The Basic Economics of Tort Liability
From the economic point of view, the efficiency of the tort system is measured by how well it minimizes the sum of several types of costs:
- The costs of injuries (including medical costs, lost productivity, and pain and suffering);
- The costs of efforts to prevent or avoid injuries (including efforts to make products safer, which tend to raise consumer prices) and the opportunity costs of goods and services that are not provided (such as potential medical drugs that do not reach the market or municipal pools that are closed for fear of lawsuits) or goods and services that are provided but forgone by some risk-averse consumers (such as air travel);
- The costs of administration and implementation (particularly attorneys’ fees and the administrative costs of insurance that potential injurers and victims buy to redistribute the risks they face); and
- Indirect costs to the economy (such as the disruption costs of plant closings and bankruptcies).
What constitutes equity in relation to the tort system is ultimately subjective, but there is consensus that compensating victims for their injuries—at least in some cases and to some degree—is equitable.
Tort liability is only one means by which society addresses the efficiency and equity issues posed by injuries; other means include market forces, regulation, and public insurance funds. Market forces can help control injury costs in several ways. Under conditions of competition and good information, producers of goods and services respond to consumers’ desires for safer products, employers respond to employees’ desires for safer workplaces, and insurance companies offer policies to respond to potential victims’ desires to reduce the uncertainty they face.
One efficiency rationale for supplementing market forces with some form of government involvement is simply that many injuries—automobile accidents, releases of toxic chemicals, and so forth—are unrelated to any economic transaction. Indeed, some academic economists favor restricting the scope of tort liability to such “stranger” injuries. For other types of injuries, making an efficiency argument for government intervention requires the existence of some market imperfection: perhaps potential victims lack good information about the risks they face, suffer from biases that limit their ability to use the information, or have few choices because of monopoly or collusion in the market.4 Of course, government actions have their own weaknesses and thus may not improve efficiency in practice. For example, regulation requires centralized information about costs and benefits, and regulators may be co-opted by the parties they regulate.
Tort liability supplements the market in a more decentralized way. The basic idea is that making injurers pay for the harm they cause not only compensates victims but also gives injurers (if not victims) appropriate incentives to reduce the frequency and severity of that harm. The different liability standards used by the courts aim to achieve those goals in different ways: in particular, under the doctrine of strict liability, injurers are responsible regardless of how much care they exercise in trying to minimize injuries, whereas under the doctrine of negligence, they are responsible only if their actions fail to meet a standard of due care.5
The tort system is no panacea, however, even in principle—it is difficult if not impossible to craft liability rules that can consistently achieve the desired levels of both efficiency (taking into account all of the relevant costs) and equity. For example, because the expected level of compensation may affect the degree of care that potential victims exercise, the efficiency objective of cost-effective deterrence can conflict with the equity objective of compensation. Moreover, because the terms of that trade-off can vary, a single rule may not achieve the desired balance between efficiency and equity in all cases.
In practice, tort liability is further limited because information—particularly the information needed to determine the cause of an injury—is incomplete and costly. The transaction costs of the tort system derive from information problems: lack of complete information is what allows plaintiffs and defendants to hold divergent views and encourages them to devote resources to proving their respective cases. Information problems are also the root cause of courtroom errors, and they can make it hard to set standards for due care at efficient levels.
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4. There is no presumption that market forces tend to produce equitable outcomes; hence, arguments for government intervention can also be made on equity grounds.
5. Even in a case judged under strict liability, the injurer may not be held responsible if the victim’s own behavior contributed too much to the occurrence of the harm.
