But I Know it When I See it: An Economic Analysis of Vague Rules
31 Pages Posted: 1 May 2000
Date Written: January 2000
This paper focuses on the interaction between rules that are well defined and the evasions of those rules which are facilitated by their very precision. A vague rule reduces entrepreneurs' ability to erode the rule through loopholes by making it more difficult to predict what actions will be permitted ex post. However, because a vague rule creates uncertainty about which activities are prohibited and which ones are not, it causes a chilling effect on economic activity and introduces inefficiency into the legal system. The optimal amount of vagueness in a rule strikes a balance between the costs of loopholes, the chilling effect on economic activity, and the inefficency created in the legal system. A potential solution is for rules to be written that are relatively strict so as to offset the expected erosion from loopholes. This imposes costs that differ across entrepreneurs in proportion to their skill at creating loopholes. Vagueness is a substitute for strictness that limits the erosion of rules without disproportionately harming less skilled entrepreneurs. We show that an "Orwellian equilibrium" in which rules are both vague and overly strict maximizes social welfare.
JEL Classification: G18, K20, L50
Suggested Citation: Suggested Citation