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Friday, July 31, 2009

System Externalities

Traditional welfarist analysis considers whether a given change in law is optimal by considering the incentives and disincentives it will have on affected actors. Take cap and trade for example. If we give carbon emission credits to domestic industries and allow them to buy and sell them, we can limit emissions, efficiently distribute the production of those emissions, and generate revenue for low-pollution industries—apparently a Pareto-optimal move.

Similarly, if there are couples out there who want babies but can’t conceive, and women who want money and have a womb to spare, we can simply allow those women to rent out their uteruses (uteri?) to the couples, and bingo—Pareto-optimality again, right? Well, not so much it turns out. A large and very interesting literature questions whether markets in surrogacy (and organs, and living babies, and many other things) should be permitted.

There are many different angles to the critique of taboo markets, so I’ll focus instead on one classic objection to them that leads in a slightly different direction. Some work (e.g., Margaret Radin’s “Market-Inalienability”) suggests that even when the parties to a transaction are made better off by exchange, the fact of the law’s ratifying that transaction can itself have dynamic, and possibly deleterious, effects on society. A legal regime that permits women to rent out their wombs for profit might begin to regard uteruseses, or women, or bodies in general, as indistinguishable from other objects in trade, and these distributed social costs may overwhelm the localized welfare gains of permitting the transactions.

This is just one example of what I’ve come to think of as “system externalities”: situations where the law’s approbation of conduct or transactions may send messages or have other negative effects on our worldview that cut back against the immediate welfare gains created by the conduct or transaction. I give several other examples of system externalities, and raise some other questions about them, below the fold.

Some examples

System externalities are most familiar from the forbidden markets literature, but they arise in many other legal contexts. Last week I wrote a post about Doug Lichtman’s interesting IP Colloquium conversation about the Shepard Fairey case. During that conversation, Mark Lemley (Fairey’s counsel) raised a concern that requiring artists like Fairey to get permission in advance of creating appropriation art could lead to a “permission culture” that is “corrosive”. Bracketing for now the question whether Lemley’s assertion is accurate, this is a classic system externality argument. I understand Lemley to be suggesting that even if it would have been Pareto-optimal for Fairey to have obtained permission from the owner of the Obama photo in order to use it, the law would be entrenching a problematic norm by requiring artists to always seek permission before use. Such a norm could chill the increasingly robust remix culture emergent on the internet, for example.

System externalities appear in work of various ideological and methodological stripes. A classic work in this vein is one of my favorite classic law articles, Richard Epstein’s “Blackmail, Inc.” This article addresses the blackmail puzzle: why does law make blackmail illegal when it makes both parties better off? Epstein’s answer is that by countenancing blackmail, the law would incentivize the creation of industries that profited off blackmail, the effect of which would overwhelm any welfare gains produced by permitting that conduct.

Objections to certain kinds of stem cell research may also fall into the system-externality category. If the materials used for such research exact no costs on living humans, and using these materials for medical research may produce important health gains, it seems hard to understand why the government should stand in the way of this research, at least from a purely utilitarian point of view. Among the objections to stem cell research are that permitting it may cause us to think of human life as less precious and more cheap, and if this perception became widespread it could make all of us worse off.

General thoughts

Since blogs are the water coolers of legal academia (albeit “bugged” water coolers, as Kate Litvak pointed out), I wrote this post to see what others might make of this. Here are a few more specific inquiries.

First, does “system externalities” seem a promising or interesting way to slice across various subject matter and substantive areas of law, as I’ve suggested it is? Or do all these examples seem disparate in some way? On the other hand, maybe someone out there has already sliced things this way, rendering this all redundant. (I freely admit that I’ve done no preemption checking on this so far, though I worry that this is just a re-tread of the law-and-norms and/or expressivist literature that was in vogue during the early 2000s.)

Second, do judges ever invoke system externalities explicitly in cases, or do they implicitly rely on this idea when making decisions? Here’s a possible example from property law: spite fences. These are structures built on one owner’s property that are eyesores designed to antagonize a neighbor, and courts typically bend over backwards to enjoin them (even in the absence of a clear positive-law basis for doing so). Perhaps system externalities provide an explanation: even if the value the owner derives from building the spite fence is greater than the costs suffered by his neighbor, it might still be a good idea to enjoin the owner because we don’t want to live in a world littered with spite fences.

Third, how can we fit system externalities into a welfarist decision-making calculus? System externalities are often dismissed as purely expressive or aesthetic arguments, but I don’t think this tells the whole story. They are often (though not always) expressive arguments, but they have real-world impacts; the idea is even law’s most localized decisions construct the world in particular ways that can have long-term, distributed negative impacts. But even if you buy the theory, it’s hard to say just how these kinds of delayed, systemic effects should be folded into a decision-making process involving two transacting parties.

Posted by Dave_Fagundes on July 31, 2009 at 12:36 PM in Legal Theory | Permalink


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It seems to me that you are opening a real can of worms here, because the number one "system externalities" argument I can think of being made is the one against same-sex marriage and homosexual sodomy.

Posted by: anon | Jul 31, 2009 12:58:36 PM

I sympathize with the general thrust of the argument, but I would be very hesitant to institutionalize this in any way. To my mind, the problem rests with the phrase "we don’t want to live in a world," which raises all the questions typical of nosy preferences, moralism(see the first post), and paternalism: who is the "we," why should the opinions or preferences of "we" matter to the transacting parties, where do rights fit into this (in a strict welfarist framework, the answer is nowhere, of course), etc.

I guess my general point - and something I'm exploring in a book I'm currently avoiding working on - is that not all externalities are created equally, and not all of them should impact, or should be made - through law - to impact, transactions between consenting parties.

Posted by: Mark D. White | Jul 31, 2009 1:28:28 PM

Debra Satz's paper on voluntary slavery might be helpful w/r/t the third question -- iirc (it's been a while since reading this), although she argues that welfare economics can't capture the wrongness of voluntary slavery, part of her argument does hinge on an actual welfare loss attendant on having this particular market option available (which seems like a solid system externality), and cites elaborations of that claim.

Posted by: Paul Gowder | Jul 31, 2009 1:53:47 PM

Thanks, all, for the comments. Paul, the objection to voluntary slavery strikes me as a classic system externality argument, much akin to the objections that Radin has voiced to baby and organ markets, and also like the concerns that Lemley (and Lessig) have voiced to "permission culture". Thanks for that tip.

The gay marriage question is interesting. Can we regard this as a system externality? There are at least two kinds of objections that fit this category. In some cases, the claim is that allowing gay marriage will increase divorce and harm families; in other cases, it's a more aesthetic or ideological objection that gay marriage will cheapen the institution of marriage (not advocating this point, just noting that it exists).

The latter point makes me wonder: is the category I've identified above too broad? How are "system externalities" different than "externalities" generally? I wonder if "expressive externalities" may make more sense and/or provide a more coherent limit.

Posted by: Dave | Jul 31, 2009 3:09:17 PM

Hi Dave,

I'm a big fan of your work, including the Crystals in the Public Domain article and the forthcoming Property Rhetoric and the Public Domain, so I'm excited to see your ideas on the front end. That said, at first glance, I find it hard to distinguish what you are describing as "system externalities" from conventional "externalities." The organ sales transaction makes both buyer and seller better off, but we regulate (here, by prohibiting) it because it negatively affects those who are not parties to the transaction, i.e., it has negative externalities. This is a perfectly conventional economic claim, that some transactions have negative externalities and that such externalities provide reasons to regulate.

Is the difference that the externality somehow makes the system worse off overall? If so, isn't that just a big externality that affects everyone? Perhaps you aren't concerned with the size of the negative impact but its quality, i.e., these aren't dollar "costs" in the traditional sense (the cost is the moral fabric of society). But economic externalities needn't be in terms of wealth, since you can define utility in a variety of ways.

It's possible that I'm missing something big and obvious here, but I think that means you need to express the concept more clearly at least.

Posted by: anon | Jul 31, 2009 3:16:11 PM

I think perhaps you are trying to paint system externalities as "holistic" externalities, which impact society as a whole while the effects on any one individual are negligible (especially in material terms).

Symbolic utility on a social scale may be another way to put it.

Posted by: Mark D. White | Jul 31, 2009 3:51:32 PM

Anon, one thing that's different about system externalities is that they may not be derived from individual transactions at all. It's possible that the mere fact that a certain transaction is permitted will cause externalities, e.g., because of the expressive impact that allowing the transaction has on others, or because permitting the transaction would distort other kinds of markets. For example, suppose it were legal to hold redheads in slavery? That would create a negative impact on redheads, and society as a whole, even if no redhead were actually held in slavery, both because a) it would express social contempt for redheads, and b) because it would, e.g., totally distort the labor market if bosses could threaten redheads with enslavement.

By contrast, a traditional externality is tied to an actual transaction.

Posted by: Paul Gowder | Jul 31, 2009 5:46:40 PM

Interesting thoughts about taboo markets. Personally, I was surprised to learn that we let women rent out their wombs but not sell their breastmilk. Linda Fentiman is doing some interesting work in this area (http://digitalcommons.pace.edu/lawfaculty/542/).

Posted by: jessica owley lippmann | Aug 3, 2009 12:48:23 PM

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