How important is the internalization of values by citizens to the effectiveness of the state? Civic acts by citizens help the state to overcome potentially crippling agency problems. Law influences the behavior of citizens through expression, deterrence, and internalization. Distinguishing these effects shows the importance of each, and also shows why the state can express and deter more easily than it can induce citizens to internalize values. In a rational, self-interested theory of the internalization of values, people change their preferences to increase their opportunities for cooperation with others. Since officials have remote relationships with citizens in modern states, the state lacks the information needed to reward virtuous citizens. Instead of promoting civic virtue directly, the state must rely on families, friends, and colleagues to encourage civic virtue. To achieve this goal, the state must first align law with the social norms that facilitate private cooperation.

This article develops an economic theory of expressive law. By expressing social values, law can tip a system of social norms into a new equilibrium. This process can create or destroy a social norm without changing individual values. In addition, law can change the individual values of rational people. Internalizing a social norm is a moral commitment that attaches a psychological penalty to a forbidden act. A rational person internalizes a norm when commitment conveys an advantage relative to the original preferences and the changed preferences. I call such a commitment a Pareto self-improvement. By creating opportunities for Pareto self-improvements, law induces rational people to change their preferences. Inducing change in this way respects individual preferences, rather favoring a particular moral theory.

Sustained growth occurs in developing nations through improvements in markets and organizations. These entrepreneurial innovation resembles a biological mutation that is unpredictable before it occurs and understandable afterwards. It is unpredictable because it begins with the innovator possessing private information by which he earns extraordinary profits. It is understandable because its ends with the public figuring out the innovation and profits approaching the ordinary rate of return. These characteristics of innovation have important consequences for law and policy to foster economic growth. Specifically, government officials who rely on public information cannot predict which firms or industries will experience rapid growth. Consequently, industrial policies that promote growth are unlikely to succeed. Proponents of industrial policy today make the same mistake as the mercantilists whose interventions Adam Smith attacked as a cause of national poverty. In contrast, secure property and contract rights, and effective business law (especially the laws regulating financial markets), create conditions under which competition naturally produces entrepreneurial innovation and nations become rich.

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In civil disputes, the plaintiff must prove his case by the preponderance of the evidence. To reach this standard, the plaintiff accumulates evidence by combining facts. I compare two models of this process. Decision makers can adapt their behavior for improved results, as assumed in some psychological models. Adaptive models predict that court practice will allow the plaintiff to combine facts according to relatively simple rules. Alternatively, decision makers can optimize their behavior for best results, as assumed in most economic models. Optimization models predict that court practice will require the plaintiff to combine facts in ways that conform to the laws of probability theory. The two predictions contradict each other when simple, adaptive rules violate the laws of probability theory. I show that actual practice in a California court allows the plaintiff to combine facts according to relatively simple rules that sometimes violate the laws of probability theory. Adaptation is, consequently, a better descriptive theory than optimization. Procedures that violate the laws of probability theory, however, are vulnerable to withering criticism. Given that trials proceed with deliberate speed under expert guidance, suboptimal adaptations are irrational. Optimization, consequently, is a better normative theory than adaptation.

Some crimes involve the cooperation of two or more criminals for mutual gain. Instead of deterring these crimes, the state can prevent them by creating distrust among criminals. The state should offer amnesty and a bounty to the criminal who first secures punishment of the other participant in a cooperative crime. We especially focus on bribes, which occur when someone pays an agent to violate a duty owed to the principal. To prevent bribes, the principal offers amnesty and a bounty to the debtor or agent who secures the other party’s punishment. Under certain conditions, the game’s equilibrium changes from cooperation to non-cooperation (prisoner’s dilemma), so bribes disappear.

In recent years, ingenious entrepreneurs have invented new commodities by bundling contingent claims and marketing them. A liability right can be viewed as a contingent claim and analyzed like stock options or commodity futures. Since law prohibits markets for liability rights, no one knows how they would work. I assume no legal impediments to unbundling, packaging, and selling liability rights. I then predict how a competitive market would price liability rights. I use such an ideal market to critique the actual system of tort liability. Competition can solve many of the problems attributed by courts to contracts that reallocate tort liability.