Econ 522 Economics of Law Dan Quint Spring 2017 Lecture 19.

Econ 522 Economics of Law Dan Quint Spring 2017 Lecture 19

Logistics Second exam Monday
No tort law – includes everything until tort law 1 1

Recapping So far in tort law, we considered the incentives created by different liability rules Strict liability leads to efficient precaution and activity by injurers, but no precaution and excessive activity by victims Negligence rules lead to efficient precaution by both parties, excessive activity by injurers Also looked at what happens when injurer is a business Businesses and strangers: strict liability leads to efficient activity, negligence leads to excessive activity Businesses and their customers: depends on customer perception of risk 2 2

Recapping Looked at effects of errors in implementing these rules
Random errors in damages have no effect Strict liability: systematic over- or under-calculation of damages lead to over- or under-precaution Negligence: small systematic errors in calculating damages don’t matter, but errors in setting standard of care effect precaution Random errors in standard of care lead to over-precaution After working through all these results, it’s natural to ask… 3 3

Does it all really matter?

Gary Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?
Reviews a wide range of empirical studies Finds: tort law does affect peoples’ behavior, in the direction the theory predicts… …but not as strongly as the model suggests Next question: does it all matter? That is, given all the time that we’ve just spent developing a formal economic model and examining its implications, it’s fair to step back a bit and ask the question: does the model work? Is there any evidence from the real world that a choice of liability rule affects peoples’ behavior in the way the model predicts? The usual assumption we make in economics is that if you make something more costly, people will do less of it. But when people get in their cars, do they really think about the amount they will have to pay in the event of an accident when deciding how fast and how far to drive? Do people really think about liability rules when deciding whether to get in a bar fight? This is exactly the question (not the bar fight question, the more general question) addressed in the paper by Gary Schwartz, “Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?” He reviews a wide range of empirical studies in different areas of tort law, and comes to the following, not that startling conclusion: Tort law does affect peoples’ behavior, in the direction the economic model predicts, but not as much as a literal reading of the model would suggest

Reviews a wide range of empirical studies Finds: tort law does affect peoples’ behavior, in the direction the theory predicts… …but not as strongly as the model suggests Most academic work either… took the model literally, or pointed out reasons why model was wrong and liability rules might not affect behavior at all Schwartz: the truth is somewhere in between He points out that most of the academic work prior to that point was either implicitly assuming that people behaved exactly as in the model; or pointing out various critiques of the model, and reasons why liability rules would not impact behavior at all but that the truth lay somewhere in between. One of the obvious ways in which the model is “wrong”: the model suggests that, under a negligence rule, injurers will always take the mandated level of care – that is, there will never be any negligence and yet there are lots of studies showing that negligence is rampant in auto accidents, in medical malpractice, and in other areas Nonetheless, studies in a variety of industries show that a greater degree of liability does lead to greater overall levels of precaution.

“Yet between the economists’ strong claim that tort law systematically deters and the critics’ response that tort law rarely if ever deters lies an intermediate position: tort law, while not as effective as economic models suggest, may still be somewhat successful in achieving its stated deterrence goals. …The information [in various studies] suggests that the strong form of the deterrence argument is in error. Yet it provides support for that argument in its moderate form: sector-by-sector, tort law provides something significant by way of deterrence.”

“Much of the modern economic analysis, then, is a worthwhile endeavor because it provides a stimulating intellectual exercise rather than because it reveals the impact of liability rules on the conduct of real-world actors. Consider, then, those public-policy analysts who, for whatever reason, do not secure enjoyment from a sophisticated economic proof – who care about the economic analysis only because it might show how tort liability rules can actually improve levels of safety in society. These analysts would be largely warranted in ignoring those portions of the law-and-economics literature that aim at fine-tuning.” Schwartz has a funny line toward the end of the paper He argues that since people do not respond as precisely to incentives as the model predicts, we shouldn’t spend so much time trying to “fine-tune” the law to achieve perfection: “Much of the modern economic analysis, then, is a worthwhile endeavor because it provides a stimulating intellectual exercise rather than because it reveals the impact of liability rules on the conduct of real-world actors. Consider, then, those public-policy analysts who, for whatever reason, do not secure enjoyment from a sophisticated economic proof – who care about the economic analysis only because it might show how tort liability rules can actually improve levels of safety in society. These analysts would be largely warranted in ignoring those portions of the law-and-economics literature that aim at fine-tuning.”

Worker’s compensation rules in the U.S. Employer is liable – whether or not he was negligent – for economic costs of on-the-job accidents Victim still bears non-economic costs (pain and suffering, etc.) “…Worker’s compensation disavows its ability to manipulate liability rules so as to achieve in each case the precisely efficient result in terms of primary behavior; It accepts as adequate the notion that if the law imposes a significant portion of the accident loss on each set of parties, these parties will have reasonably strong incentives to take many of the steps that might be successful in reducing accident risks.” He also points out, since “fine-tuning” may not work, that simple rules start to make more sense He looks at the example of worker’s compensation in the United States Worker’s compensation holds the employer liable (whether or not he was negligent) for the economic costs of on-the-job accidents, while leaving the victim bearing all non-economic costs such as pain and suffering Schwartz argues: “Analyzed in incentive terms, this regime of “shared strict liability” takes for granted that there are many steps that employers can take, and also many things that employees can do, to reduce the work accident rate. Yet workers’ compensation disavows its ability to manipulate liability rules so as to achieve in each case the precisely efficient result in terms of primary behavior; it accepts as adequate the notion that if the law imposes a significant portion of the accident loss on each set of parties, these parties will have reasonably strong incentives to take many of the steps that might be successful in reducing accident risks.” This may be a better answer to the question we looked at last week – why comparative negligence became more common in the U.S. Comparative negligence is a fairly natural “simple, good enough” type of rule – if we both contributed to the accident, we both bear part of the cost

Relaxing the assumptions of our model

Our model thus far has assumed…
So far, our model has assumed: People are rational Injurers pay damages in full They don’t run out of money and go bankrupt There are no regulations in place other than the liability rule There is no insurance Litigation is costless We can think about what would happen when each of these assumptions is violated Many of the objections Schwartz points out in his paper – reasons that people may not respond to liability laws in the way the “standard model” predicts – can be seen as violations of what Cooter and Ulen refer to as the “core assumptions” of the model Specifically, the model as we’ve explained it so far assumes: Decision-makers are rational Injurers pay damages in full (for example, they can’t run out of money and go bankrupt) There are no regulations in place beyond the liability rule There is no insurance Litigation costs are zero We can relax each of these assumptions in turn, and see what effect this will have.

Assumption 1: Rationality
Behavioral economics: people systematically misjudge value of probabilistic events Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk” 45% chance of $6,000 versus 90% chance of $3,000 Most people (86%) chose the second 0.1% chance of $6,000 versus 0.2% chance of $3,000 Most people (73%) chose the first But under expected utility, either u(6000) > 2 u(3000), or it’s not So people don’t actually seem to be maximizing expected utility And the “errors” have to do with how people evaluate probabilities Assumption 1. Rationality Cooter and Ulen give two examples of ways in which the rationality assumption may be violated. The first is on the basis of a growing literature in behavioral economics that says that many people systematically misperceive the value of probabilistic events That is, a number of experiments have shown that when people evaluate probabilistic events, they make choices that are not compatible with the usual expected-utility framework. One classic example of this comes from a classic paper by Daniel Kahneman and Amos Tversky, called “Prospect Theory: An Analysis of Decision under Risk.” They found that given a choice between a 45% chance at $6,000 and a 90% chance at $3,000, most (86%) of their sample chose the latter; but given a choice between a 0.1% chance of $6,000 and a 0.2% chance of $3,000, most (73%) chose the former. Under the standard expected-utility setup, either u(6000) is twice as high as u(3000) or it’s not; here, people were clearly doing something other than maximizing expected utility; and it seems to do not with how they evaluate the value of money, but how they evaluate probability.

People seem to overestimate chance of unlikely events with well-publicized, catastrophic events Freakonomics: people fixate on exotic, unlikely risks, rather than more commonplace ones that are more dangerous More recent work by the same authors – cited in the textbook – argues that people tend to overestimate the likelihood of events with well-publicized, catastrophic results, like accidents at nuclear power plants The resulting panic makes the few that occur stick in peoples’ minds, so they imagine them to be more frequent than they actually are. (There’s also a chapter in Freakonomics about how people fixate on the “wrong” risks That is, people freak out about very unlikely events, leading to lots of regulations about flame-retardant childrens’ pajamas But they ignore much more likely risks that seem more commonplace, such as swimming pool accidents.) All these examples build the case that maybe people don’t make perfectly rational expected-gain tradeoffs the way we expect them to Given that, we wouldn’t expect people to correctly trade off the expected incremental cost of probabilistic accidents, – p(x)’ A, against the certain cost of increased precaution, w.

People seem to overestimate chance of unlikely events with well-publicized, catastrophic events Freakonomics: people fixate on exotic, unlikely risks, rather than more commonplace ones that are more dangerous How to apply this: accidents with power tools Could be designed safer, could be used more cautiously Suppose consumers underestimate risk of an accident Negligence with defense of contributory negligence: would lead to tools which are very safe when used correctly But would lead to too many accidents when consumers are irrational Strict liability would lead to products which were less likely to cause accidents even when used recklessly Cooter and Ulen consider the implications of this in a setting of bilateral precaution, accidents with power tools Power tools can be designed to be safer, and they can be used more cautiously. Suppose consumers underestimate the likelihood of a power tool accident (People assume that any product on the market must be very safe, so they exercise no caution whatsoever.) A negligence rule with a defense of contributory negligence is common for product liability This would lead chainsaw companies to design chainsaws that are perfectly safe (or at least, efficiently safe) as long as they are not used negligently Under perfect rationality, this would lead consumers to take efficient care in using them, and all would be well But if irrational consumers underestimate chainsaw risk, this would lead to too many accidents On the other hand, a strict liability rule – along with the manufacturer knowing that its consumers will be negligent – will lead chainsaw manufacturers to design even safer chainsaws, which are less likely to cause accidents even when used recklessly In a world with irrational consumers, this is a good thing.

Another type of irrationality: unintended lapses “Many accidents result from tangled feet, quavering hands, distracted eyes, slips of the tongue, wandering minds, weak wills, emotional outbursts, misjudged distances, or miscalculated consequences” The second type of irrationality Cooter and Ulen consider is unintended lapses, that is, accidental negligence Poetically, they write, “many accidents results from tangled feet, quavering hands, distracted eyes, slips of the tongue, wandering minds, weak wills, emotional outbursts, misjudged distances, or miscalculated consequences” Which they summarize as “lapses” The idea: people try to exercise due care, but once in a while, they fail. The example they give is from a world without cruise control The speed limit on a road is 70, and so driving faster than that constitutes negligence A driver intends to drive 65, but from time to time his mind wanders and he looks down to find himself driving 73 If one of these times, he’s in an accident, he’s liable. (A driver who sets out to drive 75, but mistakenly finds himself doing 67 when he hits someone, is not liable) Cooter and Ulen’s discussion here is weirdly moralistic They seem to take the position, both that speeding is somehow immoral, and that “not wanting to speed” is somehow more important than actually not speeding They point out that a driver who realizes he may occasionally lapse will rationally target a level of precaution higher than the legal standard, to lessen the frequency of these lapses taking him below the legal standard x~ (This is exactly the same effect as the overprecaution we expect as a result of random uncertainty about the exact legal standard.) As they point out, however, a liability rule that required intentional negligence, rather than accidental negligence, would be almost impossible to enforce Proving intent is even harder than proving negligence, which was already harder than proving harm and causation Such a rule would likely lead to most injurers avoiding liability altogether, leading to no incentives for precaution They give the rather creepy notion that GPS in cars will eventually allow us to distinguish the habitual speeder from the “accidental” speeder, and then move on.

Assumption 2: Injurers pay damages in full
Strict liability: injurer internalizes expected harm done, leading to efficient precaution But what if… Harm done is $1,000,000 Injurer only has $100,000 So injurer can only pay $100,000 But if he anticipates this, he knows D << A… …so he doesn’t internalize full cost of harm… …so he takes inefficiently little precaution Injurer whose liability is limited by bankruptcy is called judgment-proof We’ve said strict liability causes an injurer to internalize the harm done by accidents, leading to efficient precaution That is: if ex post, society can charge me money equal to the harm I caused… …then ex ante, I consider this part of my private cost, and make efficient decisions But we also saw that if D < A – if the damages I owe are less than the harm I caused – I take less than efficient precaution So what happens if I’m broke? If I have $100,000 in the bank and I cause an accident causing $1,000,000 in harm, I expect to only pay $100,000 So my incentive to take precautions is much lower It might not matter that much for individuals – if I don’t have enough money to pay damages in full, I might still value the money I have a lot, because it’s all I have But consider a situation in which a firm’s liability is more than its net worth, that is, more than the value of the company The firm has no way to come up with the damages owed; so it declares bankruptcy Thus, bankruptcy places a limit on the damages that can be paid If damages that will actually be paid are less than the actual harm, then the firm is not internalizing the full cost of accidents As a result, the firm will take inefficiently little precaution. The book considers the example of a hazardous waste disposal company If the company intends to stay in business forever, it will be very careful in transporting hazardous waste, in order to avoid accidents/liability On the other hand, it might take a different strategy: dump recklessly, earn short-term profits, pay them out to shareholders, remain undercapitalized and expect to go bankrupt the first time an accident happens An injurer whose liability is limited by bankruptcy is referred to as being judgment-proof That is, they are immune to judgments beyond a certain level

Example of judgment-proofness (from old final exam)
Owner of an oil tanker Accident (oil spill) would do $50,000,000 of harm Upgraded navigation system would cost $225,000, and reduce likelihood of an accident from 1/100 to 1/500 Precaution reduces expected harm from $500,000 to $100,000, costs $225,000, so efficient to take precaution If company would be forced to pay $50,000,000 after an accident, then under strict liability, would choose to buy new nav system Suppose the business is only worth $5,000,000 If there’s an accident, pay the $5,000,000 and go out of business Now nav system reduces expected damages from $50,000 to $10,000 – not worth the cost So judgment-proof business would take too little precaution There is no perfect solution to the distortions that this causes But there are some ways to reduce them One of which is regulation, which is the third extension we consider

Assumption 3: No regulation
What stops me from speeding? If I cause an accident, I’ll have to pay for it Even if I don’t cause an accident, I might get a speeding ticket Similarly, fire regulations might require a store to have a working fire extinguisher Regulations supply additional incentive to take precaution The next extension is that some settings are governed by both a liability rule and safety regulations For example, if I speed and cause a car accident, I may be liable But if I get caught speeding, I’ll get a ticket, even if I didn’t cause an accident Similarly, fire regulations may require a store to have a working fire extinguisher, and fines may be issued to stores that fail safety inspections But on top of the regulations, if a fire in the store injured a customer, the store would still be liable (When there is both liability and safety regulation, courts could adopt the safety standards as the required standard of care, or could still impose a separate standard. The textbook gives examples of reasons a court might worry industry regulators might set standards either too low or too high.)

Continuing the example of judgment-proofness from before…
We saw, if business is only worth $5,000,000, liability does not create enough incentive to upgrade nav system Now suppose government passes regulation requiring modern navigation systems on all oil tankers If business doesn’t upgrade, 1 in 5 chance of being caught by safety inspector and having to pay a $1,000,000 fine Now, combining liability with regulation… Upgrade: cost of new nav system is $225,000, expected damages are $10,000  private cost is $235,000 Don’t upgrade: expected damages are $50,000, expected government fine is $200,000  private cost is $250,000 Liability + regulation gives enough incentive to take precaution, even though either one alone would not be enough

Assumption 3: No regulation
When liability > injurer’s wealth, liability does not create enough incentive for efficient precaution Regulations which require efficient precaution solve the problem Regulations also work better than liability when accidents impose small harm on large group of people As we just saw, when liability exceeds an injurer’s total wealth, the injurer goes bankrupt, but cannot be held liable for the full amount of the harm In settings where damages would bankrupt a firm, expected damage payments would be lower than p(x)A, since damages would be limited to an amount less than A. This would lead to insufficient precaution under a strict liability rule However, regulations which hold a firm to the efficient level of care avoid this problem, since large fines could be assessed to firms in violation of safety standards before an accident occurs Thus, in industries where severe accidents are likely to bankrupt firms, safety regulation may work better than liability in encouraging precaution. Regulation may also be better than liability when accidents impose only a small harm on a large group of people: since going to trial is costly, it may not be worth it for victims suffering only a small harm, and firms might escape liability because nobody finds it worthwhile to sue. (Class action lawsuits also get around this problem – we’ll get to that later.) In these cases, liability alone might also lead to insufficient precaution, while regulation can enforce the efficient level of care.

Assumption 4: No insurance
We assumed injurer or victim actually bears cost of accident When injurer or victim has insurance, they no longer have incentive to take precaution But, insurance tends not to be complete insurance Going back to the fundamental assumptions we’ve been making in tort law… If I drive more carefully, I cause fewer accidents If I face greater liability when I cause accidents, I choose to drive more carefully On the other hand, if I have insurance that covers me when I cause accidents, then the liability rule chosen may not affect me, only my insurance company The third assumption we made in the original model was that either the victim or the injurer bears the cost of the accident – that is, neither side has insurance. In reality, the victim might buy insurance for harm caused by accidents, and the injurer might buy insurance to cover his liability. However, insurance tends not to be complete The victim’s car insurance may include a deductible (the insurer doesn’t pay the first $500 of damage), coinsurance or copayment (the insurer pays some fraction of damage rather than the full amount), and coverage may only be for tangible losses, not all damage. The injurer’s liability insurance may also be incomplete – in addition to deductibles or coinsurance, an accident may cause his future premiums to go up, so the injurer is not completely insulated from the cost of the accident.

Assumption 4: No insurance
Insurance reduces incentive to take precaution Moral hazard Insurance companies have ways to reduce moral hazard Deductibles, copayments Increasing premiums after accidents Insurers may impose safety standards that policyholders must meet Insurance reduces the incentives to take precaution. In insurance, this is referred to as moral hazard. (If I insure my car against theft, I don’t worry as much about where I park it.) Insurance companies have lots of ways to reduce moral hazard, mostly ones we’ve already mentioned – deductibles, coinsurance, and making a customer’s premiums depend on his past driving performance. Nonetheless, insurance clearly leads to lower levels of precaution. To deal with this, liability insurers may impose safety standards that policyholders must meet. For example, a fire insurance company may require its customers to maintain fire extinguishers. Or a car insurance policy might not cover you if you’re driving drunk Like before with safety regulators, insurance companies can impose ex ante standards – or, to put it in our terms, they can make even insured customers face liability if they are negligent The book goes on for a while about insurance – trying to use insurance to argue whether strict liability or no liability is better. They point out that in a strict liability world with insurance, a manufacturer who makes a lot of defective products might find their insurance rates going up over time, giving an incentive to reduce defects. In addition, if a manufacturer buys liability insurance, the insurance company would have an incentive to monitor the manufacturer and make sure they’re making safe products. (They also mention two reasons the insurance industry is thought to be “unstable” – the fact that correlated losses may exhaust reserves, and the problem of adverse selection.)

Assumption 5: Litigation costs nothing
If litigation is costly, this affects incentives in both directions If lawsuits are costly for victims, they may bring fewer suits Some accidents “unpunished”  less incentive for precaution But if being sued is costly for injurers, they internalize more than the cost of the accident So more incentive for precaution The final assumption Cooter and Ulen relax is the assumption that litigation costs nothing They point out that if litigation is costly on both sides, it skews the incentives in both directions If suing for damages is costly for victims, we would expect them to bring fewer suits; this means more accidents would go “unpunished”, providing less incentive for precaution. On the other hand, if being sued for damages is costly for injurers, this adds an additional cost to the damages they expect to pay; this increases the incentives to avoid trial in the first place by preventing the accident, leading to greater precaution.

An example from Polinsky, “An Introduction to Law and Economics”
I hit you with my car and did $10,000 worth of damage We both know I was negligent But courts aren’t perfect If we go to trial, 80% chance I’ll be found liable, 20% I won’t If I’m held liable, damages are correctly set at $10,000 So on average, if we go to trial, you expect to recover $8,000 But if we go to trial, we both have to hire lawyers Suppose this costs us each $3,000 Now your expected gain from going to trial is $8,000 – 3,000 = 5,000 And my expected cost is $8, ,000 = 11,000 An example from a book by Mitch Polinsky, “An Introduction to Law and Economics” I hit you with my car and did $10,000 worth of damage. (Sorry.) You and I both know that I was negligent But we also both know that courts aren’t perfect If we go to trial, there’s an 80% chance I’ll be held liable, and a 20% chance I won’t If I am held liable, damages will be correctly set at $10,000 So if we go to trial, you expect to recover (on average) 80% X $10,000 = $8,000. However, if we go to trial, we’ll both have to hire lawyers, and lawyers are expensive Suppose going to trial will cost each of us $3,000 So now your expected net gain from going to trial is $8,000 – $3,000 = $5,000 Similarly, my expected cost if we go to trial is $8,000 + $3,000 = $11,000 Of course, since a trial will (in expectation) cost me $11,000 and earn you $5,000, it’s possible we can agree to settle without going to court. Any settlement between $5,000 and $11,000 makes both of us better off. So perhaps this will happen.

Why does costly litigation matter?
Under strict liability… We said injurers internalize cost of accidents  efficient precaution But this assumes cost of being sued = damage done If courts are unpredictable and litigation is costly, private cost of being sued for damages could be > or < cost of accident Which could lead to too much or too little precaution But also… If we can’t settle out of court and cases go to trial… …then social cost of an accident includes both the harm done, and the resources expended during the trial! If trial costs $6,000, then social cost of the accident isn’t $10,000, but $16,000 – which increases the efficient level of precaution Recall that under a strict liability rule, the injurer bore the cost of accidents, and therefore internalized these costs and took efficient precaution But this assumed the cost of being sued was equal to the damage done With unpredictable courts and litigation costs, the private cost of being sued for damages can be either greater or less than the actual cost of the accident So this could lead to either too much or too little precaution. But it’s trickier than that as well Suppose we believe that settlement talks are likely to break down, and most cases will end up going to trial Then the total social cost of an accident includes the resources expended during a trial That is, rather than $10,000, the cost of an accident might really be $16,000 – the harm done, plus the cost of a trial If accidents do more harm, this means more precaution is cost-justified – the optimal level of precaution is higher than before!

With costly litigation comes possibility of “nuisance suit”
Nuisance suit: lawsuit with no legal merit, purely meant to extract an out-of-court settlement Suppose trial costs $10,000 for plaintiff but $50,000 for defendant If case goes to trial, plaintiff will get nothing Threat points are -10,000 and -50,000 Gains from cooperation if settlement reached are 60,000 If gains are split evenly, defendant pays settlement of $20,000, even though case had no merit

Who pays the costs of a trial?
In U.K., loser in a lawsuit often pays legal expenses of winner Discourages nuisance suits But also discourages suits where there was actual harm that may be hard to prove In U.S., each side generally pays own legal costs But some states have rules that change this under certain circumstances Another important question is who pays the costs of the trial. We already mentioned that some courts (but not all) charge fees for filing a complaint and for various other stages of the legal process. In the U.K., the loser in a lawsuit generally has to pay the legal expenses of the winner That is, if someone brings a baseless suit against me and loses, they have to pay my legal expenses This discourages “nuisance suits” of the type we described earlier However, it also discourages suits where there was actual harm that will be hard to prove. In the U.S., each side usually pays their own legal costs. However, some states have rules that change this under certain circumstances.

Rule 68 of Federal Rules of Civil Procedure “At any time more than 10 days before the trial begins, a party defending against a claim may serve upon the adverse party an offer [for a settlement]… If the judgment finally obtained by the offeree is not more favorable than the offer, the offeree must pay the costs incurred after the making of the offer.” “Fee shifting rule” Example I hit you with my car, you sue Before trial, I offer to settle for $6,000, you refuse If you win at trial, but damages are only $5,000… …then under Rule 68, you would have to pay me for all my legal expenses after I made the offer

Rule 68 does two things to encourage settlements: Gives me added incentive to make a serious settlement offer Gives you added incentive to accept my offer But not actually as generous as it sounds Not all expenses are covered Asymmetric Plaintiff is penalized for rejecting defendant’s offer Defendant is not penalized for rejecting offer from plaintiff The rule does two things to encourage settlements: it gives me an added incentive to make a serious settlement offer and it gives you an added incentive to accept my offer. Your incentive is because if you don’t accept my offer, you may be stuck paying some of my legal costs My incentive is the same: if I make you an offer and you refuse, I may end up getting some of my legal costs covered This should lead to fewer cases going to trial. Rule 68 is not actually as generous as it sounds For one thing, attorney’s fees are not always counted as part of the legal fees that are covered Also, note that it is one-sided: plaintiffs are penalized for rejecting defendants’ settlement offers, but defendants are not penalized for rejecting plaintiffs’ offers.

A clever (but unrealistic) way to reduce litigation costs
At the start of every lawsuit, flip a coin Heads: lawsuit proceeds, damages are doubled Tails: lawsuit immediately dismissed Expected damages are the same  same incentives for precaution But half as many lawsuits to deal with! Cooter and Ulen give a funny example of how litigation costs could be reduced, if all we’re concerned about is maintain the right incentives. Consider a world where any time someone sues for damages, a coin is flipped. With probability ½, the case is dismissed immediately, before the trial begins. With probability ½, the case goes to trial, and whatever damages are deemed fair, they are doubled. Beforehand, the injurer faces the exact same level of expected damages, and so he behaves exactly the same. After the fact, however, we’ve reduced the number of costly trials by 50%. Obviously, this isn’t likely to happen In fact, a Virginia judge was removed from the bench last year for, among other things, deciding which parent would have visitation rights for Christmas by coin flip The judge apparently had other problems too, though. When we get to criminal law, we’ll look at the tradeoff between probability of enforcement and severity of punishment, and the effect this has on criminal behavior.

Perfect Compensation

Perfect compensation But in some cases, hard to determine level
Perfect compensatory damages (D = A) Returns victim to original level of well-being (Works like insurance) And sets correct incentive for injurers But in some cases, hard to determine level Might be no price at which you’d be willing to give up a leg Certainly no price at which a parent would be indifferent toward losing a child One thing that we’ve been taking for granted is that damages can be set to exactly match the level of harm. That is, we’ve been assuming the possibility of perfect compensatory damages Meaning, damages that make the victim indifferent between having been in the accident and received damages, and never having been injured in the first place Perfect compensatory damages accomplish two things: First, it returns the victim to their original level of well-being – not so important from an efficiency point of view, but appealing in terms of fairness. (In addition, this means that liability functions like insurance – if we imagine that people are risk-averse, this is probably a good thing.) Second, if the “price” of injuring someone matches the actual harm done, the injurer exactly internalizes the externality he’s causing by his actions, leading to correct incentives In some instances, compensatory damages like this are not too hard to calculate. If I cause an accident that destroys your car, we can figure out the market price of cars similar to yours. Even if your car is a rare antique, there’s probably some price at which you would have been willing to sell it; figuring out that price might be tricky in practice, but isn’t a big deal conceptually. However, there are some items for which there is nothing approaching a market substitute, and no amount of damages is likely to make someone indifferent. There might be no price at which you would be willing to give up an arm or a leg There is certainly no price at which most parents would be indifferent toward losing a child. Calculating damages in these cases is a hard problem, and there is no clear guideline for what they should be

Perfect compensation And from California:
Recommended jury instructions, Massachusetts: “Recovery for wrongful death represents damages to the survivors for the loss of value of decedent’s life. There is no special formula under the law to assess the plaintiff’s damages… It is your obligation to assess what is fair, adequate, and just. You must use your wisdom and judgment and your sense of basic justice to translate into dollars and cents the amount which will fully, fairly, and reasonably compensate the next of kin for the death of the decedent. You must be guided by your common sense and your conscience on the evidence of the case…” And from California: “…You should award reasonable compensation for the loss of love, companionship, comfort, affection, society, solace or moral support.” Cooter and Ulen cite recommended jury instructions from a couple of states, to point out that juries are not given much of a theoretical framework for calculating the value of a life

One other odd feature of compensatory damages…
Most people would rather be horribly injured than killed Which means killing someone does more damage than injuring someone But compensatory damages tend to be lower for a fatal accident than an accident which crippled someone When someone is badly injured, may require huge amount of money to compensate them In wrongful-death case, damages compensate victim’s loved ones, but no attempt to compensate victim So these damages tend to be smaller The book also points out an odd characteristic of compensatory damages Most people would rather be horribly injured than killed, so killing someone does more damage than injuring someone However, compensatory damages tend to be lower for a fatal accident than for an accident which cripples someone This is because when someone is badly injured in an accident, it may require a huge amount of money to compensate them: ongoing medical treatment, pain and suffering, and the change in quality-of-life over the remainder of their life When someone is killed, they are no longer able to receive compensation, so no attempt is made to compensate them Damages in a wrongful-death case are meant to compensate their loved ones for their loss – lost income the victim’s family would have received over the rest of his working life, and lost companionship Because no attempt is made to compensate the dead victim, these damages tend to be smaller. Recent article on slate.com about how this is especially true in China, leading to people deliberately trying to kill pedestrians after hitting them: “In China the compensation for killing a victim in a traffic accident is relatively small—amounts typically range from $30,000 to $50,000—and once payment is made, the matter is over. By contrast, paying for lifetime care for a disabled survivor can run into the millions.”

What’s a life worth?

Estimated cost per life saved
What’s a life worth? Assessing damages in a wrongful death lawsuit requires some notion of what a life is worth Safety regulators also need some notion of what a life is worth Kip Viscusi, The Value of Risks to Life and Health Regulators need to decide “where to draw the line” Regulation Estimated cost per life saved Courts are not the only entities who sometimes need to relate some amount of money to the value of a life: so do regulators Safety regulators can always save incremental lives by imposing tougher and tougher regulations, which will then be more and more costly to comply with. Knowing when to stop requires a cost-benefit analysis, which in turn requires some notion of how much saving a life is worth. The paper by Kip Viscusi, “The Value of Risks to Life and Health” Viscusi points out that the cost to save an incremental life varies wildly across different types of safety regulation: Airplane cabin fire protection costs $200,000 per life saved; automobile side door protection standards save lives at $1.3 million each; Occupational Safety and Health Administration (OSHA) asbestos regulations save lives at $89.3 million each; Environmental Protection Agency (EPA) asbestos regulations save lives at $104.2 million each; and a proposed OSHA formaldehyde standard cost $72 billion per life saved. Airplane cabin fire protection $ ,000 Car side door protection standards $ ,300,000 OSHA asbestos regulations $ ,300,000 EPA asbestos regulations $ ,200,000 Proposed OSHA formaldehyde standard $72,000,000,000

Kip Viscusi, The Value of Risks to Life and Health
Let w be starting wealth, p probability of death There might be some amount of money M such that Breaks down when p = 1 not because can’t equate death with compensation, but because second term vanishes If we can find M, we can “solve for” u(death)! Ask a bunch of people how much money they would need to take a 1/1000 chance of death? Do a lab experiment where you expose people to a risk of death? Better idea: impute how much compensation people require from the real-life choices they make p u(death) + (1 – p) u(w+M) = u(w) Most people won’t answer if you ask them how much money they would demand to allow you to kill them That is, there’s no amount of money that would make them indifferent between living and dying Conceptually, part of the problem here is that, once you’re dead, you get no benefit from having the money It’s entirely possible that there is some amount of money you could give someone to make them willing to take a probabilistic risk of dying That is, for a given risk of dying p, there could be some amount of money that, enjoyed the rest of the time (when you don’t die), makes that risk of death acceptable if w is your starting wealth, D is death, and p is the probability, there could be some amount of money M such that p u(D) + (1-p) u(w + M) = u(w) When p goes to 1, this breaks down not because you can’t equate death with compensation, but because the second term vanishes So in theory, if we wanted to know what a life was worth, we could poll a bunch of people and ask how much money they’d demand to take a 1/100 risk of death, or a 1/1000 risk of death, or even a 1/10 risk of death, and see what they said However, there’s no way to test whether what they’re saying is right That is, unlike some economic experiments, where we can put a bunch of students in a lab and have them play for actual money, there’s no way to carry out an experiment where we actually intend to deliberately expose people to a risk of death. However, there is a way around this: we can try to impute the compensation people demand for risk from the choices they actually make.

Lots of day-to-day choices increase or decrease our risk of death Choose between Volvo and sports car with fiberglass body Take a job washing skyscraper windows, or office job that pays less Buy smoke detectors and fire extinguishers, or don’t “Hand Rule Damages” Hand Rule: precaution is cost-justified if cost of precaution < reduction in accidents X cost of accident Suppose side-curtain airbags reduce risk of fatal accident by 1/1000 If someone pays $1,000 extra for a car with side-curtain airbags, it must mean that $1,000 < 1/1000 * value of their life or, implicitly, they value their life more than $1,000,000 There are lots of things we do in day-to-day life that increase or decrease our risk of death we choose between a sports car with a fiberglass body and a Volvo we take a job washing skyscraper windows, or a job answering phones that pays less we buy smoke detectors and fire extinguishers, or we don’t If we observe the choices people actually make when facing these tradeoffs, we can try to impute the value people place on their own life. The textbook points out that this can be done by reinterpreting the Hand rule for efficient precaution Recall that the Hand rule said that precaution is cost-justified if cost of precaution < reduction in likelihood of accident X cost of accident The same rule applies for individuals: we expect people to take precautions to reduce risks to themselves when they are cost-justified Suppose that over the lifetime of a car, side-curtain airbags reduce the risk of a fatal accident by 1/1000 And suppose buying a car with side-curtain airbags costs an extra $1000 When we see someone paying $1,000 more for a car with side-curtain airbags, it suggests that they find the precaution cost-justified meaning that $1000 < 1/1000 * value of their life or they value their life more highly than $1,000,000. The book refers to this as “Hand rule damages” – using the Hand rule to figure out how highly people value their lives, and applying this to calculations of damages. And in fact, this is exactly what the Viscusi paper does

Viscusi surveys lots of existing studies which impute value of life from peoples’ decisions Many use wage differentials How much higher are wages for risky jobs compared to safe jobs? Others look at… Decisions to speed, wear seatbelts, buy smoke detectors, smoke cigarettes Decision to live in very polluted areas (comparing property values) Prices of newer, safer cars versus older, more dangerous ones Some used surveys to ask how people would make tradeoffs between money and safety Each paper reaches some estimate for implicit value people attach to their lives The Viscusi paper (“The Value of Risks to Life and Health”) is a survey of a large number of existing papers, which try to impute the value of life from decisions people make that affect their risk of death Many of the studies use wage differentials: how much higher wages do people demand to work in risky jobs rather than safe ones? There are several difficulties with this approach: working in a coal mine may be riskier than answering phones; it may be worse for other reasons too jobs with a higher risk of death probably also carry a higher risk of nonfatal injuries, so the wage differential will account for both of these, and it’s hard to isolate just the death part if we accept that people rationally trade off money against risk, the people who choose to take risky jobs probably have lower-than-average valuations for dying mentioned earlier, people may systematically misestimate the effects of low-probability events, so wages demanded will be based on biased estimates of the actual riskiness of the profession Nonetheless, there are a number of papers that have tried to overcome these challenges, and use wage data to estimate how highly workers are revealed to value their lives. Several papers that look at decisions other than jobs, and impute value of life from decisions people make: decisions to speed (trading off risk of death versus value of time) decision to use seatbelts (trading off some disutility, or discomfort, of wearing them) decision to buy smoke detectors, decision to smoke cigarettes decision to live in particularly polluted areas (by comparing property values) prices of new, safer cars versus older, more dangerous ones (Also several where people were asked in surveys to make hypothetical tradeoffs between money and safety.) Each paper comes up with some estimate for the implicit value people attach to their lives, probabilistically.

What does Viscusi find?

What does Viscusi find? 24 studies based on wage differentials
Implicit value of life

What does Viscusi find? 7 studies using other risk-money tradeoffs
Nature of Risk, Year Component of the Monetary Tradeoff Implicit Value of life ($ millions) Highway speed-related accident risk, 1973 Value of driver time based on wage rates 0.07 Automobile death risks, 1972 Estimated disutility of seat belts 1.2 Fire fatality risks without smoke detectors, Purchase price of smoke detectors 0.6 Mortality effects of air pollution, 1978 Property values in Allegheny Co., PA 0.8 Cigarette smoking risks, 1980 Estimated monetary equivalent of effect of risk info 0.7 Fire fatality risks without smoke detectors, Purchase price of smoke detector 2.0 Automobile accident risks, 1986 Prices of new automobiles 4.0

What does Viscusi find? 6 studies based on surveys
Nature of Risk Survey Methodology Implicit Value of Life ($ millions) Improved ambulance service, post-heart attack lives Willingness to pay question, door-to-door small (36) Boston sample 0.1 Airline safety and locational life expectancy risks Mail survey willingness to accept increased risk, small (30) U.K. sample, 1975 15.6 Job fatality risk Willingness to pay, willingness to accept change in job risk in mail survey, 1984 3.4 (pay), 8.8 (accept) Motor vehicle accidents Willingness to pay for risk reduction, U.K. survey, 1982 3.8 Automobile accident risks Interactive computer program with pairwise auto risk-living cost tradeoffs until indifference achieved, 1987 2.7 (median) 9.7 (mean) Traffic safety Series of contingent valuation questions, New Zealand survey, 1.2

What does Viscusi find? Wide range of results
Most suggest value of life between $1,000,000 and $10,000,000 Many clustered between $3,000,000 and $7,000,000 Even with wide range, he argues this is very useful: “In practice, value-of-life debates seldom focus on whether the appropriate value of life should be $3 or $4 million… However, the estimates do provide guidance as to whether risk reduction efforts that cost $50,000 per life saved or $50 million per life saved are warranted.” “The threshold for the Office of Management and Budget to be successful in rejecting proposed risk regulations has been in excess of $100 million.” C&U: NHTSA uses $2.5 million for value of traffic fatality Current: EPA $9.1 MM, FDA $7.9 MM, Transpo Dept $6 MM So, what does Viscusi find? He finds is a wide range of results, but with nearly all of them ranging from a little below $1,000,000 to a little above $10,000,000. He claims that “most of the reasonable estimates” are clustered between $3 and $7 million, although this may be based on defining “reasonable” as estimates in the middle of the range. He points out, though, that even with this wide range, the information is useful: “In practice, value-of-life debates seldom focus on whether the appropriate value of life should be $3 million or $4 million… However, the estimates do provide guidance as to whether risk reduction efforts that cost $50,000 per life saved or $50 million per life saved are warranted.” He also notes: “The threshold for the Office of Management and Budget to be successful in rejecting proposed risk regulations has been in excess of $100 million.” (Cooter and Ulen add that the National Highway Traffic Safety Administration often values a traffic fatality at $2.5 million in cost-benefit analyses. Since the textbook was written, the estimates used by various agencies have gone up. A recent (Feb ) New York Times article showed current estimates of $9.1 million in use by the Environmental Protection Agency, $7.9 million by the Food and Drug Administration, and $6 million by the Transportation Department (which had been using $3.5 million at one point during the Bush years The article is at

Econ 522 Economics of Law Dan Quint Spring 2017 Lecture 19.

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Econ 522 Economics of Law Dan Quint Spring 2017 Lecture 19.

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