George Mason University SCHOOL of LAw The economies of tort law: A Precis Giuseppe Dari Mattiacci Francesco parisi 03-49 LAW AND ECONOMICS WORKING PAPER SERIES This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection http://ssrn.com/abstractid=458701
George Mason University SCHOOL of LAW The Economics of Tort Law: A Précis Giuseppe Dari Mattiacci Francesco Parisi 03-49 LAW AND ECONOMICS WORKING PAPER SERIES This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection: http://ssrn.com/abstract_id=458701
Giuseppe Dari Mattiacci-Francesco Parisi The economics of tort law a Precis ABSTRACT: Economic analysis has long been employed for the study of tort liability This paper revisits the main contributions to the subject emphasizing the inherent impossibility for tort liability to set perfectly efficient first-best incentives to take outcomes. The paper provides a pathfinder through the literature in various areas of tort law and economics The relatively simple structure of a tort problem provides one of the most fertile areas for the application of economic analysis to law. The positive economic theory of tort law maintains that the common law of torts is best explained as if judges are trying to promote efficient resource allocation, i.e maximize efficiency. The Coase (1960) theorem shows that if parties are allowed to tiate and transaction costs reallocated efficiently. In f tort acciden transaction costs are high. This is easily understood because the parties potentially involved in an accident are not easily identifiable ex ante, and the cost of acquiring the relevant information for bargaining can be high. This renders contractual arrangements a la Coase impracticable. In most tort situations the legal system thus needs to provide rules to give potential injurers and potential victims appropriate incentives to act as if they had to bear the total social cost of their activities. This is an important goal of tort law. Tort law is therefore justified when bargaining is not possible because high transaction costs are present, and banning an activity is undesirable given the social value of the risk-creating activity( Calabresi and Melamed, 1972)
1 Giuseppe Dari Mattiacci – Francesco Parisi The Economics of Tort Law: A Précis ABSTRACT: Economic analysis has long been employed for the study of tort liability. This paper revisits the main contributions to the subject emphasizing the inherent impossibility for tort liability to set perfectly efficient first-best incentives to take precaution for all parties to an accident and the need to choose among second best outcomes. The paper provides a pathfinder through the literature in various areas of tort law and economics. The relatively simple structure of a tort problem provides one of the most fertile areas for the application of economic analysis to law. The positive economic theory of tort law maintains that the common law of torts is best explained as if judges are trying to promote efficient resource allocation, i.e., maximize efficiency. The Coase (1960) theorem shows that if parties are allowed to negotiate and transaction costs are sufficiently low, legal entitlements will be reallocated efficiently. In the case of tort accidents, transaction costs are high. This is easily understood because the parties potentially involved in an accident are not easily identifiable ex ante, and the cost of acquiring the relevant information for bargaining can be high. This renders contractual arrangements à la Coase impracticable. In most tort situations the legal system thus needs to provide rules to give potential injurers and potential victims appropriate incentives to act as if they had to bear the total social cost of their activities. This is an important goal of tort law. Tort law is therefore justified when bargaining is not possible because high transaction costs are present, and banning an activity is undesirable given the social value of the risk-creating activity (Calabresi and Melamed, 1972)
In order to create optimal incentives, liability rules need to induce parties to minimize the total social cost of accidents The relevant variables for this tort problem are the cost of accidents, the cost of accident avoidance(precaution) and the administrative costs of the justice system. Every legal system chooses from various liability rules(e.g, negligence, strict liability, etc. )and safety standards to minimize the overall cost of accidents The goals of tort law A first intuitive end of tort law is to compensate the victims for losses due to accidents. This is indeed an important task of tort adjudication but is not the central issue concerning the design of tort rules. It has been shown that tort law is a very expensive means of compensating harms, because it involves high dministrative cost due to the functioning of the judicial system. Insurance, to the contrary, is a much cheaper and quicker system(Shavell, 1987, at 263 ):if the only goal were to compensate victims, first-party insurance would be preferable over tort liability. Moreover, the cost of insurance can be paid by the potential injurers, shared among potential victims or financed by taxpayers, in order to redistribute the costs(McEwin, 2000) On the contrary, economic analysis suggests that the primary reason fo utilizing the tort system is to allow risk-creating activities to be carried out only if the social value of the activity justifies the risk created. This balancing of costs and benefits is currently endorsed by North American tort doctrine and is clearly summarized by the Restatement( Second)of Torts$ 291:"Where an act is one which a reasonable man would recognize as involving a risk of harm to another, the risk is unreasonable and the act negligent if the risk is of such magnitude as to outweigh what the law regards as the utility of the act or of the
2 In order to create optimal incentives, liability rules need to induce parties to minimize the total social cost of accidents. The relevant variables for this tort problem are the cost of accidents, the cost of accident avoidance (precaution), and the administrative costs of the justice system. Every legal system chooses from various liability rules (e.g., negligence, strict liability, etc.) and safety standards to minimize the overall cost of accidents. 1. The goals of tort law A first intuitive end of tort law is to compensate the victims for losses due to accidents. This is indeed an important task of tort adjudication but is not the central issue concerning the design of tort rules. It has been shown that tort law is a very expensive means of compensating harms, because it involves high administrative cost due to the functioning of the judicial system. Insurance, to the contrary, is a much cheaper and quicker system (Shavell, 1987, at 263): if the only goal were to compensate victims, first-party insurance would be preferable over tort liability. Moreover, the cost of insurance can be paid by the potential injurers, shared among potential victims or financed by taxpayers, in order to redistribute the costs (McEwin, 2000). On the contrary, economic analysis suggests that the primary reason for utilizing the tort system is to allow risk-creating activities to be carried out only if the social value of the activity justifies the risk created. This balancing of costs and benefits is currently endorsed by North American tort doctrine and is clearly summarized by the Restatement (Second) of Torts § 291: “Where an act is one which a reasonable man would recognize as involving a risk of harm to another, the risk is unreasonable and the act negligent if the risk is of such magnitude as to outweigh what the law regards as the utility of the act or of the
particular manner in which it was done(The Restatement(Second)of Torts SS 292 and 293, indicate the criteria for verifying utility of conduct and magnitude of risk.) More specifically, economic analysis suggests that tort law should be designed in such a way as to provide potential injurers and victims with appropriate incentives to avoid the accident by internalizing the externalities created by their activities. In the absence of tort liability, potential tortfeasors would bear the private cost of their precaution without internalizing any of the enefits thereof. The benefits(of precaution) are external with respect to the decision(on how much precaution). This would lead to suboptimal levels of sive accident rates. Through tort liability, a potential tortfeasor internalizes the benefits of his precaution, that is, the re liability. Tort should thus be designed to induce parties to internalize external costs of their activities and to adopt optimal levels of precaution In addition, tort law gives parties incentives to acquire information about the accident. With respect to risk, the tort law system should enhance an optimal allocation of the risk between victim and injurer, but this goal can be reached via insurance. With respect to transaction costs, the goal of the tort law system is to minimize the administrative cost associated with the functioning of the system itself(mainly the costs of courts and lawyers and the indirect costs borne by litigants. Calabresi(1970) presented the first formulation of the ends of liability in those terms, while Brown(1973) formalized an economic model of accidents. We will focus on incentives toward optimal precaution and discuss the other
3 particular manner in which it was done” (The Restatement (Second) of Torts §§ 292 and 293, indicate the criteria for verifying utility of conduct and magnitude of risk.) More specifically, economic analysis suggests that tort law should be designed in such a way as to provide potential injurers and victims with appropriate incentives to avoid the accident by internalizing the externalities created by their activities. In the absence of tort liability, potential tortfeasors would bear the private cost of their precaution without internalizing any of the benefits thereof. The benefits (of precaution) are external with respect to the decision (on how much precaution). This would lead to suboptimal levels of care and excessive accident rates. Through tort liability, a potential tortfeasor internalizes the benefits of his precaution, that is, the reduction in expected liability. Tort rules should thus be designed to induce parties to internalize the external costs of their activities and to adopt optimal levels of precaution. In addition, tort law gives parties incentives to acquire information about the accident. With respect to risk, the tort law system should enhance an optimal allocation of the risk between victim and injurer, but this goal can be reached via insurance. With respect to transaction costs, the goal of the tort law system is to minimize the administrative cost associated with the functioning of the system itself (mainly the costs of courts and lawyers and the indirect costs borne by litigants). Calabresi (1970) presented the first formulation of the ends of liability in those terms, while Brown (1973) formalized an economic model of accidents. We will focus on incentives toward optimal precaution and discuss the other aspects aside
2. A taxonomy of liability rules There are several ways in which legal systems can apportion liability between parties. Historically, a broad variety of liability rules has been developed by legal systems. Most early legal systems adopted liability rules that did not depend on the fault of the tortfeasor. This feature of early legal systems has been explained as instrumental to promoting appeasement between the parties and to avoiding cumbersome and controversial ascertainment of the subjective elements of a tort(Parisi, 1992 and 2001). Gradually, legal systems began to recognize fault as a viable basis for liability and in modern legal regimes strict liability is seen as an exception to the norm. Liability for accidents should arise only in the case of tortfeasor fault (including both negligent and intentional wrongdoing) We shall proceed with the presentation of some of the most common liability rules, starting from strict liability to simple negligence and more complex legal regimes. In our analysis we shall utilize the conventional terminology by which the injurer is defined as the individual who does not suffer harm in an accident and the victim as the individual who suffers such harm. In this survey, we shall focus on two-party accident There are two fundamental possibilities in a two-party accident The first occurs when both parties have to take precaution in order to avoid the accident (bilateral precaution). The second is given by situations in which either party ident(alternative precaution) In the second case, there is a waste of precaution cost if both parties take precaution, since one party's precaution would have been already enough. A particular and common case of alternative precaution is unilateral precaution As in alternative precaution, one party's precaution is enough to prevent the
4 2. A taxonomy of liability rules. There are several ways in which legal systems can apportion liability between parties. Historically, a broad variety of liability rules has been developed by legal systems. Most early legal systems adopted liability rules that did not depend on the fault of the tortfeasor. This feature of early legal systems has been explained as instrumental to promoting appeasement between the parties and to avoiding cumbersome and controversial ascertainment of the subjective elements of a tort (Parisi, 1992 and 2001). Gradually, legal systems began to recognize fault as a viable basis for liability and in modern legal regimes strict liability is seen as an exception to the norm. Liability for accidents should arise only in the case of tortfeasor fault (including both negligent and intentional wrongdoing). We shall proceed with the presentation of some of the most common liability rules, starting from strict liability to simple negligence and more complex legal regimes. In our analysis we shall utilize the conventional terminology by which the injurer is defined as the individual who does not suffer harm in an accident and the victim as the individual who suffers such harm. In this survey, we shall focus on two-party accidents. There are two fundamental possibilities in a two-party accident. The first occurs when both parties have to take precaution in order to avoid the accident (bilateral precaution). The second is given by situations in which either party can take precaution and successfully avoid an accident (alternative precaution). In the second case, there is a waste of precaution cost if both parties take precaution, since one party’s precaution would have been already enough. A particular and common case of alternative precaution is unilateral precaution. As in alternative precaution, one party’s precaution is enough to prevent the