The Role of Norms and Law in Economics: An Essay on Political Economy

Working Paper #461

Posted: 21 May 1998

See all articles by Kaushik Basu

Kaushik Basu

Cornell University - Department of Economics; IZA Institute of Labor Economics; Brookings Institution

Date Written: March 1998


The standard view of law in economics and related social sciences is that of a body of instructions or codes which changes the set of strategies open to an individual or the payoff function of the individual. If, for instance, the law does not permit emitting pollutants into the atmosphere, then the payoff that you would expect when you build a factory will be different from the payoff that you would expect in cases where there are no laws against pollution. In the former case you would have to subtract from the profit the expected cost of installing equipment for curbing pollution or of being caught and having to pay a penalty for emitting pollutants. Given that the payoff function and strategy sets are an integral part of a "game", the traditional view of law may be summarized as something that changes the game that citizens play.

This paper argues that this ubiquitous view of law is fundamentally flawed. It would be valid if the agents of the state--the tax collectors, the police and the judges--were exogenous to the game; that is, if they were like programmed robots carrying out the dictates of the law mechanically. In reality, those who work for the government are also individuals with their own motivations, strategies and payoffs. In brief, they are also players in the economy game. It is argued in this paper that once everybody, including the enforcers of the law, are included in the game, as they should be, a law is nothing but some ink on paper. There being or not being such ink cannot alter the game that the citizens play.

This does not mean that the law has no effect on society. One of the central theses of this paper is that the law does not affect the payoff functions of the players nor the game, but it can and does influence the outcome of the game. It does so by creating focal points, and by giving rise to beliefs and expectations in the minds of the individuals.

The paper begins by reviewing the meaning of social norms and the traditional view of law. It then presents the central thesis outlined above, and, finally, discusses its implications for related areas of research, such as the modeling of rights and liberty.

JEL Classification: K00

Suggested Citation

Basu, Kaushik, The Role of Norms and Law in Economics: An Essay on Political Economy (March 1998). Working Paper #461. Available at SSRN:

Kaushik Basu (Contact Author)

Cornell University - Department of Economics ( email )

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IZA Institute of Labor Economics

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Brookings Institution ( email )

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