economic analysis of tort law january 9, 2007. economic analysis of tort law private goods public...

ECONOMIC ANALYSIS OF TORT LAWJanuary 9, 2007

ECONOMIC ANALYSIS OF TORT LAW

Private Goods

Public Goods

Public Bads

Private Bads


Private Goods Property Rights Right To Pollute Right To Enjoy Property Free of Pollution Right To Contract on Property Rights Right To Damages and/or an

Injunction for Breach of Contract

Public Goods

Public Bads

Private Bads Harms or Wrongs


Private Goods Property Rights Right To Pollute Right To Enjoy Property Free of Pollution Right To Contract on Property Rights Right To Damages and/or an

Injunction for Breach of Contract

THEOREM OF COASE

Same efficiency under rival allocation of rights

EXCEPTIONS:High Transaction Costs Asymmetric InformationEmpty Core


• The alternative strategy to judicial intervention is to

• (1) attack the impediments to bargaining directly by fashioning legal rules which reduce transaction costs,

• (2) increase the information available to the parties, or

• (3) reduce incentives for strategic bargaining.


Private Goods

Public GoodsIntellectual Property

Patents Copyright Trade Marks

Trade Secrets Other

Public space

Public Bads

Crime

Divorce

Private Bads Torts

Intentional Pollution

Assault Fraud

Unintentional Negligence


• In contracts, the agents may agree to adopt a sharing rule

• In torts, the “social planner” or “law-making agency” acts to “impose” an optimal sharing rule on the agents


• In the case of perfect information the rule of strict liability against agents of externalities is socially optimal because it internalizes the cost of the externality to the producer


Private Bads Torts Intentional Pollution Assault

Fraud

Unintentional Negligence

THEOREM OF COASE

Same efficiency under rival allocation of rights

EXCEPTIONS:High Transaction Costs Asymmetric InformationEmpty Core


• Tort law is often said to be concerned with the deterrence of accidents and the compensation of victims.

• Tort law is also said to be concerned for minimizing administrative costs of recovery.


• This implies a concern with compensation.

• Accident costs include the costs of bearing a large loss, which, because of risk aversion, is greater than the quantum of the loss itself.


• In the case of contracts, the existence of asymmetric information made the application of a single rule in all cases sub-optimal

• In the case of tort liability, the existence of asymmetric information makes the rule of strict liability socially sub-optimal as the rule will fail to internalize all the relevant costs

• In some cases the rule of strict liability may internalize the wrong costs


Private Bads

Asymmetric InformationForces of Nature

Imperfect Allocation of Information


Private Bads

Asymmetric InformationForces of Nature


• In contracts the common law made implied insurers out of agents whose efforts to perform contracts were frustrated by forces of nature

• In torts the common law usually imposed a rule of strict liability on agents whose efforts to perform without injury to others were frustrated by forces of nature


• Protection of Possession• Common law actions for trespass and nuisance

were governed by the “strict liability” property rule for damages until the industrial revolution encouraged its replacement by a different rule in tort cases (Horwitz Thesis)

• Horwitz, Morton, "The Transformation in the Conception of Property in American Law 1780 - 1860', (1980) 40 U. of Chi. L. Rev. 248-290

• Schwartz, Gary, "Tort Law and the Economy in Ninteenth-Century America: A Reinterpretation', (1981) 90 Yale L. J. 1717 - 1775


Private Bads

Asymmetric Information

Imperfect Allocation of Information


• The Asymmetry Exception To Coase Theorem

• Strict Liability Rule – No longer efficient• No Liability Rule – No longer efficient• Expectation Damages Rule

» Contract – Selected Through Disclosure» Torts – Selected by Imposition By Court As Principal

ECONOMIC ANALYSIS OF TORT LAW PRINCIPAL – AGENCY

Agent

Principal

promise payment

“SUPER”Principal= Judge Its “problem” is to maximize social surplus

CONTRACT


• Parties that enter contracts fully informed through bargaining enter an optimal contract.


• In the case of contracts• Moral Hazard

Where the party acting as “agent” cannot observe what the principal “expects”, the courts motivate the agent to the expected level of performance through the imposition of damages against the agent for non-performance of an established standard of care in the absence of some express condition or incentive scheme in a contract between the parties


• Recall also that in the case of contracts• Adverse Selection

Where the party acting as “agent” cannot observe what the principal “expects” in terms of the standard of performance and so performs below expectations unless the contract sets out the expectation

The courts do not motivate the agent to the expectations of the Principal through damages against the agent for non-performance unless the principal “discloses” or “signals” its expected standard of performance

ECONOMIC ANALYSIS OF TORT LAW$C1

a1

P

NP Marginal Cost Curve of Agent 1

Expected Marginal Cost Curve of Agent 1 under Expectation Damages

a10 a1* a11


• Because the parties have better information about their own needs and circumstances than does the court, the arrangements which the parties make will be more optimal than those which the court could provide.


• This is the reason for a presumption in favour of private ordering.

• The primacy of private ordering has been explicitly recognized by the courts.

• B.G. Checo Int'l Ltd. v. B.C. Hydro & Power Authority (1993), 99 D.L.R. (4th) 577.


• Parties to a contract routinely insert clauses which are directed to circumstances that both parties hope will never arise, for example warranty provisions in case of defects, or a liquidated damages clause.

• The optimal contract, like tort law, will attempt to minimize the harm of any unanticipated occurrence, since both parties gain if such costs are minimized.

ECONOMIC ANALYSIS OF TORT LAW BILATERAL AGENCY

AGENT 1 AGENT 2

“SUPER”Principal= Judge

TORTS

Its “problem” is to maximize social surplus


Agent 2

LEGALLY IMPOSED OBLIGATION 2

Agent 1INCENTIVE COMPATIBILITYCONSTRAINT 1

LEGAL ANALYSIS

ECONOMIC ANALYSIS

Agent 1

LEGALLY IMPOSED OBLIGATION 1

Agent 2

INCENTIVE COMPATIBILITYCONSTRAINT 2


AGENT 1 AGENT 2

Obligation of Agent 1 to Avoid harming Agent 2

Obligation of Agent 2 to Avoid harming Agent 1


• In the case of torts• Moral Hazard

Where the party as acting “agent” acts on the knowledge that the “principal” in the contract cannot observe the agent’s effort in performance because they may not even know the identity of the parties until after the harm occurs, the courts motivate the agent to the expected level of performance through the imposition two rules:

(1) Impose a standard of care on the agent

(2) Impose damages on the agent in the event that the duty to follow the standard of care is breached


• So in the case of torts, as well• Adverse Selection

Where the party as acting “agent” cannot observe what the principal “expects” in terms of the standard of performance because they may not even know the identity of the parties until after the harm occurs and so performs below expectations.

• In torts, the link between adverse selection, disclosure and the standard of care is imposed by law

• Donoghue v. Stevenson

The “Court” imposes the standard of care for performance applicable to the parties who are related to each other by “proximity”


• In torts, if optimal contracting were possible, judicial intervention would never be necessary, since the parties would already have provided for all contingencies.


• Concern with compensation for the costs of bearing large losses emphasizes the importance of insurance

• La Forest J. in his decision in Canadian National Railway Company v. Norsk Pacific Steamship Co., [1992] 1 S.C.R. 1021. (Siebrasse, p. 253)


• The role of the court in both tort and contract is to approximate the optimal contract.

• Professor Cooter describes "tort as a hypothetical contract“

• R.D. Cooter, "Unity in Tort Contract and Property: The Model of Precaution" (1985) 73 Cal. L. Rev. 1.


• Professor Winter described systems of tort rules as a social contract“

• Winter and Neary, “Optimal Shares in bilateral

economic analysis of tort law january 9, 2007. economic analysis of tort law private goods public...

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