Weinberg on the Economics and History of Commercial Paper

The University of Kentucky College of Law, has posted some of its faculty’s backlist.  Here is one by Harold R. Weinberg that originally appeared in volume 70 of the Kentucky Law Journal in 1982, entitled Commercial Paper in Economic Theory and Legal History:

Commercial-paper played a significant role in antebellum America by partially filling the void resulting from the shortage of gold and silver coinage and the absence of a reliable paper currency. Although most legal historians would agree with this premise, a controversy has arisen in recent years concerning negotiability, that collection of legal rules which greatly enhanced the usefulness of bills of exchange and promissory notes in commerce and finance.

Many scholars believe that negotiability, along with other pre-Civil War legal doctrines, was intended to facilitate the development of a national market system and economic growth. This view typically holds that courts acted with the general approval of society and either ignores any major wealth redistributive consequences of these developments or assumes that such consequences were unanticipated.

A very different view of the rise of commercial paper negotiability during 1780-1860 has been advanced by Morton Horwitz. In The Transformation of American Law he argues that American judges developed negotiability primarily to protect mercantile and entrepreneurial minorities that stood to gain from an expanding market economy. This was accomplished at the expense of persons possessing a pre- or anti-commercial consciousness. The sweeping transformation described by Horwitz, which was also reflected in property, contract, and other areas of law, was one in which enterprise was subsidized and protected while farmers, workers, consumers, and less powerful groups were increasingly disadvantaged.

This controversy among legal historians bears an illuminating relationship to the work of other analysts who have sought to employ economic tools to advance the understanding of legal doctrine. Numerous studies of common law rules, including many relating to the branches of law discussed by Horwitz, suggest that judge-made law can be understood "as if" it were the product of judges who sought to maximize social wealth by utilizing a criterion of economic efficiency. This conclusion is obviously at variance with the Horwitzian view of antebellum legal history. It must also be unsatisfactory to historians whose training does not permit them to be satisfied with "as if" explanations, but which requires them to ask why common law rules approximate an efficient allocation of resources.

Analysts have begun to explore two lines of explanation for the emergence of efficient case law. “Visible hand” theories postulate the existence of judges who sought to announce efficient doctrine. “Invisible hand” theories, on the other hand, do not depend on judicial motivations. They hold, for example, that the costs imposed by an inefficient rule create an incentive for litigants to expend resources in order to obtain the rule's modification or reversal. Efficient legal doctrine might therefore have evolved even if judges were indifferent to or biased against efficiency as a decisional criterion.

Parts I and II of this article seek to advance the inquiry into the significance of commercial paper in legal history by presenting a positive economic analysis of some of the decision rules that were important to commercial paper negotiability. It is hoped that this theory might be of use to historical studies of the allocative, distributive, or other characteristics of the judicially created negotiability doctrine applied prior to the Civil War. The article's conclusion offers some suggestions concerning how this inquiry might be further advanced. It is also hoped that this analysis will have relevance to modern commercial paper law, much of which closely resembles the rules applied by nineteenth century judges.