Theories of Tort Law: Economic Analysis

Main source: Coleman, Jules and Mendlow, Gabriel, “Theories of Tort Law “, The Stanford Encyclopedia of Philosophy (Fall 2010 Edition), Edward N. Zalta (ed.), URL = .

Theories of Tort Law : Economic Analysis

Rather than surveying the range of economic theories, this entry focuses in depth on what is arguably the dominant strain of economic analysis: optimal deterrence theory. Proponents of this approach, like economic analysts more generally, see tort liability primarily as a mode of allocating the costs of accidents. Their principal claim is that tort should be understood as aiming to minimize the sum of the costs of accidents and the costs of avoiding them. Since shifting costs is itself costly, economic analysis begins with the following question: when is it worth incurring costs in order to shift costs?
2.1 The Economic Interpretation of Fault Liability

Taking the relevant social problem to be the problem of costly accidents, economic analysts deem the paradigmatic tort to be that of negligence. The law holds a person to be negligent when she imposes an unreasonable risk of injury on another. Imposing an unreasonable risk of injury is in turn a matter of failing to take precautions that a reasonable person would take. But which precautions would a reasonable person take?

Economists offer the following answer: a precaution is reasonable when it is rational; a precaution is rational when it is cost-justified; and a precaution is cost-justified when the cost of the precaution is less than the expected injury (the latter being the cost of the anticipated injury discounted by the probability of the injury’s occurrence). Imagine that you are engaged in an activity that carries a benefit of $100 and an expected injury of $90. Now suppose that the only way to prevent the injury is to stop the activity. Other things being equal, you would be irrational to forego a benefit of $100 in order to avoid a cost of $90. Foregoing the benefit would not be a cost-justified precaution. Now imagine that things are the other way around: the benefit is $90 and the expected injury is $100. Under these circumstances, foregoing the benefit would be a cost-justified precaution. You would be irrational not to forego the benefit.

As economists see things, the same standard of rationality applies when the benefit and the injury befall two separate parties. If I can spare you some injury by taking precautions less costly than your expected injury, my failure to take such precautions is irrational, hence, negligent. By the same token, if I can spare you some injury only by taking precautions costlier than your expected injury, my failure to take these precautions is not irrational, hence, not negligent; if you get hurt, the loss will rightly remain with you.

The rule of fault liability has much to recommend it from an economic point of view. In particular, it induces all rational persons – injurers and victims alike – to take all and only cost-justified precautions. If all potential injurers behave rationally, losses will always lie where they fall: with victims. Rational victims will therefore approach all accidents assuming that they will have to bear the costs. But then they, too, will take all and only cost-justified precautions. So the rule of fault liability is economically efficient: it produces an optimal level of risk-taking.
2.2 The Economic Interpretation of Strict Liability

If fault liability is efficient, what are we to make of strict liability? Can it be efficient as well? Since someone facing strict liability will bear the costs of his conduct whether or not he is at fault, one might think that a potential defendant under a regime of strict liability will have no incentive to invest in precautions. This is wrong. Suppose that I am strictly liable for some costs that I impose on you – costs of $100. Suppose further that by taking $90 worth of precautions I can reduce to zero the probability of my imposing these costs on you. What is it rational for me to do? The answer is obvious. It is rational for me to invest in $90 worth of precautions. So even under a regime of strict liability, potential defendants have an incentive to take precautions.

Indeed, under a regime of strict liability, potential defendants have an incentive to take all cost-justified precautions – just as they do under fault liability. In a crucial respect, the plight of the defendant (injurer) under strict liability is identical to that of the plaintiff (victim) under fault liability. If we assume that the injurer is rational, we can infer that under fault liability he will take precautions that will free him of the burden of liability. As a result, any loss his conduct causes will lie where it falls: with the victim. This means that we can characterize the victim as herself facing a sort of strict liability, namely, strict liability for losses not caused by another’s fault. The victim cannot shift these losses to the injurer because the injurer has insulated himself from liability by taking cost-justified precautions. So the rational victim will ask herself the following question: which is lower – the cost of taking precautions or the expected cost of incurring an injury? She will take precautions when (and only when) taking precautions is cheaper than remaining vulnerable to injury. The upshot is that strict liability and fault liability encourage the exact same degree of precaution-taking. They both induce rational persons to take all and only cost-justified precautions. If efficiency requires that individuals take all and only cost-justified precautions, then strict and fault liability can both be efficient.

If both rules can be efficient, why might we prefer one to the other? One reason is that strict liability and fault liability have different distributional consequences. A rule of strict liability makes the costs of the defendant’s conduct higher than a rule of fault liability would. A rule of fault liability makes the costs of the plaintiff’s conduct higher than a rule of strict liability would. So if we have an independent reason to privilege the plaintiff’s activity over the defendant’s (or vice versa) – maybe we want less of the first activity to occur or we feel that people should have to pay a steeper price for engaging in it – then we have an independent reason to prefer strict liability to fault liability (or vice versa).
2.3 Objections to Economic Analysis

There is no doubt that economic analysis offers valuable insight into tort law’s capacity to increase overall safety and reduce the costs of misfortune or bad luck. For all its insight, however, economic analysis is vulnerable to difficult objections. These objections speak both to tort’s substantive norms and to its structural features.
2.3.1 Substance

Many theorists believe that economic analysis offers a questionable interpretation of the legal duty to behave reasonably. In characterizing negligence as the failure to take cost-justified precautions, economic analysis identifies reasonable risk-taking with rational risk taking. Economic analysis effectively invites us to determine what risks it would be acceptable for a potential defendant to take on the assumption that he owns both the resultant benefits and the resultant injuries. This way of articulating the fault standard treats an activity’s costs and benefits as being of the same importance regardless of where they fall. But what I owe you may not be the same as what I owe myself.

Besides offering a questionable interpretation of the legal duty to behave reasonably, economic analysis arguably fails to make good sense of the concept of legal duty more generally. The norms of tort law impose duties not to injure. There are two questions we can ask about these duties: What do they require of us? And to whom do we owe them? Tort consequently distinguishes between a duty’s content and its scope. This is a distinction much emphasized by Judge Cardozo in Palsgraf v. Long Island Rail Road, the most famous American tort case. In Cardozo’s view, I have a duty to guard against injuring those who fall within the ambit of foreseeable risk associated with my conduct. Others might be injured by what I do, and what I do might be lamentable or mischievous, but those who fall outside the ambit of foreseeable risk have no claim against me in tort. This is not because I do not act badly or carelessly toward them. Ex hypothesi, I do. Nor is it because my careless behavior does not injure them. Ex hypothesi, it does. They have no claim against me because I have no legal duty to take their interests into account. The only individuals who can have a claim against me in tort are those to whom I have a legal duty. The problem for economic analysis is that the duty restriction on liability is arguably incompatible with the goal of inducing individuals to take appropriate precautions. In order for injurers to have an incentive to take appropriate precautions, each must face the costs of his activity in full. But the duty requirement allows injurers to displace at least some of these costs on their victims. Economic analysts have responded to this problem alternately by (i) offering an efficiency rationale for the foreseeability limitation and (ii) arguing that the duty requirement is an imperfection in tort law.
2.3.2 Structure

Economic analysis cares about the relationship between a particular injurer and victim only to the extent that the nature of this relationship provides evidence of the ability of either party to reduce accident costs. As far as economic analysis is concerned, there is no intrinsic reason why a victim should sue the person who injured him. Nor is there any intrinsic reason why a plaintiff should argue in court that the defendant wronged him, rather than that the defendant was in a better position to reduce overall costs.

The most basic relationship in our actual institution of tort law is the relationship between an injurer and his victim – not the relationship between each litigant, taken separately, and the goal of minimizing the sum of the costs of accidents and the costs of avoiding them. If the victim of another’s mischief brings an action in tort, he brings it against the person he believes has injured him, not against the person best situated to reduce overall costs.

We will learn the most from economic analysis if we view it as a reformist, normative theory, a theory that asks questions of the following sort: What substantive liability rules have the greatest impact on reducing the incidence of accidents at the lowest cost? What procedural rules at a trial will induce those with relevant information to reveal it? What substantive and procedural rules will lead to optimal investments in safety? These are the questions of a reformer less interested in the actual state of tort law than in how tort law can be improved. Economic analysis is less convincing if its aim is to illuminate the law from the perspective of a judge or a litigant.

Continue in Theories of Tort Law: Justice, Rights, and Duties .



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