Bryan Caplan  

Binding Arbitration: The Radical Implications

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Contracts often require signatories to submit to binding arbitration.  If a dispute arises, the parties don't go to court; they go to a private arbitrator.  This arbitrator, in turn, makes a definitive ruling neither party can refuse.  The whole point of binding arbitration is to bar parties from playing, "Heads I win, tails I break even": If the arbitrator rules against you, you can't appeal the decision to a conventional government court.

Binding arbitration has thrived in recent decades.  But on reflection, fully binding arbitration would nullify a vast swath of regulation.  Every government effort to shift the terms of trade would be in grave danger.  Imagine, for example, an employment contract specifying that alleged minimum wage violations will be resolved via binding arbitration.  Any employer who wanted to offer less than the minimum wage could contractually specify an arbitrator who invariably rules in his favor.  And any worker ready to work for less than the minimum wage would willingly sign.  After all, what's the difference between the absence of a minimum wage and a minimum wage that's never enforced?

The same principle applies to all regulation of capitalist acts between consenting adults: safety regulations, discrimination laws, product liability, and so on.  Want to work for me?  Fine, as long as my brother adjudicates all our disputes.  Parties who can contractually outsource enforcement to anyone they like can informally gut the law.

So why hasn't this already happened?  Transactions costs are part of the reason; getting every trading partner to sign a contract is a pain in the neck.  But the fundamental reason is that governments refuse to recognize fully binding arbitration - probably because its officials recognize, at least subconsciously, that fully binding arbitration would strip them of much of their power.  The Legal Dictionary explains:
The FAA gives only four grounds on which a court may vacate, or overturn, an award: (1) where the award is the result of corruption, Fraud, or undue means; (2) where the arbitrators were evidently partial or corrupt; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing or hear pertinent evidence, or where their misbehavior prejudiced the rights of any party; and (4) where the arbitrators exceeded their powers or imperfectly executed them so that a mutual, final, and definite award was not made. In the 1953 case Wilkov. Swan... the U.S. Supreme Court suggested, in passing, that an award may be set aside if it is in "manifest disregard of the law," and federal courts have sometimes followed this principle. Public policy can also be grounds for vacating, but this recourse is severely limited to well-defined policy based on legal precedent, a rule emphasized by the Supreme Court in the 1987 case United Paperworkers International Union v. Misco...
The Legal Dictionary's tone suggests that these are but mild impediments.  But they're huge.  If the government can overrule binding arbitration because the arbitrators are "partial" or "manifestly disregard the law," arbitration's radical potential stays hidden. 

Long ago, I interviewed the CEO of an arbitration firm.  When I asked him about the radical implications of binding arbitration, he got nervous.  His words were libertarian: "If you don't like the arbitration contract, don't sign."  But he clearly wanted to change the subject.  One of his key services was helping clients skirt the law - and the best way to continue providing such services was to pretend they didn't exist.  I suppose I could have thanked him for mitigating the harm of a multitude of unjust and inefficient laws, but I think that just would have spooked him further.

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COMMENTS (14 to date)
Joe Munson writes:

At risk of being nit picky, why confine contract rights/all capitalist acts to "consenting adults?

Obviously, a three year old should not be held accountable for contracts, but what about a 17 year and 364 day old person with an Iq of a 150?

Being heavily restricted in making legal contracts is a minor annoyance when you have good parents; it is a potentially lethal (and certainly extremely unpleasant reality) when you have terrible parents, or the state acts as your parent (usually by outsourcing the role to slightly less terrible but still terrible parents).

Antoine Goas writes:

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Pajser writes:

It would be surprising that state tolerates breaking of the law, no matter what arbitrator said, and whether one signed contract that he will respect arbitrator's decision or not. It is too big hole not to see it immediately. Like not seeing the possibility that someone could throw your ring in volcano.

Daniel Klein writes:

I believe Charles Murray propounded the idea, or something similar, in What It Means to be a Libertarian.

Peter H writes:

I strongly dislike mandatory binding arbitration, on what I believe to be libertarian grounds.

In particular, arbitration does not avoid the government, but rather conscripts the government into the enforcement of its rulings, even where those rulings may be contrary to other generally applicable law.

When you win an arbitration award, and the other party does not satisfy it, you then go to government court for enforcement. The government court will start issuing orders allowing (for example) government sheriffs to come seize your house.

I think it is fully proper within the confines of libertarian principles to constrain the manner in which judgments can be obtained which the government will forcibly enforce. It is for instance fully reasonable to require due process of law before allowing seizure of property by the government, which is why the 5th amendment protects that right.

adam writes:

Your focus on binding arbitration misses the mark. Minimum wage laws (like the other regulations you cite) are rarely enforced by the employee in the context of a dispute with the employer. They are enforced by a third party, i.e. a government agency that is not party to the binding arbitration agreement and who doesn't care if the employee is happy or not happy with the agreement.

Thaomas writes:

How does binding arbitration get around minimum wage laws? Arbitration involves disputes. Where is the dispute if a wage lower than the legal minimum is paid.

Patrick writes:

Isn't minimum wage law a criminal regulation that would be enforced by a criminal prosecutor rather than the two parties involved in the contract like a tort?

Ralph writes:

I wrote about this for a law school exam. The question asked how you would deal with the problem of "repeat players" - where arbitrators had a systematic bias in favor of the companies who repeatedly employed them.

I wrote that that "systematic bias" might actually be a feature, not a bug. Arbitration lets consumers avoid paying for the extra crap that regulation forces on them.

My prof hated it.

Stephen Ware writes:

I am a (and I think the only) libertarian law professor in the US who has long specialized in arbitration law.

Bryan Caplan is correct in his basic insight: "Parties who can contractually outsource enforcement to anyone they like can informally gut the law" and his belief that current law does not fully allow this. This insight captivated me in the 1990's and led to me to write an article elaborating it. It is Default Rules from Mandatory Rules: Privatizing Law Through Arbitration

Related articles are
Is Adjudication a Public Good?: 'Overcrowded Courts' and the Private-Sector Alternative of Arbitration
Vacating Legally-Erroneous Arbitration Awards

Anonymous writes:

I think Robin Hanson's proposed pragmatic approach to increasing the scope of private arbitration is definitely worth mentioning here.

Silas Barta writes:

It's my understanding that these agreements can never override the relevant regulations, no matter how much either party consents. If the minimum wage is $15 dollars/hour, and your contract says $10/hour, every worker still has the right to $15 and can appeal to government courts to secure it, regardless of how hard they promise not to.

This has come up in the Uber driver issue, where Uber will insist it contracted with the drivers to pay them $X per whatever, and the workers can still come back and say, "hey, that made us into an employer/employee relationship, which obligates you to give us this things ..."

It *is* kind of absurd, in its own way: "help, he keeps underpaying me!" "But you knew what the payment was ..."

Anyone know to what extent my understanding is wrong here?

Steve Brecher writes:

Joe Munson wrote about, e.g., 17 year olds:
"Being heavily restricted in making legal contracts is a minor annoyance ... [emphasis added]"

Well done!

P G writes:

Even putting aside the issue of minimum wage being enforced by a third party not subject to the arbitration clause (the regulator), I was under the impression that a contract that breaks the law in not a valid contract. It seems to me that the binding arbitration clauses would probably bind on the interpretation of the contract, but you could still litigate on the validity of the contract, and illegal contracts would be voided.

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