Law and Surplus: Opportunities Missed

Surplus is a ubiquitous feature of economic activity. The ubiquity of surplus challenges us to find fair and efficient ways to share resources. This is the surplus problem. In my article, Law and Surplus: Opportunities Missed, I document the miscues and mistaken assumptions that have left this topic woefully underexplored in legal scholarship.

The law can and should play a central role in addressing the surplus problem. One nice example comes from admiralty law. By limiting the rewards provided to those who carry out a rescue at sea, admiralty law’s rule of salvage discourages sailors from investing too many resources in a socially wasteful race to be the first ship to carry out a rescue. In a similar vein, requiring disclosure in certain circumstances can reduce waste from efforts to gather information that is ‘mere foreknowledge’ and does not provide any social value. These are just a few of the many ways in which the surplus problem relates to important legal questions. Yet this potentially rich area of research and insight remains largely ignored.

In my article, I detail the reasons for this shortcoming in three different areas of legal scholarship. The first group of scholars who approach but then surprisingly veer away from the study of the surplus problem are those who study ‘rent-seeking,’ where ‘rent-seeking’ involves efforts to get rich by gaining control of government-created monopoly rights. Scholars working in this field recognize that the fight for a surplus is both hard to prevent and inherently wasteful; however, these scholars then ignore the larger ramifications of their important insight.

Scholars who study rent-seeking offer various justifications for choosing to limit their investigation of the surplus problem to competition for government-created monopoly rights. One justification they offer is that the fight for surplus in the broader economy is not particularly important, because surplus in the broader economy is a minor and transitory phenomenon. This is clearly incorrect. Surplus in our society is both persistent and economically significant. I show in my article that the dollar amount of surplus in the United States in any given year is easily in the trillions of dollars. Moreover, the fight for this surplus is increasingly important, as ‘big data’ technologies have reinvigorated efforts by firms to personalize pricing. Scholars studying rent-seeking also assume that market solutions to the surplus problem will provide socially optimal incentives for private firms to invest and innovate. This is also incorrect. Market solutions to the surplus problem can easily lead to both too much and too little investment and innovation.

The second group of scholars I consider are those who study within the law and economics tradition. Unlike the scholars who study rent-seeking, law and economics scholars do not provide an explicit justification for failing to fully address the surplus problem. One can discern, however, several implicit assumptions that have led most law and economics scholars to avoid this topic. These assumptions are: 1) that private parties will negotiate around any legal intervention designed to alter surplus sharing arrangements, 2) that it is morally wrong to use legal rules to alter the surplus sharing arrangements private actors willingly agree to, 3) that legal scholars can rely on the failure of economists to identify predictable social costs from price discrimination (the practice of charging different customers different prices for the same product) to justify avoiding study of the surplus problem, and 4) that it is, in any case, a mistake to include fairness concerns in an economic analysis of how legal rules might help to divvy up surplus more efficiently. All four of these assumptions prove to be flawed for reasons detailed in the article.

The third group of scholars who surprisingly fail to address the surplus problem are those who study consumer protection law.  Scholars studying laws designed to protect consumers would appear to be among those most likely to consider how legal rules can insure that economic surplus is shared in the most fair and efficient manner possible. However, many of these scholars instead base their arguments for consumer protection on traditional market failure arguments, such as those arising from a lemons market or from behavioral exploitation. Problems for consumers arising from a lemons market or behavioral exploitation are certainly worthy of careful investigation. However, firms can also seize surplus in many situations where these market failures do not arise. Consumer law scholars should not ignore these activities.

The failings among legal scholars to grapple with the surplus problem raise a deeper question. Why has the study of law’s role in addressing the surplus problem been overlooked? The most likely explanation is that legal scholars have unwittingly but systematically fallen into a familiar trap. These scholars have failed to recognize that markets do not work equally well at addressing two related, but quite distinct challenges. The first challenge involves efficiently allocating scarce resources. The price mechanism, with modifications as needed, provides an elegant solution to this challenge.

The second challenge that arises in a market economy involves figuring out how best to share a surplus. In addressing this second challenge, the ‘invisible hand’ is as likely to destroy as to create value. Leaving the fight for surplus to private parties must rest on different analytical foundations than does a choice to rely on markets to allocate resources efficiently. Legal scholars have missed this subtle but important distinction. My article begins the process of correcting this confusion, a confusion that has limited investigation of the important relationships between law and surplus for far too long.

Michael Guttentag is a Professor of Law at Loyola Law School