The Efficiency of the Tort System as a Mechanism for Deterrence
In the more typical case of torts that are intended to provide deterrence as well as compensation, economists have not reached a consensus about whether costs are efficient. The tort system may conceivably improve efficiency, despite its high transaction costs, if it is particularly effective in reducing the number and severity of injuries. Such effectiveness has not been demonstrated, however.
One key issue is the relationship between actual costs to victims and the liability costs that are faced by injurers. In a situation in which potential injurers anticipate paying an extra dollar for every additional dollar of injuries or transaction costs they cause, they have the right incentive to take cost-effective steps to reduce future costs.
However, potential injurers may expect to pay more or less than one extra dollar in liability for each additional dollar of social costs they cause. If liability awards exceed actual injury losses—for example, because of punitive damages—potential injurers may be motivated to over-spend on precaution (provided they can identify enough promising ways to do so). As an example, suppose a firm expects to pay two dollars in liability for every dollar of actual social costs it produces. In that case, it will perceive investments in precaution to be twice as valuable as they are to society as a whole, and thus it will have an incentive to spend up to two dollars for every additional dollar in actual costs saved. All of the spending that returned less than one dollar per dollar from society’s standpoint would reduce the net savings from precaution, making it less likely that tort costs on the whole were efficient. Ironically, the inefficiency associated with excessive precaution may result in increased risk. For instance, drug manufacturers may withdraw or withhold otherwise valuable medicines from the market, and physicians may withdraw their services.10
Efficiency may also suffer if potential injurers find ways to reduce their liability exposure without reducing the actual risk of injury. Such avoidance efforts typically have real resource costs but do not add to the social benefits of tort liability. That problem arises from errors in assigning liability: if injurers were held responsible for all of (and only) the injuries that they truly caused, they would have no opportunities to reduce expected liability costs without reducing actual risks. A commonly cited example is “defensive medicine,” in which medical professionals conduct low-value procedures in hopes of avoiding the costs and stigma of being sued.11
Finally, if potential injurers expect to pay less than one dollar in liability costs per dollar of additional social costs —or, more to the point, expect to save less than one dollar per dollar of reduced social costs—they will have too little incentive to take preventive action. That situation may occur if liability judgments have a significant arbitrary component, if avoidance efforts succeed in obscuring injurers’ roles in causing some losses, or if injurers insure their liability costs and the premiums they pay do not fully reflect their injury record. Underinvestment in prevention can even arise from perverse incentives that associate increased care with higher liability costs—as in the case of a company that refrains from researching ways to make its products safer lest it create a paper trail of safety-related data that could be used against it in court.12 Whatever the cause, underinvestment in prevention has the same effect on efficiency as overinvestment: the net savings from precaution are lower than they would be in the ideal case (here, because some worthwhile opportunities are neglected), and thus they are less likely to outweigh the other costs of the liability system.
9. Suits over asbestos and other “hindsight torts” could conceivably help deter future injuries associated with other products by serving as cautionary examples. But once the example was well established, as seems likely with asbestos, any further suits would have negligible value as additional deterrents.
10. Whether or not potential injurers overreact (they may not if they lack effective opportunities to reduce their liability), excessive awards can increase risk in a second way: through decreased consumption of risk-reducing goods and services, such as medical care. Consumption of such goods and services is likely to decline as their prices are driven up by liability costs or as price increases for products in general leave consumers with less real income.
11. Most of the available evidence about defensive medicine comes from anecdotes or conjectural surveys of practitioners. That evidence does not rule out doctors’ own financial incentives under fee-for-service payment systems as an alternative explanation for “unnecessary” tests. However, Daniel Kessler and Mark McClellan have shown that passage of state laws limiting liability for doctors led to lower spending for certain heart procedures. See Kessler and McClellan, “Do Doctors Practice Defensive Medicine?” Quarterly Journal of Economics, vol. 111, no. 2 (May 1996), pp. 353-390. In addition, Lisa Dubay and coauthors found in one study that areas with a high risk for medical malpractice claims tended to have a higher incidence of cesarean births, but without significantly better birth outcomes. In another study, they found a lower incidence of prenatal care in areas with a high risk for medical malpractice claims. See Dubay and others, “The Impact of Malpractice Fears on Cesarean Section Rates,” Journal of Health Economics, vol. 18 (1999), pp. 491-522, and “Medical Malpractice Liability and Its Effect on Prenatal Care Utilization and Infant Health,” Journal of Health Economics, vol. 20 (2001), pp. 591-611.
12. See François J. Castaing, “The Effects of Products Liability on Automotive Engineering Practice,” in Janet R. Hunziker and Trevor O. Jones, eds., Products Liability and Innovation: Managing Risk in an Uncertain Environment (Washington, D.C.: National Academies Press, 1994), pp. 77-81, available at www.nap.edu/openbook/0309051304/html/77.html.