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Does product liability law make economic sense? Ask a random group of economists and you will get, in all probability, three basic answers: 1) yes, sort of; 2) no, sort of; and 3) maybe, it depends.
The question of the economic rationale (or lack of rationale) behind product liability law arises periodically along with calls for reform of product liability law. There is no shortage of writing on this subject, and if you search diligently through the pile, you can pretty much be assured of finding at least two or three learned opinions with which to support any side of any argument.
One thing on which economists tend to agree is that law should promote economic efficiency. In product liability law, economic efficiency lies at the point where the product is safe enough and useful enough and is sold at a price that the market accepts. Consumers may be willing to forego a certain amount of safety for lower prices and more efficient products. For example, it may be possible to build absolutely safe cars (say, out of foam rubber), but what would they cost? And would they be as useful (offer the same level of “utility,” in economic terms) as metal cars? The market is willing to sacrifice some level of safety for reasonable prices and greater utility.
Many ' but by no means all ' economists believe that the market, if left to its own devices, will find the optimal level of economic efficiency, ie, the point at which the cost of the product, its usefulness to individuals, and the cost of any problems arising from the use of the product is satisfactory to all parties concerned.
Most economic thinkers, however, tend to be skeptical of the notion that fairness and equity can be somehow legislated or engineered independent of economic efficiency. Guido Calabrese, former dean of the Yale Law School and current Second Circuit Court of Appeals judge, writing on the topic of law and economic efficiency, notes that “'Negligence' is essentially a moral judgment.” Although the question of negligence lies at the heart of tort law, economists do not inquire into morality. Many economists note that laws that attempt to create conditions of fairness and equity often (or invariably) lead to unintended and economically inefficient consequences. For example, “pro consumer” laws may hurt consumers by raising costs.
The chief issue in product liability law is what some economists call the “negative externalities” ' the harmful consequences of useful industry. The negative externalities of car manufacturing include traffic deaths and injuries. What system ' tort liability, regulatory or contract ' promises to deal most efficiently with negative externalities while delivering the goods to the market at the optimal price? Three thinkers who have studied this problem ' economist Ronald Coase, economist W. Kip Viscusi and law professor Marshall S. Shapo ' offer three interesting viewpoints on the issue of economic efficiency and product liability.
Ronald Coase
Ronald Coase (pronounced “Coze”), a British economist, holds that assigning liability is hardly the way to achieve economic efficiency. He posits that, if the parties involved in a transaction are able to negotiate on an even footing, economic efficiency is the natural and inevitable result ' laws assigning liability are unnecessary, assuming the negotiations between parties are free of what are termed “transaction costs,” which are, basically, the costs of doing business.
Transaction costs can include the cost of gathering the information needed by both parties prior to the exchange, bargaining costs ' the time effort and expense required to reach an agreement ' and “enforcement” costs, the cost of making sure each party lives up to the agreement. Coase gained fame for his examination of the role of transaction costs in a variety of economic exchanges. He was awarded a Nobel Prize in 1991. He comments on the economic effects of law in his article “The Problem of Social Cost,” written in 1960.
While Coase did not comment specifically on product liability law, he did examine the economic implications of the assignment of liability in torts where manufacturers' activities produced negative externalities ' factories that produced noxious smoke in a residential neighborhood, for example. Most economists, Coase wrote, would say that the problem is how best to restrain the factory from hurting the residents. However, he says, such restraint tends to hurt the manufacturer and may not lead to the greater economic good.
Coase posited that, in an exchange that does not involve transaction costs, the assignment of liability has no effect whatsoever. If both parties ' the residents and the manufacturer ' are able to negotiate on an even footing, without transaction costs, the result will always be the most economically efficient outcome because the party that would benefit most would be willing to pay the most, leading to the best economic outcome for everyone.
Unfortunately, according to Coase, “costless” transactions are unrealistic. There will always be a transaction cost of some kind. (In product liability, other economists have noted, perhaps the most significant transaction cost is that of gathering information. For example, it may be extremely difficult for consumers to gather sufficient information to judge whether or not a product is safe.) Thus, courts and regulations, along with well-defined property rights, are required to ensure economic efficiency, but courts should understand the economic consequences of their decisions; “equity” does not necessarily translate to economic efficiency, Coase warns.
W. Kip Viscusi
W. Kip Viscusi, a Harvard professor who has written extensively on economics and the law, firmly believes that product liability law is not economically efficient. In “Reforming Product Liability Law,” written in 1991, Viscusi maintains that the concept of strict liability is, in essence, a form of insurance whereby the cost of injuries from defective products is spread out among all consumers of the product. Car companies, he writes, should not be expected to insure all accident victims. “Many of the most pronounced shortcomings of product liability stem from the overambitious allocation of the insurance responsibility to defendants,” Viscusi writes.
The problem, he says, is how to design an appropriate mechanism to control risk and compensate victims. In seeking ways to compensate victims of defective products, courts are performing a role that would be better left to government regulatory agencies, he writes. Rather than using liability law to act as the insurer of victims of defective products, other insurance mechanisms would be much more efficient. He suggests a scheme designed along the lines of the workers' compensations model: To achieve the most efficient levels of risk and “insurance,” firms should be exempt from liability in design-defect cases if they can show that they complied with specific government safety regulations or if they implemented a hazard-warning system that gives consumers the information needed to assess risk accurately and make informed decisions.
He also suggests universal government compensation for all disease victims, eliminating huge, industrywide liability for toxic torts (with regulatory punishment, rather than civil suits, to discourage bad conduct by companies).
Marshall S. Shapo
Marshall S. Shapo, a professor of law a Northwestern University School of Law, writes frequently on product liability issues. His view of product liability law and economics is for the most part optimistic. He believes that, though flawed in many ways, the present system has led incrementally to efficient outcomes and is continuing to evolve toward greater economic efficiency.
In his book, Product Liability and the Search for Justice, Shapo examines the views of many law and economics commentators and then makes a convincing case that radical reform of product liability law is unnecessary.
He points to one overlooked problem with current commentary on product liability law ' the fact that manufacturers can manipulate consumer expectations with sophisticated marketing techniques. This aspect of our consumer culture requires more study, he writes: “It is ironic that economists should rightly place such emphasis on consumer information, but fail to focus on the process by which sophisticated promotional techniques create demand and feed expectations. … It would improve analysis to focus initially on the ways sellers establish [consumer] expectations.” Shapo also rejects the notion that the market alone is the best vehicle for regulating product risks:
In a free economy, the market is the foundation stone of control. Using price, quality and variety of goods, it sorts out consumer preferences, including risk preferences. But we must remember that 'the market' is not independent of the law. Indeed, it is inconceivable that in modern society markets could work without a fairly complex set of legal rules. The law of fraud alone places significant constraints on conduct.
Moreover, Shapo feels, the best sources of legal rules governing product liability issues are state courts, not overarching federal legislation:
It is paradoxical that, in an America grown suspicious of federal involvement … the business community should seek to nationalize a body of law that has developed through the application of local jurisprudence in individual disputes. Federal legislation would stultify the creative process of local lawmaking and at the same time pose baffling problems of interpretation and reconciliation on state courts.
Conclusion
Whether you believe that product liability law is in need of an overhaul, or feel, like Shapo, that it is working fairly well as it is, the fact is that the law continues to evolve, as economists would say, at the margin ' case by case. It is hard to imagine a set of laws that would ensure economic efficiency, and perhaps the best we can hope for is that each case is resolved in a manner that promotes, however incrementally, economic efficiency as well as moral equity.
Does product liability law make economic sense? Ask a random group of economists and you will get, in all probability, three basic answers: 1) yes, sort of; 2) no, sort of; and 3) maybe, it depends.
The question of the economic rationale (or lack of rationale) behind product liability law arises periodically along with calls for reform of product liability law. There is no shortage of writing on this subject, and if you search diligently through the pile, you can pretty much be assured of finding at least two or three learned opinions with which to support any side of any argument.
One thing on which economists tend to agree is that law should promote economic efficiency. In product liability law, economic efficiency lies at the point where the product is safe enough and useful enough and is sold at a price that the market accepts. Consumers may be willing to forego a certain amount of safety for lower prices and more efficient products. For example, it may be possible to build absolutely safe cars (say, out of foam rubber), but what would they cost? And would they be as useful (offer the same level of “utility,” in economic terms) as metal cars? The market is willing to sacrifice some level of safety for reasonable prices and greater utility.
Many ' but by no means all ' economists believe that the market, if left to its own devices, will find the optimal level of economic efficiency, ie, the point at which the cost of the product, its usefulness to individuals, and the cost of any problems arising from the use of the product is satisfactory to all parties concerned.
Most economic thinkers, however, tend to be skeptical of the notion that fairness and equity can be somehow legislated or engineered independent of economic efficiency. Guido Calabrese, former dean of the
The chief issue in product liability law is what some economists call the “negative externalities” ' the harmful consequences of useful industry. The negative externalities of car manufacturing include traffic deaths and injuries. What system ' tort liability, regulatory or contract ' promises to deal most efficiently with negative externalities while delivering the goods to the market at the optimal price? Three thinkers who have studied this problem ' economist Ronald Coase, economist W. Kip Viscusi and law professor Marshall S. Shapo ' offer three interesting viewpoints on the issue of economic efficiency and product liability.
Ronald Coase
Ronald Coase (pronounced “Coze”), a British economist, holds that assigning liability is hardly the way to achieve economic efficiency. He posits that, if the parties involved in a transaction are able to negotiate on an even footing, economic efficiency is the natural and inevitable result ' laws assigning liability are unnecessary, assuming the negotiations between parties are free of what are termed “transaction costs,” which are, basically, the costs of doing business.
Transaction costs can include the cost of gathering the information needed by both parties prior to the exchange, bargaining costs ' the time effort and expense required to reach an agreement ' and “enforcement” costs, the cost of making sure each party lives up to the agreement. Coase gained fame for his examination of the role of transaction costs in a variety of economic exchanges. He was awarded a Nobel Prize in 1991. He comments on the economic effects of law in his article “The Problem of Social Cost,” written in 1960.
While Coase did not comment specifically on product liability law, he did examine the economic implications of the assignment of liability in torts where manufacturers' activities produced negative externalities ' factories that produced noxious smoke in a residential neighborhood, for example. Most economists, Coase wrote, would say that the problem is how best to restrain the factory from hurting the residents. However, he says, such restraint tends to hurt the manufacturer and may not lead to the greater economic good.
Coase posited that, in an exchange that does not involve transaction costs, the assignment of liability has no effect whatsoever. If both parties ' the residents and the manufacturer ' are able to negotiate on an even footing, without transaction costs, the result will always be the most economically efficient outcome because the party that would benefit most would be willing to pay the most, leading to the best economic outcome for everyone.
Unfortunately, according to Coase, “costless” transactions are unrealistic. There will always be a transaction cost of some kind. (In product liability, other economists have noted, perhaps the most significant transaction cost is that of gathering information. For example, it may be extremely difficult for consumers to gather sufficient information to judge whether or not a product is safe.) Thus, courts and regulations, along with well-defined property rights, are required to ensure economic efficiency, but courts should understand the economic consequences of their decisions; “equity” does not necessarily translate to economic efficiency, Coase warns.
W. Kip Viscusi
W. Kip Viscusi, a Harvard professor who has written extensively on economics and the law, firmly believes that product liability law is not economically efficient. In “Reforming Product Liability Law,” written in 1991, Viscusi maintains that the concept of strict liability is, in essence, a form of insurance whereby the cost of injuries from defective products is spread out among all consumers of the product. Car companies, he writes, should not be expected to insure all accident victims. “Many of the most pronounced shortcomings of product liability stem from the overambitious allocation of the insurance responsibility to defendants,” Viscusi writes.
The problem, he says, is how to design an appropriate mechanism to control risk and compensate victims. In seeking ways to compensate victims of defective products, courts are performing a role that would be better left to government regulatory agencies, he writes. Rather than using liability law to act as the insurer of victims of defective products, other insurance mechanisms would be much more efficient. He suggests a scheme designed along the lines of the workers' compensations model: To achieve the most efficient levels of risk and “insurance,” firms should be exempt from liability in design-defect cases if they can show that they complied with specific government safety regulations or if they implemented a hazard-warning system that gives consumers the information needed to assess risk accurately and make informed decisions.
He also suggests universal government compensation for all disease victims, eliminating huge, industrywide liability for toxic torts (with regulatory punishment, rather than civil suits, to discourage bad conduct by companies).
Marshall S. Shapo
Marshall S. Shapo, a professor of law a
In his book, Product Liability and the Search for Justice, Shapo examines the views of many law and economics commentators and then makes a convincing case that radical reform of product liability law is unnecessary.
He points to one overlooked problem with current commentary on product liability law ' the fact that manufacturers can manipulate consumer expectations with sophisticated marketing techniques. This aspect of our consumer culture requires more study, he writes: “It is ironic that economists should rightly place such emphasis on consumer information, but fail to focus on the process by which sophisticated promotional techniques create demand and feed expectations. … It would improve analysis to focus initially on the ways sellers establish [consumer] expectations.” Shapo also rejects the notion that the market alone is the best vehicle for regulating product risks:
In a free economy, the market is the foundation stone of control. Using price, quality and variety of goods, it sorts out consumer preferences, including risk preferences. But we must remember that 'the market' is not independent of the law. Indeed, it is inconceivable that in modern society markets could work without a fairly complex set of legal rules. The law of fraud alone places significant constraints on conduct.
Moreover, Shapo feels, the best sources of legal rules governing product liability issues are state courts, not overarching federal legislation:
It is paradoxical that, in an America grown suspicious of federal involvement … the business community should seek to nationalize a body of law that has developed through the application of local jurisprudence in individual disputes. Federal legislation would stultify the creative process of local lawmaking and at the same time pose baffling problems of interpretation and reconciliation on state courts.
Conclusion
Whether you believe that product liability law is in need of an overhaul, or feel, like Shapo, that it is working fairly well as it is, the fact is that the law continues to evolve, as economists would say, at the margin ' case by case. It is hard to imagine a set of laws that would ensure economic efficiency, and perhaps the best we can hope for is that each case is resolved in a manner that promotes, however incrementally, economic efficiency as well as moral equity.
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