0. Econ 522 Economics of Law
Dan Quint
Spring 2017
Lecture 20

1. Announcements HW3 grades are up, MT2 will be returned next week
HW4 is up online, due Thurs April 27 at midnight
No office hours Monday
Rest of the semester
Today: wrap up tort law
Next week: two days on criminal law
Week after (Apr 24 and 26): behavioral law and econ; revisiting efficiency and wrapping up
Mon May 1: I’ll solve sample exam problems
Wed May 3: no class, lots of extra office hours
Sun May 7: final exam (10:05 a.m., Van Vleck B102)
Midterm 2 grades should be up in the next couple days 1 1

2. Something to think about
I assume everyone knows about the doctor who got kicked off the overbooked United flight a few days ago
Ticket agreement clearly stated United had a right to do this
Passenger refused to get off, everyone seemed pretty outraged that he was forced to
From Marginal Revolution:
“…Due to social media it will be increasingly difficult to write and enforce retail contracts with legal meanings very different from their “common sense” meanings. Maybe I’ll write a separate post on whether that will raise or lower transactions costs, but I suspect a bit of both.” 2 2

3. A quick experiment

4. A couple variations on liability4 4

5. Vicarious Liability
Vicarious liability is when one person is held liable for harm caused by another
Parents may be liable for harm caused by their child
Employer may be liable for harm caused by employee
Respondeat superior – “let the master answer”
Employer is liable for torts of employee if employee was acting within the scope of his employment
These are instances when someone is held responsible for harm caused by someone else
One example of this is parents being held liable for harm caused by their child
The most common version, however, is an employer being held liable for harm caused by an employee
The legal doctrine is referred to as respondeat superior, “let the master answer”
Roughly, an employer will be held liable for unintentional torts of his employees if the employee was acting within the scope of his employment
For example, I hire someone to deliver packages in a company truck
If he speeds on his delivery route and causes an accident; I am held liable
But if I hire someone to deliver packages and he goes quail hunting during his lunch break and shoots another hunter, I am not liable
He was not acting within the scope of his employment when he caused the accident
(It might have been before your time, but from 1979 to 1993, Domino’s had a thirty-minutes-or-less guarantee or your pizza was free. In the early 1990s, a couple of car accidents caused by speeding delivery drivers led to multi-million-dollar lawsuits against Domino’s and that was the end of the guarantee.)

6. Vicarious Liability Gives employers incentive to...
be more careful who they hire
be more careful what they assign employees to do
supervise employees more carefully
Employers may be better able to make these decisions than employees…
…and employees may be judgment-proof
A rule of respondeat superior gives employers incentives to take greater care in who they hire, and what they assign them to do
If employers are better positioned to make these decisions than employees, this may result in greater efficiency
Also, employees might have less money, and therefore be judgment-proof
Respondeat superior gives the employer an incentive to keep an eye on his employees and make sure they are behaving responsibly

7. Vicarious Liability Vicarious liability can be implemented through…
Strict liability rule: employer liable for any harm caused by employee (as long as employee was acting within scope of employment)
Negligence rule: employer is only liable if employer was negligent in supervising employee
Which is better? It depends.
If proving negligent supervision is too hard, strict vicarious liability might work better
But an example favoring negligent vicarious liability…
Vicarious liability can be implemented through either a strict liability or a negligence rule.
Under negligent vicarious liability, the employer is only liable if the employer was negligent in supervising the employee
Which rule is better depends on the situation.
Proving negligence is always harder than just proving harm and causation
If proving negligent supervision is too hard, then a rule of vicarious liability is worthless, since it will never be successfully applied.
The book gives the example of a negligent nurse in a hospital
Proving the hospital was negligent in supervising the nurse adequately might be nearly impossible
So negligent vicarious liability would lead to no incentives for the hospital to supervise its staff properly
Strict vicarious liability would lead the hospital to reduce accidents.
For an example favoring a negligence rule, the book gives the following example:
“A sailor on a tanker might negligently discharge oil onto a public beach at night.
Informing authorities quickly will reduce the resulting harm and the cost of cleanup.
The employer might be the only person besides the sailor who knows that the harm occurred or who can prove that pollution came from its ship.
Strict vicarious liability gives the employer an incentive to remain silent in the hope of escaping detection.
In contrast, a rule of negligent vicarious liability gives the employer an incentive to reveal the harm to the authorities immediately in order to show that it carefully monitors its sailors.”

8. Joint and Several Liability
Suppose you were harmed by accident caused by two injurers
Joint liability: you can sue them both together
Several liability: you can sue each one separately
Several liability with contribution: each is only liable for his share of damage
Joint and several liability: you can sue either one for the full amount of the harm
Joint and several liability with contribution: the one you sued could then sue his friend to get back half his money
Suppose that you are injured in an accident caused by two injurers
For example, a friend and I are drag-racing our cars, and one of us hits you
Suppose the total harm done is $1,000
We are jointly liable if you can sue both of us at once, naming us as co-defendants and recovering $1,000 from us together
We are severally liable if you can sue each of us separately
Several liability with contribution is when each of us is only liable for a share of the damage, or your total recoveries are limited to the total harm done
Several liability without contribution would be if you could sue us each separately for the full $1000, but this is generally not allowed
We are jointly and severally liable if you can sue either one of us for the full amount of damages, $1,000
With contribution would mean that if you sued me and won $1,000, I could then sue my friend to pay me back his share of it.

9. Joint and Several Liability
Joint and several liability holds under common law when…
Defendants acted together to cause the harm, or…
Harm was indivisible (impossible to tell who was at fault)
Good for the victim, because…
No need to prove exactly who caused harm
Greater chance of collecting full level of damages
Instead of suing person most responsible, could sue person most likely to be able to pay
Joint and several liability holds under the common law when the defendants acted together to cause the harm,
Or when the harm was indivisible, that is, it’s impossible to tell who was actually at fault. (For example, the two hunters simultaneously shoot the third guy.)
There are several advantages to joint and several liability from the victim’s point of view.
First, the victim does not need to prove exactly who caused the harm.
The book gives the example of an anesthetized patient being injured during an operation
Under joint and several liability, he or she could sue anyone in the operating room at the time
Which is good, since the patient would have no idea what had happened while he was unconscious
Joint and several liability also increases the victim’s chances of collecting the full level of damages
This is because instead of going after the person most directly responsible for the harm, he can go after the person most likely to be able to pay, that is, the one with the deep pockets.
For example, suppose an uninsured drunk driver blows a stop sign and hits you.
You claim that the driver and the state highway department are jointly responsible
the driver for being drunk and hitting you
the highway department because the stop sign was not placed in the right location or did not use proper reflective paint.
Under joint and several liability, you need only convince the court that the state was 1% responsible, then you could still recover 100% of damages from the state
leaving the state to try to recover the other 99% from the driver
(Cooter and Ulen seem to push this as a good thing; others argue this as a negative. It’s clearly good for the victim, though.)

10. Punitive damages

11. Inconsistency of damages
Damage awards vary greatly across countries, even across individual cases
We saw last week:
As long as damages are correct on average, random inconsistency doesn’t affect incentives (under either strict liability or negligence)
But, if appropriate level of damages isn’t well-established, more incentive to spend more fighting
Cooter and Ulen also go on for a while about the inconsistency of damages – across countries, and even across similar accidents within a country.
As we saw last week, as long as damage awards are correct on average, random inconsistency won’t have much effect on precaution, under either a strict liability or a negligence rule.
However, aside from fairness, there are other costs associated with this inconsistency
Since the appropriate level of damages is not well-established, there is more incentive to spend more resources fighting for higher damages.

12. One problem with inconsistent damages: more incentive to fight hard
Example: each side can hire cheap lawyer or expensive lawyer
Cheap lawyer costs $10, expensive lawyer costs $45
If two lawyers are equally good, expected judgment is $100
If one is better, expected judgment is doubled or halved
Defendant
Cheap
Expensive
90, -110
40, -95
Cheap Lawyer
Plaintiff
155, -210
55, -145
Expensive Lawyer

13. Punitive damages What we’ve discussed so far: compensatory damages
Meant to “make victim whole”/compensate for actual damage done
In addition, courts sometimes award punitive damages
Additional damages meant to punish injurer
Create stronger incentive to avoid initial harm
Punitive damages generally not awarded for innocent mistakes, but may be used when injurer’s behavior was
“malicious, oppressive, gross, willful and wanton, or fraudulent”
What we’ve been talking about so far is compensatory damages – damages which are meant to “make the victim whole,” or to compensate for the damage actually done
In addition to this, courts will sometimes award punitive damages – additional damages intended solely to punish the injurer, in order to create a stronger incentive to avoid the harm initially
Most states have a rule for when punitive damages may be awarded
Punitive damages are generally not awarded for innocent mistakes; as a general rule, they are considered when the injurer’s behavior is
“malicious, oppressive, gross, willful and wanton, or fraudulent”

14. Punitive damages
Calculation of punitive damages even less well-defined than compensatory damages
Level of punitive damages supposed to bear “reasonable relationship” to level of compensatory damages
Not clear exactly what this means
U.S. Supreme Court: punitive damages more than ten times compensatory damages will attract “close scrutiny,” but not explicitly prohibited
How punitive damages are calculated – both how they should be, and how they actually are – is even murkier than compensatory damages, and therefore subject to even more uncertainty and inconsistency
They are supposed to bear a “reasonable relationship” to the level of compensatory damages, but “reasonable” has never been precisely quantified
The U.S. Supreme Court has held that punitive damages more than 10 times compensatory damages will attract “close scrutiny” as possibly being too high, but doesn’t explicitly rule them out.

15. Example of punitive damages: Liebeck v McDonalds (1994) (“the coffee cup case”)
Stella Liebeck was badly burned when she spilled a cup of McDonalds coffee in her lap
Awarded $160,000 in compensatory damages…
…plus $2.9 million in punitive damages
Case became “poster child” for excessive damages, but…
Many people have heard of the “coffee cup case”, Liebeck v McDonalds
a 1994 case where a woman who was burned when she spilled a cup of McDonalds coffee in her lap
she was awarded $160,000 in compensatory damages, and an additional $2.9 million in punitive damages.
This is often held up as the “poster child” for excessive damages, although the actual facts of the case give a different picture.

16. Liebeck v McDonalds (1994)
Stella Liebeck dumped coffee in her lap while adding cream/sugar
Third degree burns, 8 days in hospital, skin grafts, 2 years treatment
Initially sued for $20,000, mostly for medical costs
McDonalds offered to settle for $800
McDonalds serves coffee at degrees
At 180 degrees, coffee can cause a third-degree burn requiring skin grafts in seconds
Lower temperature would increase length of exposure necessary
McDonalds had received 700 prior complaints of burns, and had settled with some of the victims
Quality control manager testified that 700 complaints, given how many cups of coffee McDonalds serves, was not sufficient for McDonalds to reexamine practices
Stella Liebeck bought coffee at a McDonalds drive-through, then parked to add cream and sugar
When she took the lid off, she dumped the cup on her lap; the coffee soaked into her sweatpants and was held against her skin for 90 seconds, giving her third degree burns
She was in the hospital for 8 days, and required skin grafts; after that, she had two years of treatment.
She initially sued McDonalds for $20,000, mostly to cover $11,000 in medical costs
They offered $800
She hired a lawyer, and sued for more
McDonalds refused a number of offers to settle.
At trial, it was revealed that McDonalds serves coffee at degrees.
Liebeck’s lawyers presented evidence that at 180 degrees, coffee can cause a third-degree burn requiring skin grafts in seconds
They claimed that lowering the temperature would increase the length of exposure required for severe burns, giving the victim time to deal with the spill.
McDonalds, it turned out, had received 700 prior complaints of burns, and had settled with some of the victims.
The quality control manager for McDonalds testified that the number of injuries (given how many cups of coffee McDonalds served) was not sufficient to cause McDonalds to reexamine its practices.

17. Liebeck v McDonalds (1994) Rule in place was comparative negligence
Jury found both parties negligent, McDonalds 80% responsible
Calculated compensatory damages of $200,000
times 80% gives $160,000
Added $2.9 million in punitive damages
Judge reduced punitive damages to 3X compensatory, making total damages $640,000
During appeal, parties settled out of court for some smaller amount
Jury seemed to be using punitive damages to punish McDonalds for being arrogant and uncaring
The jury used comparative negligence, and found McDonalds 80% responsible for the injury
They calculated compensatory damages as $200,000, which they reduced to $160,000
And they added $2.9 million in punitive damages
The judge reduced the punitive damages to three times compensatory damages, making the total award $640,000
during appeal, the parties settled out of court for some amount less than that.
In this case, the jury seemed to be using punitive damages to punish McDonalds for being arrogant and uncaring. (The quality control guy from McDonalds was apparently a complete jerk on the stand.)

18. What is the economic purpose of punitive damages?
We’ve said all along: with perfect compensation, incentives for injurer are set correctly. So why punitive damages?
Example…
Suppose manufacturer can eliminate 10 accidents a year, each causing $1,000 in damages, for $7,000
Clearly efficient
If every accident victim would sue and win, company has incentive to take this precaution
But if some won’t, then not enough incentive
Suppose only half the victims will bring successful lawsuits
Compensatory damages would be $5,000; company is better off paying that then taking efficient precaution
One way to fix this: award higher damages in the cases that are brought
We’ve noted all along that when compensatory damages are perfect, incentives for precaution are set correctly. So what is the purpose of punitive damages?
Cooter and Ulen give one economic justification
They give the example of a manufacturer who can spend $7000 in quality control to eliminate 10 accidents a year, each causing $1000 worth of damage
Clearly, this is efficient precaution, and therefore desirable.
If every accident victim will bring a lawsuit and receive damages, the company has an incentive to spend the money
However, if some of the victims will not – because they aren’t award of what caused the accident, or can’t prove it – then there is not a sufficient incentive to take precaution.
Suppose half the victims will bring successful lawsuits. Compensatory damages in these cases would total $5000; the company is better off paying this than taking efficient precaution.
One way to fix this is to increase damages when they are awarded
We pointed out before Thanksgiving that a rule which randomly threw out half the cases brought, and doubled the damages in the other ones, would give the same incentives for precaution
Here, the logic is the same. Punitive damages can be added to compensatory damages to correct for the fact that not every victim will successfully sue; done right, this restores efficient incentives for precaution.

19. This suggests…
Punitive damages should be related to compensatory damages, but higher the more likely injurer is to “get away with it”
If 50% of accidents will lead to successful lawsuits, total damages should be 2 X harm
Which requires punitive damages = compensatory damages
If 10% of accidents lead to awards, damages should be 10 X harm
So punitive damages should be 9 X compensatory damages
Seems most appropriate when injurer’s actions were deliberately fraudulent, since may have been based on cost-benefit analysis of chance of being caught
This suggests punitive damages should be related to compensatory damages, but higher the more likely the injurer is to “get away with it”
If the probability of being successfully sued is 1/10, then total damages should be ten times the actual harm done, in order to create the right incentive; this requires punitive damages 9 times as great as compensatory damages.
This sort of logic seems most appropriate when the injurer’s actions were deliberately fraudulent, since they may have been based on a cost-benefit analysis of the likelihood of getting caught
Allowing punitive damages in these cases again causes the injurer to internalize the expected costs of his actions.
Historically, punitive damages have always been paid to the victim, which seems arbitrary
victim is already being made whole by compensatory damages
creates a much greater incentive to sue – accidents become jackpots
some states now have laws that a share of punitive damages goes to the state
this creates its own set of issues, since the state now has a vested interest in victims being awarded punitive damages!
In terms of setting the injurer’s incentives (or “punishing” him after the fact), it doesn’t matter where the money goes – setting it on fire would achieve those purposes
But would obviously be inefficient…

20. How should we think about the legal process itself?20 20

21. Over the last three months, we have…
Developed theories of property/nuisance law, contract law, and tort law
Looked at how rules of legal liability create incentives
Thought about how these rules can be chosen to try to achieve efficient outcomes
Over the last two months or so, we’ve
developed theories of property and nuisance law, contract law, and tort law
we’ve looked at how rules of legal liability create incentives
and thought about how these rules can be chosen to achieve efficient, or close to efficient, results

22. We’ve been thinking of normative goal of minimizing social costs
Property law
Goal was to allocate resources/entitlements efficiently…
…or, to minimize inefficiencies due to misallocation
Contract law
Goal was to further facilitate trade…
…or, to decrease inefficiencies due to unrealized Kaldor-Hicks improvements
Tort law
Goal was explicitly to minimize social costs…
…which consist of cost of accidents plus cost of precaution

23. Implicitly, we’ve generally been assuming two things so far
The legal system works flawlessly
Whatever theoretical goal we set, we can implement correctly
(In tort law, we’ve considered effect of errors)
The legal system costs nothing
Gave us nice theoretical results for achieving efficiency
Example: injunctions when TC low, damages when TC high
Example: strict liability when injurer activity matters a lot; negligence when both sides’ precaution matters a lot
Next: what additional concerns are there when trying to put a legal structure in place to enforce these ideas?
Implicitly, we were making two big assumptions:
the legal system works flawlessly
the legal system costs nothing
The first assumption we made explicitly – by assuming we could set damages precisely in relationship to actual harm
In tort law, we even examined the effect on incentives when it is violated
The second assumption we made implicitly
By ignoring the costs of the legal system in figuring efficiency
And also by ignoring the private costs of litigation when considering the parties’ incentives.
Over the next two lectures, we will relax these two assumptions, and explicitly consider the details of the legal system and the incentives it creates.

24. What is the goal of the legal system itself – i. e
What is the goal of the legal system itself – i.e., how we implement the rules we chose?
Start with the best possible benchmark
Theoretically perfect rules, implemented flawlessly and costlessly
That’s obviously the best we can hope to do
How does reality differ?
1. Rules actually implemented won’t be the perfect ones
Imperfect rules will lead to imperfect incentives, leading to less-than-perfectly-efficient actions and outcomes
Think of any loss of efficiency due to imperfections in legal system as error costs
2. Actual system won’t be costless – administrative costs
Goal of legal system: minimize sum of these two costs

25. Administrative costs and error costs
Hiring judges, building courthouse, paying jurors…
More complex process  higher cost
Administrative costs are obvious.
If a legal process is going to require judges, you have to hire judges.
If it’s going to require courtrooms, you have to build a courthouse.
If it’s going to require jurors, you’ll have to pay the jurors.
The more complex the process is, the more it is likely to cost.

26. Administrative costs and error costs
Hiring judges, building courthouse, paying jurors…
More complex process  higher cost
Error costs
Any legal process is imperfect
Errors are any judgments that differ from theoretically perfect ones
An error in computing damages after the fact only affects distribution, not efficiency
But anticipated errors affect incentives, which may lead to actions which aren’t efficient
Error costs are costs of distortions in actions people take (precaution, activity levels, etc.) due to flaws in legal system
Error costs are less obvious.
Any legal process will be imperfect
some defendants will not be found liable when they should be
damages will sometimes be set incorrectly, and so on.
We can think of an error as any judgment that differs from the theoretically perfect judgment
That is, any result that is different the judgment a court would impose if it were infinitely wise and had perfect information
An error in computing damages after the fact will affect distribution but not efficiency
That is, after the fact, me paying you very high damages, or not being found liable when I should be, will matter to us
But since the damage is already done, it won’t affect efficiency
But anticipated errors also affect the costs that each side perceives as stemming from their actions
And therefore change incentives, and may lead to actions which are not efficient.
Error costs are the costs of any distortions in actions (precaution, activity levels, etc.) due to imperfect incentives caused by flaws in the legal system
An example we already saw: if courts make errors in sometimes not finding injurers liable, this may lead to lower precaution, which is inefficient
This inefficiency – however much the results differ from what would happen if damages were always set correctly – is an error cost

27. The goal of the legal process
So theoretically, the efficient legal process is the one that minimizes the sum of…
The direct costs of administering the system, and
The economic effects of errors due to process not being perfect
We’ve already seen the tradeoff between these two types of costs
Tradeoff between “simpler” versus “more complex” rules
We’ve seen this several times

28. We’ve already seen tradeoff between administrative and error costs
Whaling law – “fast fish/loose fish” vs. “iron-holds-the-whale”
FF/LF: lower administrative costs (fewer disputes)
IHTW: lower error costs (better incentives for whaling)
Pierson v. Post (fox hunt case)
Majority: first to catch, otherwise “fertile source of quarrels”
Dissent: first to chase, hunting foxes is “meritorious”
Privatizing ownership of land
Expanding property rights adds admin costs (boundary maintenance)
But lowers error costs (better incentives for efficient use of resource)
Demsetz: privatize when gains outweigh costs
Same as: pick system with the lower sum of admin + error costs
This tradeoff will almost always be present when choosing between a simpler rule and a more complex, nuanced rule
Which rule ends up being more efficient depends on the particulars
With right whales, error costs from fast fish/loose fish are small, that’s the more efficient rule
With sperm whales, error costs from fast fish/loose fish are too high, iron holds the whale is more efficient
When hunting was just for food, error costs from overhunting weren’t too large, communal ownership of land was more efficient
With commercial fur trade, error costs were larger, private hunting rights became more efficient

29. Another application: how costly should it be to sue somebody?
Worth it for victim to sue if
Expected value of legal claim
Cost to initiate lawsuit
>
Probability of winning at trial, times expected judgment…
Or likelihood of a settlement, times expected amount…
Minus costs expected to be incurred
“Filing fees”

30. Expected value of claims
Filing fees
Expected value of claims should vary widely
Probability
Filing Fee
Obviously, different injuries in different situations are different, so the expected value of claims should vary widely
So we can think of there being some big probability distribution of different values for different types of claims
Whatever this distribution, filing costs basically divide this distribution into those where the victim will find it worthwhile to sue, and those where he won’t
Higher filing costs mean fewer actions (at least on a per-injury basis).
In the U.S., courts do charge fees for filing a claim and for subsequent stages of the process, but these fees are much less than the actual cost to the state
that is, the state bears much of the cost of the legal process, but does charge some fees
In some civil law countries, the state charges no fees at all for using the civil courts
SUE
DON’T SUE
Expected value of claims

31. So what level of filing fees is efficient?
The efficient legal system minimizes the sum of administrative costs and error costs
Higher filing fees  fewer lawsuits  lower administrative costs
But, higher filing fees  more injuries go “unpunished”
 greater distortion in incentives  higher error costs
Filing fee is set optimally when these balance on the margin:
Marginal cost of reducing fee = marginal benefit
Administrative cost of an additional lawsuit = error cost of providing no remedy in the marginal case
Coming back to our earlier point: economically, the ideal legal system is one that minimizes the sum of administrative costs and error costs
Higher filing fees mean fewer actions, and therefore lower administrative costs
But higher filing fees also mean a greater number of injuries will go unpunished, leading to a greater distortion in incentives and therefore greater error costs
The filing fee is set optimally when these two exactly balance on the margin:
that is, when the administrative cost of an additional complaint is equal to the error cost of providing no remedy in the marginal case (the case which is right on the border between justifying a lawsuit and not justifying a lawsuit)

32. How high should filing fees be?
Error costs
If we’re only concerned with efficiency, we don’t care about distributional effects
That is, we don’t care if a particular victim is or isn’t compensated
So the size of error costs depends on how much peoples’ behavior responds to the incentives caused by liability
“The social value of reducing errors depends on whether the errors affect production or merely distribution”
When errors have large incentive effects, filing fees should be low
The size of error costs depends on how strongly peoples’ behavior responds to the incentives caused by liability
The textbook puts this another way:
the social value of reducing errors depends upon whether the errors affect production or merely distribution.
Recall with contract law, we discussed the difference between “productive information” and “redistributive information”
The distinction here in the same
The question is whether errors introduced by the legal system only affect who gets how much of the pie, or whether the errors lead to a shrinking of the pie as well
In some situations, behavior might be very sensitive to incentives
Consider a contract setting where I paid up front for you to provide a valuable service
Whether or not you want to live up to your end of the deal might depend very much on whether you think I’ll bother to sue you if you walk away
So failing to “punish” the marginal breach might have a substantial impact on production – it affects whether you actually perform the service, or even whether I agree to the contract in the first place.
So we conclude that when errors have large incentive effects, filing fees should be kept low

33. How high should filing fees be?
Error costs
If we’re only concerned with efficiency, we don’t care about distributional effects
That is, we don’t care if a particular victim is or isn’t compensated
So the size of error costs depends on how much peoples’ behavior responds to the incentives caused by liability
“The social value of reducing errors depends on whether the errors affect production or merely distribution”
When errors have large incentive effects, filing fees should be low
When errors have small incentive effects, efficiency requires higher filing fees
In other situations, failing to provide a remedy for a harm will impact distribution, but will not change anyone’s behavior
This might be the case with lawsuits involving hunting accidents
My reasons for not wanting to shoot my friend probably have very little to do with how worried I am about paying his widow if I kill him.
So failing to “punish” the marginal hunting accident might be bad for widows and good for hunters…
…But it won’t have any impact on the number of accidents
So the social cost of these errors is very small
When errors have small incentive effects, efficiency requires higher filing fees – lawsuits are costly, but a reduction in lawsuits won’t effect behavior much.
The textbook goes on to make some obvious, and uninteresting, points about the effect of the number of lawyers on the supply of legal services, and therefore on price. Feel free to read about it if you like.

34. Expected value of claims
Class Action Lawsuits
Probability
Cost to initiate lawsuit
SUE
DON’T SUE
As long as there are any filing fees or other litigation costs, there will be some situations where the harm done to each victim is below the threshold to justify a complaint
One solution when the harm is small to each individual but large overall is one we mentioned earlier: a class action lawsuit
Expected value of claims
As long as there is any cost to litigation, some harms will be too low to justify a lawsuit
When harm is small to each individual but large overall, one solution is a class action lawsuit

35. Class Action Lawsuits
One or more plaintiffs bring lawsuit on behalf of a large group of people harmed in a similar way
Example: California lawsuit over $6 bounced-check fee
Court must “certify” (approve) the class
Participating in a class-action suit eliminates victim’s right to sue on his own later
If suit succeeds, court must then approve plaintiff’s proposal for dividing up the award among members of the class
Class-action suits are desirable when individual harms are small but aggregate harms are large…
Especially when avoidance of liability has strong incentive effect
But there’s also a danger
This is where one or more plaintiffs bring a lawsuit on behalf of a large group of people harmed in a similar way
The book gives the example of a California man who sued his bank over a $6 fee for bouncing a check
$6 obviously exceeds the costs of pursuing the claim, so he sued on behalf of all the bank’s customers who were charged the same fee.
In order for a class-action suit to proceed, the court must decide to “certify” the class
This has to be done thoughtfully, since participation in a class-action suit extinguishes each victim’s right to sue later
(Some class action suits do allow individuals to choose whether to participate or opt out, preserving their right to sue on their own.)
If a class-action suit succeeds – if it leads to either a settlement or a judgment at trial – the court must then approve the plaintiff’s proposal for distributing the award to the other members of the class.
Efficiency suggests that class-action lawsuits are desirable when individual harms are small but aggregate harms are large, since these cases might otherwise go unpunished
And especially desirable if the avoidance of liability will have a strong incentive effect
However, there’s also a view that class-action suits come with a danger
In some scenarios, a “class” might be so large that losing at trial would be so catastrophic for the defendant
Then even if the claim is dubious, maybe the defendant can’t take the risk at trial, and would basically be forced to settle
These have been referred to as “blackmail settlements”
(We already discussed “nuisance suits”)

36. Tort liability vs regulation – “the rise of the regulatory state”36 36

37. Liability and regulation
Earlier, we discussed how liability and regulation interact
Especially for judgment-proof injurers, liability alone doesn’t provide enough incentive for precaution…
…but regulation can help
Example was my oil tanker business
I “ignore” threat of $50,000,000 damages award if I cause an accident, because I wouldn’t be able to pay it anyway
But I’m afraid of $1,000,000 fine, because it’s higher probability and I could actually pay it

38. Glaeser and Shleifer, “The Rise of the Regulatory State”
“Before 1900, significant commercial disputes in the United States were generally resolved through private litigation.”
This changed dramatically between 1887 and 1917
“Reformers eroded the nineteenth-century belief that private litigation was the sole appropriate response to social wrongs.”
“…Regulatory agencies at both the state and the federal level took over the social control of competition, anti-trust policy, railroad pricing, food and drug safety, and many other areas.”
Why?
Edward Glaeser and Andrei Shleifer, The Rise of the Regulatory State, Journal of Economic Literature 41 (June 2003), pp

39. Glaeser and Shleifer give some historical context
“By the late nineteenth century, the development of tort law was greatly accelerated by the industrial revolution, especially the railroads.”
“Trains were also wild beasts; they roared through the countryside, killing livestock, setting fires on houses and crops, smashing wagons at gate crossings, mangling passengers and freight. Boilers exploded; trains hurtled off tracks; bridges collapsed; locomotives collided in a grinding scream of steel. Railroad law and tort law grew up, then, together.” (Lawrence Freidman)
Very little regulation – instead, private litigation (victims bringing lawsuits)

40. As firms got larger/more powerful, it got harder for individual victims to win damages
“Duane Lockard and Walter Murphy (1992) claim that judges supported corporations because of “a campaign to ‘educate’ judges about the sacredness of private property.”
“The thrust of the rules, taken as a whole, approached the position that corporate enterprise should be flatly immune from actions for personal injury” (Friedman)
“In addition to influencing the selection of judges and prosecutors, nineteenth-century corporations projected substantial political influence, superior lawyers, and ready access to large legal war chests. Their lawyers produced briefs that exonerated their clients and slowed down the wheels of justice for years.”
Also corruption: “intimidation and bribery of witnesses, payments and political pressures on judges and legislators, and theft and destruction of evidence…”

41. Led to political pressure to do something
Individual states, then federal government, started passing regulatory acts and forming regulatory bodies to ensure better behavior
Pure Food and Drug law in 1906
Federal Reserve Act of 1913
several others
Over time, negligence (hard to prove) replaced with strict liability combined with regulation

42. We’ve been assuming our institutions are not corruptible
Injurer who is legally liable will be found liable in court and forced to pay damages
Legislature and judges might try to shape law toward efficient outcomes, enforce “right” standards, etc.
But what if that’s wrong?

43. Regulatory capture
“Regulatory capture” refers to regulatory bodies designed to regulate an industry which get “captured” by the industry
Instead of serving public good, regulator now acts to maximize profits of the firms in the industry
Doesn’t always mean no regulation at all – firms may use regulation to make it harder for other firms to enter, reduce competition, etc.

44. Glaeser and Shleifer’s point: liability system is also corruptible – maybe more!
Suppose there’s some cost X to subvert any legal institution
Cost of bribing judges, or electing favorable legislators, or whatever
If I owe Y in damages under a liability system…
I’ll pay if Y < X, I’ll subvert system if Y > X
If I owe a fine of Y under a regulatory system…
But regulation relies on smaller fines, while liability relies on large low-probability damage awards

45. Their conclusion: optimal legal regime depends on the details
Efficient form of social control
Size of accidents
Regulation
Strict liability rule
Do nothing!
Negligence rule
Do nothing!
Less law and order, or larger scale of industry
More law and order, or smaller scale of industry

46. And this seems to explain a lot
Glaeser and Shleifer show this pattern explains a lot of what happened in the US...
…and also explains why tort reform has not been effective in some developing economies (and laissez faire seems to be tolerated in some)
Lots more details in the paper, of course

47. One final funny story to wrap up tort law47 47

48. From Friedman (Law’s Order)…
“A tort plaintiff succeeded in collecting a large damage judgment.
The defendant’s attorney, confident that the claimed injury was bogus, went over to the plaintiff after the trial
and warned him that if he was ever seen out of his wheelchair he would be back in court on a charge of fraud.
The plaintiff replied that to save the lawyer the cost of having him followed, he would be happy to describe his travel plans.
He reached into his pocket and drew out an airline ticket –
to Lourdes, the site of a Catholic shrine famous for miracles.”