But I Know it When I See it: An Economic Analysis of Vague Rules

31 Pages Posted: 1 May 2000

See all articles by Michael F. Ferguson

Michael F. Ferguson

University of Cincinnati - Department of Finance - Real Estate

Stephen R. Peters

Kansas State University - Department of Finance

Date Written: January 2000

Abstract

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

Ferguson, Michael F. and Peters, Stephen R., But I Know it When I See it: An Economic Analysis of Vague Rules (January 2000). Available at SSRN: https://ssrn.com/abstract=218968 or http://dx.doi.org/10.2139/ssrn.218968

Michael F. Ferguson (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business Administration
Cincinnati, OH 45221
United States
513-556-7080 (Phone)

Stephen R. Peters

Kansas State University - Department of Finance ( email )

Manhattan, KS 66506
United States

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