Law and Institutional and Organizational Economics

By Henry E. Smith

As an important set of social institutions, law and the legal system have played an important part in the development of the Institutional and Organizational Economics (IOE). And while a good number of legal scholars use institutional and organizational economics in their work, there is room for growth in the application of IOE to law.

The most obvious point of contact between law and IOE is through transaction cost analysis. Coase’s 1960 article is the most cited ever by the legal academy. Indeed the entire field of law and economics takes that article as its most important starting point. There is no small irony in this, because Coase himself did not intend to analyze the legal system. His purpose was to show, through a thought experiment based on a hypothetical world without transaction costs, that transaction costs are important to the working of the economy. His target was the style of theorizing based on perfect completion models – in what he termed “blackboard economics” – which unrealistically assume all sorts of transaction costs away. Years later Coase (1988:174) lamented that far from being “Coasean,” the zero transaction world is precisely what he was trying to persuade economists to leave.

The larger message of Coase (1960) is that no institutional arrangement can be spoken of as “efficient” without knowing what the alternatives are – in the real world. This is where law comes in. Law is not the only social institution governing people’s behavior – and work by Robert Ellickson (1991) and others has shown how important extralegal or even illegal social norms are – but law is a framework and set of constructed incentives that shape behavior. And, crucially, law is not costless: different legal solutions will carry with them different sets of benefits and costs, in terms of administrability, understandability, the effect on actors’ behavior, the impact on the feasibility of exchange, and so on.

Where does law fit into the total set of economically significant institutions? [...]

This post is the abbreviated version of an article written for the "Our field" section of, which can be fully read here.