Evolution of Legal Systems
Emanuela Carbonara – University of Bologna
ESNIE
23 May 2008
Outline
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How do legal systems evolve?
The economics of legal harmonization
The evolution of legal systems
Does evolution favor efficiency?
What is the effect of rule competition on efficiency?
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How Do Legal Systems Evolve?
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Market for Rules: The “Supply Side”
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States can
1. Enact new laws
2. Transplant rules from other legal systems
3. Harmonize/Unify
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The Supply Side
1.
2.
Follow - “mimic” legal rules from other jurisdictions
 Import rules and adapt them to your existing rules
and culture
Lead - “compete” with other legal systems
 Produce rules more attractive to the global market
• They become the rules most often chosen in
transnational commerce;
• Firms incorporate in the jurisdiction with the
most “attractive” rules;
 Transaction costs (legal barriers) for domestic firms
are minimized
• Examples: Delaware, “race-to-the-bottom v.
race-to-the-top”
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Market for Rules: The “Demand Side”
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Global market
Economic agents demand :
 Ability to choose between domestic and foreign law
 Clear “choice-of-law” and “choice-of-forum” rules
Globalization demands harmonization of legal systems
 Increasing importance of transnational markets
 Elimination of the “border effect”
The WTO is pushing countries for faster
harmonization
 Harmonization benefits trade (Rodrik, 2004; Turrini
and Van Ypersele 2006)
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Legal Barriers
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Estimates that transaction costs for advanced
economies amount to 40% in ad-valorem terms
Only 5% is due to typical trade barriers (Rodrik
2004)
Turrini, van Ypersele (2006)
Study the “border effect” assuming it might be
due to legal differences
Find striking result that even within a single
country, trade between two regions is higher
when subjected to the same court of appeal.
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Bridging the Legal Gap I
1.
Legal transplantation
 countries import statutes and principles belonging to other
legal systems
 Unilateral (non co-operative) effort by one country
 Driven also by legal competition
 Example 1: The Turkish actual legal system was established in the
years 1924 - 1930. The various Codes were chosen from what were
seen to be ‘the best’ in their field for various reasons. No single legal
system served as the model. Civil law, the law of obligations and civil
procedure from Switzerland, commercial law, maritime law and
criminal procedure from Germany, criminal law from Italy and
administrative law from France.
 Example 2: Ninety seven percent of the draft of book 2 of the new
Armenian civil code, Obligations, was taken straight from the
Russian civil code.
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Bridging the Legal Gap II
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Legal harmonization and unification
 Countries bargain on a set of objectives, then each one
amends its legal system to reach the chosen objectives
 Coordinated multilateral effort
 Harmonization and unification differ for the degree to which
the gap between legal systems is actually reduced
 With unification countries agree to adopt a unified set of
rules, replacing their national rules
 Examples of harmonization and unification are the
“directives” and “regulations” approved by the Council of the
EU
• Directives “harmonize” by setting common goals and
standards
• Regulations “unify” by replacing national laws with
common rules
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The Costs of Legal Change
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Countries have to change their legal systems
 costs of drafting a new law
 costs of learning foreign legal rules
Jurisprudence and doctrine become obsolete
Courts and lawyers have to learn new legal rules
(application and interpretation problems)
Increase in uncertainty and litigation due to lack of
legal precedents and doubts on the interpretation of
the new law by courts.
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The Costs of Legal Change II
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Stronger impact of mandatory rules a reduced legal
efficiency-enhancing lex shopping (Ribstein and
Kobayashi, 1996)
Influence costs by lawyers and legal practitioners
who lose their grip on the “supply of legal skills”
(Ogus, 2002)
Political costs of change (reputation)
Social costs (Legrand 1997)
Free riding incentives (Garoupa Ogus 2006)
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The Costs of Legal Change III
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The “Transplant Effect” (Berkowitz, Pistor and
Richard 2003)
Empirical study on 49 countries: “countries that
transplant the law have less legal order than
“origins”, unless transplanted statutes that were
close to the original law or where adapted.
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The Economics Of Legal
Harmonization
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Issues & Questions
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Countries tend to resist to legal harmonization
notwithstanding undeniable benefits
There are the costs of legal unification
Adaptation and switching costs
Would countries be willing to invest to reduce such
costs to facilitate legal harmonization?
When legal unification occurs, do efficient rules
prevail?
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Legal Harmonization: The Model
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Carbonara and Parisi (2007)
2 countries, A and B, with different legal systems
A has legal system a
B has legal system b
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a and b are equally efficient
There are legal and commercial transactions between A
and B
Legal differences between the legal systems impose
costs on A and B, reducing legal benefits from
commercial transactions
Information is complete and symmetric
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Legal Distance
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D is the difference between a and b
 D= - xA- xB
Define
  = initial distance between a and b
 xj = distance-reducing effort by country j (j =A, B)
A and B know the value of D at each moment in time
With legal transplantation, countries choose xA and
xB simultaneously and non cooperatively given 
With legal harmonization, countries choose xA and xB
to maximize joint surplus. They bargain to share the
surplus
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Distance Reducing Effort
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xA and xB are strategic substitutes
 The unilateral move of A towards B (or viceversa) reduces the incentives of B to move
towards A. The optimal xA is decreasing in xB
Free riding
Distance is always positive in equilibrium
Distance is larger when countries transplant
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Countries Can Control Switching Costs
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2 – stage game:
 Adjustment costs are endogenous
 At stage 1, prior to the choice of x, country A
can change its adjustment cost
• This requires a costly investment
• Adjustment costs can be decreased or
increased
 At stage 2, A and B choose xA and xB
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Effect of Changing Switching Costs
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Direct effect on welfare
higher adjustment costs increase resources
needed to reduce legal distance
reduce welfare
Strategic effect
higher adjustment costs reduce xA
by strategic substitutability xB increases
more costs to reduce D are born by B
this enhances A’s welfare
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The Strategic Effect
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If strategic effect dominates
A invests to increase m. switching costs
precommitment strategy to reduce own ability to
adapt to b in stage 2
size of strategic effect depends on reactivity of
equilibrium xB (ultimately on B’s reaction
function)
• B’s adjustment costs
• B’s costs of legal distance
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Changing Adjustment Costs
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Raising some of the rules to the level of constitutional rules,
requiring supermajorities or aggravated procedures for their
amendment
Recognizing specific rules as fundamental principles of the
system, thus creating a strong presumption against their
modifiability.
Introduce more complicated bureaucratic procedures and red
tape or new institutions like committees or authorities
 They would strongly oppose change, increasing political
obstacles.
Calling for a referendum to approve changes (like those called in
several EU countries to approve the new European
Constitution).
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Changing Costs and Cooperation
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In general, it can happen that A invests to increase
m. switching costs more when stage 2 is
cooperative
B can be forced to increase xB to a larger extent if
stage 2 maximizes joint welfare
There are cases where A invests to reduce m. s. costs
when stage 2 is non-cooperative and invests to
increase m.s.costs when stage 2 is cooperative
These cases might result in less harmonization under
cooperation paradox
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Conclusions
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Adjustment costs impede full transplantation
Harmonization increases legal uniformity but does
not lead to unification
Countries may invest strategically to increase
adjustment costs
Investment may well be higher when the second
stage is cooperative, so that cooperation results in
less harmonization
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The Evolution Of Legal Systems
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Efficiency and the Evolution of Law
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Market-for-Rules Metaphors
 Freedom of choice for applicable law leads to an
expansion of the “size of the market” for legal rules.
 Forum shopping and choice-of-law-rules enlarge the
set of rules applicable to a transaction.
Efficiency Hypothesis -- Efficient rules should win the
competition (Mattei, 1997, Ogus, 2002)
 Demand-Side Explanations: They are chosen more
often by private parties
 Supply-Side Explanations: Legislators introduce most
often chosen rules in their national legal systems
 This should induce the convergence of legal systems
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Evolution of Law and Path Dependency
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Diffusion of legal norms is path and history
dependent
There are substantial network effects
If many countries adopt a rule, the gains from
adopting it increase, independently of its efficiency
There is a “tilting point” (critical mass)
Once the number of countries adopting a given
rule is high enough, all countries may switch to that
rule
Due to the “critical mass effect”, an inefficient
norm might become universally widespread
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Coexistence of Legal Norms
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If such critical mass is not reached, norms can
coexist in the steady state
This explains how legal families originated
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Assume the evolution of law follows a replicator –
like/payoff monotonic dynamics
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A Digression:
Evolutionary Equilibria
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A New Idea of Rationality
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We abandon the idea that players are perfectly
rational
The strategy of an individual in its interactions is
predetermined by its phenotype
E.g. fight or retreat
A population is a mix of phenotypes: different pairs
randomly selected from it will interact using
different strategies
Individuals using strategies on average better suited
for those interactions will have greater evolutionary
success (fitness).
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Biology Meets Economics
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Individuals “inherit” one strategy to play
Cultural transmission
Socialisation
Background & education
Past experience
Different individuals “inherit” different
strategies
Strategies (on average) more successful over the
mix of strategies played in the population
proliferate and are adopted by more & more
players
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Evolutionary Equilibrium
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A strategy that cannot be upset by any successful
invasion of another is part of an evolutionarily
stable equilibrium (ESS).
Monomorphic and Polymorphic Equilibria
Two or more strategies can be equally fit,
coexisting in certain proportions
Then the population is said to be Polymorphic
Polymorphism is a concept close to the notion of
mixed strategy.
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ESS and Replicator Dynamics
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Replicators are entities (genes, strategies) who can
“copy” themselves, thus spreading in a
population.
Replicator dynamics is the selection mechanism
determining which of the potential replicators will
grow at the expenses of “competitors”.
The rate of change of a replicator is assumed
proportional to the difference between
a) The replicator’s current payoff;
b) The current average payoff in the population.
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Competition And Efficiency
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A Model of Evolutionary Competition
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Carbonara and Parisi (2008): evolutionary model of
contract law with international trade and endogenous
legal barriers
Barriers depend on how widespread a rule in the
world and on the actual use of the rule in
transactions
States face switching and adaptation costs when
changing their law
States and economic agents are independent actors
Rules compete
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Results
“Victory” in rule competition is only partially driven
by strict efficiency.
2. Relevance of network effects
 Percentage of countries adopting the same rule;
 Rules shared by the majority of commercial
partners.
3.
Choice-of-law rules play an important role:
 With more restrictive rules countries and firms
tend to go in the same directions
 With laxer rules the two processes can go in
different directions
4.
More competition not necessarily desirable?
1.
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The Model
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There are two legal rules A and B
Rule A is the “efficient” rule
It allows higher gains from trade when used in
business contracts
Rule A and B compete
Extent of rule competition is determined by choiceof-law rules
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Choice-of-Law Criteria
1.
2.
3.
Choice-of-law clauses are validated according to a lois
suppletive test
 Parties are not allowed to select a governing law
deviating from mandatory provisions of their legal
system of origin
 Rarely applied nowadays
Choice-of-law clauses are validated according to a
substantial relationship test
 The chosen rule has to bear a close relationship with
the parties or with the object of their contract
Choice-of-law clauses are validated according to a ordre
public test
 Parties are free to choose the law governing their
contract as long as non-derogable principles of their
domestic legal system are not undermined
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Modeling Choice-of-Law
1. Very restrictive: firms have no freedom to choose a rule
different from the one adopted in their country of origin
2. (Semi) restrictive: freedom of choice in transnational
contracts; domestic transactions subjected to national rules
3. Permissive (Free): firms are free to choose the legal rule
they prefer, even for domestic transactions.
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Countries
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There are N countries
In each country there are m (symmetric) firms
engaging in transnational trade
Countries are symmetric but for the legal rule they
initially follow
At time t, nt percent follow legal rule A
Countries can transplant a new rule
They face switching costs
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Firms
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Firms have transactions with national and foreign
parties
The rule chosen by their country affects firms’
transaction costs
When choice-of-law is allowed firms choose the
rule governing their transactions with foreign
parties
Using a rule different from their country’s one costs
a firm  >0 (application cost)
At time t, xt percent use legal rule A (if legal)
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Trade
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Firms are matched randomly in pairs
A firm is matched
with a trading partner from A with probability n
with a trading partner from B with probability
(1-n)
(0,1) measures the “legal barrier”
When firms can choose foreign rules they apply the
efficient rule whenever possible
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The Dynamics in the Very Restrictive
Choice-of-Law Regime
n
1
VA-VB>SCBA
No Move Region
VB-VA>SCAB
x
0
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The Dynamics in the Restrictive
Choice-of-Law Regime
a2
b1
a1
b2
1 x
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The Dynamics in the Liberal Choiceof-Law Regime
n
a2
(1,n° )
b1
a1
b2
c1
B
nxF(x)
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An Equilibrium with Rule
Coexistence…
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where only one rule is used in transactions (A)
but all countries adopt the other rule
Equilibrium evolutionarily stable iff  and  low
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Which Choice-of-Law Regime?
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Ideally, optimal regime
 Should minimize costs of reduced international trade
 Should favor selection of efficient rules
 Should maximize speed of convergence to the
(efficient) steady state
 Should minimize costs of the transition to the
(efficient) steady state
Is it true that more permissive regimes have better
chances of achieving all the above goals?
Are efficient rules more likely to “win the competition”
under a permissive choice-of-law regime?
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Case I: The Very Restrictive Regime
Wins!
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 and  are high
Initial situation: a relatively high n but relatively few
firms use A
Then
RR leads to steady state A
R and F lead to steady state B
• Intuition  high  : too many firms should
bear  in order to use A,  they contract using
B.
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Case II: Liberal Regimes Can Win!
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Again,  and  high
Different initial conditions, low n and very high x
Result
R and RR lead to B
F leads to A
• Intuition: lots of firms use A at the initial
condition.
• Majority of contracts under F are written using
A. Strategy A is very attractive to countries as it
helps saving on “application" costs .
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Competition Fails
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 and  are low
RR leads to steady state B
R leads to steady state A
F leads to steady state D
• Intuition  low  : strong incentive for firms to
invest use A independent of their legal rule of
origin
• low : the weight of the “border effect” is too
high compared to the application cost 
increase trade at the least possible cost and let
firms seek efficiency
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Are Liberal Choice of Law Regimes
Always Socially Efficient?
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A very restrictive regime by efficient countries
might speed up convergence to efficient rule
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A very restrictive regime by inefficient countries is
always harmful
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No universal “superiority” of open choice of law
regimes
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