AN ECONOMIC MODEL OF PRECAUTION TO ACHIEVE OPTIMAL TORT LIABILITIES RULES

-by Sherry Shukla & Arpit Lahoti

Introduction:

The economic model of precaution deals with two main objectives to be achieved i.e. first being minimization of social cost associated with the activities that involve risky behaviour and the second being evolution of the socially efficient or optimal level of precaution. It mainly focuses on two aspects i.e. cost of harm and the precaution taken to avoid such harm.[1]

Cost of harm includes 3 basic components:

Firstly, the level of precaution (more money results into more efficient precaution and vice- versa);

Secondly, probability of accident (if the precaution taken is more, the probability of accident will be less and vice-versa) and;

Thirdly, expected harm (monetary value incurred for the harm caused and that will happen when the accident or any misfortune will occur otherwise not).[2]

How to achieve Maximum Level of Precaution?

Social cost needs to be minimized to achieve an efficient level of precaution and for this, we have to look at the below-mentioned graph which shows the relationship between the level of precaution taken and the social cost.[3] This indicates that by taking precautions, reduction both in the chance of accident and harm can be achieved.

New Doc 2020-04-16 17.20.56.jpg

Now, we will see how the incentive to take precautions varies in different liabilities rule.[4]

Under the No liability rule:

In no liability rule, the injurer cannot be held liable for the harm incurred by him and consequently does not have to bear the cost of the accident. Hence, the level of precaution or preparedness for the injurer or defendant under this rule will be zero (x = 0). This is because,  under this rule, no liability is incurred on the defendant, therefore, the social cost cannot be minimized as it will be as high as Ch in the above graph amounting to very high damages. The plaintiff, in this case, has to bear all the costs and has to exercise excessive care. In this rule, sanctions will be imposed in the form of moral grounds. So, we can say that under this rule, the outcome is not socially optimal as x= 0. Now, since the level of precaution is zero here, the harm caused by one person on another will not be accounted for by anyone i.e. externalities will not be internalized in this scenario.[5]

Under the Strict liability rule:

Under a Strict Liability rule where no defence of contributory negligence could be taken, liability is shifted from victim (plaintiff) to injurer (defendant) and the latter had to pay for the losses incurred irrespective of who was negligent. The defendant had to take the optimal or efficient level of precaution or care to minimize the expenses.[6] Injurer or defendant under this rule has more incentives to maintain the cost-justified precaution to avoid an accident.  For example, manufacturer of a product is liable for the defects in their products to their consumers.

When courts find the defendant to be held liable, damages are calculated by them to provide for perfect compensation to the victim. However, in the case of strict liability, this is not the case as the defendant has to take the optimal level of precaution i.e. here level of x will be higher that x* i.e. efficient level of precaution.[7]

Pigouvian tax is used to control any activity that generates externalities i.e. administrative costs are incurred and these costs are worn either by the govt. or a particular individual. As already stated above administrative cost is reduced in this case and the liabilities or taxes imposed will be just like a functional Pigouvian tax. Externalities will be internalized at a social cost, i.e. E (SC) = Cp+Ch (see the above graph) and will be internalized at x = x* just like functional Pigouvian tax (see figure below). This is because the point of maximum efficiency in terms of social cost and precaution will be at x = x*.[8]

New Doc 2020-04-16 17.22.32.jpg

Now, since the liability will be Pigouvian tax and will be worn by the victim and not the government. we can say that there is a high incentive for the injurer to take precaution to escape from the liability.

Under the Negligence rule:

It is important to take a due standard of reasonableness i.e. what precaution a prudent man will take in the negligence rule. Hence, the injurer, in this case, is held to be liable until he proves that he exercised due care or what is the due standard of reasonableness. Now, x* is a point where there is a switch between strict liability and no liability rule. So, in negligence rule, to reduce or minimise the social cost we have to look into the below-mentioned equation:-

x                                  ; if x >= x*

E (SC) = Cp + Ch             ; if x < x*[9]

New Doc 2020-04-17 16.34.51.jpg

If the level of care considered by the courts equals socially optimal level, then the injurer has an incentive to take an efficient level of precaution or due care to escape the liability and vice versa. So, this outcome is a representation of the Nash Equilibrium which means that one prudent man believing that another prudent man will exercise due care, will automatically step forward to exercise due care to escape the liability.[10]

Now, after seeing the incentives to take precaution and how to minimise social cost in all the cases, we arrive at the following conclusion: –[11]

One thing that has to be looked upon is the commission of the error by the court while calculating liability. Two factors are to be looked upon while calculating error i.e. in calculating x* and victim’s injury. If x* is over-estimated it will be against the victim and will not be efficient. So, out of the three, the court will commit fewer errors in strict liability.[12]

Also, strict liability leads to more efficient self-selection of injuries and the same cannot be obtained by negligence rule as “highest degree of vigilance” as compared to the “reasonable man standard” is not at all viable.

In negligence rule, the injurer knows that he can skip the liability by taking due care so he will not focus on the fact that what his activity will have an impact on others while in strict liability internalization occurs to achieve a socially optimal level.

Now an important advantage of negligence rule is that it will have more public information on how to escape the liability as the court will to maintain due care devise certain guidelines but in strict liability, no such mechanism to escape liabilities is there.

Also, negligence rule is better in case of joint tortfeasors as the damage compensation will get distributed between them and an efficient deterrence is there.

Analysis

Earlier more emphasis was placed on corrective justice that means the injurer has to pay for all the losses incurred to the plaintiff but it is not possible to pay for the physical damage or mental injury he faced. The point becomes more crucial when it comes to the dignity of the plaintiff like the case of a rape survivor or an acid-victim as nothing could get back them their original position. So, allowing someone to claim for compensation gives them the right not to be harmed in the first place. That is why tort law focuses on giving compensation to the victim by calculating the liability incurred on the injurer and also provides for injurers to escape the liability by way of taking an optimal level of precaution so that harm or accident is not caused at the first place.[13]

Sherry Shukla and Arpit Lahoti are law undergraduates at Maharashtra National Law University Nagpur


[1]    Richard A. Posner & William M. Landes, The positive economic theory of tort law, University of Chicago law school, (April 12, 2020), https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=2548&context=journal_articles.

[2]    Louis Kaplow & Steven Shavell, Economic analysis of law, Harvard Law School and National Bureau of economic research, (April 12, 2020), http://www.law.harvard.edu/faculty/shavell/pdf/99_Economic_analysis_of_law.pdf.

[3]    128 Bruno Deffains & Sebastian Rouillon, Dans Revue d’économie politique (April 13, 2020),  https://www.cairn.info/revue-d-economie-politique-2018-1-page-41.html.

[4]    Allan M. Feldman & John M. Frost, A simple model of efficient tort liabilities (April 13, 2020), https://www.brown.edu/Departments/Economics/Faculty/Allan_Feldman/AMF%20Significant%20Published%20Papers/A%20Simple%20Model%20of%20Efficient%20Tort%20Liability%20Rules.pdf.

[5]    Keith N. Hylton, Duty in Tort Law: An Economic Approach, 75 Fordham Law Review (April 14, 2020), https://ir.lawnet.fordham.edu/flr/vol75/iss3/16.

[6]    Darryl K. Brown, Strict Liability in the Shadow of Juris, Public Law, and Legal Theory Research Paper Series 2014-33, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2433243.

[7] Economic Analysis of alternative standards of Liability in accident law, the Bridge, (April 15, 2020), https://cyber.harvard.edu/bridge/LawEconomics/neg-liab.htm.

[8]    54 Steven Shavell, Corrective Taxation versus liability as a solution to the problems of harmful externalities, The journal of Law and Economics, https://www.jstor.org/stable/10.1086/661944.

[9]    Karapanou V., Strict Liability versus Negligence, Encyclopedia of Law and Economics, Springer, New York NY.

[10]   Hans-Bernd Schaefer and Frank Mueller-Langer, Strict liability versus negligence,  University of Hamburg, Institute of Law and Economics, pg. 12, (April 16, 2020), https://mpra.ub.uni-muenchen.de/40195/7/MPRA_paper_40195.pdf.

[11]   Frech, H. Edward III, ‘State-dependent Utility and the Tort System as Insurance: Strict Liability versus Negligence’, 14 International Review of Law and Economics, 261-272.

[12]   Calabresi, ‘The Decision for Accidents: An Approach to Non-Fault Allocation for Costs’, 78 Harvard Law Review.

[13]   Coleman, Jules et.al, “Theories of the Common Law of Torts”, The Stanford Encyclopedia of Philosophy, Edward N. Zalta (ed.) (April 17, 2020), https://plato.stanford.edu/entries/tort-theories/.

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