observable regulation in many markets for ideas: speciﬁcally, it allows us to explain the extensive regulation of the courts, the form of regulation in markets for scientiﬁc ideas, the regulation of advertising messages and ﬁnally, it tells us why the political marketplace is not and should not be regulated. The last argument provides the basis of our case for free speech. Essentially, we are suggesting, contrary to the agrument of Coase, that the broad observable pattern of regulation in markets for ideas can be rationalized on eﬃciency grounds. This should not be taken to imply that we do not believe that improvements in regulation are possible. However, a more fully developed model than that provided here would be necessary before useful recommendations in that direction could be made. Our purpose is the relatively modest one of trying to make sense of existing regulatory structures. As indicated, we shall develop our argument by considering each of the four markets listed above. The structure of the argument is, however, the same in each case, so that a brief preliminary summary of it may be useful. It consists of ﬁve propositions:

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Proposition 1. Competition distinguishes truth from error if experimentation (direct testing of competing hypotheses) is possible. Where this is not possible, or where it is too costly, unregulated (perfect) competition does not necessarily distinguish truth from error. Instead, adverse selection may occur; when it does error tends to drive out truth in the same way that bad products drive out good ones in Akerlof’s (1970) model of the market for ‘lemons’. The necessary conditions for adverse selection are: (i) buyers cannot distinguish ‘good’ products from ‘bad’ ones (because the cost of experimentation is too high), and (ii) information is distributed asymmetrically – sellers may, for example, have more information than buyers about the quality of their products. In the ideas markets we shall be considering, both of these conditions are fulﬁlled.2 Proposition 2. If the two necessary conditions just listed hold, eﬃcient regulation – restrictions on freedom of speech – can improve the working of markets for ideas. These restrictions may take any form, including self-regulation, namely, regulation imposed by the sector on its own members. Leland (1979) showed that where the conditions for adverse selection ((i) and (ii) above) obtain, regulation, in the form of licensing, which successfully (eﬃciently) removes (ﬁlters or screens) low-quality products from the market can improve (in the Pareto sense) the functioning of goods markets. The same proposition holds in ideas markets where ‘good’ ideas can be deﬁned as those which contain a high proportion of the truth, ‘bad’ ideas as those which possess a high proportion of error and eﬃcient regulation as that which, on balance, successfully (though not necessarily perfectly) removes bad ideas from the market. Some ideas are obviously bad – condition (i) pertains to the kind of information which needs to be screened out because it is deceptive: false information which appears to be true or which, for one reason or another, would command greater credence than it deserves.3 Proposition 3. screen.

It does not pay (even if it were possible) to use a perfect

Consequently, some truth is always screened out in the process of regulating ideas markets. We deﬁne the level of repression in an ideas market as the extent to which true information is kept out of the marketplace.4 This notion is, of course, diﬃcult to quantify precisely and we make no attempt to do so here. We shall assume, as does everyone else who discusses the subject, that rough and ready judgements are possible.

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Proposition 4. The set of regulations governing speech (the screening device) in any ideas market is what we shall term an ‘enforced monopoly’. The reasons are best explained in the context of each of the speciﬁc ideas markets considered. The rationale for it, however, may be brieﬂy stated: it follows from the objective which, as we shall see, holds in all the ideas markets considered, that the same set of regulations be consistently applied to all statements made in that market. We shall refer to the set of regulations governing speech in any ideas market as a collective screening device. To illustrate, consider the rules of evidence used in the judicial system. In order that the objective of justice be met, the same set of regulations must be enforced across defendants in similar cases: to the extent that the rules are weakened for some and not for others, justice is not obtained. Moreover, there are many possible sets of rules of evidence which could be used, and there is, in fact, considerable variation across judicial systems in the rules that are used. The requirement that in each jurisdiction, only a single system can prevail implies the existence of monopoly power which can be captured by certain groups who are favored by a particular system. Although the argument that the set of regulations governing speech in an ideas market constitutes an ‘enforced monopoly’ applies to ideas markets such as science or justice, the category of enforced monopoly is broader than that of ideas markets. Consider for example, phenomena such as a country’s national ﬂag, its monetary system, system of weights and measures, or its legal system. In each case, the social objective (national identity in the case of ﬂags, the reduction in transaction costs in the case of money or weights and measures, and justice in the case of the legal system) requires that only a single ordering device (the ﬂag, the monetary unit, the units of weights and measures, and the set of laws) be used. In each case, the monopoly is not necessarily ‘natural’ and private incentives to deviate from it (e.g. to use the ﬂags of ethnic groups, foreign currencies, other systems of weights and measures, or to ‘buy’ justice) must be policed and the monopoly ‘enforced’. Proposition 5. Because the collective screening device is a monopoly, ideas markets are not perfectly self-regulating. In none of the markets considered are the ideas ‘sold’; consequently the social problem caused by monopoly in ideas markets is not the usual one of price exceeding marginal cost. Instead, the problem is to guard against undue or excessive repression of information. As a consequence, a second kind of regulation is needed for eﬃciency, namely, regulation by the state or by some other authority to protect minority viewpoints and to guard against ineﬃcient entry. In what follows, we hope to show that this framework is an illuminating way to explain the existing pattern of regulation in ideas markets. We

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shall discuss each of the four markets in turn, beginning with the courts, then going on to consider scientiﬁc ideas, advertising and ﬁnally political ideas.

The courts The aspects of the courts with which we are concerned is their role as fact ﬁnding bodies, that is, as markets for ideas in which attorneys on each side of a case compete to convince an impartial tribunal of the truth or justice of their own side.5 Direct experimentation or testing is obviously impossible here; indeed, court hearings may be thought of as substitutes for this. As Coase emphasized, participants in these markets are not free to say all they desire or to introduce any evidence they wish. For brevity, we shall refer to the set of regulations prevailing in any jurisdiction as the rules of evidence. One function of those rules is to act as a screen to remove deceptive information from the market. For example, in most and possibly in all (democratic) jurisdictions, the evidence obtained from lie detector tests cannot be used in the courts. This restriction is surely based on the notion that lie detector tests appear to have a validity that they do not in fact possess. In that sense the information they convey is deceptive. However, by screening these tests out, some true information is, at the same time, rejected. The validity of the information obtained from the lie detector tests is on a par with the validity of information derived from (say) econometric tests; that information is probably also deceptive in the same sense, but the consequences of accepting it as true if it is not, are very diﬀerent than the consequence of accepting as true the results of lie detector tests when they are not. Proposition 3 states that screening devices are never perfect. That seems to be clearly true for judicial rules of evidence. It follows that some good information will be screened out and some bad information let in so that errors in the administration of justice will occur. Moreover, since direct experimentation is ruled out, it will seldom be known whether justice is done in any particular instance. Usually, all that can be known is whether justice is done in terms of whether the procedures followed were those prescribed by the judicial code. As long as it is believed that a correspondence between justice in this sense and true justice exists, procedural justice can serve as an indicator of the latter. [This is, of course, the standard argument for the eﬃciency of screening, see Stiglitz (1975).] The enforced monopoly argument (Proposition 4) follows directly from this. For, if establishing whether true justice is done is decided on the basis of whether procedural justice is observed, it follows that the same rules of evidence must be applied to everyone. The requirement of consistency of treatment implies that everyone must be dealt with according to the same rules. This requirement is easy to rationalize: since direct comparison of the results with ‘true’ justice is diﬃcult, if not impossible, it can never be known whether deviations from the rules result in a closer or further approximation to true justice. From this follows the requirement of uniformity of treatment

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according to a particular set of rules and that, within any jurisdiction, the existing set of rules is a monopoly. Finally, from Propositions 3 and 4 (to the eﬀect that the rules of evidence are a monopoly, and that the monopoly, as a screen, is imperfect), it is easy to infer Proposition 5: the case for regulation to protect citizens against the biases in the rules. In practice, such regulations are embodied in constitutional provisions guaranteeing the rights of defendants, in the appeals process, in the provision of state-ﬁnanced lawyers to the indigent, and so on. In these and other ways, the state acts as a regulator to protect citizens against undue exercise of the monopoly power contained in the rules of evidence. But such protection is also embodied in the basic right of citizens to make changes in or overturn the existing rules via the political process. The issue of how changes in the rules are eﬀected is discussed in section 5 (on political ideas). We hope that this brief discussion has shown, however, that the notion of restrictions on free speech in the market for judicial decisions is quite sensible. We now turn (in somewhat greater detail) to our second case: the market for scientiﬁc ideas.

Scientiﬁc ideas Models of science There appear to be two main competing views of how scientiﬁc ideas markets work.6 According to the ﬁrst, which Newton-Smith (1981) calls the ‘rational’ model – we will call it the ‘rationalist’ approach – the objective of science is to get at the truth. The chief exponents of this view are Popper (1968) and Lakatos (1978). Popper states this goal precisely as ‘verisimilitude’, namely, the process of continually increasing the degree to which theories approximate the truth. Popper suggests that the method of scientists in achieving this objective is that of ‘conjecture and refutation’: hypotheses are conjectured and scientists are led nearer to (but never reach) the truth through experimentation and the refutation of false hypotheses. Accordingly, the great leaps forward by men like Darwin, Einstein, Bohr or Keynes are just an extension to a higher level of a procedure the average scientist engages in every day. Lakatos (1978) diﬀers from Popper in his emphasis on scientiﬁc research programs: sequences of theories in which each theory is generated by modifying its predecessor. This concept enables Lakatos to explain (as Popper cannot) the apparent fact that scientiﬁc theories have typically not in practice been rejected just because they have led to false predictions. Lakatos, however, is a rationalist. Competition among rival scientiﬁc research programs sorts out the good theories from the bad: in his language, scientiﬁc research programs either progress or degenerate, and whether they do one or the other depends only on their relative success in predicting empirical phenomena.

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The diﬃculty with the rationalist approach in any of its versions is that it does not appear to describe what scientists do at all accurately. Rather, it pronounces on what they ought to do, in general disregard for what they typically do and have historically done. In economics, for example, the theory of utility-maximization is never tested against some other hypothesis. There is no alternative hypothesis. As Stigler has put it: ‘It is essentially inconceivable (but not impossible) that the theory of utility-maximizing is wrong, and the purpose of empirical investigation is not to test this assumption (pace Friedman). . . . Indeed there is no alternative hypothesis’ [Stigler (1975, p. 139–140)]. This seems to be an accurate reﬂection of the view of most economists. As a result, there is a basic corpus of economic theory which is simply never subjected to test. Kuhn (1962), the major ‘non-rationalist’ philosopher of science, explains this and other phenomena with his well-known concept of a paradigm.7 ‘Normal science’ – what ordinary scientists do on a day-to-day basis – is conducted within a paradigm – the central body of accepted theory of a discipline.8 The paradigm is expected to yield further knowledge, but exactly how it does so is not known. Normal science is like puzzle-solving. As puzzles get solved knowledge grows and cumulates within the paradigm. Kuhn suggests that a science is only a ‘mature science’ if it operates within a paradigm. In the absence of a paradigm, knowledge is not cumulative. As a consequence, what distinguishes scientiﬁc knowledge from other forms of knowledge is the property of cumulation. However, with the growth of knowledge, normal science also yields a growing stock of anomalies: puzzles which the paradigm should, and was expected to explain, but cannot. According to Kuhn, the growth of anomalies and the growing recognition of them eventually results in a scientiﬁc ‘revolution’: the creation of a new paradigm. This is how new hypotheses are created. An obvious example is the replacement of Newtonian by Einsteinian mechanics. If the revolution is successful, scientiﬁc activity reverts to normal puzzlesolving activities within the new paradigm. The so-called non-rationalist element in Kuhn’s approach enters at the level of paradigmatic choice. Kuhn puts this in a number of diﬀerent ways. For example: ‘[t]he choice [between paradigms] is not and cannot be determined merely by the evaluative procedures characteristic of normal science for these depend in part upon a particular paradigm, and that paradigm is at issue’; ‘[the] issue of paradigm choice can never be unequivocally settled by logic and experiment alone’ [Kuhn (1962, p. 94)]. Scientiﬁc revolutions are like ‘changes of world view’9 or changes in gestalt perception. His fundamental point is that the choice among paradigms does not, and cannot, depend on logic and experimentation alone, but upon other ‘non-rational’ (in Newton-Smith’s sense) criteria, such as the relative inﬂuence or power of diﬀerent groups within the scientiﬁc community.

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An economic model Kuhn’s view of how markets for scientiﬁc ideas operate is based on the history of science and not on a logical theory of scientiﬁc method. That view can, however, be given a logical or eﬃciency rationale using the model proposed in this paper. In that model, a paradigm is simply a screening device which sorts hypotheses into two categories: those which are consistent with (may be derived from) the paradigm and those which are not. The function of paradigms, like that of any screen, is to economize on the costs of testing or experimentation (Propositions 1 and 2). While paradigms themselves are never tested, hypotheses may be derived from them which can be. This permits the accumulation of knowledge about propositions which are themselves diﬃcult or impossible to test directly, such as the proposition in economic theory that people are rational. All of the propositions or empirical hypotheses which may be derived from the paradigm are necessarily consistent with one another. Empirical documentation of any one tends to raise the conﬁdence of the scientiﬁc community in all of them and in the paradigm itself as an ‘engine of truth’, as Marshall described supply and demand analysis, the basic paradigm of economic science. From our point of view the central diﬀerence between the rationalists and the non-rationalists is not between rationality and irrationality, but between competition and monopoly. According to the rationalist view, scientiﬁc truth is the outcome of free competition among diﬀerent hypotheses as decided by the impartial test of logic and experimentation. For the ‘non-rationalist’, on the other hand, the creation of alternative hypotheses and, therefore, of scientiﬁc truth is an entirely diﬀerent activity from that of normal science; the ruling paradigm is a monopoly, displacement of which requires a scientiﬁc revolution. Competition among paradigms is competition ‘for the ﬁeld’, as in Demsetz’ (1968) discussion of the bidding for the rights to provide the services of public utilities. In contrast to Demsetz and to more recent theories of this process which emphasize the contestability of natural monopoly markets,10 Kuhn may be interpreted as suggesting that the market for scientiﬁc paradigms is not perfectly contestable: the scientiﬁc community has some genuine monopoly power which can be exploited in the choice of paradigm. This explains why the goals of scientiﬁc communities and even the use of techniques of persuasion can be important in determining the choice of paradigms. To the extent that economists have attempted to model the market for scientiﬁc ideas, they have, usually implicitly, opted for the rationalist approach. This is the case for the older models among which one can note those of Marshall (1890), Keynes (1891) and Wicksell (1901, 1934), but it is also the case for the more recent models used in the debate launched by Friedman’s celebrated essay (1953) and joined, among others, by Machlup (1955), Koopmans (1957), Rotwein (1959), Samuelson (1963, 1966), Melitz

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(1965) and Bear and Orr (1967). All of these deal with the nature of the tests that can falsify hypotheses and theories and implicitly with the competitive process among economic scholars which is assumed to lead to truth.11 In our model, on the other hand, there is competition among scientiﬁc hypotheses, but this competition is conducted within a paradigm which is itself a monopoly. What is the source of this monopoly power? Costs of experimenting and the demand for screening do not imply this result, for the screening process could be competitively organized, as it is, for example, for many consumer goods. Indeed, for some products, a considerable selection of screens is available such as critics for movies, plays or books; expert appraisals from hi-ﬁ magazines, automobile magazines, and periodicals such as Consumer Reports; advice from agencies such as Better Business Bureaus, home service counselling; and many others. By sampling screens and comparing the rankings they yield with their own direct experience, consumers can choose those whose rankings are most consonant with their own. Competitive screening is feasible for consumer goods because of the twin postulates of consumer rationality and consumer sovereignty: rationality means that each consumer is assumed able to rank bundles of goods and services in a consistent order of preference; acceptance of consumer sovereignty implies that the ranking by each consumer is the best possible for him or her. Diﬀerent consumers may assess the qualities of goods in very diﬀerent ways. Since there is no consistency requirement across consumers’ rankings, there is no consistency requirement across screens. Accordingly, screening of consumer goods can be competitively organized, and consumers can choose among screens. Some aspects of scientiﬁc screening are indeed organized competitively. For example, journals, as screens, are organized on a competitive basis. The quality of an article is diﬃcult to assess and many scientists ﬁnd it convenient to rely on the reputations of journals and of their referees to screen out good articles from bad. Competitive screening is possible here for the same reason it is for consumers: by sampling the articles published by diﬀerent journals, each scientist can compare the standards used by the journals with his or her own. Could individual scientists choose among competing paradigms in the same way as they do among journals? Kuhn suggested that, as a factual matter, they do not behave this way, and that in general, there are no purely logical or factual grounds on which paradigms can be compared, and on which one paradigm may be said to be better than one another: paradigms are ‘incommensurable’. Of course, judgements among paradigms are made; indeed, such judgements are implicit in the process whereby one paradigm displaces another— Kuhn’s ‘scientiﬁc revolution’. In what sense, then, can one paradigm be said to be better than another? Basically, in the sense the it is the consensus of the relevant scientiﬁc community that the one paradigm is better than another. Hence the consistency requirement (Proposition 4) and hence the diﬀerence

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between a goods market and a pure ideas market. In the ﬁrst, the ultimate judgement or ranking is individual, in the second, it is collective. To be sure, there have been and will undoubtedly be further attempts by philosophers of science to provide a logical standard with which paradigms can be compared.12 The present model suggests, however, that this problem is inherently insoluble, so that there can be no substitute for the collective judgement of the scientiﬁc community. Paradigms could be compared either in terms of their assumptions or their implications. Our model supports Friedman’s (1953) contention that the ‘realism’ of assumptions cannot be the basis for comparison. Indeed, it provides a simple economic rationale for it: in our model, the assumption of a paradigm cannot by deﬁnition be easily compared with reality, because the costs of direct experimentation to determine their truth or falsehood is high. So the ‘realism’ of paradigms can only be compared in terms of their implications. But how can paradigms be ranked on that basis? A paradigm will be clearly superior to another if it can predict or explain all that the other paradigm does and more. That may indeed be the case in some comparisons – for example, of Einstein’s and Newton’s mechanics, or in the comparison of the neoclassical and labour theories of value. Beyond this one cannot go: consider any two paradigms, each of which predicts or explains some phenomena that the other does not. No matter how much more one of them explains as compared to the other, so long as one can explain some phenomena that the other cannot, choosing among them is a judgement of values, not of logic. On this count, there can never by any absolute standard for comparing paradigms other than the collective judgement of the scientiﬁc community. The same line of argument explains why collective screening is used in the courts: there is no ultimate standard of justice other than a collective value judgement, which can be used to compare rules of evidence. The same relationship exists between scientiﬁc truth and truth in an abstract sense as that between justice according to a particular set of rules and abstract justice. In both cases, the abstract notions are the objective: ‘Justice is the ﬁrst virtue of social institutions, as truth is of systems of thought’ [Rawls (1971, p. 3)]. In science, as in justice, however, it can never be known if that objective is met: no scientiﬁc proposition can ever be demonstrated to be absolutely true and no judicial decison can ever be shown to be truly just. According to Proposition 3, the use of a paradigm – a screening device – implies the presence of some degree of repression. The use of paradigms may be justiﬁable on eﬃciency grounds and if the paradigm in use is in fact the best available, the repression that takes place is eﬃcient in some sense, but it is repression nonetheless. The proposition can be illustrated by reference to the neoclassical paradigm in economics. Within the conﬁnes of that paradigm, it is very diﬃcult to explain such phenomena as wage and price stickiness, involuntary unemployment, why people vote, why they sometimes behave altruistically, why discrimination persists under competitive circumstances, and why apparent gains from trade are not exploited and give rise to strikes,

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divorces, torture, and other similar refusals to trade. These phenomena must be classed as ‘anomalies’ which, despite considerable eﬀort and ingenuity, have remained puzzles which have deﬁed solution. Moreover, if one steps outside the neoclassical paradigm, solutions to some of these problems can be found and some are even ‘obvious’ to the non-economist. Attempts are therefore made to ‘explain them away’, to deny the facts, or to suggest that their explanation is properly the task of some other discipline.13 There are other forms of scientiﬁc repression besides the attempted suppression of anomalies. All points of view other than that embodied in the ruling paradigm are repressed. One cannot use the propositions of Marxian economics or the views of (say) Galbraith, for the simple reason that the ideas embodied in these models cannot be derived from the neoclassical paradigm. Consequently, some knowledge of ‘reality’ is lost (repressed) by adhesion to the neoclassical paradigm. The problem is that the use of a paradigm is an either-or choice: one cannot use the neoclassical paradigm to analyze some problems and the Marxist one to analyze others. If one does this, one may gain insight, but not scientiﬁc knowledge, the cumulative character of which follows from its being consistently based on a single paradigm. Finally, Proposition 5 follows from these considerations: because of the monopoly character of the ruling paradigm, regulation is needed, both to protect ‘dissidents’ – minority viewpoints within the scientiﬁc community – and to ensure that the ruling paradigm will not survive beyond the point at which it should be replaced. Of course, actual regulation might be ineﬃcient and serve to protect an outmoded paradigm against dissidents. This is discussed further in section 5. But, in addition, there is the theoretical possibility of ineﬃcient entry, to which recent developments in the theory of contestable markets have drawn our attention. Even in perfectly contestable markets, such entry is possible, as Baumol, Panzar and Willig (1982) have shown. The resulting ineﬃciency can be eliminated by regulation. Let us brieﬂy consider one form of ineﬃcient entry. Suppose that a monopolist produces a line of outputs which if it was produced by two or more ﬁrms would entail higher average costs. This ‘subadditivity’ derives from the presence of one or more sharable inputs in the production process which give rise to economies of scope. An entrant who, through innovation, successfully undercuts the monopolist and captures the market for even one single product would, by so doing, raise the average cost of producing the remaining outputs. It is possible that the increase in average production costs of the monopolist would be large enough to cancel any gain from the lower price of the product captured by the successful entrant, thus making the entry ineﬃcient. To see how this applies to scientiﬁc paradigms, consider economics and suppose that the various ﬁelds which comprise the discipline – industrial organization, public ﬁnance, labor economics, international trade, microeconomics, monetary economics, etc. – reﬂect genuine economies of scope which in turn derive from joint use of the paradigm – a

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sharable input. The ﬂow of analytical propositions would then be produced at minimum ray average cost [Baumol (1982)], that is, at costs which were a minimum for each bundle of propositions. Suppose now that a successful entrant – call it mathematical economics – captures the ﬁeld of microeconomics. Imagine further that this successful capture reduces the extent to which researchers can practice (and publish in) both microeconomics and applied ﬁelds. As a consequence, research in microeconomic theory and in applied ﬁelds would tend to be increasingly performed by diﬀerent individuals (ﬁrms), and theory and application become increasingly estranged from one another. Would such a successful capture represent ineﬃcient entry? It would if the increased cost of obtaining propositions in applied ﬁelds and the costs of the lost progress in microeconomics due to reduced contact with the ﬁelds were greater than the beneﬁts of the progress which mathematics made possible in microeconomic analysis.14 Granted that for these reasons, regulation is essential for an eﬃcient accumulation of knowledge, might it not be that science, unlike justice, is ‘self regulating’, i.e., that the members of the scientiﬁc community could be counted on to regulate themselves in an optimal fashion? There are two reasons why this could be so. First, it would seem that in their role as producers of knowledge, scientists have an incentive to seek to replace a paradigm which is relatively unproductive. The matter is, however, not that simple. Competition between scientists for the rewards of professional activity will mean that younger members of the profession will have an incentive to overthrow the paradigm even when the proposed replacement is less productive than the old (the problem of ineﬃcient entry). Elders, on the other hand, will seek to maintain the existing paradigm even when it has outlived its usefulness; the value of what they themselves have accomplished will depreciate rapidly if the paradigm is replaced, so that their incentive to invest in a potential replacement is smaller than that of younger scientists. Elders will therefore tend to overprotect the paradigm. Kuhn has noted that if a revolution occurs in their lifetime, most never accept it: the way that the new paradigm replaces the old is by older scholars dying out. Samuelson (1964, pp. 315–316) has argued that something like this took place at the time of the Keynesian revolution. A second argument to the eﬀect that science could be self-regulating considers scientists in their role of demanders rather than producers of truth. Suppose, for purposes of illustration, that one important reason scientists choose their line of work is love of truth. Assuming that it is truth they love (and not merely, say, the aesthetic beauty of theorems) and that the members of a scientiﬁc discipline are the only consumers of its output, the scientiﬁc community would indeed be perfectly self-regulating. That community could then be counted on to ‘police’ its members to prevent over- or underexploitation of a paradigm, so that external regulation would not be required.15 The problem with this line of reasoning is that scientists are also supported by, and ‘sell’ their output to, the rest of society. To the extent that they do, the

56 Albert Breton and Ronald Wintrobe interests of scientists as producers intent on selling their output, will also enter into the way the scientiﬁc professions regulate themselves. The smaller the fraction of the total demand for scientiﬁc output made up by the scientists themselves, the more their interests as producers will dominate. Hence the need for outside (state) regulation to protect minority viewpoints is larger, the larger the fraction of output consumed by the outside world. This may explain the presence of outsiders on governing boards of universities and of granting agencies. The institution of academic tenure, which might be thought of as a device to protect minority viewpoints, is in fact mixed: academic tenure does protect the views of those who have it. In order to be given tenure, however, one must either publish – and virtually the only way to publish in suﬃcient volume to merit tenure is to work at puzzlesolving within the existing paradigm – or kow-tow to elders, who, we have just seen, have a vested interest in the existing paradigm.16 Consequently, the institution of tenure protects the minority viewpoints of the relatively old and unproductive, while ensuring that young, would-be ‘revolutionaries’ must, for the most part, stay within the boundaries of the paradigm handed down to them by the elders of their profession.

Commercial advertising and goods markets The market for commercial advertising is diﬀerent from the other ideas markets considered so far in that it is not a pure ideas market. The function of commercial advertising is to induce people to purchase goods. In other words, direct contact with the real world is available in principle. Indeed, for many goods, the cost of experimenting is low. For one class of goods, which Nelson (1970, 1974) calls search goods, qualities can be discovered prior to purchase by acquiring information on them. For others (experience goods) experimentation is only possible by purchasing, but for many goods, such as those which are bought repeatedly, the costs of experimenting may still be quite low. For these classes of goods, the problem of adverse selection cannot be very large. In addition there is always the possibility of regulating the qualities of the goods themselves, rather than regulating the advertising of them. On both these counts, the demand for screening of advertising messages is low relative to the demand for it in pure ideas markets. The second diﬀerence between advertising and pure ideas markets has already been pointed out. It rests on the fact that even where screening is desired, it is often possible for the screening process to be competitively organized. On the other hand, many countries regulate advertising. In Canada and the United States, the authorities screen commercial advertising for deceptive messages and issue cease and desist orders in those cases where a message is deemed deceptive; in the U.S., sales promotion devices (such as trading stamps) are subject to the FTC’s ‘fairness’ doctrine. Governments also regulate some goods and prohibit others from being sold entirely, which is in part a restriction on advertising, for if the prohibited goods (e.g. some

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drugs) are sold on the black market, sellers are prevented from advertising in the media, or are restricted in the ways they can advertise. We can refer to the whole body of regulations that is in one way or another aimed at controlling commercial advertising as the advertising code. That code, like rules of evidence in the courts and the scientiﬁc paradigm, is a screening or ﬁltering device which has the character of an enforced monopoly. How can the regulation of advertising be explained if the postulates of consumer rationality and of consumer sovereignty are accepted? The answer is that they are not always accepted, and they are least acceptable precisely in those areas where the basic axioms of consumer choice are least plausible. For example, it is well known that consumer choices do not satisfy the axioms of rationality (comparability and transitivity) if consumers are experimenting with goods, rather than choosing among known sources of satisfaction.17 Our model implies that the greatest demand for the regulation of advertising – for the replacement of individual screens by a collective one – will be revealed in at least two cases: (i) when the cost to individual consumers of experimenting and, therefore, the cost of generating an eﬃcient ranking of goods and services are much higher than the cost of such experimentation to consumers collectively, as, for example, in the case of prescription drugs; (ii) when the cost of collective screening is low, because individual variation in what is demanded is unimportant, as is the case with weights and measures or with traﬃc signals to mention only two examples. Even if there is a demand for a collective screening device, this does not imply that the actual regulation or advertising code is necessarily eﬃcient. The reason is that, as with justice and science, the collective advertising code is a monopoly. Such a code necessarily entails a ‘consistent’ treatment across goods. In some instances, the degree of consistency may be greater than what is optimally eﬃcient. But the use of any advertising code is repressive, which, as the reader will recall, means that information about goods and services which consumers would ﬁnd useful does not get to them. This last point brings to mind the question raised by Coase of the relationship between commercial and political advertising. Some information is repressed in the marketplace for commercial ideas, while information very much like it in the political marketplace is not repressed. To analyze why this is so, we must turn our attention to the functioning of this second marketplace.

Politics The political marketplace is, in some respects, like the market for goods. The primary function of political competition and political debate is not to sort out truth from error, but to sort out ‘good’ public policies from ‘bad’ ones, where the standard of what is good is the preferences of citizens. In one respect, however, political markets are more like pure ideas markets: the cost of experimenting is typically high. The reason is that many public policies

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possess characteristics of public goods. Consequently, experimentation can only be performed by a whole political jurisdiction at once.18 Moreover, because it is diﬃcult, if not impossible, to control the other variables which aﬀect the outcome, the results of experiments are muddy. It is diﬃcult, in other words, to judge whether the outcome in any particular instance is due to the variable whose inﬂuence it is sought to measure, or to the eﬀects of other changes which occur during the period in question. Has the U.K.’s experiment in ‘monetarist’ economics correctly isolated the eﬀects of that policy? Did the U.S. ﬂirtation with supply-side economics conclusively show that those policies do not have the eﬀects claimed for them by their proponents? Did the 1964 tax cut in the U.S. prove that Keynesian economics works? The same question can be asked of any innovation in public policy, and the answer is always the same: only when policies have been tried a large number of times by many diﬀerent jurisdictions under diﬀerent conditions is it possible to hold a view with some conﬁdence. Yet the costs of these experiments are very large. Because these costs are so high, it would seem to be of paramount importance that the market in political ideas function eﬀectively and sort out good political ideas from bad ones. Yet observation of the level of debate in this market – the speeches and utterances of politicians, the coverage of politics by the media, and the contributions of social critics and individual citizens – suggests that this is not the case. This, of course, is one way in which economists explain the fate of their own policy prescriptions in the political marketplace. Consider only those (relatively few) issues on which the profession is virtually in agreement, such as the beneﬁts of free international trade, or the harm done by rent controls, wage and price controls, marketing boards, and minimum wage laws. Have not economists conclusively shown that these policies are bad? Yet they are continually being implemented by ruling politicians in democratic countries, and the frequency and duration of their use hardly appears to be diminishing. How can the implementation of these policies be rationalized? One explanation suggests that, though ineﬃcient, they are implemented because of their income-redistribution features [e.g., Breton (1964), Stigler (1971), Peltzman (1976), Buchanan, Tollison and Tullock (1980) and Becker (1983)]. But such an explanation is itself incomplete. The number of those who gain by such policies is usually trivially small compared to the majority required to elect the government which promises them. It must therefore be explained how it happens that the majority of voters who do not gain, but lose, from these policies are persuaded to vote for them. To put it diﬀerently, an election in a democratic country is a paragon example of a contest in ideas, and if the victorious policies are typically ineﬃcient, this must be explained as the result of a process of competition for the minds (‘and hearts’ as the saying goes) of voters.19 Alternatively, it may be that these policies are in fact good ones, and that economists have been unable to see this. But this simply raises the same

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diﬃculty in a diﬀerent way. For it must then be explained why the set of policies which are successful in the political marketplace (even if rightly so) are unsuccessful in the scientiﬁc marketplace for economic ideas. One reason for the diﬀerence is that the restrictions on speech imposed in the journals of economics are vastly greater than those in the political marketplace. The speech of economists in professional journals is heavily regulated: one cannot publish an article which makes an assertion unless that assertion is backed up with facts or references, one cannot explain events without articulating a speciﬁc model, and so on. If the restrictions on speech in the economists’ marketplace are productive, so that the economists are correct (the policies are bad), then it must be that the triumph of bad ideas in the political marketplace is an instance of adverse selection, that is, of bad ideas driving out good ones. Put diﬀerently, bad ideas triumph because the political marketplace is unregulated. There are virtually no rules which regulate the content of political debate.20 There is nothing to prevent a politician from claiming, for example, that his or her policies have had the opposite of their actual eﬀects (e.g., that they have reduced inﬂation when they have in fact increased it), or that some proposed policies would, if implemented, have the opposite of their likely eﬀects. Assertions may be made without proof or backed up with false or misleading evidence. Virtually anyone can speak and do so at any time. Not only is this generally true in practice in democratic countries, but it is held to characterize an ideal democracy. How can this ideal be justiﬁed if it results in a low level of debate and in the implementation of bad policies? Alternatively, why not regulate speech in the political marketplace, nesting the regulatory powers in the constitution? Could it not be that the beneﬁt derived from improvements in the eﬃciency of the political process would outweigh the costs due to the restrictions on liberty? Even if people value liberty for its own sake, they surely also value the goods and services provided by the political process.21 Finally, as we have seen, other major ideas markets are regulated. How can a ‘corner’ solution – zero restrictions on liberty of speech – be justiﬁed in politics? We suggest that freedom of speech in politics can be justiﬁed in three ways. The ﬁrst is that it would only be possible to regulate political speech through constitutional provisions if the regulators could be placed à la Buchanan and Tullock (1962) or à la Rawls (1971) behind a ‘veil of ignorance’ and thus be deprived of all information pertaining to their own interests. Real world constitutions are seldom, if ever, written behind veils of ignorance if only because they have to evolve in response to changing historical realities [see, for example, Gordon (1976)]. Those who write and amend constitutions can in such circumstances, hardly be expected to resist the temptation of altering the constitution and its interpretation in ways favorable to their own interests. Furthermore, constitutions must be enforced; what guarantees can one have that those doing the enforcing will not favor one party to the detriment of the others?

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The second reason for unrestricted freedom of speech in politics is that in any political jurisdiction, of all the political parties competing for oﬃce, only one (or one coalition) can be in oﬃce at any one time and only that one, of all those competing, can supply goods and services to citizens [Tullock (1965)]. It follows that competition in political ideas is, in any jurisdiction, the main and in many instances the only form of competition between political parties. Indeed virtually all substitutes to competition in ideas that come readily to mind – stuﬃng ballot boxes, strong arm tactics and gerrymandering – are not the type of competitive behaviors that characterize a well-functioning political marketplace. To put it diﬀerently, regulation of commercial advertising still allows business ﬁrms to compete with each other on a more or less equal footing using the great variety of instruments at their disposal (style of products, durability, price, etc). In politics, regulation of speech impedes the use of the only instrument of competition available to non-governing political parties. It goes to the heart of the competitive process itself and works to destroy it. On this ground alone, the case for freedom of speech in politics is stronger than it is in the market for goods. The third reason pertains to the particular relationship that exists between the political marketplace and the other markets for ideas. Judicial rules of evidence, scientiﬁc paradigms and advertising codes are or can be controlled by what goes on in the political marketplace. Changes to the judicial rules and to the advertising code are usually the outcome of political decisions made in the political marketplace. Changes in scientiﬁc paradigms are not, in democracies, decided directly by the political process, but the allocation of public funds to scientiﬁc activity surely is. In addition, the instances in which governments22 have chosen to directly control the evolution of scientiﬁc ideas are suﬃciently numerous not to require documentation. The outcome of competition ‘for the ﬁeld’ in science, justice, and advertising is, therefore, inﬂuenced or controlled by what goes on in the marketplace for political ideas. Restrictions on free speech, in other words, restrict competition ‘for the ﬁeld’ in all ideas markets: the danger that comes from restrictions on free speech in politics is simply that they weaken competition in ideas generally. Now, it is well known that the social loss from monopoly varies with the extent to which the substitutes for a good are monopolized. A monopoly in the form of the only restaurant at the corner of Main and Third may give the ﬁrm a less than perfectly elastic demand curve, but the social loss from this is likely to be minute. But if all sources of food are monopolized by one ﬁrm, the loss from monopoly can be colossal. And the danger is obviously much greater than this when government can control all markets in ideas. That was, of course, Orwell’s vision of 1984 and more or less the same spectre supported Hayek’s (1944) and Arendt’s (1951) analysis of the political process in what Arendt called ‘totalitarian’ regimes. In those admittedly polar representations of autocracy, all ideas are governed by a single ordering device which is ‘the’ ideology of the state: the paradigms of science, the action of the courts, the educational

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system and all media must conform to that ideology. All others are suppressed. Real world dictatorships never achieve this objective because they can never completely suppress competition in the marketplace for ideas.23 Still, there is an element of danger in the polar model and it is that danger, we suggest, which explains why democracies protect the right of their citizens to free speech. This protection is necessary to ensure competition in all ideas markets.

Conclusion In the foregoing discussion, we have presented a simple model of the regulation of speech in ideas markets. The questions we have addressed pertain to the extent of regulation and to what should be the appropriate regulatory body under diﬀerent conditions in diﬀerent ideas markets. Four ideas markets were considered to illustrate how these conditions change: justice, science, advertising and politics. The ﬁrst two are ‘pure’ ideas markets: only ideas are exchanged (by a process which we have left unspeciﬁed) in them. In the second two, ideas are merely the vehicles of goods. Science, justice and politics are all alike, however, in that if information on the buyer’s side is poor (the cost of experimenting is high), adverse selection problems result. This is a prominent feature of some goods markets as well, but by no means all. Where it is important, adverse selection implies that participants in the markets could, with proﬁt, jointly agree to some restrictions on their freedom of speech in order to improve the working of the market. In the courts, these restrictions are called the judicial rules of evidence; in science, the ruling paradigm; and in advertising, the advertising code. In politics, restrictions could be nested in the constitution; the constitution of democratic countries, however, typically forbids that laws be passed which restrict freedom of speech. None of these markets is self-regulating. In each market where restrictions are agreed to, the restrictions themselves are an enforced monopoly. So there must also be regulation to ensure competition ‘for the ﬁeld’. This competition takes two forms: competition from other ideas markets (as Galileo’s ideas competed with those of the Church, or as economic theory nowadays competes with the modes of thought in sociology or law); this competition is, however, inherently weak. The second form of competition, and the most eﬀective, is competition ‘for the ﬁeld’ from other practitioners within the same ideas market. The last point leads to our case for freedom of speech. Changes in the judicial rules of evidence, in scientiﬁc paradigms, and in advertising codes are collective decisions which are either made in, inﬂuenced or implemented by the political process. The political marketplace is therefore unique in that regulation or restrictions on speech in that market would reduce competition in all ideas markets.

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Notes *

1 2 3

4

5 6 7 8 9 10 11 12 13

14

The ordering of the authors’ names is random. We would like to thank Ronald Coase, Allan Hynes, Stan Liebowitz. John Palmer, Paul Rubin, George Stigler and the seminar participants at the universities of Perugia, Roma (La Sapienza). Torino, Venezia and Western Ontario for helpful comments and suggestions. Any remaining errors are our responsibility. Quoted in Coase (1974, p. 388). The conditions are necessary but, of course, not suﬃcient; the latter are rather diﬃcult to specify. See Leland (1979). On the diﬃculties of precisely deﬁning ‘deceptive’ information, see Beales, Carswell, and Salop (1981). Kuran (1987, 1991) assumes that all individuals engage in preference or belief falsiﬁcation, which he deﬁnes as favoring a policy in public that diﬀers from what the individual favors in private. This is appropriate for his purposes, but does not get at the degree or extent of deceptiveness of an idea or statement, central to the problem examined here. An alternative deﬁnition of repression is the extent to which any information, including bad or false information, is screened out: in that case the level of repression and the level of regulation are the same. The deﬁnition given in the text seems to us to accord better with common usage. Posner (1977, pp. 399ﬀ) takes a similar viewpoint. Both authors are amateurs in the philosophy of science. The account given here has had to rely heavily on that of experts such as Newton-Smith (1981) and Kuhn (1962). Of course, there is nothing ‘non-rational’ about this in the economist’s sense of that term; the term (in Newton-Smith’s nomenclature) pertains to the purely scientiﬁc goal of pursuing the truth. Many diﬀerent deﬁnitions of the term ‘paradigm’ are possible. Masterman (1970), in a study of Kuhn’s (1962) work, has counted twenty-one diﬀerent deﬁnitions. The deﬁnition we use in the text is suﬃcient for the purposes of this paper. Kuhn (1962); the title of Chapter 10. For a deﬁnition of perfectly contestable markets, see Baumol (1982), especially p. 3. Among economists, Coase (1982) is the only one known to us to have adopted a ‘non-rationalist’ approach. For recent examples, see Kordig (1971) or Newton-Smith (1981). Attempts to suppress anomalies are similar to what psychologists call ‘cognitive dissonance’ – the often observed fact that people are incapable of holding to two seemingly contradictory ideas. Akerlof and Dickens (1982) have discussed the economic consequences of this phenomenon. They do not, however, propose a rational explanation for it, suggesting simply that people have preferences over their beliefs. The present model shows that cognitive dissonance need not be irrational: just as the eﬃcient accumulation of knowledge by the scientiﬁc community requires the use of a paradigm, and hence the repression of anomalous facts or observations, so does the eﬃcient processing of information by the human mind. A related issue is whether competition among scientiﬁc disciplines results in the optimum division of labour. Coase (1978) suggests that it does. The diﬃculties of paradigm comparison would, however, seem to be exacerbated when the comparisons are made across disciplines. In addition, there is an obvious barrier to entry – knowledge of a discipline cannot be eﬀected by acquiring the purely logical structure of its central paradigm, if there is one; it is also necessary to master factual knowledge and to hone one’s empirical imagination and intuition. This explains why mathematicians who could learn the mathematics of economics in a

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15 16 17 18

19

20

21 22 23

63

matter of hours do not, by so doing, become economists. For the same reason, it is inconceivable that law could be taken over by neoclassical economics, in the way Ptolemaic astronomy was taken over by the Copernican paradigm. Coase also suggests that the recent ‘invasion’ by economics of the ‘contiguous disciplines’ of political science and law is likely to be only partial and limited, and for essentially this reason. Ignoring, of course, the free rider problem, which originates in the fact that even though each scientist has an interest in seeing all scientists self-policing themselves, he or she has no incentive to do so. Carmichael (1988) provides a diﬀerent theory of academic tenure. For a simple exposition of this point, see Hirshleifer (1980, p. 64). This point is also made by Olson (1973). He argues that, because of the higher cost of experimenting in the public sector – whether to ﬁnd optimum production techniques or optimum quantities of public goods and services – the public sector is technically less eﬃcient than the private sector. Kuran (1987) provides an explicit model of an ideas market in which agents may engage in deception, and in which the key element is that the relative inﬂuence of a particular belief depends on the share of society that asserts it. Multiple equilibria are possible, and there is no presumption that this market works eﬃciently. He does not, however, consider the question of the eﬀects of regulation on the market. It is true that the Question Period which is the occasion of important competition between governing and non-governing parties in Parliamentary governments is subject to certain rules and procedures, but these relate more to the allocation of time, courtesy and general deportment than to the content of what is said and to the evidence that is admissible. Hayek (1960) suggests that liberty is the only ultimate value. For an eﬀective rebuttal, see Stigler (1978). For some evidence that citizens do not, in fact, appear to value basic political rights very highly, see Noam (1981). When there is no separation between church and state, it is a matter of convention to whom one imputes the responsibility for political control of ideas. Wintrobe (1990) develops a simple model of a totalitarian dictatorship, which suggests that there is a conﬂict between the dictator’s maximization of power and the perfect repression of the population (even if the latter were possible).

References Akerlof, George A., 1970, The market for ‘lemons’: Qualitative uncertainty and the market mechanism, Quarterly Journal of Economics 84, 488–500. Akerlof, George, A. and William T. Dickens, 1982, The economic consequences of cognitive dissonance, American Economic Review 72, 307–319. Arendt, Hannah, 1951, The origins of totalitarianism (Harcourt, Brace, Jovanovitch, New York). Baumol, William J., 1982. Contestable markets: An uprising in the theory of industry structure, American Economic Review 72, 1–15. Baumol, William J., John Panzar and Robert Willig, 1982, Contestable markets and the theory of industry structure (Harcourt, Brace, Jovanovitch, San Diego). Beales, Howard, Richard Carswell and Steven Salop, 1981, The eﬃcient regulation of consumer information, Journal of Law and Economics 24, 491–540. Bear, D.V.T. and Daniel Orr, 1967, Logic and expediency in economic theorizing, Journal of Political Economy 75, 188–196.

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Becker, Gary S., 1983, A theory of competition among pressure groups for political inﬂuence, Quarterly Journal of Economics 98, 371–400. Breton, Albert, 1964, The economics of nationalism, Journal of Political Economy 72, 376–386. Breton, Albert 1974, The economic theory of representative government (Aldine Publishing, Chicago). Breton, Albert and Ronald Wintrobe, 1986, The bureaucracy of murder revisited, Journal of Political Economy 94, 905–926. Buchanan, James M. and Gordon Tullock, 1980, The calculus of consent (University of Michigan Press, Ann Arbor, MI). Buchanan, James M., Robert Tollison and Gordon Tullock, eds., 1980, Towards a theory of the rent-seeking society (Texas A&M University Press, College Station, TX). Carmichael, H. Lorne, 1988, Incentives in academics: Why is there tenure?, Journal of Political Economy 96, 453–472. Coase, Ronald H., 1974, The economics of the ﬁrst amendment: The market for goods and the market for ideas, 64 American Economic Review, 384–391. Coase, Ronald H., 1977, Advertising and free speech, 6 Journal of Legal Studies, 1–34. Coase, Ronald H., 1978, Economics and contiguous disciplines, Journal of Legal Studies 6, 201–212. Coase, Ronald H., 1982, How should economists choose? (American Enterprise Institute for Public Policy Research, Washington, DC). Demsetz, Harold, 1968, Why regulate utilities?, Journal of Law and Economics 11, 55–66. Friedman, Milton, 1953, The methodology of positive economics in essays in positive economics (University of Chicago Press, Chicago, IL). Gordon, H. Scott, 1976, The new contractarians, Journal of Political Economy 84, 573–590. Hayek, Friedrich A., 1944, The road to serfdom (University of Chicago Press, Chicago, IL). Hayek, Friedrich A., 1960. The constitution of liberty (University of Chicago Press, Chicago, IL). Hirshleifer, Jack, 1980, Price theory and applications, 2nd edition (Prentice-Hall, Englewood Cliﬀs, NJ). Keynes, John Neville, 1891, The scope and method of political economy (Macmillan, London). Koopmans, Tjalling C., 1957, Three essays on the state of economic science (McGraw Hill, New York). Kordig, R., 1971, The justiﬁcation of scientiﬁc change (D. Reidel Publishing Co., Dordrecht). Kuhn, Thomas S., 1962, The structure of scientiﬁc revolutions, 2nd edition (University of Chicago Press, Chicago, IL). Kuran, Timur, 1987, Preference falsiﬁcation, policy continuity, and collective conservatism, Economic Journal 97, 642–665. Kuran, T., 1991, The role of deception in political competition, in: Albert Breton, Gianluigi Galeotti, Pierre Salmon and Ronald Wintrobe (eds.), The competitive state: Colombella papers on competitive politics (Kluwer Academic Press).

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Lakatos, Imre, 1978, The methodology of scientiﬁc research programmes (Cambridge University Press, Cambridge). Leland, Hayne E., 1979, Quacks, lemons, and licensing: A theory of minimum quality standards, Journal of Political Economy 87, 1328–1346. Machlup, Fritz, 1955, The problem of veriﬁcation in economics, Southern Economic Journal 22, 1–21. Marshall, Alfred, 1890, 1952, Principles of economics, 8th edition (Macmillan, New York). Masterman, M., 1970, The nature of a paradigm, in: Imre Lakatos and A. Musgrave (eds.), Criticism and the growth of knowledge (Cambridge University Press, Cambridge). Melitz, Jack, 1965, Friedman and Machlup on the signiﬁcance of testing economic assumptions, Journal of Political Economy 73, 37–60. Nelson, Phillip, 1970, Information and consumer behaviour, Journal of Political Economy 78, 311–329. Nelson, Phillip, 1974, Advertising as information, Journal of Political Economy 82, 729–754. Newton-Smith, W.H., 1981, The rationality of science (Routledge and Kegan Paul, Boston, MA). Noam, Eli, 1981, The valuation of legal rights, Quarterly Journal of Economics 96, 465–476. Olson, Mancur, Jr., 1973, Evaluating performance in the public sector, and reply, in: M. Moss (ed.), The measurement of economic and social performance (National Bureau of Economic Research, New York: Columbia University Press, 1973). Peltzman, Sam, 1976, Toward a more general theory of regulation, The Journal of Law and Economics 14, 211–240. Popper, Karl, 1968, The logic of scientiﬁc discovery (London: Hutcheson). Posner, Richard, 1977, Economic analysis of law, 2nd edition (Little, Brown, Boston, MA). Rawls, John, 1959, A theory of justice (Harvard University Press, Cambridge, MA). Rotwein, Eugene, 1959, On ‘the methodology of positive economics’, Quarterly Journal of Economics 73, 554–575. Samuelson, Paul A., 1964, The general theory, in: R. Lekachman (ed.), Keynes’ general theory: Reports of three decades (St. Martin’s Press, New York). Samuelson, Paul A., 1963, 1966, Comment on Ernest Nagel’s ‘assumptions in economic theory’, American Economic Review 53, reprinted in J.E. Stiglitz (ed.), The collected scientiﬁc papers of Paul A. Samuelson (MIT Press, Cambridge, MA). Stigler, George J., 1971, The theory of economic regulation, The Bell Journal of Economics and Management Science 2, 3–21. Stigler, George J., 1972, Economic competition and political competition, Public Choice 13, 91–106. Stigler, George J., 1975, The citizen and the state (University of Chicago Press, Chicago, IL). Stigler, George J., 1978, Wealth, and possibly liberty, The Journal of Legal Studies 2, 213–217. Stiglitz, Joseph E., 1975, The theory of ‘screening’, education, and the distribution of income, American Economic Review 65, 283–300. Tullock, Gordon, 1965, Entry barriers in politics, American Economic Review 60, 458–466.

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Wicksell, Knut, 1901, 1934, Lectures on political economy (George Routledge and Sons, London). Wintrobe, Ronald, 1987, The eﬃciency of the Soviet system of production, European Journal of Political Economy, extra issue. Wintrobe, Ronald, 1990, The totalitarian and the tinpot: A simple economic theory of dictatorship, American Political Science Review 84, 849–872.

5

A free press is bad news for corruption Aymo Brunetti and Beatrice Weder

1. Introduction Freedom of speech and a free press are generally considered important human rights and powerful controls against government malfeasance. An independent press is probably one of the most eﬀective institutions to uncover trespassing by government oﬃcials. The reason is that any independent journalist has a strong incentive to investigate and uncover stories on wrongdoing. Countries with a free press should, therefore, ceteris paribus, have less corruption than countries where the press is controlled and censored. This paper presents an empirical evaluation of this proposition. The paper is motivated by recent research which has shown that higher corruption is detrimental to economic performance and which has led to a general acceptance that corruption is one of the central issues in development policy.1 This has given rise to the question of how diﬀerences in corruption across countries can be explained and a few recent studies started to explore possible determinants of corruption in small country samples. This paper argues that of the probable controls on bureaucratic corruption a free press is likely to be among the most eﬀective ones – a proposition that is supported in an empirical analysis of a large cross-section of countries as well as by evidence from time series. The paper is organized as follows. Section 2 reviews possible determinants of corruption discussed in the literature and explains how press freedom could aﬀect corruption. Section 3 describes the main data, the speciﬁcations estimated and the econometric approach. Section 4 shows cross-section empirical results for a range of speciﬁcations. Section 5 tests the sensitivity of results to alternative measures of corruption and press freedom. Section 6 presents some panel data evidence and Section 7 concludes.

2. Determinants of corruption and the role of press freedom In theory the incidence of corruption can be explained by three types of determinants, which also reﬂect the diﬀerent approaches in the literature. The

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ﬁrst focuses on the role of internal mechanisms and incentives within the bureaucracy in controlling corruption. A second branch stresses the role of external mechanisms in checking corruption, such as an independent judiciary or watch body. Finally, the third branch argues that corruption can be explained by more indirect factors, such as culture or the level of rents that can be appropriated. In this categorization press freedom is an external control mechanism on corruption. Before discussing the role of press freedom we brieﬂy summarize the potential other determinants of corruption in each of the three categories. This motivates our choice of control variables in the speciﬁcations used in the empirical analysis. 2.1. Determinants of corruption Internal controls include all systems and incentives that control corruption within the bureaucracy. Corruption tends to be high in an administrative environment where there is a lack of explicit standards of performance which are strictly enforced and in an environment where the individual bureaucrat is poorly supervised. Rauch and Evans (2000) argue that an important aspect of internal control is whether the recruitment and promotion process in the bureaucracy is based on meritocracy or on nepotism. Less nepotism tends to reduce the probability that internal control is eliminated by collusion among bureaucrats. Rauch and Evans (2000) test this point by constructing an index of meritocratic recruitment and promotion and showing that it is signiﬁcantly associated with corruption in a sample of less developed countries. Van Rijckeghem and Weder (2001) argue that a low level of public sector wages compared to wages in the private sector increases the incentives for bureaucrats to accept bribes. In an empirical test of this hypothesis they ﬁnd a negative relationship between the level of public sector wages and corruption for a sample of less developed countries. External control of corruption is exercised by individuals or organizations outside the administration. In a working system of checks and balances this is mainly performed by the judiciary power. A court system where corrupt bureaucrats can be easily and eﬀectively sued sharply reduces the potential rewards of corruption. In countries with less-developed checks and balances other parts of the society can play the role of external controller. Rahman (1986) describes such a mechanism in the case of Singapore where citizens committees were established which enable citizens to vent their grievances and seek redress. An empirical analysis of the eﬀects of external control on corruption is diﬃcult since there are few convincing empirical measures for cross-country diﬀerences of the power of external control mechanisms. Empirical studies such as Ades and Di Tella (1999) therefore use rather indirect measures such as the general level of development and education to capture the ability of the civil society to control government performance. We argue that a free press is another potentially powerful external control on corruption.

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Finally, indirect determinants of corruption identiﬁed in the literature include culture and the level of distortions in the economy. Lee (1986) for instance suggests that a culture of bureaucratic elitism may lead to a disassociation of civil servants with the rest of society and breed corruption. Tanzi (1994) argues that the absence of a culture of arms-length relationships may lead to corruption becoming systemic. Shleifer and Vishny (1993) suggest that more ethnically diverse countries are prone to particularly harmful forms of corruption. In an empirical study Mauro (1995) indeed ﬁnds evidence of a positive relationship between ethnolinguistic fractionalization and corruption. A second indirect determinant of corruption are distortive policies. Tanzi (1994) for example suggests that government interventions in free markets create rents and lead to a sharp rise in corruption payments. Kaufman (1997) tests the relationship between an indicator of regulatory discretion and corruption and ﬁnds a strong correlation in a small sample of developing countries. Ades and Di Tella (1999) generalize this argument by pointing out that monopolistic powers of bureaucrats are an important precondition for the occurrence of corruption. They also provide empirical cross-country evidence that more competition is associated with less corruption. 2.2. Press freedom and corruption This paper focuses on a particular mechanism of external control, namely, press freedom. A free press is potentially a highly eﬀective mechanism of external control on corruption because it works not only against extortive but also against collusive corruption. Extortive corruption means that the government oﬃcial has the discretionary power to refuse or delay a service (say a business license or the approval of a new construction project) in order to extract a rent from the private agent in the form of a bribe. Hindricks et al. (1999) describe extortion in a model analyzing mechanisms against tax evasion and they argue that this is a particularly serious form of corruption, Klitgaard (1988) provides drastic examples in his case study of the corruption structures in the Philippine tax system. He describes how taxpayers were extorted simply to receive the treatment legally due to them. Diﬀerent strategies were applied by dishonest bureaucrats to extort taxpayers. For example, the tax inspector would assess an unrealistically high payment on the taxpayer. In the Philippine legal framework it was very costly and time-consuming to appeal and in addition the taxpayer in many cases was not sure, what the correct due really was. The tax assessor could take advantage of this situation by extorting a payment in exchange for the correct assessment. Faced with such blackmailing the taxpayer has the option of either paying the bribe or complaining to a higher oﬃcial or the judiciary, i.e., use channels of internal or external control. By ﬁghting extortion the private agents help in limiting corruption. This is rather likely to occur as the private agent has a

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strong incentive to do something against this kind of corruption. However, if the costs of appealing are very high which means that the formal mechanisms of internal and external control are not working well, the taxpayer might in fact be better oﬀ by surrendering to the extortion. A free and active press constitutes an additional channel of external control which can substantially reduce the costs of ﬁghting extortive corruption. A ﬁrm can reveal (or credibly threaten to reveal) the bureaucrat’s behavior to a journalist and the (potential) media reports will raise the costs for the bureaucrat as the probability of being detected and punished is increased. In particular it will be much harder for an administration to keep up ineﬀective internal control mechanisms such as low penalties or ineﬀective external control mechanisms such as a weak judiciary if this fact is likely to be regularly reported in the media. For extortive corruption the press, therefore, reinforces the reaction possibilities of the private sector by providing a platform for voicing complaints. The second form, collusive corruption has been rather extensively treated in the theoretical literature on tax evasion (see, e.g., Besley and McLaren, 1993 or Flatters and MacLeod, 1995). With collusive corruption the incentives are somewhat diﬀerent than with extortion. The oﬃcial again has some discretionary power in her application of rules. Take for instance a customs inspector who has information about the value of a ﬁrm’s imports. For a ‘fee’ she could make a deal with the ﬁrm’s management to reduce the overall tariﬀ liability of the company. This is unlikely to be detected by other oﬃcials – unless there are very good internal control systems in place – and the ﬁrm also has no incentive to report the corruption. Again, Klitgaard (1988) describes an example of this form of corruption in the Philippine tax system; there this kind of corruption is called arreglo (arrangement). In a typical case the taxpayer would submit a return with understated income or too many deductions. If the tax collector discovered these ‘errors’, arreglo frequently occurred. The taxpayer would for example pay half of the correct taxes and of the other half two-thirds would be paid as a bribe to the tax collector whereas the taxpayer could keep the rest. In this form of corruption the private agent cooperates in the corrupt act and always pays the bribe. Obviously, this is much more diﬃcult to ﬁght than extortive corruption as the arrangement is beneﬁcial for both, the bureaucrat and the ﬁrm and they will do everything to hide it. In contrast to extortive corruption the private agent can, therefore, not be trusted to help ﬁghting this illegal action. A free press is probably the most eﬀective institution to control collusive corruption. Independent journalists have incentives to actively investigate any wrongdoing. Other outside bodies, such as the judiciary or even watchdog bodies such as anti-corruption commissions may be less eﬀective, unless their internal incentive structures are closely aligned with the goal of discovering and prosecuting corruption. There is a substantial danger that internal control agencies will be included in the arrangements and get a share of the pie. It may be much harder for the architects of corrupt

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arrangements to apply the same strategy to journalists. If the press is free and competitive it might be possible to buy some journalists but this only increases the incentives for other journalists to detect such arrangements and publicize this. The more involved a corrupt arrangement the more fame an investigative journalist can earn by uncovering it. As long as there is free entry in journalism and in publishing – which is one of the deﬁning features of a free press – it will be diﬃcult to form an eﬀective cartel which encompasses all journalists. Therefore, in theory press freedom can help to ﬁght extortive corruption and may be a particularly eﬀective institution to ﬁght collusive corruption where client and bureaucrat have a mutual interest in the corrupt act.

3. Data and empirical strategy This section presents the data on press freedom and corruption, derives the speciﬁcations tested in the empirical analysis, and explains the econometric methodology used.2 3.1. Measure of press freedom Our main measure of press freedom is assembled by Freedom House, a think tank that is known for having published widely used indexes for political rights and civil liberties for the last 25 years. Since 1996 Freedom House in addition has compiled expanded indices of press freedom for 145 countries based on experts’ opinions, ﬁndings of international human rights groups and press organizations, analysis of publications and news services and reports of governments on related subjects. The motivation for collecting this kind of information derives from Article 19 of the Universal Declaration of Human Rights, which postulates that “everyone should have the right to freedom of opinion and expression.” The idea is to gain a comprehensive assessment of press freedom by not focusing exclusively on actual incidents of censorship like for instance arrests or assassinations of journalists but on the overall structure of the news delivery system. Therefore, several dimensions of potential violations of press freedom are evaluated.3 1

2

Laws and regulations that inﬂuence media content reﬂects “our judgment of the degree of actual impact on press freedom (. . .), not simply the ceremonial commitment to press freedom.” For instance, “if private broadcast media are owned by government with no dissent allowed, the rating will be 15 (i.e., the worst score)” but if “a government that owns all broadcast media may permit widely pluralist ideas, even active dissent from government positions” then the rating will be more favorable. Political inﬂuence over media content captures “political pressure on the content of both privately owned and government media and takes into

72 Aymo Brunetti and Beatrice Weder

3

4

account the day-to-day conditions in which journalist work.” It also includes “threats from organized crime” which may lead to selfcensorship. Economic inﬂuence over media content: reﬂects “competitive pressures in the private sector that distort reportage as well as economic favoritism or reprisals by government for unwanted press coverage.” Repressive actions: measures actual acts which constitute violations of press freedom. For instance, arrests, murders or suspensions of journalists, physical violence against journalists or facilities, self-censorship, arrests, harassment, expulsion, etc.

All four categories are rated for both, the freedom of print media and the freedom of broadcast media. In the ﬁrst three categories countries are rated on a scale from 0 to 15 (0 meaning absence of violation of press freedom and 15 meaning the highest degree of such violation). The fourth category is rated from 0 to 5. The overall measure of press freedom is the sum of these eight subcomponents, and ranges from 0 (equals total freedom of the press) to 100 (equals the highest degree of violation of press freedom). For instance in 1997 Norway with a rating of 5 was the country with the freest press. Most OECD countries are in the quintile with the best ratings. At the bottom end we ﬁnd North Korea, Iraq, and Burma with a rating of 100 each. Many of the countries of the Former Soviet Union fall in the fourth quintile together with a few of the East Asian tigers. Overall the world wide picture is one of rather high degrees of violations of press freedom; the worldwide average of the index is 46 points.4 3.2. Measures of corruption Measuring corruption is obviously tricky because of its illegal nature. It is further complicated by a wide range of deﬁnitions of a corrupt act. And ﬁnally, there seem to be many diﬀerent expressions of corruption, which range from routine “tips” and “speed money” to complicated schemes of favors between businessmen and civil servants. Data on corruption levels across countries are available from various sources, which are all based on surveys of experts or entrepreneurs. Our main measure of corruption is an indicator collected by the International Country Risk Guide (ICRG). This ﬁrm produces annual ratings of corruption levels by using surveys among country experts. The indicator ranges from 0 to 6. A low score means that “high government oﬃcials are likely to demand special payments” and “illegal payments are generally expected throughout lower levels” in the form of “bribes connected with import and export licenses, exchange controls, tax assessment, policy protection, or loans.” 5 Of all such country risk services ICRG covers by far the largest number of countries. We use the average for 1994–1998 which is available for 128 countries. In addition we use corruption measures from three alternative

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73

sources (World Bank, Institute for Management Development and Transparency International) which are discussed below. 3.3. Speciﬁcation As noted above, the theoretical and empirical literature have identiﬁed a number of determinants of corruption. On the one hand there are direct internal and external control mechanisms. On the other hand there are more indirect determinants such as distortions and sociological determinants of higher corruption. This suggests that estimates of corruption should at least include proxies for the direct control mechanisms which leads to our following preferred speciﬁcation: CORRi = β0 + β1 PRESSi + β2 BUREAUi + β3 RULEi + εi.

(1)

We are mainly interested in the sign and the signiﬁcance of β1 which we expect to be signiﬁcantly negative since a higher value of CORR means less corruption and a higher value of PRESS means less press freedom. The indicator of internal control BUREAU is a measure of the quality of the bureaucracy. The variable is provided annually for a large number of countries by ICRG based on evaluations from country experts.6 It indicates the degree of “autonomy [of the bureaucracy] from political pressure” the “strength and expertise to govern without drastic changes in policy or interruptions in government services” as well as the existence of “established mechanisms for recruiting and training.” A higher value of this indicator means better quality of the bureaucracy so that we expect β2 to be positive. RULE is our measure of external control and is also provided by ICRG. The indicator marks the presence of “sound political institutions, a strong court system, and provisions for an orderly succession of power” and reﬂects the degree to which “citizens of a country are willing to accept the established institutions to make and implement laws and adjudicate disputes.” This broad measure covers not only external control through checks and balances but also the degree to which citizens exercise control power. The higher this indicator the better established is the rule of law so that we expect β3 to be positive. These variables are available for a large number of countries, which allows us to estimate this speciﬁcation even for corruption measures where we have relatively small country samples. In addition, we test a second, broad speciﬁcation which includes a number of the other potentially relevant determinants of corruption discussed above: CORRi = β0 + β1 PRESSi + β2 BUREAUi + β3 RULEi + β4 GDPi + β5 HUMCAPi + β6 TRADEi + β7 BLACKi + β8 ETHNICi + εi.

(2)

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Aymo Brunetti and Beatrice Weder

This speciﬁcation includes two more proxies for external control, two proxies for distortions and one proxy for cultural factors. GDP and HUMCAP measure the level of per capita GDP in 1995 (calculated at purchasing power parity), and the educational attainment. Both of these variables proxy for external controls since the ability of civil society to judge government performance and act as an external control on corruption in the administration tends to increase with the level of development (see, e.g., Ades and Di Tella, 1999). We therefore expect β4 and β5 to be positive. TRADE and BLACK are proxies for distortions and restrictions of competition in an economy. TRADE measures the exposure of an economy to foreign trade and is deﬁned as the sum of exports and imports as a percentage of GDP. For instance Ades and Di Tella (1999) argue that open countries are subject to larger competitive pressure that in turn reduces monopolistic rents and thus corruption. β6 is therefore expected to be positive. BLACK measures the black market premium on foreign exchange and is a broad indicator of the degree of government-created distortions in an economy and we expect β7 to be negative. Finally ETHNIC measures the degree of ethnolinguistic diversity which is a proxy for the cultural background of a country. Mauro (1995) has found a positive correlation between this variable and corruption and we expect β8 to be negative. This second speciﬁcation captures almost all relevant variables discussed in Section 2. 3.4. Econometric methodology The dependent variable is the corruption measure from ICRG. We use a short average of this index (1994–1998) in order to match the timing with our main measure of press freedom while avoiding shocks which would be particular to 1 year (e.g., a ﬁnancial crisis) and which might aﬀect corruption ratings that are based on subjective evaluations. The dependent variable is therefore a continuous variable and this allows estimates using ordinary least squares. An alternative strategy would be to use the last available value of corruption as dependent variable. In this case the dependent variable can only take on integer values and the ordered probit model is the appropriate method. In the econometric analysis we also show estimates for an ordered probit model for corruption values in a single year. We conduct tests to determine whether the relationship between press freedom and corruption is driven by outliers or by the diﬀerence between developed and less developed countries. We test extensively for robustness to measurement of both the corruption and the press freedom variables. White’s test for heteroskedasticity in the residuals of the basic speciﬁcation rejects the null of no heteroskedasticity, thus all standard errors of coeﬃcients are calculated using White (1980) correction. A potential criticism is that press freedom may be endogenous since corrupt regimes may tend to limit press freedom. In theory this eﬀect should only be relevant where corruption is systemic, i.e., where all journalists

A free press is bad news for corruption

75

participate in the revenues from corruption or where there is a political machine and extreme repression. In all other cases the causality is likely to run from press freedom to corruption rather than the other way around. The reason is, that journalists have incentives to uncover corruption and it is unlikely that all journalists can be brought to cooperate in corrupt arrangements. Such a cartel would be diﬃcult to sustain in an environment with many independent journalists and high reputational proﬁts from uncovering corrupt arrangements. On the empirical level we address this issue of endogeneity in three ways. First we exclude the countries with highly repressive regimes from the sample. Second we use several instruments for press freedom and ﬁnally we exploit the time series dimension of alternative data set on press freedom. It should be said from the beginning that we cannot fully resolve the issue of causality since we have only imperfect instruments and little time series variation to work with.

4. The cross-section results Figure 5.1 shows a scatterplot that illustrates the close relationship between corruption and press freedom. Recall that the negative relationship observed

Figure 5.1 Corruption and press freedom. Note: corruption index ranges from 0 (highest corruption) to 6 (lowest corruption), index of press freedom ranges from 0 (highest press freedom) to 100 (lowest press freedom).

76 Aymo Brunetti and Beatrice Weder in the ﬁgure implies that less corruption is associated with more press freedom. Inspection of the raw data suggests that there exist no important outliers. Table 5.1 presents the cross-section results. The dependent variable is the average corruption level from 1994 to 1998. Column (1) shows the result for the base speciﬁcation which includes 125 countries. The coeﬃcient of the indicator of press freedom has the expected negative sign and is signiﬁcant at conventional conﬁdence levels. The coeﬃcients of both control variables have a positive sign and are signiﬁcant at the 1 percent level. This indicates that, as expected, corruption is lower in countries with a well-working bureaucracy and in countries with a well-established rule of law. The base speciﬁcation explains two-thirds of the variation in the corruption levels between countries. Column (2) documents that the signiﬁcant relationship between press freedom and corruption is not driven by the diﬀerences between developed and less developed countries alone. This regression estimates the base speciﬁcation for a sample containing only less developed (non-OECD) countries. The coeﬃcient of PRESS is signiﬁcant and of the expected sign. BUREAU remains signiﬁcantly related to corruption whereas the coeﬃcient of RULE is not signiﬁcant in this regression. Compared to regression (1) the adjusted R 2 drops sharply from 0.67 to 0.38 indicating that including the developed countries in the sample improves the ﬁt of the regression. To exclude possible outliers we restricted the sample to observations with residuals plus minus two standard deviations (results not reported). The results are not aﬀected (the coeﬃcient of press freedom is 0.017 with a t statistic of 5.4). Column (3) shows the results of a two-stage least-square estimation instrumenting with the level of political rights.7 The results of the estimates remain largely unchanged compared with the previous estimates the size of the coeﬃcient on press freedom is larger.8 Column (4) includes other variables that could impact on corruption. The coeﬃcient PRESS is again signiﬁcant at conventional conﬁdence levels and the coeﬃcients of BUREAU and RULE remain positive and signiﬁcant. The coeﬃcient of the logarithm of GDP per capita has the expected positive sign whereas the measure of human capital is negatively related with corruption. Both coeﬃcients are however, insigniﬁcant. The coeﬃcients of the two variables that proxy for distortions in the economy are both insigniﬁcant. Whereas TRADE has the expected positive sign, the positive coeﬃcient of BLACK is unexpected. Finally the proxy for the degree of cultural fractionalization ETHNIC has the expected negative sign but is insigniﬁcant. Adding these explanatory variables only marginally improves the ﬁt of the regression (the adjusted R 2 increases from 0.67 to 0.74) but comes at the cost of reducing the sample size signiﬁcantly. Column (5) reduces the sample to the less developed countries and shows that the relationship between press freedom and corruption holds also for within this set of countries in the extended speciﬁcation.

125 0.67

2.560 (10.508) −0.017 (−6.350) 0.220 (2.893) 0.265 (3.482)

93 0.38

2.614 (10.516) −0.015 (−4.789) 0.254 (2.708) 0.146 (1.624)

(2) OLS (LDCs only)

104 0.67

3.392 (5.003) −0.028 (−3.266) 0.221 (2.310) 0.143 (1.527)

(3) TSLS

68 0.74

1.945 (1.721) −0.017 (−4.023) 0.200 (2.058) 0.259 (2.583) 0.104 (0.681) −0.043 (−1.007) 0.002 (1.103) 0.001 (1.882) −0.246 (−0.690)

(4) OLS

47 0.38

1.506 (1.260) −0.015 (−3.501) 0.128 (1.220) 0.068 (0.607) 0.226 (1.358) −0.085 (−1.562) 0.004 (2.091) 0.001 (1.288) −0.053 (−0.154)

(5) OLS (LDCs only)

Note: t Statistics in parentheses; White-corrected standard errors; political rights as instrument in Columns (3) and (7).

Observations Adjusted R 2

OECD

LATIN

AFRICA

ETHNIC

BLACK

TRADE

HUMCAP

log(GDP)

RULE

BUREAU

PRESS

Constant

(1) OLS

Table 5.1 Dependent variable: average corruption from 1994 to 1998

2.946 (2.180) −0.020 (−4.439) 0.089 (0.942) 0.154 (1.530) 0.107 (0.538) −0.052 (−1.058) 0.003 (1.358) 0.001 (1.350) −0.457 (−1.170) −0.142 (−0.521) −0.563 (−2.298) 0.419 (0.983) 68 0.77

(6) OLS

4.139 (1.867) −0.037 (−1.926) 0.073 (0.663) 0.044 (0.0251) 0.127 (0.523) −0.064 (−1.088) 0.003 (1.367) 0.001 (0.730) −0.410 (−1.021) −0.102 (−0.252) −0.857 (−2.530) 0.075 (0.150) 68 0.72

(7) TSLS

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Aymo Brunetti and Beatrice Weder

Column (6) shows the results of another sample test; it checks whether there are diﬀerences among continents that are not captured in the explanatory variables used in the broad speciﬁcation. The result on press freedom is unchanged and only the Latin American continent dummy is signiﬁcant. Finally, Column (7) shows the two-stage least-square estimates for this speciﬁcation. Again the results are largely unchanged, although the signiﬁcance of the indicator of press freedom drops somewhat. Given that all other control variables are insigniﬁcant, and that sample size is a consideration in the following sections, we will estimate the base speciﬁcation in the remainder of this paper. Overall the results presented in Table 5.1 indicate that there is a close relationship between press freedom and corruption which is robust to speciﬁcation and sample variation. Furthermore, the eﬀect of press freedom on corruption is sizable. The absolute value of the coeﬃcient varies between 0.017 and 0.028 for the full sample of countries. This means that an improvement of 46 points in the press freedom indicator (that is a move of the average country to full press freedom) could reduce corruption by about 1 point.9 With the mean corruption at 3.4 (on a scale from 0 (highest) to 6 (lowest) corruption) this implies that a complete move to press freedom would lead to a dramatic reduction of corruption in the average country. This does not include any indirect eﬀects that higher press freedom might have through improving other bureaucratic controls and other external controls. We conducted additional tests of sensitivity to speciﬁcation not reported in the tables. We included in the base speciﬁcation one by one, inﬂation, government consumption, a diﬀerent measure of openness (provided by Sachs and Warner, 1995) and a diﬀerent measure of human capital (secondary school enrollment) as further determinants of corruption. However, these variables were insigniﬁcant and the result on press freedom was unchanged.10 We substituted BUREAU with more direct measures of internal controls, namely an index of meritocracy and of relative salaries between civil servants and private sector employees (both provided by Rauch and Evans (2000)). Both indicators are only available for 35 less developed countries and the results are similar to those obtained in Table 5.1, Column (2), for the sample of developing countries. We now turn to an alternative estimation model. The corruption measure used in Table 5.1 is a continuous variable by virtue of averaging 4 years of an ordered variable that can only take on discrete values between 0 and 6. However, one could argue that averaging does not really change the discrete nature of the measure which could be interpreted simply as an ordering. This interpretation would be pertinent if the indicators were based on country rankings rather than numerical ratings, but most expert surveys provide explicit numerical ratings with the understanding that they are linear. Supposedly it is for this reason that the literature on determinants of corruption has so far treated the corruption indicators as a continuous variable and has used OLS estimates. However, under the interpretation of an ordered

A free press is bad news for corruption

79

variable, OLS would not be appropriate since this method treats the difference from one value to the next equally, although it is only a ranking. To address this issue, and test its inﬂuence on the results, in Table 5.2 we show results of ordered probit estimates of the basic speciﬁcation using the corruption value for one single year. The equations show that press has the expected negative sign and the z value indicates that it is signiﬁcant at conventional levels. The same applies to the other two control variables. The interpretation of coeﬃcients in the ordered probit model is not straightforward (see Greene, 1997), therefore in the bottom panel we show the marginal eﬀects of the changes in the regressors. Since in all classes the marginal eﬀects are evaluated at the mean of the respective explanatory variable the sign must change when moving from lower to higher classes. Take for instance a large value of PRESS. If our reasoning is correct this should reduce the probability for a country to have high corruption ratings (e.g., classes 1 or 2) and vice versa for small values of PRESS. The signs of the marginal eﬀects displayed in Table 5.2 show that this is indeed the case as these eﬀects are negative for the low classes of corruption and switch to positive in the high classes. The signs of the marginal eﬀects are as expected for the other two control variables as well. In the remainder of the paper we only report the OLS results because they can be interpreted more readily. Using ordered probit estimations does not alter any results. Next we address possible concerns about endogeneity. Table 5.3 presents the results from a sample test and estimates with alternative instruments for press freedom. Recall from above that the danger of reverse causality should be largest in authoritarian and repressive regimes (that also happen to be corrupt) where the press would be stiﬂed. Column (1) demonstrates that the relationship between press freedom and corruption exists also for the sample of countries that cannot be classiﬁed as repressive. The estimate includes the controls of the base speciﬁcation (not shown) but excludes all countries that are classiﬁed as authoritarian, according to Gastil (1989). The number of observations drops substantially but the results on PRESS are not aﬀected.11 Alternatively by restricting the sample to medium and low corruption countries we obtain the same results. Columns (2) and (3) are variants of the TSLS estimates in Table 5.1. Column (2) shows the results using the Jaggers and Gurr (1996) democracy measure as an instrument. In Column (3) press freedom is instrumented with a proxy for European inﬂuence, the fraction of protestants in the population and the fraction of the population that speaks a European language as their ﬁrst language.12 The results are similar to those obtained earlier.13

5. Sensitivity of the results to measurement The last section has shown results for speciﬁc measures of corruption and press freedom. This raises the question whether these results are characteristics

−0.0169 0.3504 0.3712

PRESS BUREAU RULE

127 0.28

0.0050 0.1162 0.1177

Std. error −3.3824 3.0162 3.1546

z statistic

PRESS BUREAU RULE

−0.000012 0.00024 0.00025

−0.00023 0.00485 0.00514

−0.00181 0.03750 0.03973

Marginal eﬀects (evaluated at the mean of each variable) Variable Class 1 Class 2 Class 3

Observations: Likelihood ratio index:

Coeﬃcient

Variable

−0.00467 0.09691 0.10267

Class 4

Table 5.2 Ordered probit estimation; dependent variable corruption in 1995

0.00348 −0.07220 −0.07650

Class 5

0.00295 −0.06118 −0.06481

Class 6

0.00030 −0.00613 −0.00649

Class 7

A free press is bad news for corruption

81

Table 5.3 Sample tests and two-stage least-square estimates using various instrumentsa

PRESS Adjusted R 2 Number of observations

(1) OLS excluding repressive regimesb

(2) TSLS instr: democracy

(3) TSLS instr: fraction of protestants, fraction of European language

−0.017 (−3.072)

−0.016 (−3.109)

−0.012 (−2.135)

0.72 62

0.69 113

0.46 66

Notes: t Statistics in parentheses; White-corrected standard errors. a All estimates include a constant as well as BUREAU and RULE as additional control variables (not shown). b Deﬁned as an average a value of the Gastil political rights index of higher than 5 (on the scale from 1 to 7 = most authoritarian).

of this data since both corruption and press freedom are not easily observable. In this section we use alternative corruption measures and alternative measures of press freedom in order to address this question. 5.1. Alternative corruption measures We test the robustness of the results by using three other measures of corruption. All of them are based on surveys and they cover a smaller number of countries than the measure by ICRG. The ﬁrst is a measure of corruption for 1997 based on a ﬁrm level survey done for the World Bank’s World Development Report 1997.14 The second corruption indicator is from the annual business executive’s survey done by the Institute for Management Development for the World Competitiveness Report. The last indicator is from Transparency International and is based on a “poll of polls,” an average of about ﬁve diﬀerent corruption indices. We use the 1998 value of this indicator. Table 5.4 shows regression results for each of these corruption measures. In all cases the indicator of press freedom has the expected sign and is signiﬁcant at the 10 percent level in the estimates of two out of the three regressions. It is not signiﬁcant in the regressions at the corruption indicator provided by IMD. This seems partly to be due to sample composition since IMD includes mostly industrialized countries with high ratings in BUREAU and RULE but little variation among themselves. 5.2. Alternative measures of press freedom As a next step we check whether the results are conﬁrmed by an alternative measure of press independence collected by Humana (1992) for the World

82

Aymo Brunetti and Beatrice Weder

Table 5.4 Testing the eﬀects of press freedom for alternative corruption measuresa Dep. variable: PRESS

Corr-IMD 0.008 (0.364)

Observations Adj. R 2

46 0.67

Corr-WB −0.010 (−1.738) 55 0.42

Corr-TI −0.028 (−2.667) 78 0.71

Notes: t statistics in parentheses; White-corrected standard errors. a All estimates include a constant as well as BUREAU and RULE as additional control variables (not shown).

Table 5.5 Testing alternative measures of press freedom (dependent variable: average corruption from 1994 to 1998)a Measure for press freedom Press freedom measure:

Overall press Censorship Independence Independence Independence freedom (lack of) newspapers book publishing broadcasting 0.052 (2.915)

Observations 97 Adj. R 2 0.63

0.257 (2.970)

0.118 (1.650)

0.228 (2.348)

0.154 (2.087)

98 0.63

98 0.60

98 0.62

98 0.61

Notes: t statistics in parentheses; White-corrected standard deviations. a All estimates include a constant as well as BUREAU and RULE as additional control variables (not shown).

Human Rights Guide. This guide contains ﬁve indicators related to media freedom, all ranging from 0 (least freedom) to 3 (most freedom). The indicators measure political censorship of the press, independence of newspapers, independence of book publishing, independence of radio and television networks and the possibility to teach ideas and receive information all for the year 1991. Table 5.5 shows the results of the basic speciﬁcation for the overall indicator of press freedom as well as for individual subcomponents. The indicator of overall press freedom is the sum of the sub-indicators; it is scored from 0 (no press freedom) and 15 (highest press freedom); therefore we expect a positive relation with corruption. The overall indicator has the expected sign and is highly signiﬁcant. The results for the individual subcomponents give more detailed information on the relationship. They are all signiﬁcant, however, the sizes of the coeﬃcient indicates that lack of censorship may be the strongest curb on corruption. Interestingly, the relationship between independent newspapers and broadcasting with low corruption is less strong. Independence of newspapers is just signiﬁcant at the 10 percent level. In economic terms, the eﬀect of press

A free press is bad news for corruption

83

freedom on corruption is somewhat smaller than the one found earlier: here a one standard deviation improvement in overall press freedom reduces corruption by 0.25 points. Overall the results indicate that the relationship between press freedom and corruption is robust to alternative measurements.

6. Panel data evidence This subsection presents some panel data evidence using a 5-year panel with the Humana press indicator (which is available for three individual years) and a yearly panel for the Freedom House press indicator (1996–1999). Both panels use the ICRG corruption index, the only one that oﬀers time series. It is worth noting that by and large the corruption data varies more across countries than over time, which is probably due to the fact that changes in corruption levels within a country are diﬃcult to detect and may take a long time. The within country variation is only 13 percent of the total variation. Therefore, much of the research on determinants of corruption has focused on the cross-section. In Table 5.6 we present results from both panels. Columns (1) and (2) use the Humana index and Columns (3) and (4) the Freedom House press indicator. Table 5.6 Panel data evidencea Dep. variable:

PRESSb (Humana) PRESSc

(1) CorrICRG 5-year averages 1982–1995 0.028 (2.333)

(2) CorrICRG 5-year averages 1982–1995 0.027 (2.421) −0.945 (−2.747)

LOG (GDP)

(3) CorrICRG yearly panel 1996– 1998

(4) Diﬀerence in log CorrICRG, yearly panel 1996– 1998

−0.004 (−3.906)

−0.092 (−1.909)

No 491 125 0.005

Lagged LOG (Corr-ICRG) Fixed Eﬀects

Yes

Yes

0.861 (38.029) No

Observations Number of countries Adj. R 2

155 70 0.84

150 70 0.86

497 125 0.85

Notes: t statistics in parentheses; White-corrected standard errors. a Columns (1) and (2) include BUREAU and RULE and Columns (3) and (4) a constant (not shown). b Measured at the beginning of the period (i.e., 82, 86 and 92). Expected sign for press indicator from Humana is positive. c Using the 1 year lagged value in Column (3) and the log diﬀerence in Column (4). Expected sign for press indicator from Freedom House is negative.

84

Aymo Brunetti and Beatrice Weder

Column (1) includes country ﬁxed eﬀects in the base speciﬁcation. We ﬁnd that the coeﬃcients of press freedom are signiﬁcant and of the expected sign (positive for the Humana Press index and negative for the Freedom House indicator) though smaller than in the cross-section estimates. The Humana indicator is measured (approximately) at the beginning of each 5-year period while the corruption and the control variables are 5-year averages. This contributes to mitigate the concerns about causality. Column (2) includes GDP per capita as a further control variable. The results are not altered. Columns (3) and (4) relate to the yearly panel for the mid to end 1990s. For this period our standard control variables (BUREAU and RULE) were not available, thus we run more parsimonious regressions. Regression (3) ﬁnds that the 1-year lagged panel indicator of press freedom is signiﬁcantly associated with lower corruption (expected sign is negative for this indicator). The coeﬃcient is much smaller though than the one found in the cross-section estimates. The coeﬃcient of the 1-year lagged endogenous variable shows that corruption is highly persistent. We also tested ﬁxed and random eﬀects with the lagged press indicators only (i.e., excluding the lagged endogenous since it would lead to biased results): press was signiﬁcant in the random eﬀects regression but not signiﬁcant in the ﬁxed eﬀects regression. One way of addressing the problem of omitted variables that are country speciﬁc and vary little over time is to look at ﬁrst diﬀerences. In this short period of time many of the fundamental determinants of corruption can be assumed to be time invariant. Thus, the last regression (4) uses ﬁrst (log) diﬀerences and again ﬁnds that an increase in press freedom is associated with a decrease in corruption.

7. Conclusions The empirical evidence presented in this paper shows a strong association between the level of press freedom and the level of corruption across countries. The results suggest that an independent press may represent an important check against corruption. This result is not sensitive to the speciﬁcations estimated and for alternative measures of corruption and press freedom. Theoretical considerations, estimations with various instruments as well as panel data evidence suggest that the causation runs from more press freedom to less corruption. All in all the results indicate that press freedom might be an important check on corruption. How much improvement in corruption can countries expect from more press freedom? The estimated coeﬃcients range from −0.015 to −0.037. This suggests that an improvement of one standard deviation in press freedom could reduce corruption between 0.4 and 0.9 points (on the scale form 0 to 6). Alternatively, one could ask how much an improvement in press freedom to the level of Norway (the country with the freest press) would aﬀect the corruption index for countries with particularly repressive practices. Even using the lower bound of the estimates we ﬁnd that the eﬀect might be substantial. By way of illustration, in the case of Indonesia it would mean a

A free press is bad news for corruption

85

reduction in corruption to the level of Singapore, for the Russian Federation it would imply reaching the corruption level of the Slovak Republic, and for Nigeria the level of Belgium.

Acknowledgements We thank two referees, Boris Zürcher, Peter Kugler, George Sheldon, and seminar participants at the University of Basel, the University of Saarland, the University of St. Gallen and the University of Fribourg for helpful comments. Financial support from the WWZ Förderverein is gratefully acknowledged.

Appendix A. Data deﬁnitions and sources PRESS

Press freedom in 1997 for the cross-section estimates and yearly data from 1996–1999 in the panel estimates (Freedom House) (0 = highest, 100 = lowest level of press freedom) PRESS (Humana) Press freedom in 1982, 1986 and 1991 (Humana, 1992) (0 = lowest, 15 = highest level of Press Freedom) Corr-ICRG Average corruption 1994–1998 (International Country Risk Guide) (1 = highest, 6 = lowest level of corruption) BUREAU Average quality of the bureaucracy 1982–1995 (International Country Risk Guide) (1 = lowest, 6 = highest level of bureaucratic quality) RULE Average rule of law 1982–1995 (International Country Risk Guide) (1 = lowest, 6 = highest level of rule of law) HUMCAP Average educational attainment (Nehru et al., 1995) TRADE Average Trade ((Export + Import)/GDP) 1970–1992 (The World Bank, World Development Indicators) BLACK Black market premium on foreign exchange 1974–1989 (Pick’s Currency Yearbook) ETHNIC Ethnolinguistic fractionalization (Easterly and Levine, 1997) POLRIGHTS Average political right 1974–1989 (Gastil, 1989), GDP GDP per capita in PPP terms, 1995 (The World Bank, World Development Indicators) DEMOCRACY Level of democracy (Jaggers and Gurr, 1996) (0 = lowest, 10 = highest level of democracy) Frac Prot Fraction of Protestants in a country (La Porta et al., 1998) Frac Eur Fraction of European Languages spoken in a country (Hall and Jones, 1999) Corr-IMD Corruption indicator in 1996 (Intern. Institute for Management Development)

46.23 47.00 100.00 5.00 24.51

129

3.20 3.00 6.00 0.89 1.52

BUREAU

PRESS BUREAU RULE Log(GDP) HUMCAP TRADE BLACK ETHNIC Corr-ICRG

1.00 −0.63 −0.73 −0.69 −0.60 −0.01 0.34 0.47 −0.74

PRESS

129

3.33 3.04 6.00 0.90 1.49

1.00 0.87 0.80 0.69 0.20 −0.32 −0.36 0.79

122

8.39 8.34 10.54 6.11 1.12

1.00 0.83 0.64 0.20 −0.39 −0.41 0.83

82

5.82 5.73 12.58 0.57 2.71

1.00 0.79 0.22 −0.45 −0.60 0.75

137

71.98 61.90 328.12 12.86 42.31

TRADE

1.00 0.14 −0.41 −0.47 0.58

HUMCAP

HUMCAP

Log(GDP)

Log(GDP)

RULE

RULE

BUREAU

Table 5A.2 Correlation matrix

Observations 145

Mean Median Maximum Minimum S.D.

PRESS

Table 5A.1 Descriptive statistics

1.00 −0.11 −0.11 0.20

TRADE

96

57.42 9.21 732.44 −0.27 121.75

BLACK

1.00 0.41 −0.28

BLACK

99

0.42 0.43 0.92 0.00 0.30

ETHNIC

1.00 −0.43

ETHNIC

128

3.37 3.00 6.00 0.80 1.22

Corr-ICRG

1.00

Corr-ICRG

99

8.92 10.00 15.00 0.00 4.89

PRESS (Humana)

A free press is bad news for corruption Corr-WB Corr-TI

87

Corruption indicator in 1997 (Brunetti et al., 1998) (1 = highest, 6 = lowest level of level of corruption) Aggregate corruption indicator for 1998 (Transparency International) (0 = highest, 10 = lowest level of level of corruption)

Notes 1 The costs of corruption have been a topic of academic debate for a long time (see, e.g., Rose-Ackerman, 1975). Case studies such as Klitgaard (1988) and De Soto (1989) helped to popularize the notion that corruption is a major obstacle to growth in developing countries. This notion has been conﬁrmed in a series of recent empirical cross-country studies. Mauro (1995) showed that corruption negatively aﬀects rates of investment. Knack and Keefer (1995) and Brunetti et al. (1998) ﬁnd that corrupt institutions lower growth through lower accumulation of resources as well as misallocation of resources. Mauro (1996) shows that corruption distorts the allocation of public expenditures and Johnson et al. (1998) ﬁnd that countries with more corruption have a larger informal sector. For surveys of research on the economic eﬀects of corruption see, e.g., Bardhan (1997) or Tanzi (1994). 2 Data sources, descriptive statistics and correlations are in Appendix A. 3 Source of quotes: Freedom House (1997). 4 Restrictions of press freedom come in many guises. In many countries, the press is regulated through an array of laws which claim to protect national security, personal privacy or even ‘the truth’. To take a few examples: In 13 Latin American countries journalists can be penalized for insulting or violating the privacy of oﬃcials. Exposing illegal actions by a government oﬃcial may thus be charged against the journalist rather than the oﬃcial. In Uganda, a bill could impose 5 years of imprisonment and large ﬁnes for a journalist publishing (unspeciﬁed) ‘false’ or ‘aggravating’ information. In Colombia a regulatory commission has the authority to take television news programs oﬀ the air to protect the nation’s ‘honor’. In Bolivia and Botswana laws are planned that impose ethical standards for the press to regulate alleged ‘abuse’. In Malawi a law denies journalists the right to protect their news sources. The press in Gambia is hit with high start-up fees and extreme penalties for libel are considered in Brazil and Congo. In 1996, 46 journalists are known to have been murdered on the job and 372 arrested. See Freedom House (1997) for a more detailed discussion. 5 See Knack and Keefer (1995). 6 Sources and precise description of data for control variables are in Appendix A. To reduce endogeneity problems the timing of independent variables is chosen such that they are long averages for a period (10–15 years) previous to the corruption measure. 7 In OLS a good instrument is highly correlated with the instrumented variable but orthogonal to the residual. On this account the political rights instruments could be problematic since there may be multiple interactions between various features of a political system and bureaucratic outcomes. However, it is not obvious that more autocratic countries should a priori be more corrupt and vise versa. Corruption has been known to ﬂourish in democracies as well as in autocracies. Ades and Di Tella (1999), for instance, fail to ﬁnd a signiﬁcant positive relationship between political rights and low corruption and explain this ﬁnding with the fact that a number of countries such as Iraq, Hong Kong and Singapore combine low corruption with low levels of political rights. By the same token, democracy does

88

8 9 10 11 12

13 14

Aymo Brunetti and Beatrice Weder not automatically reduce corruption but only through its eﬀect on improving the level of external and internal controls on the bureaucracy, e.g., through the control exercised through a free press. In this view it seems reasonable to assume that our instrument is uncorrelated with the error term. Tests for nonlinear relationships did not produce better ﬁts of the data. Alternatively, an improvement of press freedom by one standard deviation decreases corruption by about 0.5 points. The ﬁnding on inﬂation is consistent with Braun and Di Tella (2000). This result is robust to a higher or lower cut oﬀ for the deﬁnition of an authoritarian regime as well as using the democracy measure by Jaggers and Gurr (1996) to deﬁne this cut oﬀ. A key feature of Western European expansion around the world was the value attributed to freedom of speech, which of course implies press freedom. Since the expansion of European values can be taken as exogenous, indicators of European inﬂuence can serve as instruments. We follow Hall and Jones (1999) and use the fraction of Western European languages (English, French, German, Portuguese, and Spanish) spoken as a ﬁrst language as a proxy for European inﬂuence. A second, measure of a particular kind of European values is given by the fraction of protestants in the population. The other instruments used in Hall and Jones (1999) are the distance from the equator and the predicted trade share of the economy, based on a gravity model. However, these variables are not necessarily natural measures of European inﬂuence and indeed their correlation with press freedom is low. The same is true for an indicator of French legal origin. Hausmann’s test of overidentifying restrictions could not reject the exogeneity of the instruments on conventional levels (P value > 0.4). See Brunetti et al. (1998) for a more detailed presentation of the survey.

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