REPLACING NEOCLASSICAL MAXIMIZATION IN THE REALM OF HUMAN ACTION Pierre Bentata

CAE Centre dAnalyse Economique, Universit Paul Czanne, Aix Marseille III 3 avenue Robert-Schuman 13628 Aix-en-Provence cedex 01 Septembre 2009-09-29

Replacing Neoclassical Maximization In The Realm Of Human Action Pierre Bentata Septembre 2009 JEL No. B41, A11, A12, D6, K19

ABSTRACT

The aim of this paper is to propose an original articulation of neoclassical and Austrian understanding of human behaviours into one logical sequence of human process of decision. We claim the methodological debate among economists on the representation of human action is due to a wrong interpretation of both neoclassical and Austrian economics: these two methodologies do not study the same step of human action. Far from being opposed, neoclassical and Austrian concepts of rationality and maximization can be articulated in a logical understanding of why and how do people act, and gathered into a global frame within neoclassical maximization is the conclusion, the final step, of the Austrian decision process. From this economic frame, we deduce a normative definition of economic efficiency and draw severe critics of neoclassical concepts of efficiency and redistributive justice as potential normative goals of economics. Besides, this conclusion leads to the definition of a new role for the economist in Law & Economics analysis: neoclassical economics should be used carefully and in very specific situation to enhance existing legal rules based upon non-economic goals, but never as a way to design laws according to their economic efficiency.

1. Introduction

Man is always a utility maximizer said George Stigler when he received his Nobel Price. Each human being has subjective preferences placed on a welfare scale: this scale is called the utility function. Although the concept of subjective utility (subjective happiness or well being) is difficult to negate, the concept of its maximization remains very problematic. In this essay, we offer a new interpretation of human action, which reconcile neoclassical and Austrian understanding of economic behaviour and design normative conclusion based upon both economic efficiency and legitimate expectations of beings. To understand this logical link, it is necessary to study the corner stone of neoclassical economics: maximization. Maximization means the capacity to any person to reach highest level of utility given the means at their disposal. It can be understood as acting purposefully or as a more elaborated calculus. To cope with maximization, it is necessary to know what are the variables that make the utility increase or decrease. Thus to conclude that every man is utility maximizer and to find out interesting information from this method, the neoclassical economist needs to use a tool: an artificial[DBR1], made-up function. This function is based on the observation of humans behaviours, used to draw a theory of maximization that is at the end verified by the final experiment: the final confrontation of the theory with the reality. This hypothetico-deductive method[DBR2] - whereby the scientist deduces hypotheses from the observation of phenomena and builds a theory upon them before confronting his theory to others phenomena to verify its explicative power - used in natural sciences, leads in social science to the creation of an artificial world within people react to stimulus in a predicable way. This is for two main reasons: first to simplify the complexity of the real world in which the amount of information is too great; second to overcome the lack of laboratory to confront the theory to the real world. Thus it becomes easy to find a representative agent: the homo economicus. [DBR3]This positivist analysis is based on an ambiguous definition of the rationality: according to Maurice Allais a man is rational if he pursues coherent goals and uses coherent means to achieve these goals.[DBR4] We will see that the neoclassical use of this definition is true only in a specific context, at a very particular moment: once the agents decision has been made and only the mathematical question of how to get the maximum of that good? remains. Though, how can we analyze the means? How can we objectively judge the coherence between means and goals?

Whatever the problems arising from this definition of rationality, utility is nevertheless used in almost all the current theorizing, especially in the new fields of the law and economics analysis or economics of non-economic institutions such as crime or mariage1. Thus it is essential to analyze whether this definition does respect the subjectivity of human beings and their free will: their own judgement of what goal is relevant to pursue and what means is the best to achieve it; to put it in other words does this definition respects peoples choice to act? This acting being is called by Mises Homo Agens.2

We will see that the neoclassical analysis, being systematic and built to predict behaviours, leads to give up normative conclusions or to root conclusions on the maximization of an arbitrary social welfare. In the second part, as a critic of the neo-classical maximization hypothesis, we[DBR5] will look at the characteristics of the utility function and the definition of the homo economicus[DBR6] the representative agent used by neo-classical economists in their models - to show that this representation of peoples behaviour is only a part of the broader problem of human action; in a third part we will see that a realistic definition of a human being - a complex being whose actions are not only reactions to external stimuli, who is not constraint by hypothesis on his behaviour and whose definition reflects both universality and uniqueness of each human being - to study economic phenomenon is necessary to embrace and to understand peoples action and decision in an uncertain environment. In the fourth part, we will show that these two conceptions homo economicus and homo agens lead to different realities that can be gathered and articulated into an original sequence of human action i.e. neoclassical framework brings conclusions that are universally verifiable only under particular cases and is only the conclusion of the whole process of action of the homo agens. To summarize the homo agens acts and chooses, once his choice is made, he becomes a homo economicus who maximizes. In the fifth part we give normative conclusions consequence of this sequence on the role of neoclassical economists in the design of regulation and law making. Finally we give further research issues on the implication of this economic sequence in Law & Economics analysis, in the sixth part.

See recent works in the field of microeconomic analysis, from Becker to Lewitt, and in a quite different way, all the behavioural economics. 2 We use these terms in the sense given by Mises (1944)

2. Neoclassical methodology as the final step of action

Neoclassical economics presents the homo economicus[DBR7] as a perfect being able to calculate and predict the course of events in order to reach the best solution. The homo economicus is always able to solve the problem of scarcity: he allocates scarce resources in the most efficient way to maximize their use and creates abundance. However, does such a person exist, and does the homo economicus, whose life is to obey to a specific rule (i.e. maximization) in a determinist environment, still exist into a nondeterminist world?

2.1. Methodological failures

Neoclassical economics is a science whose goal is to build a theory or an hypothesis to do valid prediction about events not yet observed, according to Milton Friedman. Then as we can predict the movement and the speed of a ball thrown from a given distance with a given force, the behaviour of a man walking in a supermarket with a certain amount of money should be predictable too. Then the hypothetico-deductive method shall be used in social sciences: we shall observe regularities in human behaviour to formulate empirical laws, and draw models and theories. The fundamental step is the last one: the falsifiability3: the theory is falsifiable but not yet falsified, and enables to explain a lot of phenomena. Then in natural sciences, because we have laboratory to test the theory by doing experience, the unrealism of the hypothesis does not matter as much as the ability to predict and explain phenomena4.[DBR8] For instance even if we do not know whether the quanta exist, it is obvious that theories based on quanta work (informatics particularly). The fact that unrealistic hypothesis are used does not matter in natural science because we can directly observe and repeat the phenomena in laboratory. Because the goal of the scientist is to explain a lot of different events with the same theories, he shall use vague hypothesis to avoid the falsifiability of the theory, hence the vaguest the hypothesis, the better.[DBR9] Of course the final aim is to explain a lot of different phenomena but here is the adverse effect. Milton Friedman wrote that the same must be done in economics, and because economics is not an exact science, not vague but even empirically wrong hypothesis could be
3 4

Popper (1973) Milton Frideman (1966)

[DBR10]used! There are many problems with Friedmans claim. First, it is impossible to test the theory in laboratory in human science and thus the experiment cannot be controlled. Second, as Murray Rothbard5 showed, the use of the Popperian method in natural sciences is due to the fact that it is possible to observe events but not to understand the fundamental cause (we cannot know the causes a priori), so the use of unrealistic hypothesis is necessary, in economics on the opposite, it is impossible to observe a particular event, because of the importance of the context, the environment, but contrary to natural sciences, the fundamental cause is known: humans act to change the course of events when they think that they will be better off in doing so. Rather, it is by using logic that it is possible to deduce true theories from the apodictically6 true axiom of Action: humans act purposefully and freely, their actions are conscious. As Mises showed, there is no way to negate this axiom without giving another proof that it is fundamentally true7. What we observe with the homo economicus is quite different, his action is not really free since he maximizes an already made choice8. The homo economicus does not fit into this definition of the action, because he is simply reacting to stimuli sent by his environment: he is the conclusion, the final step of the decision process but in no case he can explain the whole process of acting to make himself better off. Moreover, the final experiment remains very problematic in social sciences. As Friedman explains it is easy to observe the maximizing behaviour of firms: only firms that maximize their profits as if they were on a perfectly competitive market survive, the others disappear9. But such a statement is very tricky because it is impossible to prove that all the firms behaving as profit-maximizer will survive and only these ones. It would need to verify each company; that is the reason why Popper [DBR11]criticized the induction process. Then the final experiment in the neoclassical models is biased and one can wonder whether the theory explains the reality or creates its own reality. This bias is due to the fact that the first and the last levels of the creation of a theory are the same in a neoclassical model: first they observe the environment to draw hypothesis, then with these hypothesis they create a theory that they use to explain the event they observed first. Because of the complex nature of social sciences, the first observation is very difficult and the last experiment is impossible because it is impossible to create twice the same
5 6

Murray Rothbard (1991) Immanuel Kant (1797) 7 Mises (1944) 8 We call an it an already made choice because Agents preferences and utility function are built and given as exogeneous variables, thus the choice is made a priori and the only thing that remains is to maximize the Agents utility. 9 Friedman Methodology of Positive Economics (1966)

conditions in a market to study peoples reactions. Even if there were laboratories to analyze agents behaviours, the results will not be twice the same because of the active nature of human being: each experiment (even the repetition of a experiment) provides new knowledge. The adaptive nature of human beings makes the hypothetico-deductive method a weak tool compared to its use in natural sciences. Behavioural and experimental economics show that people act in a very specific and unpredictable way that refute the hypothesis of neoclassical rationality or add moral values not taken into account by neoclassical economists. The neoclassical world is thus totally artificial because it forgets the fundamental reason of human action: improving welfare by the use of knowledge and creativity to find out new opportunity that are welfare improving. It is worth noting that to improve his welfare, the agent has to acquire useful knowledge too. [DBR12] This neoclassical environment is thus particular and cannot be observed in the complex real world. As Frank Knight wrote we are living in a paradoxical world, the most striking illustration is that the existence of a knowledge problem lies on the idea that future and past are different whereas its resolution lies on the idea that future and past are identical.10 To solve economic problems such as predicting humans behaviour and maximizing utility, that exist only because we do not know the future we assume that people will always behave as they did before. What are knowledge and experience all about if acquiring new information do not change peoples understanding of their environment and perspectives of welfare improvement? To be coherent we have to choose: - either people will continue to behave as they did till now and knowledge problem is only a new mathematical calculus (a new optimum given the new quantities) or - people will adapt their behaviour to the changes in their environment and use the knowledge they acquired. In the last case, far from being predictable, their actions will result for economists in qualitative, ex-post observations. As Grard Bramoull used to say Pretending that people will act in the future as they did in the past has as much sense as the driver who looks at his rear-view mirror to drive to the road ahead. Notwithstanding methodological problems, we will see neoclassical concept of maximization remains a useful tool to predict peoples behaviour under specific circumstances.

10

Knight (1922)

2.2. Homo Economicus, a passive and omniscient being

How does homo economicus make his choice? The answer of that question is rooted in the definition of neoclassical rationality. According to neoclassical economics, the agent looks at his direct environment and understands all the different possibilities he has in the present as in the future. He understands the consequences of each choice and is even able to put probabilities on the different states of the world in order to draw a unique utility function in which he classified all the different states of the world according to his preferences11. Criticizing this assumption because of the cognitive limits of human being is pointless, because even neoclassical economists agree with that point. A more important problem is the inability of this theory to explain the behaviour of rational agents. Indeed assuming that the rational agent already knows all the possibilities he faces and the consequences of each choice, how can economists explain that people change their mind and their strategies to reach their subjective goals? And how can they do mistakes? The only [DBR13]explanation is that the agent has discovered new information - or has simply changed his mind in an unchanged world, which is impossible to foresee and to explain - but he already knows everything and even more. The assumption of perfect knowledge is not compatible with changes in agents behaviours and when the agent adopts new strategies, it refutes either the assumption of perfect knowledge or the transitivity of preferences. The way out is to acknowledge that people act in an uncertain world, they cannot foresee, with absolute certainty, the result of their action. Schakle notes that to take decisions, people need a sufficient knowledge and it is impossible to know in advance if such knowledge is available. To act purposefully people need some concrete knowledge. [DBR14]Boland answers, it is not worth having such knowledge, it is sufficient that the agent thinks he has enough information to take the best decision.12 This has a strong consequence in the study of human behaviour. Indeed agents beliefs are different from one to another, and their decision whether to act depend on their subjective valuation of the information they think they have. Then there is no universal behaviour

11 12

H.A. Simon (1986), p.13-14 Boland (1981)

The maximization becomes subjective and it is impossible to predict any behaviour nor to draw any model of behaviour[DBR15] - except in very specific situations, when the hypotheses of transitivity of preferences and perfect knowledge hold for everyone: situations where the choice has been made already, the other variables are given as exogenous and the only problem is the calculation of the utility optimum once the action is done in any other situations, as soon as uncertainty appears, it is possible for a rational agent to disrespect either the rule of transitivity of preferences or the rule of perfect knowledge. In other words, an agent cannot be rational, perfectly informed and respect the transitivity of preferences at the same time, except when the problem is only about the calculation of the maximum given the choices of the agent. But the informative power of the model is then very weak: it provides quantitative information about an unexplained action. The economist knows the optimum of utility the agent can get with one decision but he has no information on how did he take this decision. This is due to the fact neoclassical economists do not pay attention to the very important fact that people have intuition, get experience and knowledge all the time. Hence it is impossible to have a relevant model with the immutability of preferences and the rationality as hypothesis at the same time, in a dynamic model.

2.3. Myth of social welfare

Each agent knows is preferences and is able to rank them. The neoclassical economist, because he pretends he is able to observe and to discover these preferences, thinks he can rank and aggregate them into a social utility function, and then he builds the fallacy of the social welfare. Though it is impossible to calculate a social welfare without using implicitly the concept of general equilibrium: all the people could be better off at the same time and more than that, they could be totally happy so that they do not need to change their behaviour anymore. The Pareto optimum is generalized to the society as a whole. The neoclassical economist thinks he is able to find that particular state of the world through the aggregation of the subjective preferences of the beings of the society. To deal with social welfare, he needs to assume that those subjective utility functions can be aggregated in a social one and this social utility can be simply maximized. Though it is not sure that all the subjective utility functions have the same variables.

According to Hayek, the fact that prices change all the time on the market reflects the fact that people change their mind, acquiring new knowledge, they find new goods, new prospects of profits. Once they reach one goal, they immediately look for another, so that no equilibrium is possible. Moreover the action of one creates information for another so that when one reaches his temporary equilibrium another sees new perspectives to increase his welfare and changes his behaviour, providing information for the others. If such an equilibrium had been reached even one second on the past, it would have remained stable, unchanged now, because if everybody is perfectly satisfied at the same time, the world just stop moving, no one has any interest to change anything.13 Then the essence of the action makes a general equilibrium impossible, there is no as if as Friedman said.[DBR16]14 Social welfare is then only a chimera and an arbitrary [DBR17]decision has to be taken to know what are the preferences of the whole society. The authority is the economist who uses models to find the best way to make people better off, even if he does not know their preferences in advance and it is impossible to make all of them be better off at the same time. In such a situation the rational agent is not a human being but an instrument to reach a higher goal: the social welfare.

2.4. Myth of Marginal Utility

Neoclassical economists do another strong assumption that is totally irrelevant with the idea of rationality to calculate the social welfare. They pretend they can calculate the marginal utility of rational agent as a quantitative and continue function. Then to reach an optimum it is easy: at an individual level, he has to equalize the marginal utility provided by each good he consumes, and at a social level, it has to equalize the marginal utility of each member of the society. It is worth noticing that at the social level, agents are organic members of the society considered as a whole body. Then the definition of a natural person totally disappears. It is well known that dealing with social welfare leads to controversial results according to individual utility. The Kaldor-Hicks method that presents any situation - within some people

13 14

Hayek (1968) Friedman (1966), notes that everything works as if people were perfectly informed and able to calculate the results of any action in any state of the world even if this is not totally the case.

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are made better off and able to hypothetically compensate the ones who are worse off in that situation - as socially desirable has been criticized and is questioned by a lot of economists.15 Whereas individual maximization is hard to quantify, social maximization is clearly impossible to assess from individuals bases since as we stated earlier variables are not the same and even if universal variables exist they are valuated by subjective mind. Therefore claiming that this regulation or that law increase the welfare of the whole society defined by an utility function becomes an intellectual fallacy: the only way to cope with social welfare should be qualitative using that we know they will improve everyones utility (a pure Pareto improvement). The homo economicus, presented as an approximation of the real human being, has no inner preferences or ability to change is mind, in spite of his extraordinary cognitive abilities. He is an empty tool that reveals his power once the action is done and the result appears. Indeed he does not exist as long as the decision is not made but once it is, the homo economicus facing only a mathematical problem with few variables in a determined environment, is able to calculate the best combination of those given variables.

2.5. Neo classical positivism: Redistributive justice and social welfare

Acting is betting. People act because they expect to be better off thanks to this action. As Mises showed people face an infinite amount of alternatives and they act purposefully, taking the decision they think is the best. Because they acquire information each time they act, they will not live twice the same situation, and they will accept routine only if they think it is still the best solution. Thus Game Theory does not help to understand humans behaviour, since it negates the knowledge side by limiting the human action at a binary choice made by a person who has a determined role, position. Neoclassical economists pretend that rational agents gives probability to uncertain events. However to know these probabilities it is necessary to know what all the other agents think and will do about this event. Because the occurrence of an event depends on the actions of everybody, the only means to predict it is to know exactly what each person is about to do. To avoid this problem, the neoclassical economists use the concept of ceteris paribus but as Mario Rizzo explained, it is a fallacy because when the logic link between a cause and his

15

For instance Kelman (1981)

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consequence is falsified and the ceteris paribus clause is used, we do not know whether it is the logical reasoning or the existence of the clause that is falsified.16[DBR18] The only way to predict humans behaviour is to give a strong meaning to rationality[DBR19] because the economist has to decide what is rational and most of the time he fails defining rationality without using moral or value judgments: a rational man is then a reasonable man. Otherwise it is impossible for neoclassical economists to predict anything nor to draw social welfare function. The homo economicus, far from being an actual person, is a particular being [DBR20]with given role, who can only live into the well-defined environment the economist has created. In such an environment everything being predictable and modifiable, the use of rules to gives to best incentives according to the final goal (i.e. social welfare) seems to be relevant. Indeed the rational agent reacts to any stimuli and then a fine tuning is made possible by the use of different rules whose effects are perfectly known. The homo economicus explains the final calculus resulting from the decision but not the process of deciding what action has to be done. He answers to a simple mathematical problem not to an economic one. The creation of this artificial person leads to a strong positivism in law, where only the results of actions matter: redistributive justice.[DBR21] Peoples actions and decisions are predictable; they are the result of a calculus the legislator knows. It is easy for the legislator inciting people to act in the desired way since results are foreseeable and social utility is well defined and known. The fair compensation defined and used by the Kaldor-Hicks criterion works smoothly: in this view it is easy to enforce laws that are harmful for a minority and then to compensate them. Though once we are aware of the critics made earlier, this legal positivism looks less efficient: the calculus are arbitrary since the choice of what is really maximized depends on the legislator or the law & economics searcher. So far, we have seen that neoclassical representation of action is relevant once the environment is perfectly known, and peoples preferences and strategies are clear. In the following part, we will look at the formation of peoples decision; before they make their actual decision and do maximize their utility in the neoclassical world.

3. Austrian methodology to understand the first step of action

3.1. Homo Agens, a free active being

16

Rizzo (1978) p. 44

12

To understand the reason of peoples action, we have to go back to a broader definition of rationality. Rationality in its broadest sense is defined by the fact that people act because they believe there actions will make them better off, according to their subjective goals17. Humans act in an unpredictable[DBR22] quite unpredictable way, pursuing subjective goals that no one can perfectly understand before their actions become observable. The key is to understand economic phenomena. The fundamental element of any economic phenomenon is the human action. If one accept this basic idea, the use of methodological individualism as methodology is obvious. Any decision can be understood through the analysis of human action. Praxeology explains this process. The action is a dynamic process: during his action each man has to cooperate with other active human beings and adapt his behaviour. Interactions become a fundamental part of the problem of human action and we cannot isolate someones action from his relation to they others. Far from being only a problem of maximization, economics is the problem of choice and interaction: the combination of action (praxeology) and interaction (catallaxy) defines the entrepreneurial behaviour of each human being.. Behaviourists spent much time and efforts to show how environment and specific context influence humans. By the use of biases and heuristics, they showed how a rule or a norm does influence the behaviour and the understanding of people. Actually it is obvious that the external context matters, and any decision is taken according to the environment within people live. Though this does not mean that people simply react to stimuli sent by the environment. Indeed there are two reasons that are sufficient to negate this assumption. First of all, when an unexpected event occurs, any rational being faces a choice between adapting his behaviour or not. Thus he still has the choice and what is called a reaction is more than that: it is an action. That is the reason why Mises writes: sometimes one stimuli can lead to different responses, and two different stimuli can lead to the same response.18 Then whatever happens in his direct environment, the rational being acts purposefully, consciously. Secondly the statement the environment influence humans behaviour is intrinsically wrong. Indeed what is called the environment is the result of peoples interactions. This means that people act and their actions have consequences on others actions. Thus adapting to the environment means adapting to each others actions. It is correct to say that people does
17 18

Mises (1944) Mises (1944)

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influence each other, but then again, it is impossible to state that because of this influence people are not free anymore.

3.2. What to maximize?

The action is an observable process of a certain length in a certain place. Then the only way to understand human actions and complex phenomena is what Bergson calls une intuition, la sympathie par laquelle on se transporte lintrieure dun objet pour concider avec ce quil a dunique, et par consquent dinexprimable19 The experience is named Verstehen (understanding in German). The method is not only a method used by historians but also the universal experience people use to understand a specific event. To understand what and how do people maximize it is necessary to use the Verstehen. Because this universal experiment is an experiment of sympathy (what is more often called now empathy), it is essentially qualitative.20 [DBR23]The willingness to determine quantitative value of the utility function is pointless and can lead only to conclusions that negate the deep nature of human beings. Boland tried to solve this problem by the use of what a he called an all-and-some statement21: every humans are maximizing something is a statement that cannot be verified nor falsified. Then he says that everything goes as if people were maximizing their utility and any action is the result of such maximization. However when he tries to explain why some actions have inefficient result, he says that it is the best result given the past maximization and then it is necessary to go back in time until the first maximization. Though it is impossible and then to Boland, it is not necessary to look in the past to be sure that his statement is true. Hence he does not manage to go out of the Fries Trilemma since he uses psychologysm and dogmatism to explain his statement. Thus, before using neoclassical maximization, it is necessary to understand peoples actions and decisions as qualitative variables and the mathematical problem of maximization arises only once decisions are clear and observable. In other words, neoclassical maximization is relevant once human action has been explained through the prism of Austrian praxeology.

19 20

Mises (1944) p.122 Adam Smith (1759) 21 Boland (1981)

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4. Economic sequence of Action

4.1. Austrian action, Neoclassical maximization

Neoclassical economics deals with the result of human decision, once preferences and environment, given as exogenous variables, are perfectly known. In this framework, the only problem for an agent is to maximize his welfare given particular variables (prices, revenues, probability of occurrence of a certain event, preferences). When we broaden the scope and deal with endogenous subjective preferences and uncertain environment, there is no way to use neoclassical maximization to cope with human action. Thus Austrian concept of action comes first to explain someones behaviour in a complex and uncertain world. Once ones preferences and knowledge are known and can be drawn as exogenous variables, neoclassical calculus is possible. The original sequence can be summarize as follow: before acting, people face plenty of opportunities, and way to reach their goals. They have to choose among these opportunities, to discriminate in order to engage into one way (sometimes only driven by their nose as Kirzner said with humour). Once their decisions have been taken, they face a practical problem: how to make the best of the new situation given the means they have chosen. In other words: Action precedes Maximization. Neoclassical maximization is the end, the final step of the process of decision and action. Once he has made his choice among all the opportunities he saw, he tries to make the best of his resources to get the maximum of the goods he chose before.22 The entrepreneur is homo economicus only once his choice is made. Maximization, of any kind, is not the central point anymore, the process of human action is more relevant to analyse for the economist. What matters to increase any social welfare then is the protection of humans freedom to act.

4.2. Normative implication

Social welfare, defined as the aggregation of individual welfare into the society, makes no sense outside of the concept of human action since only the capability to act leads to a potential improvement of someones welfare. Thus any economic goal based upon economic

22

Huerta de Soto (1998)

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efficiency or redistributive justice has to be subordinated to the protection of peoples freedom to act. Praxeology deals with rational human beings (not reasonable, since even a mentally ill person is rational to Mises) following their own goals[DBR24]. Then they get rid of the position and the role they have in the neoclassical society. The only things that really matters then is to preserve peoples freedom of action to reach their subjective goals. Therefore, it is necessary to discover universal rules of living together. Following this conception of entrepreneur and action, the legal order has only one purpose: protecting peoples right to act to improve their welfare. The definition of human being can be sum for the law & economics scholar as a self-directed agent whose liberty to self perfect himself ought to be guaranteed by the political legal order through the protection of basic individual rights.23 Thus, the economic sequence makes the normative conclusion of economics clear and reveals why normative economics remains a fundamental issue. Indeed, this implication does not reduce the scientificity of economics but appears as a logical conclusion of economic science.

5. Fundamental issues in Law and Economics

Law & Economics methodology is driven by the concept of cost-efficiency, but as we saw in the former paragraphs, this cannot be an objective per se. The implication of the economic sequence for Law & Economics analysis is great because as we saw, neoclassical economics can be used only to cope with technical issues and is subordinated to Austrian normative conclusions.

5.1. Cost-effectiveness fallacy

The immediate consequence of the economic sequence is that Kaldor-Hicks concept of compensation is irrelevant with praxeology. The fact of compensating one agent in a situation that make the society better off is not relevant because it does not take the opportunity costs of agents into account. Thus, it seems impossible to choose among different rules on the basis of social utility because neither peoples welfare not people opportunity costs are well defined. However, neoclassical economics remains useful in the understanding of what will be the result of law enforcement.

23

We use the terminology of Douglas Rasmussen and Douglas Den Uyl in Norms of Liberty (2005)

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Indeed, we know that neoclassical economics works well when people are defined by their particular positions (profit maximizing, utility maximizing when preferences and environment are known) and this works the same way in Law & Economics. As long as people can be defined by their role in a given situation, their behaviours might be predictable and incentives might be given to reach regulators or scholars purpose. These so called roles are known as potential injurer, potential victim, criminal and so on. Thus the conclusions are relevant in the following frame: in a given situation, the potential injurer will either take care or not. 5.2. Neoclassical economics and legal design

Law & Economics use of neoclassical maximization makes sense to answer the following questions: what is the optimal level of care the potential injurer should bear to protect potential victims, at the lower costs, or what amount of fines do best prevent potential criminal to engage in criminal activities or Is prison deterrent? Yet it does not answer the fundamental anterior questions: What is a crime?, What should be legally protected or prevented? or Who is defined as a victim? The final aim of the Law, that can be defined as avoiding (and solving) conflicts between to persons as (and before) they occur, is not concerned by maximization and social welfare (since the final goal of social welfare has to be set arbitrarily). Neoclassical economics is efficient in L&E to balance benefits and costs of legal rules enforcement and application. It is relevant to improve (on a cost-effectiveness basis) already existing rules that arise because of existing conflicts among people but not to define rules.

6. Conclusion

Neoclassical and Austrian economics are not opposed and there is no need for scholars to choose between them. As a matter of fact, neoclassical methodology and its maximization come as a conclusion of the Austrian process of action. The great debate among neoclassical and Austrian economists can be solved once it is clear for them that they do not study the same step of the whole process of decision making, and thanks to this sequence, we are able to understand which method has to be used given the problem to solve. We claim economists should be aware of the economic sequence when debating on normative conclusions based on economic models, to avoid inefficient solutions and sterile arguments. 17

7. Further research issues in the field of Law & Economics

We have shown neoclassical conclusion on social welfare maximization are not relevant to cope with Law & Economics analysis as a whole. Our normative conclusion is that neoclassical analysis of law should be subordinated to legal scholars understanding of a legal phenomenon i.e. legal scholar finds out what law ought to be enforced (in the light of protecting individual ability to act) and neoclassical scholar has to draw models representing the effects of that law, to predict peoples response and to make the law efficient according to its purpose (revealing the incentives and adverse effects of the law, the costs of enforcements). We give two examples of the difficulties arising for Law & Economics scholars when dealing with neoclassical economics. We state that the use of transaction costs and the Coase theorem to design efficient law may lead to a new concept of justice defined only as economic efficiency. i) One important issue in economic analysis of tort law is causation. Causation remains very problematic for Law & Economics scholars, because the use of the Coase theorem leads to define the injurer as the least-cost avoider of a specific conflict, consequently the victim is defined as the injurer under certain circumstances. Here, the problem is clearly about the use of economic efficiency to design a rule. Using another criteria to define a good rule could allow scholars to overcome that problem. ii) Another important issue lies on economic analysis of property rights and more specifically on expropriation. Should state expropriation be allowed if it reduces transaction costs to provide any public good, given that a public good may increase social welfare?

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