Contract Law's Inefficiency

Abstract

Neoclassical economic theory seems to aptly characterize contract law’s essence. Contracts enable two parties to reach a mutually beneficial agreement, thereby facilitating economically efficient transactions. It would seem to follow that the achievement of economic efficiency serves as contract law’s major goal.This article, however, examines an alternative hypothesis, that contract law is about enforcing inefficient bargains in order to provide enough security to facilitate cooperation among economic actors over long periods of time. On this account, contract law manages change over time, rather than achieves static efficiency. While recognizing that parties execute contracts in order to realize an efficient exchange, this article argues that contract law exists largely to enforce bargains that have become inefficient over time. It argues that inefficient contract law performs important macroeconomic functions in stimulating economic growth. The analysis developing this tension between efficient contracting and inefficient contract law casts some doubt on a major rationale for making efficiency the dominant goal for contract law. It also adds an important dimension to the existing explanation of the scholarly literature’s many inconsistencies in conclusions about the efficiency of contract rules. Finally, it helps explains the major exceptions to the rule that courts enforce inefficient contracts found in doctrines of impossibility and impracticability. This article endorses an economic dynamic approach to contact law in light of the tension between efficient contracting and inefficient contract law and describes the components of an economic dynamic analysis rooted in institutional economics. It shows that some of our leading scholars have already tacitly employed this approach effectively to shed new light on contract law.